Making Performance Work (BetaCodex10)

1. Make it real! MAKING PERFORMANCE WORK Whyperformancesystemshavetochange,andhowyoushouldapproachthis: Fromfixedtorelativeperformancecontracts,andtowardssimple,ethical andempoweringwaysofdealingwithvaluecreation 10 BetaCodexNetworkAssociates NielsPflaeging&GebhardBorck&AndreasZeuch WhitepaperJan2009–RevisedandextendedDec2011andFeb2013

2. WhatistheproblemwithPerformanceManagement asweknowit? Almosteverything. Thispaperexploreswhymost PerformanceSystemsarebroken, andhowtoreinventthem.

3. Traditionalmanagementprocesseskeepteamsfromstrategic thinking,andmotivatecounterproductiveorunethicalbehavior Financialproblems •  Processtakestoolong •  Plansbecomeobsoletequickly •  Plansareoflittleornouse Vision Targetsand strategicguidelines Strategicproblems ProfitabilityinpetrochemicalindustryinEurope 600 500 •  Targetnegotiation •  Definitionofincentives •  Activityplanning •  Resourceallocation •  Coordinationofplans •  Approval 400 300 Fixed 200 performance contactsand “keepontrack” 100 0 198419861988199019921994199619982000 Source:ChemSystems Behavioralproblems Budget Performancecontrol (plan-actual) Bonus (vs.targets) ... Source: BBRT

4. Managementprocessesincommandandcontrol organizationsare“straightjackets” “Fixed”performancecontract Strategy •  Period •  Targets [Fixed] [Fixed] Strategic learningcycle •  Compensation •  Plan •  Resources •  Coordination •  Control •  Agreedthrough [Fixed] Annualplan Fixed Performance Contract [Fixed] [Fixed] Budget [Fixed] [Fixed] Management controlcycle [Negotiation] •  Signedby: [Manager/Director] Control Tayloristicmanagementworkslikethis:Ascentralistic-burocratichierarchies, heldtogetherthrougharegimeoffixedperformancecontracts! Source: BBRT 4

5. Currentpracticesaremisalignedwiththe CriticalSuccessFactorsoftoday'scompetitivemarketplaces Six“CriticalSuccessFactors” Sixexamplesofmisalignment •  Fastresponse ?  Annualplanningprocessretardsit ?  Centralizedbureaucracystiflesit •  Innovation ?  ‘Spend it or lose it’mentalityfightsit •  Operationalexcellence ?  Shorttermtargetspreventit •  Customerintimacy ?  Extrinsic‘motivators’undermineit •  Bestteam ?  Dysfunctional,evenunethicalbehaviour conflictswithit •  Ethicalbehaviour • Valuecreation • Inferiorfinancialresults Whenpressureis applied,misalignment getsworse!

6. Ourprofoundlyflawedapproachtodealing withpresentperformance,andthefuture Aboutfuturizing,planning, forecastingandstrategy

7. Canyoureadthefuture,fromthebottom ofacupofcoffee?Ordoyouhaveacrystalball thatletsyoutolookintothefuture?Canyou readthecardsandseewhatwillhappennext year?Well,ifnoneofthisactuallyworks, andifweacceptthatit´simpossibletopredict thefuture,thenwhydowestillspendmassive energyandtimeonformaltechniquesthattry toachievejustthatforbusinesses?

8. Companies. Don´t Need.Period. Planning.

9. Asmallelitegoverningthe powerlessmasses.Aneconomic systemheldtogetherbytight planning,andcontrol.Mistrustin entrepreneurialinitiative. Thosewerekeyfeaturesofthe sovietunion. Nowguesswherethiskindof governanceremainsinplace today:Itistheworlds corporationsandsmalltolarge- sizefirms.Itisjustthatwecall thepracticeof“management”.

10. Organizationsneedatrust-basedformof“future-directed thinking”,notplanning-basedcommandandcontrol Thesecretofsuccessisnottoforeseethefuture. Buttobuildanorganizationthatisabletoprosperinany oftheunforeseeablefutures. Michael Hammer

11. Wehavecometobelievethatthesourceofgreatperformanceisgoodplanning.ButplanningWehavecometobelievethatthesourceofgreatperformanceisgoodplanning.Butplanning actuallynever (ever!) isthesourceofperformance.Preparationis.Whileplanningmeans fiddlingwiththefuture (inyourhead),preparationmeansdoingtherealwork,bybecomingfit forperformance.Itenablesindividualsandteamstoachievehighperformance. JustlikeinaRacingTeam.Thesituationpicturedhereisafineexampleofacasewherehigh performanceisproduced,andinfactrequired.

12. Ifyouthinkaboutit,aFormula1teamdoesnotrelyonintenseplanningatall.ButonIfyouthinkaboutit,aFormula1teamdoesnotrelyonintenseplanningatall.Buton intense,andhighlydisciplinedpreparation.Thingsthatteamslikethisindulgeinare: • All-teammastery:Everyteammemberhastobeamaster.Noexception.Thisenablesthe teamtosenseandrespond.Toimprovise.Tobeintuitive.High-performanceteamsoften haveano“baby-sitting”culture,internally. • Trying.Trying.Moretrying.Youcannotrunenoughtestraces.Sciencecallsthis “deliberatepractice”Thisismorethanjustpracticing.Infact,sciencealsoshowsthat “talent”iscompletelyoverrated. • Intenseandopencommunicationflow.Everyoneisalwaysuptodate. • Ritualsforgroupcohesionandacultureaimedatwinningtogether,notindividually. Thesecharacteristicsaretypicallylargelyabsentfromlargerorganizations.Askyourselfwhy.

13. Awiserapproachthanplanning “Iwillprepare myselfand mytime mustcome.” AbrahamLincoln, lawyer,statesman

14. ApplyingtheBetaCodexmeans: Fromfixedtoadaptivemanagementprocesses Traditionalmodel“Alpha”: fixedperformancecontracts, negotiatedinadvance Newmodel“Beta”: :relativeperformancecontracts, assessedwithhindsight) Relative performance contracts strategy Changing processes Fixed performance contracts Dynamic coordination control •  Fixed,annualprocesses •  Fixedtargetsandincentives •  Centralizedand bureaucraticcontrol •  Dynamic,continuousprocesses •  Relativetargets/compensation •  Self-control,transparencyand peerpressure

15. Theunderlyingissue Abouthumannature,motivation,andthefrequently misunderstoodperilsofcontemporaryHRpractices

16. Butthereisafurtherchallenge.Whichiswhymosttheoriesabout leadership,aswellasmostadvicefromconsultants,areflawed... Onecannottalksensiblyaboutleadership,orpeople management,nordesigndecentmanagementprocesses, unlessweclarifybeforehandourbeliefswithregardstowhat peopleinorganizationsarelike. Wehavetoarriveatasharedunderstandingofhuman natureandoftheconsequencesofthatforourorganizations. Niels Pflaeging, Leading with Flexible Targets

17. Mostperformancepracticesaredeeplyflawed... TheoryX vs. TheoryY DouglasMcGregor

18. Theindustrialagemanagementmodelnotonlyfailsbecause marketshavechanged.Itisalsomisalignedwithhumannature “TheoryX” “TheoryY” Attitude Peopledislikework,finditboring, andwillavoiditiftheycan. Peopleneedtoworkandwanttotakeaninte- restinit.Underrightconditions,theycanenjoyit. Direction Peoplemustbeforcedorbribed tomaketherighteffort. Peoplewilldirectthemselvestowards atargetthattheyaccept. Responsibility Peoplewouldratherbedirectedthan acceptresponsibility,whichtheyavoid. Peoplewillseekandacceptresponsibility, undertherightconditions. Motivation Peoplearemotivatedmainlybymoney andfearsabouttheirjobsecurity. Undertherightconditions,peoplearemoti- vatedbythedesiretorealizetheirownpotential. Creativity Mostpeoplehavelittlecreativity-except whenitcomestogettingroundrules. Creativityandingenuityarewidelydistributed andgrosslyunderused. BasedonDouglasMcGregor,‘TheHumanSideofEnterprise’,1960

19. DoyoubelieveinTheoryY? Firmly? Good.Becausewearesurethenyouwouldnever, everpractice (orsupport,ortolerate) HRprocessesandtoolsthattreatpeoplelike children,oranimals,orworse.Right?Suchasperformance appraisals,individualtargetsetting,incentivecompensation, meritocracy,orcontrolofwork-hours…

20. Question: Howoftendothesystems, especiallytheHRsystems, getinthewayofchange,transformation, visionandstrategicthinking? Answer: Fartoooften. HistoryoftenleavesHRpeopleinhighlybureaucratic personnelfunctionsthatdiscourageleadershipandmake alteringhumanresourcepracticesabigchallenge. Source: based upon John Kotter, Leading Change, p, 110-111

21. DoyourHRsystemsmakeitinpeople'sbestinterestto implementyournewvision? WhatismeantbyHRsystems? ?  Performanceappraisal ?  Compensation ?  HiringandPromotions ?  Successionplanning ?  ... Mostoften,examinationofafirm'shumanresourcesystemsreveal: ?  Performanceevaluationprocesseshavevirtuallynothingtodowithcustomers orstrategy–yetthatistypicallyatthecoreofanewvisionormanagement model ?  Compensationdecisionsarebasedmuchmoreonnotmakingmistakesthan oncreatingtherightandusefulchange ?  Promotiondecisionsaremadeinahighlysubjectivewayandseemtohaveat bestalimitedrelationshiptothechangeeffort ?  Recruitingandhiringsystemsareadecadeoldandonlymarginallysupport thetransformation Source: J. Kotter, Leading Change, HBSP, p, 110-111

22. Performance&Pay Aboutbonuses,incentives,andpay-for-performance schemes–andwhytheycannotwork.Alsointhis chapter:Practicalrecommendationsforhowtocreate betterpaysystems

23. Let'sstartwithcompensationthen. Firstofall,let'sbeclear.Carrotsdon'twork. Theymightbeattheintellectofdonkeys.Buttheycertainly don'ttrickhumanbeings,whoallhave“TheoryY” wiringinsidethem.Incentivessimplydon't haveapositiveinfluenceonorganizational performance.Period. Sowhydosomanyofusstillapply inthecarrot-and-stickmethodwithpeople?

24. Real-worldstoriesontheeffectsofperformancemanagement ThecaseofMarieTaylor Thisiswhathappened: MarieTaylor,asalespersonfromourorganization,generatedincome thatgoesagainsthercompany´sprinciple“Alwaysacttothebenefit ofourcustomers“. Thedecision:MarieTaylorwastransferredtotheinternalsales supportdepartment.Allherbonusesrightswereimmediately cancelled. Thebackdrop: Itistrue–allsalespeopleinthefirmwereobligedtoactintheinterestof theircustomers.AndMariedidnotactaccordingly. Butitisalsotruethat40%ofMarieTaylor´ssalarydependedontheamount ofnetsalesshegenerated.

25. Real-worldstoriesontheeffectsofperformancemanagement ThecaseofFrankMiller Thisiswhathappened: FrankMiller,aconsultant,overchargedduringhisworkwith clients,whichmeanshesystematicallyinflatedtheamountof hoursworkedchargedtohiscustomers. Thedecision:FrankMillerwasfiredandleftthecompany immediately. Thebackdrop: Itistrue:FrankMilleractuallyactedagainstthelawbychargingformorethan hehadreallyworkedforathisclients. Butitisalsotruethat25%ofFrankMiller´sincomedependedonthehours chargedtoclients…

26. Anexample:“motivation”,or“threat”? Whatcompensationsystemsreallydo... Systemwithno variablecompensation Systemwithvariablecompensation (bonus,incentive,etc.) 30% Variable compensation 100% Basesalary 100%:Total compensation expectedby employee. 70% Isthisan“energizing promise”,orisit justapitifulthreat? Basesalary “Wehaveanaggressivepay philosophy:30%ofyourtotal compensationwillbepaidinformof abonus.ThetotalisUSD 100.000,00,bytheway.“ “Wehaveaconservativepayphilosophy. Yourbasesalaryequalsyourtotal compensation,whichisUSD 100.000,00.“

27. SocialscientistAlfieKohnsays: Iamarguingagainst….. (1)  attributingmoreimportancetomoneythanitactuallyhas, (2)  pushingmoneyintopeople'sfacesandmakingitmore salientthanitneedstobe,and (3)  confusingcompensationwithreward (thelatterbeingunnecessaryandcounterproductive). Theproblemisn'twiththedollarsthemselves, butwithusingdollarstogetpeopletojumpthroughhoops.

28. And: Pay-for-performanceisanoutgrowthofbehaviorism,whichis focusedonindividualorganisms,notsystems-and,truetoitsname, looksonlyatbehaviors,notatreasonsandmotivesandthepeoplewho havethem. ItellFortune500executives (oratleastthosefoolishenoughtoaskme) thatthebestformulaforcompensationisthis:Paypeoplewell,paythem fairly,andthendoeverythingpossibletohelpthemforgetaboutmoney. Howshouldwerewardourstaff?Notatall!Theyarenotourpets. Paythemwell,respectandtrustthem,freethemfromdisturbance, providethemwithallavailableinformationandsupporttoperform onthehighestpossiblelevel. 1.  Paypeoplewell 2.  Paypeoplefairly 3.  Andthendoeverythingpossibletotakemoneyoffpeoplesminds! Allpay-for-performanceplansviolatethatlastprecept!

29. 1verysimpleprinciple: Neverusebonusesandincentives. Applyprofitsharingand/orshareholdingconcepts forconnectedness.

30. Let´sleavecompensationmythsbehind! Wefoundnosystemicpatternlinking executivecompensationtotheprocessof goingfromGood to Great. JimCollins, From Good to Great, 2001 Individualincentivepay,inreality,under- minesperformance–ofboththeindividual andtheorganization.JeffreyPfeffer, Six Dangerous Myths about Pay, HBR 1998 Spendingtimeandenergytryingto “motivate”peopleisawasteofeffort... Thekeyisnottode-motivatethem. Jim Collins, From Good to Great, 2001

31. 1verysimpleprinciple: Alwaysdisconnectcompensationfromtargets. Always.

32. Theproblemwith“incentives”:Howtraditionalmanagement systematicallyforcespeopletocheat Bonus limit Bonus hurdle Variable area “Ceiling” Commonpractice: “Payforperformance“ compensation profilewithfixed performancecontract: Createsmaniuplation incentiveinanysituation! Reductionin- centive:Lower resultmore! Maximization incentive:Anticipate results Reductionincentive: postponeresultsto nextperiod Salary/ bonus Basesalary 80% oftarget 100%: target 120% oftarget Performanceas% oftargetrealization Abettermodel:Result orientedcompensation profilewithrelative performance contracts: Noincentiveto manipulation. Linearcompensationcurvewithoutbreaks: variablecompensationbecomes decoupledfromtargets Salary/ bonus Freefrom incentivetomanipulate Actual result#1 Actual result#2 Actual result#3 Performancein relativeevaluation Source: Michael Jensen

33. 1verysimpleprinciple: Paytheperson.Nottheposition. Always.

34. Variablecompensation:Unbundlingfixed,individualpayfor performancecontractsinfavorofrelativeteamimprovement BetaCodexprinciplesadvocatebasingevaluationandcompensationon relativeimprovementcontractswithhindsight, ratherthanfixedperformancecontractsagreeduponinadvance. Informulatingacompensationpolicy,theBetaCodexmindsetleadsto eightkeyrecommendations: 1.  Usethelanguageandthinkingofgainsharing,notincentives. 2.  Alignpaywithstrategicmeasures,notbudgets. 3.  Basecompensationonrelativemeasures,notfixedtargets. 4.  Measureandreward (ifneeded) theperformanceofteams,notindividuals. 5.  Alignpaywithinterdependentgroups,notparochialinterests. 6.  Useclearandtransparentmeasures,notunfathomablenumbers. 7.  Makecompensationfairandinclusive,notunfairanddivisive. 8.  Tohighlightoutstandingcontributions,usecompanyvalues,notthenumbers.

35. Conclusions: Allemployeesshouldearna shareofthefinancialsuccess: Restrainfromtheideaof “motivatingthem“! Organizationscanfreethemselvesfrom conventionalformsof“payforperformance”, throughsimpleandmoretransparent compensationsystems.

36. Resourcecoordination,reinvented Afewwordsabouthowtoemployresourceswell, withoutthemanaging

37. Resources.Whatmostorganizationsdowiththemisbasicallythis: Onceayear,theydefinethesizeofthepie.Then,theyinvitemanagersto fightforapieceoftheaction…Organizationalresearchhasshownoverand overthatthisisthefundamentalmechanismorganizationsuse…andthatit inevitablyleadstosub-optimization,tosaytheleast. Happily,thereisafarbetterwaytosteerresources.Justimaginefora momentthatyousimplywouldn'tdefinethesizeofthepieforafixedperiod anymore.Andthatyouwouldtakeimportantresourcedecisionstogetherin ateam,andalwaysaslateaspossible! (Yes,youreadthatright!)

38. Employingresourcesdynamically:Atypicalwayofdoingit, aspracticedbySydneyWater,Australia Resources Incomeas “total (expected)availableresourcesovertime“- forecastedas“limitingfactor“ Yetuncommitedresources– workactivelyonavailable “optionsforabetterfuture“ Alreadyapprovedinvestments- activelyhandledas“dynamicportfolio“ Operationalresources– controlledbyKeyPerformanceIndicators (KPIs) – activitiesarefocusedoncontinuousimprovement! Projected period (e.g.5quarters) Source: Sydney Water

39. Settingdirectioninanageofuncertainty Abouttargets,thefailedpromiseofMbO, andtheillusionofsteering

40. True,itistemptingtobelievethatwecan “control”,or“steer”organizations.Lookingatthe reports,andindicators,andaccounting statements,itappearsthatanintelligent executivemightbeabletoremote- controlacompany,right? Now,theproblemis: That'sjustabeautifulillusion.

41. MorpheustoNeo: "Youtakethebluepillandthestoryends.Youwakeinyour bedandbelievewhateveryouwanttobelieve.... YoutaketheredpillandyoustayinWonderlandandIshow youhowdeeptherabbit-holegoes."

42. Theworldofcommandandcontrolmanagementandplanning-basedsteeringhasalotTheworldofcommandandcontrolmanagementandplanning-basedsteeringhasalot todowiththefictitious,machine-generatedworldinthemovietrilogy"TheMatrix". Actually,likeinthatcrucialsceneinthefirstmovieoftheseries,traditionalmanagementis muchlikethebluepillthemovie'sheroNeoisoffered,andtheBetaCodexistheredpill. Organizationshavethechoicetoeitherstickwith theillusionofcontrolthattheir“managementby numbers”delivers,ortoacknowledgethatthereisa wholeworldofperformancemanagement“beyond planningandcontrol”.Onethatdoesn'tdenyuncertainty andparadoxes.Andthatmakesfarbetteruseofpeople's talentandpotential.

43. Whytraditionalmanagementwith“fixedperformancecontracts“ regularlyfoolsus:Wehavelostcontrolalongtimeago… Thebluepill:Fixed,negotiatedtargets Theredpill:Relative,self-adjustingtargets Target:absoluteROCEin% (here:15%) Plan Target:relativeROCEin% (tomarket) Target Actual Actual Comparison: Market-Actual Comparison: Plan-Actual Target:„ROCE in%better thanmarket average” Most important competitor (28%) Most important competitor (28%) Market (25%) Market (25%) Actual (21%) Actual (21%) Plan (15%) [expected market Ø: 13%] [independent from expected market Ø] •  Interpretationwithinactual-actualcompa- rison:Performancewas4percentagepoints belowcompetition!>negativeinterpretation •  Absoluteassumptionsatthemomentof planningdon'tmatter. •  Targetsalwaysremainupdatedandrelevant! •  Interpretationwithintheplan-actual- comparison:Planwasoutperformedby6 percentagepoints>positiveinterpretation •  BetterROCEofthemarketaverageandthe mostimportantcompetitorremainunnoticed!

44. Relativetargetdefinitionthrough“leaguetables“ (rankings) – insteadofplanned,fixedtargetsandinternalnegotiation Strategic „cascade” Banktobank Return on Equity (RoE) 1.  BankD 2.  BankJ 3.  BankI 4.  BankB 5.  BankE 6.  BankF 7.  BankC 8.  BankH 9.  BankG 10.  BankA Regiontoregion Return on Assets(RoA)etc. Principles 31% 24% 20% 18% 15% 13% 12% 10% 8% (2%) Branchtobranch Cost/income ratio etc. 1.  2.  3.  4.  5.  6.  7.  8.  9.  10.  RegionA RegionC RegionH RegionB RegionF RegionE RegionJ RegionI RegionG RegionD 38% 27% 20% 17% 15% 12% 10% 7% 6% (5%) Relativetargetsand relativecompensation 1.  2.  3.  4.  5.  6.  7.  8.  9.  10.  BranchJ28% BranchD32% BranchE37% BranchA39% BranchI41% BranchF45% BranchC54% BranchG65% BranchH72% BranchB87% Continuousplanning/ control “Ondemand“flowof resources/ dynamiccoordination Result & value contribution Leadstolowestoperationalcost!

45. Let´slookatperformancedifferently Aboutreporting,metrics,indicators,andmeasuring performance,withoutneedforplanning

46. Doesyourorganizationuse“trafficlight”reporting? Thosered,orangeandgreendotsindicatingwhattopayattentionto? Mostofthesereportsaremadeformanagersandexecutives, because,sothethestorygoes,thosepeoplehaveshortattention spansand“need”thecolorcoding. Now,isn'titfascinatingthatorganizationshavesuchalowopinionof theirsupposedly“top”people?

47. Toevaluateperformanceinanadaptiveanddynamicway, thefoundationsofperformancemeasurementmustshift From:Againstplan To:Againsttime •Priorperiods •Progresstowardsachievementof medium-term (2-3years) targets From:Internalfocus To:Externalfocus •Internalpeers •Competitors •Benchmarks/Stretch From:Annualfocus To:Trendsand“asneeded”,alwaysrolling From:Financialmeasures To:Fewkeyindicators From:Closedsystems To:Openinformationsystemsforall From:Puremeasurement To:Mixedapproachofmeasuring/judging “Indicatorsonlyindicate“,thereisno“truth”inthe numbers–livingsystemscannotbeevaluatedby measuringalone! To:Stoppingmeasurementatteamlevel From:Controllingindividuals

48. Principlesforgoodmetrics: 1Itrelatestoastakeholder’sgoal 2Ithelpsimprovepartofthesystem 3Dataiscollectedbythosewhoneedit

49. Simple,elegantandrelevant:creatingreports withoutactual-plan-variances,fixedtargets,orplans last month Indicators or Groupsofaccounts Same month last year Same month prev.. year Ø last 12 mnths Ø 12 prev. mnths Company KPI RegionsKPI Compe- titorA CompetitorA CompetitorE CompetitorC Us CompetitorB CompetitorD CompetitorG CompetitorF 31% 24% 20% 18% 13% 12% 10% 8% RegionG7% RegionE7% RegionB6% RegionF4% RegionA3% RegionD3% RegionC1% RegionH0% Our unitA KPI2 Compe- titorB Us Our unitB KPI1 Ranking (Leaguetable) ext./intern. Snapshot (static) withbenchmarks Accouts/KPIsvs.Previousperiods (A) Maximum Tolerancelevels Us (B) Glidingaverage KPI KPI KPI Us CompetitorA Curvewithvariance Time (Actuals) Time (Actuals) Time (Actuals) Trendwithtolerance Trendwithbenchmark Trendwithreferences

50. Remember: Metricscanbehighlyuseful. Targetsusuallyaresuperfluous. Incentivesarealwaysabominable.