This week, the Harvard Business Review article Capitalizing on Capabilities by Dave Ulrich and Norm Smallwood was assigned reading. In this article, Ulrich and Smallwood discuss the idea of pay-for-performance, noting that:
“Some firms claim a pay-for-performance philosophy but give annual compensation increases that range from 3.5% to 4.5%. These companies aren’t paying for performance. We would suggest that with an average increase of 4%, an ideal range for acknowledging both low and high performance would be 0% to 12%.” (page 3)
I wanted to research this topic of pay-for-performance more to see how widely it is used and what the feelings are about this compensatory approach in industry or academia.
Harvard Business School Professor Michael Beer’s Pay-for-Performance Doesn’t Always Pay Off article featured at http://hbswk.hbs.edu/item/3424.html discusses the many downsides of implementing a pay-for-performance system at Hewlett-Packard in the 1990’s. In the article, Beer explains that pay for performance schemes can be complicated especially with the process of conception, design, and implementation.
According to Beer:
“In the early 90s, Hewlett-Packard (HP) seemed a perfect setting for innovations in pay. A so-called ‘built-to-last’ company, it was highly decentralized and enjoyed a sense of mutual trust, high commitment, and wide use of management by objectives. The workforce was salaried and the merit system was based on peer comparisons at the salaried level. There were no executive bonuses. Stock options were awarded as recognition. But there was also a lot of pressure in the company. Managers of thirteen units took the initiative of appealing to headquarters to try something new to spur on their employees.”According to Beer, managers in many companies expect:
· Pay-for-performance will attract and motivate people
· Performance standards will outweigh the costs of whatever incentives they put in place
· Protection against business exigencies, so the company is not stuck permanently with new costs if a market soursAccording to Beer, the vast majority of employees, in general, also want pay-for-performance. Beer notes that
“While they may not think their current pay system is unfair, they do think pay-for-performance is an opportunity to make it more fair. They think they can outperform whatever pay they get; they usually assume they will benefit in terms of higher pay.”
Beer also outlined the controversies surrounding traditional pay versus pay-for-performance, noting that:
· some scholars assert that pay becomes an entitlement, and an employee’s pay is based on his/her level and not actual performance.
· Other scholars note that pay-for-performance can impact employee self-esteem, creativity, and teamwork.
· Beer also mentions that one scholar feels the pay incentive works too well, in that employees focus excessively on the work needed to gain rewards, sometimes at the expense of doing other things that would help the organization.
Beer notes that an implicit negotiation going on between what management wants and expects, and what employees want and expect. This implicit negotiation is "embedded" in the context of pay-for-performance, but often goes undiscussed and unacknowledged, he suggested. Misunderstandings about goals are the result. Beer believes that pay-for-performance may also have a natural life cycle that managers are unaware of.HP’s San Diego site tried pay-for-performance across 13 departments. For the first six months, everyone loved the new system. Because the payout was greater than expected, management adjusted the goals upward. Then the complaints began:
· Teams grew frustrated with factors out of their control (i.e. delivery of parts affecting their work)
· High-performance teams often refused to admit people whom they thought to be below their level of expertise, leading to disparities among the teams.
· There was reduced mobility between teams, preventing the transfer of learning across teams.
· Employees built their lifestyles around the higher level of pay, and were angry when they could not achieve it consistently.Ultimately, HP managers felt they were spending too much time reengineering the pay system. They concluded that “it did not motivate employees to work harder or, perhaps more importantly, to learn. It was also hard to maintain consistency of pay across the larger site. Managers also grappled with the question of sustaining pay-for-performance over time. There were clear short-term benefits but also clear longer-run costs, including the cost of constant redesign and negotiation of the system. Other HP units ran into similar difficulties.”
Beer noted the most striking finding from these pay-for-performance experiments was the size of the gap between managers' expectations of benefits and the reality that they experienced in terms of costs.
My question to the class:
Clearly HP’s implementation of pay-for-performance had a number of issues. Has pay-for-performance worked well in other companies or specific industries? If so, which ones? If so, what aspects of the system and characteristics of the company/industry have helped make it so? What implementation tips would you recommend to someone who was beginning to implement a pay-for-performance plan at their company?