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Monday, July 11, 2011

On rewarding and performance systems...



The ideas of "pay-for-performance", and it's twin sister "management by objectives" exist to try and increase the performance of a group and ultimately the whole company. The basic idea is: promise them a carrot and they'll work more / better. But is that true? Can a company really perform better by promising people they will get more money if they individually perform better?

It is an appealing though. Instead of working with the people, managers are advised to put the right rewards in place and let people loose. Things will magically work out, or so the theory goes.

Although there is some truth to that, the fact is that this simplistic view of reality hides, or ignores, the deeper impacts of the individual performance reward culture:

  • First, by placing rewards at the centre of the performance system, the companies shift the conversation to rewards and away from work
  • Most people feel they perform above average, but reward systems tend to grade people on "the curve". This leads the lower performers to get a higher grade than they deserve (but still lower than they think it should be) and the top performers a lower grade than they deserve because of the need to "follow the curve". This has the notorious effect of leaving everybody unhappy.
  • Most importantly, the reward mechanisms that focus on individual performance completely miss the fact that a company exists in a complex environment. Especially non-trivial work (like software), is impossible to reduce to a set of repetitive steps. The immediate consequence of this is that, even if all the people perform at their best and get the top evaluation, the company could still totally fail to meet the level of their competitors. The performance of the system (the company) depends on the complex interactions between the different people in the company. If all try to optimize their personal performance, the system as a whole can perform a lot worse.http://www.blogger.com/img/blank.gif


What amazes me is that there are still people who advocate "pay-for-performance" in complex environments like software development.
The fact that we work in a complex environment all but ensures that "pay-for-performance" is at best indifferent to the overall company's performance and at worse an active value detractor for the company.

An additional bonus


Deming and Shewhart proved that in a stable system, trying to change it's performance from the outside can actually reduce the performance of the whole system. Deming called this "tampering": messing about with a system you don't understand (link to Deming and tampering).
"Pay-for-performance" and "management by objectives" are an instance of "tampering". Instead of messing about with a system we don't understand we, as managers, should focus our energy on understanding that system and changing the system through the use of small and controlled experiments.

This is not as easy as it sounds, but is the only way in which managers add value to their companies.

If you still want to have variable salary costs in your company, then use a profit sharing scheme: where everybody shares in on the success and pain, rather than individuals independently. Besides, can you really evaluate a single individual's contribution to the success of the whole company? (Especially when the company is not succeeding and that individual still claims their bonus?)

One question that is raised against the view I tried to explain is: "Fine, but how do I keep top performers? They certainly want to be rewarded by their good work, right?" My answer to this question is that people value many different things. While some people are influenced by short term gains, most people do not act consistently with that hypothesis. There's evidence that people react more consistently with (see this video):

  • "meaning", i.e., they are more motivated and committed when they feel that their work has meaning; or
  • "peer-recognition", i.e., people tend to feel more committed and motivated in an environment where their work is appreciated by their peers.

A better way to keep your best people is to work on creating an environment where people's work is recognized by their peers, and the meaning or nexus of that work is clear to everyone.

You, as a manager, have to focus on those things!

Photo credit: L2F1 @ flickr

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7 Comments:

  • Hi Vasco,

    Interesting post! I agree so much on the subject.

    Besides the reasons you mention, there is another negative side effect on bonuses for individual performance, and that is niche-creation and CYOA (Cover your own ... well, you know what) practices. Basically, people for their own, rather than for the good of the company / team / area.

    I've heard of many companies that are using a "global bonus" approach with very good results. More senior people have higher bonuses than junior people, but these bonuses are publicly known along the company, and bonus-payment criteria is global: if the area meets its target, all its member receive the bonus.

    The system itself isolates underperformers. Peers ask each other to work at peak performance, because everyone's effort is needed for everyone's good.

    There's a famous case of one of the very first companies that used a system of compensation similar to this one: the famous headhunter Egon Zehnder International.

    Best Regards,
    Walter.

    By Anonymous Walter Ariel Risi, at July 24, 2011 7:13 AM  

  • @Walter Do you have the link to the studies/cases you mention?

    By Blogger Vasco Duarte, at July 25, 2011 10:25 PM  

  • Hi,

    The first case is from a friend's company ... I'd rather not disclose it before asking him.

    The second, Egon Zehnder, is well known, and described in Daniel Goleman's Book "Working with Emotional Intelligence" http://www.amazon.com/Working-Emotional-Intelligence-Daniel-Goleman/dp/0553378589/ref=sr_1_1?ie=UTF8&qid=1311646708&sr=8-1

    Hope you find it interesting!
    Regards,
    Walter.

    By Anonymous Walter Ariel Risi, at July 26, 2011 5:21 AM  

  • @Walter Thank you for the reference! I'll look at it.

    Have you read about "Beyond Budgeting", they also talk specifically of how Bonuses can distort the behaviour of people in the organization and have some suggestions on how to tackle that problem.

    Check out Bjarte Bogsnes book: http://www.bookdepository.co.uk/Implementing-Beyond-Budgeting-Bjarte-Bogsnes/9780470405161

    By Blogger Vasco Duarte, at July 26, 2011 9:07 AM  

  • Hi Vasco,

    No, I hand't hard about Beyond Budgeting. I'm adding the book to my wish list, sounds interesting!

    Best regards,
    Walter.

    By Anonymous Walter Ariel Risi, at July 27, 2011 4:21 AM  

  • By Blogger Lorenzo, at September 20, 2011 10:00 PM  

  • Great links @Lorenzo! Thanks!

    By Blogger Vasco Duarte, at September 21, 2011 6:03 PM  

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