Expert Perspective From Grahall
The article titled “Pay-for-Performance Compensation Limits Innovation” by Thomas Claburn (of Information Week) published in the May 8th edition of Information Week resulted in a broad ranging discussion among the Grahall Editorial Board members at our weekly meeting this past Monday.
Our initial observation was that Pay for Performance certainly didn’t stifle ‘creativity’ at AIG. Those folks who used credit default swaps to establish irresponsibly high risk position that ended in disaster were nevertheless well paid for their ‘innovative thinking’. Not only were they well compensated for performance when these positions were profitable, but they also received retention payments even after the economic meltdown and ensuing bailout. Perhaps this would be an example of a compensation scheme that ‘tolerates failure’. And in the case of AIG, the failure of the project or person would have dismantled the entire enterprise (and with it perhaps much of the world’s economy) had the government not ultimately backstopped the shareholders against the losses that were incurred.
But rather than delve further into AIG’s morass, let’s stay with this article. Based on his lemonade stand research, Professor Manso concludes: “compensation schemes that…reward long term success promote innovation”. Perhaps the point that Manso is trying to make is that focusing on performance makes it difficult to invest in positive net present value (NPV) projects even though those projects might come with huge benefits down the road. A manager is often given two alternatives: 1) invest in a project with a long-term benefit but short-term cost and the possibility of failure, or 2) do nothing. In a poorly designed system, doing nothing may allow a manager to keep their job and meet short-term performance goals at the expense of investing for long-term competitive advantage.
As an aside, in sports people often talk about “good risks to take.” Even though it might not work out, coaches want their athletes to be aggressive if the situation favors success. We’d like to have the same system for executives but in fact there may be a bias toward conservatism if the executive perceives that he or she has everything to lose and little to gain from taking a chance, even if it’s a good one.
We agree in principle that rewarding folks in part for long-term performance is smart and likely to help a company achieve long-term success. However, one concept we have been examining carefully is “sustainable performance”. Let’s consider the S&P 500. Probably less than 20% of the companies comprising the S&P 500 were also in that list in 1975. What one can extrapolate from that statistic is that about 400 of the top performing companies in 1975 are no longer top performers. Which raises the question of whether “sustainable performance” over the very long term is really even a realistic expectation. In the US economy, disruptive innovation drives new markets and lower prices in our “survival of the fittest” environment, and also like the natural world, companies go through life cycles from start-up, to growth to decline to (hopefully) renewal.
But for some companies, renewal isn’t possible. In fact there is a question for those companies that can renew themselves and begin the life cycle again if there is a practical limit on the number of times a company can make profound changes. Liken it to a chain that breaks and has to be repaired again and again. It is weakened not only by its primary use, but also by the repairs themselves.
During these cycle of changes, of upswings and downswings, it’s not just the company itself that is strained, but also the employees of the company. An example of this occurs when cost cutting in a downturn results in layoffs. Clearly the employees who lose their jobs are impacted, but so are those who remain. The message from management during these times, is “do more with less”, which translates into employees making less money to do more work. Rarely does management stop to consider that the re-engineering process might be necessary, and inevitably, when the situation improves, staff hiring begins again in earnest but the outdated, overly complex and manual processes that were part of the high cost remain in place.
Workforce reductions during tough times also have the very real and unavoidable consequence of damaging the overall employer/employee relationship. Employees see that past hard work is not a guarantee of future employment. They hear the unspoken message from employers: “Don’t unpack your bags – you are all expendable.” Loyalty is a two-way street and employers have been failing to demonstrate their loyalty to employees for many years now.
But is loyalty really so important? The answer to that question depends on the company’s business strategy. An organization whose product or service is highly commoditized, or which competes primarily on price (think Wal-Mart) may not need to worry so much, since the employees they need may not require specialized skills or training and the learning curve for new employees is short. For other companies whose products or services are highly specialized or heavily reliant on the expertise of their employees, the employer/employee bond needs to be much stronger.
So is Manso’s conclusion accurate? It’s clear that his lemonade stand study presents some possibly interesting findings, but how do lemonade stands relate to banks, or oil companies or law firms? Not too directly we think. Further, innovation occurs by chance, and often by accident. Success comes after repeated failure. Although Manso properly identified tolerance for early failure as a critical success factor for innovation, he failed to address the fact that for creative thinkers, the reward programs need to match, and encourage, their creativity. We have included below an interesting real life case study of a company (not a lemonade stand) and the challenges of addressing the rewards needs of true innovators an the R&D division.
Grahall believes the best rewards strategies, and frankly the only ones that work, are those that are developed to support both a company’s overall business strategy and its people strategy. As a company evolves, its business strategy will evolve and therefore so must its rewards strategy. There is no “one size fits all” choice; there is no “do it once and it’s done forever” solution.
Contact us, we can help you sort through this and make the most of the money you are spending on your rewards programs.
CASE STUDY: One Example of What Unique Innovators Wanted as Unique Rewards
There was a client who had disappointing results from their R&D department. After a typically exhaustive consulting effort involving surveys, focus groups and the like, we concluded that the best reward we could bestow upon this group was the right to smoke, as smoking had been banned from the company. This worked because the R&D employees had thought of it – after all they were the ones paid to innovate not management. In their business, speed to market was important and in their work, uninterrupted concentration was critical to that end. So, allowing them to smoke enabled them to stay at their desks and get stuff done. Another reward deviation we made for R&D was removal of the medical benefits managed care network. R&D employees could then go to any doctor they wanted at any time. This enabled R&D employees to seek medical care at “off hours”, accommodating THEIR schedules. Since R&D employees’ available time to work on the project was far more valuable than the cost of non-network health care, this was an easy choice for the employer and a highly desirable benefit for the R&D employees. The “cash carrot” was a bonus based on how quickly the R&D projects were complete and market ready. R&D employees were allowed to fail all they wanted because all that mattered was the final successful outcome and the speed at which they were able to get there. The R&D employees viewed their jobs differently from other employees. For R&D, when the product or project was complete and market ready, they saw that as the freedom to go and do something new, either at the same company or at another company with a more interesting opportunity. Their emotional attachment was to the project, not the company. By making their jobs easy to do (with an environment of convenience and concentration) the employer got more projects to market faster. Poorly conceived, designed, communicated, and executed can stifle innovation but if rewards are properly structured, they can engender innovation.
As we said above, every company and every situation is different, there are no “one size fits all” solutions. The case study represents a very unique situation and the results were eye-opening to all involved, it is certainly not a prescriptive R&D rewards program but that said, be prepared for equally unique solutions each time.. Often, a company’s business model does not succeed or fail based on innovation at all. Or, as in this case study it did but the innovation was contained in one business unit and the reward program was customized to that unit. Contact Grahall for more information.