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Merit Pay, Differentiation and the Tragedy of the Commons

December 8, 2008
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Related Topics: Variable Pay, Compensation Design and Communication, Featured Article, Benefits
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Merit pay is tough. Making it work—truly work— requires three things: the ability to differentiate people based on their performance, the willingness to reward them accordingly, and a commitment to balancing the long-term interests of the larger group with the short-term interests of an individual. That’s a tall order, even in the best of times.

    As with any other pay-for-performance approach, the notion of merit pay rests, by definition, on a foundation of differentiation. It is based on having both the ability and the willingness to differentiate employees by their individual performance.

    The ability to differentiate, by genuinely and fairly discerning performance differences, usually requires the presence of a performance-assessment process or tool. The majority of organizations of any size have a performance management program of some sort in place. While most performance programs could undoubtedly be improved, my experience suggests that the biggest obstacle to true performance differentiation is not the ability to recognize performance differences, but rather the willingness to do so.

    In some places, there is an organization-wide cultural barrier that stands in the way of differentiation. These employers choose to embrace the idea that every employee is outstanding and makes exceptional contributions. I’ve heard senior leaders make statements to this effect in all-staff meetings. Perhaps the statements are true, perhaps not, but taking the stance that every employee is an above-average performer makes differentiation all but impossible.

    The only way to depart from the norm in circumstances like these is to go downward, and that tends not to happen, except in the face of an extreme performance deficiency. Some of these companies attempt to create differentiation by establishing a new, even higher performance level—let’s call it "super exceptional." But guess what? In these organizations it is only a matter of time— one or two performance cycles at most—before virtually everyone floats up to the new level of excellence.

    These organizations must do some real soul searching to determine whether they truly can or even should pay for performance. Not every employer is able to go the pay-for-performance route. The key is honesty about where the organization stands. Don’t tell employees that pay is based on merit if everyone gets the same salary increase. You aren’t fooling them, and your credibility will be the worse for it.

    More often than not, though, the willingness problem appears at the level of the individual manager. The organization accepts and promotes the concept of differentiation, but managers are unwilling to call out differences among their own reports. This plays itself out in a fashion similar to the classic dilemma called "the tragedy of the commons."

    The theory underlying the tragedy of the commons dates back as far as Aristotle, but it was popularized in modern times by theessay of the same name by Garrett Hardin in Science magazine. Essentially, the essay describes the dilemma that occurs when the short-term interests of individuals are at odds with the long-term interests of the group.

    Following is a summary of Hardin’s 1968 article (courtesy of Wikipedia):

This story describes a group of herders having open access to a common parcel of land on which they could let their cows graze. It is in each herder’s interest to put as many cows as possible onto the land, even if the commons is damaged as a result. The herder receives all the benefits from the additional cows but the damage to the commons is shared by the entire group. Yet if all herders make this individually rational decision, the commons is destroyed and all will suffer.

    As Hardin and others point out, the tragedy plays itself out in a wide range of modern-day commons, beginning (but not ending) with our use of resources such as water, parks and wetlands, fish stocks and oil. I believe we see a similar dynamic at work among managers when it comes time to assess their subordinates' performance and hand out merit increases.

    The actions of many managers suggest to me that they see their role and their primary objective in the merit-pay process to be getting the highest possible increases for each of their reports, however that might be accomplished, rather than distinguishing the genuine performance differences between their subordinates and rewarding them accordingly. If gaming the pay system is the most expedient way to get the highest increase for each report, then so be it.

    The outcome of this behavior is that the ability of the organization to make merit pay work, to differentiate and reward the employees who truly go above and beyond in their roles, is compromised in favor of the individual manager trying to maximize the pay levels of his particular group of employees. Merit pay ultimately fails for lack of willingness to differentiate.

    How do we address this workplace version of the tragedy of the commons? Many organizations respond with training to improve managers’ skills in setting performance expectations, in coaching employees and in providing constructive feedback. While this is all good, it is not, to my mind, a remedy for the problem of the managers’ unwillingness to differentiate. To deal with the root issue, we must go to the very definition of what it means to be in a management role.

    One of the most important aspects of the role of a manager—perhaps the most important role—is that of stewardship. A good manager means being a good steward of the organization’s economic and human resources. Stewardship involves actively balancing the needs of both the employees and the organization. A manager putting the short-term interests of his employees above the longer-term interests of the larger group is failing as a steward.

    I believe that stewardship is the only way to make merit pay work. Until we hold managers accountable for their roles as stewards, the willingness obstacle will remain. Accountability begins with consequences: positive consequences for doing the right thing and unpleasant consequences for getting it wrong.

    A manager who encounters only positive consequences as a result of putting his immediate interests ahead of those of the organization ("I am a hero to my team!") is not being held accountable. But what if there really were accountability? What if that manager's superiors were to challenge and express concern about that action? What if the manager was called on to defend that action in a forum of peers? What if the manager’s personal performance was assessed as "needing improvement," leading to no raise or a low raise, directly as a result of the shortsighted and self-serving nature of his actions? These negative consequences would probably cause the manager to rethink his approach.

    Merit pay is tough, particularly in these difficult times. When things are tough, however, can we afford not to recognize and reward those performers whose efforts and actions set the example and help drive the organization toward better times? Stewardship is a high standard for managers, but it is ultimately the only way to make merit pay work. Until we hold managers accountable for their roles as stewards, we will be unable to conquer the tragedy of the commons, and our merit-pay efforts will be doomed to fail.

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