The following information comes from Jamie Resker, Practice Leader and Founder of Employee Performance Solutions. Jamie is speaking on performance management at the 2018 Maine HR Convention both Tuesday and Wednesday. Jamie can be contacted at Jamie@employeeperformancesolutions.com
In my 30+ years of being in HR (yes, I started when HR was known as Personnel), stripping away annual reviews and ratings must be the most contentious and hotly debated topic in our field. It is a system long overdue for change, and it is encouraging to see the progress. One question that arises again-and-again is, “If we move away from annual performance reviews and ratings, then how will we make pay decisions?”.
If you want to evolve your performance management system, but have been stymied by the pay question, then the good news is this: you can still measure performance and make pay decisions without some version of the traditional 5-level rating scheme.
Here’s what you need (some of which you already have in place):
- Employee Performance Measurement Metrics: The ability to differentiate employee performance
- Pay Range Structure: Market data or an internally developed salary scheme (which should correlate to market data) will determine the minimum, mid, and maximum pay ranges for the positions in your organization
- Merit Budget: Typically a fixed dollar amount set aside to recognize and reward employees
- Pay Increases: Reflected as dollar amounts versus percentage increases
I have put together a five-minute video outlining my process. A deeper dive into how everything works can be found in the rest of the post below.
Step 1: Establish Employee Performance Measurement Metrics
Decoupling ratings and pay decisions does not mean walking away from assessing employee performance (don’t drop ratings without a replacement system). However, the 5-level rating scheme (exceeds, meets, etc.) is too limited to make meaningful distinctions. Establishing a new, more robust measurement system is a must.
I use the Employee Performance Continuum for a snapshot-in-time to identify an employee’s coordinates in relation to the two performance dimensions:
- Work Results (combination of job responsibilities, goal attainment, and technical skill-set)
- Observable Behaviors (tone, approach, actions you can “see” and describe).
You can draw this four-square model can be on a napkin, but here’s a downloadable form with instructions. Watch this video to see how the employee performance continuum, a visual model, can evaluate an employee’s performance without ratings.
The Continuum helps your managers sort employee performance into five categories:
- High Accountable Employees (ranging between the steady/reliable contributors to individuals who have made a significant impact on your organization/business)
- New to Role and Making Steady Progress (new hires and promotions)
- Off Target Work Results, but On-Target Behaviors (despite making an earnest effort, has met only some goals and job responsibilities; leaving others to pick up the slack)
- On-Target Work Results, but Off-Target Value Detracting Behavior (the impact of the behavior leads to disruption, depletes the time and energy of others, undermines team effectiveness, and slows the progress of work)
- Combination of Off-Target Work Results and Off-Target Value Detracting Behavior (I like to say, this is the individual who retired, but forgot to tell you)
For the past 15+ years, I have been teaching managers and HR professionals to use the Employee Performance Continuum model to differentiate performance. Here’s the percent range when a sample group of employees is plotted (30+ people):
40-65% High Accountable
10-15% New to Role and Making Steady Progress
10-15% Off-Target Work Results, but On-Target Behaviors
15-25% On-Target Work Results, but Off-Target Value Detracting Behavior
8-10% Combination Off-Target Work Results and Off-Target Value Detracting Behavior
I have had many debates on how this plotting is just “ratings in disguise.” However, the Employee Performance Continuum, when used correctly, goes much further than the typical five-point rating system. During a recent calibration session using the Continuum, a senior executive commented that the model forced the manager to articulate their view while also enabling a robust discussion with peers, and leading to new viewpoints.
I advise doing this process twice yearly (once outside of salary administration time), and with input from peers and the second level supervisor. So, continue measuring employee performance, but get rid of categories too narrowly defined as they will keep falling short of accurately describing human performance (no matter how often you reconfigure and alter the categories).
Tip: The 9-Box as a Performance Metric
A note about the 9-Box, commonly used measure of Performance and Potential. The 9-Box grid can be a useful tool for succession planning, but you do not need the dimension of “Potential” for performance management purposes. Simplify the process, by removing the “Potential” dimension and break “Performance” into the components of “Work Results” and “Observable Behaviors.”
Where to Spend the Money
By now it is probably clear on where to spend the bulk of the merit budget:
Consider significantly reduced or no change-in-pay for off-target performance related to value detracting behaviors, low work output/results or a combination of the two. This way you have more money to spend on your most valuable people (the 40-65%).
Download a sample model of the Employee Performance Continuum and recommended pay increases (modify for your organization):
Element 2: Determine your pay structure and compensation philosophy
Benchmarking jobs based on market data or an internally developed pay structure http://www.salary.com/pay-structures will determine the minimum, mid, and maximum pay ranges for the positions in your organization.
Does your organization have a philosophy, such as “paying to the mid-range” over time, or perhaps paying above market for some key positions? Once you have established your philosophy, consider these guidelines for allocating pay increases:
Consider larger increases for:
- High Accountable performers paid in the lower range
- Employees who have made a significant/measurable impact on the business/organization
- Employees needing a market adjustment
Consider smaller increases for:
- Employees already in the upper salary range dimension
- Consider bonuses to supplement merit pay as a reward for top performers close to or in danger of exceeding the salary cap limit
Consider significantly reduced, or no increases, and performance plans for:
- *Off-target performance related to value detracting behaviors, low work output/results (or a combination of the two).
*Remember, this is pay decision time. Actively managing performance means training and supporting managers to optimize employee performance through ongoing conversations designed to align and drive On-Target performance.
Element 3: The Total Merit Budget (Dollar Amount Available) and Allocation
Just like any other budget line item, the finance department must forecast payroll expenses. The merit budget is usually established by multiplying total payroll dollars by a number (commonly 3%). The finance department will use this figure to help project payroll costs:
3% of a $20,000,000 payroll = $600,000
In this example, there are $600,000 to allocate (this pot of money may cover merit, bonus and market-pay adjustments).
Allocations to Budget Holders
Next, the $600,000 will likely be allocated to the budget holders: For example, the VP of Engineering receives $48,000 (an amount equal to 3% of Engineering’s payroll of $1,600,000). The $48,000 may even be allocated to individual directors or managers who will then recommend merit increases based on each employee’s assessed performance contributions.
The practice in your organization probably works similarly. Now that the budget is known let’s get back to the Employee Performance Continuum. Once employee performance is measured, the performance levels will inform how to allocate merit pay (and sometimes bonus and equity in stock options).
The “ultimate” budget owner, the VP of engineering in this example, grants final approval for individual pay recommendations. The budget owner will look at the broader picture to fine-tune and adjusts proposed pay changes. Adjustments involve taking some dollars from one individual and rewarding someone whose performance impact is higher in the grand scheme.
Element 4: Reflect Pay Increases as Dollar Amounts
If you are stepping away from ratings, one crucial gesture is to express pay increases in dollars instead of percents. I had a conversation with a sizeable NYC-based not-for-profit who said that pay increases correspond to ratings. If you are rated a “3”, then you receive a 3% increase. If you are dropping ratings and still communicate pay increases as a percentage, then you are perpetuating the belief that the 1-5 rating scheme remains a factor.
This way the manager gets to say,
“Thanks for your hard work Barbara, you will see an increase of $3,750 in starting with your March paycheck.”
“Thanks for your hard work Barbara, you are receiving a 2.75% increase effective March 1.”
Do you think one of these sounds better than the other? If you have moved away from ratings, then does telling someone they have received a 3% increase lead them to believe they received an average rating (i.e., meets expectations)?
Here’s a sample pay philosophy statement:
“At (Your Organization) our philosophy is to provide a competitive total compensation package. Besides being aware of and paying to market, a merit budget is allocated to (departments/functional areas).
We measure overall performance effectiveness according to What is accomplished (a combination of job responsibilities and goal attainment) and How the person conducts him or herself (observable behaviors). Managers have been trained to assess performance based on these two factors. Managers will check their assessment of individual and team performance with their direct manager. Managers will articulate and explain the performance contributions of individual employees, based on work results and behaviors. After a thoughtful discussion around overall performance, we make informed pay decisions within the fixed budget. Pay increases (merit and bonus) are communicated as dollar amounts and are reflected in paychecks during the month of __________ each year.”
If you are in the process of rebooting your performance management system, consider the pay implications and propose a sensible solution that includes:
- Measuring and differentiating performance (beyond the 1-5 rating scale)
- Establishing and tying budget dollar limitations to merit recommendations
- Considering the “place-in-range” market or internal salary structure position.
- Reflecting pay increases in dollars
- Training managers on these elements to help them make informed merit increase suggestions and communicate to employees about compensation changes
How are you Making Pay Decisions in Your Organization?
During an August 2017 webinar, How to Move to a Continuous Conversation Based Performance Management Process (here’s the recording), sponsored by Synergita, one poll question was: Does your organization use performance review ratings to make pay decisions? Here are the results:
Sixty percent answered yes. I wished I could have had a dialogue with the 40% of organizations who have found an alternative. Is your organization thinking about getting rid of traditional performance ratings? Have you replaced ratings already? If so, how are you measuring performance and making pay decisions? What questions, comments, or suggestions do you have about anything I have described?