Sometimes Major League Baseball megabucks player contracts include clauses such as; if you hit 40 home runs you will get an additional $500,000. Make the All Star team and get a $100,000 bonus. Maintain a .300 batting average and drive in 100 runs and you get another $250,000.
This is not an unusual deal in today’s baseball world. These are examples of true “pay for performance” agreements.
Pay for performance also is becoming more common in the business world.
In a recent article in The Wall Street Journal, the author stated that annual raises in 2008 are expected to be at 3.9 percent, the same as in 2007. This percentage is slightly above the cost of living increase for the same period.
In a survey just completed by Towers Perrin of Stamford, Conn., of companies in 60 countries, they found that there is a movement away from increases tied to fixed pay and towards tying pay increases to employee performance. This concept was at one time limited to middle and top managers and is now filtering down to frontline and production employees. For years in the garment industry, both in union and non-union shops, sewers were paid on piece work. The more they produced, the more they made. This was a basic incentive-based system.
Over the years, this approach found its way into the ranks of top and middle management. During the 1980s, it was called “management by objective” or MBO. Each executive sat down annually with their manager and negotiated their goals for the upcoming fiscal year. The goals were tiered in a way that if you met the minimum, you received the base increase. If you met the average goal, you received the minimum plus a bonus percentage. Once you met the “stretch” goal and exceeded the average goal, you were entitled to an increase above the minimum and a sizeable bonus.
This system was used by the Dayton/Hudson Corp. in the 1980s at their Dayton, Target and Hudson department stores. Similar approaches were used throughout retailing and in sales and manufacturing for middle and upper level executives. During this time the compensation gap grew between the hourly worker and management.
So why are companies in Europe, Asia and the United States looking at performance based compensation systems? If you believe the theories put forth by Peter Drucker, then you believe money is a short-term motivator. Some believe we are driven by Maslow’s theory of needs and are constantly looking to reach the pyramid’s pinnacle, “self actualization.” Or is it Hertzberg’s satisfiers that will drive our desire to raise our work ethic and assist in increasing our employer’s profitability?
The answer is yes to all of the above, because each of us is motivated in a different fashion. Many of us are self-motivated and do not need to be seduced by the fancy titles, offices with outside windows or additional perks. We are motivated by the desire to achieve and be recognized as a contributor to the entities success. Performance based compensation is designed to recognize the employee who through their work ethic and self-motivation contribute in a positive manner to the profitability of the enterprise. This generation and the generation before it desire immediate feedback and gratification for their efforts. They have grown up with PDAs that provide instant messages, real time emails and streaming video. Performance based compensation fills the need for instant feedback and fits well into their need structure.
From a management perspective, pay for performance is a win/win scenario. If productivity goes up, quality increases and customer satisfaction continues to grow, higher profits will flow to the bottom line. It fits also into the team mentality, in that we all share in the benefits of a strong team performance.
But there are some down-side risks to this approach that need to be considered. First, how do you fairly measure performance when it is qualitative, not quantitative? Second, what will be the long-term impact on morale within the enterprise?
Let’s address each of these separately.
In the matter of measuring performance, there are two approaches, the quantitative and the qualitative. When you measure productivity in a quantitative manner, you are measuring units produced, calls processed and key strokes per hour, per day, per month. You are also measuring rejection rates, number of sales calls made and closed, and net sales for a period. These are all simple measures to develop. In some cases, you might require the services of an engineer who is familiar with job design to assist you in determining an achievable level of performance. For instance in the garment industry, the production of a jacket sub-assembly, i.e. a sleeve would be influenced by the type of fabric, the machine used to sew it and the size of the garment. The same would go for bottoms, pants and skirts. At JH Collectibles, it was not uncommon to have the union request that we re-engineer a rate for a new garment whose fabric was more difficult to sew.
With regards to the qualitative measures, these can be more difficult to develop and maintain. Many employers rely on customer feedback through surveys to determine the level of satisfaction with an employee or group of employees. At DeVry University, Keller Graduate School, the compensation for an instructor is directly influenced by the ratings their students provide on a semester basis. In order for an instructor to maintain senior faculty status, instructors must achieve and then maintain the predetermined rating level. Instructors that cannot maintain that rating level could lose the elite status and return to a lower grade of compensation.
So let’s now address the potential down-side risks of performance based compensation programs. The first risk is a drop in overall morale if the performance goals set are not achievable with increased effort. Frustration will set in and the employee will lose interest in trying to achieve the unachievable. Secondly, the employees who are dependant on others in the organization for the support of their activities will pressure these other employees to keep them supplied in order achieve their goals. This pressure will be felt up and down the line. In order to reduce this pressure, supervisors and mangers will need to reduce any and all obstacles to improved performance.
In basic management classes students learn about the Hawthorne experiment conducted at Western Electric in Chicago. When the lighting levels in a plant were increased, productivity went up significantly. It was assumed that the lighting increase directly impacted productivity. But, after further research, it was found that the employees were responding to management’s concern for their comfort by increasing the light levels in the plant. This was supported by the fact that even when the lighting levels were decreased, productivity still continued to increase.
So in order for the employee to achieve their newly agreed upon productivity goals management needs to be involved. When performance goals are negotiated a dialogue needs to take place in order to determine what if any obstacles need to be removed in order to clear the path to higher productivity levels. Without this type of two way communication effective and achievable performance goals cannot be established.