Think Pay for Performance Will Go Away? Well, Think Again...

There's been much web-based discussion of late about pay for performance and incentives (the Dan Pink video controversy and recent WorldatWork community debates to name just a few).  These debates have prompted a number of HR and reward professionals to question whether performance based rewards really work or whether, perhaps, they should be relegated to the dustbin in favor of a more enlightened worldview.

My position is essentially this:  If you think the link between performance and rewards is going to go away any time soon, especially as we move into the new post-recession reality, you'd better think again.  One of the (many) reasons why is that business operations overall, particularly customer-supplier relationships, appear to be trending strongly in that direction.

An article Pay for What You Get: Putting Performance-Based Contracting to the Test in this week's issue of Knowledge@ Wharton discusses recent "breakthrough" evidence, reported by researchers at Yale University's School of Management, of the power of performance-based contracting.

A little background from the article:

PBC -- also known as performance-based logistics (PBL) or power by the hour (PBH) in some circles -- isn't new, though its use has been limited. Often associated with maintenance agreements at aerospace and defense companies, it was first embraced by the likes of U.K.-based aircraft engine manufacturer Rolls-Royce some 30 years ago.

But under pressure to cut costs and improve efficiency, others have hopped on the bandwagon more recently. A case in point: the United States Defense Department, which has required widespread adoption of PBC for new military equipment since 2004. More companies should follow suit. The reason? According to its proponents, PBC is the most economical way to cover the maintenance costs of big-ticket items like F-22 fighter jets and commercial airplanes. They add that PBC increases the reliability of these items by decreasing the number of major repairs they need.

There's other good news for cost-conscious companies. With PBC, it's easier to keep a lid on overall capital expenditure.

(More about the topic and this trend can also be learned from an earlier Wharton article Power by the Hour: Can Paying Only for Performance Redefine How Products are Sold and Serviced)

At its essence, this trend represents an effort to align incentives between suppliers and their customers.  Based on the results of their study, Yale researcher and professor Morris A. Cohen predicts that PBC could dramatically change how customers and suppliers work together.  Which could mean a dramatic change coming down the pipe for organizations that provide products and services to other businesses, ultimately raising the bar for how they measure, manage and reward performance.  And, by logical extension, for how they measure, manage and reward the efforts of their workers.

One of the most popular justifications raised for abandoning pay for performance is that we do such a lousy job of it.  I can't argue that there isn't an element of truth there; we certainly have lots of room for improvement.  Lots.  But that doesn't mean it isn't right and necessary. Given the current economic climate and the likelihood that our organizations will, indeed, be asked to link their income to performance, we have a clear imperative to take the steps necessary to do better.

That's what I think.  You?

Comments

[Barry Brown]

Couldn't agree more, Anne! Most of the PFP plans we find are sadly lacking the basic metrics of success. Absent a good measure, it is up to the supervisor - the one with poor people skills and a complete lack of understanding about performance and rewards.

I think pay-for-performance will be around as long as there are employers and employees. Great post!

- Barry

[E James (Jim) Brennan]

Right on. You don't throw the baby out with the bathwater.

[Wally Bock]

An interesting and important post, Ann. I doubt that pay-for-performance will go away. The concept makes too much sense. There are places where it seems to work, like Nucor, but there you have a very different culture and a very different mix of rewards of all kinds than most corporations.

[Ann Bares]

Barry:

Thanks, glad you like it. It is destined to be around long-term, so I guess our work is cut out for us, eh?

Jim:

Xactly my point - thanks!

Wally:

You're right, and the fact that some organizations (and I've "met" them, too) are able to make it work suggests that it is not impossible. Thanks for the comment!

[Andy Klemm]

A major kurfuffle surrounding the anti-pay-for-performance movement was fueled in the early to mid-1990s by Alfie Kohn, author of Punished By Rewards. Alfie is still around, and appears focused on where he came from - early childhood education and removing any aspects of competition from it.

There is sound research that contradicts the anti crowd, plus the primary reason the antis will not overcome is that business people believe that pay for performance works.

I agree Anne and the other responders that effective design, implementation, and administration are the prime keys to having a success system.

[Ann Bares]

Andy:

Couldn't say it better than you just did - thanks!

[Dan Walter]

Ann,
Thanks for the posting. Here are some of my thoughts on the topic

Legitimate Pay-for-Performance is difficult but attainable.

First let me note that this entry may not make me any friends in the executive compensation world.

A big piece of this puzzle is that shareholders, advisors and most executives are stuck in a world of “executive summaries”. They focus on small bullets of that improperly summarize very complex information rather than the meat of the topic. Because of this, we tend to look at performance delivery as the final result, rather than the pieces that drive the final result. For performance to work it must be about achieving the many steps on the road to a result, not just about the result.

Just as coaches and players in the NFL say they “take it one game at a time” and the Super Bowl is just a culmination of all of those games. Executives should be asked to take it one step at a time and the final performance payout should the result of all the steps that preceded it. This will reduce payouts on false performance and provide accountability in the process. At times this will mean meeting goals without immediate cash value for compensation. At other times this will mean payouts even when the stock price, or some other corporate indicator of performance is down.

The result will be more consistent performance that more people can agree upon. This doesn’t mean that compensation will always be more consistent, or even predictable. But I think that’s fine. If we were right about our predictions in the past we would not have so many people upset about executive compensation right now. If we start now, we should be able to get it right in the next 4-5 years.

NOTE: I do not believe that executive compensation or equity compensation were a big driver of our current economic crisis. Unfortunately, in our world if simplicity it is easier to focus on this highly visible issue that it is to educate people about all of the complex underlying causes.