Performance-based compensation

By : Jim Pinto,
San Diego, CA.
USA

Today's compensation systems were originally developed during the era of hourly-paid factory workers. For today's knowledge-based employees, performance-based compensation is necessary. And it's important to include team-success factors. Employee-ownership has the best results.

This article was published by:

Automation World, July 2005

Rooted in the past

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 has to cutback, they’re the first to go.

There's the old cliché, "I've paid my dues". New people tend to follow the "culture", and problems arise when old cultures don’t adapt to new business environments. Companies tend to drift along with an old culture, replete with out-of-date processes not compatible with today’s reality.

Performance-based

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 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 10-15% of employees were rewarded, the middle 70% were compensated adequately, and the remaining 10-15% 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.

GE and other forward-looking companies started these kinds of changes in the 1980’s. But sadly, many companies still cling to the old 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.

In today’s knowledge-worker business environment, the best form of compensation is performance-based. It gives people immediate and meaningful feedback. But, there’s always the human element. Direct supervisors (the people who do the reviews) may have a personal bias which short-changes some good people and advances others who may simply be currying favor.

The best form of compensation is performance-based, with measurable objectives. The easiest targets to quantify are those based on bookings, shipments and profit. Pay is based on whether or not plans or budgets are met – usually monthly, but quarterly and even annually for top managers.

It’s 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 extended 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 every part of the enterprise.

Employee-ownership

This brings up the question of ownership. In a capitalistic society it's 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.

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