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"If the essence of performance management is to set and manage goals to move employees,
the essence of compensation is to keep capable people inside the company."
Since modern times, as companies have grown larger, gone global, and divided their work — and as HR management techniques became more systematic — the dominant theme for executives worldwide has been how to deploy people more efficiently to drive higher performance. To answer the executives' booming demand for answers, countless economists and social scientists have repeated their studies. On the foundations of that research, modern companies have learned to check labor behavior by time and link it to compensation, to differentiate rewards by having superiors evaluate the performance of their subordinates, and to manage motivators and the elements that satisfy minimum baseline needs as separate categories.
Among the cases of companies raising their performance by evaluating people, the most famous is undoubtedly GE. Former GE CEO Jack Welch ran a high-intensity restructuring to save GE from its management difficulties, and in the process he placed every employee in a single line — and used the so-called "10% rule," which exited the bottom 10% every year — to maximize the results of restructuring.
From then on, the practice of separating low performers through relative evaluation became the foundation of performance evaluation in every organization. Most companies divided employees into evaluation grades through a five-tier rating distribution, and as GE did at the time, it became common sense that high-rated employees would receive promotion and high compensation, while low-rated employees would receive low compensation or be moved into roles that effectively pushed them out.
More recently, however, company workforces have become further segmented and specialized, and corporate forms have moved away from large bureaucratic organizations toward flexible combinations of small, purpose-driven units that are merged, distributed, and reshaped at a faster pace than before. Naturally, it has become harder to put every employee into the same line and compare their performance against each other. And yet, many organizations still cannot easily let go of this relativized evaluation framework.
The most important reason many companies still cannot escape the traditional evaluation method is not that it is the best — but more accurately, that "there is no alternative." Even though organizations have changed, jobs have segmented, and the cohort now called Millennials makes up most of the talent pool, companies still cling to the last breath of traditional evaluation while wondering and worrying about which vine they should grab next.
Recently, changes that make this period of contemplation even more urgent have been accelerating across organizations and HR. The most representative is the emergence of "agile organizations." An agile organization is a kind of "party" — like the ones in fantasy fiction — formed by gathering experts from different fields. They produce and manage tangible results at the team level and absorb the entire value chain needed to develop, sell, and manage a product, business, or service at the team level. They are given visible shared goals, and these goal-driven teams are bundled together at the business unit level for headcount and resource management. The goals a single team holds change moment by moment depending on progress. Rather than emphasizing methodology reviews, reports, and multi-stage decision-making processes through documentation, they prioritize building products and services that can actually function and finding improvement points from there to approach the substance. What moves them is engagement with shared goals, specialized role assignments, and agile management techniques (Scrum, Kanban, etc.) that share and manage the team in real time.
This kind of organizational change requires a much more flexible performance management approach than today's. If certain interim outputs are quickly completed and frequently put on trial, goal setting and management cannot remain fixed to an annual evaluation cycle as it is now. And when specialists from different fields gather to work — as in agile organizations — leaders cannot uniformly measure each individual's contribution against a common standard and assign ratings. Because these organizations have shared goals, their level of goal achievement cannot be quantified individually either.
In keeping with this, performance management has recently turned its attention to OKRs (Objectives & Key Results), made famous by Google. The biggest difference between MBOs — the representative of traditional performance management — and OKRs is "flexibility." OKRs encourage the achievement of frequent, non-standard outputs (Key Results) and accelerate the pace toward longer-term, directional goals (Objectives) through ongoing daily CFR (Conversation, Feedback, Recognition), naturally monitoring the process at the same time. This offers a different dimension of flexibility from the MBO approach of measuring goal attainment quantitatively through formulas, planning and reviewing within a given period (a year or a half-year). In other words, the OKR-led, continuous-performance-management-based evaluation system is the product of thinking about a method better suited to evaluating the recent reality of work — where outputs occur frequently and in non-standard form.
Even so, the speed of this generational shift is not yet fast enough. Even in the United States — where modern HR was born — only 10–20% of Fortune 500 companies have abandoned the annual performance review and are introducing absolute evaluation systems based on employee development and growth. In Korea, this phenomenon is even more pronounced: despite the changed environment, the vast majority of companies still treat traditional performance management as gospel. So if it is not the method of performance management itself, what exactly is the problem?
The problem is that wholesale replacement of the performance management method does not solve the issue. Performance management already serves as too important a pillar of corporate HR. The inputs for promotion, movement and assignment, and rewards all come from evaluation, and performance management is the foundation of evaluation.
Promotion, assignment, and rewards — all tightly entangled with evaluation results — are all problems of allocating limited resources to someone. Even if everyone's evaluation results are good, you cannot promote everyone, and you cannot give bonuses to every employee. The thing that solved this limited-resource allocation problem at its root, with great ease, was the relative-rating system. Through it, even when every single employee worked hard and exceeded their assignments, you could still queue them up, concentrate the raise budget on the top 10%, and reserve promotion opportunities for those who received an S grade.
But because compensation and promotion — which inevitably become everyone's concern — all flow from evaluation, this ended up contaminating evaluation itself. To smooth communication with employees, managers gave higher ratings to those with longer tenure or those who had been with the team for a long time, and gave new employees lower ratings without much choice. For the average employees in the middle, even when there was no clear basis for any difference in performance, ratings were distributed by "feel" to fit the guideline.
The errors that emerged in the rating system produced the fatal result of making employees distrust evaluation itself. In the short history of relative evaluation, that history has been a string of failures — to the point where today, only 14% of surveyed employees say they trust their performance evaluation results and find them helpful in achieving better performance. Recent research even shows that the relative-rating result itself further reduces motivation in employees.
What is more, the relative evaluation of traditional performance management already has a built-in disconnect from reality. Traditional performance management assumes that the distribution of employees' performance achievement follows a bell-shaped normal distribution. But many studies show that, in fact, very few people deliver high performance, and they deliver overwhelmingly higher performance than others — while the vast majority show roughly similar levels of performance. The problem is forcing them into five tiers and drawing lines between middle performers (who differ very little) and the rest of the high and low performers.
Because evaluation, having lost its credibility, is so tightly linked to rewards, differentiated compensation has come to be seen as failing to provide enough motivational effect for employees. Sensing this noise, companies — to defend the mission of improving performance — began to invest more resources in monitoring evaluators and tightly controlling their evaluations. Even though the essence of performance management is "what performance to manage," companies that became too sensitive to this noise began to obsess over "how to selectively manage only quantitative and objective performance."
As a result, every metric was required to be quantified, and questions about objectivity continued endlessly. The level of goals was forced to be set to a difficulty similar to that of peers and neighboring organizations. In the process, tedious tug-of-war battles between line workers and HR over the ambition and feasibility of goals took place. Only by doing all this, it was thought, could trust in relatively distributed ratings be restored. All of this came from believing we had to pursue the maximization of employee performance through differentiated compensation.
This belief — that we could motivate through differentiated compensation, which we held as truth without doubt — has its roots in fairly old management theory. F. Herzberg classified the factors that motivate people to work into two: factors whose absence is unpleasant (hygiene factors) and factors whose presence generates motivation (motivators). Compensation, common sense had it, belonged to the latter — the motivators. But more recent research has confirmed that compensation has the character of a hygiene factor — making people leave the company when it is insufficient — while it remains unclear whether it carries the character of a motivator that generates greater performance when ample. In other words, the belief that we can motivate and maximize performance through differentiated compensation may not actually align with reality.
To verify this relatively recent doubt, people have collected evidence. According to a 2019 Glassdoor survey, more than half of 5,000 office workers chose culture, not compensation, as the most important factor in workplace satisfaction, and according to other research, only 20% said differentiated compensation helps improve performance.
So what could be the most important alternative for filling these people's motivation? Frequent communication and timely feedback can actually get them to work. According to Gallup, when feedback was given once a week, the rate at which it was perceived as meaningful feedback was 5.2 times higher than when ratings were communicated once a year, motivation toward work performance was 3.2 times higher, and engagement with the workplace and the desire to stay were 2.7 times higher. The saying "praise can make even a whale dance" was not just empty talk. Continuous performance management can contribute to performance improvement on its own — without having to ride the vehicle of compensation.
Even after all this, there are still many obstacles to overcome before the real world can run on a new order. Just a few years ago, introducing continuous performance management was difficult — it required not only a change in employee perception but also infrastructure to monitor performance and track non-standard performance records that occur frequently. Recently, however, various continuous-performance-management tools, combined with powerful data analytics, are providing a great deal of help so that continuous performance management can be carried out by employees on PCs and mobile devices much more easily.
If there is one final challenge, it is: "Then how should compensation be decided?" This is still an unverified, uncharted area at many companies, but we can look at the following methods being attempted in the field.
As highly specialized jobs emerge and their value begins to circulate externally — forming a "job market" — the important benchmark for compensation has become the value in that job market. In countries where the job market is highly developed, and even in Korea, around rapidly growing industries, a job market is forming. In organizations like these, the scarcity and marketability of the job capabilities and skills an individual holds naturally become the key elements of compensation decisions — rather than differentiation based on individual evaluation results — and evaluation will function as a motivational device to deepen those capabilities.
Even at companies based on traditional industries with low job diversity, there are cases showing that breaking away from differentiated compensation and refocusing on the original function of compensation — maintaining employees' competitive pay — yields more positive results. At Lear, the U.S. auto parts manufacturer, after eliminating all traditional evaluation for its 110,000 employees and breaking the link between differentiated compensation and evaluation, leadership has assessed that there has been a remarkable increase in collaboration and work engagement.
Some companies, drawing on the characteristic of performance distribution discussed earlier — that a small number of high performers deliver differentiated results while the rest deliver roughly similar levels — give managers discretion to apply differentiated compensation only to those who create truly exceptional performance (and who are unanimously acknowledged as high performers). Microsoft also realized — by watching the Silicon Valley stars who had left Microsoft — how many top talents the long-running practice of relative-rating differentiated compensation had pushed out, and ultimately chose a new compensation distribution method focused on the small number of super-high performers.
A joint study by SHRM and Globoforce found that peer evaluation produced 35.7% more positive results for company performance than vertical evaluation by managers. The same study found that when companies spent an additional 1% of total payroll on mutual recognition and encouragement, 85% of organizations enjoyed a visible increase in engagement. Drawing a hint from this, some experimental organizations give employees a compensation budget they can give to others as a sign of recognition. Centered on startups with horizontal cultures, we can also observe approaches that distribute compensation decision authority to employees and run it in connection with gamification.
If the essence of performance management is to set and manage goals to move employees, then the essence of compensation is to keep capable people inside the company. So far, the marriage of the two has been a binding of one to the other. The time is approaching to let each find its own place again.