Welcome back. The influence of compensation on performance is very nuanced, even though compensation is the most easily quantifiable aspect of people management, and it is usually the largest expense of any organization. Connecting compensation to performance is very tricky. It may motivate or demotivate the employees. Some go as far as suggesting that linking compensation to performance is self-defeating and demoralizing and hurts not just poor performers but also top performers. On the other hand, some believe there is no alternative as to pay for performance, this is the only model. At Netflix, it's a video streaming company known for its very strong performance-driven culture, high performers are paid top of the market compensation. That applies not just when they're hired. Their compensation is reviewed regularly to make sure it is still in line with the market value of any particular employee regardless of the job title. The formula goes as follows, what could the person get elsewhere, what would we pay for replacement of this person, what would we pay to keep that person? Very simple. Mercer consultants call this model membership or efficiency wage. In this model, the organization keeps an above the market pay level and employees are motivated to perform in order to stay and grow within the organization. This model is different from the tournament model where employees compete for career advancement, not for bonuses or other incentives within their current level. Finally, there is a third model. Bonding, it puts an employee into a trajectory of planned pay increases from early to late in their career once performance is credibly demonstrated. Employees and their firm-specific knowledge are retained over the long period of time. At the same time, there are strong proponents of traditional pay for performance model, although it may create an overly competitive environment in an organization if established improperly. But with no pay for performance at all you're at risk to demotivate high performers because of the people's, in their sense of equity. And equity almost never means equality and is almost always relative. High performers expect to be rewarded more relative to those who underperform. And in cultures where effort is valued, poor performers who expect the reward for great effort feel left out and underappreciated. Wrong calculations with regards to compensation can lead to unexpected consequences, sometimes disastrous for an organization. A case in point is a credit card processing company called Gravity Payments. The founder decided to make $70,000 annual payment the minimal salary at his company. His good intentions actually backfired as senior employees who spent a lot of time with the company and invested a lot of effort in it felt that the decision was unfair because the underperformers got a huge raise while senior employees actually didn't get one. Indirectly the decision affected both the minority shareholders and employees holding stock options which both disliked it and the company suffered. Some companies seek to strike balance between pay-for-performance model and nonequitable model where pay is not connected to performance. SAS Institute, for example, doesn't set individual goals for its sales people. Instead it uses team metrics. One of the problems with team metrics is, of course, the free rider dilemma. Many employees will try to shun their responsibilities in the expectation that someone else will do their work. That can be mitigated by what James Sesil and other researchers call mutual or reverse monitoring. It is a practice when team members have an incentive to both help and monitor each other and incentivize to work with more effort. Another concept worth mentioning is choking. A series of experiments demonstrated that high stakes can reduce one's ability to perform due to stress. Modern MRI equipment allowed some researchers to see how brain regions responsible for encoding reward information get deactivated once the stakes are too high. They also noticed that some people see the opportunity for victory in critical situations and the reward level does not correspond to their actions. The opposite of choking is paying too little. Researchers found that sometimes it is better not to pay at all than to pay less than fair. Benefits also cost money, and it is critical to carefully analyze their effects on productivity and performance. The fact that employees appreciate them is not enough. What's important is that the appreciation is translated into increased productivity and reduced attrition, and overall improved performance. In 2007, Google was trying to solve the problem of turnover of new mothers, their departure rate was twice the average. After conducting research, they introduced a new policy. They gave five months of paid time off with full benefits for the new mothers at their headquarters in California. And seven weeks elsewhere globally. The results were phenomenal. 50% reduction in turnover among the new mothers. A huge deal, given the replacement costs. We'll be thinking about replacement costs of employees in the future module on recruitment.
