18 Feb 2010
Managing for results — pay for performance schemes and the like — are fundamentally flawed if that is the only criterion for evaluating managers. We have observed more than the average share of businesses, managers and employees, and we have serious doubts about this almost universal approach to managing firms. Far better, we believe, to reward people for their decisions and decision-making processes. Our argument is based on six assertions.
1. Results are irrelevant as a measure of decision quality.
People, including managers and business leaders, typically equate the quality of a decision with the quality of the result. When people observe a good result, they conclude that they made a good decision. Likewise, when a bad result is observed, people conclude that a bad decision was made. This is not true. Decisions and results are two different things. Time elapses between a decision and the realisation of its result. Decisions are made at a specific moment in time; afterwards, people implement these decisions, and the result is observed in the future. The future is uncertain: there are no facts about the future, and nobody has a crystal ball. In the future, events can happen that managers and organisations cannot control. Also, events can happen that managers could not foresee. Such events can cause good decisions to have a bad result — and vice versa. Therefore, the quality of the result is not an indicator of decision quality, and the result is irrelevant as a measure of decision (and execution) quality
2. Results don’t necessarily reflect a high-quality process.
Decision quality is measured at the moment someone makes a decision, but decision making is a process. To determine quality, in general, we need a criterion. So it is for the quality of decisions. There are thousands of criteria in business: in the Finance area, managers use profit, cost, return on investment, cash flow and price/earnings ratios. In Marketing, the criteria include sales volumes, market share and customer satisfaction. Go to Operations and one finds inventory levels, efficiency and production quality. Walk to Human Resources and one finds employee satisfaction, turnover and organisational morale. In sum, people make decisions in all functional areas in business; but the underlying process is the same. That’s why decision making is a generic leadership skill.
The ultimate criterion for good decision making is tied to three critical questions:
What are we trying to achieve with this decision? (the criteria)
What can we feasibly do? (the alternatives)
What do we have to watch out for? (the consequences)
The answers to these questions will reveal the alternatives, actions and choices that the decision makers have — and, on the third question, the answer leads us to specify the consequences of our possible alternatives. Good decision making also requires relevant and useful information.
Deciding is (1) valuing your alternatives at the moment you have them (2) on the criteria you have identified and (3) with the best information available at that time. Value is the only justification for your actions in business. The answers to the questions on criteria, alternatives and consequences come from the decision makers’ knowledge, understanding, experience and intuition about the business issues. The process of decision making, therefore, is a mechanism to leverage the collective knowledge, experience and intuition of a group, team or organisation. It allows this intuition to be discussed, challenged and refined. Intuition is at the bottom of the decision-making pyramid, for it is the foundation.
The experience of people in a business is always relative. In some situations, a person making a decision has more experience than others in the workplace; in other situations, less. Therefore, good decision making requires managers to be humble, recognising the context and ascertaining whether their knowledge, experience and intuition applies more or less. Good decision making starts by recognising that there is no monopoly on wisdom; we can all learn something from each other. The process of decision making forces us to be reflective, analytical. We all know we have to use some process while making decisions. However, how many times do people really do this consciously? Typically, both managers and employees would rather act first then reflect later (if at all).
The process of decision making is critically important and essentially about effective communication, which is reflected in the three questions noted above. As a result of effective communication, the parties involved develop a shared understanding of the issues they are dealing with. This ultimately leads to joint commitment to action, which means that, even if a person’s favourite alternative has not been chosen at the end of a decision-making process — by virtue of having participated in a good process, there is a much greater chance that he or she will still support the alternative decided upon.
3. Using results as a measure of decision quality leads to organisational crises, even bankruptcies.
It is wrong to use a result as a criterion for a decision-making process. Assume a great business opportunity arises in which a manager makes a good decision but experiences a bad result because of some outside uncontrollable and/or unforeseen event. This manager will typically not be promoted and could even be fired, after being blamed for the bad result. By this action, the boss has fired a good decision maker, but the boss has done something much worse to the organisation. Eventually, the terminated manager’s colleagues — his team, his business division and, in time, the whole organisation — will soon realise that he or she was unjustly held accountable for the bad result, that the fired manager was blamed and punished unjustly. From that point forward, who else in this organisation will want to take initiatives, make decisions, experiment and innovate? No one. People will realise that, even when they make a good decision, a bad result will result in blame or termination, irrespective of the quality of the decision-making process.
A blame culture triggered by bad results stifles experimentation, innovation or trial and error. If leaders do not tolerate failure and error in our business innovations, they will kill the prospect of anyone taking any initiative. Since business activity is the primary engine for personal income growth, value creation and societal economic development, an organisational culture built on blame and punishment has implications beyond the boundaries of our any one business. Taken to national proportions, a blaming culture inhibits societal growth, development and evolution. Managing for results leads to crisis, at the least; it can lead to bankruptcy, at the worst.
4. Being accountable only for results is not the right standard for performance.
Of course, people must be held accountable for what they do in a business context; but they need to be held accountable for the right things. They need to be held accountable for things under their control, that is, operating with a good process of high quality. They should not be held accountable for uncontrollable events.
Conversely, if business leaders only want good results, it is easy to understand that, ultimately, any process to achieve good results will become acceptable — even an illegal process. This is yet another way in which managing for results can become the origin of crisis and bankruptcy. A manager who achieves an excellent result but, in the process of achieving it, has demotivated his team is clearly not a good leader.
Think of the current economic crisis. Sub-prime mortgages were driven by banks wanting to do more business without carefully considering creditworthiness, the risks involved in borrowers not being able to repay their mortgages. A few years ago, almost anybody could get a mortgage. And banks repackaged thousands of these unsafe loans into CDOs (collateralised debt obligations) to sell as a bundle of bad loans to investors — again, doing more and more business without looking at the quality of the transactions, that is, the inherent risk associated with such business.
Tools such as Management by Objectives and Balanced Scorecards are, when used properly, helpful. Such management tools help people review and better understand the criteria involved in the process of decision making. Their proper use, then, is for setting objectives, criteria and measuring progress on them. However, such tools should never be used for evaluating people working towards a set of objectives.
5. It’s not enough to measure organisational leaders on results; how they achieved them is equally important.
Of course, results are not irrelevant for organisations and their leaders. A company that always makes good decisions and is always excellent at execution — but, too often, yields bad results — will go bankrupt. The CEO is ultimately responsible for the good results for the organisation, a responsibility to the shareholders who demand good results. But this question must also be considered: what can companies do to achieve good results?
Companies typically do two things to achieve, on average, better results. First, they implement a good process. Managers can learn to become better business executives. They can learn the process of decision making, learn how to be better at execution and build their business via the knowledge, experience and informed intuition that is inherent in decision making and execution. Out of this, managers will find that they are becoming better, more thoughtful business leaders — more aware and better informed about what they are doing.
Second, companies manage the risk inherent in any single business project, division, product, market, service and delivery channel. Diversification is a way of managing risk inherent in single projects. By having multiple products, markets (on a global scale), services and delivery channels, an organisation diversifies its risk. Some projects and businesses will be successful; others might be less successful; still others might fail.
That is why the CEO can (and must) be held responsible for the overall results of the enterprise. CEOs oversee a sprawling and usually complex organisation, and their personal career risk is diversified as a result. That is, they are judged by the average of all (both good and bad) results inside the corporation. However, going down the organisational hierarchical chain, those managing the divisions, departments, teams and projects become less and less diversified. It is a bad CEO who enforces the requirement for everyone in the company to deliver good results all the time.
But isn’t that exactly what many CEOs have been doing? That is, they desired universal good results and, therefore, they have delegated this responsibility to everybody else in their organisations. This is unreasonable and ineffective. Down the organisational hierarchy, many managers are in charge of single products, single markets, a single delivery channel and/or a single service. As a consequence, they are exposed to the inherent risk associated with these single business projects. Many CEOs have not understood this very well. It is a bad CEO who does not shield his or her managers from the risk inherent in their less-diversified projects and who do not recognize quality of process as being more important than occasional bad results.
6. Being compensated only for results doesn’t measure one’s true contributions to the organisation.
Managers traditionally get bonuses for good results. Corporate compensation systems are built around achieving good results. This is simply wrong. It is wrong to use a financial bonus to motivate and encourage managers to achieve good results, if that is the only reward they can earn. If a bonus is used to reward good results, it implies that managers are evaluated only on their results; and, ultimately, managers can (and have!) found themselves doing anything to achieve good results so as not to forfeit a bonus. Managers have even been found to engage in illegal activities in order to make the results required to earn a bonus.
An important note: we are not opposed to bonuses. The proper use of a bonus is for enjoyment — collective organisational enjoyment — of the good fortunes of the organisation if good results happen. Any other use of a bonus is misplaced. However, good managers will, in the long run, yield good results by adhering to a good process more often than bad managers using a poorly thought-through or malevolent process.
It is, of course, possible that bad managers using wrong processes will sometimes enjoy good results. But their luck will run out eventually. Therefore, in the long run, it is necessary for organisations to evaluate the quality of a manager’s decision-making process over the span of his or her career. Over time, managers will make many decisions and take many actions. In this sense, the cumulative body of their decisions and actions can be seen as diversified. If they use a good process for making decisions, then, on average, they will experience good results more often than bad results. Organisations should therefore reward on the longer-term performance achievements of managers. This can be done by many means, such as promotions to levels of higher responsibility or authority as well as base salary increases. Ultimately, managerial career progress and base salaries should reflect a company’s commitment to the overall quality of a manager’s contributions to the organisation. It may seem controversial, but we firmly believe that even managers with bad results should be rewarded — if they have used a good decision-making process.
Bert De Reyck (firstname.lastname@example.org) is Adjunct Professor of Management Science and Operations and Zeger Degraeve (email@example.com) is Professor of Decision Sciences, Management Science and Operations at London Business School