Academic journal article The McKinsey Quarterly

Has Pay for Performance Had Its Day? the Way to Get Your Employees to Focus on Both the Present and the Future Is to Adjust Your Culture and to Weaken Your Financial Incentives

Academic journal article The McKinsey Quarterly

Has Pay for Performance Had Its Day? the Way to Get Your Employees to Focus on Both the Present and the Future Is to Adjust Your Culture and to Weaken Your Financial Incentives

Article excerpt

Pay for performance has these days achieved the status of a management mantra. A generation of executives, motivated by performance-measurement systems linking their actions to results and, ultimately, to compensation, has embraced the creed and practice of making assets "sweat." To continue flourishing, however, companies need to innovate as well as to exploit their existing assets. Yet most find it very hard to motivate their people to develop new business ideas and, simultaneously, to manage current performance.

The natural reflex might be that people should receive higher pay for innovating effectively. But our research (1) suggests otherwise. Surprisingly, the secret of persuading people to focus simultaneously on developing new businesses and managing current operations may be to rely less on pay for performance. In fact, companies that achieve both objectives de-emphasize performance pay or use it in a more nuanced, less intense manner. Crucially, they combine it with an unusually inclusive culture. In these companies, employees feel that their interests and those of the business are much the same, so they naturally try to do what is best for its current and long-term welfare, just as they do for themselves in their personal lives. Pay for performance may still have an important job to do in such a culture, but as a supplemental boost rather than a primary driving force.

Encouraging growth and performance

With few exceptions, corporate incentive schemes encourage managers to concentrate either on executing current tasks or on developing and implementing new business ideas to fuel future growth, but not both. Most such schemes are designed to motivate current performance: retail organizations, for example, tie rewards to current sales, manufacturing companies to production costs and volumes. In such companies, the need to meet performance targets leaves people with little time to innovate. As one harried manager in a global industrial company put it, "We are very welcome to do innovative stuff--after 11:30 PM."

Incentive mechanisms emphasizing current performance tend to be more common because measuring the familiar tasks that boost it--the exploitation that leverages existing competencies--is so much easier than measuring the exploration and experimentation that may lead to future growth. (2) So, for example, a company that wants to motivate its sales representatives to sell more goods or services will track how many contracts its agents close, adjust the scores for differences beyond their control (such as the number of customers in each area), and reward them accordingly. Effort and score are usually clearly linked, so the company can expect agents to work hard if high scores are well rewarded.

But the achievements of these agents would be a lot harder to measure if the company wanted them to bring back ideas for new product offerings based on the changing needs of its customers. A simple tally wouldn't do. since it might be years before an idea's real value could be assessed. The company would also have to adjust for more elusive factors, such as the willingness of customers to provide information about their preferences. All this is so difficult to quantify that to use formal incentives effectively a company would have to monitor, in minute detail, the way each sales agent actually behaved with customers.

And performance in highly exploratory tasks--biochemical research, for instance, or scenario planning--can't really be measured at all. Who knows, in advance, which experiments will yield fruitful results or which scenarios will yield valuable insights? Proxy measurements can give a rough idea in some contexts. Management consultants, for example, who often work in teams, use peer observation to assess one another's ability to come up with new ideas. But few companies have a performance-management system that assesses how well employees deal with growth-oriented tasks as accurately as it assesses their current performance. …

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