Putting merit back into annual pay actions requires tough decisions and it may take several performance cycles to achieve. Nonetheless, meeting the challenge can be worthwhile. Studies show that the existence of pay consequences based on individual performance and impact promotes employee engagement in the success of the organization.
Following are several tested ideas from companies that are getting more bang for the buck in their base pay increase and bonus budgets.
Clearly Define Performance Expectations and Communicate that the Organization Rewards Top Performers. Employers who embrace this approach identify what they expect and what constitutes superior performance—and then reward accordingly through merit pay and incentive opportunities.
Take the case of a multi-billion-dollar retailer that had been teetering on the edge of bankruptcy for several years when a new CEO stepped in. Two years later, he was widely acclaimed by employees and investors alike for having “saved” the company. So it was a bit of a surprise when he made the following statement at a town hall employee meeting: “To help you calibrate this year’s performance evaluations and corresponding pay expectations, you should know I am a three [strong contributor] on the five-point performance evaluation scale used for merit increases. That’s what the board has told me. In my career I have earned a higher rating only a few times.”
The CEO was addressing the fact that, during the company’s many years of poor performance, almost all the workforce had been rated a four (outstanding) or five (superior) on the performance scale. As a result, the company had been distributing its limited merit increase pool with little differentiation, which made no sense.
In just one performance cycle, the ratings fell into an almost perfect bell curve.
The company recognized and rewarded key contributors at all levels and many nonperformers left. Vibrancy and credibility were restored to the pay-for- performance linkage.
Create Employee “Ownership” of the Performance Outcomes that Fund the Base Salary Increase and Bonus Pools. Ideally, employees who receive wage increases and year-end bonuses exhibit superior performance and skill building and make meaningful contributions to the organization’s success. This, of course, assumes that they know what they must do to drive the desired business perfor- mance outcomes, which, in turn, fund the merit increases and bonus pools.
Some employers say, “Our employees won’t understand and can’t do anything about all this financial stuff. It’s just easier to tell them that we didn’t meet our targets and there isn’t much money for base salary increases and bonuses.” Others, however, see an opportunity to create an economic win–win situation for the company and its employees.
One meat processing company analyzed its business economics and devel- oped sophisticated “value trees” that began with return on capital and flowed through each financial and nonfinancial measure that affected returns. When this analysis led the senior leadership team to conclude that the company would need more belt-tightening (including wage freezes) in order to ensure business success, the senior vice president in charge of plant operations protested the ivy-tower corporate view. “I bet if we can educate my guys on the slaughter floor about how we make money, we can get improvements that will generate money for wage increases and bonuses.”
The senior vice president set up a simple financial literacy program for his employee group. It included a discussion of how the company and its customers make money (and how the company can help its customers make more money).
After introducing them to a simplified version of the value trees, he asked his employees to work in teams to figure out what they could do in their day-to-day actions to improve the trees’ financial outcomes. The “guys on the floor” took ownership of the performance outcomes and identified process improvements and individual skill development opportunities that improved profitability and sustainability—and consistently resulted in “meaty” merit budgets and bonus pools.
Aggregate Merit Budgets and Annual Bonus Pools so that Small Departments can Participate Fully. A growing number of employers combine their merit increase budgets for small departments with those for the next level or create merit budgets that cover at least 30 employees under three or more managers. In this way, the organization can address the concern that small departments with only a few employees cannot differentiate pay.
As an added advantage, the managers of these small departments learn to talk about pay and performance. Through these peer discussions they establish a clearer
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standard that differentiates top performance from expected performance. Further, groups of managers that the organization holds accountable for allocating a limited merit pool find a way to differentiate performance equitably.
For example, a food distribution company had a multitude of three- to four- employee teams, each with its own manager. These teams, all located at head- quarters, provided a specific support service to the field operations. Although the teams were used to thinking of themselves as isolated units, when their merit increase budget was aggregated the managers were forced to think about all of their employees as part of a total service process. In their examination of the total process, it became very apparent which individuals and which teams were carry- ing more than their load in serving the field. The managers distributed the merit dollars accordingly and also started to revamp aspects of the process that were delivered inefficiently or ineffectively.
Form Groups of Managers to Calibrate Performance Ratings, Merit Increases, and Bonus Pool Allocations to Lessen Manager-to-Manager Differences. One frequently heard employee complaint is: “The system isn’t fair because my manager rates tougher than your manager.” One way to solve this problem is to convene a group of peer managers to calibrate performance ratings, merit increases, and bonus awards prior to finalization (see Figures 7.1 and 7.2).
Managers bring to this meeting a set of preliminary ratings and merit recom- mendations. Like the aggregation of budgets approach discussed above, these meetings help define what performance looks like at the highest ratings. Managers learn how to analyze the performance of their subordinates, are more diligent in documenting it, and seek out corporate-sponsored opportunities to learn how to manage it better.
A large multinational manufacturer adopted the group calibration of ratings approach. After the first, very painful, attempt at group calibration there was (and continues to be) an increase in the number of “hits” on the relevant on-line learn- ing modules and increased attendance at company-sponsored training sessions on performance management and calibration.
Calibration also increases employee confidence in the process. Employees who know that managers in addition to their own review their performance have more trust in the fairness of the decisions.
Create Set-Asides to Reward Top Performers Accordingly. A top performer set-aside pool (merit increase and/or bonus) ensures that the organization system- atically identifies top performers and sees that they receive greater financial
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ASSUMPTIONS
• All employees have similar base salary
• All managers have a $7200 merit increase budget
• Rating Scale: Exceptional (E); Outstanding (O); Meets (M); Below Meets (B)
Manager A (Easy Rater)
Manager B (Tough Rater)
Manager C (Tough Rater with Some
Differentiation)
Manager D (Balanced Rater)
Employee 1 E $1800 Employee 5 M $1800 Employee 9 O $3300 Employee 13 E $3600 Employee 2 E $1800 Employee 6 M $1800 Employee 10 M $1300 Employee 14 O $2000 Employee 3 E $1800 Employee 7 M $1800 Employee 11 M $1300 Employee 15 M $1000 NOITARBILAC-ERP Employee 4 E $1800 Employee 8 M $1800 Employee 12 M $1300 Employee 16 M $600
TOTAL $7200 TOTAL $7200 TOTAL $7200 TOTAL $7200
Manager A Manager B Manager C Manager D
Employee 1 O $1500 Employee 5 M $1200 Employee 9 O $1500 Employee 13 E $3500 Employee 2 M $1000 Employee 6 M $1000 Employee 10 M $1000 Employee 14 O $1500 Employee 3 M $1000 Employee 7 E $3500 Employee 11 M $1000 Employee 15 M $1200 NOITARBILAC-TSOP Employee 4 E $3900 Employee 8 E $3500 Employee 12 O $1500 Employee 16 M $1000
TOTAL $7400 TOTAL $9200 TOTAL $5000 TOTAL $7200
OBSERVATIONS Pre-Calibration:
• Distribution of Ratings: Exceptional = 5, Outstanding = 2, Meets = 9
• Distribution of Merit Increase: Exceptional = $1800 - $3600
Outstanding = $2000 - $3300
Meets = $600 - $1800
Post-Calibration:
• Distribution of Ratings: Exceptional = 4, Outstanding = 4, Meets = 8
• Distribution of Merit Increases: Exceptional = $3500 - $3900
Outstanding = $1500 (decision made to reward all outstanding performers similarly)
Meets = $1000 - $1200(decision made to recognize specific capability
achieved by two individuals with an additional $200 “premium”)
FIGURE 7.1 Peer manager base salary calibration
Source: Sibson Consulting
would provide an average additional $1,500 merit increase for the company’s top 10 percent of performers and still allow for an average basic merit increase of
$1,250 for all 6,000 employees.
Companies that use a set-aside pool find that the allocation determination process is beneficial in itself. For instance, in order to tap into its top performer
ASSUMPTIONS
• Total Bonus Pool: $48,000
• Rating Scale: Exceptional (E); Outstanding (O); Meets (M); Below Meets (B)
• Annual incentive decisions made after base salary and performance recalibration
Manager A Manager B
Employee Rating Base AI Employee Rating Base AI Employee 1 O $1500 $3600 Employee 5 M $1200 $1600 Employee 2 M $1000 $1600 Employee 6 M $1000 $1600 Employee 3 M $1000 $1600 Employee 7 E $3500 $5100 Employee 4 E $3900 $5500 Employee 8 E $3500 $5100
Manager C Manager D
Employee Rating Base AI Employee Rating Base AI Employee 9 O $1500 $3600 Employee 13 E $3500 $5100 Employee 10 M $1000 $1600 Employee 14 O $1500 $3600 Employee 11 M $1000 $1600 Employee 15 M $1200 $1600 Employee 12 O $1500 $3600 Employee 16 M $1000 $1600
OBSERVATIONS
• Distribution of Ratings: Exceptional = 4, Outstanding = 4, Meets = 8
• Distribution of Annual incentive: Exceptional = $5100 - $5500
Outstanding = $3600 (decision made to reward all outstanding performers similarly)
Meets = $1600 (decision made to reward all “Meets” similarly)
• Managers wanted to give those at the “Meets” level “just enough” to make a difference (amount of award was set at the level it would take to buy a major home appliance)
• Managers wanted “Outstanding” performers to receive at least twice what “Meets” performers received
• “Excellent” performers were to receive at least three times what “Meets” performers received
FIGURE 7.2 Peer manager annual incentive calibration
Source: Sibson Consulting
set-aside pool, one multimillion-dollar service provider requires managers to
a pure merit pay process. However, four years later, it still uses it because of these valuable side benefits:
■ The truly top performers hold their manager accountable for performance discussions and the nomination process.Employees know they are eligible for nothing more than the across-the-board increase unless their manager gives evidence of their superior performance through a “top performer”
nomination.
■ The design of the nomination form helps frame what top performance “looks like.”After the first year (when there was a flood of nominations), managers developed a better understanding of “what it takes” to rate a merit increase from the top performer set-aside pool.
■ Allocating the pool requires “silo-breaking” cross-organization calibration.
It also involves thoughtful senior management discussions about performance expectations.
■ Performance conversations at the senior management team level provide valuable insights into the organization’s depth and quality of talent.They now inform the company’s evolving human capital planning process.
Reposition the Organization’s Mindset so it Views Merit Increases and Bonuses as Investment Spending. The merit increase budget and annual bonus pools are long-term investments in talent that will drive the organization’s sustainable success.
Investing in employees who have not demonstrated the level of performance and skill building that the company expects does not make financial sense.
Repositioning the organization’s mindset requires consistent and frequent communication with executives, managers, and employees. For example, a mid- sized financial services employer talks the language of its business to its employ- ees. This firm positions all compensation discussions in terms of an investment.
Employees understand that decisions with respect to individual merit increases reflect an evaluation of prior-year individual performance and applicable skill acquisition and the expectation of continued further “returns on [the merit increase] investment.”
A large insurance company took the “return on investment” concept in a courageous direction. Its go-forward business strategy totally restructured the products offered and the markets served. As a result, the company’s talent needs changed dramatically. Unfortunately, there was no increase in merit and bonus dollars to attract, engage, and retain the specialized talent needed to execute the go-forward business strategy. To address the issue of financial resource constraints, the company segmented its talent by business performance impact. The limited merit and bonus dollars were “invested” in the high performers in those roles that were critical to driving long-term sustainable business success, i.e., the high performers
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in roles with the largest return on investment potential for the company. The com- pany said “no” to any future base pay and bonus investments in those talent segments where skills were no longer aligned with the company’s needs.
Simplify the Performance Evaluation Process—Aim for Less Paperwork and More Meaningful Conversation. Even when merit increase budgets and bonus pools are more robust, many employers still question the time and effort it takes to recognize and reward employees based on differentiated performance. In many cases, the protocols and processes are too complex—and sometimes too deper- sonalized and mechanical.
A global 25,000-employee engineering firm decided to automate its traditional, highly interactive approach to performance evaluation and pay action determina- tion. An elegant 100 percent online solution replaced the performance-contracting dialog between managers and employees. All interactions were Internet-based. It was a very efficient system: The firm met every payroll deadline associated with merit increases, the merit increase and bonus pools were exactly spent and there were no tough, time-consuming, face-to-face conversations. Everything was on time, on budget, “on spec.”
After several years with the online approach, the firm analyzed the outcomes.
Among the findings was that managers and employees alike had learned to
“game” the system. There was little differentiation of performance (and thus pay increases); almost everyone was a four or five on a five-point rating system. The on-line forms were complicated and time-consuming to complete. Employees and managers saw the process as a burdensome “joke.” Even more important for a firm that prided itself on “high performance,” its annual performance targets (strategic, operational, and financial) were achieved but not exceeded.
As a result, the firm made several important changes. While it preserved the document trail associated with the online system, it introduced simplified forms and restored face-to-face interactions between managers and employees. The updated approach required specific manager–employee and manager–manager
“conversations” as well as cross-unit managerial calibration of performance ratings, merit increases, and bonus determinations.
The most lauded aspect of the new approach was a “Beginning of Cycle”
small group meeting where the firm’s strategic, operational, and financial perfor- mance imperatives for the New Year are reviewed. Employees and managers discussed the performance expectations required to deliver on those imperatives.
The employees then used this information to develop their annual individual goals,
SUMMARY
Small base pay increase budgets and tiny or nonexistent bonus pools have caused many employers to ask themselves: “Can this ‘little package’ of merit increase and year-end bonus dollars really allow us to differentiate ourselves among employ- ees?” and “Is it worth the time and effort to do so?” Indeed, some organizations are now in the habit of answering “no” to both questions. As a result, almost every- one gets essentially the same annual base pay increase and year-end bonus regard- less of how they perform, squandering the opportunity to “make merit matter.”
In order to make a difference, increases in an individual’s wages and the size of a year-end bonus must be attributable to superior individual performance, effective skill building, and contributions to the organization’s success. Employers must clearly define performance expectations, communicate that top performers will be rewarded, and then take the necessary steps to make it happen. Only then will annual pay actions, no matter how small they may seem at first glance, be meaningful.
Although each of the approaches described in this chapter has been used successfully, before an organization adopts any one (or a combination) of them, it should evaluate how it “fits” the organization’s current and desired performance culture. Most important, the organization needs to assess its leadership’s capability and its willingness to “put its money where its mouth is” and tell its employees,
“We’ll show you that your performance matters.”
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C H A P T E R
JOB ANALYSIS,