Most companies today uses differentiated salaries for their employees. This is something that is in general considered to be the way it must be; the companies needs the system in order to attract and keep talent employees to secure future profits for the business. This was also my belief until a few years ago; I thought that companies should pay more to the ones that produce more value to the business. Even if I saw cases where I thought people got too big salary increases and others too low at the annual salary review, I believed that in the long run the salaries would reflect the true values of each employee.
But during the last few years I have started to think differently. I do not believe in differentiated salaries any more, at least not for knowledge work like product development. There is too much evidence that the system you need to have in order to enable salary reviews each year, is impeding the progress of the business and lowers its result and profit. Knowledge work is based around motivated employees that have the support and environment they need to be creative during their daily work. Appraisals system, which is needed to implement differentiated salaries, is demotivating for the employees instead, and is therefore working against the high performance of the organization. Also, differentiated salaries is created under the belief that it is external motivations that drive people to be high performers, but as Pink describes in his book, Drive, it is autonomy, mastery and purpose that motivates people, i.e. intrinsic aspects instead.
This is also like Dr. Deming says in his book Out of the Crisis:
Evaluation of performance, merit rating, or annual review… The idea of a merit rating is alluring. the sound of the words captivates the imagination: pay for what you get; get what you pay for; motivate people to do their best, for their own good. The effect is exactly the opposite of what the words promise
My own experiencealign to this as well, both as an employee and as a manager, where I personally have witnessed the negative effect the system has had on its people and the company.
Implicit or explicit appraisals systems
All companies that I have worked at have used differentiated salaries, but the systems that decides the salary increases have varied quite a lot. Since all differentiated salaries are built on some kind of appraisals, all companies have them, but they may either be an implicit or explicit part of the performance review.
- Implicit appraisals system: At one company the manager tried to observe the employees by himself and used one-to-one meetings with each employee once a year in order to decide on the salary increase. This meeting was a negotiation between the employee and the manager where both sides presented their point of view and argued for a specific salary increase. This system was very efficient and had a low direct cost impact on the company. But it was highly subjective and based on each individual’s capability to argue for his or her sake.
- Explicit appraisals system: In another company we had a very thorough process during the year with several feedback gatherings and performance reviews. The managers used the system to grade each employee and used that as a basis for calculating the different salary increases. This system was less subjective but had a high cost impact on the company. The managers spent quite a lot of their time on the performance reviews throughout the year, and all employees had to spend time at least twice a year to write feedback to their peers and managers.
My own experience as an employee
I have always been considered to be a high performer. In companies with appraisals I got high grades in general. I appreciated it, but I didn’t put too much attention on the grade since I loved my work and always did whatever I could do to make the projects successful anyway. Then when I was promoted to manager and principal developer, I entered another grading level where it was much tougher to get high grades at the reviews. This may be ok, if you have more responsibilities but also higher expectations on you, then it should be tougher to get the top-level grades. But what bothered me a lot was that the performance review was used for motivating a specific grade rather than to give me honest and concrete feedback about my performance. At one occasion, the only feedback I got, beside a lot of very positive feedback, was that I needed to improve my presentation skills. The problem was that I hadn’t done any presentation during the evaluation period! Due to this my motivation was always a bit lower before and after the performance review; I knew that I wouldn’t learn anything new from them.
My own experience as a manager
As a manager I put quite a lot of effort into making the reviews as valuable as possible for my employees, and I really tried to make the grades as fair as possible. I spent a lot of time during the year in order to understand the employee’s daily work. I also did my best to write down feedback to the employees, both to help them grow as professionals, and as a use to motivate the different grades. But two things were very clear for me during this process.
- No matter which motivation I put forward in the synchronization meeting with the other managers, I could not give the grade I wanted to give. The organization normalized the grade distribution, and even if I thought that most employees in my group had done a great job during the year, I had to push down several grades due to the normalization.
- No matter how much energy and time I spent trying to understand my employees daily work and performance, I always missed a lot of important aspects. In some cases I really missed central parts, which made me pick an unfair grade at the end. You could argue that I was incompetent as a manager, but my belief is that this was due to the serious errors in the underlying assumptions of the performance appraisals.
There are a lot of research describing the negative impact appraisals have on both individuals and organizations. Below I list a few of them. At the end of this post I list a few books that I highly recommend reading if you are interested in the subject.
- The system controls performance. According to Deming, 94% of performance outcomes are attributable to the system. Everything from training, work environment, support provided to the employees and organizational culture has a huge effect on the employee’s performance.
- Performance is an emergent property from all people included in a system and the interactions between them. It is impossible to pinpoint the performance of one person in a team since it depends on the interaction between all team members, and you cannot see for sure who is the source of someone’s high performance.
- All categorization and rating is biased from ones own background, values, experience and preferences. A programmer that has worked a lot in waterfall methodologies as a specialist, will rate people differently from a coach with a long experience in Agile. And, none of them would have a valid and correct rating of the target.
- Most people think they are high performers but only a small part of them will be rated as being that. One study found that 98% of people saw themselves in the top half of all performers. Another study showed that 80% of people saw themselves in the top quarter of all performers. Performance reviews systemize demotivation for the employees.
- As is noted in Robert Austins book about measuring performance in organisations; measuring systems introduce costs that must be taken into account. This cost is often neglected without any real ROI calculation of what the appraisals system give the organisation in the end.
I had one-and-one meetings with my group throughout the year as a way of coaching and helping my employees, but also as a preparation for the reviews. I wanted to understand their daily work so that I could motivate the grades at the end of the year. At that point of time I liked the one-and-one meetings, but now I believe that they are just a way of implementing the control and appraisals system. Without the appraisals, the manager could spend more time on the floor helping the teams communicate and collaborate with each other. The managers could do Gemba walks to understand what’s happening instead. The doors should of course be open if any employee has something they need to discuss, but it should be up to the employees to take the initiative instead of the managers mandating the meeting every second week or every month.
Conflicts with Agile values
The performance review also conflicts with the agile values and will therefore work against a successful implementation of Agile thinking in the organizations.
For example, the appraisals system’s focus on individual accountability compared to the agile perspective on collaborative teams. Also, the organizations tries to use the appraisals system to motivate people by extrinsic incentives through controlling structures, but Agile is based on self-organization, emerging structures and intrinsic motivation.
Finally, there is a clear distinction between how you optimize your organization. The appraisals system is based on the belief that you optimize it by focusing on the individuals, which is like optimizing the parts of the system. Agile focus on optimizing the whole instead, where the employees work on team structures, interaction between teams and systematic issues in the organization that are stopping a high performance in the projects and teams.
What to do instead?
The root problem is the differentiated salaries. If you do not have it, then you do not need the appraisal system. I therefore think companies should employ job-based salaries. Everybody with the same kind of job or title should get salary increases according to a mathematical formula. For example, it could increase a lot in the beginning when you are new at the position, but after that, the slope decreases year after year, according to a predefined transparent formula.
Another use of the appraisals is to use it in order to promote employees to new positions. This is a highly subjective and biased way to reward people in the organization, and we would benefit a lot by eliminating it, even if it hadn’t anything to do with appraisals. Instead, the companies could let all employees apply for new positions, positions that are published by the managers because they are needed, not because they want to reward someone they like. This would remove some of the subjectively selection criteria where the managers selects the employees that they think deserves a promotion.
When you have removed the appraisal system, the managers can change focus to work on the system instead, and to look for systematic issues that impede the organization from increasing its performance. And, they can spend more time coaching the employees in their professional career, and to make sure they have the environment they need to be creative and productive. There may grow an honest and healthy relationship between the employees and the managers where the employees could be transparent about their work without the risk of being negatively assessed at the annual review.
I will in future blogs write more in detail about why performance reviews and individual based salaries are damaging. Stay tuned!
For those who are interrested, I recommend you to read the following list of books, and blogs, to get more information regarding the systematic problems with differentiated salaries and the appraisals system.
- Abolishing Performance Appraisals: Why They Backfire and What to Do Instead by Tom Coens
- Out of the Crisis by W. Edwards Deming
- Freedom from Command & Control by John Seddon
- The Fifth Discipline: The Art & Practice of The Learning Organization by Peter M. Senge
- Measuring and Managing performance in organiszations by Robrt D. Austin
- Drive: The Surprising Truth About What Motivates Us by Daniel H. Pink
- The Minding Organization: Bring the Future to the Present and Turn Creative Ideas into Business Solutions by Moshe F. Rubinstein