The Beauty of the Bell Curve
Chicago-based hardware retailer True Value Co., which operates as a cooperative, decided that it didn't need to create new standards for merit raises so much as make sure that the old standards stuck. As is the case at many companies, True Value had drifted away from its performance-review guidelines even though managers had a 5-point rating system to apply to the 3,000-member workforce. They routinely handed out 4's (outstanding) or 5's (superior), and almost everyone received some pay boost from a pool of approximately 3.5 percent of payroll. That, of course, meant that top performers made little more than their less productive peers. "We found that we were really hurting the better performers with that approach — they got frustrated," says Amy Mysel, True Value's senior vice president of human-resources and communications. "When you don't have a bell curve, then everything comes unglued."

Things began to be reassembled in 2005, when veteran Sears executive Lyle Heidemann became True Value's CEO. Joining the company during midyear performance reviews, he saw how ineffective the system was. "His message to employees was that he himself had often been rated as a 3 [strong contributor], and he wasn't ashamed of it," says Mysel. "He said that in his entire career he'd worked with only a couple of 5's. That sent a strong signal."

Helping to tamp down grade inflation is a system in which every merit decision is reviewed by a manager's supervisor. With a collective eye cocked toward potential abuse, True Value has shrunk the number of 4's and 5's being doled out, and the gap has been restored between the average merit raise and that earned by top performers. "At the end of the day, the difference may be only a couple hundred dollars a month," says Mysel, "but the symbolism counts."

Getting It All Right
At Agilent Technologies, a Santa Clara, California-based measurement-products company with a 21,000-person global workforce, an oft-used "three-band" rating system separates the top 20 percent of employees (high performers) from the next 70 percent ("core" performers) and the bottom 10 percent (who receive no raises or bonuses). High performers receive a larger share of the 2.5 percent merit pool than do core employees. (The pool, incidentally, can run much larger in other countries if competition dictates; in India, Agilent's merit pool is a hefty 12 percent.)

At Agilent, however, bonuses represent the biggest incentive opportunity. But even there Agilent sees it as vital to use its merit-pay policy to help reward top performers because the company "must be competitive in the total reward package: base pay, short-term and long-term incentives, and in the way we provide equity," says its vice president of compensation and benefits, Dominique Grau. Thus, the same three-band system is used to qualify high-achievers for short-term bonuses twice a year and for an annual bonus paid in restricted stock units (RSUs). High-achiever status is determined by performance against goals established during reviews. One-third of the bonus rating reflects individual performance, while two-thirds reflects business-unit and corporate return on invested capital.

Grau especially likes the three-band system. "Having multiple bands simplifies communication with your employees," he says. "It's basically the two extremes you have to focus on. And for the top performers, you focus on the rewards."

X Factors
But just as Xcel has difficulty in quantifying the value of its good-ideas fund, other companies struggle with measuring payback from incentive compensation plans. Agilent, for example, looks carefully at its turnover rate, and at its win rate when it bids against rival companies for the best and the brightest. "The problem isn't so much retention," says Grau. "We have very low attrition. The problem is attracting the right people — and there the switch to RSUs is a great thing."

That switch was prompted by a study last year of which equity forms provided the strongest motivation. Agilent, a longtime user of stock options, changed course because "employees wanted to have a bit more assurance of the potential cash flow they will have," Grau says. RSUs gave them full-value stock, without the concerns about the fluctuating worth of options.

In Xcel's case, too, the success of its incentives is measured by the quality of the people it attracts. As the utility industry moves away from the paternalism of past years and its attendant low turnover rates, "we're very much competing for talent with an entrepreneurial market," says Fowke. If the retooling of merit pay alone isn't enough, Xcel may set up a long-term incentive plan for top-performing nonexecutives, rewarding them with the same restricted stock awards that senior executives receive as part of their bonus program.

At True Value, the link between pay and performance for some employees is more concrete. Under a "gain-sharing" plan, "when warehouse workers hit certain productivity targets, they actually see it in their paychecks each week. It's very motivating," says Mysel. "If they're working for $10 an hour and productivity goes up, they'll make $10.50 or $11." While the additional amount is a bonus rather than a merit increase to base pay, she says that workers "really don't like to see that hourly pay go down." So the productivity goals often are met in succeeding weeks as well, keeping the whole company's productivity climbing. (True Value regularly monitors the targets set for warehouse productivity, Mysel says, to make sure they stay accurate.)

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