In recent times, many companies euphorically and rather media-effectively jumped on the bandwagon of abolishing performance ratings. Most, however, were still trying to hang onto their legacy pay-for-performance concepts based on individual objectives. These organizations are now quietly making major amendments to their new models after having realized that they have lost the data basis for subsequent compensation management decisions.
Closer inspection reveals that many of these adjustments have turned out to be a gradual return to traditional mechanisms, with minor alterations at most, leaving mere rewordings aside. The outcome – despite all efforts to portray this backflip as an innovative leap into the future – is generally more a case of “old wine in new wineskins.” Unfortunately, often the new wineskins are of inferior quality than the old ones.
While this has been a sobering realization for many of those early-adopting companies, it is hardly coming as a surprise for more neutral observers. Why? Because every variable payment system that is based on individual performance requires an assessment of this individual performance. To this end, it is necessary to have transparent criteria or objectives that are defined and assessed in a non-arbitrary process. The retrospective comparison between actual achievements and initially defined criteria or objectives allows a unique statement about an individual’s performance – or, to put it more bluntly: a rating.
Traditionally, this assessment was expressed as a discrete value in the form of school grades or other classification schemes and nomenclatures. This involved some unpleasant decision-making and communication to be performed by competent people managers. However, it enabled transparency, computer-aided calibration, in particular for large staff cohorts, as well as a ranking process – which is essential for certain decisions, such as allocating limited promotion slots.
Under the current “performance management revolution,” rather prosaic feedback approaches have instead been propagated: rating free feedbacks, with a higher frequency of the manager-employee dialogue. It must be noted that there is no compelling correlation between these two aspects, and that the latter is undoubtedly sensible while it has always been the norm for strong people managers. Rating-free, prosaic feedback approaches allow managers to mitigate critical feedback or even avoid it completely, because of not having to commit to a decision (yet).
However, all feedback finally needs to be translated into a figure for bonus payments or salary adjustments under any pay-for-individual-performance regimes, where the available funds sensibly are confined. Hence, criteria are required to identify those employees who should receive just as much below the average as the top performers receive above it – if allocations are not to be clustered around the employees’ individual 100% entitlements (which is the average). After all, the mathematical reality is that on payday not all employees can, on average, receive more than the average which is determined by the sum of all employees’ 100% entitlements divided by the number of recipients.
What does all this lead to? Instead of formal and transparent objectives, criteria and ratings, managers create their own “shadow accounting,” or HR is providing “decision criteria catalogs” that shall assist managers in making the necessary differentiation between employees. This delegation of the dissolution of a conceptual inconsistency to the people managers then often goes by the headline of “manager empowerment.” In practice, applying such “assessment criteria” to derive employee assessments represents a classic de facto performance assessment and rating process, albeit one that is quietly carried out by managers behind closed doors. As mentioned above, sometimes new wineskins can actually be improvements for the worse (in literature, this is sometimes also referred to as the “Cobra Effect”).
With or without formal and transparent ratings, the outcome of both approaches is the same: Based on individual performance assessments, allocations from the available funds are made for each employee with regards to bonus payments, pay raises, or promotion increases.
Or to put it another way: Wishing to make distinctions in variable compensation models that are based on individual performance requires a basis for the decision-making that is in some way linked to the individual performance of employees. For this to work, performance must be determined and expressed in such a way that it allows traceable and transparent conclusions about the differentiation decisions made in the process. Anything else rather goes by a gut feeling at best.
On the other hand, those who do not want any ratings – and not even any trace of them (“shadow ratings”) – must accept that the only variable compensation system that is matching such an approach is one in which the bonus amount for all employees (except for the sales organisation) is determined solely based on the company’s overall success. In a world without ratings, individual objectives and performance measurements can no longer be used due the systematic reasons outlined above. In this instance, “pay for performance” means “pay for company’s performance.”
In such models, there is normally a huge boost in teamwork, while selfish, dog-eat-dog mentalities that involve maximising personal gains are kept well at bay. On the other hand, all types of performance incentives and employee motivation stemming from the ability to differentiate rewards between employees are lost. Outstanding performers often can no longer be attracted or retained for the organization. Spot awards throughout the year for special individual achievements can to some extent mitigate these undesirable effects, though.
In terms of expenditure, this performance and compensation management approach is far superior to all others, coming in at a fraction of the cost. Instead of having all people managers defining individual objectives for their employees, assessing attainment, and then allocating bonuses based upon those performance assessments, this method uses a simple, centrally and automatically executed rule of three, adjusting the contractual 100% bonus entitlements of employees to the company results in order to keep bonus payments in sync with the overall financial health of the business.
Based on the proverb “in for a penny, in for a pound,” the situation can be summarized as follows: Companies no longer wishing to explicitly assess their employees must also accept that they can no longer determine bonuses and pay raises based on individual performance.
Or they must acknowledge that their initial assumptions and hopes about the elimination of ratings were too optimistic, incorrect, or partially incomplete. The monocausal logic of this wise adage is actually not as inevitable as we had been led to believe from an early age.
Both performance management approaches – rating-based and rating-free – are essentially viable options and both come with advantages and disadvantages, as well as with implications, especially regarding compensation management. Those characteristics and implications need to be weighed up in a company-specific context. But definitely impossible is a hybrid mix that is combining elements of both approaches.
For more on HR trends, see 4 Best Practices To Improve Talent Calibration.