Performance Management

Separating Compensation from Performance Development

By Betterworks
June 21, 2016
7 minute read

In today’s workforce, we’re seeing a fundamental shift around how we manage the performance of our workers and how we evaluate them, in large part because who our workers are and what they value has changed. To ensure we continue attracting and retaining the best talent, we need to make sure that as our workers change, we’re keeping up with them.

Twenty years ago, we knew what motivated employees: perks, benefits and salary. We thought that compensation drove engagement, behavior and performance. These days, however, that doesn’t work—and more and more of us are getting the message. Only one in five employers say they believe their existing merit pay approach is [tweet text=”Only 1 in 5 employers think their approach to bonuses is effectively driving performance”]effective in driving performance,[/tweet] and already 10%-20% of Fortune 500 companies have done away with the annual performance review.

Today’s workplace is less siloed, more collaborative and more transparent, and [tweet text=”How do we pay a workforce that’s motivated by opportunities for learning and purpose?”]our workforce is motivated[/tweet] by opportunities for growth, development, learning, meaning and purpose. What we’re realizing is that the practices that used to be linked so tightly—goals, compensation and performance appraisal—are now separate topics. At BetterWorks, we’ve gone even further, splitting the concept of performance management into performance evaluation (reviews and compensation adjustments) and performance development™ (ongoing conversations for feedback, mentoring and coaching). In a modern world, these items remain connected and possibly overlap (as evidenced in the graphic below), but they are not as directly linked as previously thought. In short, the world is a more nuanced place.

How BetterWorks drives performance internally

If compensation doesn’t work to drive employee performance, what does? First, giving employees meaning and purpose in their work, and second, having frequent conversations with them to keep them engaged and on track, which a Gallup study pointed to as having the biggest impact on engagement. We need to connect employees’ work to the big picture, listen to them and help them grow. And never tie monetary rewards to performance.

That’s not to say money isn’t important, but it needs to be a different discussion than the conversations with employees about how to challenge themselves and grow. Tightly coupling goals with compensation results in a number of potential problems. For instance, paying employees a percentage of their salary based on the percentage of goals they achieve will only incentivize employees to sandbag their goals to ensure they achieve 100%. Doing so will also penalize the employee who sets ambitious goals and achieves only 90% of them—but who likely accomplishes more than the sandbagging employee, given that working toward stretch goals drives greater performance.

Google’s SVP of People Operations and author of Work Rules! Laszlo Bock agrees, “If you want people to grow, [tweet text=”Google’s SVP of People Ops agrees with @KDuggan: let’s decouple compensation and performance”]don’t have those two conversations at the same time.[/tweet] Make development a constant back and forth between you and your team members, rather than a year-end surprise.” As Bock points out, the cadence of the discussions is also very different. While compensation discussions may happen only once or possibly twice a year, development conversations should happen regularly.

Development conversations

In my prior leadership role, we used to utilize management by objectives and executive team bonuses to drive employee performance. Here at BetterWorks, we focus on creating a transparent and accessible culture, ensuring that individual goals align to corporate initiatives and guaranteeing frequent feedback, mentoring and coaching. When employees know what the organization’s priorities are and understand exactly how their own work relates to corporate strategy, they’re more likely to feel their work is meaningful, which can dramatically improve their sense of connection and engagement.

Handling the compensation question

At BetterWorks, our approach to compensation is to [tweet text=”This is the @BetterWorks compensation model: pay fair wages & set high expectations for work”]pay employees a fair wage and set really high expectations for work.[/tweet] Goals are only loosely coupled to pay, which means they’re one of the inputs used for performance evaluation and merit increases, but they have a stronger purpose in ongoing performance development. This is in stark contrast to some of the traditional models for employee compensation, which can often backfire.

Management by Objectives (MBOs)

Management by Objectives is a process in which management and employees define and agree upon specific and measurable goals to be achieved in a certain amount of time. When employees meet or exceed their goals or objectives, they’re paid a bonus. But MBOs typically only cover one goal—such as “Write five blog posts in Q1 for $2,500” or “Maintain 95% NPS in Q1 for $5,000”—because dividing an incentive amount by all goals would result in amounts so small they’re meaningless. And the result is an achievement and incentive that doesn’t provide a full picture of a worker’s accomplishments.

Plus, MBOs don’t address under- or over-performance. What happens if the achievement goal for the payout is three deliverables, but the employee does two or four? If employees aren’t rewarded for overachievement, they’re effectively [tweet text=”Here’s why @KDuggan believes MBOs encourage employees to under-commit on their #goals”]taught to under-commit or underplay their goals.[/tweet] And if a worker misses their goal, managers—who aren’t compensation experts—have to make difficult decisions. In the example above, it might not be so difficult for a manager to decide how to award a bonus for four blogs instead of five, but it’s unclear how to handle missing the goal of maintaining a net promoter score (NPS) of 95% throughout a quarter. Managers don’t tend to take the time to build out a complete compensation model for the reward, and therefore, as a goal tied to a financial incentive, the MBO doesn’t make sense from a practical and implementation standpoint.

Because MBOs end up focusing on a subset of an employee’s goals, and because they aren’t typically modelled out correctly to anticipate all possible outcomes (and, most importantly, overlook stretch aspects), we don’t use them at BetterWorks. Employees tell me they [tweet text=”Small bribes don’t motivate employees long term, says @KDuggan”]appreciate that we don’t use these “small bribes” as leverage against them,[/tweet] and instead that we simply provide an environment for them to do great work.

Variable Incentives

In some professions, such as sales or customer success, a percentage of income can be tied to performance, up to as much as 50% of total income in some cases. While we believe it’s still necessary for some roles to have variable incentives in place, we recommend it only where the outcomes are clearly and completely measurable, such as a dollar-value sales quota. Where issues with variable incentives tend to arise is when a significant portion of compensation is tied to more qualitative outcomes, such as onboarding a new employee or meeting with a certain number of new prospects, for which measurement isn’t as clear-cut.

Example Goal Mix
Deliver $250K in sales by the end of the quarter Tied to compensation
Meet with 30 new prospects Not tied to compensation
Onboard new employee Not tied to compensation
Attend 2 networking conferences Not tied to compensation

Team Bonuses

Bonuses can also be tied to teams of employees achieving a particular goal, often used to incentivize executive teams to hit company revenue targets. Similar problems occur with teams as with individuals, specifically what to do if the goal isn’t achieved. The boss is in the difficult situation of being hated if the bonus isn’t paid out. But if they pay it out anyway—and more than 25% of companies pay bonuses to employees even when they fail to meet expectations—the team learns that goals, targets and rules aren’t real and don’t matter. Of course, in some cases, workers don’t know how bonuses are even calculated. They simply receive a bonus at the end of the year, which has no hope of actually encouraging performance.

Compensation best practices

At BetterWorks, we advocate for eliminating MBOs and team bonuses, and we only encourage variable incentives when clearly appropriate. But if that’s not possible or if you hold different views on merit pay, our recommendation is to [tweet text=”However you choose to compensate employees make sure to empower managers to handle adjustments”]empower your managers[/tweet] to have discretion around how to handle compensation adjustments and also do frequent coaching and training with them on calibration, to be sure they’re consistent in their approach. It’s also important to consider some of the pitfalls that can occur in the execution of merit-based rewards.

For example, anyone involved in a performance appraisal process should be aware of and work to overcome biases. These are typical and often unconscious preferences that many managers carry with them into evaluation situations, such as recent trends or patterns of behavior overshadowing past actions (“recency” effect) or the converse, a spillover effect, when present performance is evaluated only on the basis of past performance, not recent. Another might be a “horn” or “halo” effect, where the worker’s performance is appraised solely on the basis of a perceived negative or positive quality or feature. Or the bias might be one of excessive leniency or severity, in an effort to be kind or well-liked on one hand, or motivational on the other.

The best way to combat biases is the same method for conducting a thorough evaluation: make sure to have a full record of everything the employee worked on in the performance period, and take a holistic view of their efforts, including goals, conversations and any other 360 feedback available from the company. Performance appraisals and evaluations should be driven by more than just what the participants remember happening last week—they should be a rich and data-driven process.

Being aware of a possible issue is half the battle, whether that’s the possibility of bias or the potential demotivating influence of traditional compensation approaches. Whatever you’re able to do—whether it’s the best-in-class approach to compensation of paying a fair wage and maintaining high expectations for employee performance or whether it’s providing your managers with more training to tackle traditional merit increases or a bonus pool—forewarned is forearmed. And regardless of your approach, you can also reap benefits by one simple move: [tweet text=”One simple move to better workplace compensation: be transparent about how your model works” says @KDuggan”]being completely transparent[/tweet] about how your compensation model works (while still keeping compensation details confidential), in order to promote greater understanding throughout your organization.

How important is actual pay to an employee?

While all employees would like to be paid their worth, the actual dollar amount may not be the sole reason that they continue to work at that particular company. In fact, there are often many other factors noted in various forms of feedback.

An employee must be initially satisfied with their pay to typically accept a job in the first place. However, that usually isn’t the primary reason employees stay at a company long-term. It’s employee engagement.

What are some ways to drive performance management?

To drive performance management, companies are getting more and more innovative, and not relying solely on financial compensation. Instead, there are many other viable options.

Today, team members appreciate the opportunity to grow within the company, and to receive promotions and more responsibilities. A sense of purpose is often a much better development than a raise.

Are team bonuses more opt to build engagement than individual bonuses?

Individual bonuses are nice, especially when you are a goal-oriented employee who can be productive without much direction. However, relying on only yourself doesn’t exactly build engagement that is derived from professional relationships.

When employees are working together toward a common goal, they become much more team-oriented. This can create employee engagement in a simple, organic way.


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