Making Performance Work (BetaCodex10)

MAKING
PERFORMANCE
WORKWhy performance systems have to change, and how you should approach this:
From fixed to relative performance contracts, and towards simple, ethical
and empowering ways of dealing with value creation
Make it real!
BetaCodex Network Associates
Niels Pflaeging & Gebhard Borck & Andreas Zeuch
White paper Jan 2009 – Revised and extended Dec 2011 and Feb 2013

What is the problem with Performance Management
as we know it?
Almost everything.
This paper explores why most
Performance Systems are broken,
and how to reinvent them.

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

4
Management
control cycle
Budget
Strategy
Strategic
learning cycle
Annual plan
Control
Management processes in command and control
organizations are “straight jackets”
Fixed
Performance
Contract
“Fixed” performance contract
•  Period [Fixed]
•  Targets [Fixed]
•  Compensation [Fixed]
•  Plan [Fixed]
•  Resources [Fixed]
•  Coordination [Fixed]
•  Control [Fixed]
•  Agreed through [Negotiation]
•  Signed by: [Manager/Director]
Source: BBRT
Tayloristic management works like this: As centralistic-burocratic hierarchies,
held together through a regime of fixed performance contracts!

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

Our profoundly flawed approach to dealing
with present performance, and the future
About futurizing, planning,
forecasting and strategy

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?

Planning.
Don´t
Companies.
Need.

A small elite governing the
powerless masses. An economic
system held together by tight
planning, and control. Mistrust in
entrepreneurial initiative.
Those were key features of the
soviet union.
Now guess where this kind of
governance remains in place
today: It is the worlds
corporations and small to large-
size firms. It is just that we call
the practice of “management”.

Organizations need a trust-based form of “future-directed
thinking”, not planning-based 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

We have come to believe that the source of great performance is good planning. But planning
actually never (ever!) is the source of performance. Preparation is. While planning means
fiddling with the future (in your head), preparation means doing the real work, by becoming fit
for performance. It enables individuals and teams to achieve high performance.
Just like in a Racing Team. The situation pictured here is a fine example of a case where high
performance is produced, and in fact required.

If you think about it, a Formula 1 team does not rely on intense planning at all. But on
intense, and highly disciplined preparation. Things that teams like this indulge in are:
• All-team mastery: Every team member has to be a master. No exception. This enables the
team to sense and respond. To improvise. To be intuitive. High-performance teams often
have a no “baby-sitting” culture, internally.
• Trying. Trying. More trying. You cannot run enough test races. Science calls this
“deliberate practice” This is more than just practicing. In fact, science also shows that
“talent” is completely overrated.
• Intense and open communication flow. Everyone is always up to date.
• Rituals for group cohesion and a culture aimed at winning together, not individually.
These characteristics are typically largely absent from larger organizations. Ask yourself why.

“I will prepare
myself and
my time
must come.” Abraham Lincoln,
lawyer, statesman
A wiser approach than planning

Traditional model “Alpha”:
fixed performance contracts,
negotiated in advance
New model “Beta”:
:relative performance contracts,
assessed with hindsight)
Applying the BetaCodex means:
From fixed to adaptive management processes
strategy
control
Fixed
performance
contracts Dynamic
coordination
Relative
performance
contracts
•  Dynamic, continuous processes
•  Relative targets/compensation
•  Self-control, transparency and
peer pressure
•  Fixed, annual processes
•  Fixed targets and incentives
•  Centralized and
bureaucratic control
Changing
processes

The underlying issue
About human nature, motivation, and the frequently
misunderstood perils of contemporary HR practices

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

vs.
Theory Y Douglas McGregor
Theory X
Most performance practices are deeply flawed...

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

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…

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.
Source: based upon John Kotter, Leading Change, p, 110-111

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

Performance & Pay
About bonuses, incentives, and pay-for-performance
schemes – and why they cannot work. Also in this
chapter: Practical recommendations for how to create
better pay systems

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. Period.
So why do so many of us still apply
in the carrot-and-stick method with people?

Real-world stories on the effects of performance management
The case of Marie Taylor
This is what happened:
Marie Taylor, a sales person from our organization, generated income
that goes against her company´s principle “Always act to the benefit
of our customers“.
The decision: Marie Taylor was transferred to the internal sales
support department. All her bonuses rights were immediately
cancelled.
The backdrop:
It is true – all sales people in the firm were obliged to act in the interest of
their customers. And Marie did not act accordingly.
But it is also true that 40% of Marie Taylor´s salary depended on the amount
of net sales she generated.

Real-world stories on the effects of performance management
The case of Frank Miller
This is what happened:
Frank Miller, a consultant, overcharged during his work with
clients, which means he systematically inflated the amount of
hours worked charged to his customers.
The decision: Frank Miller was fired and left the company
immediately.
The backdrop:
It is true: Frank Miller actually acted against the law by charging for more than
he had really worked for at his clients.
But it is also true that 25% of Frank Miller´s income depended on the hours
charged to clients…

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

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.
Social scientist Alfie Kohn says:

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!
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 very simple principle:
Never use bonuses and incentives.
Apply profit sharing and/or shareholding concepts
for connectedness.

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
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
Individual incentive pay, in reality, under-
mines performance – of both the individual
and the organization. Jeffrey Pfeffer,
Six Dangerous Myths about Pay, HBR 1998

Always disconnect compensation from targets.
Always.

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

Pay the person. Not the position.
Always.

Variable compensation: Unbundling fixed, individual pay for
performance contracts in favor of relative team improvement
BetaCodex principles advocate basing evaluation and compensation on
relative improvement contracts with hindsight,
rather than fixed performance contracts agreed upon in advance.
In formulating a compensation policy, the BetaCodex mindset leads to
eight key recommendations:
1.  Use the language and thinking of gain sharing, not incentives.
2.  Align pay with strategic measures, not budgets.
3.  Base compensation on relative measures, not fixed targets.
4.  Measure and reward (if needed) the performance of teams, not individuals.
5.  Align pay with interdependent groups, not parochial interests.
6.  Use clear and transparent measures, not unfathomable numbers.
7.  Make compensation fair and inclusive, not unfair and divisive.
8.  To highlight outstanding contributions, use company values, not the numbers.

All employees should earn a
share of the financial success:
Restrain from the idea of
“motivating them“!
Organizations can free themselves from
conventional forms of “pay for performance”,
through simple and more transparent
compensation systems.
Conclusions:

Resource coordination, reinvented
A few words about how to employ resources well,
without the managing

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!)

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

Setting direction in an age of uncertainty
About targets, the failed promise of MbO,
and the illusion of steering

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.

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."

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, like 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 the BetaCodex 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.

The blue pill: Fixed, negotiated targets
Most
important
competitor
(28%)
Market
(25%)
Plan
(15%)
Actual
(21%)
Target: absolute ROCE in % (here: 15%)
[expected
market Ø: 13%]
Plan
Comparison:
Plan-Actual
Actual
Why traditional management with “fixed performance contracts“
regularly fools us: We have lost control a long time ago…
•  Interpretation within the plan-actual-
comparison: Plan was outperformed by 6
percentage points > positive interpretation
•  Better ROCE of the market average and the
most important competitor remain unnoticed!
The red pill: Relative, self-adjusting targets
Target: relative ROCE in % (to market)
Most
important
competitor
(28%)
Market
(25%)
Target: „ROCE
in % better
than market
average”
Actual
(21%)
•  Interpretation within actual-actual compa-
rison: Performance was 4 percentage points
below competition! > negative interpretation
•  Absolute assumptions at the moment of
planning don't matter.
•  Targets always remain updated and relevant!
[independent
from expected
market Ø]
Target Actual
Comparison:
Market-Actual

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

Let´s look at performance differently
About reporting, metrics, indicators, and measuring
performance, without need for planning

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?

To evaluate performance in an adaptive and dynamic way,
the foundations of performance measurement must shift
From: Against plan To: Against time
• Prior periods
• Progress towards achievement of
medium-term (2-3 years) targets
From: Internal focus To: External focus
• Internal peers
• Competitors
• Benchmarks/Stretch
From: Annual focus To: Trends and “as needed”, always rolling
From: Financial measures To: Few key indicators
From: Closed systems To: Open information systems for all
From: Pure measurement To: Mixed approach of measuring/judging
“Indicators only indicate“, there is no “truth” in the
numbers – living systems cannot be evaluated by
measuring alone!
From: Controlling individuals To: Stopping measurement at team level

Principles for good metrics:
1 It relates to a stakeholder’s goal
2 It helps improve part of the system
3 Data is collected by those who need it

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

Remember:
Metrics can be highly useful.
Targets usually are superfluous.
Incentives are always abominable.

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.
Consult the BetaCodex Network's other white papers and
presentation slides for further content-rich material about the
BetaCodex (formerly: the Beyond Budgeting model)
and about how to approach transformation.
By applying the 12 laws of the BetaCodex (on the next page),
you will revolutionize performance management.

The 12 laws of the BetaCodex (formerly: Beyond Budgeting)
are a full set of design principles for a new organization type
Law Beta Alpha
§1 Freedom to act Connectedness not Dependency
§2 Responsibility Cells not Departments
§3 Governance Leadership not Management
§4 Performance climate Result culture not Duty fulfillment
§5 Success Fit not Maximization
§6 Transparency Intelligence flow not Power accumulation
§7 Orientation Relative Targets not Top-down prescription
§8 Recognition Sharing not Incentives
§9 Mental presence Preparedness not Planning
§10 Decision-making Consequence not Bureaucracy
§11 Resource usage Purpose-driven not Status-oriented
§12 Coordination Market dynamics not Commands

© BetaCodex Network – All rights reservedWhite paper – The 3 Structures of an Organization 1
Find all BetaCodex Network white papers on www.betacodex.org/papers and on Slideshare.
Special

Edi+on

Special

Edi+on

The BetaCodex Network white papers - so far

www.organizeforcomplexity.com
The “Organize for Complexity” book
English - paperback
German edition
English - ebook
Turkish edition
with Selcuk Alimdar
Portuguese edition

betacodex.org
Get in touch with us for more information about leading BetaCodex transformation,
and ask us for a keynote or a workshop proposal.
Make it real!
Niels Pflaeging
contact@nielspflaeging.com
nielspflaeging.com
New York, Wiesbaden
Valérya Carvalho
mvaleriacarv@gmail.com
LinkedIn
São Paulo
Silke Hermann
silke.hermann@nsights-group.de
insights-group.de
Wiesbaden, Berlin, New York
Lars Vollmer
me@lars-vollmer.com
lars-vollmer.com
Hannover, Stuttgart

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