Performance Management (pt. 3)

“Only 29% of employees “strongly agree” that their performance reviews in the workplace are fair, and even fewer — just 14% — say they’re inspired to do better thanks to their feedback” – Gallup 2017

In a previous post, we walked through a typical annual review cycle and proposed a solution that moves us from a reactive, engagement killing process to a proactive business management process. In our new process we meet with each resource on a weekly basis and have a quick conversation to ensure alignment, offer assistance, provide feedback, and then make a short note in our performance management system. In making this change we have moved from an archaic backwards view of past perception to a proactive system of engagement and leadership.

Now that we’ve tackled the annual review process, let’s look at the so-called performance management aspect of the cycle, perhaps more accurately defined as an internal business compensation management process.

The purpose of this process is to allocate rewards to meet retention and succession plans. It has little to do with managing performance. A once per year feedback session provides little opportunity to adjust behaviors and outcomes; it is just a report on past perceptions.

What is the true business need?

Let’s quickly review what the true business need is from the performance management portion of the annual review process. Going forward, let’s refer to this portion as the compensation management process because that is really what it is. (The annual review was a feedback session on performance. We have now repositioned that aspect into our weekly check-in process; we are now left with the annual merit and compensation process).

The business has two primary needs from the compensation management process, retaining its current workforce at market rates and ensuring it can meet succession needs in the future. That is it. All other associate expense and development plans spin off of those two needs.

In meeting these needs and mixed with concepts such as rewarding for greater performance, retaining top talent, attracting new talent at market rates, while staying within budget has resulted in a misguided need to stack rank employees relative to each other. Somewhere along the evolution of this process it became absolute and complicated and, in the end, not achieving its purpose at all.

So, let’s breakdown the compensation management process and look at it in more detail so that we can understand the current shortcomings and understand how to fix the system.

With the old approach the next step would be to stack rank each associate for purposes of distributing merit increases, rewarding exceptional performance, allocating development opportunities and supporting succession planning. In this process the manager would be required to rate all associates in their control from best to worst along an arbitrary scale that must result in a normal distribution performance curve. The curve must be met on a team-by-team basis, leaving no opportunity to recognize relative team performance and putting team members in competition with each other for compensation and development opportunities.  What could possibly be wrong with this approach?!

Why stack ranking is so wrong

Rater bias and lack of metrics are the primary downfall of any attempt to rate and rank employees. Studies have consistently revealed that each manager has a different perception of performance and ratings vary accordingly. One of the most complete studies ever conducted in this area was published in 2000 in the Journal of Applied Psychology. In that study in which 4,492 managers were rated on certain performance dimensions by two bosses, two peers and two subordinates found that 62% of the variances in ratings could be accounted for by individual raters’ peculiarities of perception. Actual performance accounted for only 21% of the variance. According to Marcus Buckingham, “Although it is implicitly assumed that the ratings measure the performance of the ratee, most of what is measured by the ratings is the unique rating tendencies of the rater.”

The lack of key metrics across the team is another shortcoming of this approach. Recall in our opening post about the manager being challenged to rate the performance of an employee against all others in his or her team. The challenge was that, “I do not have a consistent set of metrics that truly reflect your performance in comparison to your peers or the overall goals (assuming that you even perform the same function as they do), and so I am left with my perceptions and intuition.”

So without metrics to truly measure and compare performance, the evaluator is left with their perceptions, intuition and biases. Try as they might to be fair and even in their rating and ranking, personal bias and preferences that the evaluator may not even realize they have will impact the “fairness” of the results. A hidden bias against perceived stereotypes, personalities, physical traits, gender, race and other discriminators are now in play. All of the things listed are the nightmares of HR departments around the world, and we are using this system to allocate raises and opportunities. Yikes!

In fact, considering the inconsistencies that are possible with this approach, many major corporations are discontinuing their “rank and stack” practices given the current litigation environment. In fact, Ford and Goodyear recently settled litigation regarding the “fairness” of their practices. Troubled by possible litigation as well as costs and ethical considerations, even prior advocates for this practice have turned away from the stack ranking approach. In 2013 Microsoft ended their use of this practice. Even long-time proponents such as General Electric, Adobe and Deloitte have abandoned the practice, with Deloitte going so far as to “declare the system dead” in a Wall Street Journal opinion article.

Proper use of a performance curve

Continuing with the current process, having now created a stack ranking comparing the perceived performance of each individual relative to their teammates, it is quite common that the manager is asked to group these ratings into broad categories possibly rated one through five. These ratings are to be fit to a normal distribution curve, sometimes called a bell curve. The idea being that it will identify the top performers for additional merit and development opportunities as well as expose and penalize a group of low performers that require performance improvement or potential release from employment. The policy may dictate that no more than 10% be rated as “high performing” and 10% be rated as “needs improvement”, with everyone else being spread equally across the center of the curve.

Let’s take a look at the impact of this process in more detail:

• First we limit the number of potential high performers. In a team of 12 – 25 employees, this limits the process to just one or two individuals. What if there are more with high potential and performance in this team? How will they react to not being recognized?
• Secondly, we force those at the bottom of our imprecise and biased assessment system to become the absolute losers. They will not be considered for merit, advancement or development. They must change the perception of their performance before the next review period or risk loss of their employment. What if we missed it, what if they fell into one of our blind spots or biases, what if they are good performers and we just do not know them well enough?
• The remaining group is the middle of the pack, which is more or less rated average. The policy requires splitting hairs between individual performances to make sure it fits the curve. Interesting enough, from a financial perspective, this is where the majority of the merit increase budget is spent (not on high performers), but we are splitting pennies between resources for average performance. The difference between a 2.1% and 2.2% increase is insignificant at the individual paycheck level.
• This practice creates a class system of winners and losers, pitting the team against itself for survival. This is clearly not a cultural characteristic commonly attributed to creating teamwork or high performance organizations. The resources are now focused on internal competition rather than collaborating to focus on external threats and competition.
• It creates an environment where associates will come to believe that their performance is not the true driver of opportunity and success. They may realize that in spite of their outstanding efforts and results they may not be recognized and possibly even penalized by being part of this group. It can certainly be a cause of higher “churn” within a team or turnover at the company level.

The net result is that this policy and approach do not yield the results the business really wants. It does not properly recognize and reward performance, creates a culture of conflict, lowers engagement and misappropriates corporate funds and opportunities.

A significant problem with the use of the bell curve as a measuring and metering tool is that it is the wrong curve. Research conducted in 2012 across 633,000 people in 198 different categories of work found that performance across 94% of these groups did not follow a normal distribution (bell curve) but rather into a power law distribution. We are more familiar with power law distributions with names like the Pareto Curve or the 80/20 rule, also referred to as “long tail” curves.

The research found that typically there is a small number of “hyper-performers” that are clearly outperforming the rest of the population and the remaining group that are simply “good performers” and that there is very little statistical difference in the performance of the good performers.

These findings are further validated by another study conducted in 2012 that concluded that the top five percent of workers in most companies outperform average ones by 400%.  In an article published in the McKinsey Quarterly in 2016 titled “Ahead of the curve: The future of performance management”draws several key conclusions from these observations:

• “…bear in mind the bigger news about power-law distributions: what they mean for the great majority of employees. For those who meet expectations but are not exceptional, attempts to determine who is a shade better or worse yield meaningless information for managers and do little to improve performance.”
• “The point is that such 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.“

The net of these finding is that the use of the bell curve or normal distribution curve does not drive a process that meets the needs of the business. Instead a simpler approach using a power curve such as the Pareto curve (80/20) will produce much better results with less effort.  To further simplify, what we want to do is identify the top 20% that are the clear contributors and heap rewards and opportunities on this group. The balance of the group which will be the majority of the population will all receive the same base merit increases based on retaining this group at current market rates. As McKinsey points out, there is little benefit to be had in trying to identify the shades of differential performance among the majority of the employees. To do so risks evoking the unfairness of the stack ranking approach over the broader population with all of the risks that go with that approach. The 20% that are leading the pack are easy to identify and most readily accepted by all of those around them as being high performers.

For the annual merit and compensation cycle we use a performance curve that allows us to reward the clear performers and not penalize everyone else. As managers we all know the people who have made outstanding contributions and we all know those that are not performing. We do not need a complicated and discriminatory process to deal with those situations. We encourage everyone to develop their skills and potential and let their personal drive and performance sort out the achievers.

The use of the power curve approach meets the needs of the business. It achieves the goal of providing a process based on meritocracy, rewarding those producing the greatest results, without the downside of creating internal team strife and competition. It accomplishes this while being able to keep labor expenses manageable by keeping the cost of labor at market rates.

Summary

In summary, many businesses are stuck in the past using an approach that is over 35 years old and repeatedly failing to produce the results the business needs. The process requires that the entire organization becomes distracted from their core business activities to perform the annual review process, often taking months to complete at a huge expense.

The process starts with attempting to recall all of the accomplishments for each associate over the past year and summarize in self-reviews. We are then required to bundle all of this together, combine it with our comments from the performance review and hold an annual review/feedback session with each associate. Based on concepts such a pay-for-performance, meritocracy, and overall fairness, the business would smugly declare that their process effectively ties performance and reward into a tightly managed and effective process, rewarding performers, providing development for future leadership needs, delivering feedback to drive engagement, and manage associate performance.

Here is the net effect of the process according to recognized authorities on performance management:

• “Today’s widespread ranking- and ratings-based performance management is damaging employee engagement, alienating high performers, and costing managers valuable time.” – Deloitte Insights 2014
• “In a public survey Deloitte conducted recently, more than half the executives questioned (58%) believe that their current performance management approach drives neither employee engagement nor high performance.” – Marcus Buckingham – HBR 2015
• “Only 16% of employees feel they benefit from their annual review; 76% don’t feel heard during reviews.”– INC Apr 2016
• “In 2016, only 33% of employees in the United States were engaged, and employee engagement as a whole increased only 3% from 2012-2016.”– Gallup 2017 Employee Engagement Report
• “Annual review cost estimates run from $35 Million for a 10,000 employee company ($1.2 Million for a 500 employee company).”– Accenture 2018

So let me sum this up. The typical annual performance management process is a waste of time, it is expensive and is counterproductive. Why do we still do this? If you are in executive leadership, why do you let this happen? For all of the rest of us, when are we going to express our sincere dissatisfaction with this process and push for change? If you need help with this, contact me.

Here is the next question, “so if I am not able to change the current system, how can I best operate within its limitations and do the least damage?” I think this will be a great topic for next time. In the meantime, let me know your thoughts on performance management through the annual review process.

Thanks,

Skip Gilbert