The Science behind Performance Management: A Postmortem

If you have ever managed a team or have been part of human resource management function, this is one of the core activities that you must have been involved. The terminologies have changed over the years, but the primary objective has been the same since industrial revolution.

This involves few steps, starting from assigning targets to front line employees to almost every level till the CEOs. In some organization, its straightforward called target but in knowledge management, it called KPIs or ‘Key Performance Indicators’. At times, these are little complex and have quality, timeliness, and other aspects along with the amount of output, named target. For higher level, it may include cost savings, EPS, compliance etc. In KPIs, you can also give weightages to each component like quality or timeliness to come up with a consolidated ballpark number for each employee.

After these data is generated, the next job is adding the employees into buckets. The number of buckets may differ from organization to organization but mostly they are divided into four buckets:

1. The breakthrough performers
2. People who aren’t breakthrough but exceeded the expectation
3. People who just achieved their targets / KPIs
4. Requires Improvements

Technically, when you generate the graph and you KPIs or Targets are good, it should fall into a normal distribution curve, famously known as ‘bell curve’. If the data does not fall into a normal distribution curve, human resource function or you manager will call out your data and you might fight it out or back calculate the scores to fit into the bell curve.

This process has been running for ages without many questions. Let’s try to postmortem of the entire system.

The first step is what’s the objective of the process?

There are two sides, one mostly, the performance management is linked to monetary reward, called bonus or stock options and even access to funding for learning and development. The organization wants to reward its top performers more from a budget pool and this extra money is funded by the other three categories mentioned above.

It’s like Airlines industry, where space inside an aircraft is same, the business and first-class passengers get little more space at the cost of reduced space for coach or general class passenger. If you are not a communist or socialist, this should not bother you much as its similar to a capitalist thought process. Bonus is a for a business and it not just about distributing the money evenly.

However, the other underlying objective for the organization is to motivate its workforce to perform higher than the expectation, if they get see the next performance appraisal cycle (not at the bottom of the curve). The question is let’s see what science says about this tool to motivate people to overachieve.

In the first case, first we will talk about how human behavior works, when someone achieve his/her target.

In the next part, we will deep dive into behavioral economics and mathematical philosophy to analyze if money motivates people, if yes, how much money?

“People often adopt short-term goals that they strive to achieve but not necessarily to exceed. They are likely to reduce their efforts when they have reached an immediate goal, with results that sometimes violate economic logic.” – Sounds familiar?

Let’s start with an interesting story that everyone resembles well. Have you tried to book an Uber or Yellow Taxi in New York in a rainy day? “The cab drivers, for example, may have a target income for the month or the year, but the goal that controls their effort is typically a daily target of earnings. Of course, the daily goal is much easier to achieve. (and exceed) on some days than on others.

On rainy days, a New York cab never remains free for long, and the driver quickly achieves his target; not so in pleasant weather, when cabs often waste time cruising the streets looking for fares. Economic logic implies that cab drivers should work many hours on rainy days and treat themselves to some leisure on mild days, when they can “buy” leisure at a lower price. The logic of loss aversion suggests the opposite: drivers who have a fixed daily target will work many more hours when the pickings are slim and go home early when rain-drenched customers are begging to be taken somewhere.” - If you have tried catching for a cab during rain, independent of, which part of the world you live in, you have the same experience.

This is not only true for cab drivers, it’s equally true for Golfers. The economists Devin Pope and Maurice Schweitzer, at the University of Pennsylvania, did a study that shows “every stroke count in golf, and in professional golf every stroke counts a lot. According to prospect theory, however, some strokes count. more than others.

Failing to make par is a loss, but missing a birdie putt is a foregone gain, not a loss. Pope and Schweitzer reasoned from loss aversion that players would try a little harder when putting for par (to avoid a bogey) than when putting for a birdie. They analyzed more than 2.5 million putts in exquisite detail to test that prediction. This difference is not trivial. Tiger Woods was one of the “participants” in their study.

If in his best years Tiger Woods had managed managed to putt as well for birdies as he did for par, his average tournament score would have improved by one stroke and his earnings by almost $1 million per season.”

Isn’t this fascinating that the core objective of performance management and “pay per performance” actually defies the objective in short run and current state. - Is this the reason, most of the people in the organization are mapped between one or two standard deviation in normal distribution curve?

The next interesting point for this comes from Psychology. The idea that people evaluate many outcomes as gains and losses, and that losses loom larger than gains, you should not be surprised unless you are a trader.

However, there is no silver bullet, there are different ways how affluent people reacts is different from how not so affluent people react to the same performance rewards, even within the same organization.

Again, I would love to quote Daniel, who said, “being poor, in prospect theory, is living below one’s reference point. There are goods that the poor need and cannot afford, so they are always “in the losses.” Small amounts of money that they receive are therefore perceived as a reduced loss, not as a gain.”

“The money helps one climb a little toward the reference point, but the poor always remain on the steep limb of the value function. The poor are not indifferent to the differences between gaining and giving up. Their problem is that all their choices are between losses. Money that is spent on one good is the loss of another good that could have been purchased instead. For the poor, costs are losses.”

Well, so if you have offices in multiple cities in the same country or in multiple countries and demographics and standard of living, your performance management system might work a bit or damage a lot in the objective.

Well the next point is interesting too as in ‘Pay for Performance’ culture, we need to start with if money is the motivator and if yes how much money is enough?

The two-factor theory (also known as Herzberg's motivation-hygiene theory and dual-factor theory) states that there are certain factors in the workplace that cause job satisfaction while a separate set of factors cause dissatisfaction, all of which act independently of each other.

Two-factor theory distinguishes between:

Motivators - (e.g. challenging work, recognition for one's achievement, responsibility, opportunity to do something meaningful, involvement in decision making, sense of importance to an organization) that give positive satisfaction, arising from intrinsic conditions of the job itself, such as recognition, achievement, or personal growth.

Hygiene factors - (e.g. status, job security, salary? fringe benefits, work conditions, good pay, paid insurance, vacations) that do not give positive satisfaction or lead to higher motivation, though dissatisfaction results from their absence.

Have you ever heard the term that ‘there should be individual respect in whatever you do?

Well, the ‘Pay’ comes as Hygiene factor but not motivator, this means definitely pay has a role to play and without the pay, people are not satisfied at work but the pay itself does not motivate people.

If you think this is just an old-fashioned obsolete theory today, let’s try something mathematical. It’s good that now we can use MRI scan and other advanced equipment are helping us to detect the brain signal quite clearly.

Let’s look at utility theory in a gamble. In utility theory, the utility of a gain is assessed by comparing the utilities of two states of wealth. For example, the utility of getting an extra $500 when your wealth is $1 million is the difference between the utility of $1,000,500 and the utility of $1 million. And if you own the larger amount, the disutility of losing $500 is again the difference between the utilities of the two states of wealth. Will the wealth make a difference in your choice?

Last but not the least, let’s do a small experiment. Evaluation is relative to a neutral reference point, which is sometimes referred to as an “adaptation level.” You can easily set up a compelling demonstration.

“Place three bowls of water in front of you. Put ice water into the left-hand bowl and warm water into the right-hand bowl. The water in the middle bowl should be at room temperature. Immerse your hands in the cold and warm water for about a minute, then dip both in the middle bowl. You will experience the same temperature as heat in one hand and cold in the other.

For financial outcomes, the usual reference point is the status quo, but it can also be the outcome that you expect, or perhaps the outcome to which you feel entitled, for example, the raise or bonus that your colleagues receive. Outcomes that are better than the reference points are gains. Below the reference point they are losses.” - Kahneman, Daniel. Thinking, Fast and Slow.

Did I confuse you?

The idea for performance management and “Pay per Performance” bonus was ages old, when people work in factories, they receive some amount of money for per additional piece of good that they produced over and above the target and the model may have well suited there but when it was copied in today's industries including knowledge management, there is a significant need to reform.

However, the core challenge is neither business nor human resource functions are data driven and well versed with statistics. I should perhaps blame it on education systems for not combining these subjects into the curriculum but still it needs a solid support from the senior leadership to challenge the status quo.