Why Your Pay Doesn't Stack Up

By Howard Risher

August 1, 1997

The pressure to change the way you are paid is building up steam as agencies struggle to modernize.

In a reinvention drive that has relied on many private sector tools for improving the behavior of organizations and their employees, pay incentives are the missing link. Other techniques--such as quality management, process improvement, reengineering, de-layering--haven't produced hoped-for gains. So now experts are concluding that financial rewards must be part of the equation for improved performance. At least in the private sector, some say, "you get what you pay for." In the federal arena, recently announced pay experiments at the Defense, Commerce and Veterans Affairs departments reflect a willingness to test this idea.

Today, organizational change initiatives in the corporate world pay close attention to employee compensation systems. As a consequence, traditional wage and salary programs are on the endangered list as experts aggressively design more effective pay programs as tools to support new work paradigms. Bonuses and other incentives have become increasingly important components of compensation, on the theory that behavior that is rewarded is likely to be repeated.

Measured against evolving private sector practice, federal compensation programs do not stack up. There is precious little personal financial incentive to do a better job in most agencies. Yet a few agency pay demonstration projects now in the planning stages reflect a desire to encourage significant cultural change. The best example to date is the recently announced experiment in Veterans Benefits Administration regional offices in New York and Detroit, which will include pay incentives to stimulate improved customer service. The new pay system at the New York office, which is a National Performance Review reinvention lab and a pilot site for the 1993 Government Performance and Results Act, is only one element of a comprehensive reinvention strategy. Likewise, a planned demonstration at the Defense Department links salary increases to improved employee competence.

Private Sector Changes

Corporations have learned to move carefully in changing pay systems. Change can be disruptive because the way employees are paid unfortunately is interrelated with their personal status, and, for many, pay is the crux of their relationship with an employer. When a new pay system is introduced, some employees feel like winners, which makes others feel like losers--a flash point for resentment.

Pay has often been disregarded when organizational changes are rolled out. That may have made sense, until employers initiated quality management programs and realized that the results were not meeting expectations. The same thing happened with reengineering initiatives. Quality management and reengineering transformed the work but overlooked the need to get workers to climb onto the bandwagon.

Now, even Michael Hammer, the godfather of reengineering, has broadened his focus to include people-management issues. "We can no longer give lip service to the ideas of people as a resource while managing them as a commodity," Hammer said in a promotional brochure for a recent conference. "Transforming the work force has become the most important strategic issue facing companies that hope to succeed in the new century."

So pay programs have become a key management tool. The goal of performance improvement requires behavioral change: People have to approach work with new attitudes and new behaviors, and they need incentives to overcome their comfort with work as usual. Companies such as General Electric have learned it is advantageous to align corporate goals such as quality with employee rewards such as cash bonuses. If the goal is to create a learning organization, then employees have to be rewarded accordingly.

"Our behavior is driven by a fundamental core belief: the desire and the ability of an organization to continuously learn from any source, and to rapidly convert this learning into action is its ultimate competitive advantage," says Jack Welsh, GE's chief executive officer. "We have made major changes in the compensation system to support this learning behavior. Bonuses, as well as salaries, reward the finding and sharing of ideas even more than their origination. You can talk--you can preach--all you want about a 'learning organization,' but from our experience, reinforcing management appraisal and compensation systems are the critical enablers that must be in place if rhetoric is to become reality."

Even the most conservative companies are working to assure that their pay programs are not an impediment to change. While it's still true that only a handful of corporate executives can expect to get rich, there is a growing willingness to allow everyone to share in the success of the company. Pepsi-Cola, for example, grants stock options to all employees. Other corporations have introduced group incentive plans that promise bonus awards to enable employees to share in financial gains.

Corporations have tried incentive pay programs before. In the 1930s, industrial engineers designed piece-rate pay systems (i.e., pay per unit of output) as an incentive to increase productivity in factories. Those systems--still in use at a few companies--were resented by workers and often proved ineffective. The engineers determined "optimal" hand-and-arm motions on the production line--with little regard for employee input--and the pay system was an incentive for speed.

The management view of workers as mere tools of production prevailed for 50 years. But now it's on the way out. The new work paradigm taps unused employee skills. "After decades of meaningless statements in annual reports about workers as an important asset, corporations are moving rapidly toward people-management strategies that recognize the contribution that empowered workers can make to the organization's success," says Hammer. Pay is still being managed as an incentive, but the goal is to encourage employees to grow in their jobs and to assume increased responsibility. Changing the pay system is integral to this emerging strategy.

Government's Reluctance

In comparison to the private sector, government has been slow to abandon its traditional pay system. Many years of discussion in the late 1980s preceded enactment of the locality pay concept in 1990. Clinging to a national salary schedule was creating serious problems. In high-pay areas such as Manhattan, hiring and retaining qualified job candidates had become virtually impossible. Though the problem was widely acknowledged, the necessary political support for change took years to develop.

An extensive government-sponsored survey of salary management practices conducted in 1987 confirmed that large companies rarely rely on a national salary schedule--except for a handful with union contracts. Locality pay was a win-win proposition for government and for the work force, but there was enormous reluctance to embrace such radical change.

Part of the problem is the history of the General Schedule, which was formally adopted in 1949, but which has existed in essentially the same form since the 1920s. The conceptual logic of the classification system is more than 100 years old and has survived despite periodic reports recommending a sweeping overhaul.

Jobs are ranked with GS grade assignments, as they were in 1949, and not much differently from the hierarchy defined in the 1923 Classification Act. Moreover, until the 1990 Federal Employees Pay Comparability Act (FEPCA), new hires started at Step 1 of their assigned grades, regardless of their qualifications, and progressed by schedule. There are a few exceptions, but the schedule is rigidity at its worst.

Labor markets, in contrast, are driven by economics and the balance of supply and demand for specific knowledge or skills. Pay rates are higher for the best qualified individuals. Since 1949, for example, pay rates for professional occupations have been going up faster than the prevailing rates for clerical jobs. The GS system is stuck in the 1920s. The annual adjustment in the GS salary ranges is planned to reflect overall market increases, but fails to adjust ranges that might be too high or too low for a specific job.

When workers were seen as an extension of a machine, qualifications such as relevant experience or a degree from an elite college were immaterial. Now, when government refuses to acknowledge that keeping starting salaries as low as possible affects its ability to compete, it implicitly ignores the value of qualified employees.

Empowering federal workers is an ongoing theme in the National Performance Review's reinvention reports. The value of workers and their contribution is a prominent issue. Yet the history of the GS program both before and after FEPCA shows no shift in philosophy.

And most often, when government attempts change, it does so clumsily. In the corporate world, the chief executive has the power to mandate program changes and while the goal is always to help the financial bottom line, better managed corporations place a high priority on helping employees accept changes. In government pay reform initiatives, little emphasis is placed on the benefits to agencies or on communicating those benefits to employees. An exception to this rule, however, occurred at the Naval Ocean Systems Center at China Lake in California. Its pay demonstration project, launched in 1979, came in response to staffing problems associated with the merger of two units. The commanding officer met with his department and division heads and acknowledged their concerns, but said unless they thought the program changes were a bad idea, he expected their full support. The new pay program is as successful as any, public or private.

But most often, no one in government can take the lead on pay reform, but a hundred or more could derail it. Just about every employee group has someone looking out for its interests. Members of Congress from districts with large numbers of federal workers are key supporters of pay reform. The unions are aware of the need for change, but are looking for a quid pro quo and public recognition of their importance before they will support change.

Inadequate political support for resolving federal workers' pay problems offsets any interest in improving the program. Despite Congress' willingness to enact FEPCA in 1990 and accept the need for locality pay, the pay gap is still an issue in every one of the metropolitan areas defined for locality pay differentials. Bureau of Labor Statistics surveys show that federal pay--not including locality payments--lags behind prevailing local rates by at least 24 percent (Orlando, Fla.) and as much as 48 percent (San Francisco). FEPCA represented a breakthrough, but it has not been adequately funded and agencies are still finding it difficult to compete for qualified workers.

The National Performance Review has been on record since its initial report in 1993 with strong statements of support for simplifying the pay and classification systems, and for allowing agencies to develop their own performance management and reward systems. The National Academy of Public Administration has also issued a series of reports calling for change. A NAPA task force's 1991 report called for broad banding--the simplification of the GS grade structure by shifting to a small number of broader salary ranges--and won widespread support.

Government officials have made public statements expressing interest in moving toward a corporate pay model, but the changes to date fail to capture the real essence of that model--support for a culture that emphasizes performance. The GS program is not a reward system. The use of the word "schedule" is meaningful in that pay rates are scheduled in the same way that they might have been posted for blue-collar factory jobs in the 1930s.

This rigidity makes gaining employee support for a new model difficult. With the current system, employees understand where they stand and what they can expect. The best performers can expect a few advantages over time, and the worst performers also can expect their step increases. Federal employees are dissatisfied, but they are cynical that any program changes will be any better. At least with the GS program, no one has tried to take away the step increases.

There is an obvious reluctance to link pay to performance. When pay reform was working its way through a series of public meetings starting in 1989, Constance Newman, then director of the Office of Personnel Management, voiced support for merit pay. Critics saw too many problems associated with paying for performance. Somehow, employers almost everywhere can support a credible merit pay policy, except in government unless one counts the Navy's China Lake project and a few local government programs as harbingers of change in the public sector.

Paying for Performance

Government recognizes a need to shift to a performance-based management philosophy. "We suffer not only a budget deficit but a performance deficit," said the 1993 National Performance Review report. The political importance of making this shift is obvious to anyone outside Washington.

Also in 1993, the Government Performance and Results Act was passed to compel agencies to change the way they do business. Agencies have been working to develop strategies to comply with the law. Last year, agencies began to link their long-term goals and objectives to annual performance plans. Those plans are to be sent to Congress and the Office of Management and Budget by Sept. 30.

GPRA institutes systems that are conceptually the same as the standard corporate planning process. Corporations are not universally good at looking into the future and putting together long-term plans, but they emphasize the process of planning. It's difficult to set accurate goals a year in advance, especially in a rapidly changing economy, but corporations that don't try could lose their focus. Realistically, the need to be profitable is the reason corporations devote so much energy to planning.

The bottom line provides a shared focus, or rallying point, for corporate employees. Financial results are omnipresent in internal reports and executive conversations, and often are routinely distributed to rank-and-file workers. The value of making employees aware of their company's performance is a key issue in the concept of open-book management. In addition to financial data, corporations track performance on almost every aspect of their operation from quality to customer satisfaction to delivery times to absenteeism. Data are generated to compare performance against the operating plan, against prior periods and against competitors. Measurement is a fundamental consideration in any initiative to improve performance. Companies have learned that when performance is measured and the data is shared with employees, performance improves.

From that perspective, GPRA is essential in improving government performance. John Koskinen, deputy director of OMB, recently told the House Committee on Government Reform and Oversight that the intent is to enable federal managers to answer three questions: "What is [the organization] trying to achieve? How will its effectiveness be determined? How is it actually doing?" A lesson to be learned from industry is that employees below the management level should also be able to answer those questions.

Corporate executives are accountable for their organization's success and failure. Not all of them have opportunities to become wealthy, but company success can have significant rewards. Along with the rewards, corporate executives have to accept the risk of termination if performance is inadequate. The acceptance of that accountability and risk is a quid pro quo for the reward opportunities.

The proposal to create performance-based organizations (PBOs) is an attempt to produce similar environments within government. The chief operating officer of a PBO would be competitively hired, commit to annual performance agreements and have a share of his or her pay ride on the organization's performance. Thus far, nine organizations have been identified as prospective PBOs. These agencies share a common thread of reasonably routine services, such as OPM's retirement benefit services or manufacturing at the U.S. Mint.

The model bill developed for PBO authorization breaks new ground for the federal government in the use of financial incentives. While some of the current personnel regulations are untouchable (e.g. merit system principles), organizations designated as PBOs will have broad latitude to develop performance management processes and reward systems that meet their needs. As with GPRA, goals or objectives for assessing organization performance are to be set and used to establish cascading goals for work groups and individuals. Base pay adjustments (i.e. merit pay) would be based on performance relative to the goals. Bonuses could be made for superior individual or group accomplishments, documented productivity gains, or sustained superior performance. That language would make it possible to introduce a truly effective reward system.

In the corporate world, cash incentive plans are a basic component of most executive compensation packages. Research has shown that corporations with executive incentive plans outperform those that do not. Pay-outs are an integral component of the compensation package, not an add-on as they are currently for federal executives. A basic design concept is the so-called target or guideline award, which is expressed as a percentage of salary. The target award is the amount plan participants will earn when they perform and/or the company performs at planned levels.

Target amounts vary typically from 10 percent to 20 percent for the lowest participants (typically managers with base salaries of $50,000 to $60,000) to 50 percent or 60 percent of salary for a CEO. In years when the company performs better than expected, incentive pay-outs will exceed the target amounts. In years when performance is poor, plan participants can expect reduced pay-outs. A manager with a target of 20 percent and a base salary of $50,000 would earn $10,000 when performance is at planned levels. In a particularly good year, he or she might earn $15,000 or more; in a bad year the pay-out might be $5,000 or less. The potential swing and the predictability of pay-outs provides an effective incentive.

Pay as a Management Tool

Executive incentives are important, but the full potential for creating a high-performance environment rides on the commitment and productivity of people below the management level. Research confirms that a new work paradigm that taps underutilized employee capabilities substantially increases productivity--at least 30 percent to 40 percent.

The shift to a performance-based culture will not be easy or without problems. There are anecdotal stories in industry of what by traditional expectations are phenomenal increases in productivity. However, it takes a concerted, integrated strategy that focuses on organizational change to raise the bar. Pay is an important element; at some point employees are likely to ask, "What's in it for me?" But even a corporation as well-managed as Xerox has had trouble cloning its success from one location at another.

When a compensation system is not redesigned, employees see little reason to adopt, and are more likely to resist moving to, new work practices. They know they are entitled to their salary increases as long as they stay out of trouble.

The new generation of demonstration plans show a shift in the willingness to use pay to drive changes in the way employees approach their jobs. The VA experiment is based on a strategy to reward employees for improved performance. Employee compensation will be tied to the achievement of specific goals. The Defense Department's plan links salary increases to an assessment of each employee on a set of performance dimensions or standards related to the employee's contribution. The Commerce Department will look to supervisors to rank employees by performance within peer groups, and salary increases will depend on the rankings. The plans are different, but the common thread is the use of pay to influence job performance--a fundamental shift for government.

Howard Risher, senior fellow at the Wharton School's Center for Human Resources, is co-editor and principal author of New Strategies for Public Pay (Jossey-Bass, 1997). He was the managing consultant to OPM on federal pay reform and served on the NAPA task force on broad banding.


By Howard Risher

August 1, 1997

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