Pay-for-performance – The Good, The Bad, and The Ugly

“You May Run The Risks, My Friend, But I Do The Cutting. If We Cut Down My Percentage… Who Knows? It Might Just Interfere With My Aim.”

Blondie

Many private companies consider the implementation of a formal annual bonus plan to be something “required” prior to an IPO. After all, if you pay people to do something, they are more likely to do it, right?

Pressure from investors, management, and recruiters can often lead to bonuses being implemented without any research or employee consultation into whether it will drive results, increase employee satisfaction, or well…anything really. Many companies skip this decision process entirely and focus on the mechanics of the plan itself.

It is worth bearing in mind that several very successful IPO companies didn’t bother with a bonus while they were private – Arista and Zoom, for example. Furthermore Amazon and Netflix still haven’t bothered with a formal bonus. And they seem to be doing okay.

First off it is important to distinguish between individual pay-for-performance, tied to the achievement of individual goals or Management by Objectives, and team/company-based performance that reward for group achievement. When we talk about a formal annual bonus, many people assume that this will have an individual and team component but this is not always the case.

The Good

You don’t need to look much further than the sales team to realize that in the right setting, individualized incentives can be highly motivating. For individuals driven by their personal performance, and in situations where goals and performance can be accurately and transparently measured, individual incentives remain an effective tool.

If we take the sales team as red, what about everyone else? Well there is certainly data to show that individual incentives work but this depends on consistent measurement of performance and may depend on the group of employees that we are looking at. Simplicity and transparency appear to be the driving forces behind the success of these plans.

Studies have also shown that extrinsic rewards like pay-for-performance can have positive influences in the workplace.

There are a handful of studies that examine the roles of individual and team-based incentives separately. This study attempted to figure out which approach had a stronger impact on productivity and found that team-based incentives are especially effective at increasing organizational productivity. This stands to reason if you are incentivizing individuals to focus on the performance of the team, rather than their own output.

The Bad

In the wrong setting, an annual bonus, particularly individual incentives, can be demotivating. This applies especially to team-oriented individuals who see their success and failure linked to the team and not themselves. To introduce an individual incentive can seem counter to the way they have learned to work and create interpersonal competition to the detriment of collective success.

It is also important to be aware of the true cost of a formal bonus. Along with the financial cost, there is also the implementation, performance management, communication, management time, staff training, and exorbitant external consulting fees1 associated with getting these programs off the ground.

The Ugly

As the Human Resources function continues to evolve, many companies are starting to evaluate the role of HR in the collective happiness of their workforce leading to the rise of the “Chief Happiness Officer” in some organizations. Increasingly companies are figuring out that employee happiness can be the biggest obstacle to, and the biggest driver in worker efficiency and various studies have shown a causal link between happiness and output.

This study across 1,309 companies covering over 300,000 employees in Denmark demonstrated that employees have a 3-6% increase in the usage of anti-depressant and anti-anxiety medication at companies that have recently adopted pay-for-performance.

Pay-for-performance is not a panacea for improving employee productivity

Conclusion

There is clearly no right or wrong answer to pay-for-performance. The best conclusion that I can come up with is that implementing pay-for-performance is not a panacea for improving employee productivity.

Implementing a successful pay-for-performance system means careful evaluation of possible approaches, a recognition of the nuances between different personalities, and extensive dialogue with employees throughout the process. The most successful pay-for-performance environments are clear about the culture they are trying to promote and ensure that the plan is supported at all levels of the business.

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