Performance-based compensation

Most of today’s employee compensation systems were originally developed in the old, factory environment stemming from how hourly workers were paid, and graduating upwards in the hierarchy.

A job received fixed pay, with annual pay increases based on performance and the expectation of lifetime employment.

The problem with this system is the expectation that pay will continue to escalate. Indeed, resentment develops when compensation does not increase, at the very least to keep up with the cost of living. So with time, some may be paid too highly when compared to new hires. People who’ve had many years of service tend to get comfortable and overpaid for what they’re doing. And when the company must cut back, they’re the first to go.

There are two ways to motivate people—the carrot and the stick. Competitions—prizes (carrots) for the winners—tend not to work because only the top few who feel the awards are within reach tend to try harder. Most of the others, recognizing that for them, winning is not possible, simply ignore the competition and continue to plod.

Jack Welch, of General Electric, came up with a solution to this paradox. When he took over, GE was profitable, but it had already become relatively stodgy and too comfortable for people who had been there a long time. To affect change, he implemented several strategic initiatives, the most significant of which was a performance matrix. The top 10 percent to 15 percent of employees were rewarded, the middle 70 percent were compensated adequately, and the remaining 10 percent to 15 percent were targeted for elimination. Everybody shaped up, because nobody wanted to be at the bottom. Most people agree that GE improved significantly during Jack Welch’s tenure.

Increasing jeopardy

GE and other forward-looking companies started these kinds of changes in the 1980’s. But sadly, many companies still cling to the archaic systems and processes of lax reviews and annual automatic pay increases across the board. This results in increasing jeopardy for employees whose pay has escalated over the years to a level that simply cannot compete in the modern global environment.

The best form of compensation is performance-based, with measurable objectives. It gives people immediate and meaningful feedback. The easiest targets to quantify are those based on bookings, shipments and profit. But the drawback of the human element, where direct supervisors (the people who do the reviews) with a personal bias shortchange some good people and advance others who may simply be currying favor, must be avoided.

It is my contention that reasonable, measurable goals and performance incentives should be the basis of compensation for everyone at every level, no matter what their job. Objectives should be made achievable and quantifiable to provide everyone with incentives for good performance.

Should the performance measurement and reward system be for individuals, or should it include teams, or extend to the entire organization? In my view, it can and should be all of the above—parts of an individual’s incentive should include broader results to encourage everyone’s involvement in the success of the enterprise.

This brings up the question of ownership. In a capitalistic society, it is important for people at all levels to share in the growth and success of the enterprise. Indeed, this has given rise to the spread of employee ownership plans, stock options and other forms of participative involvement. And there’s another element of capitalism that eventually kicks in—if you own enough stock, you don’t have to work.

Jim Pinto is an industry analyst and commentator, writer, technology futurist and angel investor. You can e-mail him at: jim@jimpinto.com. Or review his prognostications and predictions on his Web site: www.jimpinto.com

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