Navigating the Complexities of Annual Compensation Reviews
Welcome to Fall as we embark the final week of the quarter and prepare for annual compensation reviews in Q4. Annual compensation adjustments are intricate and challenging, particularly in the realm of knowledge work. As the CEO of InnovaSystems International, LLC from 1997-2022, I had the privilege of spending 25 years refining this process, transforming our company from a small startup to a large software enterprise with outstanding results in engagement and retention throughout most of those years. My approach was very hands-on, working closely with our CFO, COO, and HR Director on both performance management and compensation on a regular basis.
In this blog, I will share the lessons I learned and the best practices that I still adhere to today, drawing on my experience and advice from experts in the leadership and HR communities. Additionally, I will be a panelist on an upcoming webinar with strategy experts Paul Niven and Kevin Baum on September 26, 2024 at 9am PT (link to register here), where we will discuss the connection between strategic objectives contribution, OKRs, performance, and compensation.
John Doerr brought Objectives and Key Results (OKRs) and Continuous Performance Management (CPM) into the spotlight in 2018 with his NY Times best-seller, Measure What Matters. In Chapter 15, he recommends that companies "Divorce compensation (both raises and bonuses) from OKRs," a notion that has left many leaders perplexed, as evidenced by the numerous articles, comments, and discussions since the book's release.
Doerr goes on to say, “Now, I’m not proposing that performance reviews and goals can or should be completely severed. A data-driven summary of what someone has achieved can be a welcome antidote to ratings biases. And since OKRs reflect a person’s most meaningful work, they’re a source of reliable feedback for the cycle to come. But when goals are used and abused to set compensation, employees can be counted on to sandbag. They start playing defense, they stop stretching for amazing. They get bored for lack of challenge. And the organization suffers most of all.”
Since Doerr doesn’t suggest how to address compensation any further, it seems that many leaders have misinterpreted his intentions by keeping objectives out of consideration for raises and bonuses. My take on his advice is that he is recommending that companies avoid using formulas to calculate compensation based on specific progress results of OKRs. I don’t believe that he is suggesting that OKRs not be considered as part of the compensation process, but instead to use caution when and how results are used to determine raises and bonuses. If a company develops a policy where specific progress on objectives puts employees into a raise category such as 100% progress = highest raise bracket, then naturally, objectives will be set to be 100% achievable as much as possible. However, I believe his recommendations on CPM with frequent 1-1 conversations, feedback, and recognition are spot on and something that we’ve practiced with success for over 25 years.
Key Lessons and Best Practices for Compensation Reviews
Hold Regular Performance Reviews
Conducting quarterly or tri-annual light-weight performance reviews enables continuous check-ins on goal progress and allows for timely course corrections throughout the year. Replacing a biweekly 1-1 at the beginning of the quarter with a performance agreement to clarify goals and expectations and then again at the end of the quarter to check-in on progress with an AI-assisted self-assessment and manager appraisal is a practical way to ensure that employees stay aligned with strategic objectives and receive the necessary feedback to improve their performance.
Emphasize Fairness
Fairness in compensation is crucial. Not every employee can contribute to an annual strategy at the same level. Acknowledging and recognizing contributions in various areas such as overall role performance, competencies and company values alignment to ensure a balanced approach is necessary. Be clear about which roles are expected to align with the strategy and track those diligently.
Recognize Star Performances
Star performers must be recognized differently than average ones. Below-average performers should be addressed promptly through coaching or other actions. Differentiated recognition ensures that high performers feel valued and motivated. Giving out standard raises and bonuses across the board with little deviation from the average, will have your star performers looking elsewhere.
Understand Market Value
Understanding the market value for all positions is essential. Regularly benchmark compensation against industry standards to ensure competitiveness and fairness.
Set and Clarify Competencies
Set and clarify competencies that will be evaluated alongside objectives. We emphasized “Developing Self” to encourage continuous learning/improvement and “Develop Others” for leaders to act as coaches in their frequent one-on-one meetings.
Involve Leadership at All Levels
Involve senior and middle leadership in strategy definition, execution, evaluation, and compensation recommendations. We worked very closely with our Business Unit Leaders (BULs) who manage groups of 50-100 employees with team sizes of 5-10 who know their managers well and are familiar with all contributors through biweekly one-on-one conversations. Our BULs were able to review their appraisals and then calibrate them into an overall performance category by knowing which managers were more lenient graders than others. We also asked functional directors to comment and rate the potential of each employee in their business unit to provide a balanced perspective in a 9-box tool that immensely helped our compensation committee to normalize performance and assure a fair raise.
Frequent One-on-One Meetings
Frequent one-on-one meetings are key to:
- Clarifying expectations
- Avoiding surprises at the end of the year
- Coaching individual performance
- Learning about key contributors at the BUL level
- Keeping processes simple and avoiding lengthy and difficult procedures
Balance compensation with other policies
Fair compensation, along with other company policies, keeps engagement and retention high. Balance goal progress with individual development, career growth, competencies, overall impact, social engagement, charity events, consistent leadership, smart processes, and ensuring every voice is heard through regular surveys.
Focus on Employee Success
Focus on helping all employees succeed in contributing to the strategy and their careers. Providing support and development opportunities fosters a motivated and high-performing workforce. Employ the Conversations, Feedback, and Recognition (CFR) approach, which is embedded within the Inspire platform. Regular recognition of performance as it is achieved is a great way to keep employees engaged, optimally motivated and encouraged to continue to innovate.
Implement a Leadership Development Syllabus
Leadership Development throughout the organization is important for a consistent approach to coaching and a strong understanding of CPM. We drew from several sources including FranklinCovey, Blanchard, LinkedIn Learning, leadership partners and internal experts.
Avoid Recency Bias
Avoid distorted recency bias by using a continuous performance management (CPM) system like Inspire Software that tracks goal progress, check-in status summaries, conversations and performance conversations throughout the year and also utilizes AI to summarize that data in a meaningful way.
Conclusion
By holding regular reviews, emphasizing fairness, recognizing star performances, understanding market value, and focusing on employee success, organizations can effectively navigate the complexities of annual compensation reviews. These best practices will be discussed further during the upcoming webinar with Paul Niven and Kevin Baum. Stay tuned for more updates and insights as we continue to explore the intersection of strategic objectives, performance, and compensation.
