The State of Compensation Raising the Performance Bar

April 28, 2006
New York nonprofit TIAA-CREF has always been known as a nice, conservative financial services company. But four years ago, the new CEO began realizing that nice guys often finish last.

   Reeling from losing its contract to manage New York state’s $1.8 billion college savings plan in 2003, Herb Allison set out to improve the company’s performance. One of his ideas was to create a new compensation system that would reward top talent with bigger bonuses and identify and weed out underperforming employees.

   Half a continent away in Topeka, Kansas, Payless ShoeSource was having similar troubles. After seeing its market share erode over several years, in 2003 it embarked on a business turnaround plan, under which the company devised a compensation system that would differentiate between its strong performers and other employees.

   "We have always had a very caring organization, but when that goes too far it can breed mediocrity," says Betty Click, vice president of human resources operations and learning and development. "We wanted to create a culture where employees were individually accountable for their performance."

   As the job markets pick up, more employers like TIAA-CREF and Payless are making employees accountable for their performance by matching their compensation to it. According to a June 2004 study by Synygy, World at Work and Sibson Consulting, 72 percent of companies say that paying rewards based on individual performance was the top goal of their organization’s performance management program.

   Skills shortages and rising benefits costs mean that companies can no longer afford to have broad-based compensation programs that merely reward employees when the company does well, says Laurie Sejen, a consultant with Watson Wyatt Worldwide. Fifty-eight percent of employers report at least moderate difficulty attracting critical-skill employees in 2005, compared with 40 percent in 2003.

   Their efforts seem to be working. Seventy-nine percent of employees say their bonus awards vary based on their individual performance, according to Watson Wyatt. Fifty-five percent think that it has become harder to earn a bonus in the past three years.

Culture shock
   TIAA-CREF initially started raising the bar for employee performance in 2003 when it introduced a five-point rating system for its 6,000 employees. This marked a huge shift in culture for the firm, which had never paid bonuses and salary increases based on an individual’s performance, says Shelly Carlin, vice president of HR for rewards and operations.

   Under the new program, an employee rated as a 5 receives a merit increase and bonus around the 75th percentile of the industry, while a manager would review employees with low scores to make sure they were in the appropriate jobs and getting the right training.

   But in 2004, the first year the ratings system was in place, TIAA-CREF did not give managers guidance on how to apply the ratings. As a result, the company saw a high number of 4 and 5 ratings, but that didn’t match up to the company’s business performance. It was clear that managers were hesitant to give their employees a 3 because it connoted "average," Carlin says.

   To correct the situation, last year TIAA-CREF told managers that only 32 percent of all employees could get 4s and 5s. Managers and employees complained, saying the new system was unfair. "Employees felt like they were working harder than ever and could not understand why they were not 5s," Carlin says.

   TIAA-CREF realized it needed to get its managers to understand the thinking behind the ratings. In December and January, Carlin and her staff held 90-minute training sessions for managers to make sure they understood the business need for performance ratings and differentiation. They got tips on how to explain to upset employees why they were not 5s.

   "We had to make sure they understood that we are raising the bar for the entire company," Carlin says. TIAA- CREF will review employee feedback and whether the company paid for performance and differentiated between high performers and other employees to gauge the success of the program. "But the real test is how people feel about it," she says.

Accountability for all
   At Payless, the company’s 1,500 associates received bonuses based on the company’s earnings. But in February 2005, the firm made 20 percent of employees’ bonuses based on individual performance. Last spring, Payless began basing employees’ merit increases on individual performance as well.

   Like many companies, Payless had been hesitant to determine salary increases based on individual performance for fear of demoralizing employees, Click says. But now, more companies are doing this because it helps retain top performers and gives more teeth to the culture of accountability. The average salary increase for high performers jumped from 9.5 percent in 2004 to 9.9 percent in 2005, while the average merit increase only rose 0.2 percent over the same period.

   Payless’ new program requires its 12 business unit leaders to create a "nine box," which is just what it sounds like: a chart with nine boxes. Each box details an employee profile, how the manager should address the employee’s performance and growth potential and what the range of the salary should be.

   For example, one box may name a "derailed employee," who would not receive an increase in compensation and for whom the manager needs to establish an exit strategy. On the opposite side of the chart would be the star performer, whose compensation should come in above the 85th percentile of the market, and for whom the manager needs to create a promotion and retention strategy.

   "The system not only creates accountability for the employee when they get their reviews, but it makes the managers accountable for developing and managing their talent," the company’s Click says.

   After soliciting feedback from their managers and plugging the names of their staff members into the boxes, executives review their charts with their HR managers and then with the CEO to make sure they are focusing on competencies and not on "why this employee is a great guy," Click says.

   It’s a lot of work. Click estimates that managers are now spending 50 percent more time on the review process.

   This year, Payless managers will hold their first employee reviews under the new system. And then they will know if all the work is worth it.

   To measure the program’s success, Payless will review employee feedback, as well as retention of key talent and how well the company does at moving identified talent up through the organization, says Sally Burk, director of compensation.

   But the real test for every company trying to create accountability through compensation is not in the design, but in execution, she says.

   "Do we have the stomach to make the tough decisions to deliver the differentiation we are looking for?" Burk asks. "Those are the questions we all need to make sure we know the answers to."

Workforce Management, April 24, 2006, pp. 31-32 -- Subscribe Now!