Ratingless Compensation and Benefits

Traditional Performance Management is on its way out. Evaluating your employees once a year, and giving them a rating as a stamp of (dis)approval is changing towards a more continuous process. However, at the end of the day people still need to get paid. If you’re contemplating a change in your performance management, this article will give you a blueprint to link your compensation strategy. We’ll cover the basics and dive into a process that pays for value and maximizes development.

A new Comp & Ben strategy is not Mission Impossible.

The world is evolving at a blistering pace, and businesses are struggling to keep up. As a result of this rapidly changing environment, jobs are growing more and more complex. Due to AI and automation a lot of today’s simple tasks will no longer require a human element a few years from now. This means your current workforce will have to evolve, and gain a much broader skill set to deal with tomorrow’s challenges. How will we get there?

As a response to this VUCA world businesses are adapting their processes in order to gain more flexibility and grow more agile, challenging the existing framework for evaluations and compensation. Most performance management processes are still based on pre-set, superficial objectives and a yearly evaluation which makes it impossible to adequately determine a person’s performance and/or value in today’s market. Whereas it was useful to evaluate people based on what they achieved in the year leading up to their evaluation, the future calls for a future-proof system in order for employees to be ready for a changing environment. People have to grow and develop new skills.

So if we’re all aware of this outdated process, then why are nearly nine out of ten companies around the world keeping their eyes wide shut concerning performance management?¹ I think it’s pretty obvious that we can’t evaluate John based on objectives set at the beginning of the year, if said objectives have changed throughout the year. Or determine John’s performance during a yearly one-time evaluation. Let alone link compensation to said performance.

Seen a fax machine around an office lately?

There’s a lot to be said of the traditional industrial-era performance management system, and it’s not all bad. For starters, it gave employees and employers a safe foundation and managed expectations. Jobs were straightforward, and people were judged on how well they executed. If John had to screw 100 bolts and nuts a day, and John screwed a 100 bolts and nuts, well then John was A-okay.

Ever since General Electric introduced the world to the stacked ranking approach, a lot of companies implemented this way of working. Said model, now also referred to as forced distribution or more eloquently rank and yank, divides employees into three categories based on 1–5 scale rating. According to this theory most employees are believed to be average, while smaller percentages are either low or high performers. This gaussian view is represented in a Bell curve.

Bell Curve showing the three categories.

The model allows companies to allocate their budgets to a tee, and gives managers an easy to use framework to evaluate employees and serves as a link towards compensation. However, it’s not all gold that glitters. Studies suggest there’s little proof of a direct correlation between performance ratings and actual performance.

As a perverse effect — hence forced distributionmanagers and companies use this as a starting point, rather than an outcome. Say you have a thousand employees, then according to this theory you would have budgeted for 200 high performers. To follow the budget, certain people would be deemed average instead of high or low and vice-versa. As an example, take the situation where a manager would like to rate someone a 5, but due to other reasons than the person’s performance (e.g. budget), has to rate her a 3 or 4.

By linking compensation to their placement on the Bell Curve every evaluation turns into a negotiation. People have the tendency to view themselves in a better light than what reality dictates. Since their rating equals a raise, getting a high score is the only thing that matters. Conversations with their manager that should focus on development now focus on determining a score.

This often creates a feeling of being treated unfairly. If you think you’re a 4 but your manager thinks you’re a 3, the evaluation will not be centered around development. Instead you will argue your case and try to change your manager’s perception of what you did in the past year. This does not help develop potential and fails to look further than the current situation, and allows for the squeakiest wheel to get the grease. Being the loudest and most argumentative employee will get you somewhere, and that’s not how you want to value and/or compensate you workforce.

On top of that, a manager’s personal bias can’t be understated. If your manager likes you, she’ll tend to give you a higher rating than someone she doesn’t like. Keep in mind there are also lenient and strict managers. For the same employee doing the same work, the former will give a higher rating than the latter. Meaning someone is a lot more likely to receive a high score, and thus be a high performer if her manager is of the lenient kind. Have a strict manager? Tough break, pal. In large companies, managers often trade ‘available spots’ with between teams. The lenient manager would ask for the budget to allow for a few extra high performers, while the strict manager would be left with hardly any high performers.

Most businesses are fully aware of the fact that their current process is outdated, but have no clue as to what else to do. I’ve tried to refrain from giving my personal opinion, but indulge me on this: If the only reason why you’re doing something is that you’ve always been doing it that way and have no idea what else to do — it wouldn’t hurt you to look at some alternatives. Maintaining an essentially flawed system due to lack of alternatives could prove to be very costly.

By the way, pioneer GE has since moved away from their annual reviews: “It’s abandoning formal annual reviews and its legacy performance management system for its 300,000-strong workforce over the next couple of years, instead opting for a less regimented system of more frequent feedback via an app. For some employees, in smaller experimental groups, there won’t be any numerical rankings whatsoever.”²

While compensation and performance management are strongly linked to the Bell curve, research suggest that this does not accurately reflect reality. Human performance⁴ is more adequately represented with a so called Pareto curve, which looks more like a power-law distribution. Also known as the 80–20 principle, it suggests that 20% of the people are driving up to 80% of your productivity and success. Following the curve, a study in 2012 has shown that that top 5% of workers outperform average ones by 400%³ and as the complexity of a job increases, so do these percentages. Given the expected rise in job complexity, how you deal with and detect your top performers should be at the top of priorities.

Bell Curve vs. Long Tail⁵

This confirms what most managers already know, high potentials (HiPo’s) are responsible for most of the success. This makes HiPo’s extremely valuable, and having a forced distribution does not allow companies to adequately recognize and incentivize these people. If you challenge, recognize and reward all of your employees equally, then your best ones (the left side “head” of the power distribution) will leave and your below average ones (the right side “long tail”) will stay.

Real high performers will experience this as ‘unfair’ and should be treated differently than others. Since they are responsible for most of your success, it makes sense to reward them handsomely as well. Imagine Michael Jordan being paid the same as Luc Longley⁶ (who? exactly).

Since a few good men⁷ are responsible for the lion’s share of your business, your compensation strategy needs more flexibility than what the Bell curve allows.

Most of you reading this will have a good idea of what it means to have a Growth mindset rather than a Fixed mindset. To briefly sum up: People with a Fixed mindset believe they have a certain set of skills, that can hardly be developed. They tend to shy away from challenges, and get demotivated by other people’s success. This is totally different for people in a Growth mindset. They believe to have skills that are in constant development, improved through hard work, feedback and inspiration through other people.

Given these concepts, it’s pretty clear that companies would rather employ people in a Growth mindset than a Fixed mindset. However, most are still using a performance management strategy that encourages the latter.

So where’s the link with compensation? The traditional evaluations tend to reward the effort and results of the past year, by use of a rating. This stimulates people to remain in a fixed mindset: “I have my fixed number of objectives and will stay in this comfort zone to get the outcome I desire”. This works against the growth mindset, where learning and progress, seeking help and trying new things are very important.

Risk-taking should never be completely mitigated. When people are given a fixed set of objectives linked to a rating, they will never try to over-deliver or optimize with the risk of failure looming. This is never beneficial to a company, as organizations that embody a growth mindset should always encourage appropriate risk-taking and should reward employees for important lessons learned.

Since the Bell curve labels the majority of people as ‘average’ — meaning their performance meets expectations — most of your time is spent determining exactly how average they are. This tedious and time-consuming process does not help develop your workforce. But since scores are King, there’s really no way around this. People expect a rating, and are willing to go to great lengths to get the highest rating as possible.

Deloitte recently did an internal study, and found out they spent over 2 million hours a year determining employee ratings — is this person a 3 minus, or a 3 plus? “We wondered if we could somehow shift our investment of time from talking to ourselves about ratings to talking to our people about their performance and careers — from a focus on the past to a focus on the future.”

Performance should be the basis for compensation, but companies have naturally grown into this generally accepted but messed up situation where an evaluation leads to a person being reduced to a rating. It’s how you score that ultimately decides your compensation. Time for us to change the narrative. In order for companies to survive, their employees have to evolve and develop into the best version they can be, through a performance management focused on forward-looking coaching rather backward-focused rating and ranking.

An evaluation should focus on how an employee can grow, and should consist out of how you value an employee and advice wherein she can improve to maintain value for the company. In other words, enable their performance. This means stepping away from disclosing ratings. People should walk away from their evaluation with concrete ways to get better, rather than a rating.

The Pareto Curve seems to be a much better fit to accommodate this growth mindset. Instead of limiting the number of people at the top of the curve, you try to build more of them.⁴ This means focusing on collaboration, professional development, coaching and empowering people. Which is exactly what an evaluation should be about, rather than moving back-and-forth between ratings.

We’ve established that following the Bell Curve can lead to less than desirable situations. High performers stuck in the average bucket will feel like they’re treated unfairly, while low performers are happy just hanging out. As Bersin⁴ points out, every employee has the potential to be a high performer. Instead of giving people a rating we should give them advice in order to reach that potential.

Everyone has the potential to turn into a Top Gun.

Where do we start? Drop the (outspoken) rating. Change the mindset. Encourage development.

Instead of rating, give your employees a clear idea of what’s expected of them. This is what‘s defined as an ‘average’ rating which functions as a bare minimum. If you meet expectations, then you are on par. During evaluations, focus on what they can do to improve. Not in order to get a higher rating, but to evolve and maintain or increase their value. Open up this conversation, and no longer limit people to a fixed set of objectives. Encourage the Growth mindset, and allow them to work on their areas of improvement that benefit their personal development. And as a result, their and the company’s value.

Bersin raises an interesting notion on stepping away from ratings: “If I find I’m not very good at the job I’m in now, I would hope my manager will help me move to assignments or jobs where I can become a superstar. Companies that simply rate me a 3 may not give me that opportunity. If we create a more variable and flexible process of evaluation we have to enable people to move into higher value positions”.

As an added bonus, this stimulates collaboration as well. In the old system, a fixed number of places are reserved for the high potentials. Without anyone actually acknowledging this, everyone within a team is competing with their team members and every incentive to collaborate is taken away. Pushing others down, in order to gain higher ground with your manager is beneficial for you. What you actually want is that everyone is trying to be the best version of themselves, not compared to their peers. Remove your ratings and peers will no longer be competing with colleagues for a fixed number of ratings.

Trust the process

Your new process should be something along the lines of this framework:

Performance Management: Old vs. New

1. Performance Enablement is not Performance Measurement

For a lot of companies, this either is the same thing or their process keeps them intertwined. There should be a clear separation between the two. Measurement is trying to determine how well a person performed over a certain period — eg. Ratings. Enablement is everything that concerns coaching and the development of people. Companies should try to enable their people to the best of their abilities, and a good start is to implement a continuous process with feedback and frequent one-on-one’s. However, if enablement coincides with the measurement, people will rarely be honest about development and will avoid revealing areas of improvement.

By separating these two, you can really focus on enablement during your coaching conversations, in a safe environment where development is key. These talks have no impact on how a person is measured, or compensated. So you’re left with two different processes: One that measures performance, and one — more frequent — that enables performance through regular conversations. Using a tool helps structure these processes, and gives both employees and managers a platform to focus on development. Ask us about the check-ins process in intuo!

2. The process

We want to encourage people to grow into high performers, so an alternative way of determining who is and who isn’t becomes really important. In most companies people generally have a good feeling as to who’s who, but it’s up to the managers, or a committee of, to make the decision.

A first step is creating a continuous process, with a lot of touch-points and ideally with feedback incorporated. This gives managers more input, without actively having to solicit opinions from people in her team. It also allows you to act quickly, rather than waiting to re-act.

A continuous process means moving from a few moments in the year, to frequent moments where a manager will have to allocate time to one-on-one’s and coaching. This makes it a company’s responsibility to invest in coaching and training the managers to create as many high performers as possible.

Since we want the manager to have more autonomy when evaluating an employee (see below), it’s important to provide them with as much information as possible. Using the right performance data and input will get you a long way. Crowdsource your information, collect opinions from clients and have continuous conversations and feedback in order to solidify your evaluation.

For example GE, who as mentioned have stepped away from rankings, rolled out their own app to collect data. It’s up to today’s companies to equip their managers — and generally their workforce — with the right tools to aid them in the detection of high and low performers. Feel free to contact us to see if intuo’s app could help you get the input you need.

It’s okay if you’re still skeptical up to this point. Patty McCord, Chief Talent Officer at Netflix from 1998 until 2012 said this⁹: “HR people can’t believe that a company the size of Netflix doesn’t hold annual reviews. “Are you making this up just to upset us?” they ask. I’m not. If you talk simply and honestly about performance on a regular basis, you can get good results — probably better ones than a company that grades everyone on a five-point scale.”

As far as bonuses are concerned, there’s no one-size-fits-all. For example Netflix didn’t use any performance based bonuses. People with the right attitude — growth mindset — won’t work harder or suddenly get smarter due to a bonus. I personally feel additional raises given by the manager is the right way to go. This makes it even more clear that one of the main priorities within in company should be educating and providing the managers with the tools to do so.

3. The bulk

When stepping away from the traditional yearly process towards a continuous way of evaluations, compensation will still need to be determined. As we’ve covered in this article, the current yearly process of determining the rating and more pressingly the level of averageness for the bulk of your employees is very time-consuming and doesn’t really scratch the right itch.

Along with the new mindset (focus on growth), let everyone know that if they meet expectations and are on par they will follow an external benchmark. This assures that wages are competitive compared to the market, and saves you heaps of time.

Their performance evaluation should consist out of two things. First of all a few reasons why you appreciate the employee and what their biggest strengths are. Secondly, it should incorporate an advice on how to improve certain aspects to encourage growth and evolution.

Drop the outspoken rating. This helps to change this from a negotiation on ratings, to a moment that’s focused on Performance Enablement rather than Measurement. Ideally you drop ratings entirely, but so called “shadow ratings” between managers could be used while bridging the gap to a completely rating free system. Although I have to say that we hardly ever suggest this.

4. The Unicorns

Along with this process for the bulk of your employees, a system should be set in place to focus on the individuals who are a step function away from average — your high and low performers. Rather than making them follow an external benchmark, or giving them a fixed raise linked to a high rating, it makes a lot more sense to give power to the people who are best placed to evaluate and compensate these Unicorns. The Managers.

Difference in Performance Evaluation and Pay.

Like with the bulk of the employees, their performance evaluation should consist out of two the same two things. However, a low-performer will receive a strong warning, will not receive a raise and efforts should be put in how the advice can be best followed up. A high-performer will get the (p)raise she deserves, determined by the manager. It’s up to the manager to allocate the budget and maybe check the decision with a committee or other parties within the company.

So how could a review look like?

Hi Annie,

This is your yearly management review. As the management team we wanted to let you know we really appreciate you for the following reasons:

Reason A

Reason B

Reason C

From what we’ve seen the past year, we think you might be able to grow in these areas. Your coach will guide you on how we can help you to do so:

Advice 1

Advice 2

Advice 3

This is your basic template for the yearly review, which everyone in the company will get. The unicorns (LoPo/HiPo) in the company will get something more on top: either a warning, or praise along with a bonus.

First of all, this allows the management team or salary review team to go over everyone, which they like to do even though they no longer have direct contact. They will base this review on the information received from the coaches/managers. Second of all, the person will still be expecting some kind of formal review. This type of review could be a great way to accommodate those wishes, and serve as a way to transition towards a process without a formal review.

5. Pay for value

Most companies are afraid to make this change, but it’s a lot easier than you might think. Leading companies such as Google, Accenture and Adobe are blazing the trail and their travels are well documented. It all boils down to the same thing: In order to be ready for the future, and the people of tomorrow, a change is needed.

As far as I’m concerned, I’d rate the new approach 5/5. It allows you to pay for the value your employees deliver, now and in the future. This sounds obvious, but think about it, how much of your employees’ wages are solely based on tenure and history instead of what they (are able to) bring to the table?

  1. See “The measure of a man,” Economist, February 20, 2016.
  2. M. Nisen, Why GE had to kill its annual performance reviews after more than three decades, https://qz.com/428813/ge-performance-review-strategy-shift/
  3. B. Ewenstein, B. Hancock & A. Komm, Ahead of the curve: The future of performance management, https://www.mckinsey.com/business-functions/organization/our-insights/ahead-of-the-curve-the-future-of-performance-management
  4. J. Bersin, The Myth Of The Bell Curve: Look For The Hyper-Performers, https://www.forbes.com/sites/joshbersin/2014/02/19/the-myth-of-the-bell-curve-look-for-the-hyper-performers/#3065be9c6bca
  5. J. Stephenson, 7 Tips for Embracing the 80/20 Rule With Employee Talent, http://www.exacthire.com/blog/workforce-management/7-tips-for-embracing-the-8020-rule-with-employee-talent/
  6. https://en.wikipedia.org/wiki/Luc_Longley
  7. For the sake of reference the phrase “A few good men” was used. Let’s be clear, women are what makes the world go ‘round and are at the least equal to men. Every notion of gender-bias should be seen within the context of the writer’s article.
  8. M. Buckingham & A. Goodall, Reinventing Performance Management, https://hbr.org/2015/04/reinventing-performance-management
  9. P. McCord, How Netflix Reinvented HR, https://hbr.org/2014/01/how-netflix-reinvented-hr
  10. K. Duggan, Six Companies That Are Redefining Performance Management, https://www.fastcompany.com/3054547/six-companies-that-are-redefining-performance-management
  1. https://www.mckinsey.com/business-functions/organization/our-insights/attracting-and-retaining-the-right-talent?cid=soc-app
  2. http://uk.businessinsider.com/google-policy-to-pay-unfairly-2015-4?r=US&IR=T
  3. https://hbr.org/2017/10/there-are-two-types-of-performance-but-most-organizations-only-focus-on-one
  4. https://hbr.org/2017/10/what-science-says-about-identifying-high-potential-employees
  5. https://www.mckinsey.com/business-functions/organization/our-insights/ahead-of-the-curve-the-future-of-performance-management
  6. https://empxtrack.com/blog/bell-curve-for-performance-appraisal/
  7. https://www.forbes.com/sites/joshbersin/2014/02/19/the-myth-of-the-bell-curve-look-for-the-hyper-performers/
  8. http://www.exacthire.com/blog/workforce-management/7-tips-for-embracing-the-8020-rule-with-employee-talent
  9. https://qz.com/428813/ge-performance-review-strategy-shift/
  10. https://www.strategy-business.com/article/00275?gko=c442b
  11. https://hbr.org/2016/01/what-having-a-growth-mindset-actually-means
  12. https://www.shrm.org/resourcesandtools/hr-topics/employee-relations/pages/performance-reviews-are-dead.aspx
  13. https://www.cipd.co.uk/knowledge/fundamentals/people/performance/what-works-in-performance-management-report
  14. https://hbr.org/2014/01/how-netflix-reinvented-hr
  15. https://www.fastcompany.com/3054547/six-companies-that-are-redefining-performance-management