Companies are rapidly replacing annual appraisals with new performance management approaches based around regular coaching conversations and feedback.
But this has led to a conundrum for organisations who operate performance related pay models which have traditionally used ratings taken from annual appraisals. If you remove the annual appraisal, how do you make your performance related pay decisions?
A Guiding Principle
A number of new approaches to performance related pay have started to become apparent. However, one principle that is common to these new approaches is that performance measurement needs to be decoupled from developmental performance conversations and feedback. An employee is unlikely to be honest about their areas for development 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.
As the CIPD stated in their 2016 Performance Management research report:
“Introducing some clear water between assessments that inform pay and promotions and those [processes] that help employees improve should make erformance 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 making talent and pay decision, which sits outside of your regular check-in discussions, as shown in the diagram below:
Should we still rate performance?
Some organisations have adopted the de-coupled approach shown above but have stuck with traditional ratings for the time being, choosing instead to focus their efforts on embedding a culture of coaching conversations and feedback. However, organisations are moving away from ratings due to the problems of manager bias and of managers reverse-engineering the ratings to get the reward outcome that they want.
The alternatives to performance differentiation that we are seeing can be loosely categorised into three groups:
1. The manager discretion approach
In 2016, General Electric decided to get rid of performance ratings in favour of managers being able to use their discretion to distribute an agreed reward pot amongst their team. The new approach was received extremely positively by managers and employees. One of their HR Executives, Anastasia Kuzmina, gave a compelling argument for their decision:
“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.”
Their approach allows managers to be asked targeted questions taking a number of factors into account when deciding on pay – performance, potential, risk and impact of leaving, changes in market rate.
2. The simplified rating approach
A number of organisations having recognised that traditional 5 point ratings make it difficult for managers to be objective and consistent, and 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 company or team performance, market rate, job responsibility, etc. 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.
The major disadvantage is that it doesn’t accommodate the awarding of extra pay to higher performers.
3. The partial differentiation approach
The purpose of most performance related pay schemes 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 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.
As McKinsey recently put it, “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.”
Of course the problem remains about how to identify the top and bottom performers. We’re seeing organisations innovate in this space by asking highly targeted questions instead of traditional ratings. For example:
Has this person made an exceptional impact above and beyond their job description and agreed objectives throughout the year? Yes/no.
The way forward
Whatever direction you take, keep in mind that pay decisions will be more objective if you have a performance management process based around ongoing, meaningful conversations and feedback, rather than a once-a-year appraisal meeting.
