Companies Are Shifting from Evaluating Performance to Developing Talent: Will It Motivate Employees?

Rigid rankings hinder the teamwork and risk-taking necessary for innovation. But what combination of methods works best?

Holiday shopping, year-end deadlines, and emotional family dramas aren’t the only stresses in December. ’Tis the season for some companies to embark on that dreaded annual rite, the often bureaucratic and always time-consuming performance review. The process can be brutal: As many as one-third of U.S. corporations evaluate employees based on systems that pit Page 128them against their colleagues, and some even lead to the firing of low performers.

Fans say such “forced ranking” systems ensure that managers take a cold look at performance. But the practice increasingly is coming under fire. Following a string of discrimination lawsuits from employees who believe they were ranked and yanked based on age and not merely their performance, fewer companies are adopting the controversial management tool. Critics charge that it unfairly penalizes groups made up of stars and hinders collaboration and risk-taking, a growing concern for companies that are trying to innovate their way to growth. And a new study calls into question the long-term value of forced rankings. “It creates a zero-sum game, and so it tends to discourage cooperation,” says Steve Kerr, a managing director at Goldman Sachs Group Inc., who heads the firm’s leadership training program.

Even General Electric Co., the most famous proponent of the practice, is trying to inject more flexibility into its system. Former Chief Executive Jack Welch required managers to divide talent into three groups—a top 20 percent, a middle 70 percent, and a bottom 10 percent, many of whom were shown the door. A few years ago, GE launched a proactive campaign to remind managers to use more common sense in assigning rankings. “People in some locations take [distributions] so literally that judgment comes out of the practice,” says Susan P. Peters, GE’s vice president for executive development.

Striking that balance between strict yardsticks and managerial judgment is something every company, from GE to Yahoo! to American Airlines, is grappling with today. But finding a substitute for a rigid grading system is not an easy task. It drives truth into a process frequently eroded by grade inflation and helps leaders identify managers who are good at finding top talent.

GE has removed all references to the 20/70/10 split from its online performance management tool and now presents the curve as a set of guidelines. Individual groups are freer to have a somewhat higher number of “A” players or even, says Peters, no “bottom 10s.” Even those low achievers are getting kinder treatment, from a new appellation—the “less effectives”—to more specific coaching and intervention than in the past.

The changes are key for a company trying to evolve its culture from a Six Sigma powerhouse to one that also values innovation. Tempering such rigid performance metrics, says Peters, “enables individuals and organizations to be more comfortable with risk-taking and with failure.” To drive that point home, the company’s top managers were evaluated for the first time on five traits, such as imagination and external focus, that represent the company’s strategic goals. And more recently, GE announced plans to do away with annual performance reviews all together, focusing employee evaluations on frequent discussions and ongoing coaching by supervisors via a new app called “PD@GE”—performance development at GE.

Separating stars from slackers remains a long-standing part of GE’s performance-driven culture. But for most companies, especially those without such cultures, the benefits of adopting a forced ranking system are likely to dissipate over the long term.

A recent study lends hard data to that theory. Steve Scullen, an associate professor of management at Drake University in Des Moines, Iowa, found that forced ranking, including the firing of the bottom 5 percent or 10 percent, results in an impressive 16 percent productivity improvement—but only over the first couple of years. After that, Scullen says, the gains drop off, from 6 percent climbs in the third and fourth years to basically zero by year 10. “It’s a terrific idea for companies in trouble, done over one or two years, but to do it as a long-term solution is not going to work,” says Dave Ulrich, a business professor at the University of Michigan at Ann Arbor. “Over time it gets people focused on competing with each other rather than collaborating.”

Yahoo!, too, was looking for better dialogue and less demoralizing labels when it substantially changed its rating system, which compared employees’ performance to an absolute standard rather than to each other. Libby Sartain, Yahoo!’s senior vice president for human resources, knew that review discussions at the Sunnyvale, California, tech leader frequently included the wink-wink “I wanted to put you here, but I was forced by human resources to do something different” comment that discredits so many appraisals. Yahoo! stripped away its performance labels, partly in hopes that reviews would center more on substance and less on explaining away a grade.

But that doesn’t mean Yahoo! went all Pollyanna on its employees. To do a better job of finding and showering top performers with the rewards necessary to keep them from jumping ship in talent-tight Silicon Valley, the company also instituted a “stack-ranking” system to determine how compensation increases are distributed. It asks managers to rank employees within each unit—a group of 20 people would be ranked 1 through 20, for example—with raises and bonuses Page 129distributed accordingly. During reviews, employees are told how their increases generally compare to those of others.

Some Yahoo! managers are livid about the new system. “It’s going to kill morale,” laments one senior engineering manager who says he’s getting a stronger message to cull his bottom performers. Yahoo! says its new program doesn’t automatically weed out a bottom group and was designed specifically to reward its stars.

Indeed, what Yahoo! has introduced in place of its old system shows how hard it is for companies to find ways to foster merit-driven cultures that coddle standouts while staying tough on low performers. Whether a company calls it stack ranking, forced ranking, or differentiation, “there’s no magic process,” says Sartain. “We just want to make sure we’re making our bets and that we’re investing in the people we most want to keep. That’s what this is all about.”

Best-Practice Ideas

Review season is here, with all the time-consuming bureaucracy and stress that come with it. Here are five ideas to help put performance back into the process:

Meet More Often

Time-strapped managers may sound a collective groan, but year-end reviews on their own are hardly enough. The best managers meet at least three times a year, if not four—once to set goals, once or twice for an update, and finally, to review—with many informal check-ins in between. In this quickly shifting economy, goals may change, and fewer surprises will surface at year-end.

Make Room for Risk

As innovation trumps efficiency, some companies are putting some wiggle room into their rankings and ratings. But more flexible guidelines have to have teeth, too: Low-performing units shouldn’t get more than their share of top grades, for example. Exceptions should go to people who set aggressive goals and come close to achieving them.

Adjust Goals along with Grades

While many companies use “calibration” sessions to check that performance assessments level out among different managers, less than 10 percent fine-tune up-front goals across groups, according to Hewitt Associates.

Choose Words Wisely

Whether or not you strip the labels off your performance reviews entirely, as Yahoo! has, faint-praise terms such as “fully satisfies” make essential B-players feel like also-rans. Try “strong” or “successful” to drive home their value.

Build Trust

With so much focus on the tools and tricks of performance management, it’s easy to lose sight of what really matters: the conversation. The University of Michigan’s Dave Ulrich suggests putting three simple words—“help me understand”—in front of difficult feedback.

Questions

What’s your opinion regarding forced ranking performance appraisals? Do they motivate employees? Explain.

How would equity theory explain some employees’ negative reactions to forced rankings? Explain.

Based on Chapter 5, if you decided not to use forced rankings at your company, how would you motivate employees?