The New State of Performance Management

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1 REWARD STRATEGY AND PRACTICE The New State of Performance Management Brooke Green and Tom McMullen, Hay Group * Hay Group interviewed more than 1,600 senior decisionmakers in global firms across more than 30 countries about their business strategies in light of today's global economic challenges. It found business leaders demanding an unprecedented increase in employee productivity gains to deliver the competitive advantage needed to hit more demanding performance targets. For many organizations, this will require a radical rethinking of their company's historical approaches to and this may be the burning platform regarding seeing real change in the current state of processes. Despite several years of economic turbulence and uncertainty around the world, organizations continue to set ambitious performance goals for the next several years. Although markets around the world are struggling, the imperative remains for global organizations to achieve strong growth. For developed economies, this means outperforming at markets and for emerging economies, it means capitalizing on burgeoning economic expansion. Given this backdrop, Hay Group interviewed more than 1,600 senior decision-makers in global rms across more than 30 countries about their business strategies. We found business leaders demanding an unprecedented increase in employee productivity gains to deliver the competitive advantage needed to hit more demanding performance targets. For many organizations, this will require a radical rethinking of their company's historical approaches to and this may be the burning platform regarding seeing real change in the current state of processes. THE PRODUCTIVITY CHALLENGE Global business leaders told Hay Group that, on average, they were targeting an ambitious 6.7 percent year-on-year growth rate for the next three years. Across the rapidly expanding markets of the Asia- Paci c region, these targets averaged almost 8 percent. Even in crisis-hit Western Europe, they exceeded 6 percent. For European rms, this is a tough ask with analysts 1 predicting an economic contraction * TOM MCMULLEN is a Vice President and North American Reward Practice Leader for Hay Group based in Chicago. Brooke Green is a Principal and Western Region Reward Practice Leader for Hay Group based in San Francisco. 29

2 Journal of Compensation and Bene ts of 0.4 percent in the region for 2012, and growth of just 1 percent for In Asia, growth forecasts are far rosier, but still lag behind CEOs' targets, at 6.3 and 6.7 percent for the next 2 years. As a result, over half of global business leaders (55 percent) admit that their threeyear growth objectives present a signi cant challenge. So how will organizations in developed markets outperform this economic outlook? How will businesses in developing economies capitalize on the robust growth forecast for their regions? According to business leaders, the answer lies primarily in their workforces. Leaders plan to demand an increase in employee productivity by an unprecedented 6 percent. Having exhausted business improvement initiatives such as cost cutting, supply chain integration and growing inorganically via merger and acquisition, business leaders are turning to the performance of their people. The majority (57 percent) are asking increased performance from sta. This approach is not without risks (see gure 1). More than two fths of senior leaders (44 percent) fear their employees are already too stretched to deliver current business objectives. In the past several years, we have seen organizations lay o signi cant portions of their workforce while not eliminating or reducing the work itself. In addition, employee engagement scores have been decreasing, base salary increases have been constrained and incentive payouts for many have not been up to prerecession levels. The gure below notes executives concerns over this stretching of the workforce. PERFORMANCE MISMANAGEMENT Achieving a step-change in workforce productivity will require a signi cant focus on performance management. In our research, over half (52 percent) of business leaders plan to implement more rigorous individual performance management processes. But effective is more than just boosting 30 the performance of individuals. It means improving the performance of the entire organization, clarifying the organization's performance model and building a culture of organizationwide performance so the entire

3 organization can deliver on its performance commitments. Business leaders know this. Two thirds (64 percent) agree that is an important driver of the overall success of their business and about half (43 percent) believe it makes a measurable di erence to the bottom line. However, organizations have a di cult time putting these beliefs into action. Many view their existing performance management procedures as a bureaucratic HR procedure, focused on process rather than business outcomes. Almost two fths of business leaders (37 percent) describe it as primarily an administrative tick-box exercise. About the same percentage of leaders (38 percent) believe their managers do not actively support their organization's processes. As a result, CEOs lament the time it takes to execute their strategies. They ask: We have a strategic plan and have taken the time and e ort to communicate it clearly. So why isn't it being carried out? And where are the results we expected? The answer isn't necessarily new, but it is obviously takes time, energy and tenacity to implement. In the early 1990s, Kaplan and Norton 2 demonstrated that, to be e ective, must Reward Strategy and Practice be aligned to the organization's business strategy. More than 20 years later, global rms are still failing to connect the two. Only a quarter of companies (27 percent) studied by Hay Group align their performance management approach to their company's business strategy. To compound the challenge, our research revealed that the connection with strategy alone is no longer enough. While nine out of 10 business leaders (91 percent) stressed that organization culture has an important in uence on the e ectiveness of, less than a quarter of rms (24 percent) align their performance management processes to their company culture. And compounding this, only 13 percent of organizations align their performance management programs to their business strategy and work culture. What these ndings demonstrate is that there are in fact two dimensions of performance management: E understanding and leveraging the organization's performance model as it relates to the achievement of business strategy and the alignment of its target work culture 31 E aligning this organization performance model with the downstream performance management functions of individual performance planning and goal setting, coaching and feedback processes, performance assessment and linkage to reward systems. Work culture is one of the most di cult enterprise assets to realign. An organization's culture is always present, and is typically regarded as an invisible force simply the way we do things around here. It is so pervasive that it is rarely questioned by those who work within it. Understanding how any organization's work culture in uences is critical because culture a ects how the formal and informal processes are used and viewed by the organization and its employees. For example, culture in uences decisions about reward policy, salary increases, bonus allocation, succession planning and promotion. In turn, these decisions directly a ect employee engagement, morale, trust, and loyalty; and can also in uence public perceptions about the organization. Business leaders would like to think that their enterprise culture is an enabler of their business strategy. And HR leaders would have them believe that their culture supports e ective performance management. As illustrated by our survey results, this is not

4 Journal of Compensation and Bene ts generally the case. A fresh approach to managing performance is needed if executives are to harness and deliver the targets promised to shareholders. CONNECTING THE HARD AND SOFT So what is this fresh approach and how do companies reinvent? The critical and often missing link is the connection between the hard (i.e., the business strategy) and the soft (i.e., organizational culture). By connecting three elements people, strategy and culture organizations can improve their e ectiveness, enhance employee productivity and increase the likelihood of achieving ambitious business objectives. The link between the hard and the soft can only be strengthened by the development of a unique performance model (see gure two), arguably the most signi cant step in performance management design. Many organizations have some unwritten rules on how they manage performance but they are not being made explicit or documented in any place. A well-designed process should build in a deliberate pause for leaders to articulate and agree upon conscious de nitions of key performance elements before charging ahead to the tactics. This process forces leaders to think about the reason for, the character they want the system to re ect, the rules of the game, and the primary metrics that will steer employee behavior. It is important to build a coherent set of systems and processes, which needs the performance model as the starting point. Without this level of clarity, how can an organization ensure that both strategic intent and culture will be hardwired in the design of its processes, tools and practices? It can't. 32

5 Reward Strategy and Practice Figure 2: The Hay Group strategic model LEVERAGING THE PERFORMANCE MODEL The problem with a system that focuses only on the downstream processes of performance management (i.e., planning coaching, reviewing, rewarding, promotion, etc) is that the framework misses the upfront attention to the performance drivers and the link to business strategy. The performance model provides general direction for all the downstream applications by de ning how it is today and what is needed for the future. Purpose. If we have the best system in the world, what will be the outcome? The answer to this question will certainly yield di erent answers from company to company and can change over time within an organization. In fact, it must change as the organization's business strategy changes. The purpose of will be shaped by beliefs leaders 33 have about the role people play in achieving results whether they want employees to be agents of production who follow prescribed rules or individual stars who drive results through unique e orts and innovation, or somewhere in between. Philosophy. An organization's philosophy about performance management can shed signi cant light on the organization's culture. For example, a philosophy that tolerates a fair

6 bit of ambiguity or discretionary performance assessment would be found in a di erent type of company than would a rigid, arithmetic measurement system based on well accepted nancials with a forced distribution of rankings. Often a philosophy is rooted in core beliefs of leaders about what motivates individuals. Are employees driven by extrinsic factors such as money, incentives or praise or intrinsic rewards such as ful lment or job security? These beliefs will help to determine whether the focus will be slanted on inputs (how and what people do) or outputs (the outcomes or results of employees' actions) and how much accountability is shared. Principles. The principles are the guidelines that drive performance management policies, such as who manages performance and what does managing mean anyway? In some companies, means a twice-yearly session between supervisor and employee and in others a leader is a full-time coach who never really stops managing and feeding back performance that's his primary job. Performance management principles also dictate the model of consequence management for high or low performance, which governs whether a company manages up or out or gives Journal of Compensation and Bene ts second, third, fourth to an in nite number of chances to meet expectations. They will also inform how performance in uences reward strategy as well as the degree of link between company, team and individual performance. Key metrics. Key metrics are the indicators to act on and monitor to achieve expected performance. Within the performance model, the crucial and leading key performance indicators for the organization are determined. Financial goals are a critical part of the implementation of business strategy and they set the quantitative starting point for any performance management system. Non- nancial metrics are equally important as hard numbers and developing the performance model will result in clarity on the nature and balance of the desired metrics (e.g., qualitative vs. quantitative; individual vs. team; short-term vs. long-term) along with the degree of transparency that will be provided. ALIGNMENT WITH KEY DOWNSTREAM FUNCTIONS With the foundation in place, work can begin on alignment between the performance model and the more traditional downstream applications most people think of when they think about managing performance. 34 Performance Planning: Performance planning sometimes called goal setting is about what needs to be achieved and how. Performance planning should result in clarity about where the business needs to go, what individuals must do to get it there, and how the organization expects employees to behave in the pursuit of those accomplishments. It begins with the hard job objectives (the what), before moving to the soft objectives (the how) which will be very much based on culture of the organization and the performance philosophy. And while cascading goals down as part of the planning process is important, organizations must rst ensure the leadership team is aligned with the CEO's objectives. Otherwise, functional leaders tend to get caught between the priorities for their function and the priorities of the businesses that they support and the resulting focus on strategic goals ends up being not clear and imbalanced. Coaching Performance: According to Daniel Goleman, the leading mind on emotional intelligence, excellence in this competency is emerging as one of the most critical skills among superior leaders, and, in some cases, the most critical. Performance coaching is something di erent from the personal coaching someone can receive on personal e ectiveness, not linked to the job itself. Perfor-

7 mance coaching should be about making employees more e ective in their job and helping them to realize their objectives during the year. It is the daily/ weekly round of: E Observation and listening (Planning) E Feedback ( What you did and The e ect it had ) (Coaching) E Listening to their responses, concerns, obstacles (Coaching) E Feed-forward (Suggestions for what to do di erently or better) (Coaching) E Follow-through (Review and Reward/Recognize). Reward Strategy and Practice Reviewing Performance: Although coaching may have picked up some aspects of reviewing during the year, reviewing performance is both an ongoing process and the completion of the cycle set up by planning/goal-setting. The process not only needs to identify whether objectives have been achieved but also to what extent. The same is true for expectations of displayed competencies. Many organizations conduct calibration sessions to review individual performance assessments for members of their teams against benchmark employees who clearly represent di erent levels of performance rating. The process of calibration works best if it starts during the time of planning, to make sure expectations are set consistently. An e ective performance review discussion aligns performance with career development and succession planning. Ratings may be used to better inform decisions around promotion and assessment of high potentials, but performance and potential do not constitute the same thing. Rewarding Performance: Rewards are anything the organization provides the employee that is of perceived value. They are a primary reinforcement tool for the program. Rewards should be aligned with performance measures that are appropriately balanced between: E The hard and the soft measures ( nancial, customer, operational and human capital measures) E Short-term and long-term objectives E Individual, team and corporate objectives. The organization's performance model and reward strategy as opposed to external market reward practices should drive the money, mix and messages of rewards. The degree of differentiation between rewards for high and low performers will be dictated by the principles established in developing the performance model. GETTING STARTED Creating a culture of sustainable performance is not easy. To do so requires looking beyond and reward processes to identify the more foundational, yet less visible things that really drive employee motivation. The challenge then is to harness these motivational drivers and create a work environment that enables people to perform at high levels and motivates them to do so because they nd their work challenging, meaningful, and satisfying. Here are ve steps to get a jump-start on the path to strategic : 35

8 Action step Intended results 1) Survey employees Conduct a survey of employees to gauge their perceptions of existing practices. Results should reveal the extent to which the leadership and culture of the organization are currently supporting. With a snapshot of the as is state, begin to outline the to be state and determine the level of culture change required. 2) Conduct a performance audit Audit the performance system to assess the health of the processes and the degree of alignment with the business strategy and culture. The result should be a report card on what is working well and what can be improved. Based on the ndings, the leadership team can work together to create a roadmap to x the problems. 3) Engage line leaders Rather than having the process imposed upon them, managers should be enrolled in its design and implementation. Line managers need a clear understanding of the value proposition behind the process on three levels: what is the value to the rm, for themselves and for their teams? This means providing them with a forum to express their needs and those of the employees they supervise. 4) Find new ways to di erentiate rewards 5) Create a culture of dialogue Journal of Compensation and Bene ts Use all the levers of the total rewards toolkit: salary increases, incentive compensation, equity, bene ts, promotions, long-term career opportunities, training and development, and job design to create higher rewards for best performers. As budgets continue to be constrained, non- nancial rewards will be the crucial frontier in the drive for high performance. Change the organization mindset of being a fundamental and an ongoing process, not a once-or-twice-a-year activity. Embed the philosophy into all leadership activities beyond the formal calendar and routine. In a true culture of dialogue, feedback is given candidly and consistently in small doses like an IV and the annual review becomes a non-event. CONCLUSION With CEOs setting ambitious growth targets in a challenging economy, and asking more from their employees to achieve them, leaders need to place a greater focus on the performance management process to drive business results. As a result, they can no longer a ord to view as an afterthought or the role of the HR department. Performance management needs to become strategic and aligned with the organization's business priorities and work culture as opposed to mimicking best practices from other organizations. Performance management is a powerful tool to help implement business their strategy and reinforce their desired work culture if organizations invest the time and resources to clarify these linkages. Most haven't. Managers and employees generally want to do the right things, but they need help in knowing what the right thing is, and understand their impact on delivering business objectives. 36 Senior executives need to ensure that their performance management system is aligned to their corporate strategy and organizational culture and their actions reinforce the culture needed to achieve the business' objectives. Leaders need to ensure that their line managers are truly engaged with the process and enabled to use it to best e ect and that employees at all levels understand and rewarded for their contribution to the rm's goals. By creating a system that is aligned with the organization's strategy and cul-

9 ture and thinking through and implementing it thoughtfully within the organization, organizations will be in a stronger position to deliver the performance growth expected of them. By ensuring that is aligned both with Reward Strategy and Practice strategy and culture, executives have a much greater chance of being one of the 10 percent of organizations that realize the full bene ts of their e orts. NOTES: 1 Goldman Sachs, GDP forecasts end FY11. 2 Drs Robert Kaplan and David Norton developed a framework called the Balanced Scorecard to give managers and executives a more balanced view of organization performance. 37