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Do You Pay for Performance? Here’s Why You Shouldn’t.

Pay for Performance

A few years ago, I saw Jim Collins, the author of Good to Great, speak at a leadership summit. Someone in the audience asked him a question about incentive programs, whether it worked to motivate performance through the payment of bonuses. 

Collins’s response was immediate, clear, and passionate: “Incentive programs most often destroy companies and never create great companies,” he said. “You cannot turn the wrong people into the right people with money. You can’t.”

Collins then briefly recapped a key finding reported in Good to Great. When they did a full analysis of the role of incentive programs in companies that moved from good to great versus comparison companies, the result was a complete scatterplot. There was no correlation between incentive plans and outcomes, no matter how they sliced the data. 

Collins was enlivened during this spiel, perhaps because of how stubbornly common pay-for-performance schemes still are. All the way back in 1993, Alfie Kohn told us that “according to numerous studies in laboratories, workplaces, classrooms, and other settings, [monetary] rewards typically undermine the very processes they are intended to enhance.” Nevertheless, incentive programs hit an all-time high in 2014, when an estimated 82 percent of organizations offered employees some form of incentive pay.

Some studies have even found that the people paid the most to perform cognitive tasks also performed the worst. This issue is so commonly mishandled by managers that it’s worth taking a moment to explain exactly why incentives don’t work and what we should be doing instead.

Why Don’t Incentives Work?

At one job, I got a 4 percent pay increase because I was kicking ass in the role, while the person next to me—a workplace dud—got a 2 percent raise. I was supposed to be excited about this, but in reality, the measly 2 percent just made me wonder why we kept my desk neighbor at all. It definitely didn’t increase my motivation. Generally, when you give people a pay raise, if it improves their morale, it does so only briefly. Very quickly their sense of worth rises to match the new compensation, and any fleeting bit of motivation disappears.

The other issue is that, if you’re going to pay people based on their work performance, you’re going to have to craft a very complicated system to decide what exactly gets rewarded—and you’re probably still going to make a lot of employees feel they are being treated unfairly. Especially in sophisticated organizations, it’s difficult to extract one person’s work from another. A salesperson might think he’s the only one involved in the sale and should therefore be rewarded for his numbers, but his numbers rely on the brand, the marketing team, the economy, the territory he’s given, and much more. 

True pay-for-performance requires a standardized measurement of performance—and that’s not easy to come by for knowledge workers.

What to Do Instead

To get around these dynamics, I have always managed with the philosophy of paying people consistent market rates across the board and rewarding the top performers with growth and development opportunities

I have been so insistent on decoupling performance and pay that I never discuss the two topics with the employee at the same time. They are two separate discussions. I also review the employee’s pay on the anniversary of the hire date rather than do everyone together at the end of the year. This way, each case is treated individually, and we avoid the year-end water cooler discussions that plague so many other firms.

This approach has worked for me for decades, and I believe it’s because it removes an aggravating factor in motivation (low pay), creates a sense of fairness—everyone is paid based on the same data—and energizes people by giving them the opportunity for growth and advancement. You may have a few questions about how to apply this approach:

First, how do I determine market rates for salaries?

There are a few ways. You can use anecdotal data, such as asking in the interview process what candidates’ other offers are; you can subscribe to services that include market data on salaries; or you can even do formal surveys. When salaries on your team are set this way across the organization, there are no funny inconsistencies you have to explain, and you remove employee-versus-employee competition. 

If your process is rigorous enough and the culture is right, you can even move to total pay transparency, where everyone knows everyone’s salary. This is best done across the whole organization, so it’s likely you cannot personally make this decision, but I’m a big fan of it when it’s done right.

Second, what if I don’t set my employees’ salaries or am very tightly constrained by the budget?

This happens a lot. You may inherit a group of ten people, each paid based on someone else’s management philosophy, and then be asked to divvy up a 3 percent annual increase among them. When you have this small level of latitude, the situation becomes difficult, and the best approach is to be honest. Rather than maintain some illusion that you base salaries on performance or that you have the power to hand out raises, simply tell them you don’t control pay.

Third, what does “rewarding people with opportunities for growth and development” actually look like?

There are many ways to reward A-players through growth opportunities (and increase their market value in the process). It may be paying for a certain type of training or course that aligns with the person’s long-term career goals, even if it won’t benefit the company immediately. You might also offer the employee a promotion within the team or appoint her lead on a big project she cares about.

Or you could use the hugely undervalued reward of simply talking about the A-player to your peers and boss. This grows the employee’s recognition within the organization as someone who’s doing good work. A lot of managers are reluctant to do this because they don’t want to lose their employee. But you’ve got to be willing to tell everyone in the organization about the A-player’s abilities so she has a chance at new opportunities, even if they’re outside your group. No employee wants to be pigeonholed into a role just because he is good at it.

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You can’t give people an excuse to leave because of low pay, but money can never be a major motivator of employees on its own. In my experience, the approach of decoupling pay and performance can drastically lower turnover, increase motivation, and eradicate almost all disputes over salary.

Picture of Joel Trammell

Joel Trammell

Joel has learned the value of great managers over a quarter century serving as CEO of both public and private companies. As CEO and cofounder of NetQoS, a network management software firm, he delivered 31 consecutive quarters of double-digit revenue growth and a $200 million valuation. In 2010, Joel cofounded Cache IQ, a storage software company that NetApp acquired two years later. He is the author of two books, The CEO Tightrope and The Manager’s Tightrope—a complete guide to the manager’s role. He currently serves as CEO of Khorus, a company he founded to provide a business management system for chief executives.

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