Summary: Promise and peril in implementing pay-for-performance

Ann Livermore, VP at Hewlett Packard (HP) at OracleOpenWorld 2008Summary of “Promise and peril in implementing pay-for-performance” by Michael Beer and Mark D. Cannon on 2004, Human Resource Management, volume 43, pages 3-48

Decades of empirical research in a variety of areas indicate that financial incentives are a potent motivator, however, despite the breadth and sophistication of topics being examined in research related to pay-for-performance, the crucially important issue of managers’ approach to implementation has not received much attention.

Significant potential problems with implementing pay-for-performance programs:

  • Destructive effect on intrinsic motivation, self-esteem, teamwork, and creativity
  • Motivate employees to focus excessively on doing what they need to do to gain rewards, at the expense of doing other things that would help the organization.

Implementation barriers that need to be overcome:

  • Difficulties in measuring performance
  • Factors outside the control of individuals and groups being paid for that performance
  • Managers and peers are uncomfortable with rating employees differently
  • Employees can come to rely on the additional compensation
  • Employees are biased toward overestimating their own contribution
  • Corporate budgets for bonuses often limit payout
  • Changing circumstances that make it difficult for managers to sustain links between pay and performance in a way that will avoid perceptions of unfairness and inequity

Pay-for-performance program might be more easily implemented in an organization that has distinctive characteristics, such as the following:

  • The culture discourages opportunism
  • Top management reinforces this culture by its example
  • Employees have long-term careers or professions in which their reputation is a valuable commodity

Pay for performance programs at HP
Beginning in the early 1990s, HP authorized a diverse set of 13 different alternative pay programs. Most of these involved team- and skill-based pay systems; some involved gain sharing and some cash incentives or bonuses. Half the sites were outside the United States and were spread across five countries.

HP’s corporate human resource department tracked these programs and learned that all were discontinued within approximately three years.

HP San Diego Site
In an effort to support a transition to self-managed teams and encourage a focus on team rather than individual
performance, the San Diego site initiated team pay-for-performance(TPP)
Results:

  • During the first six months, team members liked the TPP program and significantly outperformed the performance goals set at the beginning of the experiment.
  • Management concluded that they had set the performance standards too low and decided to adjust them. This effort was met with great resistance from team members.
  • External factors outside of the team’s control affected goal accomplishment and irritated many of the employees.
  • High-performing teams often refused to admit anyone to their team who they thought might be below their level of competence.

Management conclusions:

  • Team structure together with training would have provided the same benefits
  • The pay system did not motivate employees to work harder or learn

HP Boise Printer Formatter Shop
Skill-based pay system – Within a skill level, pay could be increased variably depending on individual and team performance. The evaluations were to come from peers and management.
The results were very much like those at San Diego.
Team members had a very difficult time judging the work of their respective team members.

HP PRCO Loveland
PRCO is a printed circuit fabrication shop that was slow in reaching its targets.
Management offered a $250 cash bonus to all of its employees if they reached 95% of the shop’s target goal.
Results:

  • The shop didn’t reach its goal
  • Some employees felt insulted by the fact that the company tried to “bribe” them to reach a goal that they were already motivated to reach.

HP Colorado Memory Systems
Management instituted a local gain-sharing program that they hoped would augment CMS’s base salary and
provide employees with total compensation that matched or exceeded HP’s total compensation package.
Results:

  • Positive effects:
    • increased visibility between departments
    • effective use of cross-functional teams to achieve goals
    • heightened awareness of business fundamentals and financials
    • clearly defined and communicated quarterly objectives
    • high level of uniform company-wide focus.
  • Negative effects
    • employees wanted their compensation program to be the same as other HP employees
    • employees also perceived the program to be promoting short-term behavior
    • The program credibility was damaged due to lack of success in closing the gap with the HP pay scale

HP Workstations Group
The pay program offered two different bonus packages, one for managers and one for engineers, to be paid at the completion of the project:

  • For managers – 10% of salary stock grant and 5% of salary in cash, 6 months after completion of the project to ensure quality of product and customer service.
  • For engineers – between 5–7% of salary

The pay program was intended to motivate effective completion of the project with no intention to continue it.
Results:

  • The project was completed six months ahead of the target date.
  • The pay program did nothing more than communicate the utmost importance management was placing on this project.

Hewlett-Packard Conclusions:
(From HP’s internal research into the pay systems)

  • The local managers who enthusiastically initiated these pay-for-performance programs ran into difficulties in implementation and maintenance and were ready to abandon them so they could allocate their efforts elsewhere.
  • Team-based work environments appear to be producing increasing business results.
  • Alternative pay systems have not proven necessary to produce positive results.
  • HP’s current pay system and other tools are sufficient to support the work team environment.
  • Even though HP has gained valuable organizational learning from alternative pay experiments, the high resource commitment necessary to design and implement pay system changes, and the limited return so far, indicates that HP does not need additional experiments unless they are markedly different.

Managerial decision making in implementing pay-for-performance:

  • Thinking was driven foremost by a pragmatic commitment to finding ways of improving performance.
  • Managers made overly optimistic assumptions about how much time would be required and how difficult it would be to administer and make adjustments in these pay programs.
  • Managers were overly optimistic about the benefits that would be achieved.
  • The biggest problem was setting performance standards that would strike the right balance between paying out enough to make incentives motivational without paying out too much.
  • The efforts by management to change payout standards in response to new technology or simply unanticipated performance improvements and payouts also threatened trust and commitment of employees.

There is an implicit negotiation going on anytime a pay-for-performance system is introduced. Both management and employees accept the new pay practice based on unstated and undiscussed expectations. When circumstances change, a “negotiation” about how to alter the pay system to meet these expectations is very difficult.

Conclusion
That Hewlett-Packard managers abandoned the pay-for-performance programs they initiated with great hope tells us more about how managers were conceptualizing their options for influencing employees than it does about pay-for-performance programs per-se.
While pay-for-performance systems theoretically promise many motivation and performance benefits, researchers and managers have under-appreciated the costs incurred when these systems are implemented, particularly in high-commitment systems.

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