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How to reward the best without alienating the rest.
Alix Stuart, CFO Magazine
October 1, 2005
Executives who need a lesson in the delicate balance between leadership and teamwork should consider a key off-field move made by NFL quarterback Tom Brady.
This past spring, the star player, who has won three of the past four Super Bowls for the New England Patriots, agreed to defer nearly half of his signing bonus. By doing so, he has reduced the impact of the payment on the team's compensation budget, which is subject to the National Football League's salary cap. That means his teammates can be better compensated, which, Brady hopes, gives the team a better shot at getting to the Super Bowl again in 2006. "Anybody who chooses to play on the Patriots realizes that [the team] goal supersedes what any player goal might be," Brady was quoted as saying.
Granted, Brady stands to gain more than $30 million in the next two years, making him one of the highest-paid players in the league. But his rationale for sharing the wealth reflects an understanding of why it's important to reward the group that one CFO calls "the mighty middle."
"It's true that you have to identify top performers," says Patrick Moore, executive director of finance for BellSouth, "but we focus so much on the top that the mighty middle is often overlooked." He fears that if this group continues to be neglected, he will see his current attrition rate of up to 2 percent skyrocket when the economy picks up.
Few companies actively decide to ignore their middle performers. Yet because of time and budget constraints, many focus solely on the top-performing and high-potential employees. "With A-players, you're very interested in what motivates them — is it money, recognition, titles?" says Jose Zeilstra, vice president in JPMorgan Chase & Co.'s auditing department. "You want to keep your B-players and keep them happy, but you don't go the extra mile to figure out the motivation piece, which is unfortunate."
The consequences of such benign neglect can include excessive turnover, reputational damage, or even poor performance. "You need to know who your top people are, but you also have to watch out for the message you're sending, because a disenfranchised middle can be just as damaging to your business as the loss of all of your top talent," says Martin Cozyn, vice president of human resources for Ontario, Canada-based Nortel Networks Inc., which has revised its performance-rating system twice in the past five years to be more "middle-friendly."
To be sure, no one is advising that companies pay all employees even close to equally. General Electric famously advocated a policy of disproportionately rewarding the top 20 percent of its performers, and companies as diverse as Microsoft and JPMorgan adhered to similar principles in incentive compensation. According to a recent Watson Wyatt Worldwide study, firms with sharply differentiated bonus payouts have far better stock performance than those with less differentiation. Those in the top quartile, with an average 47 percent return (including dividends) to shareholders over three years, paid their best performers 4.7 times more in bonuses than they paid lower performers. Companies in the bottom quartile paid their stars only twice as much in bonuses.
"Differentiation is absolutely key, and the more, the better," says Ilene Gochman, organization effectiveness practice director at Watson Wyatt and leader of the study. More companies are taking that approach. According to a survey by Mercer Human Resource Consulting, in the past year alone 36 percent of respondents increased short-term incentive differentiation based on individual performance.
So how can you reward the star quarterback without depressing the competent linemen who make his plays possible? Here's a hint: it's not necessarily more money. Instead, a combination of honest communication, clear metrics, and reasonable career mobility will keep your employees playing like a team.
Pumping Up the Middle
The first critical step in segmenting talent is managing the message. "You want to define the middle as a good place to be, because that's where most of your workforce is," says Dan Boccabella, general manager at Gainesville, Florida-based MindSolve Technologies Inc., an employee-performance-management software vendor. He advocates avoiding overly precise numerical grades and words that convey a stigma, like "average" or "meets expectations" in performance reviews.
Libby Sartain, chief people officer at Yahoo, would even avoid the common "high-potential" label. "When you segment someone as a 'high-po,' it seems as if you think the other 95 percent of your workforce are 'low-po's' or something, and that's what causes the friction," says Sartain, who helped Yahoo craft its first-ever pay-for-performance bonus system three years ago.
In its performance-review system, Yahoo's middle (and most commonly used) category is "performs well." "They're the workhorses; they get the job done and we want to keep them," says Sartain. At Yahoo, even people in the middle range get salaries and bonuses above the market averages, with further incentives in stock options. "The people we don't want to retain are in the 'does not meet expectations' group," she says.
Nortel Networks learned the lesson of message management the hard way after it instituted a "Top Talent" retention program in 1999. It was "a very black-and-white system," says HR head Cozyn, one that used precise numerical rankings to divide employees into "critical" and "noncritical" groups. Several employee-discrimination lawsuits regarding similar practices at other companies, notably General Motors, "forced a lot of companies, including us, to review the nomenclature and process for identifying these top performers," says Cozyn. That lesson, coupled with an industry downturn and massive layoffs, made it all the more imperative for Nortel to reach out to its entire employee base.
Since then, the company has broadened performance categories to top, high, core, and low contributors, and eliminated the forced distribution system that allowed only a certain number of employees to be deemed "top." Although the bulk of employees — 65 percent — still fall in the middle, or "core contributor," category, Cozyn says the system is working well. The attrition rate for his top contributors is half the rate for the core contributors and one-eighth the rate for low contributors — exactly the ratios he targets. "If you're labeled top, we'll treat you special," he says. "If you're core, we'll give you every opportunity to grow."
Adding Some Definition
The second key to keeping the middle ranks on board is to make the incentive system objective through clearly defined goals and precise definitions of various performance levels. "A lot of the employee reaction to [bonus] differentiation depends on how well you define high performance," says Watson Wyatt's Gochman. "If you have the goals very clearly outlined and you can objectively measure them, that's motivating. But if they seem murky and bonuses depend on who you know, that can be demotivating."
When Cambridge, Massachusetts-based Forrester Research Inc. moved to align pay with performance ratings eight years ago, employees began requesting more clarity about the ratings. Once bonuses were riding on it, "people began asking what excellence was," says Tim Riley, chief people officer for Forrester. In response, the company developed competency models that provided standard definitions of excellent, good, and substandard performance for various job types and skills. "We try to take as much subjectivity out of the process as possible," Riley says.
Now each employee has a quarterly meeting with managers to review past performance against those definitions, set goals, and calculate bonus payouts. Even though some employees will receive no bonus each quarter, while others will get up to 150 percent of the target bonus for that particular quarter, Riley says the system works because "it's very transparent; people know their objectives and how they're going to be graded," to the point that "most employees can sit down and do the math on their own."
At Idaho Asphalt Supply Inc., in Idaho Falls, Idaho, managers go so far as to spell out criteria for partial bonuses. For example, one company goal is to reduce its cost per ton of materials sold to $15 or less across the board, says CFO Steve Rehnberg. The managers of a plant that starts at $18 per ton would get nothing if they can cut costs by only $1 per ton, but they would get 66 percent of their potential bonuses if they drop to $16. "We try to think about what's reasonable, but we also draw bright lines," says Rehnberg. Such detailed scenario-planning ahead of time eliminates potential subjectivity at the end of the year, he says, while still allowing for best efforts to be recognized.
Poor differentiation in pay is often due to a lack of clarity about goals, says Gochman. "If you don't have confidence that you can explain to people what their goals are and how they performed against them, then you're going to be worried about this whole fairness issue" and give everyone about the same bonus, she says. It's still rare for a company to give low-performing employees no bonuses at all.
How to Succeed in Business (If You Really Try)
Once the right semantics and expectations are in place, the best long-term strategy for making all employees feel valued is to encourage career development in a way that lays out a path to the top for those who want to follow it. "The most powerful way to move the middle is through nonfinancial rewards such as career development — rotational assignment, training opportunities, special projects, and more exposure to executives," says Peter LeBlanc, managing partner of Chicago-based Axiom Consulting Partners LLC. "Those are powerful rewards for everybody, but getting the middle trained and developed also helps increase the chance they can return more knowledgeable and more engaged."
Career-development strategies for the mighty middle became top of mind for BellSouth's Moore after an assessment of the program for high-potential finance employees made him realize how little attention had been paid to the others. As it stands now, BellSouth has a financial staffing task force, made up of about 15 senior leaders, that meets quarterly to review the development of the 100 to 150 most likely candidates for promotion. To be considered, Moore says, an employee must be deemed promotable to one to two levels above his or her current position.
The program is reinforced by BellSouth's bonus structure. Employees receive a single numerical rating based on a weighted average of all performance variables. This rating directly affects annual salary treatment and bonus-payout results. High performers can receive as much as 120 percent of the average payout, while low performers may get only 60 to 80 percent.
Moore admits that the numerical rating "has been met with a lot of employee anxiety," but says the upside is that managers are forced into "those tough-love conversations; you're not allowed to soft-pedal." He hopes that such honesty will encourage more employees to seek out development opportunities to boost their scores. To that end, BellSouth is aiming to create a junior version of the financial staffing group, which will create a rotation plan for any employee who has been in a job two to three years, and potentially link more employees with mentors.
"One of the benefits of our high-po program is that we proactively move people around [through rotational assignments]. But if you're not in the high-po group, individual movement can become difficult," says Moore. That's in large part because of logistics, but also because most managers have limited time for development activities. "If you go beyond the top 5 or 10 percent of the workforce," he says, you're dealing with more people than a manager can process. Given the beleaguered state of the telecom industry, however, Moore is concerned that without a concerted effort, his department's current 2 percent attrition rate could "go up dramatically."
In the interest of clarifying and communicating performance objectives, BellSouth is compiling all available career-development tools, including a directory of 400 job descriptions and detailed explanations of the difference between meeting and exceeding expectations in areas like business knowledge and team-building. The information is accessible to all on an internal Website.
Not every finance employee will have a shot at the top job, of course. "But everyone must develop their skills," Moore says, "either to improve at their current job, or to be able to take their manager's job."
Managing incentive compensation will only become more complex, at least in the short term. Projected variable cash pay budgets for 2006 are lower for all categories of employees than they were in 2005, according to a recent WorldatWork survey, which will probably force even more differentiation in bonuses. Stock-option expensing means many companies will reduce the number of employees who receive grants. But whether companies adhere to high-po or no-po systems, unless (metaphorically speaking) they want to field a football team with only one player, they'll have to find a way to keep the middle ranks motivated.
Alix Nyberg Stuart is senior writer at CFO.
It's the Little Things
How companies motivate the mighty middle.
Free doughnuts on Friday doesn't sound like much of a compensation strategy, but such "feel-good" awards — given with high frequency and independent of salary grade — are becoming more common, say consultants. Mercer Human Resource Consulting found that 70 percent of companies now use some type of nonmonetary recognition for incentive rewards, while 55 percent use spot cash awards.
Such awards, often attached to individual performance on a particular project or a one-time exceptional effort, can spread out incentives in a way that yields higher performance than more-targeted approaches. Sales groups, for example, often have a "president's club" for the top 2 to 10 percent of the sales force, leaving other salespeople feeling "like they don't have a chance," says Rodger Stotz, vice president of St. Louis-based Maritz Inc., a provider of performance-improvement solutions. So some have now developed a separate "par club" for salespeople who exceed quotas by a certain percent, or show dramatic improvement over past performance. "That way," says Stotz, "they're competing against themselves instead of the top 10 percent," which should lead to better performance overall. One insurance company that Maritz worked with on such a program saw sales growth among the B-players increase 16 percent more than that of the top performers, generating overall sales growth that was three times more than the industry average.
Recognition programs must be carefully managed to avoid becoming popularity contests, of course. The first year Yahoo offered its annual Super Star cash-bonus award, "we got lots of complaints from people who said, 'How dare you single out people when we're all one big team,'" says chief people officer Libby Sartain. But with management overseeing the list of peer-nominated candidates, she says, "we make sure it's someone we'd all be proud to list."
A few companies, including Best Buy, have even begun running companywide competitions for stock options. Projection-equipment company InFocus Corp., for example, is trying such a program. Each quarter, department heads nominate outstanding performers to receive bonus stock options. The candidates are then "racked and stacked in a grading system against one another" by a team made up of CFO Michael Yonker, CEO Kyle Ranson, and HR head Treasure Bailey. Before, grant distributions were "hierarchically based on pay grade" according to title, says Yonker. "Now, it doesn't matter who you are in the company — everyone below the vice-president level is equally eligible regardless of title, and that provides motivation for all our employees." — A.N.S.
Measured by Rank
Corporate versus individual performance.
Many companies vary the amount by which individual performance and corporate goals affect bonuses depending on how high-ranking the employee is. According to a recent Mercer Human Resource Consulting survey, individual performance drives 18 percent of an executive's award — which is more tied to meeting corporate goals — but 25 percent for both nonexempt and nonunion employees. "Companies vary in how well they link their [corporate] goals to compensation plans as they go down the organization," says Bill Coleman, vice president of compensation for Salary.com. "It's pretty easy to align executive and sales goals with corporate goals, but in general, it's not as easy to make the connection for the rest of the workforce."
Still, some companies stick with a single metric. Casual Male, for example, bases bonuses for its top 50 decision-makers on the company hitting an EBIDTA (earnings before interest, debt, taxes, and amortization) target, with individual performance affecting only base pay levels.
"To a large degree, [the single metric] binds the team," says CFO Dennis Hernreich. "Now finance pays more attention to what marketing is doing and vice versa."
Of course, there's a big difference in how much the bonus matters to different categories of employees. For nonexempt hourly workers, 2005 bonuses were 5.3 percent of base pay on average, according to an annual survey of some 2,720 companies conducted by WorldAtWork. For managers, they were more than twice that — 11.8 percent — while executives saw average bonuses that were 33.9 percent of their base salaries. — A.N.S.