It’s now widely recognised that annual appraisals are no longer appropriate for managing performance in today’s organisations. A new methodology known as Continuous Performance Management is being widely adopted in organisations around the world across all business sectors. This methodology is based upon three simple principles:
- Employees should be working towards achieving near-term goals or objectives at all times
- They should be getting frequent real-time feedback on their work
- They should be having regular, future-focused ‘check-in’ meetings
Whilst this approach is straightforward in principle, organisations interested in adopting Continuous Performance Management are often left asking a number of questions concerning the practicalities. We answer most of these questions in our free Continuous Performance Management eBook. In this article, I am going to address the most burning question that we are hearing right now from organisations:
How can I manage performance related pay or bonuses using Continuous Performance Management?
Why is this a concern?
Most organisations who use performance related pay, either for their base pay, or for bonuses, have traditionally based their decisions on ratings taken from their annual appraisals. But if you remove the annual performance appraisal and replace it with ongoing discussions and feedback throughout the year, how do you make your performance related pay decisions?
The short answer
The answer is surprisingly simple. When it’s time to make decisions about pay, you simply ask your managers to tell you how each of their team members has performed over the period in question, and use that data to inform your performance related pay. This of course brings up further questions such as how should your managers measure their team members performance and how do you ensure fairness and objectivity? I’ll be answering these questions over the course of this guide.
An essential guiding principle
Whatever approach you take to measuring performance, and there are many, you should adhere to one essential principle:
De-couple your performance measurement from your regular performance conversations
We know from numerous research studies that we improve performance by having regular, meaningful, developmental performance conversations. However, if we try to add any form of performance measurement or assessment into those conversations, the performance improvement impact is immediately lost. An employee is rarely going to be honest about their areas for development or improvement if they know a performance rating is coming at the end of the conversation. This is one of the key reasons why traditional appraisals aren’t effective.
So as the Chartered Institute of Personnel and Development (CIPD) stated in their recent Performance Management research report:
“Introducing some clear water between assessments that inform pay and promotions and those [processes] that help employees improve should make performance management a far smoother, more productive and less fraught process.”
In practice, this means having a separate process that you operate periodically with the sole purpose of assessing performance and potential, which sits outside of your regular check-in discussions, as shown in the diagram below:
In our Clear Review performance management software, we call this process Viewpoints (although it can be called whatever you want) and it enables HR to collate the views of their managers about the performance and/or potential of their team members using a simple, customisable online form. The answers can then be reported and analysed. Our customers typically do a round of Viewpoints annually, bi-annually or quarterly, depending on the nature of their business and how fast moving it is.
Measuring performance for pay: the ratings approach
The classic approach to measuring performance for pay purposes has been for managers to allocate a rating to each of their team members which then partially determines their pay or bonus outcome. There is no reason why you can’t still collate performance ratings at the end of the year under a continuous performance management approach, ensuring you make it a separate process, as explained above.
However, research studies have shown that there is little correlation between performance ratings and actual performance. This is due to a combination of manager bias and managers reverse-engineering performance ratings to get the reward outcome that they want for their team members. This is one of the main reasons why surveys consistently show that most employees find annual appraisals to be unfair, despite the numerous hours of work that typically go into rating calibration. Research has also found that linking performance ratings to pay ends up demotivating the majority of employees, which ironically is the exact opposite of what performance related pay is attempting to achieve.
This has led many organisations to adopt alternative approaches to ratings and studies are now finding these alternatives to be more effective than ratings. For example, a study of 22 companies that had removed formal ratings and were between two and five years into their new performance management framework found that employee engagement went up in all of them after the new system was in place, and it has continued to do so since.
Let’s explore some of the practical alternatives to performance ratings when it comes to making decisions about pay.
The manager discretion approach
When General Electric, one of the largest organisations in the world, adopted continuous performance management, they also decided to get rid of ratings. In 2016 I saw one of their HR Executives, Anastasia Kuzmina, present at the CIPD Performance Management Conference and she gave a compelling argument for their new approach. She said:
“Our managers were telling us that they are able to make multi-million dollar decisions about business projects, yet they are not allowed to decide whether a team member should get a 2% or 3% pay rise. They felt it was a crazy situation”.
So now GE run an annual pay review process and give each manager a pay pot and the managers can determine how best to spend that within their team. This allows managers to take a number of factors into account when deciding on pay – performance, potential, risk and impact of leaving, changes in market rate, etc.
To minimise subjectivity, managers are asked a series of performance-related questions to help frame their thinking, such as:
- “How has this person made an impact in areas above and beyond their priorities?”
- “Would the absence of this person have a negative impact on the business and on customers?”
The fact that managers are having regular check-ins with their staff and are seeing feedback from a range of sources throughout the year also helps to increase objectivity. Additionally, HR business partners are able to challenge decisions where they feel there is unfair bias.
So far, the results at GE have been incredibly positive with employee satisfaction regarding pay awards now higher than when ratings were used and 77% of managers say they find it easier to differentiate performance under the new approach.
The simplified rating approach
A number of organisations, including some of our own customers, having recognised that traditional 4 or 5 point ratings are actually hard for managers to use objectively and consistently, have opted for a simplified approach whereby employees are either designated as ‘On track’ or ‘Off track’, or similar terminology. Where an employee is ‘On track’ they receive a pay or bonus award, based on one or more of the following:
- company performance
- divisional performance
- team performance
- market rate
- changes in job responsibilities
Where an employee is ‘off track’, their pay or bonus award is reduced.
This approach has a number of advantages. It is simple so everyone understands it, it saves time as there is no calibration required, it reduces anxiety amongst employees as most employees will be ‘on track’ most of the time, yet it still allows under-performance to be addressed. Additionally, as managers only have two rating options, they are able to rate employees much more objectively than with a multi-point rating scale, even if they are not experienced performance raters.
The major disadvantage of this approach is that it has no scope to award extra pay to higher performers.
The partial differentiation approach
The purpose of most performance related pay schemes that I have encountered is to recognise high performers with additional reward and to pay less to poor performers. If that is the aim, then we don’t actually need to differentiate every single employee’s pay and performance. Instead, we can simply identify just our highest and lowest performers to differentiate their pay and give the majority of employees who are on track the standard pay or bonus percentage based on company or divisional performance. This approach is recommended by McKinsey who state that “many companies now think it’s a fool’s errand to identify and quantify shades of differential performance among the majority of employees, who do a good job but are not among the few stars.”
I personally like this approach a lot as it simplifies things significantly. We need to recognise that however we decide to measure performance, there will always be further discussion and analysis that needs to take place to help ensure fairness and to deal with the inevitable disagreements that arise. So if we can limit the scope of this to say just the top and bottom 10-20% of the workforce, we’re saving a significant amount of time, effort and potential staff dissatisfaction. We’re also vastly limiting the scope of potential subjectivity.
So how do you go about identifying your top and bottom performers without a rating? It may be tempting to put together some kind of pseudo-scientific formula based on weighted achievement of objectives and demonstration of values or behaviours, something that many performance management systems offer (not ours). However, these systems end up being counterproductive because:
- They are time consuming to complete so they end up becoming a ‘tick-box’ exercise, detracting from meaningful, performance enhancing discussions
- Employees need to understand the formulas and weightings behind them in order for them to form an opinion about whether or not they have been treated fairly, something that is hard and time consuming to achieve
- Once employees and managers understand the formulas, they will inevitably ‘play the system’ to get the best reward outcome. Research has shown that when employees are assessed against achievement of specific objectives, they avoid setting stretching objectives and overall performance ends up decreasing.
- There are many factors outside of the employee’s control that impact their ability to achieve their objectives. So rewarding them against achievement of objectives ends up either demotivating employees, or with managers arguing that exceptions need to be made for specific employees (meaning that we are effectively back to manager discretion again but with a lot more work involved!)
The solution is once again to keep things as simple as possible. If you want to find out who your best and poorest performers are, ask your managers. But to ensure objectivity, you need to ask the right questions, which leads us onto our final performance measurement approach of using targeted questions.
The targeted questions approach
In 2015, Deloitte worked out that they were spending 2 million hours a year rating every employee’s performance and potential, collating those ratings, discussing and calibrating them. They also realised that the end results were not particularly accurate, meaning all that time and effort was achieving very little. So instead of rating employees as part of an annual appraisal, their managers now answer four questions about each of their team members each quarter:
- Given what I know of this person’s performance, and if it were my money, I would award this person the highest possible compensation increase and bonus.
- Given what I know of this person’s performance, I would always want him or her on my team.
- This person is at risk for low performance.
- This person is ready for promotion today.
Whilst there will always be an element of subjectivity when measuring performance, it’s easy to see how these questions are more likely to yield more accurate results than a classic 1-5 rating.
Although I like the concept of these questions, they are particularly suited to Deloitte’s professional services culture. So I spent some time developing a set of questions that could be used in a wide range of organisations who wish to:
- identify and provide additional reward to their top performers (a good strategy according to McKinsey who found that 80% of value is generated by only 20% of employees)
- identify poor performers (and potentially give them less reward)
- identify employees with potential for promotion right now
Here are the 5 questions that I came up with:
- Has this person made an EXCEPTIONAL impact above and beyond their job description and agreed objectives throughout the year? [Yes/No]
- Has this person CONSISTENTLY demonstrated our organisation’s values and behaviours throughout the year? [Yes/No]
- If you have answered YES to BOTH of the above two questions, are you nominating this person to receive an additional discretionary bonus? [Yes/No]
- Do you have concerns about this person’s performance over the last 6-12 months? [Yes/No]
- Is this person ready to be promoted today? [Yes/No]
Where you have answered YES to any of the above questions, please provide additional details to support your answer(s)
Questions like this can easily be added into the Viewpoints module of our Clear Review Performance Management software, enabling you to collate the answers from managers online and analyse them quickly and easily. Here’s what a manager would see when answering these questions in Clear Review:
What to do if you have to use a rating
We’ve spoken to a number of HR professionals who recognise that ratings are not particularly effective and want to replace them but their hands are tied, for example because their CEO or CFO is wedded to them, or because of an edict from head office that ratings must be used. If this is the case, you can still improve the effectiveness of your performance management and improve its objectivity by:
- Using Continuous Performance Management to ensure that ratings are based on a number of performance discussions and pieces of feedback rather than on a single annual appraisal
- Decouple the rating process from your regular, developmental performance discussions
- Ask managers to answer a few preliminary questions, such as those in my example above, to frame their thinking before they give their rating
- Provide guidance or training to managers on the different types of rating bias and how to recognise them
I hope that this guide has given you some insight and ideas on how performance related pay can be managed effectively with a continuous performance management approach. The approach that you choose will need to suit the culture and goals of your particular organisation. If you are still unsure of how to proceed, my advice is to go back the first principles and think about what you really want to achieve from performance related pay and what is the simplest and easiest way of achieving it.
Good luck, and do let us know how you get on by emailing us your comments and experiences at firstname.lastname@example.org
P.S. If you want to learn more about how to adopt Continuous Performance Management in your organisation, download our free eBook here.
About the author
This guide was written by Stuart Hearn, Founder and CEO of Clear Review. Stuart is an experienced performance management consultant, writer, speaker and former HR Director with over 20 years experience in Human Resources, specialising in Performance Management and HR technology.