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Paying people for work, without destroying their motivation, is one of the most difficult challenges for management. Regrettably, most compensation systems are unfair and unscientific. That’s why it …

Paying people for work, without destroying their motivation, is one of the most difficult challenges for management. Regrettably, most compensation systems are unfair and unscientific. That’s why it would be wise to consider some lesser known alternatives that are
based on real merits instead of imagined earnings.

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  • 1. merit (c) 2006 Cindy money 1 Management 3.0 Workout © 2013 Jurgen Appelo
  • 2. Money can’t buy happiness, but it can make you awfully comfortable2 while you’re being miserable. Clare Boothe Luce, American author (1903 – 1987)
  • 3. Paying people for work, with-out destroying their motiva-tion, is one of the most difficultchallenges for management.Regrettably, most compensa-tion systems are unfair and un-scientific. That’s why it wouldbe wise to consider some less- 3er known alternatives that arebased on real merits insteadof imagined earnings. However, today he wants to allow himself something extra. The ex- ports to Norway last month earned him twice the amount he makes in Germany. And his Chinese customer finally paid the invoice he had already written off. And hurray! After two years of ignoring hisJojo runs a business. His revenues are good, but the income varies marketing, the Americans have now discovered his services too.significantly. One month he wonders if he is able to survive the slow- Jojo thinks this all calls for a little celebration, and a pat on his back,ness of summer, another month he wonders if his bank account can by himself. After all, he did all the work, didn’t he? He considers asurvive the next stampede of customers. And yet, Jojo pays himself transfer of a little extra money to his private account, just for once.the same somewhat conservative salary every month. It’s enough Maybe he can read his next novel in a new pay for his food, mortgage, and novels, but not enough for thatvintage Eames Lounge chair he has always wanted. Why not? He earned it.
  • 4. Earnings What if Jojo is not a one-per- son company but a bigger organization? Should it be EARNINGS= any different? In many or- salaries + extras ganizations employees get a steady monthly salary, which The question is, is conservative enough for the how do we determine4 organization to survive, but what people earn? enough for people to pay the bills at home. So far, so good. But what if the business climate is fa- some workers more than others. And keep- they earn. And what people earn is an emer- vorable and there’s some extra money ing the money on the organization’s bank gent result of an organization’s interaction available? Increasing everyone’s salaries account is virtually the same as passing with its environment. An organization’s is often not an option. You should only the outcomes of the workers to the busi- income cannot be fully predicted, therefore do that when you know it is sustainable. ness owners. what people earn is the sum of their (predict- Spending the money on improvements in able) salaries and any (unpredictable) extras the office is fine, but usually this benefits I believe that workers should be given what the organization can afford to hand out.
  • 5. (c) 2011 Kazuhisa Togo Bonus SystemA practice that has infiltrated the western business world like a pes-tilence in a shanty town is the annual bonus system. The idea ofthis practice is that managers give workers targets, and calculateannual bonuses which usually depend on people’s performanceratings, job position, salary, overtime, age, shoe size, and a host ofother variables. The common rationale behind the bonus system isto incentivize performance. But actually, it stinks. My skepticism begins with the paradox that we recruit a person into 5 what we proudly claim to be a knowledge organization boiling over with interesting tasks and challenges. We offer a fair base salary, but then add that “We really do not expect you to do your best. The tasks and the environment we can offer is probably not motivating enough. We will therefore put you on a bonus system. Only then do we expect you to go that extra mile.” Unintentionally, this kind of message says quite a lot about the company and our new colleagues. Bjarte Bogsnes, Implementing Beyond Budgeting [L:737]
  • 6. Decades of research has confirmed, again and again, that bonus systems rarely have a positive effect on people’s performance when they are involved in creative knowledge work [Pink, The Surprising Truth about What Motivates Us] [Kohn, Punished By Rewards]. On the contrary, the effect is just as likely to be negative [Fleming, “The Bonus Myth”] [Spolsky, “Incentive Pay Considered Harmful”]. There is so much wrong with traditional incentive programs, it is impossible to list all their problems. But I feel incentivized to give you the most important ones here: 1 People get addicted to regular rewards, and if they don’t get their anticipated reward, they will feel disappointed or punished. 2 Individual rewards disrupt collaboration, which is crucial in creative knowledge work. It stimulates competition and cheat- 3 Traditional bonus systems rely on objective measures, but reality is far too complex to capture in numbers. The metrics ignore6 This ultimately destroys motivation and ing, which destroys relationships between the soft side of great performance, includ- thus performance. [Kohn] [Pink] workers, and also between workers and ing teamwork and collaboration. [Kohn] their managers. [Kohn] [Fleming] [Pink] [Spolsky].
  • 7. 4Research shows that rewards distract peo-ple from complex work, disrupt creativethinking, and increase people’s stress lev- 5 The research also shows that bonuses un- dermine intrinsic motivation and altruism. As soon as rewards are handed out peopleels. This causes them to play safe and prefer start to think, “They pay me extra for this 7easy tasks, while innovation requires the work thus it cannot be fun, interesting, oropposite: taking risks and doing complex good.” [Kohn] [Fleming] [Pink]tasks. [Kohn] [Fleming] [Pink].
  • 8. The Flat System Some people argue that organizations should get rid of their bonus systems. They say most of an organization’s performance is in the system, not in the people, and therefore it’s best not to differentiate between employees. Everyone should get the same bonus. However, by the same reasoning it then also follows that everyone should be getting the same monthly salary. After all, how can you measure that the ceo works any harder than the receptionist?8 I believe a flat compensation system doesn’t address the challenge of paying employees what they really earned. First of all, there is the A Merits System problem that roughly 80% of all people think they perform better than average [Haidt, The Happiness Hypothesis p.67], and thus, when everyone gets the same as everyone else, 80% of the workers will feel underpaid. (It won’t be true, but you can’t argue with feel- In an agile organization, working in an uncertain environment, I ings without real data.) Second, while bad fortune in business is usu- believe workers should have a steady salary that is predictable and ally absorbed with conservative salaries and incidental layoffs, good slightly conservative. On the other hand, they should also get ex- fortune should likewise be enjoyed with extra payouts and by hiring tras depending on the unpredictable part of the environment. Both new people. When you don’t pay any extras to workers, the workers salaries and extras should be brutally fair and based on merits, share the burden of setbacks, while only the business owners reap not equality. This has led me to suggest the following practical the benefits of success. This is probably not motivating to most peo- constraints, for better compensation systems, based on the five ple. It has certainly never motivated me. problems listed earlier:
  • 9. 1 mance measurement.Always keep it a surprise. When bonuses be- 3Salaries should be expected, but Peer feedback is the main perfor- Use compensation to nurture theirbonuses should not. intrinsic motivation. Contributions to a shared purpose are best 5 Make money a reflection, not a competitor,come frequent and anticipated, they ought detected and evaluated by peers, not by of people’s curiosity, honor, acceptance,to be converted to regular salaries. managers. Only the whole system knows all mastery, and all other intrinsic motivators. 2 4 details. Of course, implementing these suggestions 9 for a compensation system is not a trivial thing. But I discovered different ideas thatEarnings should be based on collab- Use creative thinking to grow the seem to work pretty well for various creativeoration, not competition. compensation system. organizations, and which turned out to beWhen determining how much people should Expect that people can (and will) game any quite compatible with each other, and withearn, the main criteria should be their contri- system, and tap into that creativity by inviting the science of behavioral economics [Ariely,butions to a common goal, or shared purpose. and supporting it, instead of driving it out. Predictably Irrational].
  • 10. Coins, Credits, or Candies Any manager can start a mer- company-wide revolution, either by yourself or by disgruntled em- its-based earning system in ployees. Take it easy. Start in a way that allows you to fail and learn. her organization, and for the The second thing to do is to create a virtual currency to represent the merits that people can accumulate over time. You can use cred- remainder of this text I will its, points, coins, hugs, beans, candies, bananas, or anything else to represent people’s recognition in the network. It is important assume you are a manager. not to use real money because the monetary value of the virtual currency is zero until management decides there is a good reason to convert virtual money into real money. For the virtual coins I will use the term hugs in this text, because a hug clearly has no mone- (As an individual employee you could do this too, but when your tary value, and we generally give hugs to others, not to ourselves. span of control covers just your own money it makes little sense (I tend to hug myself when I’m sleeping, not when I’m working.)10 to redistribute your salary and bonus to yourself.) The distribution The exchange rate of a hug to a euro, dollar, yuan, or other official of money is a sensitive topic; therefore the first thing for you to do coinage is 1 to nil. is to set up a safe-to-fail environment. One can think of reserving 10% of the next salary increase on the new system, or just 20% of The third thing to do is to decide which organizational units can the current annual bonus system. It is not necessary to ignite a receive hugs collectively, besides getting them individually. With- in a self-organizing team recognition of merits is a relatively easy thing. People all know each other personally, and they have a good sense of knowing who contributed what to the team’s collaborative work. I have a pretty good idea which of my team members helped me get an article published before a deadline. I know who paid for coffee last time. (It certainly wasn’t me.) And I know who nicked my socks. (Yes, I know where they are!!) On the other hand, I get good service from my accountant, but I don’t know if it’s really him or the team behind him doing all the work. More generally, when organi- zational units work with representatives, others in the organization usually cannot distinguish between the work of the representative and the work of the entire unit. As a manager you should therefore decide whether entire units can also be the beneficiaries of hugs.
  • 11. Recognition and RewardsNow we get to the core of the merits system. You have just created a market for merits, The central idea of the merits system is thatThe next step is for you to define the total and, like in any other market, you can ex- nobody can claim to have the best defini-amount of hugs available, and how often pect to witness unpredictable and amazing tion of what performance is, and what col-they will be passed out. My suggestion creativity. One worker may decide to share laboration means. We should therefore usewould be to do this once per month, but I’m her hugs equally among all her team mem- everyone’s opinion, equally. Some might callsure other frequencies (weekly or quarter- bers. Another worker can use a personal it the wisdom of the crowd. And instead ofly) are possible too. metric, such as compliments received, or claiming rewards, which is usually the case productivity observed, for the distribution in salary negotiations and annual bonusAnd then the fun starts. of his hugs to his peers. Another worker systems, all merits have to be earned. After can give half of her hugs to one colleague all, the science says human beings are keenThe single most crucial aspect of a merits who helped her out when she was feeling observers of other people’s behaviors, butsystem is that every individual can only depressed and on the verge of quitting her piss-poor at evaluating their own [Haidt,recognize the contributions of other peo- job. Workers are also allowed to give away p.66]. Therefore, the claimed hugs (every-ple, and that the opinions of all individuals hugs to people or units outside their own one claiming an equal share) only become 11have equal weight. Therefore, everyone in team. After all, good working relationships meaningful by converting them to earnedthe organization gets an equal share of the don’t limit themselves to formal organiza- hugs (through peer feedback and recogni-hugs, but every employee must give away tional boundaries. tion by others).his hugs to others [Boyd, “At IGN, Employ-ees Use a Viral Pay System”].
  • 12. The criteria for passing out hugs should be What happens to people who get less than related to a shared purpose. The business units in an organization should be working expected? toward a common goal. It’s the same with departments, the same with teams, and the same with employees. Thus the question that people should ask themselves is: It is said that 80% of all people believe they perform “How much did other better than average. However, depending on the people, and units, do for distribution of hugs roughly 50% of the workers me that helped me to make will get more hugs than the average. This means progress toward my12 that an estimated 30% of the workers could feel goals, in my subjective disappointed that their work is not recognized by experience?” their colleagues, or at least not as much as they had expected. These people have a choice. They can Given the fact that a healthy organization either learn how to do better, accept the fact will have a mixture of individual goals, team goals, and other organizational goals, that not everyone can win the Olympics either, or it will be up to the individuals to consider a healthy balance of the needs and favors else find another place where they believe their of employees and units. No written policy or procedure can calibrate intrinsic desires contributions will be better appreciated. in an organizational network. That task is better left to the most complex device in the known universe: the human brain. All avail- able brains, in fact.
  • 13. Every month management could set aside a bonus, with a total val- ue depending on business profits. They could then ask the newest employee (or someone else who has the least to gain from a possible payout) to throw two dice. Management will only allow hugs to be cashed when the number of eyes thrown is three (or some other fa- vorite number). If any other number of eyes is thrown, the bonus will simply roll over to the next month. This means the bonus money be- comes available only once per year on average, accumulating each month, but paid out at random intervals. It would make sure people will feel less stressed about anticipated bonuses, which is important for creative thinking. The financial value of hugs can be published like shares on a stock market. It will depend on the bonus money available, and the num- ber of outstanding hugs. When the hugs become cashable, people could have a choice. Either they convert their hugs now to real mon-From Hugs to Cash ey, or they save their hugs for the next round, in the hope that the value will go up. (An additional idea is to have an expiration date on 13 hugs, similar to frequent flyer miles with airlines.)After a number of iterations, with people’s earned hugs accumu-lating over time, there will (hopefully) come a time for hugs to be Several alternative programs can be conceived, depending on thecashed, using a certain exchange rate. There are different ways for culture of the organization, the kind of business it is in, and thedoing this. bonus money available. But whatever specific implementation an organization comes up with, merits systems in general are much more likely to help people focus on shared purpose and collabora- tion than traditional programs with numerical targets and annual bonuses.
  • 14. The 6 Rules for Rewards The merits-based system as described here satisfies most of the six criteria for rewards in organizations: 1 Don’t promise rewards in advance. People know what salary they get every month, but (in the ideal version of this prac- 2 Keep anticipated rewards small. Monthly salaries are anticipated, of course. However, since workers receive their sal- 3 Reward continuously, not once. The merits system has a regular cadence be- cause workers reward each other frequently. tice) they don’t know if and when there will aries whether they achieve good results or Feedback doesn’t wait until the end of the14 be something extra. Bonuses should depend not, this anticipation will not interfere with year, therefore the chance of forgetting on the environment, not on a calendar. their stress levels and performance. things is small. (c) 2007 Derbeth, Creative Commons 2.0
  • 15. 4Reward publicly, not privately.In the ideal version of this practice the hugsare earned publicly. Transparency makes 5 Reward behavior, not outcome. People will give hugs for the things that they did for each other, which is about behav- 6 Reward peers, not subordinates. Management switches from managing the earnings of people to managing thesure that everyone knows what is going on, iors. The final outcome will depend on the constraints of the system. The recognitionand what is appreciated by others, so they environment, and people cannot be made that people get is from peers, not from 15can adapt accordingly. responsible for that. management. Like any other useful recipe the six rules for rewards should be considered as guidelines, not laws. Nevertheless, it is encouraging to see that our merits system is very much in line with these guide- lines, which were derived from a host of motivational experts. (c) 2011 Guillaume Paumier
  • 16. (c) 2008 Lawrie Cate, Creative Commons 2.0 Experimentation16 and Customization The system described in this text is a generic practice for earnings based on merits. It can (and should) be customized in many, many ways. For example, instead of hugs or beans the creatively challenged organizations among us may prefer a term such as credits or points. And instead of full openness of the process, the transparently chal- lenged organizations may want to keep part of the process anonymous and reveal only a small part of the results to the participants (such as the “top 10 best recognized people in the organization”). The system can also be introduced gradually. At first you could do this for a small part of the traditional bonus or annual raise. Later, with more experience and buy-in from employees, you can increase the percentage and impact of the system.
  • 17. What if…?In various discussions I hadabout the merits system,people are always positivelyinterested, while at the sametime being genuinely con-cerned about several variantsof the “What if” question: 17 I don’t have ready-made answers to all these questions. The way I “What if two people decide to give see it is that any merits system, despite the flaws that will surely each other all their hugs?” come to the surface, will nevertheless always be better than the dysfunctional financial reward systems most organizations have “What if people demand hugs in re- institutionalized now. Why worry too much if a new system might turn for good behavior?” demotivate 10% of the people, when the current system demoti- vates 90% of them? “What if extroverts get more hugs than introverts?” With simple rules, fair governance, and sufficient transparency, people will be able to adapt to each other’s behaviors (both the good “What if people are just pretending ones and the bad ones). Ultimately, the only remedy to self-organ- to be interested in collaboration?” ized misconduct and emergent unfairness, will not be the addition of extra rules and procedures, but the positive creativity of peers. “What if intrinsic motivation is de- The best way to deal with problems is to turn the financial stuff into stroyed when someone gets no hugs?” a real complex adaptive system.
  • 18. 18 Money and emotions are tricky things and to adapt to each other’s strategies, and therefore any system that involves both management can tweak the constraints, will have to be set up in a way that is safe all in favor of collaboration and working to fail. With small increments (such as towards a common purpose. weekly or monthly experiments instead of quarterly or annual outcomes) the feed- Finally, ultimately, hopefully, the merits back cycle is shorter and people will learn market described here should grow a more faster how to improve the system. The use collaborative culture in the organization. of valueless virtual currency instead of But one thing is certain: because recogni- real money will allow people to experiment tion of merits (and allocation of money) is more comfortably, and it will be easier for transferred from management to workers, them to decide that a chosen path is not it absolves management of performance working, and change direction, or start reviews, salary negotiations, and bonus from scratch. We must also realize that calculations. This means that managers creative people will game the system. But can start leading and servicing people, in- this creativity can be exploited to grow a stead of managing their money [Markow- more resilient system. The short iterations itz, “3 Weird, Game-Changing Ways to and valueless currency should help people Make Employees Happy”].
  • 19. Whatyour organization is ready now?Let’s see ifto introduce its own merits system.1. With this practice it is very important that you first create a safe-to-fail en- vironment. For example, announce the new program by saying that you will first want to gain experience with a trial period of a couple of iterations, and that you will surely do a reset of the whole system after that period.2. Alsoof the regular bonus?of people’saincome theof (the raisesapply. Will itannualto a small define to which part system will apply part Maybe to small part of) people’s salaries? 193. Think of the logistics, such or the name of thewhether currencycan use, whether as virtual to to introduce it physically electronically, people reward en- tire teams and business units, and how much of the system will be transparent.4. Getcommitmentfromfirstwatchtheeffectsonotherpeopleandonthebusinessasavolun- key leaders in the organization. Allow people to get involved tarily, so that they can whole.5. Evaluate the trial period with all stakeholders, before doing a real introduction.
  • 20. Experiment now Get rid of your unfair and unscien- tific compensation system. Make a plan to turn it into a system based on merits and real earnings. But do it in small steps, and in a safe-to-fail environment.20 Express yourself Did you experiment with a merits system? Do you have some interes¬ting feedback or photos to share? Do you have questions, or tips on how to improve this practice? Via you can find discussi- ons on Facebook, Google+ and LinkedIn.
  • 21. 21 Experience itExplore for free Do you want to see the workout practices in action? Management 3.0 events are organized all overOn we are the world by many internationalgrowing a collection of great management work- facilitators. From two-day coursesout practices. Visit the site to find out which to four-hour workshops, all eventsother articles, exercises, games, and downloads make a lasting impression. Atare available for you. And remember, all materi- are available for free! you can find the full calendar.
  • 22. References • • Ariely, Dan. Predictably Irrational: The Hidden Forces that Shape our Decisions. New York: Harper Perennial, 2010. Print. • • Bogsnes, Bjarte. Implementing Beyond Budgeting: Unlocking the Performance Potential. Hoboken, N.J: John Wiley & Sons, 2009. Print. • • Bomann, Nikolaj. “Bonus Schemes Should Be Handled with Care” <>, 27 June 2009. Web 3 January 2013. • • Boyd, E.D. “At IGN, Employees Use a “Viral Pay” System to Determine Each Other’s Bonuses” <> Fast Company, 16 December 2011. Web 3 January 2013. • • Fleming, Nic. “The Bonus Myth: How Paying for Results Can Backfire” <> NewScientist, 12 April 2011. Web 3 January 2013. • • Haidt, Jonathan. The Happiness Hypothesis: Finding Modern Truth in Ancient Wisdom. New York: Basic Books, 2006. Print. • • Kohn, Alfie. Punished by Rewards: The Trouble with Gold Stars, Incentive Plans, A’s, Praise, and Other Bribes. Boston, Mass: Houghton Mifflin Co, 1999. Print. • • Markowitz, Eric. “3 Weird, Game-Changing Ways to Make Employees Happy” <>, 11 May 2012. Web 3 January 2013. • • Pink, Daniel. Drive: The Surprising Truth about What Motivates Us. New York, NY: Riverhead Books, 2009. Print. • • Spolsky, Joel. “Incentive Pay Considered Harmful” <> Joel on Software, 3 April 2000. Web 3 January 2013. Jurgen Appelo is the author of the book Management 3.0, which describes the role of the manager in Agile organizations, and How to Change the World, which descri-22 bes a model for organizational change. This article will be part of the upcoming book Management Workout, to be published in 2013. Jurgen Appelo is also the author of the Management 3.0 course, which is available in many countries. More information about the books and course is available on