The Employment Contract: Let’s Make A Deal

Employment is a contractual relationship between two parties… an organization and an individual. The contract may be emotional and not legally binding, which makes if more of an agreement about a relationship. Both parties want the conditions of employment to be fair, competitive and appropriate… from their perspective. The organization wants to get as much value as possible from the arrangement, at the least economic cost. The individual wants to get as much value as possible, at the least personal cost. Given these realities it is necessary to reconcile these diverse wish lists.

Fairness is a concept that must be defined. If an employee wants his or her compensation to be “fair” there must be some measure of fairness and a method of determining if fairness exists. The employee may compare to other employees when determining if fairness (internal equity) exists. If a co-worker who seems to have similar qualifications and responsibilities and is performing at the same level is paid more the employee making the comparison may feel under-compensated. If the person making the determination does not know what the is actually other party is paid a guess will be made. The problem with the guess is that research demonstrates people will overestimate what peers and subordinates are making and underestimate what their managers are making. All of these guesses will tend to make things seem worse (less fair) than they actually are. A second approach is to compare one’s pay rate to the pay range assigned the job. If someone believes they are fully competent and performing well they may believe they should be paid in the upper part of the range. The problem with that view is that research has identified a cognitive bias that makes people believe they better (more competent and a better performer) than they actually are. That bias will be likely to influence how the employee views their pay rate.

Competitiveness must also be defined… competitive with what? There is a tendency for employees to seize upon a newspaper article or a “survey” to show that they are underpaid. And normative data shows most employees feel they are underpaid. The problem is that there is rarely an evaluation of the validity and reliability of the data used to make the determination. Additionally, cognitive bias will cause people to more readily accept information that agrees with what they believe or what they would like to be true and to reject contradictory information. Even though a reliable survey source is used correctly assessing the competitiveness of one’s pay requires a comparison to only relevant data. If the CEO of an organization with five million in revenue compares his or her pay to a survey that includes much larger organizations the comparison lacks validity. A similar problem can occur when the type of organizations included in the data is ignored… or the performance of the other organizations is not considered.

Appropriateness of one’s rewards package is also a challenging determination to make. If base pay rates are tied solely to seniority high performers may think that approach to be inappropriate. A high performing sales representative who does not earn more than someone who performs poorly is bound to be dissatisfied. The mix of the total rewards package may also be thought to be inappropriate. If a significant portion of one’s current cash compensation is in the form of variable pay (incentive or bonus plan) but the criteria for determining the size of awards are outside of the employee’s control that plan will be deemed inappropriate. And eligibility for a plan may also be the source of discontent. Being eligible for stock options is often a prestige item… even if its economic value is not large. If someone else is eligible for options and the individual is not this may result in a perception that the eligibility criteria are inappropriate.

Given all that stands in the way of employee satisfaction it is understandable that the typical employee is at least somewhat dissatisfied with their compensation. Compensation is a metric that can come to represent many things… how much the organization thinks an employee is worth… how much the employee contributes… and even whether that employee is secure in his or her employment.

Understanding that dissatisfaction is widespread does not alleviate the frustration experienced by an organization that attempts to reward its people fairly, competitively and appropriately but finds that its employees are dissatisfied. And even understanding that cognitive bias and the tendency to be self-serving often result in unjustifiable perceptions of mistreatment does not erase the frustration. This is not to say that an organization can afford to resign itself to believing dissatisfaction is inevitable. Dissatisfaction will have negative consequences. One way to moderate frustration is to compare the results of employee satisfaction surveys against normative data, rather than some unrealistic ideal, such as no employee dissatisfaction. And every attempt should be made to provide tangible evidence that policies and programs are designed and administered in a manner that results in fair, competitive and appropriate treatment of employees.

Is It The Strategy… Or The Execution?

Formulating the right strategy is critical. But an inadequate investment in training everyone on strategy execution will negate the value of having the right strategy. And if management has not ensured that people understand and adhere to the policies and practices that are required for execution not much that is good happens.

If managers and employees do not fully understand up front how a program is supposed to work and what their role in making it work the likelihood of poor execution is increased. When designing new programs, I often have to explain why I want to train employees as well as managers. The philosophy underlying this approach is that the employees are the consumers of the programs. If they are not adequately trained the programs will be viewed as something that is being imposed on them, rather than something they have a vital stake in. A new performance management system or rewards program will impact them, and they should be informed as to why the organization has adopted a new strategy or program. It is also important for them to be given evidence that establishes the strategy or program results in equitable, competitive and appropriate treatment.

Gallup research has found that the thing most impacting employee satisfaction and effectiveness is “knowing what is expected.” Employees must also know what the consequences are for meeting or not meeting expectations. Performance management is often the weakest component of talent management systems and much of the reason for that perception (reality?) is that employees only find out what was expected and how they were doing at the end of the year, in a blame allocation session (performance appraisal). So even the best designed system will fail if execution is not adequate. A pay for performance strategy can only be executed if performance is accurately and appropriately defined, measured and rewarded. And a pre-requisite for strategy execution is developing a process that ensures employees are continuously informed about both what is expected and how well expectations are being met. The model below prescribes a continuous process.


When a process like this is in place the year-end performance appraisal process becomes a review of what has already been discussed and is not a battle between a manager and an employee who remember two totally different years. Both ongoing job responsibilities and current objectives have been updated continuously. Successes and failures have been acknowledged and plans formulated for dealing with issues. Year-end appraisals drive administrative consequences, so if they are not viewed by all parties as accurate there will be dissatisfaction with those consequences.

Rewards strategies and programs serve many purposes. They can align costs with available resources. And they define an organization’s value proposition, which is a critical component of the employer brand. If they appeal to the people the organization needs, they can facilitate attraction, retention and motivation. The diversity of knowledge and skills required by organizations has resulted in workforces that consist of a wide variety of occupations. Technological developments are creating new roles, such as data scientist, as well as reshaping existing roles. This mandates that organizations assess whether their strategies and programs will be effective for different types of employees, as well as outside parties who perform work for the organization.

The effectiveness of what has been done can erode over time, and due to a lack of continuous refinement to fit the altered nature of work and nature of worker it may become necessary to make major changes. Not changing the oil and performing routine maintenance is likely to result in a major cost… rebuilding or replacing the engine. And it is difficult to maintain one’s professional image when a system that was in the past sold to employees as the new best thing is now deemed to be a disaster that needs replacement.

There is a difference between implementation and execution. Implementation is done once. Execution requires continuous effort. Unless processes that require continuous assessment of strategies and programs are in place it is unlikely that busy people will take the initiative to perform the assessments where there is no appearance of major problems. Eradicating termites is less expensive if the damage is recognized and dealt with early. Assuming strategies and programs will continue to be effective is a dangerous form of neglect.

Following Trends: A Good Idea?

Professionals and managers are exposed to an avalanche of information about what is going on in their field of practice. Some of it is derived from discussions with others, some from practitioner journals and some from ideas presented at conferences. Continuous environmental scanning is a prudent strategy, particularly in the kind of dynamic environment that exists today. But data and information must be tested to see if it is relevant evidence that should impact decision-making. Having been a consultant, practitioner and teacher in the compensation management field for several decades I have seen a pattern that suggests many practitioners attempt to identify and follow trends. Trends are practices that a lot of others seem to be adopting. There have been periods where a number of “new” approaches seemed to have been granted the status of being the “new best shiny thing.” The publications are suddenly full of testimonials that broad-banding or competency-based pay will lessen or eliminate the difficulties associated with rewarding people.

When does something become a trend? When every account one sees in print extols the virtues of an approach and suggests adopting it does not present challenges it seems rational to follow the herd. The two practices just mentioned dominated the literature for a time, which was understandable since 100% of the adoptions were deemed to be successes (recent research on salary structures showed that a minuscule percentage of participating organizations use broad-banding today).

Yet upon reflection one has to ask who would write an article describing a failure they were responsible for? In a perfect world those who tried something that did not work would inform the profession that success was not guaranteed by communicating the outcome. Admittedly this may not be the best way to advance one’s standing in the field, but it does provide useful information. Learning what does not work or what only works in certain contexts can be every bit as valuable as learning what does work in certain contexts. This severe bias in the literature exists in the academic world as well. Journal editors are unlikely to accept papers about research studies in which the results did not support the hypothesis that was being tested, despite the fact that valuable intelligence could be gleaned from the study.

There is also a bias against publishing the 50th article concluding that a practice like “paying for performance” has a positive impact on motivation and performance. The “yes, I already knew that” reaction makes the information uninteresting and once a practice has experienced an adequate amount of supporting research further supporting documentation seems unwarranted. So Editors are always looking for something that seems new. But this distorts the probabilities that different practices will be successes or failures. Ten articles in the same year claiming massive success with broad-banding pay systems seems to elevate the practice to the status of “best new shiny thing.” But if thirty failures went undocumented this is not good intelligence. And certainly a sample consisting of ten successes is hardly compelling, given the number of organizations in operation at any time. People are subject to accepting samples that are too small to be statistically valid and this bias is the source of a bandwagon effect. The claim of newness is often exaggerated, to increase the appeal of a practice. I have uncovered at least two previous lives for the “new” broad-banding approach popularized a decade ago. Since few study history rigorously it is often possible to simulate newness by changing the name of something.

When a practitioner is determining whether a specific practice that was reported as being a success at a respected organization should be emulated there are often critical items of information missing, such as a detailed description of the context within which the practice was successful. Although there may be some information about the organization it is very rare for enough knowledge about the culture, the external environment and the internal realities to be available for someone to make a reasoned assessment about the similarity of the two contexts. The common assertion that “our organization is unique” is in fact almost always true… there are no two identical organizations. So why would a practitioner make a decision that was influenced by what happened at another organization (or ten organizations) that functioned in contexts that were at least some degree different? In addition to knowing about context similarity there must also be careful scrutiny of how the adopter defined and measured success. Did growth rate increase? Profits soar? Employee engagement increase? Unwanted turnover decline? And by how much? Once the success measures are calculated did the improvement warrant the resource investment in making changes? Research studies and benchmarking processes have been two of the most widely used tools for practitioners when they attempt to predict the probability of success when adopting a new strategy or program. But using them is fraught with peril if they are not done well.

The prevalent reporting of an increasing use of workforce analytics warrants the trend lablel. It seems obvious that relevant evidence will always be valuable when making decisions. Technology advances in AI and machine learning have created tools that enable organizations to use data on what has happened to improve the ability to predict what will happen. But lest adopters assume that analytical tools have great prediction power it would be prudent for them to acknowledge that the future may not be like the present or the past. If that is the case the data used may be inappropriate for deciding what will happen if a practice is adopted. There is a similar danger in using one’s past experience as a guide for going forward. Experienced people who may even be universally proclaimed to be experts may have a knowledge base that is less relevant today and in the future than it was when acquired and applied. And when a knowledge base is used to create an algorithm the quality of that tool will be impacted by the continued relevance of the knowledge used to create it. Since algorithms prescribe decisions based on rigidly prescribed logic they will not question “is this still going to work today?” Having just published a second edition of my first book I was startled at how much had changed in five years. Classics can be useful but generally for understanding fundamental principles, rather than discovering how a particular program would work today.

Thankfully the principles of evidence-based management are increasingly being used to improve decision quality. EBM prescribes the use of all relevant evidence to inform decisions. But meeting the relevance test is devilishly difficult. And the interpretation of the body of evidence can require a decision-maker to “grade” the quality of the different sources of evidence, especially when the sources seem to disagree. Making a good decision has not gotten any easier, despite the proliferation of data, information and new technology. All these sources can increase decision quality if properly interpreted and applied.

Jumping on the bandwagon when a “new” approach is dominating the literature without a rigorous process of examining the evidence can lead one down the foot worn path… which can be the wrong path for a particular organization at a particular point in time.

Aligning Talent Management Strategy With Organizational Strategy

An organization’s talent is potentially its most valuable asset. But this statement is only true if the workforce is made up of the right people, with the right knowledge/skills and the right motivation. In addition, it must be managed effectively. The talent management strategy provides a framework for creating the right talent pool. Staffing and developing the workforce and effectively and appropriately defining, measuring, managing and rewarding performance are the pre-requisites for success. And the profile of the optimal approach is one that will focus the right workforce on organizational objectives.

Figure 1 shows a model for deriving the human resource (talent) strategy from the organizational context and the business strategy. The context is a function of the vision/mission of the organization, the culture and the internal and external realities with which the organization must deal. Each organization must determine its context before examining alternative business strategies, since different strategies work or do not work depending on their fit to the context within which they must be executed. Then it can formulate a strategy for acquiring and managing the right talent pool.

The need to continuously evaluate the human resource strategy to be certain it is aligned with the context is particularly critical now. Technology and globalization are changing talent requirements. That type of change often demands new skills that may not be present in the current workforce. In some cases organizations have attempted to replace a significant part of their workforce with new employees better suited to the new talent requirements (e.g., newspapers replacing type setters with IT personnel when adopting automated front-end systems). Others have attempted to retrain existing employees, so they are competent to function in the new strategy.

However, there are significant costs associated with each of these approaches. Changing out the workforce has separation costs, hiring costs, training costs and potential litigation or even violence. Retraining the existing workforce can feel like repainting a commercial airliner while it continues scheduled runs, not to mention the significant training costs for the painters. Deciding which transitional approach to use should be based on a cost/benefit analysis and consider both the short and the long term.

Figure 1

Aligning Human Resource Strategy with Organizational Context

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Staffing and Development Strategy

By profiling the types of employees fitting the current talent strategy using competency models, an organization can use workforce planning to evaluate the adequacy of the current workforce and plan for future needs. The model in Figure 2 illustrates how to continuously evaluate the workforce in light of changes to the organization’s needs.

Evaluating workforce demographics can facilitate planning for impending retirements. The Water Research Foundation did a study that concluded that half of water utility critical skill people were eligible for retirement within five years. Failure to know that early and to act on it could create a crisis in a utility. And taking positive steps, such as improving job design, doing effective performance management and investing in career management programs can increase the capabilities of the existing workforce. That productivity increase can preclude the need to hire new talent. And making a business case for employee development can help to secure the resources to invest in the current workforce.

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By doing continuous environmental scanning and using scenario-based planning to plan for a range of possible futures an organization can continuously evaluate how well its talent fits its needs. As technology and globalization have provided new sources of talent each organization must decide whether the work that needs to be done can best be done by employees or if the use of contractors, consultants and freelancers can produce a better result. Both the global mobility of talent and the ability to have work done anywhere using technology have increased the potential supply. But attempting to integrate the work of outsiders and that being done by employees can be challenging. And it is often necessary to modify the value proposition to attract the best talent from the new sources.

Performance and Rewards Management Strategy

How effectively and appropriately an organization defines, measures, manages and rewards performance will have a significant impact on employee focus and motivation. If employees do not believe performance management is done poorly and/or their rewards are not equitable, competitive and appropriate that perception can reduce employee satisfaction and engagement, as well as increasing unwanted turnover.

If what is defined as performance changes over time the new criteria and standards must be clearly defined and understood by all parties. Effectively rewarding performance requires that rewards accrue to those who produce the results desired. For example, if a software provider wants to ensure its designers create products that are commercially successful, rather than just technologically superior, it might provide an incentive package that ties rewards to product acceptance by customers. Basing a portion of the awards on the product sales for the first one or two years provides a clear message that dazzling potential customers is not enough, they must be dazzled enough to buy the product.

The use of outsiders brings into question whether the performance and rewards management strategies used for employees will be effective for those working under different arrangements. This is especially true when using freelancers (gig workers). Contractors and consulting firms are typically evaluated and rewarded using pre-determined contractual agreements. But freelancers may require individualized strategies, whether they are acquired through talent platforms or they deal directly with the organization. If they are satisfied with their treatment it will increase the chance that the best freelancers will view future engagements with the organization favorably.

Alignment Matters

The degree of alignment between the human resource (talent) management strategy and the organizational strategy will be a major factor in determining how effectively an organization manages its talent pool. Getting the right people on board is the first step. The second is to align their efforts and to focus it on meeting the objectives of the organization. This can be facilitated by effectively utilizing their talent and defining appropriate roles for them within a coherent structure. The third is to develop a performance model that defines and measures performance at the organizational, unit/group and individual levels using the appropriate criteria. The fourth is to reward performance equitably, competitively and appropriately, which will provide the motivation to extend one’s best effort and to focus that effort on what will contribute to organizational success. And the talent strategy must be continually assessed, considering the current context and the organizational strategy. Change may be challenging but rigidity can preclude success.

One On One Unstructured Interviews: A Flawed Selection Tool

When research informs us that a practice is not viable it would be expected that organizations would avoid relying on it. Yet one on one unstructured interviews continue to be the most widely used basis for selecting new hires from groups of candidates. Since research has shown that the practice has virtually no validity or reliability there must be something that prompts its continued use.
Being subject to numerous cognitive biases is a human condition. Kahneman & Tversky won a Nobel Prize for research that identified about 100 such biases, as well as developing an explanation of how we think. One of their useful insights differentiated between fast (System 1) and slow (System 2) thinking.

System 1 is activated automatically and is quick to find explanations for what is seen and for making snap decisions.

System 2 is calculative and is activated when System 1 is puzzled, senses contradictions or is exposed to evidence that is contradictory to held beliefs. In the book Blink Gladwell also pointed out our propensity to make snap decisions based on first impressions (a characteristic of System 1 being in charge). Some of the common biases also work against making good decisions:

  1. Overconfidence that one “knows” something (most common among experienced people);
  2. Tendency to filter evidence in a manner that results in being overly receptive to information that confirms existing beliefs or what one wishes were true;
  3. Over reliance on samples that are too small to be statistically sound;
  4. Over simplifying complex issues resulting in simplistic decisions;
  5. Susceptibility to physical characteristics being considered, eroding decision quality.

I was hired for my first job out of undergraduate school into a high potential program managed by a highly respected organization, based on a one on one unstructured interview. I was not well suited to the organization. To this day I am convinced that my success in being selected among many candidates with advanced degrees from more prestigious schools was due to the fact that the interviewer and I had both served as paratroopers in elite airborne divisions. How that discovery occurred I do not remember, but since the discussion was unstructured chance occurrences were made possible Since the role I was selected for did not require the combat skills I learned in the service the selection criteria I believe resulted in my hiring were inappropriate. The fact that my being hired subsequently resulted in excellent training in all aspects of business that I have used throughout my career makes it difficult for me to be so critical of a process that led to that selection. But my PhD training in Behavioral Science has made me a believer in sound research and has equipped me to override impulses and intuition when research findings so dictate.

Using flawed processes can also produce consequences for an organization that are more serious than just making low quality selection decisions. Another one of the biases we are subject to is preferring people who we like and who are like us. This can result in inappropriate decisions and result in statistically significant impact on protected classes, opening the door to employment bias litigation. And globalization has made talent more mobile, resulting in culturally diverse workforces and candidate samples. This diversity can create another problem. If one candidate has been socialized in a culture that encourages humility while another candidate has been taught to aggressively market one’s qualifications two equally qualified candidates can seem to be unequal when unstructured one on one interviews are used. Interviewers are of course influenced by how a candidate answers questions and represents him or herself and this may degrade the quality of a selection decision. Trompenaars prescribes 3Rs for dealing with cultural diversity:

  1. Recognize that cultural differences are present,
  2. Respect the right of people to hold different beliefs and values,
  3. Reconcile the issues those differences raise.

Kahneman cites research that shows interviewers who have abundant sources of evidence that seems relevant do not generally do better than someone using a straight forward algorithm to make final decisions. For example, an algorithm for selecting new students for a university that relies on high school grade point average and a relevant aptitude test to select students usually outperforms interviewers with a wider variety of information. If the university is trying to predict if the person will make contributions as an alum knowing about family circumstances may be relevant. And if the school aspires to produce graduates who will be active in the community then high school activities may be relevant. But if the goal is to predict who will successfully complete their studies and do well that additional information is a contaminant that lessens decision quality. Suprisingly the act of predicting the future quality and price of a Boudreaux wine was done better by an algorithm using Spring rainfall, Summer rainfall and Summer temperatures than it was done by a panel of experts. Medical algorithms have diagnosed more reliably than trained specialists. All of these facts do not argue for a “machine replacing human” approach, but rather a blending of expert opinion and a structured decision process used consistently.

It has been shown that parole decisions by judges are impacted by how long it has been since their last meal and/or the cases that preceded the current one. This illustrates the fallibility of people across decisions. When left free to make decisions without common factors and factor weights the reliability of their decisions will suffer since physiological differences over time will produce inconsistent standards.

It is a “both – and” rather than an “either – or” approach that will produce the best decisions made by people. When an algorithm can be developed based on data, using AI and machine learning tools, its consistent use will produce more reliable decisions over time. But the validity of the decision is generally maximized by using both data and human judgment. Panel interviews with structured questions can help to moderate individual bias and to ensure everyone is asked to respond to the same questions posed in the same manner. When panel members have individually rated candidates they can then meet to compare their ratings and to discuss what led them to their conclusions.

Managers who will be responsible for the chosen candidate may believe they should be in control of a hiring decision. But they will often be subject to overconfidence bias and may resist the imposition of a structured process that gives other parties a say in the decision. Some Behavioral Science 101 training may convince them that utilizing a structured process will at the very least give them a trimmed down list of final candidates that contains only qualified people. They may still believe that they are the only one who can truly judge whether the manager and the person will work well together. But at the very least there should be a third party review of the rationale used by the manager during the final selection to minimize personal bias. And since the new hire will be an employee of the organization who just happens to work for a specific manager initially the organization should have a say about who joins its workforce.

Managing The Human – Technology Interface

The title of my third book, published in 2018. is “The Most Important Asset: Valuing Human Capital.” Although I believe what that title suggests it does not mean other assets are not critical. Financial, customer and technological capital are the vehicles through which people work to achieve organizational objectives. Of late there seems to be a belief that technology is the key to success, given the dramatic progress made in that arena. But when relative importance is debated there is often an “either – or” mindset that results in a competition between the types of capital. We are living in a “both – and” world where things are particles and waves, not one or the other. Perhaps the best way to relate human capital and technological capital is to conclude they are both necessary, but individually not sufficient, pre-requisites for success.

If the premise that both people and technology are critical is accepted it becomes apparent that the interface between them must be managed well. Either can undermine the effectiveness of the other. The concept of socio-technical systems came on the scene several decades ago. One of its principal prescriptions is that there needs to be a mindset that embraces the compatibility between the two types of capital. But because of the considerable rhetoric about robots and algorithms replacing people there is a danger that a people vs. technology war might break out. Even if technology does not replace someone it might significantly alter the knowledge and skill requirements people must possess and that can be threatening. People were selected into roles based on their qualifications to perform in those roles and if the work changes the qualifications change and the people must change. Mid and late career people may not be enthusiastic about “going back to school.” And they may feel betrayed if they think they were led to believe what they know and are able to do is all that is and all that will be required.

Recent research by the Workforce Institute at Kronos suggests employees often feel the technology they use at work is not as easy to adopt as the consumer applications they use, such as social media tools and games. If someone has learned to search for entertainment, do their banking and communicate with others seamlessly and with limited effort it is understandable that they would expect that work technology could be similarly effortless. Yet fewer than ¼ of those surveyed found that to be the case. These findings held true across the globe. In response to other questions asked over 1/3 felt that outdated processes and legacy technology made their jobs harder rather than easier. And younger workers believed this more strongly than those in mid to late career phases.

Despite dramatic advancements in technology the people who must use it are not happy with it. Since people have to create the technology there must be a disconnect between those that design it and those who use it. This can lead to a negative impact on employee engagement and satisfaction, which will produce a decline in performance level. Everyone has been frustrated by user manuals that are supposed to tell you how to put a product together or how to perform actions such as sending a text message. Successful consumer products generally are designed so that using them is intuitive. Yet much of the software used in workplaces seem to be the result of designers who did not think that important. If trying to use technology is frustrating, intimidating and more work than doing something manually there will be less adoption of new tools, even though they might increase productivity once a person figures them out.

When communicating with others employees must decide on whether to use the “efficient” digital approach or walk down the hall and have a person to person conversation. The latter approach is not feasible if the number of recipients is large or if they are scattered across the globe. Most people believe that communication is much less prone to misinterpretation when it is done face to face. But globalization and the increased use of outsiders to do work have both increased the probability that communication is going to be between parties who do not share history and who do not understand how others expect things to be done.

Organizations should consider the person – technology interface when deciding on what technology to adopt. Opting for the newest and shiniest object may be exciting and viewed as being progressive but if it fails to produce the desired results it is just disruption. And if people struggle with incorporating technology results are unlikely to meet expectations. If AI or machine learning algorithms replace human judgment there will be resistance from those who are likely to feel disrespected and diminished. But if the algorithms relieve drudgery by doing the well-defined repetitive work the reception is apt to be much warmer. If I have been lifting 100 pound objects all day and the organization reallocates that part of my job to a robot I am good with that… assuming I still have enough work to do to justify my employment.

Ergonomics (human factor engineering) has helped organizations design workplaces that make people more productive and help them avoid repetitive motion and vision problems. There should be designated experts responsible for doing the same oversight on workplace technology. When people and technology are compatible they both become more valuable.

Rewarding Performance With A Limited Budget

Economists are divided about the direction the current economic environment will take over the next few years. The last five years have been prosperous for many organizations, domestic and global. But compensation levels have not increased rapidly, despite very low unemployment rates. During recent years the rate at which pay levels have increased has been very low compared to historic averages, although pay rates have recovered somewhat from the economic downtown that started in 2007-8. According to the Salary Budget Survey published by the World at Work the low point for salary budgets was 2.2% in 2009, when the full force of the downturn that began in 2007 was felt. Since then the budgets have slowly increased to 3%, where they are projected to stay for 2019.

With unemployment being as low as it is in the U.S. it has surprised many that pay levels have not increased at a more rapid rate. Possible explanations have been plentiful but whether it is uncertainty on the part of organizations or some other factor the historically low rate of 3% does not provide the resources required to reward performance adequately… at least in the way most organizations have allocated budgets. Over the last 45 years salary budgets have on average exceeded the inflation rate by 1%, which offered organizations the latitude to keep raises larger than the cost of living. But during the 2005-11 period the gap between inflation and budgets was less than 0.5% (the exception was in 2009 when inflation was zero or negative). Since 2016 there has been a gap of less than 1% between budgets and inflation.

Given the current realities the question facing most compensation planners is how to optimally allocate the 3% budget. Since inflation was 2.4% in 2018 and is not expected to change much in 2019 organizations will struggle to increase real wages for their workforce by much. A second challenge has been moving employees through established salary ranges at a rate the convinces employees they are being fairly compensated. Since structures are typically anchored by tying the range midpoints to competitive averages prevailing in the labor markets an employee who has been in a job for at least five years and performed well will be likely to believe that (s)he is entitled to be paid at or near the midpoint. Making that happen given the current realities is a big challenge.

Optimal Allocation of Budgets

Most organizations using merit pay systems, the most common form of pay for performance, create guidelines to help managers allocate the budgets they are given. An example of a model for guiding increases is shown below. The assumptions are:

  1. a 3% budget,
  2. pay rates are evenly distributed across the pay range, and
  3. performance ratings are distributed as indicated in the table.

There are two principles underlying this approach:

  1. People who perform at higher levels should receive larger increases,
  2. Since increases are expressed as a % of current pay those in the lower part of the range should receive a higher % of their relatively low pay than those in the upper part of the range whose pay is significantly higher. If both parties were to receive the same $ increase the effect would be similar. If an organization has a weak performance management system this approach will not work well, since measuring performance accurately is not possible. And if an organization does not believe in differentiating based on performance their system will not result in pay actions that motivate performance.

Many public sector entities still use automatic, time-based step increases, which ties pay adjustments to longevity rather than performance. These systems do not provide motivation to perform well and they do not work well when economic conditions vary. The U.S. President claimed to have frozen pay for federal employees in the GS system for two years during the economic crisis, but in fact only froze the pay structure. Employees still got 5% step increases irrespective of their performance, which cost taxpayers more than competitive market conditions would have dictated. And when pay rates escalate more during good economic times the step rate system fails to reflect the realities prevailing in the market. Over the last decade a large number of public sector entities have converted their step rate structure to open ranges that enabled them to align more closely with competitive practice.

Although the merit pay guideline model is widely used there remains the issue of how well the system motivates people to perform well. In the model shown here the increase for an outstanding performer is twice that of someone who meets standards, assuming their pay rates are in the same zone of the range. The relative size of the increases would seem to send the message that performance is valued and rewarded. But the absolute size of the increases is likely to be the focus of employee scrutiny. Is a 5% increase (which is only 2.5% greater than the increase for someone meeting expectations) adequate for someone who is in the top 10% and whose current pay rate is at or near market average levels? When that employee asks why the reward for “leaving it all on the field” was not greater one of the responses could be that the budget is small and that employees who meet standards should receive some reward, even though it is only half of theirs on a relative basis. If that outstanding performer has read a good book on compensation management they might respond by saying someone who is at or near market and who just meets standards may not need an increase.

Finding the optimal allocation approach is important if employees are to view the distribution of budgets as equitable, competitive and appropriate. But there is no one “best” answer for an organization. There are other ways to approach allocation. One is to introduce performance-based cash awards. If pay rates are reasonably in line with competitive levels further base pay increases increase fixed costs, since pay adjustments are career annuities in most cases. By allocating 1% of the 3% budget to performance-based cash awards the approach shown below can provide a greater reward for performance. It also reduces the rate at which payroll cost is compounded.

This approach increases the impact of performance ratings on awards and for that reason it should not be considered if the performance management system is not well designed and accepted as sound by the parties at interest. Hooking up higher current appliances to old wiring may not be wise and differentiating this dramatically based on performance ratings should be considered only when those ratings are trusted.

A final option when there is considerable uncertainty about the organization’s short-term economic outlook is to replace base pay increases with cash awards, at least in the short-run. This avoids increasing fixed costs and receiving the award in one lump sum may be more attractive to employees than working the whole year to get the full amount.

Organization culture will certainly impact decisions about how to allocate budgets. So will the nature of an organization’s revenue stream. If revenue is highly variable spending the budget for base pay adjustments increases fixed costs and that can cause a misalignment between revenue and costs… not a good long-term strategy. If revenues fall dramatically and management decides payroll cost must be frozen or even reduced another set of issues arises. Payroll reductions can be accomplished by reducing pay rates or reducing staff size. I was asked by the HR Director of a city how they should reduce payroll by 1.5% without terminating employees during a crisis period. The person was astute and realized that given the costs associated with terminations would probably outweigh the savings in the short run (see Responsible Restructuring by Wayne Cascio for an excellent treatment of these issues). We discussed ways of reducing pay rates, the last option on the table, and decided they could cut the rates of the highest paid people by 3%, those in the middle by 1.5% and not to cut the pay of those closest to subsistence level. But the complexities of executing that strategy were daunting and another option surfaced. Employees were contributing only 5% to the cost of health care benefits, when the competitive range was more like 20-25% of the cost, so increasing the contribution rate could produce the savings needed. This was an approach that had the double benefit of avoiding pay cuts and also adjusting the employee contribution share to a more reasonable level. Pay cuts can be viewed as a breach of an emotional, if not legal, contract and the prospect of cutting pay can spur ingenuity by compensation practitioners.

The good news would be that everyone is in the same boat, struggling with allocating small budgets optimally. But that is of course not the case. Some organizations are in a position to budget more for awards, whether they be in the form of base pay increases, cash awards or even equity. The playing field is not level. Each organization needs to compete for talent in a manner that fits their realities. Some may choose to differentiate across the workforce, rewarding people in critical occupations that are in short supply more generously. Although that can raise equity issues economic realities may mandate it. To reiterate my favorite principle: what works if what fits… a specific organization at a specific time.