Performance or merit-related pay has been a tool much loved by senior management at many companies since the late 1980s, but just as the recession has tested a whole number of cherished assumptions, so too has performance-related pay come under scrutiny. Tighter budgets have led to smaller pay pots, undermining the prospect of staff motivation that merit pay promises. And the principles involved have increasingly begun to be questioned by staff. In some instances, the lack of transparency surrounding the distribution of performance-related pay has resulted in arguments between employers and employees.
2012 saw a number of high-profile disputes over the allocation of merit pots. At the Financial Times, an initial offer set aside a comparatively large proportion of the pay budget for discretionary merit payments. ‘Discretionary’ seemed to be the key term here, with staff concerned about the apparent opacity involved. Journalists and editorial staff finally accepted a pay deal worth 3.5 per cent on the pay bill, after a reduction in the merit element of the offer and a corresponding increase in the general portion of the award.
As part of the 2013 pay deal at HSBC, the bank has agreed to take what the union representing staff, Unite, calls a ‘sensible approach’ to the forced distribution of performance ratings. According to the union, 93 per cent of its members at the bank regard the ‘calibration’ process as unfair. The union hopes that, following a recent review that led to many employees with the lowest performance scores leaving HSBC, there will be ‘a commensurate reduction in the required percentage at these ratings amongst remaining employees at year end.’
One of the main charges levelled at merit-based systems is that far from encouraging employees, they undermine teamwork and so reduce companies’ effectiveness. A recent article in Vanity Fair magazine charted how the performance pay system at Microsoft led to a ‘lost decade’ for the once-dominant IT giant.
The approach at Microsoft, known as ‘stack ranking’, meant that each business unit had to declare a certain proportion of staff as ‘top’ performers, another percentage as ‘good’, then ‘average’, ‘below average’ and finally, those rated as ‘poor’.
One former employee explained: ‘If you were on a team of ten people, you walked in knowing that, no matter how good everyone was, two people were going to get a great review, seven were going to get mediocre reviews and one was going to get a terrible review.’ He goes on to explain the effect this had: ‘employees focussing on competing with each other rather than competing with other companies.’ According to the article, many high-flying Microsoft staff avoided working alongside other high performers, for fear they would be ranked lower. This hampered teambuilding, and with it, the firm’s famous ability to innovate.
So why do companies stick with it? This seems to be mainly down to the opportunities merit pay presents them to control their paybill. In their November 1996 issue, the US-based Compensation and Benefits Review quoted a consultant’s view that ‘merit pay has never been truly performance-based, except in the cases of those individuals who are performance outliers – the highest and lowest performers. This is because most jobs don’t have a direct economic impact on a business, don’t create results that are easy to measure, or don’t consist of solo or independent work that makes it easy to measure individual accomplishment. [As a result] merit pay has become just a cost-of-living increase in drag.’ As such, it is hardly likely to motivate workers.
Of course there are good reasons to adopt a merit-based system. It can introduce a measure of discipline to the performance management process, and ensure that managers tackle under-performing employees. Conversations between managers about how their teams compare can sometimes help a whole organisation perform better, and the cost-containment aspect is obviously attractive to CEOs and CFOs.
However, the downsides are likely to outweigh the gains. A key test is whether performance-related pay is appropriate for your organisation. Research in the UK by Keith Randle on the use of performance pay in a pharmaceuticals research establishment questioned the appropriateness of such schemes in a ‘knowledge work’ environment. Here, the use of pay for performance was one of the ‘most consistently disliked management practices’. Randle suggests that measuring the quality of ideas, a crucial aspect of individual performance in research, presents huge problems for managers. This is one of the reasons why ‘subjective’ measures of performance are increasingly being cast aside (or at least updated) in favour of ‘harder’ and more objective measures like competencies and professional development.
To the extent that merit pay is associated with a lack of transparency, this can be another downside. A recent report by the CIPD found a correlation between the employee relations climate in organisations and the extent of openness about pay. The report suggested that pay secrecy is linked to a poor atmosphere at work, while businesses with pay transparency are more likely to have better employee relations. This would seem to make sense. Perhaps when people know where they and their colleagues are in pay terms, they are less likely to work in ways that get one over on each other.
Crucially though, the methodological underpinnings of performance-related systems are often questionable. The methodology is often based on the idea that performance is ‘normally’ distributed and can therefore be represented graphically by a ‘bell curve’. Sometimes referred to like this, or by other scientific-sounding titles such as ‘calibration’, it appears to be one of the most widely-disliked aspects of performance-linked approaches to reward. Critics say it encourages a ‘forced distribution’, whereby the performance of a group is shoehorned into a bell curve, whether or not this accurately reflects real performance.
Even advocates concede that employee performance is not always ‘normally’ distributed within organisations. The idea of a ‘normal’ distribution – or ‘bell curve’ – is borrowed from statistics, where the subject matter is generally large, random samples of individuals. In the world of work, by contrast, workforces are more carefully selected, according to experience, qualifications and skills.
In addition most organisations train and develop their staff, with the aim of ensuring they grow in experience and apply this knowledge and understanding to their work, all in the hope that their performance, and the performance of their organisation, improves. So in practice the distribution of performance outcomes in real organisations is not generally ‘normally’ distributed, with a ‘bell curve’ shape’, but is skewed to the right. Rigidly applying a ‘normal’ distribution in such circumstances can result in outcomes that are open to challenge from employees, sometimes – and significantly – on grounds of discrimination.
Discrimination can also arise in instances – common with performance pay systems – where decisions over pay rises are devolved to individual managers. This kind of approach dovetails with a requirement for cost control, with pre-set budgets ensuring managers can’t overspend on pay. But such practices run the risk of equal pay claims from employees, especially if the processes involved have not been equality-proofed.
It is not at all clear that merit or performance pay matches the claims its proponents make for motivating employees. The alleged gains in this area are often used as a way of initially marketing such systems to employees. But once in operation, perceptions of unfairness can lead to de-motivation and disengagement. That is particularly important in the current climate, where the ‘fairness agenda’ has gained considerable ground in the wake of revelations about bankers’ bonuses and comparative largesse when it comes to executive pay rises.
Oddly enough, in the light of these developments, the Department for Education has confirmed the introduction of performance-related salary progression on the main scale for school teachers. The context is one in which the Government is sharply curbing public spending, including expenditure on pay. As such, the latest move is understandable. And it remains to be seen what sort of system schools will be expected to adopt. But the linkages between teachers’ progression and their contribution and performance in the classroom are complex. If they suspect that the main rationale behind the proposed changes is not to enhance their contribution and performance, but simply to save money, then any proposals might not get off the ground.