How Do We Link Performance Measures To Pay?

Most companies gauge performance using a variety of financial measures, although performance scorecards have been widely adopted during the past few years.

 Which type of measures do companies typically use to gauge performance, and how are those measures linked to pay?

—Connecting the Dots, senior vice president of HR, software/services, Hyderabad, India

Dear Connecting the Dots:

Traditionally, most companies gauge performance using a variety of financial measures. These include such items as net revenue, operating income, earnings before interest and taxes, return on assets and return on equity. Performance is typically assessed as compared with annual targets, which are determined by owners of the business. Generally, some or all of these financial performance measures are incorporated into incentive pay programs that provide varying levels of awards. These awards are calculated by comparing actual performance of the company (business unit, department, etc.) with predetermined threshold, target and outstanding performance expectations.

However, financials are not the only performance measures, simply the more common ones. Indeed, they are at best lagging indicators of performance. Many companies are recognizing this and adopting measures that are more predictive of, and useful for, managing business success. About 10 years ago, the concept of balanced scorecards emerged--a system that uses four general categories of performance metrics: financial, operational (internal), customer and learning/growth.

We've already detailed some standard financial measures. Operational performance includes measures such as cycle time, labor productivity, cost reduction and new-product return on investment. Customer performance is typically measured through customer retention and satisfaction, market share and customer profitability.

Finally, learning and growth goals include skill and competency acquisition, employee engagement, technology use and training, and organizational alignment. By focusing strategically on critical quantitative, non-quantitative, internal and external performance measures, management can monitor overall business success in a "balanced" fashion. Metrics provide the snapshot of how you are performing as well as clarity of priorities, depending upon the timeliness of the information. Metrics can easily be cascaded down to work units and even to individual employees.

Performance scorecards have been widely adopted during the past few years, with varied experiences. For performance measurement to be useful and meaningful, your company must adopt two other business processes. First, metrics must be combined with business-process improvement systems, such as Six Sigma. This allows you to effectively address metrics that are headed in the wrong direction. Making business-process improvement part of the arsenal is absolutely a key in making this effort a success. Involve every employee in this initiative.

Second, companies should tie these balanced performance measures to bonuses and longer-term incentives for executives, managers and employees. Many firms use the cascaded/integrated goal-setting process I mentioned previously, through which everyone in the organization in some way supports overall business goals. An employee's total compensation is thus tied to business success, but in a way that gives them "line of sight"—a direct view of how their performance affects that of the company. The best companies thus integrate business and pay strategy. They understand that an integrated scorecard for performance management fundamentally is about culture and business success, not compensation.

SOURCE: Bob Fulton, managing director, the Pathfinder's Group Inc., Naperville, Illinois, July 27, 2006.

Thanks to Crain Communications Inc. / Work Force