Jay and Pat have a recent book called “High Performance Pay, Fast Forward to Business Success,” which they released with WorldatWork, but this is not, by any means, their first book. They have a couple of other major books in the compensation area. “Pay People Right” was one of the first books I saw that was a good practical, down to earth book on using compensation effectively. “The New Pay” was another one.
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DC: The issue of pay for performance has been with us for quite a long time. Companies have been making some progress, but it in many cases it's slow progress. Pat and Jay are going to explain to us why the progress has been slow and how we can do it better. We will get into the specifics of what you need to do to align pay with performance and then we will go into their total rewards model.
Let's move to our first poll.
PZ: The question is, “Does it take one month to learn if a person is a poor performer and five years to terminate them?” If you ask an executive or an HR person, chances are they will say they know a poor performer within a month of their being hired but it takes a long time to weed them out.
Our poll indicates that we have about half and half.
DC: That is quite a clean split; better than I would expect.
JS: Yes, that surprised me. It is encouraging that people would actually make decisions and remove people that are proven to not be successful. That is very encouraging.
DC: That may be representative of a change where HR is becoming more accountable and maybe a little bit more proactive about performance issues. Jay, do you want to ask this next question?
JS: “Does everyone expect a raise every year? Is it viewed as an entitlement or does it have something to do with differences in performance from year to year?”
These poll results are interesting: ‘base pay increases are expected.’ They are probably viewed as an entitlement. My guess would be there is very little reward opportunity, except in about a small portion, 18% of the participants. So that says that base pay is not a way to pay for performance in this group.
DC: Tell me more about the culture of entitlement.
JS: Pay is the largest opportunity expense an organization usually has, which means that you can manage it; it’s a flexible and agile opportunity to give a message to people about where they are. Entitlement culture is one where everybody expects to be treated consistently without regard to performance. The way you test this is by ranking your people within a job category (e.g. programmers, managers) on performance and then looking at how they are paid. If you have an entitlement culture, the chances are that the ranking of performance will not be a big predictor of pay differences.
If you are a performance culture, we would expect that the people that you rank the best would be the highest paid in the organization.
DC: Do you actually do this with clients?
JS: Yes, we ask them to do this. Most of them will ask, “Do we have an entitlement culture?” and then Pat and I will say, “Well, here is one way to find out.” Then they do this and they come back and some are surprised and some are not, so this is a real thing, wouldn’t you say Pat?
PZ: Yes, it helps with the alignment process to say this is a delta where we are, especially if they are concerned about losing some of their high performers and when they see the mismatch between the pay and the performance ranking it helps to understand the delta and decide what they want to do about that.
DC: One of the questions we are asking today: why does paying for performance matter and one of the main reasons that it does matter is that it becomes a means of retaining your high performers. What are these other ways you test for entitlement?
PZ: First off, are the high performers earning the dollars? When Jay talked about doing that list, you could do the list on any pay element, you could do it on total cash comp or you could do it on total compensation and you will find if you do it on total compensation, when you include benefits, you start to lose a lot of the impact of the performance differences.
We ask if you aggressively manage performance. We are not necessarily saying you need to get rid of people like GE's model was, but we are saying, are you managing people? Are you giving them the training and development? Are you working with them on setting small goals so that they can show their progress? During layoffs, what is your criterion? Is it just based on seniority or is it also based on the contribution? And then, do managers review performance well? If you ask those questions, you will get a sense of whether you are using pay as a driver. Obviously you need the performance review as a foundation for being able to reward performance.
DC: That is what you are talking about isn’t it, using pay as a driver as opposed to pay simply as being a cost of doing business?
PZ: Right. You are trying to figure out the most effective way to utilize those scarce dollars.
Audience Question: Are you going to talk about rewards for high performers beyond financial compensation?
JS: The primary thing that we were going to talk about will be variable pay. But if we take a look at the total rewards, what we are saying is that the top 20% of the workforce probably gives 80% of the value added to the business. We also know that the top performers expect to be rewarded for their performance. So whatever it is you have to give away, whether it's financial rewards or non-financial rewards, the issue is that you have to get to that top group. You have to brand your organization such that it says “High performers welcome here. If you come here you will be recognized.”
PZ: An issue is customization on the non-financial things, giving things that are of interest to people. The compensation world started to go down that path, the benefits group customized benefits a bit to the person with flexible benefits but it's been harder for compensation. We would also argue that if you think in terms of the total rewards model that we will discuss a little bit later, you can start to customize it based on what people's interests are.
JS: Conventionally we struggle to pay everyone competitively. It’s a part of the entitlement idea: whether you are a top performer or not, we try to pay competitively. Pay for performance is normally window dressing. Everyone says that they pay for performance, but there is a huge knowing-doing gap in that very few organizations actually do it. A popular aim now is to become a best place to work, which means you provide liberal and attractive benefits to anyone that comes into the organization and our contention here is that that merely creates entitlement.
DC: That’s an interesting comment: that aiming for the best place to work award may not be the right focus.
PZ: Our view is companies should aim to be the best high performers' workplace, which means you are making it clear that there is a connection between organizational success and employee success. That the two are linked. And you want it to be a win-win between both parties.
DC: Jay, what's your take on that?
JS: My take is that we don’t have any choice but to begin to focus on high performance workplaces because organizations that perform best are those that actually pay for performance. We know that the best move an organization can make is putting in a variable pay plan for people below managers; your return is at least four times the cost of the program. When you are looking for high performance people, and we are talking about people in the top 20-30% of the workforce, these people want their performance recognized, so to brand yourself as a high performance workplace is going to get more than your share of these people.
DC: I am going to move on to our next poll question. I would like listeners to write a single sentence about the biggest issue in your company regarding paying for performance.
PZ: One comment is ‘we are non-profit.’ Non-profits need to, especially in the United States, be cognizant of avoiding intermediate sanctions and you can still have a lot of measures that focus people in terms of quality of service, beneficiary or customer satisfaction and managing your budget appropriately. You are not going to be sharing a percentage of the income dollars that the organization has and you are also going to be cognizant of measures that just don’t drive profitability or net revenue. You are going to be looking at other measures that are relevant, but also you can look at cost effectiveness. You are going to look at what kind of services you are providing, the volume of services that you are providing and other appropriate measures, either operational measures or customer measures, moving your services forward, future focus measures, developing new services or people focus measures like your turnover, growth and development of your people.
JS: What you are saying Pat is that being not for profit is not an excuse for not paying for performance, right?
PZ: Right.
JS: Here are more comments: ‘Subjective versus objective rating.’ One of the obligations we have is to put in metrics that define performance in terms of cascading the goals that drive organization success and communicating them down to the people who are going to be paid for performance. Managers should be selected for managing, not because they happen to be the top individual contributor but because they are willing and able to judge performance and that’s a critical issue. One of the barriers to becoming a manager should be your willingness to differentiate performance.
Pat and I had redefined the issue of equity from an issue that money should be paid equally; to everybody should be paid equally based on the value they add to the organization. What do you think about this Pat?
PZ: We struggle with small salary increase budgets and somebody said it's more dictated by the job market than by performance, but we are looking to use variable pay to help the differentiation process. It’s a difficult issue and we will show some ways that we can use a bit of those scarce dollars to differentiate in base pay because base pay goes with you for your whole career.
JS: We think paying for performance is more important than even paying competitively. Here is one comment that says ‘budget constraints.’ If you only have one dollar to distribute, you should give it to the top performers in the organization because they are the ones that you are going to have to count on when things get tough.
PZ: We agree that you want to have some objective measures, but if you ask a group of managers to identify who are the key performers, they could do that. They could have a bit of discussion about why they think these people are the key performers, but you know who they are so it's not like it’s a mystery. Sometimes setting performance criteria seems overwhelming but in reality, when you look at it, people have a better sense of performance management than maybe all of the stuff that surrounds it. Our message is to try to have a clear performance management system that makes it easier for that to happen.
DC: On this issue of managers making subjective judgments, in the courts we have judges making subjective judgments all the time based on very mixed evidence, but we empower judges to make that decision for society. Organizations do the same thing with managers. Managers are meant to make those tough subjective judgments. It's nice, if it’s a type of job where we can use objective measures, but very often that’s not the case so we either have a choice of trusting managerial judgment, or else simply giving up on pay for performance. Let's talk about what you think companies need to do so that they can do a better job of pay for performance.
PZ: A lot of times in pay policy we will just be thinking about a whole population of people. Our argument is to make sure during that discussion you are talking also about the high performing people. We don’t necessarily mean that is an absolute 20%, it could be 15%, it could be 25%. Our sense is that the rewards strategy should include them and not have them be an afterthought.
JS: Yes, we have never heard a CEO ever says, “Go out and hire all the average performers that you can find.” Everyone says, “What we need is the top performers,” so when we translate that into the rewards strategy, it should say, “If the CEO wants the eagles, then we need to have a reward strategy integrated around getting those people into the organization and satisfying their needs to be rewarded for their performance more than anything else.”
DC: You are right; typically in pay policy how to deal with high performers is an afterthought.
JS: Absolutely. The unique part of what we are saying here is that while a lot of people say they are going to do this (and I don’t know of anybody who doesn’t have it in some policy some place) they don’t translate it. The opportunity to be an excellent performer rests in the human resource organization. This is the chance to get a seat at the table, to actually reward performance and make their organization one that is branded to say that the best people are wanted here. If you do that, then that makes the human resource person closer to generating an ROI for the company from a people standpoint.
DC: Let's move on to variable pay.
PZ: As Jay said, about 80% of the organizations in the WorldatWork survey have variable pay. It could be in a variety of different forms; it could be an organization-wide plan or a team-based one. The trend now is for more individual performance being acknowledged in that incentive plan. Over the last 15 years, we have seen more companies putting in plans and having more people within the organization be participants. Our only argument is to make sure that you have some customer goals in the incentive plan, make sure that you have sufficient focus on the customer winning when the organization is winning as well.
Sometimes we get so focused on using the business plan to set goals that we don’t think of the greater context. For example, when we are looking at incentive plans for warehouse centers, the customer doesn’t care whether an individual person does what they need to do in their step of the process, the customer is only interested in did we get the product when we wanted it? The customer focus is to get there on time. Was it in the right shape or was it the right order? The distribution center is more of a team because that is what the customer is focused on. So have an overlay of ‘what is the customer thinking’ because if you align your organization with your customer's success that will make your organization successful.
If you don’t have variable pay for particular employee groups, think about which ones you might target where it would be the most effective. If your organization has trouble with incentive plans, maybe they are a non-profit that doesn’t want to go in that direction, at least increase the amount of recognition that is offered to people.
JS: We think that variable pay is the ultimate tool of reward. It's agile, it's flexible, it's not a gift, it keeps on giving, and you can change the metrics every year. If somebody was to say, what is the first thing you ought to do to reward the top 20%, we would probably vote unanimously for a variable pay plan, wouldn’t you think so Pat?
PZ: Yes, you are going to get the most bang for your dollar and you are also going to get the most focus. We see variable pay plans as a communication vehicle as opposed to a pay delivery vehicle, because people pay attention to what gets measured and what gets rewarded. Sometimes we walk into organizations and the employees say, “We have been helping the organization all along, we have improved quality, we have improved productivity but what is in it for us?” That is a legitimate statement from the employees - they need to feel like they are stakeholders.
DC: Do you want to talk about performance management in general?
JS: Well we sure do. The one-two punch of performance improvement is:
1. A variable pay plan.
2. Fixing performance management.
Performance management isn't just a form. We don’t address how many levels of performance there are or semantic differentials and all that sort of stuff. It's got to become integral to the business process. If managers don’t want to manage performance and manage the people process then you have a management crisis on your hands, because they are the people who ought to be giving the message that it isn't a matter of just filling out forms, it’s a matter of giving feedback and developmental assistance and the succession plans and communicating about skills and competencies and all that sort of stuff. So, this is a cornerstone of the whole thing. It has nothing at all to do with the form we use. We have clients that use one piece of paper and do an absolutely superb performance management job. So, this is the cornerstone overall. Wouldn't you say Pat?
PZ: Yes, and it's the process that we are talking about. Basketball coaches don’t wait until the end of the year to give somebody on the team feedback. They are giving regular feedback and coaching. We are looking to emulate that. You need to get executive leadership's commitment that this is something you want to do. It’s in their own self interest because they are more likely to accomplish their goals if the people that report to them are accomplishing their goals. Employees also want to be more involved, especially if you look at developmental aspects as to where they are going with their career. We are trying to get a process that’s engaging both groups of people instead of happening as the dreaded end of year event. It should be a process as opposed to an event. Whatever you can do to make it feel more like that is good, that’s what we are arguing for.
JS: Now the secret sauce here is, how do you select managers? A lot of times what we do is we take our best individual contributor, our best programmer, our best systems analyst, our best HR recruiter and we make that person a manager without preparing them to understand that there are different skills and competencies and one of those is feedback and managing the people process and making reward decisions. So, this is an issue of great importance.
DC: I have been looking at performance management technology recently and hearing very positive things from people who have adopted it. They are quite amazed at how it's transformed their lives. So that can be another piece of the puzzle in terms of making it easier to do.
PZ: Yes, and there is some research from the Center for Effective Organizations that showed it was a positive to have software. But on the other hand, we would argue that you need to have a conceptual overlay about what it means for your organization's performance management. If it simplifies doing the form but it doesn't make the performance management process just doing the form, if it gets them engaged in the discussion, the feedback, and the coaching then we think it’s a good thing.
JS: Yes. Our concern is that you don’t want to accelerate bad performance management practice. If an organization doesn't have a good performance management system then what the computer systems are doing is making it easier to do a bad job of performance management. You need to figure out how to cascade business goals down. How do you translate them? How do you talk to people? A computer can't talk to people. A manager has to do that.
DC: Tell us about cascading goal business.
PZ: Our main message is to make sure goals are relevant to the business. Cascading could be an interchange between the manager and the next level up but basically it's got to link a person’s goals to the balanced scorecard or key goals of the organization. We often get lots of goals and everybody loses focus or whether they are relevant to what the business is trying to do.
DC: And that is a nice, easy check when HR is reviewing the performance management system: “Are these real business goals that have been cascaded down or are they just random things coming in from all sorts of different directions?”
JS: Yes, and simple is better. People can only focus on two, three, or four roles at most and a lot of times we see instead plans with 30 or 40 goals. That is more than the human eye can follow.
DC: Now, I know we have focused on the importance of variable pay, but what do you recommend around base pay?
PZ: After being involved in consulting for 27 years my sense is that to get the most differentiation in base pay, you almost have to take it out of the personal context, which is ‘I am a manager and I find it very difficult because I have to work with the person all next year and I do not want to give him a negative message.’ I recommend having a group of managers meet with their leader and talking through where we are putting the scarce dollars that we have for base pay increases. Talking about the performance of the people that are below them, the valve added that they have provided. You get different perspectives from different managers who maybe see the people in a different light than how their immediate manager sees them. That is one thing that is very helpful.
Another thing is thinking in terms of the resulting base pay, as opposed to the percent increase, because it is very difficult for a high performer getting a percent increase to ever get to catch up to an average performer that is just getting normal increase compounding each year.
You also probably need to think more in terms of focusing them on the results that occur as opposed to behavior. Many systems weight these at 50-50, although we are seeing more organizations weighing at 75-25, or else just looking at the goal and saying was it achieved in a behaviorally appropriate manner.
DC: So if he seems to be a nice person doing nice things but the results aren't there then that doesn't count for much, but if a person gets results but the behaviors are bad it will count against you?
PZ: Right, because you are not getting results it in a behaviorally appropriate way for the organization’s mission and values.
One thing we have seen work is focus on differentiating the pay of the high performers by lump sums in addition to base pay increases. The lump sums don't fold into base pay and become an annuity.
Another useful tip is to have a separate budget for high performers. Some organizations have another two-tenths of a percent that they will reserve for high performers only. The 3.5 goes to everybody in the organization based on their performance but then just hold out an extra .2 percent budget. It's all perceptual. It is no different in a way than having a 3.7% budget but it somehow works more effectively to have a separate pool of additional dollars for the high performers. If you have 2/10 of percent that means you can give 2 extra percentage points of base pay to 10% of your performers. A little bit goes a long way.
DC: Jay, why don’t you tell us about your overall model for total rewards?
JS: When we wrote “Pay People Right” in 2000 we were saying that people are motivated by things other than pay so we built a model suggesting that individual growth, a compelling future, a positive workplace and total pay are all important. But one of the things that we missed communicating, even though we believed it, was that all of these things have to add value to the business. In other words, at the center of total rewards is a business focus.
The new book has a modified model that suggests that for an organization to provide attractive individual growth opportunities, a compelling future, a positive workplace and total pay, all of these things have to help accelerate the business and make them stakeholders in making the organization successful.
PZ: We think there is a lot more to why a person stays with the organization than pay. Is there growth? Is there development? Is there effective performance management? Does there seem to be a career path in this organization, and it can be lateral, not necessarily into managerial roles. Is there a compelling future? Are your organization's vision and values inspiring? Is somebody proud to say they work for you? Stakeholdership is more of emotional stakeholdership, it doesn’t need to be stock ownership, but there is a basic win-win premise to the organization.
In a positive workplace you see those components of effective leaders, colleagues you want to work with, work that is interesting and challenging.
Some organizations will try to be strong in all the categories. General Mills wants to be good in all of those; others will target particular areas, like Amazon.com when they first started said that they were building the future of e-retail, come work with us, that was a compelling future. So you can take this model, customize it or use some other model. It is of interest to ask, assuming I am a typical employee, how would I respond to these categories to see where an organization’s strengths are?
DC: I want to move into a case study. We see a lot of case studies of highly admired companies like GE or exciting companies like Google. The organization you are going to tell us about is as well known as GE or Google but doesn’t have quite the same cache. Do you want to tell us about this organization?
PZ: Yes. We particularly picked it because this is an organization that has had mixed performance results. The greatest challenge is becoming a best high performance place to work when you are not financially on the up curve, so although everybody wants to know about, for example, what's Google doing, in a way it's probably not the best organization to try to target your best practices on, unless you are also a highly successful organization.
JS: What you want to do is find a case study where an organization was a lousy performer and did something that turned their performance around. We picked the United States Postal Service because in 1992, we could not find a worse performing organization in the United States. This organization had missed goals, it had all kinds of morale problems, and it had individual performance problems. It is an absolutely huge bureaucracy that did not generate positive margins or anything and what was glorious about them is that since 1992, they undertook a pay for performance program and implemented it for 75,000 white collar employees. They didn’t do it for all of their 375,000 unionized employees and that is what they are working on now, but just doing it for the white collar employees changed the entire performance of the organization.
PZ: Their performance improvement was startling. They built it off goals: customer service, enhancing a performance-based culture, managing costs & generating revenue. So they had those basic categories in their balanced scorecard. They had a corporate level component, unit level and individual level components determining reward. Reward was in terms of base pay as well as variable pay once they had a particular level of base pay. So it was an exciting program that has been going on for multiple years now and you can just see dramatic curves and performance differences. It started in 1995.
JS: If the USPS can do it, anybody can. It’s a benchmark for any legacy organization that says we can't pay for performance because there isn’t anyone that had more cards dealt against them than the United States Postal Service when they started this journey.
DC: It sounds like what they did in terms of reward was not unusual. There were no brand new theories of management, they were just applying the type of pay model that you have been advocating and doing it well.
PZ: That’s a good point. With 75,000 people they needed the computer system to monitor the measures, but you are right, the basic philosophy was not startlingly innovative. It was figuring out what the key goals were and figuring out what the results would be and how they would reward those results.
JS: Just blocking and tackling. It was doing the basic things that everyone knows could be done and getting leadership to sponsor it and actually putting it in over a period of time and monitoring the metrics. It was a huge turnaround.
DC: Tell me what you expect from HR leaders.
PZ: First just educate the other leaders in your organization. They are probably thinking, “How do I get the most value from the compensation dollars that I have got?” HR is in a tougher position than finance because a lot of times their work is not easy. But we argue first educate them, talk about what things they could do with regards to compensation. Build a strategy with them first. It might not involve making wholesale changes, but we want to move down our performance path and, for example, “We know that step A is implementing a variable pay plan; step B is improving our performance management, and step C is building a base pay program that starts to differentiate performance more than market adjustment.”
Whatever your framework is, outline it and get leadership commitment. We would also say you need to involve the leaders in building the design and involve the employees to the extent that your organization is a high involvement organization to get their buy in. It’s not just the design issue, there has to be lots of communication. But as an HR leader it's incumbent on us to bring forward best practices.
DC: Should we wrap it up with your overall conclusions Jay?
JS: This is a chance for HR people to get in the sun. One of the things people say is, “Show me the money, where is the beef from pay and rewards?” Ask yourself, if you don’t pay for performance, what are you going to pay for? Lots of times you come out paying for tenure and entitlement and things that don’t add value to the organization. What we have suggested is this is a two-punch solution: one incentive and variable pay plan (and that returns four times the cost) plus repairing performance management so that it becomes a real tool of communication. These things can make a significant difference in how your organization performs in 2007 and beyond.
