Chapter 10
Rewarding Performance and Change
Built-to-Change Strategy:
Link Rewards to Skills,
Knowledge, and Organizational Performance
Organizations get the behaviors they reward. Organizations that wish to perform well and change effectively need to create reward systems that emphasize both performance and change. Sounds simple, but it is not easy to do. It is also not what most organizations do. All too often they reward stability more than change, seniority more than performance, and job size more than skill development. B2change organizations must do it differently.
Seniority-Based Rewards
When it comes to creating a b2change organization, it is hard to think of a more dysfunctional practice than basing rewards on seniority. Despite this, the array of rewards that many organizations tie to seniority is vast. Some of the rewards are relatively trivial and minor, others quite valuable and important.
In the case of our employer, the University of Southern California, seniority determines seating at football games (an important reward to some). It determines parking space eligibility (an important reward to many), and it determines the level of benefit coverage, including free tuition. However, USC does not have the practice, common in many organizations, of giving formal rewards for key employment anniversary dates: no lunches, certificates, or other recognition awards.
Although we have not seen any studies of how common seniority-based rewards are today versus ten or fifteen years ago, our guess is that they are much less popular today. They fit well in a world where organizations try to build loyalty, and individuals spend their entire careers with the same organization. They fit very poorly in a b2change organization.
Seniority-based rewards make it hard to reward current performance, but more than that, they make it hard to motivate individuals to change. They also run counter to the reality that organizations may need to have layoffs, make staffing changes to develop new capabilities, or remove poor performers. It simply is not consistent to reward people for the length of time they have been with an organization while also downsizing and churning the employee population in order to create new competencies and capabilities. Most important, there is the inconsistency of rewarding something that the organization probably does not want—namely, a long-term employment relationship with all its employees. As we have noted earlier, a b2change organization may want this arrangement with some employees, but rarely with all.
One other problem with seniority-based rewards is that often they don’t lead to the retention of the right people. Individuals with valuable skills usually are not persuaded to stay to earn a seniority reward. There are exceptions, of course; seniority rewards may retain even good performers if the rewards are large enough.
One of us was made very aware of this when giving a talk at a large engineering firm. He made the point that seniority rewards rarely retain anyone, particularly good performers. He then asked the audience if, in fact, rewards for seniority were effective in retaining them—and a surprisingly large number of employees raised their hands. Astonished, he asked the audience what the rewards for seniority were. It turns out that one of them was rather valuable: a gold Rolex watch (worth approximately $25,000!) for twenty-five years of service. This is, of course, a far cry from the typical wall clock or plaque most organizations award for long service.
Just to be clear here, we are not arguing that b2change organizations shouldn’t reward people with greater seniority more than individuals with less seniority. What we are arguing is that rewards should not be given for seniority. They should be given because individuals are performing well or are core employees who are particularly valuable to an organization and, therefore, need to be rewarded so that they are inclined to remain. This can be done through performance-based reward systems and, as we discuss next, through rewards for the skills and competencies that individuals have.
Retirement plans are an example of a seniority-based system that b2change organizations can easily adapt to suit their purposes. Instead of defined-benefit plans that guarantee increases in retirement pay for each year of service, b2change organizations can utilize a cash balance program in which individuals and their organization make annual contributions to a plan that pays out based on the dollar amount in the plan at the end of the person’s employment. These plans can be structured to encourage individuals to stay, but they don’t have to be structured that way. They can vest early and be made portable. Remember, in a b2change organization, voluntary turnover can be a positive. People should leave when what they can do doesn’t fit the strategy. Thus a good b2change reward system makes it easy for the “right” people to leave.
IBM, AT&T, and Owens Corning are among the many corporations that have dropped their traditional retirement plans in favor of cash balance plans. A number of technology firms, including Apple, have no employer-funded retirement plans. They allow employees to contribute to their own plans, but they make no company contributions to a plan that serves to “lock in” everyone. The rationale for this is simple. They are not sure they want to encourage employees to stay around long enough to retire. They have a travel-light strategy of churning the workforce to get the best young technology talent for whatever technology is hot at the moment. The idea of building loyalty through rewarding seniority just doesn’t fit the b2change approach.
Merit-Pay Plans
Merit-pay plans are the most frequently used way to reward individuals for performance. Given their popularity, merit-pay systems must be effective—right? Wrong! The evidence is clear that in most cases merit-pay plans do little to motivate performance and often do not even help retain the right employees.1
The many different merit-pay plans that organizations use follow the same general model: individual performance is appraised, usually by a supervisor, and as a result of that appraisal an adjustment (almost always upward) is made to the employee’s salary. How large that adjustment is depends on the favorableness of the appraisal and the size of the budget for salary increases. The latter is usually strongly influenced by the labor market and inflation. (Generally, the higher the rate of inflation, the higher the budget.)
In addition, the size of raises is often influenced by how well employees are already being paid compared to others doing the same kind of work. If they are highly paid relative to others and to the market, they are likely to get a relatively small raise, even if they are good performers and retaining them is a high priority. If they are paid less than others and below the market rate, they are likely to get a relatively large raise, even if they are not outstanding performers. The rationale for this approach is that good performers only need to be paid so much in order to retain them; therefore a large raise isn’t necessary if they are already highly paid. On the other hand, good performers who are poorly paid relative to the market do need large raises if they are to be retained. This rationale is often true, but what about pay for performance and motivation?
Pay cannot be much of a motivator if, in order for an employee to get a “large” raise, inflation has to be high and the employee must be both poorly paid and an outstanding performer. Talk about a weak line of sight for most employees!
There is no ultimate scientific answer to the question of how large a pay change needs to be to motivate performance. Sometimes very small changes in pay can be powerful motivators if they are seen as a form of recognition. The same can be said for some nonfinancial rewards that have a low monetary value. For example, public ceremonies, certificates, and letters may be valued highly by some individuals, even though such forms of recognition are relatively inexpensive. That said, a good guess is that to be meaningful from an economic point of view, merit-pay increases must be at least 5 percent and probably must exceed 10 percent to be truly motivating.2
Merit-based salary increases typically become a permanent part of an individual’s pay. The hope is that this will lead, over a number of years, to a pay level that reflects performance. This can happen if an individual’s performance is stable from year to year, and for some it is. But individual performance often varies considerably over a person’s working life. As a result of performance changes, poor performers can end up with very high pay and outstanding performers with very low pay. This often occurs when a new employee performs outstandingly well and a longer-term employee performs poorly.
To justify their merit-pay amounts, organizations often end up delivering a very confusing message. In essence, they tell their highly paid good performers that continuing good performance will not result in particularly large merit increases because they are already paid well. To make this message palatable, firms tell their good performers to look at their total compensation level, not their merit increases, to see the relationship between their pay and their performance.
Conversely, high-performing new employees are told that they should not look at their total compensation but at their merit increase because it indicates how well they are performing. Obviously, at this point the simple idea of rewarding better performers with bigger merit increases has been lost.
The bottom line is that merit-pay plans rarely encourage individuals to change their skills or performance. There is not enough incentive in the system to encourage individuals to make a major change in their behavior, particularly for people who have been in their job for several years and are approaching the top of their pay grade. Even if new goals are set and new challenges are presented, they may not result in a significant change in the individual’s behavior.
Furthermore, there is little the organization can do to change someone’s reward level if that person is unwilling to support a change effort. It can withhold a merit increase, but this hardly has a major financial impact on an individual. Ultimately, a merit raise pay plan creates a situation in which the only way to punish people who are not supporting a change is to fire them.
One final comment on the effects of merit-pay plans: they tend to enhance the importance of promotion. Typically, the only way for an employee to get a large pay increase in a merit-pay system is to get a promotion, because there is a separate budget for promotion increases. From the employees’ perspective, promotion also has a second desirable effect; it moves them into the lower end of a new, higher pay range, thus making them eligible for larger merit increases if they perform well in their new job.
There is nothing inherently wrong with the idea of promotion as a positively rewarded and motivating event. It is a limited tool, however, in b2change organizations, as they are flatter and there are fewer promotion opportunities available. In addition, change often requires individuals to make lateral career moves and to learn new skills, two things that a promotion-based reward system doesn’t support.
Despite the fact that merit pay plans are not effective, most companies continue to spend large amounts of time every year deciding how to distribute merit increases. For many companies, the annual merit-pay plan process has become a corporate rain dance, accompanied by great ceremony, noise, and activity. B2change organizations can put their managers’ time to much better use than administering merit-pay plans. They simply aren’t worth the time and effort they take.
Bonuses
B2change organizations that want to motivate performance with cash rewards must use bonuses. An increasingly popular form of variable pay uses the results of a performance appraisal to determine the amount of bonus that is paid to an employee. This approach eliminates one of the major failings of merit pay: not enough money being available to motivate individuals. It does this by eliminating the annuity feature of merit pay, thus freeing up dollars to be used for variable pay.
The Impact of Bonuses
B2change organizations can use bonus pay to reward individual performance as well as to retain excellent performers. It is particularly effective at retaining new employees because they can almost immediately be paid at a high level if they perform well; they do not have to wait for a series of merit increases. It also has the advantage of providing a way to quickly reduce the total compensation of poor performers. Finally, it can make very clear the relationship between a performance appraisal judgment and the amount of someone’s pay. There is no need to explain how a person’s pay history affects his or her bonus.
Bonus plans are useful in b2change organizations, especially during reorientation and transformation. Individual plans that offer relatively large bonus opportunities can provide a powerful incentive for individuals to perform well and to change their behavior when a new strategic intent calls for it.
A bonus system that ties bonus amounts to change goals can be a particularly powerful driver of change. In some situations it makes sense to have one-time bonuses awarded at the completion of a strategic change. Using short-cycle bonus periods (for example, three months) that target change implementation can speed up the installation of major changes.
When an organization bases bonuses on such organizational performance measures as profit and market share, it creates not only a reason to perform but also a reason to embrace strategic and operational change. Our research shows that the implementation of change efforts that are directed at building capability—for example, total quality management, knowledge management, and employee involvement—are more effective when pay is based on organizational performance.3 Bonus plans that are funded based on organizational performance relative to competitors and market conditions are an effective way to alert employees when the organization needs to change. Failure to change means deteriorating performance and thus fewer financial rewards, so it is not a surprise that individuals are more focused on how to improve performance and are more willing to accept change when they are paid based on the performance of their organization.
The supermarket chain Whole Foods is a prime example of a company that effectively uses bonus pay. Their philosophy starts with the belief that there should be “no secrets.” In addition to releasing a flood of financial data to its employees, it releases pay data for every employee, including executives. This provides transparency and accountability with respect to all pay decisions.
Whole Foods combines public pay information with a distinctive bonus plan. Every four weeks, individual work teams (there are usually ten in every store) are assessed for productivity, and bonuses are awarded to them. This practice establishes a clear connection between the store’s performance and the rewards that the teams in the store receive. In addition to receiving bonus checks, employees are eligible for stock options. The company says 94 percent of its options go to its nonexecutive staff.
Design Keys
It’s easy to see how and why bonus-pay systems can be effective in b2change organizations. The hard part is figuring out how they should be designed. Critical decisions include deciding on the degree to which bonuses should be based on individual, group, unit, and organizational performance, what specific metrics to use, and how much of a bonus to award. These decisions can be quite complex, because they need to support the dynamic alignment among strategic intent, talent, information systems, and shared leadership. We cannot specify an “ideal” approach; however, we can provide several general guidelines to keep in mind when designing bonus programs for a b2change organization.4
First, remember that individual bonus plans are the most effective way to drive individual behavior because they provide the clearest line of sight between performance and reward. For them to be effective, however, they must be combined with the kind of well-designed performance management system we described in Chapter Five. Unfortunately, individual plans do a very poor job of integrating the behavior of individuals. If an organization uses teams and has a highly interdependent work environment, it should have a bonus plan that primarily rewards collective performance.
Second, if a line of sight can be established between what an individual does and the performance of the entire business or business unit, then basing part or all of any bonus payments on organizational performance makes sense. In general, a bonus plan based on the performance of an entire business has many advantages. It both motivates individual performance and causes people to integrate themselves into a high-performing unit—a key step in creating the kind of virtuous spiral that every organization would like to have. It also can stimulate change if an organization’s performance drops. Individuals get smaller bonuses and, as a result, want to know what happened and what needs to change.
In the best of all worlds, business-based bonus plans lead to pay well above market rates because the organization’s performance is above average. This occurs as a result of the plan’s effectively motivating everyone’s performance as well as attracting and retaining top-performing people—a true virtuous spiral situation.
Third, operating an effective business-based bonus plan requires that people be thoroughly educated in the bonus plan. They need to know how their performance is measured, how their behavior affects the entire organization’s performance, how the performance of the business is measured, and how they will be rewarded if different parts of the organization perform at different levels. When everyone’s bonuses are determined, employees need to see how the decisions were made and what the amounts are.
One final point about bonus systems: often the best way to reward individual behavior and organizational performance is to tie the size of the bonus pool for individual rewards to the performance of a business unit or the total organization. The performance metrics that are used at the organizational level can be traditional accounting measures, operational measures, or a change target. The advantage of creating a bonus pool based on organizational performance measures is that it reinforces both individual and collective performance. And, as we mentioned earlier, it can also help focus the attention of individuals on the external environment and on how the company is performing relative to that market.
Profit Sharing
Profit sharing is the oldest and most commonly used bonus-based approach to rewarding organizational performance. In 2002, fully 69 percent of the Fortune 1000 companies operated profit-sharing plans.5
Most profit-sharing plans use the company’s publicly reported earnings to determine the bonus payment made to employees. To create a line of sight for employees, sometimes certain costs are excluded from the earnings calculation. For example, interest and taxes are sometimes not considered; similarly, one-time extraordinary costs and write-offs are sometimes ignored.
Usually a firm has to achieve some minimum level of earnings to have a payout; earnings above this level fund a bonus pool that is divided among the eligible employees. The payouts to employees may come in the form of a cash bonus, or they may be used to fund a retirement account. The amount individuals receive is usually based on a standard percentage of their salary—although an individual’s payout may be modified based on his or her performance. This, of course, represents an effort to increase the line of sight for employees by adding an individual pay-for-performance component to the profit-sharing plan.
Profit-sharing plans have a number of significant strengths and weaknesses. Perhaps their greatest weakness involves their ability to motivate employees. In large and medium-size companies, it is extremely difficult to establish a line of sight between employee behavior and corporate profitability. As a result, profit-sharing plans typically do not have a significant impact on organizational performance.6
Simplifying and taking out uncontrollable factors when measuring earnings can help a little bit. However, in a company as large as Ford, or for that matter Hewlett-Packard, which for years had a profit-sharing plan, this is not likely to make a significant difference in employees’ line of sight. In contrast, profit-sharing plans can be significant motivators in companies with fewer than five hundred employees, because they can establish a line of sight.
Profit sharing, like any other variable-pay plan, is not universally attractive to all employees. It does introduce risk in an individual’s compensation package and therefore is unlikely to be attractive to someone who cannot tolerate risk or is suspicious of how business organizations deal with employees. That profit sharing is differentially attractive to individuals may not be a major problem for b2change organizations. Indeed, it may be an advantage because it can help attract the kind of employees they need.
The major reason why profit-sharing plans should be used by b2change organizations is their impact on the way people think about their firm. When a profit-sharing plan covers most members of an organization, it can stimulate interest in the company’s financial results and create an identity that is focused on performance.
Although profit sharing may not be terribly motivating in the sense of driving people to work harder, it may motivate them to pay attention to financial results and to try to understand the business. This effect occurs because employees want to understand what their bonus is likely to be, where it comes from, and how it is computed. This in turn contributes to employees’ having a better understanding of the organization’s business model and to more knowledgeable and profit-focused decision-making behavior.
Companywide profit-sharing plans also can have the effect of integrating the members of a b2change organization. When people have a “common fate,” they are much more likely to cooperate and support each other. When change clearly will benefit everyone through higher profits, people are less resistant to change—there may even be peer pressure to change.
Generally speaking, profit-sharing plans are not a must for a b2change organization, but they can be useful, particularly for smaller organizations, for organizations that want to use a bonus pool to reward teams and individuals, and for companies that for some reason cannot award stock to employees.
Stock Ownership
Two basic methods of creating broad-based employee stock ownership can be used by b2change organizations. The first is for employees to own stock through a company-supported program, and the second is to award them stock options. B2change organizations can use either method, but because they deliver somewhat different results that in several ways complement each other, there is a strong argument for using both.
The Impact of Stock
The effect of stock plans on the motivation to perform is likely to be less than the effect of profit sharing because the line-of-sight problem is even more severe. Stock prices depend on more than just the somewhat controllable financial performance of the company. They depend on the economy and on how the stock market evaluates the corporation’s earnings, intangibles, and future prospects. These factors are less subject to the company’s control than the company’s earnings are. Thus, even for senior executives, the line of sight in relation to the value of their company’s stock may be weak.
Corporations differ dramatically in how much of their workforces they cover with stock ownership plans. One study found that over half of U.S. companies that had stock option plans covered only senior executives.7 In the case of some of companies, the size of the stock option grants to senior executives is truly astounding. Millions of options are granted to senior executives, whereas none are given to most of the employees. This practice is not one that fits a b2change organization because it does not motivate individuals throughout an organization to perform at a high level and to support change.
The strength of stock as a motivator relates to the amount of reward that people can receive. Potential gains from stock programs as a result of improvement in an organization’s stock price are virtually unlimited. The amount of money earned by a number of CEOs during the 1990s and early 2000s puts the payouts from the major U.S. lotteries to shame. Literally hundreds of millions of dollars have been made by some CEOs as a result of their stock options.
As we noted earlier, if extremely large rewards are available, even a weak line of sight can have a definite effect on motivation. Thus there is a real possibility that at the very senior levels of management, stock options are an effective motivator. The same is unlikely to be true for the rest of the employees because they often have significantly fewer shares of stock and a much weaker line of sight.
Although it is not a particularly good motivator, what broad-based employee stock ownership can do is create a culture of ownership and cause people to focus on the strategic, business, and financial objectives of the organization. As a result, it can be a powerful integrator of behavior. As is true of broad profit-sharing plans, it can create a “common fate” culture that supports performance and needed change.
Broad-based stock ownership may be a better motivator of change than profit sharing. The company’s stock price often is a better indicator of future prospects than earnings. In fact, the stock price often goes down before earnings decrease. This in turn has the potential to stimulate change before performance actually declines.
Stock plans that offer employees the opportunity to profit substantially from stock ownership can be powerful retention devices for at least as long as employees are required to stay with the organization in order for them to exercise stock options or own stock. Once these dates are reached, the retention power of the stock plan disappears, often necessitating the creation of a new stock grant.
B2change organizations that have decided to retain and develop a core group of employees should be sure that these individuals get enough stock so that they have the incentive to remain with the company. One way to do this is to give them larger than typical grants of restricted stock.
The use of stock options and stock ownership is particularly interesting with respect to attraction. High-tech companies commonly offer stock options or restricted stock when trying to attract knowledge workers. In many ways this can create a win-win situation. When the company’s stock is performing well, there is good reason to believe that employees will value stock options at a level that is greater than the options’ actual value. Thus stock options are a cost-effective way to attract employees.
Now that companies in the United States are required to reduce their reported earnings when they make option grants, stock options are being used less frequently, but they still have some advantages, particularly for new organizations.
Support for Change
Broad-based stock ownership can be particularly useful in b2change organizations. When it comes to leading change, options give the leaders of a b2change organization a platform on which to stand and talk about the advantages employees will experience with a successful change effort. They can go beyond saying that change is good for the organization and say, “Change will be good for you because it will lead to improved organizational performance and an increase in your personal wealth.” It also eliminates the possibility of employees’ sitting back and saying, “Sure, it’s all right for him to argue for change because he’s a senior executive. He has an enormous amount of stock, but I don’t, so why should I listen to his call for change when it really is only going to benefit him?”
Broad-based stock ownership can also be a real positive in encouraging people throughout the organization to take on leadership roles in support of change. Being an owner carries with it a certain role and image that can encourage individuals to demonstrate leadership behaviors that support organizational performance. It is only when members of the organization develop the attitude of shared fate and shared responsibility that a company can truly be said to have a culture of shared leadership.
Even though W.L. Gore is privately owned, it is a good example of an organization that uses stock as a major feature of its reward system. Everyone who has worked there for at least one year receives the equivalent of 15 percent of their salary in stock that they can cash out when they leave. Because the firm is private and there is no market price for its stock, independent consultants evaluate its “phantom” stock and determine its price. Gore uses the stock and its potential increase in value as a way to build a virtuous spiral and encourage individuals to continue to reinvent the business.
Overall, the impact of broad-based stock plans on organizational effectiveness and change can be an important positive. Stock plans can encourage employees to learn more about the business and reinforce an identity of ownership.
Person-Based Pay
The distribution of financial and status rewards in most organizations is primarily based on the jobs people do. Indeed, with the exception of bonuses and perhaps merit pay, the standard policy in most organizations is to assess the size of the job, not the size of person, and then set the reward level. Big jobs—that is, those with high levels of responsibility—get big paychecks; small jobs get small paychecks. This definitely is not the best system to use in a b2change organization. To begin with, b2change organizations don’t have traditional jobs. Further, focusing on what a person does motivates individuals to develop their jobs rather than themselves and to resist change that threatens the worth of what they do.
A reward system that focuses on jobs does little to produce an understanding of the new skills and knowledge individuals need or, for that matter, an understanding of what new individuals the organization needs to develop new competencies and capabilities. It also typically offers little or no incentive to develop the new skills and knowledge that will help the organization change. As a result, when organizations with job-based systems need to change their capabilities and competencies, they usually end up either failing to change or having to replace most of their existing workforce.
When an organization is constantly changing, job-based pay systems are particularly likely to create problems. In the old steady-state organization, employees and management could come to a reasonable consensus as to what various jobs were worth. In the b2change organization, there are no traditional jobs, only clusters of tasks and activities, and these are always changing. As a result, it is hard to decide what is fair and to adjust pay accordingly. In addition, paying the job runs the risk of mispricing employees in the labor market, because the tasks they are doing at the moment may not represent their total capabilities and as a result may not reflect their market value or their value to their organization.
The solution requires a radical shift. Organizations need to pay individuals for their skills and knowledge, not for their jobs. In a work situation in which people have changing task assignments, paying the person is much more effective than paying the job. When all is said and done, it is people that have a market value, not jobs. People change companies for higher pay, not jobs.
A number of organizations, including PepsiCo and P&G, have adopted person-based pay. This system involves developing the type of person descriptions we discussed in Chapter Six and using them to determine pay. Person-based pay will not necessarily produce pay rates that are dramatically different from those produced in a job-based system. The skills people have usually do match reasonably well with the jobs they are doing. It will, however, result in some employees’ being paid more or less than they would have been paid under a job-based system, depending on their skills.
Perhaps the most important changes that person-based pay can effect are to organizational identity and employee motivation. Instead of being rewarded for moving up the hierarchy, people are rewarded for increasing their skills and developing themselves. This can reinforce an identity in which personal development and a highly talented workforce are receptive to change. It can be especially helpful when an organization needs to improve its competencies and capabilities, because the company can use rewards to encourage individuals to develop the appropriate skills.
In one respect, paying employees for skills, knowledge, and competencies is not a new idea; organizations have done it for decades. For example, most technical ladders in organizations and most faculty pay structures in universities are based on this concept. What is new is the idea of paying individuals throughout the organization—not just a few technical experts—according to their skills and knowledge in order to create a b2change organization.
One way of looking at pay based on skills and knowledge is that it uses the same money that would otherwise have been spent to reward employees for promotions and greater seniority. Typically, these pay increases are automatic and do little to improve performance.
A focus on the skills of individuals is highly consistent with a b2change management approach and a strategic intent in which individuals are a key source of competitive advantage. When people are an organization’s key resource, it is logical to focus on them and what they are worth. It also makes sense to focus on their growth and development so that they can add more value to the organization’s products and services.
Egalitarian Perquisites
The absence of hierarchical perquisites makes b2change organizations easier to change. Perquisites, like pay programs that are tied to jobs and management levels, strongly reinforce a hierarchical orientation and a career mentality of upward mobility. Hierarchical perquisites are symbols of power and as such often make it difficult to move decision making to the lower levels of an organization when they belong there.
Does being a b2change organization mean having no perquisites? Not necessarily. What it does mean is that perquisites must support performance. Clearly, some people need offices and others don’t. Clearly, some people have greater needs to travel than others and face risks in travel that might warrant special accommodations.
Perquisites make sense when they support the work someone is doing and when the process for allocating them is transparent. When perquisites are allocated based simply on hierarchy and position in the organization, they are dysfunctional and have no place in a b2change organization.
Rewards for Risk Taking and Innovation
Earlier we noted that most organizations have great difficulty creating new businesses and capitalizing on new technology when it comes from their internal R&D processes. One of the major causes of this problem is that organizations find it extremely difficult to reward risk taking.
We remember interviewing a senior manager at a company that was having trouble getting a new business model going. It involved combining several new products with a traditional product. In essence, it promised to revolutionize the company’s stores and brand. When the manager was asked why he was having trouble getting the new concept in place, he said that most employees enjoyed long-term employment and steadily growing rewards. For them there was no reason to take a risk by championing a new strategy.
Rewarding risk taking and innovation requires companies to treat people who are taking risks very differently from other members of the organization, which in turn inevitably leads to issues of fairness. But that doesn’t mean it can’t be done. Senior leaders need to insist that risk taking and innovation be rewarded, and they must defend the practice as critical to the survival of a b2change organization.
In the post–Jack Welch years at GE, Jeff Immelt has had to work hard to introduce more risk taking to GE. Under Welch, GE developed capabilities focused on quality, costs, and deal making. Immelt wants to develop capabilities that lead to internal growth. To change the focus at GE, bonuses are now tied to coming up with new ideas that support growth and customers’ needs.
Google is one company that acts on its belief in the importance of rewarding innovation and change. It gives out large amounts of stock to employees who complete innovative projects. The first two of these “Founders’ Awards” consisted of giving out restricted stock that was worth $12 million in late 2004 when the awards were made. The stock went to two teams of a dozen or more employees each. Both of the teams had done an outstanding job of coming up with an innovative new product. The stock vests gradually over four years, thus acting not only as an incentive for innovation but also as a targeted retention device that rewards Google’s most valuable employees for staying on board.
Sergey Brin, Google’s cofounder, says that Google created the Founders’ Award to motivate its employees to be innovative and to encourage people to join Google. Now that the dotcom era is over, it is hard for innovative individuals to come up with new business ideas that will be funded by venture capitalists and make them millionaires. Google sees this as an opportunity. It hopes that it will continue to be organization that attracts innovative, entrepreneurial individuals by offering the potential to become millionaires. It recognizes that individuals want to be rewarded for the success of their projects and that rewards can both attract the right people to work for Google and motivate their performance once they get there.
Google has always offered bonuses and options to employees, and indeed many have gotten quite rich as a result. But the Founders’ Award raises the potential for wealth to a completely different level; employees can make the kind of money that is comparable to what might be gained from succeeding with a start-up. Clearly Google has recognized that the impact of a reward is partially a function of its size. The company can’t be accused of putting very little on the line to encourage employees to innovate.
As we mentioned when we discussed new ventures in Chapter Four, they need special systems that tie large rewards to the success of the business. Often the right reward systems can be created only by having separate business units. In this way, organizations create units that are not handicapped by the obstacles that typically hold back the entrepreneurial spirit in the existing organization.
It is hard to overstate how difficult it is for many organizations to start entrepreneurial units that truly are given the freedom to reward individuals highly for developing new businesses. We worked with a new business unit created by a large paper company to commercialize a new technology that it had developed. The company gave the managers of the unit considerable flexibility when it came to work practices and a number of other issues. When it came to the reward system, however, the firm failed to create the kind of entrepreneurial reward system that compensates high risk with high reward.
Virtually all the employees were kept on the company payroll, and it was made clear to the individuals that if the new venture failed, they would be welcomed back to the existing organization. It is easy to understand why the organization made this decision, but it had a negative impact on the motivation of the individuals in the new unit. They did not develop the kind of fire and commitment to the unit’s success they would have had if they were truly owners of the business and had their future tightly tied to its performance.
Dealing with Failure
A key reward issue in almost every major organizational change is the consequences of failure. All too often, organizations don’t distinguish between good failures and bad failures. They treat all failures as though they were the same and learn few lessons. If an organization continues to experience failures that it does not treat as opportunities for learning, the company becomes increasingly unwilling to take “good” risks and does not operate as a b2change organization.
The solution is easy to state but often difficult to put in place: reward good failures and learn from all failures. Doing so usually takes strong leadership and reward systems that are designed to reward learning and change.
Earlier we made the point that organizations starting new businesses need to establish specific goals and tie bonuses to the achievements of those goals. It is often useful to add another dimension to the reward plans of b2change organizations: a separate reward that is contingent on sharing the learnings from every new business regardless of whether or not it is successful.
The negative consequences of failure are the major reason why individuals don’t take good risks. If the punishment for failure is certain and fatal, it’s unrealistic to expect individuals to share what they learned from the failure, much less to champion major change efforts.
There is no question that bad failures need to have appropriate consequences, but sometimes failure occurs simply because of an unpredictable change in the business environment or a strategic change in the organization’s direction that could not have been anticipated. In these cases, b2change organizations need to reward the individuals who championed the change if they performed well in implementing it. This is particularly true, for example, when new products are introduced and for various reasons abandoned. A classic example of this is the pharmaceutical industry, in which many, many compounds are developed but only a few ultimately reach the market. In businesses like this, it is particularly important to reward individuals who do good research and develop knowledge even if the products ultimately never reach the market.
Conclusion
We began our discussion of rewards by pointing out that organizations get the behaviors they reward. We noted that traditional reward systems support stability and reinforce a traditional hierarchical organization structure. What traditional reward systems do not lead to is a b2change organization. The inescapable conclusion, therefore, is that organizations that wish to be high performance and b2change need to employ significantly different reward systems than the ones commonly used.
B2change organizations need reward systems that motivate performance, reward change, and encourage the development of individual and organizational capabilities and competencies. Paying the person instead of the job and using variable pay and stock are the most powerful changes an organization can make in moving its reward system toward one that supports performance and change. Decreasing the rewards for seniority and hierarchical position are important and desirable positives, but they are not likely to be as powerful as redesigning the system to reward individuals for their skills and their performance.
Of all the changes we have discussed, the most important is the shift away from the job and toward the individual as a basic building block of an organization’s design. Getting rid of job descriptions, which we advocated earlier in the book, is one step toward reducing the importance of fixed jobs. However, when organizations make the leap to rewarding individuals for their skills and knowledge, they have done something even more significant. They have reinforced the b2change approach and focused organization development efforts on an organization’s competencies and capabilities.