BBTN10 - Making Performance Management Work

Make it real! beyond budgeting transformation > network. Making Performance Management Work. From fixed to relative performance contracts, and towards simple, ethical and empowering ways of dealing with performance! Why your performance management systems have to change. And how you should approach this. BBTN Associates Associates Gebhard Borck - Niels Pflaeging – Andreas Zeuch Gebhard Borck - Niels Pflaeging – Andreas Zeuch White paper White paper January 2009 January 2009

Traditional management processes keep teams from strategic thinking, and motivate counterproductive or unethical behavior Financial problems • Process takes too long • Plans become obsolete quickly Vision • Plans are of little or no use Targets and Strategic problems strategic guidelines Profitability in petrochemical industry in Europe 600 500 • Target negotiation 400 • Definition of incentives 300 Fixed Fixed • Activity planning 200 performance performance • Resource allocation 100 contacts and • Coordination of plans contacts and 0 0 1984 1986 1988 1990 1992 1994 1996 1998 2000 Source: Chem Systems “keep on track” • Approval “keep on track” Behavioral problems Budget Performance control (plan-actual) Bonus (vs. targets) ... Source: BBRT White paper – Making Performance Management Work © BBTN – All rights reserved 2

Management processes in command and control organizations are “straight jackets” Strategy “Fixed” performance contract • Period [Fixed] Strategic learning cycle • Targets [Fixed] • Compensation [Fixed] Annual plan Fixed • Plan [Fixed] Performance • Resources [Fixed] Contract Budget • Coordination [Fixed] • Control [Fixed] Management • Agreed through [Negotiation] control cycle • Signed by: [Manager/Director] Control Tayloristic management works like this: As centralistic-burocratic hierarchies, held together through a regime of fixed performance contracts! Source: BBRT White paper – Making Performance Management Work © BBTN – All rights reserved 3 3

Current practices are misaligned with the Critical Success Factors of today's competitive market places Six “Critical Success Factors” Six examples of misalignment Annual planning process retards it • Fast response Centralized bureaucracy stifles it • Innovation ‘Spend it or lose it’ mentality fights it • Operational excellence Short term targets prevent it • Customer intimacy Extrinsic ‘motivators’ undermine it • Best team Dysfunctional, even unethical behaviour • Ethical behaviour conflicts with it • Value creation • Inferior financial results When pressure is applied, misalignment gets worse! White paper – Making Performance Management Work © BBTN – All rights reserved 4

Can you read the future, from the bottom of a cup of coffee? Or do you have a crystal ball that lets you to look into the future? Can you read the cards and see what will happen next year? Well, if none of this actually works, and if we accept that it´s impossible to predict the future, then why do we still spend massive energy and time on formal techniques that try to achieve just that for businesses? White paper – Making Performance Management Work © BBTN – All rights reserved 5

Organizations need a different, trust-based form of “future-directed thinking”, not command and control! The secret of success is not to foresee the future. But to build an organization that is able to prosper in any of the unforeseeable futures. Michael Hammer White paper – Making Performance Management Work © BBTN – All rights reserved 6

Beyond Budgeting means: From fixed to adaptive management processes. Traditional model New model (fixed performance contracts, (relative performance contracts, negotiated in advance) assessed with hindsight) Relative strategy performance contracts Changing Fixed processes performance Dynamic contracts coordination control • Fixed, annual processes • Dynamic, continuous processes • Fixed targets and incentives • Relative targets/compensation • Centralized and • Self-control, transparency and bureaucratic control peer pressure White paper – Making Performance Management Work © BBTN – All rights reserved 7

But there is a further challenge. Which is why most theories about leadership, as well as most advice from consultants, are flawed... One cannot talk sensibly about leadership, or people management, nor design decent management processes, unless we clarify beforehand our beliefs with regards to what people in organizations are like. We have to arrive at a shared understanding of human nature and of the consequences of that for our organizations. Niels Pflaeging, Leading with Flexible Targets White paper – Making Performance Management Work © BBTN – All rights reserved 8

The industrial age management model not only fails because markets have changed. It is also misaligned with human nature. Theory X (0%) Theory Y (100%) Attitude People dislike work, find it boring, People need to work and want to take an inte- and will avoid it if they can. rest in it. Under right conditions, they can enjoy it. Direction People must be forced or bribed People will direct themselves towards to make the right effort. a target that they accept. Responsibility People would rather be directed than People will seek and accept responsibility, accept responsibility, which they avoid. under the right conditions. Motivation People are motivated mainly by money Under the right conditions, people are moti- and fears about their job security. vated by the desire to realize their own potential. Creativity Most people have little creativity - except Creativity and ingenuity are widely distributed when it comes to getting round rules. and grossly underused. Based on Douglas McGregor, ‘The Human Side of Enterprise’, 1960 White paper – Making Performance Management Work © BBTN – All rights reserved 10

Question: How often do the systems, especially the HR systems, get in the way of change, transformation, vision and strategic thinking? Answer: Far too often. History often leaves HR people in highly bureaucratic personnel functions that discourage leadership and make altering human resource practices a big challenge. WhiteSource:–based upon John Kotter, Leading Change, p, 110-111 paper Making Performance Management Work © BBTN – All rights reserved 11

Do you BELIEVE in Theory Y? Firmly? Good. Because we are sure then you would never, ever practice (or support, or tolerate) HR processes and tools that treat people like children, or animals, or worse. Right? Such as performance appraisals, individual target setting, incentive compensation, meritocracy, or control of work-hours… White paper – Making Performance Management Work © BBTN – All rights reserved 12

Do your HR systems make it in people's best interest to implement your new vision? What is meant by HR systems? Performance appraisal Compensation Hiring and Promotions Succession planning ... Most often, examination of a firm's human resource systems reveal: Performance evaluation processes have virtually nothing to do with customers or strategy – yet that is typically at the core of a new vision or management model Compensation decisions are based much more on not making mistakes than on creating the right and useful change Promotion decisions are made in a highly subjective way and seem to have at best a limited relationship to the change effort Recruiting and hiring systems are a decade old and only marginally support the transformation Source: J. Kotter, Leading Change, HBSP, p, 110-111 White paper – Making Performance Management Work © BBTN – All rights reserved 13

Let's start with compensation then. First of all, let's be clear. Carrots don't work. They might beat the intellect of donkeys. But they certainly don't trick human beings, who all have “Theory Y” wiring inside them. Incentives simply don't have a positive influence on organizational performance. Full stop. So why do so many of us still apply in the carrot-and-stick method with people? White paper – Making Performance Management Work © BBTN – All rights reserved 14

Background stories we wouldn´t tell our clients: Real-life examples from companies The case of Marie Taylor This is what happened: Marie Taylor, a sales person from our organization, has generated income that goes against our company´s principle “Always act to the benefit of our customers“. The decision: Marie Taylor is being transferred to the internal sales support department. All her bonuses rights have been immediately cancelled. The background story: It is true – all sales people are obligued to act in the interest of customers. But it is also true that 40% of Marie Taylor´s salary depend on the amount of net sales she generates. White paper – Making Performance Management Work © BBTN – All rights reserved 15

Background stories we wouldn´t tell our clients: Real-life examples from companies The case of Frank Miller This is what happened: Frank Miller, a consultant, has overcharged during his work with clients, which means he has systematically inflated the amount of worked hours charged to his customers. The decision: Frank Miller was fired and is leaving the company immediately. The background story: It is true: Frank Miller has acted against the law, by charging for more than he has actually worked for his clients. But it is also true that 25% of Frank Miller´s income depend on the hours charged to clients… White paper – Making Performance Management Work © BBTN – All rights reserved 16

An example: “motivation”, or “threat”? What compensation systems really do... System with no System with variable compensation variable compensation (bonus, incentive, etc.) 30% Variable compensation 100% Base salary 100%: Total 70% Is this an “energizing compensation Base salary promise”, or is it expected by just a pitiful threat? employee. “We have an aggressive pay “We have a conservative pay philosophy: 30% of your total philosophy. compensation will be paid in form of Your base salary equals your total a bonus. The total is USD compensation, which is USD 100.000,00, by the way.“ 100.000,00.“ White paper – Making Performance Management Work © BBTN – All rights reserved 17

Social scientist Alfie Kohn says: I am arguing against….. (1) attributing more importance to money than it actually has, (2) pushing money into people's faces and making it more salient than it needs to be, and (3) confusing compensation with reward (the latter being unnecessary and counterproductive). The problem isn't with the dollars themselves, but with using dollars to get people to jump through hoops. White paper – Making Performance Management Work © BBTN – All rights reserved 18

And: Pay-for-performance is an outgrowth of behaviorism, which is focused on individual organisms, not systems - and, true to its name, looks only at behaviors, not at reasons and motives and the people who have them. I tell Fortune 500 executives (or at least those foolish enough to ask me) that the best formula for compensation is this: Pay people well, pay them fairly, and then do everything possible to help them forget about money. How should we reward our staff? Not at all! They are not our pets. Pay them well, respect and trust them, free them from disturbance, provide them with all available information and support to perform on the highest possible level. 1. Pay people well 2. Pay people fairly 3. And then do everything possible to take money off peoples minds! All pay-for-performance plans violate that last precept! White paper – Making Performance Management Work © BBTN – All rights reserved 19

True, it is tempting to believe that we can “control”, or “steer” organizations. Looking at the reports, and indicators, and accounting statements, it appears that an intelligent executive might be able to remote- control a company, right? Now, the problem is: That's just a beautiful illusion. White paper – Making Performance Management Work © BBTN – All rights reserved 20

Let´s leave compensation myths behind! We found no systemic pattern linking executive compensation to the process of going from Good to Great. Jim Collins, From Good to Great, 2001 Individual incentive pay, in reality, undermines performance – of both the individual and the organization. Jeffrey Pfeffer, Six Dangerous Myths about Pay, HBR 1998 Spending time and energy trying to “motivate” people is a waste of effort... The key is not to de-motivate them. Jim Collins, From Good to Great, 2001 White paper – Making Performance Management Work © BBTN – All rights reserved 21

The problem with “incentives”: How traditional management systematically forces people to cheat Bonus Bonus Variable “Ceiling” limit hurdle area Common practice: „Pay for performance“ compensation Reduction Maximization Reduction incentive: Salary/ profile with fixed incentive: Lower incentive: Anticipate postpone results to bonus result even more results performance contract: next period Creates maniuplation incentive in any situation! Base salary 80% 100%: 120% Performance as % of target target of target of target realization Linear compensation curve without breaks: A better model: Result variable compensation becomes oriented compensation decoupled from targets profile with relative Salary/ Free from performance bonus incentive to manipulate contracts: No incentive to manipulation. Actual Actual Actual Performance in result #1 result #2 result #3 relative evaluation Source: Michael Jensen White paper – Making Performance Management Work © BBTN – All rights reserved 23

Variable compensation: Unbundling fixed “Pay for Performance” contracts, in favor of “Relative Improvement” • Beyond Budgeting principles advocate basing evaluation and rewards on relative improvement contracts with hindsight, rather than fixed performance contracts agreed upon in advance. • In formulating a rewards policy, the Beyond Budgeting model leads to eight key recommendations: 1. Base rewards on relative measures, not fixed targets. 2. Align rewards with strategic measures, not budgets. 3. Reward the performance of teams, not individuals. 4. Align rewards with independent groups, not parochial interests. 5. Use clear and transparent measures, not unfathomable numbers. 6. Use the language and thinking of gain sharing, not incentives. 7. Make rewards fair and inclusive, not unfair and divisive. 8. Recognize and reward company values, not just the numbers. Organizations can free themselves from conventional forms of All employees should earn a “pay for performance”, share of the financial success. through simple and more transparent Restrain from the idea of Source: BBRT compensation systems.rights reserved White paper – “motivating Management Work Making Performance them“! © BBTN – All 25

Resources. What most organizations do with them is basically this: Once a year, they define the size of the pie. Then, they invite managers to fight for a piece of the action… Organizational research has shown over and over that this is the fundamental mechanism organizations use… and that it inevitably leads to sub-optimization, to say the least. Happily, there is a far better way to steer resources. Just imagine for a moment that you simply wouldn't define the size of the pie for a fixed period any more. And that you would take important resource decisions together in a team, and always as late as possible! (Yes, you read that right!) White paper – Making Performance Management Work © BBTN – All rights reserved 26

Employing resources dynamically: A typical way of doing it, as practiced by Sydney Water, Australia Resources Income as “total (expected) available resources over time“ - forecasted as “limiting factor“ Yet uncommited resources – work actively on available Already approved investments - “options for a better future“ actively handled as “dynamic portfolio“ Operational resources – controlled by Key Performance Indicators (KPIs) – activities are focused on continuous improvement! Projected period (e.g. 5 quarters) Source: Sydney Water White paper – Making Performance Management Work © BBTN – All rights reserved 27

Morpheus to Neo: \"You take the blue pill and the story ends. You wake in your bed and believe whatever you want to believe.... You take the red pill and you stay in Wonderland and I show you how deep the rabbit-hole goes.\" White paper – Making Performance Management Work © BBTN – All rights reserved 28

The world of command and control management and planning-based steering has a lot to do with the fictitious, machine-generated world in the movie trilogy \"The Matrix\". Actually, alik in that crucial scene in the first movie of the series, traditional management is much like the blue pill the movie's hero Neo is offered, and Beyond Budgeting is the red pill. Organizations have the choice to either stick with the illusion of control that their “management by numbers” delivers, or to acknowledge that there is a whole world of performance management “beyond planning and control”. One that doesn't deny uncertainty and paradoxes. And that makes far better use of people´s talent and potential. White paper – Making Performance Management Work © BBTN – All rights reserved 29

Why traditional management with “fixed performance contracts“ regularily fools us: We have lost control a long time ago… The blue pill: Fixed, negotiated targets The red pill: Relative, self-adjusting targets Target: absolute ROCE in % (here: 15%) Target: relative ROCE in % (to market) Actual Plan Actual Target Comparison: Market-Actual Comparison: Target: „ROCE Most Most Plan-Actual in % better important important than market Market competitor Market competitor average” (25%) (28%) (25%) (28%) Actual Actual Plan (21%) (21%) (15%) [independent [expected from expected market Ø: 13%] market Ø] • Interpretation within actual-actual compa- • Interpretation within the plan-actual- rison: Performance was 4 percentage points comparison: Plan was outperformed by 6 below competition! > negative interpretation percentage points > positive interpretation • Absolute assumptions at the moment of • Better ROCE of the market average and the most important competitor remain unnoticed! planning don´t matter. • Targets always remain updated and relevant! White paperNiels Pfläging Source: – Making Performance Management Work © BBTN – All rights reserved 30

Relative target definition through “league tables“ (rankings) – instead of planned, fixed targets and internal negotiation Strategic „cascade” Bank to bank Bank to bank Return on Equity (RoE) Return on Equity (RoE) Region to region Region to region Principles Return on Assets(RoA)etc. 1. Bank D 31% Return on Assets(RoA)etc. 1. Bank D 31% Branch to branch 2. Bank JJ 24%1. Branch to branch 2. Bank 24%1. Region A 38% Cost/income ratio etc. Region A 38% Cost/income ratio etc. 3. Bank I I 20%2. 3. Bank 20%2. Region CC 27% Relative targets and Region 27% 4. Bank BB 18%3. 18%3. Region H 20%1. Region H 20%1. Branch JJ 28% 4. Bank relative compensation Branch 28% 5. Bank EE 15%4. 15%4. Region B 17%2. Region B 17%2. Branch D 32% 5. Bank Branch D 32% 6. Bank FF 13%5. 3. Branch EE 37% 13%5. Region FF 15% 3. 6. Bank Branch 37% Region 15% Continuous Region EE 12%4. 12%4. Branch A 39% 7. Bank CC 12%6. Branch A 39% 7. Bank 12%6. Region planning/control Region JJ 10%5. 10%5. Branch I I 41% 8. Bank H 10%7. Branch 41% 8. Bank H 10%7. Region 8. Region I I 7% 6. 7% 6. Branch FF 45% 9. Bank GG 8% 8. Branch 45% Region 9. Bank 8% “On demand“ flow of 9. Region G 6% 7. Region G 6% 7. Branch CC 54% 10. Bank AA (2%)9. Branch 54% 10. Bank (2%) resources/ 10. Region D (5%)8. 10. Region D (5%)8. Branch G 65% Branch G 65% dynamic coordination 9. 9. Branch H 72% Branch H 72% 10. Branch B 87% 10. Branch B 87% Result & value contribution Leads to lowest operational cost! White paper – Making Performance Management Work © BBTN – All rights reserved 31

Does your organization use “traffic light” reporting? Those red, orange and green dots indicating what to pay attention to? Most of these reports are made for managers and executives, because, so the the story goes, those people have short attention spans and “need” the color coding. Now, isn't it fascinating that organizations have such a low opinion of their supposedly “top” people? White paper – Making Performance Management Work © BBTN – All rights reserved 32

To evaluate performance in an adaptive and dynamic way, the basis of Performance Measurement must shift Against plan Against time • Prior periods • Progress towards achievement of medium-term (2-3 years) targets Internal focus External focus • Internal peers • Competitors • Benchmarks/Stretch Annual focus Trends and “as needed” Financial measures Few key indicators Closed systems Open information systems for all Pure measurement Mixed approach meajuring/judging “Indicators only indicate“/there is no “truth“ in the numbers – living systems cannot be evaluated by measuring alone! White paper – Making Performance Management Work © BBTN – All rights reserved 33

Simple and relevant: creating reports without actual-plan- variances, fixed targets, or plans! last Same Same Ø Ø Company KPI Regions KPI Compe- month month month last 12 titor A last prev.. 12 prev. Competitor A 31% Region G 7% Our year year mnths mnths Competitor E 24% Region E 7% unit A Competitor C 20% Region B 6% KPI 2 Compe- Us 18% Region F 4% Indicators titor B Competitor B 13% Region A 3% Us or Competitor D 12% Region D 3% Our Competitor G 10% Region C 1% Groups of accounts unit B Competitor F 8% Region H 0% KPI 1 Ranking (League table) ext./intern. Snapshot (static) with benchmarks Accouts/KPIs vs. Previous periods (A) Maximum Tolerance levels Us (B) Gliding average KPI KPI KPI Us Competitor A Curve with variance Time (Actuals) Time (Actuals) Time (Actuals) Trend with tolerance Trend with benchmark Trend with references White paper – Making Performance Management Work © BBTN – All rights reserved 34

By applying the 12 Beyond Budgeting principles, you will revolutionize performance management. And more. You will set your people free to think and to act like entrepreneurs. You will make far better use of their talents, and finally stop de-motivating them. You will stop fighting against the reality of your marketplace. Read the BBTN´s white papers and presentation slides for further information about Beyond Budgeting and about how to approach transformation. Vortrag: Niels Pfläging 35

Make it real! beyond budgeting transformation > network. BBTN: www.bbtn.org This white paper was authored by the following BBTN Associates: Andreas Zeuch Gebhard Borck Niels Pflaeging az@a-zeuch.de gebhard@bbtn.org niels@bbtn.org www.a-zeuch.de gberatung.de metamanagementgroup.com Xing forum: www.xing.com/net/beyondbudgeting Get in touch with us for more information about leading transformation with the Double Helix Framework, or ask us about a workshop proposal.

BBTN10 - Making Performance Management Work

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