Pay for performance.docx

Pay for performance.docx

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Payforperformance

Payforperformance

Thewaytogetyouremployeestofocusonboththepresentandthefutureistoadjustyourcultureandtoweakenyourfinancialincentives.

JonathanD.Day,PaulY.Mang,AnsgarRichter,andJohnRoberts

TheMcKinseyQuarterly,2002Number4

Payforperformancehasthesedaysachievedthestatusofamanagementmantra.Agenerationofexecutives,motivatedbyperformance-measurementsystemslinkingtheiractionstoresultsand,ultimately,tocompensation,hasembracedthecreedandpracticeofmakingassets"sweat."Tocontinueflourishing,however,companiesneedtoinnovateaswellastoexploittheirexistingassets.Yetmostfinditveryhardtomotivatetheirpeopletodevelopnewbusinessideasand,simultaneously,tomanagecurrentperformance.

Thenaturalreflexmightbethatpeopleshouldreceivehigherpayforinnovatingeffectively.Butourresearch1suggestsotherwise.Surprisingly,thesecretofpersuadingpeopletofocussimultaneouslyondevelopingnewbusinessesandmanagingcurrentoperationsmaybetorelylessonpayforperformance.Infact,companiesthatachievebothobjectivesde-emphasizeperformancepayoruseitinamorenuanced,lessintensemanner.Crucially,theycombineitwithanunusuallyinclusiveculture.Inthesecompanies,employeesfeelthattheirinterestsandthoseofthebusinessaremuchthesame,sotheynaturallytrytodowhatisbestforitscurrentandlong-termwelfare,justastheydoforthemselvesintheirpersonallives.Payforperformancemaystillhaveanimportantjobtodoinsuchaculture,butasasupplementalboostratherthanaprimarydrivingforce.

Encouraginggrowthandperformance

Withfewexceptions,corporateincentiveschemesencouragemanagerstoconcentrateeitheronexecutingcurrenttasksorondevelopingandimplementingnewbusinessideastofuelfuturegrowth,butnotboth.Mostsuchschemesaredesignedtomotivatecurrentperformance:

retailorganizations,forexample,tierewardstocurrentsales,manufacturingcompaniestoproductioncostsandvolumes.Insuchcompanies,theneedtomeetperformancetargetsleavespeoplewithlittletimetoinnovate.Asoneharriedmanagerinaglobalindustrialcompanyputit,"Weareverywelcometodoinnovativestuff—after11:

30PM."

Incentivemechanismsemphasizingcurrentperformancetendtobemorecommonbecausemeasuringthefamiliartasksthatboostit—theexploitationthatleveragesexistingcompetencies—issomucheasierthanmeasuringtheexplorationandexperimentationthatmayleadtofuturegrowth.2So,forexample,acompanythatwantstomotivateitssalesrepresentativestosellmoregoodsorserviceswilltrackhowmanycontractsitsagentsclose,adjustthescoresfordifferencesbeyondtheircontrol（suchasthenumberofcustomersineacharea）,andrewardthemaccordingly.Effortandscoreareusuallyclearlylinked,sothecompanycanexpectagentstoworkhardifhighscoresarewellrewarded.

Buttheachievementsoftheseagentswouldbealothardertomeasureifthecompanywantedthemtobringbackideasfornewproductofferingsbasedonthechangingneedsofitscustomers.Asimpletallywouldn’tdo,sinceitmightbeyearsbeforeanidea’srealvaluecouldbeassessed.Thecompanywouldalsohavetoadjustformoreelusivefactors,suchasthewillingnessofcustomerstoprovideinformationabouttheirpreferences.Allthisissodifficulttoquantifythattouseformalincentiveseffectivelyacompanywouldhavetomonitor,inminutedetail,thewayeachsalesagentactuallybehavedwithcustomers.

Andperformanceinhighlyexploratorytasks—biochemicalresearch,forinstance,orscenarioplanning—can’treallybemeasuredatall.Whoknows,inadvance,whichexperimentswillyieldfruitfulresultsorwhichscenarioswillyieldvaluableinsights?

Proxymeasurementscangivearoughideainsomecontexts.Managementconsultants,forexample,whooftenworkinteams,usepeerobservationtoassessoneanother’sabilitytocomeupwithnewideas.Butfewcompanieshaveaperformance-managementsystemthatassesseshowwellemployeesdealwithgrowth-orientedtasksasaccuratelyasitassessestheircurrentperformance.

Somecompaniestrytogetaroundtheproblemofmeasuringexploratoryactivitiesbypromisingabig,one-offbonustoanyonewhocomesupwithanideathatislatercommercialized.Butthesearrangementscanprovedifficulttooperate.In1964PeterRobertsdevelopedaninnovativesocketwrenchasanemployeeofSears,Roebuck.Fortherightstothepatent,Searspaidhim$10,000,ahandsomesumtothe18-year-oldinventor.FiveyearslaterhesuedSears,claimingthatithaddeliberatelyunderestimatedthetool’ssalespotential,whichhadprovedtobeinthemillionsofdollars.Robertsreceivedanawardofmorethan$8millionand,afterSearsappealedthejudgment,settledforanundisclosedsum.

Theproblemofmeasuringperformanceinexploratorytasksmakesithardtodesigneffectivefinancial-rewardsystemsthatmotivateinnovation.Itisdoublydifficulttodesignincentiveschemesthatinducepeopletopayproperattentiontocurrentperformanceaswellasexploration.

Whoshouldmultitask?

Ofcourse,noteveryone,oreveneverymanager,mustallocatetimebetweenboth.Quitethecontrary,thebenefitsofhavingsomepeopleconcentrateexclusivelyononeortheothercanbeenormous.Tothisend,somecompaniesactuallyputexploratoryandcurrentactivitiesindifferentbusinessunits—anapproachknownas"cocooning."3Buteveninthesecompanies,somepeopleneedtoallocatescarceresourcesbetweencurrentandfutureactivities.

Cocooningtendstoshifttheburdenofbalancinggrowthandperformanceupward:

topmanagers—sometimesCEOs—mustselectthenewideasthatarepursued,drivepromisingideastofruition,ensurethatcurrentassetsaresweatedeffectively,andgetridofbusinessesthathavepassedtheirsell-bydate.Intheextremeversionofcocooning,everyoneotherthantheCEOwouldhaveonlyonetask:

tofindnewideasforthecompanyortoexpandexistingbusinesses.

Inpractice,thisapproachisunworkableexceptinthesmallestcompanies.Inlargerones,topmanagersaregenerallytoofarfromtheplaceswhereideasaregeneratedtobeeffectivejudgesandmotivators.Weakideasmaygettoomuchattentionbecausethebosshappenstolikethem,whilegreatideascanendupoutsidethebusinessasfrustratedemployeesleave.Moreover,ifthetrade-offsbetweengrowthandperformancearepushedupward,theresultcanbebottlenecksatthetopoftheorganizationandfrustratedseniorexecutiveswhoareoverloadedwithinformationbutstillneedtomaketimelydecisions.

Thebetterpracticeistohavemanagersatmanylevelspursuingnewbusinessideasandbettercurrentperformancesimultaneously.Thisapproachkeepsinnovationaliveandensuresthatnewideasarelinkedtothecompany’scustomersandmarkets.Buthowcantopmanagementmotivatepeopleatanumberoflevelstopursuetheseeminglyconflictingobjectivesofencouragingfuturegrowthand,atthesametime,improvingcurrentperformance?

Howcanthesepeoplemosteffectivelybepersuadedtodividetheirtimebetweenthetwo?

Theruleofbalancedincentives

Toencourageanyactivity,companiescanuseeitherhigh-orlow-poweredincentives.High-poweredincentivesofferpeoplebigfinancialrewardsforgoodperformanceandpenaltiesormuchlowerrewardsforpoorperformance.Topathletesonprofessionalsportsteams,forexample,havehigh-poweredincentives.Theirperformanceiseasytoobserve.Thosewhodowellreceivevastsumsofmoney;badperformersleavethegame.Bycontrast,withlow-poweredincentives—suchasfinancialbonuseslinkedtothefortunesofagrouporanentirecorporation—individualdifferencesinperformancehavelessimpactontherewardsemployeesreceive.Stillmorelow-poweredarethekindsofrewardsthatconferrecognitionandstatusratherthanpay.Insomejobs（thoseofjudgesandtheclergymaybeexamples）,itisperfectlynormaltoofferlittleornofinancialincentiveforperformance,evenwhenitismeasured.

High-poweredincentivescallforarelativelyclearandsurelinkbetweenactionsandresults,whichiswhycompaniestendtoawardstrongincentivesforcurrentperformanceandweakerincentivesforexploration.Butwithtwodisparatetaskstoperform,peoplenaturallyturntothetasktheythinkwillbringthemthegreatestrewardrelativetotherisks.Soifcompaniesfollowthenaturalpath—givinghigh-poweredrewardswheretheycanandlessintenseoneswheretheymust—theirpeoplewillprobablyrespondbyfocusingonthewell-rewardedtasks.4

Clearly,companiesneedtobalancetheincentivestheyattachtofamiliarandexploratorytasksiftheywantpeopletodobothinequalmeasure.Thisimperativemaymeangoingagainstthevogueofpayforperformance;indeed,itmayrequirecompaniestoreducethepoweroftheincentivestheyusetoencouragetheiremployeestoundertakethemoreeasilymeasured,familiartasks.Theincentiveencouragingtheleasteasilymeasurabletaskthenbecomesthestandardforallactivities.Ifaretailer,forinstance,wantsitssalespeopletospendmoretimeexploringtheneedsofitscustomers,thebestcoursemaybetolowertheincentivesforsellinguntiltheyarecomparabletothoseforgatheringinformation.

Manymanagersthinkthatthelogicofrelaxingpayforperformanceinthiswayiscounterintuitive.Yetwithafewexceptions,asystemoflow-poweredincentivesbalancedbetweenexploitativeandexploratorytaskswillprobablyworkbetterthaneitherbalancedbuthigh-poweredincentivesorthemismatchedincentivesthatmanyorganizationsusetoday.

Abalanceofhigh-poweredincentivesisrarelya