Civilian organizations searching for methods with which to provide a
competitive advantage in recruiting, enabling, and retaining quality employees have routinely turned to performance-based compensation to achieve their goals. Ideally, performance-based compensation helps accomplish organizational objectives
through a multi-faceted process of:
Attracting and retaining quality performers.
Providing an incentive that aligns employee activities with organizational objectives.
Providing motivation to develop process improvement. Providing teamwork and collaboration.
Where successfully implemented, these results may achieve financial success and employee satisfaction; however, unsuccessful execution “can have a destructive effect on intrinsic motivation, self-esteem, teamwork, and creativity” (Beer & Cannon, 2004, p. 4). The Corporate Leadership Council (2004) provides interesting insight pertaining to employee behavior, motivation, and compensation:
While rational incentives may create compelling reasons for employees to remain with organizations and meet basic performance requirements, it is the
employees who derive pride, inspiration, and enjoyment from their job and organization who put forth the highest levels of effort. In fact improvements in emotional commitment can produce three to seven times the total impact on discretionary effort achieved through improvements in rational commitment. (p. 36)
Data from the Corporate Leadership Council’s 2004 Employee Engagement Framework and Survey further support this statement. Satisfaction with total compensation resulted in a 9.1-percent increase in discretionary effort and a 21.1- percent increase in employees’ intent to retain (CLC, 2004). These numbers show the effect compensation has on two functions of a performance-based compensation system: the ability to motivate employee effort and the ability to affect employee retention. The next section discusses two large corporations that have opposite experiences in implementing performance-based compensation:
PepsiCo, the international food and beverage company
Hewlett-Packard (HP), the American-based technology company specializing in the computer sector
1. Successful Implementation
PepsiCo implemented a dual-performance evaluation system that measures employee performance in two areas: people objectives and business objectives. People objectives focus on “managing and developing people, demonstrating
teamwork and collaboration, and ensuring personal growth and development,” while business objectives focus on positive corporate growth and corporate profits (CLC, 2005, p. 9). Using a five-point performance evaluation scale, both metrics are linked to performance-based compensation for all employees and have bonuses and long- term incentives for select employees. Introduced in 2001, this evaluation structure has:
increased manager commitment to people management as well as higher levels of employee satisfaction with the performance management process. In addition, PepsiCo indicates the practice has fueled and sustained a culture shift among employees; dedication to people management, teamwork, and
self development is now an expected competency within the organization. (CLC, 2005, p. 5)
Several features of PepsiCo’s dual-performance rating system are credited, in part, for the success of its evaluation program. First, PepsiCo keeps the people- objectives rating and the business-objectives rating separate at all times. This eliminates one rating from influencing the other. Second, the people-rating is given significant clout, affecting “34 percent of managers’ merit increases and individual bonuses” (CLC, 2005, p. 5). Third, managers performing poorly in either rating category are placed on a performance-improvement program designed to achieve positive results in weak areas. Lastly, “a forced distribution overlay, introduced in 2004, enables PepsiCo to better differentiate senior executives’ performance and more accurately award long term incentives to ‘top’ performers in the organization” (CLC, 2005, p. 5).
PepsiCo reports that its performance rating system has been quite successful, which results in better manager accountability and performance
separation for people management, a positive culture shift within the organization, and a level of quality management that has transcended across all work sectors— improving both individual and team effort (CLC, 2005). Furthermore, PepsiCo states that its success is owed to several key components of its management system:
Separate performance ratings applied to nearly all employees A well-defined performance criteria in both people and business
objectives
Thorough evaluations maintaining the separation between people and business categories
Performance-based compensation separately linked to employee ratings in each category
Application of appropriate performance objectives and awards to senior leadership
In developing people objectives, PepsiCo’s management has developed four specific metrics that correspond with organizational objectives and are tied to
specific areas of responsibility. Employees’ accountability in the areas of “creating a diverse and inclusive organization, managing and developing people, teamwork and collaboration, and personal development and growth” is crucial for the growth of the individual and the organization as well (CLC, 2005, p. 10). Management works closely with its subordinate employees to align personal employee objectives with organizational objectives.
During the evaluation process, managers hold each employee to the mutually developed standards. In this process, management receives 360-degree feedback: from the employee, from the employee’s subordinates, from team members, from customers, and from organizational surveys. The process has one final step—a manager calibration meeting—which reviews ratings and ensures accuracy before assigning the final employee ratings. Employees receive a second rating on their business performance, as well. Together, these ratings determine the overall performance-based compensation, with people ratings affecting 34 percent of the overall merit increase. Accountability to correct deficient performance in either rating category is included in this rating process. Employees receiving a 2.0 or lower rating must complete a “performance improvement plan” with a 60-day to 6-month deadline to produce results (CLC, 2005, p. 16). Employees failing to improve within their allotted time are either dismissed from the company or forced to change positions within the company (CLC, 2005).
Since the program's inception in 2001, PepsiCo has reported a “positive culture change at PepsiCo; employees embrace the People Management focus and are motivated by the ability to drastically improve their performance in an attainable and clearly defined category” (CLC, 2005, p. 18).
2. Failed Implementation
In the early 1990s, Hewlett-Packard (HP) managers in thirteen divisions and sites attempted performance-based compensation initiatives to improve company performance. No initiative survived the test of time, although this does not imply that all aspects of the programs were unsuccessful. Beer and Cannon (2004) discussed details of five of the thirteen HP compensation initiatives in their study, Promise and Peril in Implementing Pay-For-Performance:
The San Diego site
Boise Printer Formatter Shop PRCO Loveland
Colorado Memory Systems The Workstations Group.
The San Diego site developed “team pay-for-performance (PFP)” to motivate team goals in the areas of process improvement, production, and quality (Beer & Cannon, 2004, p. 6). They developed three performance metrics (i.e., Levels I, II, and III); team members would receive monthly performance payouts if they achieved a certain level of performance during the previous month. Additionally, the San Diego site created a “skill-based pay system called pay-for-contribution (PFC)” which rewarded employees based on learning new competencies within the team
organization (Beer & Cannon, 2004, p. 7).
The results of these programs were mixed. Many employees prospered during the PFP program, with most teams achieving Level II or III performance marks. As a result of the unexpected success and resulting expense, in part due to the low performance metrics, managers were forced to raise the performance standards and to make them more stringent. This change had severe
consequences, as it eroded trust that management had previously developed with employees. Some workers viewed the change as an unprovoked reduction in earned salary. Another side-effect occurred as a bi-product of the success some
teams experienced; it developed competition that prevented further teamwork and team-building. By comparison, no one liked the PFC skill-based pay system. It did not develop into the competency-developing tool management had previously predicted. The institution of performance testing had the exact opposite effect, as employees could actually drop in pay level by performing poorly on these tests. The results of these efforts forced the San Diego site to drop both pay initiatives
approximately one year after they were established.
The Boise Printer Formatter Shop implemented a skill-based pay system as a function of both individual and team performance. It was administered, in part, through peer evaluation. Compensation could be adjusted within a pay level as a result of individual employee productivity, as well as through team performance. Like the San Diego site, this HP division found itself paying more than it expected in performance payouts. And, similar to the San Diego site, competition among
employees created an environment that was not conducive to teamwork. Due to the unprecedented payouts, negative competitive atmosphere, difficulties in
administering peer evaluations, and a perception that employees were overly
focused on pay instead of on organizational goals, the Boise site never experienced the intended results; it subsequently dropped the program. (Beer & Cannon, 2004)
PRCO Loveland, a fabrication division, attempted to initiate performance- based compensation as an incentive to meet end-of-period goals. The division did not reach the end-of-the-month target; therefore, PRCO Loveland never had to pay the one-time goal or attainment bonus. Though workers never received their bonus, employee productivity and motivation improved. However, an unintended
consequence resulted when some of the employees felt slighted by what they perceived as a “bribe […] to reach a goal they were already motivated to reach” (Beer & Cannon, 2004, p. 10). Management discontinued this approach in future goal setting.
Colorado Memory Systems (CMS), a company acquired by HP, developed a “gain sharing program […to] increase the following desired behaviors: individual
initiative and responsibility; willingness to learn; adaptiveness [sic]; teaming and collaboration; hustle; willingness to confront conflict; and focus and attentiveness” (Beer & Cannon, 2004, p. 10). Designed to motivate these behaviors and bring previous CMS employees’ salaries closer to the HP salary range, it positively affected employee behavior in the areas of teamwork, communication, and focus. However, issues regarding pay equality, long-range goal orientation, and program metrics led to another short-lived initiative at HP.
Finally, the Workstation Group introduced a one-time incentive package to motivate program managers and engineers in introducing a new product to the market. Successful in this endeavor, HP rewarded managers with stock and salary rewards, while engineers received a salary increase when the product was delivered six months ahead of schedule. Not without criticism, however, many employees, “including the vice president in charge of personnel, believed that the perception of high priority was the most important motivating factor leading to the early completion of the workstation” (Beer & Cannon, 2004, p. 11). Ironically, “[a]n HP survey showed that 70 percent of the employees felt that they would have worked just as hard on the project without the incentive program. But […] 60 percent of the employees surveyed recommended that incentive programs be used with other projects at HP” (Beer & Cannon, 2004, p. 11).
By the mid-1990s, all thirteen performance-based compensation initiatives had been discontinued or cancelled under company reorganization. Some programs had achieved their intended goals, such as delivering a product to the market ahead of schedule or meeting performance goals. However, managers in each of the HP divisions individually determined that the continued expense of these performance- based compensation initiatives was not cost effective compared to the existing HP business model. The business model that included trust and communication between manager and employee, a team-oriented work culture, and a proven successful compensation program proved difficult to improve.
G. Problems Implementing Performance-based