Ensuring That Your Reward And Performance Management Systems Do Not Create Compensatory Damages
A universal and expensive challenge for each and every business around the globe is that of compensating employees for their efforts. This challenge is more complex in the United States than in most other countries due to the convergence of federal, state and local laws and because of the presence of many pay methods within U.S. business. Unfortunately, many organizations pay their employees only for their "efforts" rather than for their "results". More importantly, the most effective guiding principle of compensation. . .that organizational results are much more important than individual results. . .is not currently evidenced at any level within the compensation systems of the vast majority of organizations.
"Compensatory damage" has hugely detrimental effects to the financial performance of the organization. It results in significantly reduced human productivity, increased human conflict within the organization, perceptions of internal unfairness, disconnection from customers, excess variable costs, and diminished financial performance. It has a tendency to go unnoticed, however, during periods of increased revenue and/or profitability and is easily temporarily overshadowed by macroeconomic forces.Symptoms of Compensatory Damage
Some of the easiest ways to tell whether "compensatory damage" is occurring within an organization are through the following symptoms, among others:
· Performance management and appraisal systems in use are heavily or exclusively subjective in design instead of objective in design.
· Single-rater feedback (boss to subordinate) is the methodology of performance appraisal instead of multi-rater feedback.
· Performance management systems in use are not specifically designed for the market or industry within which the organization operates.
· Variable pay is absent at any of the employment levels within the organization. In other words employees' pay is not directly tied, in any way, to organizational or team performance and results.
· The organization is heavily influenced by union(s), cost of living allowances, or across-the-board compensation adjustments.
· There is more than a 230% variance in total compensation between any management or executive employees who work closely together, or between any non-management employees who work closely together, with or without a reporting relationship. An example of this is the difference between a flight attendant's compensation ($33,000) and a pilot's compensation ($245,000), a 742% variance, or the difference between a company President’s compensation ($280,000) and a company Chairman's compensation ($725,000), a 259% variance.
· There are more than two differing reward system factors between any employees who work closely together, with or without a reporting relationship. An example of this is the case where one employee receives a base salary, company vehicle, cash incentive, stock options and an annual trip to Hawaii, and the other employee receives a base salary and cash incentive only.
· Base wage or salary labor market competitive position philosophies vary within the organization according to level or function.
· Certain employees are paid on a single dimension "incremental" basis while other employees, at any level are paid a base wage or salary only. The most common occurrence of this situation is when an organization pays incentives to sales people based exclusively on transaction amounts (commission) while not paying incentives to other employees for their activities or results.
· There are exceptionally large (greater than one times base salary) cash value awards provided to certain employees, based on "assumptive" performance and results relationships, while other employees receive no awards under the same system. The most common "assumptive" rewards are stock options and discretionary incentives.
Whenever the above situations exist within an organization, the organization's financial performance is being negatively affected in significant ways. This is not to say that there cannot be significant differences within an organization as to how much various contributors are rewarded. There should, in fact, be significant differences based on performance and immutable contribution to results. However, if reward systems within a given organization are universal and remarkably similar in structure (not necessarily in amount) that organization will consistently outperform other organizations that are committed to inefficient reward systems and organizational misalignment.
Our concept of stranded, or wasted, compensation is a natural by-product of the above situations. So is limited organizational productivity and performance.Our Recommendations
In simple form, the following are some of our recommendations as to what organizations should do to avoid these dilemmas:
· Closely evaluate and improve the means with which external candidates for employment and internal candidates for promotion are selected. If optimal candidates are selected in all cases, the challenges outlined in this article will be minimized.
· Ensure that your compensation systems are universally designed to directly impact organizational results with each and every employee. Ensure that the linkage between reward system and results is not "assumptive".
· Evaluate your performance management and appraisal system to ensure that it is largely or exclusively objectively focused.
· Ensure that your performance management and appraisal systems make optimal use of multi-rater feedback.
· Implement a well designed, preferably simple, variable pay system that ties all employee efforts together (executive through front line).
· Promote and hire only employees who enthusiastically embrace the concept that pay is related to how they and the company perform, rather than separate from it.
· Never utilize any incentive that is assumed or designed to be discretionary. Connect all payouts to definitively measured organizational results.
· Drastically minimize or eliminate rewards based exclusively on individual, versus team or organizational, performance.
· Ensure that at least 51% of all variable pay payouts within the entire organization are derived from results that current customers and prospective customers have noticed.
· If yours is a publicly held organization, honestly evaluate your stock based reward systems for "stranded compensation" (see our Performance and Reward Systems web site page for further information). The most effective stock based reward systems, through their design, will differentially drive performance during a bear market even more effectively than during a bull market. Bear markets and bull markets will occur, on a cyclical basis, for as long as public markets exist. The key is to have internal reward systems in place that will actually drive organizational performance well beyond market performance, whether bear or bull.
Because some of our areas of specialty are organizational productivity, financial performance, and compensation/performance management system design, please Contact us to subscribe to our web article notification list or call us at 480-467-0344 and we would be pleased to discuss, clarify or expand on any of the above points.