Is pay for performance is breaking under modern expectations?

[00:00:00] [SPEAKER_01] Join us on a journey where we unravel the latest trends, tackle your burning questions and explore innovative strategies that are shaping the future of compensation, all with a cup of coffee in hand. Welcome to another episode of Comp and Coffee. Pay for performance has been a cornerstone of compensation philosophy for years and that's the topic that we're going to be discussing today.

[00:00:24] [SPEAKER_01] The logic is simple. Link pay to performance, business performance, motivate continuous contribution, differentiate top performers from average ones and align your compensation spend with your business outcomes. It does sound simple, but there are definitely some things shifting in the way we work today. Organizations currently are operating to tighter budgets and honing in on how to use compensation as a strategic lever.

[00:00:52] [SPEAKER_01] Employees also have new expectations about transparency, fairness and how paid decisions are made and how performance is assessed. And of course, the nature of work is changing. Priorities are shifting faster than they ever have before. Roles are blending and changing and measuring individual performance is getting harder than it's ever been. So the debate on pay for performance isn't new. It's a topic I feel like I've been talking about for quite a while.

[00:01:20] [SPEAKER_01] But these new challenges are making us think harder about whether the construct still works. So today, that's what we're asking. What's actually working in performance related pay? What's broken? And more importantly, what should it look like in a modern workplace where flexibility, transparency and fairness matter? So my guest today has spent their career challenging the conventional wisdom around pay for performance.

[00:01:45] [SPEAKER_01] And his new book, Close the Gap, takes on some of the biggest fallacies in how we approach compensation. So welcome to Comp and Coffee, James C. Churn. Please introduce yourself to our audience and maybe tell us a little bit about the book.

[00:01:59] [SPEAKER_00] Thanks, Ruth. Thanks for inviting me. It's good to be here. Yeah. So yeah, so what I'll say is I spent the large part of my latter career challenging pay for performance. And the early part of my career, I was very much a fan of pay for performance. So I am something of a convert in this area because I've worked a lot with sales organizations. And with sales organizations, commission is king. That's a big part of the culture and a big part of the performance equation. Even if I think in sales, I think it's possibly put up on too much of a pedestal.

[00:02:29] [SPEAKER_00] But yeah, my book, I have two recent books. The book before this was called What Pay Costs. And that was really my exploration into just specifically pay, what pay can do, what it does to human nature and how it gets used and what it can and can't do in the workplace. And with Close the Gap, I kind of extended that thinking to say, well, given that pay is actually quite limited in this application in terms of what it can bring out of people, what should we be doing instead? What are the conditions for productivity?

[00:02:59] [SPEAKER_00] What are the conditions for engagement in the workforce? So that's kind of, I would say, if you're looking for a book on pay for performance, let's say, what pay costs, not Close the Gap. It's probably the introduction to that. But that's how I think about things.

[00:03:12] [SPEAKER_01] And when you're not writing books, what do you get up to, James?

[00:03:16] [SPEAKER_00] Well, I find it difficult. I don't really know anymore. So I still do consulting work. I still work with clients, but I don't do as much as I used to. And I take more of an advisor role and sometimes more of a coaching role these days. I don't do as much of the kind of job architecture comp work. But I still do some of that. And I have my own podcast as well. A rival podcast to comp and coffee. But I think it's a nice pairing. I think a pair.

[00:03:40] [SPEAKER_01] I think podcast are rivals, are they? I think they're just different perspectives, I think.

[00:03:44] [SPEAKER_00] And that's called disengaged because I see disengagement as this epidemic in not just corporate America, but globally. Two thirds of people aren't engaged with their work. And that's criminal to me. Ethically criminal, socially criminal and economically criminal. So my goal with that is to bring on thinkers that can help contribute to solving that problem. So it's a little bit of pay. And I bring a lot of pay-oriented people, but a lot of behavioral economics and organizational psychologists that have spent their careers trying to understand why these problems exist.

[00:04:15] [SPEAKER_00] And in my free time, I do like coffee as well. So I do have my coffee, by the way. So I've got the coffee part of the comp and coffee ready.

[00:04:20] [SPEAKER_01] Good. Oh, branded as well. Yes.

[00:04:22] [SPEAKER_00] Yeah, branded mug as well.

[00:04:23] [SPEAKER_01] That was going to be my next question, which is, you know, our rite of passage question here on the podcast is what's your go-to coffee order? And if you're not a coffee drinker, what's your favorite morning beverage? But you've already told me you're a coffee drinker. Any particular type of coffee?

[00:04:38] [SPEAKER_00] Well, this one I have. So I vary. If I go into a coffee shop, I'll look for an interesting single origin. You know, I do like my coffee, but I don't like milk coffees and lattes that much. That's on occasion at all. But I like a single origin. So I look for sort of Ethiopian yoga chefs. I find quite interesting coffee being the lighter ones. But I tend to just sort of go with the mood and I talk to the barista and figure out what's going on. At home, I have what's called the San Francisco Fog Chaser, which I drink on a regular basis, which is my kind of go-to medium dark roast.

[00:05:07] [SPEAKER_00] So I'm pretty uncomplicated. Most of the time, I'm just looking for a drip coffee. If I'm lucky, I'll get a single origin pour over.

[00:05:13] [SPEAKER_01] And you live in San Francisco, despite the British accent.

[00:05:17] [SPEAKER_00] Yeah, and despite 10 years here as well, I still have it as well. My wife also has a British accent as well, so we kind of reinforce each other. So every time someone says something slightly American, there's a sort of prick of the ear. It's like, what was that? So we kind of correct each other when it comes to adopting the American accent. But yeah, I'm originally from London. I spent most of my career working with European and a lot of time in the Middle East, a lot of Middle Eastern compensation projects as well. And in the last 10 years, I've been here in San Francisco, predominantly working with the startup community.

[00:05:44] [SPEAKER_00] A lot of my clients are in the VC-backed community looking for help. That really fast-paced VC-backed founder-led world. Just don't have time to stop and think about things. There's a lot of inherited assumptions about how a company should be organized without a huge amount of time to think about whether that's right for them. So I encourage companies to innovate. The most successful companies are ones that innovate not just their products and services, but around their people and their people experience as well.

[00:06:09] [SPEAKER_00] And you look at some of the highest value companies in the world, and they got there by innovating how they treated people in the workplace and encouraging innovation and free thought. So Google famously had things like 20% time and crazy offices that no one could quite accept being from the UK. I was like, why are they doing these things? And it was because they're trying to create a positive, productive, innovative place where people would come up with new, fresh ideas and move the company forward.

[00:06:34] [SPEAKER_00] So I do think that, yeah, I think companies, particularly in the VC-backed world, can afford to stop and think a bit about how to be different and differentiate themselves in the employee experience.

[00:06:45] [SPEAKER_01] And you tell a lot of those stories. I know we're a podcast, but we do have some camera, but I did read the book. Thank you for sending that through to me. I read that on holiday in Sicily, by the ball. So I loved a lot of the good case studies in there. I think they were particularly interesting. But a lot of what you were just talking about was fostering innovation and how maybe a lot of the systems that we have in place today don't support that. And I kind of think about that in the AI context as well.

[00:07:12] [SPEAKER_01] We've just finished conference here at Payscale, our big annual virtual conference. If you didn't attend listeners, you can go to Payscale.com and you can still access conference on demand. But we had an economist, Kortika Roy, do the keynote. And she was really talking about how AI is changing work, but the systems that support it haven't kept up. And I think that's another topic we can maybe dig into today when we think about HR compensation, pay performance systems.

[00:07:40] [SPEAKER_01] But I did want to talk about pay for performance because it's one of my favorite pet topics. And so that was why I did ask you here today. So let's focus there first. And let's start by defining performance-related pay because it can mean many things. Talk us through your definition of what performance-related pay is.

[00:08:01] [SPEAKER_00] Yeah. So the thing is, all pay is performance-based pay. Now, I work for myself. And if I perform, I get paid. If I don't perform, I don't get paid. I have a pay-for-performance philosophy, you could argue. So all pay in some way is connected to performance. So to me, there's always a spectrum of how salient that connection is. And the salience is a word that comes up a lot in the research literature as well. So on the one end of it, you've got, for example, a sales role. And let's say it's 100% commission. You only get paid if you sell.

[00:08:28] [SPEAKER_00] Very high salience to that pay piece. It impacts your behavior. It drives your behavior. It changes your behavior. You do things in the expectation that you're going to get paid for that behavior. On the other hand, you might just have a base salary. And you might have equity or you might have an annual bonus, which is just based on profit share or something like that. That's still, to some degree, performance-based pay or pay-for-performance. But it's much less salient. It's much less controlling. So when we normally think about this concept of pay-for-performance, what we normally mean

[00:08:57] [SPEAKER_00] is individualized pay-for-performance. The notion that you, as a person, do your job well and you will get paid more than the person that doesn't do that job as well as you do it. So there's a notion of competitiveness in that equation for me. So when I talk about pay-for-performance, when I critique the commonly held beliefs about pay-for-performance, I'm really thinking about that end of the spectrum. And the last thing I'll say before I let you ask your questions about it is that the context is hugely important here.

[00:09:26] [SPEAKER_00] So we are mostly knowledge workers these days. And by knowledge workers, I mean people that have to think creatively, think abstractly, don't know what problems are going to come up in the next year. And in many cases, it's very difficult to set goals a year up because who knows what's going to happen in a year's time? Like we just don't know. And a lot of the time you get to the end of that year and look back at your goals and you say, well, that doesn't make any sense. We completely have to pivot. So how do you assess my performance now? And that's part of the problem with pay-for-performance in knowledge work. Not only is it highly unpredictable as to what you need to do as a person to deliver

[00:09:55] [SPEAKER_00] value to the organization, but there's an implied notion that you are competing with your colleagues. You can only get more if someone else gets less. That's how it works. If you've got a merit budget, and most companies do, I've got views on the concepts of a benchmark merit budget as well. But if you've got a finite merit budget, the fact is if you want more, someone else has to get less, which means you are in direct competition with the people that you've just been told you have to collaborate with in order to deliver on results for the business. So that's where the friction comes in.

[00:10:22] [SPEAKER_00] If you are truly on your own and truly just working independently and all you need to do is do a bit more to deliver a bit more value, like sell a bit more, then yes, pay can complement those behaviors. But if what you need to do is collaborative, and if what it requires is creative abstract thought, then there are studies that have reliably shown that attaching pay to those outcomes will inhibit your ability to think creatively, not enhance it, actually reduce

[00:10:48] [SPEAKER_00] your ability to find abstract creative problems, which is the thing that companies need the most in a world where we're constantly being challenged by AI disruption.

[00:10:56] [SPEAKER_01] Yeah. And when I think about like the practical application of a merit budget, that's where I have a big problem because, I mean, I was a compensation practitioner for many years and like the years running, like the 10 years or the nine years running up to the COVID, we saw just like persistent 3% merit budgets. And at that time I was talking about what we've called peanut butter pay or just like spreading merit budgets too thinly.

[00:11:24] [SPEAKER_01] And like, what is the actual impact you can have on an individual or on your employee base by allocating base pay so thinly when someone who's a high performer is potentially going to get enough to, I think I always used to create it, I remember doing some presentations to like buying a crate of beer is probably the difference that they would be able to buy for someone who's been rated lower than them in the merit matrix. And we still see that today, you know, we kind of went through COVID, we've had disruption

[00:11:49] [SPEAKER_01] in wages, we had like slightly higher wage budgets during the Great Resignation, now coming back down to this kind of settling around this 3.5% merit budget. So I guess that's the big problem I have is, are you really going to drive behavioural change with the amount of differentiation that you get through a merit budget? What are your thoughts on that?

[00:12:13] [SPEAKER_00] Well, there's a whole bunch of assumptions in that kind of thinking. And this is my, this is what I've noticed in the, in the compensation professional profession is it starts off with a whole base of assumptions before it makes decisions. So one of those assumptions is that 3.5%, those benchmark numbers are in any way useful, which they're not. So what happens is, and I used to, and I've worked at the compensation practice that collects and reports the states. So what happens is you go out to a bunch of companies and you say, what do you think your merit budget is going to be for next year? They don't know. You know, no one knows what your pay budget is going to be.

[00:12:42] [SPEAKER_00] Like sometimes your headcount goes down. Sometimes you need to hire more. Sometimes you need to pay more to keep people like, no one knows what's going to happen to your wage bill, but everyone says, well, probably somewhere between three and 4%, because that's what I think everyone's doing right now. So they, so these compensation data houses take that data in those guesses, which they are guesses, and they put them into a database and then report back out in percentiles, which everyone thinks is scientific because a percentile sounds scientific. If you have 50th percentile, it was, oh, okay.

[00:13:10] [SPEAKER_00] So the 50th percentile is going to be 3.5% next year, which it is, I think coming up for the 2027 cycle, but it's not, you know, that's not, that's not a rule. That says nothing about your organization. So let's say, again, let's start with what pay is. Pay is delivering back some of the value that's created by your workforce to the people that created it. There are different ways you can do that. You can do it with a base salary, a bonus, probably the best natural way is equity, because then you share in the value you create for your own organization. But pay is one way to do that.

[00:13:37] [SPEAKER_00] Just because some other company thinks that it can only afford to give three and a half percent increase back to its people does not mean that's all you can afford to do. This is an investment of resources that you have generated collectively as a team. The question is, what's right for you? What do you need to do to, to protect those resources, though, that those members of your team, I hate to use the word resources as well. So I, I made a mistake that those people, those people that have created the value for your company. So first of all, we shouldn't assume that the 3.5% merit budget is useful or valid or

[00:14:05] [SPEAKER_00] statistically sound or based on fact. It isn't. It's some other company's notion of what they can afford or they think they might be able to afford. And then the idea is that you can differentiate. So that was your next part of your question. But I'll pause there because I see you're about to offer some thoughts on that.

[00:14:19] [SPEAKER_01] Oh yeah, let's talk about it for you. I mean, we, we actually do do that at PayScale here. So obviously we do our salary budget survey where we go out and survey people. I think what I have seen the difference in practice is that since the disruption of COVID, thinking that that 3.5% applies to everybody has changed because we do see such differentiation in terms of labour supply, which ultimately, you know, labour demand and supply, which is

[00:14:43] [SPEAKER_01] ultimately what drives wage rates to some degree, like the market rate has definitely shifted between sectors. So, you know, our advice always to people is, you know, don't take the 3.5% as like the word, you know, you need to consider where are you sourcing talent from? And that can be different from someone else in your industry even. And as you say, like really think about like, what is it we need to achieve as a business and what can we afford and how can we allocate funds accordingly to achieve that within the

[00:15:13] [SPEAKER_01] business? But yeah, sorry, where were you going next? You were going on to...

[00:15:16] [SPEAKER_00] Yeah, and I'll say it is useful information. It's data, it's market data, the same way as compensation benchmarking in general is data. It tells you what other companies do. That's interesting to know, but it's still just an input to decision making. It's not the answer. It's not a recommendation. So that's my caveat with that kind of data source. But then there's this idea that differentiation is a good thing, right? So there's a whole bunch of assumptions wrapped up in that. On the one side, you could argue that it's fair.

[00:15:43] [SPEAKER_00] It's fair to give people that do more, more money than people that do less. And that's probably true. But the big question is, well, do you know, are you sure you know which people did more and which people did less in an area where it's very subjective? And it's been shown repeatedly through studies that you don't. So through studies, this all hinges on a merit rating. You know, it's very one to five typically rating that you get. And this idea that you know whether somebody is a one, two, three, four or five.

[00:16:10] [SPEAKER_00] And we've shown in studies that it's heavily, heavily driven by context, not by individual. So we've shown in studies that if I measure you, Ruth, and I say, okay, one of your things this year was more executive presence or something like that, or one of your things was higher quality of client deliverable. That's subjective. Now you could create metrics like that maybe, but even the definition of those metrics is subjective. But if I assess you on something that's got different definitions, it says more about my

[00:16:39] [SPEAKER_00] interpretation of that definition than it says about your ability to meet on that thing. And this has been studied and it's called the idiosyncratic rater effect. And there's research on this and it's heavily weighted towards the person doing the rating rather than the person being rated. So that's one of the problems. If it's fair, yes, it could be fair if you could measure that definition in a fair way. And the other side of that assumption, there's a fairness argument to that, that you have to distribute it in order to be fair with pay, which is very, very difficult to do.

[00:17:06] [SPEAKER_00] And the other side of that is that there is a performance aspect to it, that if we do this, we are going to drive performance. We're going to get the most out of people by rewarding a high performance. That has a major assumption, which is that pay is the main driver of performance or should be the main driver of performance. And again, all the research would point to that being incorrect. And I come back to the research. What pay can do is persuade people that have chosen not to do something that they could do.

[00:17:36] [SPEAKER_00] That is essentially it. But it also coaches people that that is the only thing they should do. So what you see in these heavily pay for performance environments is they might, they will find a way to do it. You will get what you pay for. And I absolutely promise that if you tell people to do something and you'll offer them pay to do it, they'll do it. If I say, I'll give you $10. If you put your hand up, you'll put your hand up for $10. Then you'll say, okay, what next? What else do I need to do? So you're coaching people to basically think like children. I'll give you a treat. If you do your homework, it's essentially that mentality.

[00:18:04] [SPEAKER_00] So that's not the mentality most companies claim to want from their people. What they want is creative, free thinking people who can think about abstract, unpredictable problems and collaborate with people to fix those things. And that's the essence of innovation, which is the essence of survival. So that that's the problem with a lot. A lot of people fail to think about the assumptions that go into that cycle. And there are companies that have reset that as well. And not, they're not taking that approach.

[00:18:31] [SPEAKER_01] But I agree with you. I mean, you know, if I put my consulting shoes back on again, you know, the first thing I would tell people is just don't use a merit matrix, you know, find, look at other ways of rewarding performance if you want to through pay. But we see all the time that just people are so wedded to this concept of the merit matrix. Our CBPR data, our compensation best practice research data, we ask every year, like, what's

[00:19:00] [SPEAKER_01] the main factor that you use to drive based pay decisions? And it comes up the top every time 76% it was this year. I've been doing the research here with pay scale for five years. It's been around for 10 years. I remember being like 82%. So why do we keep, why do we keep it?

[00:19:19] [SPEAKER_00] Well, that was one of the big questions when I finished what pay costs was I got to this point. I looked through a lot of research and I was kind of like, why do we keep doing it? This is one of the questions I had. So it closed the gap. I started off by taking a much more, taking more of the route into why do we do what we do? Why do we keep doing things that don't make any sense? Why do we keep smoking cigarettes? 10 years off, we know it gave us cancer. Why do we still put children on the factory floor, even when we knew it was morally abhorrent?

[00:19:45] [SPEAKER_00] Now, why did we still use slave labor for hundreds of years, even after most people accepted that we shouldn't? It takes a long time for practice, common practice to catch up with moral and social belief systems. That's been shown. And with this idea of individualized pay for performance, we really have to go back to scientific management at the turn of the century in Frederick Winslow Taylor and his views on what America should have been at this time. And his approach was time and motion.

[00:20:12] [SPEAKER_00] You take any given process, you break it down into all its little bits, and then you only pay people if they do all those little bits. So his approach was to basically dehumanize work. And it took hold. It was very, very popular at the turn of the 20th century. Scientific management was hailed as the driving force behind American industry. It was patriotic. You know, it was a big part of what you could do. And you as an individual could earn lots of money if you did exactly what you were told. So that's really the genesis of this thinking.

[00:20:40] [SPEAKER_00] And then the psychological counterpart for that was real, really BF Skinner, who famously had these Skinner boxes in which he put rats and pigeons and showed that you could change their behavior by offering them treats, things like that. But of course, if you take a human and you put them in a box and say, I'll give you this if you do that, and I won't give you this if you don't do that, then they'll conform. Of course they will. So we look at this behavior and then it becomes a self-fulfilling cycle. So we put in place these systems and then we say, well, you can only get a bit more budget if you out-compete your colleagues, if you get a four or a five.

[00:21:10] [SPEAKER_00] And then people start doing the things that you're telling them to do to get a four or a five. And you point to that behavior and go, see, it works. They're doing all the things we're telling them to do. We just need to finesse it. We just need to figure out exactly what we need to tell them to do. And then we can make this whole paper performance system working. Rather than going back to that fundamental assumption around, well, is this the kind of human we're trying to create here? It's someone that just does what they're told in exchange for treats and prizes or with the fear of punishment, which is an even more powerful tool, of course. So that's really the genesis.

[00:21:38] [SPEAKER_00] And also what happens then is there's a huge amount of identity protection that comes with this as well. Many people in the corporate world have spent their careers climbing this ladder, and that means that they subscribe to this model. They've invested a portion of themselves into it as well. So to say, well, that's all nonsense means saying I've invested my career in something. That's all nonsense as well. So we make our beliefs not we're very irrational creatures in reality.

[00:22:05] [SPEAKER_00] And this is what behavioral economics is already about, is that we assume that we're rational. We're really not. Much of our decision making is wrapped up in our social identity. And if everyone is saying we should do pay for performance, there is a social cost to saying we shouldn't. You essentially get ostracized from that community by saying, no, that doesn't make any sense. But there is a social benefit to saying, I agree, let's keep selling that. So there is no penalty whatsoever for continuing this way of thinking from a social perspective. But there is a heavy penalty for moving away from it.

[00:22:34] [SPEAKER_00] Because frankly, I've got much less to sell now. It was much. I could sell bonus design. I could sell merit matrices. I can sell calibration. I could sell training. So when you look at what exists and what doesn't exist, it's very rarely a rational explanation for that.

[00:23:03] [SPEAKER_00] It's much more to do with social identity and inherited assumptions that we haven't stopped to question.

[00:23:08] [SPEAKER_01] And even when I think about it at a practical level, I work for a company that uses a merit matrix. And we will go through our year-end process. And yeah, I can rationalize. Oh, yeah. If I'm a higher performer, I'm going to get slightly more of that pool than someone else. I accept the system. And I feel good about that. But in reality, when you look at individualizations around pay, the amount of money that they're going to get through a merit matrix rarely meets their pay progression expectations.

[00:23:39] [SPEAKER_01] And you talk a bit about pay progression, career progression in the book as well. Do you want to kind of talk about your thoughts there? Like, how do we respond to individuals' expectations about where do you see the relationship between pay progression and career progression?

[00:23:53] Hmm.

[00:23:54] [SPEAKER_00] Well, the problem is that they're so inextricably linked. So now pay and career progression, they're the same thing. If you want career progression, you have to look for pay progression. If you want pay progression, you have to look to career progression. So it's the same as the merit cycle, but applied to a career. And what happens is, you know, there's a wonderful myth that I use, that I learned and I use in the book of Procrustes and the Procrustean bed, which comes up a lot as a metaphor.

[00:24:21] [SPEAKER_00] And the metaphor is that travelers would stop at the end of Procrustes and they would say, can I stay here for the night? He'd say, yeah, and I've got a very special magical bed. It fits everyone perfectly. And they would sit in the bed. And if they were too short, he would stretch them. So they fit the bed. And if they were too long, he would cut off their feet to make sure they fit the bed. And to me, a lot of the architecture of companies is built in this Procrustean assumption that everyone needs to fit into the model that we think is best.

[00:24:46] [SPEAKER_00] So a career, a career is an expression of purpose in the world for a human. A career is our role in society and what we can offer to it and what we get in exchange for that. A career is a very impressive thing. And work has the capacity to deliver on our purpose. And if you take away that capacity to deliver on purpose and our purpose or let people find their purpose or meet the purpose that they believe they have, then you create some very dangerous people.

[00:25:14] [SPEAKER_00] A human without purpose is a very dangerous thing. And we see a lot of that in present day political decisions and social problems. It's people that lack purpose and they look to the darker places of the world to find that purpose. Now, that's a slightly philosophical answer to your question. But what companies then do is they create this apparatus to try and get people to keep doing more in exchange for that career. They dangle that purpose at the top.

[00:25:41] [SPEAKER_00] So many years ago, not many years ago, 30 years ago, the average CEO to worker ratio in the US was about 30 to one. The average person that was getting paid got paid at a 30th of the amount of the CEO. Now, I think it's 273 to one, something like that. It ranges of 200 to 400, depending on the year. You've created a system where economic advancement and career advancement are so tied together. You have to do what you're told when you're told to do it in order to stand a chance. And again, it's circular.

[00:26:10] [SPEAKER_00] People point to that and say, see, people want to progress. People want to use the ladder. They're looking at the career ladder. They're asking me what to do within that ladder. So as long as you have an organization that has so much economic disparity between the top and the bottom, you are telling people that they have to advance their career. Now, they might be doing it. And some people do have a career calling. Many people do. And they do want to advance their career. But you're not really seeing that. You're seeing people that need to advance their career out of necessity to meet their basic needs.

[00:26:40] [SPEAKER_00] You cannot pay for your kid's education, at least in America. It's less of a problem in the UK. But if you've got two or three kids, you cannot afford to pay for their kid's education without advancing through that career system. You cannot save for retirement without advancing through that career system. We've made it an economic necessity to climb the ladder. So it's very difficult to differentiate what people want from a career perspective, what they need for their own selves, for their own personal identity, from what they need financially to survive.

[00:27:08] [SPEAKER_00] So to me, and the final thing I'll say on this, because I know this is a long answer, is I look at Abraham Maslow's research, his hierarchy of needs, which is sometimes depicted as a pyramid or what happened after his writing. But at the base, you've got your basic needs, safety, security for you and your family. That's what pay offers. That's the most it can ever offer, safety and security. And at the top of those needs, you've got personal fulfillment and development and self-actualization.

[00:27:32] [SPEAKER_00] The top is what a career can offer, that sense of joy and wonder we get when we start expressing ourselves and start finding out what we're capable of. But the more you attach pay to career and the more you tie the two, the more you attach something that can only serve our basic needs of safety and security and start intertwining it with the concept of a career. And that prevents us getting away from those lower human needs.

[00:27:55] [SPEAKER_00] We are rationing out the things that humans need at the lower end of the pyramid, the basic needs for safety and security and not worry about whether they're going to have a job tomorrow, if they're going to get laid off or they're going to be able to afford for retirement or if they're going to afford to send their kids to the schools they want to send them to. That's the thing they're worried about in a modern society. That's the thing a lot of people are worried about. They don't even have a chance to think about those higher needs of self-actualization and purpose.

[00:28:19] [SPEAKER_00] So that to me, the short answer to your question is tying pay and career is quite a dangerous thing because we don't see which one each really means to the person.

[00:28:32] [SPEAKER_01] Yeah, I know it's a very interesting perspective. I mean, and it is very much what I see in practice is, you know, people want to be want to push career progression because they want more pay because they have expectations of both. You know, it's just like I see myself having this kind of lifestyle and being able to provide this kind of lifestyle for the people that I support. And that's always a different trajectory from their, you know, their career path. But as you say, they will often like tie into each other.

[00:29:01] [SPEAKER_00] And by one, sorry, one last point on that one, actually, was that that's true. And you can coach people to believe that they are climbing a ladder. That's the dangerous thing as well. And this has been studied much in the same way you can coach people to be wealth addicts, as Philip Slater would call them to only think about the money. You can coach people to be ladder addicts. You can take a person that is initially fulfilled and belief in the mission and their purpose and the higher need.

[00:29:24] [SPEAKER_00] And the more you dangle extrinsic rewards like jumps, jumps in the ladder, pay increases that come with those jumps, the more you can coach them to believe that that's the reason they're doing these things. And there was a wonderful study done with the Israeli Defense Forces that took a group of motivated people. Actually, sorry, no, this wasn't this is within this is in the US, but with a military group as well. And they took groups. And one group said that I'm motivated by my purpose, my calling, my country and loyalty to the military.

[00:29:50] [SPEAKER_00] And one group was more oriented around the prestige, the ladder, the titles, the kind of thing. And they could coach people. And they found that the people that were once interested in the career, you could coach into caring more about the tangible results. And the more they cared about the tangible results, the less actual, the less good they were as a military person, the less altruistic they were in fulfilling their duty. The more they spent their energy, their emotional energy thinking about the next promotion or the next status or the next medal.

[00:30:19] [SPEAKER_00] So we can coach people and we do coach people. And again, it's ironic because we don't want people like that. Most people would agree that we want people that have a personal mission, that care about something bigger than just pay rises. But we coach people progressively to care about the pay rises. Yeah. That's really the cycle that I think companies are in.

[00:30:36] [SPEAKER_01] So we've talked a lot about why pay for performance doesn't work and how some of the systems have broken. Obviously, the people listening into this podcast are going to be the people trying to roll out those strategies every day. So let's try and solution for them. What are the recommendations? What should pay for performance become? If you, James, could redesign pay for performance from scratch, what would it look like in an organization?

[00:31:03] [SPEAKER_00] Yeah. So I would say think about matching the unit of pay to the unit of work. So whenever I'm thinking about whether we can attach pay to performance, that's one. So first of all, let me take one step back. Let's first of all assume, let's first of all question the assumption that we should attach pay to performance. So pay can get people to do a bit more of something they understand.

[00:31:27] [SPEAKER_00] But if you are at a company that wants innovation, you shouldn't be doing any kind of pay for performance and attaching pay to performance as little as possible. Because we know reliably since the 60s, Sam Glucksberg's experiments, right up to Dan Ariely's experiments in recent day. Dozens and dozens of studies and then matter analysis on the same thing that shows if you want people to be innovative, you will inhibit their problem solving capabilities by attaching pay to solving a given problem. And actually keep this on my desk here as well. You won't be able to see this in the podcast, but this is called a Soma Cube.

[00:31:57] [SPEAKER_00] So this was used by a very young, you can see you can take it apart into pieces here and reassemble it. I recommend everyone get a Soma Cube, that's tremendous fun. And this was used by a very young Edward Deasy, who Edward Deasy and Richard Ryan wrote the self-determination theory thesis with a lot of other researchers. And what happens is if you pay someone to do something, they will do that thing and then they will stop. And they use the Soma Cube to test that theory and show that if you didn't offer an incentive, they would keep experimenting, they would keep exploring.

[00:32:26] [SPEAKER_00] So I keep this on my desk as a reminder that you need to keep experimenting, you need to keep being curious. So the first assumption is what kind of people do you want? If we want creative, innovative, collaborative people, then you should be using pay as little as possible to do that. You want to minimize pay, you want flat pay, equal pay, you want pay to be the shortest possible conversation. The conversation should be about the work. The work is what will motivate those people. All the energy should be spent on thinking how do you make that work fun?

[00:32:54] [SPEAKER_00] How do we remove things, not add things? It's a subtractive solution. We should be taking the things away that inhibit their ability to do the work they want to do. So that's the first assumption. But if we want to use pay, then that says a couple of things. It says that we believe we can get more volume or more output from the people that we have, and we believe there's a way to do them. And it says we want people that conform to that as well. That means if we start saying this and selling this, it means we're going to attract people. So we're going to attract people that think that way as well. Is that okay? Could be okay. Okay.

[00:33:24] [SPEAKER_00] So one really good example that I used in Close the Gap is Nucor Steel, which is a steel company. And they use pay for performance very effectively. They have done for many, many years. But they match the unit of pay to the unit of work. So every single factory is an autonomous unit that gets to make its own decisions, very decentralized, very participative work culture, gets to operate independently. And the only pay for performance that that factory works on is that it needs to deliver a return on capital to the head office. Beyond that, it can do whatever it wants with the profit.

[00:33:52] [SPEAKER_00] So they share out the profit over and above that level of production to the people that produce it. If they can innovate and make it quicker, they get to share in that result as well. And there's no ever higher quota that they need to go into. So they get to keep sharing. So innovation is key. And then they can pass those innovations on to other plants. So in that respect, pay for performance works because the unit of work is the plant. And the unit of pay or the measure of performance is also the plant. And then it gets paid out in accordance with that unit as well.

[00:34:20] [SPEAKER_00] So what you're doing there is you're very cleanly and clearly attaching pay to a number of performance that people can see and understand and impact. And it doesn't inhibit everything else you want them to do. And if anything, it actually encourages them to do everything else you want them to do. And there's also an inherent quality control in that. Because of the industry, steel cannot go out if it doesn't meet certain quality thresholds. So you get dinged if that quality doesn't come in. So there can be no subjectivity when it comes to that quality.

[00:34:49] [SPEAKER_00] So to me, that's it. That matched the unit of pay to the unit of work.

[00:34:52] [SPEAKER_01] Yeah, that is a great recommendation. And I think we're increasingly seeing how can we make the transformation that we need to happen in our organizations come to life, particularly with AI disruption. And how do you distribute pay? Can you distribute pay to do that? Maybe that's more the question we should be asking. It's not how, but can we? That's what I'm hearing from you is pay the right thing to use to distribute pay.

[00:35:22] [SPEAKER_01] Or as you say, I think a really good tip, like we're trying to think about practical tips for the listeners. Like, what is it that you're trying to achieve? Because I think that always has to be the first type of question. Well, I think two key questions. What type of talent, what are you trying to achieve? And what type of talent do you need in your organization to achieve that? And I think if you can start with those questions and then say, OK, well, if we could, where does pay fit into that overall?

[00:35:51] [SPEAKER_01] And, you know, what would be the right way to distribute pay to attract, to like, you know, motivate that talent? I think maybe that's a good place for them to start asking those questions.

[00:36:01] [SPEAKER_00] Yeah. And I'd break that down into two very simple questions. Should we and can we? So the first question, should we? Is there research to show that we will get what we want by using pay to do them? And again, the research is very counterintuitive to anyone that's word to pay for performance. The research generally says, no, there's not much you can use pay to do. You can get people to do a little bit more of something they have chosen not to do. They need to know how to do it. They need to be able to do it. You need to be able to measure that thing. But that's what it gets to. And then what are the second and third order effects?

[00:36:29] [SPEAKER_00] So one of the stories I open up, what pay costs. If we have a, actually, do we have a minute? Can I share that story? Yeah, sure. I don't want to take up all the time. But there's one of my favorite stories to, because I'm very research oriented, but it's boring. So I do the boring bits so you don't have to. That's my, that's my motto. So I look a lot in the research and the research forms the foundation of my understanding. But I use anecdotes and stories because that's much more interesting to read and listen to. But one of the stories I love is this was called the Cobra Effect.

[00:36:56] [SPEAKER_00] This is in colonial India when the British were sadly colonizing India and plundering its resources. But the British were over them. And they didn't like the fact that there were so many Cobras biting them all the time. So they said to the locals, okay, bring us the Cobras. Kill the Cobras. Bring them to us. And we're going to pay you a bounty for every dead snake you bring us. Then we can get rid of the Cobra. So they did this. And the locals brought in all these dead Cobras. And the British officials said, this is wonderful. We're getting rid of the Cobras. And they looked around.

[00:37:24] [SPEAKER_00] There seems to be as many, if not more Cobras than ever around. What's going on? So they looked into it. And they found out the locals were just breeding the Cobras. So they had the reward. Yeah, to get the reward. So you get what you pay for. You almost always get what you pay for. And there's lots of stories. And I actually just dropped this into an epilogue in the back of what they cost. Because I had so much fun. I just couldn't put them all in. So in the epilogue, a few more examples of exactly this. You will get what you pay for. If you train people to think in that way, they will do what you ask them to do.

[00:37:52] [SPEAKER_00] You just don't know the second and third order effects. And I'm sure everyone can think of those second order effects. Particularly in a sales organization, you get people selling and selling and selling. But they're selling bad deals. Or they're annoying our clients. Or they're hurting our lifetime customer value in exchange for a point in time in the sale. So you will get people to do the thing that you pay them to do. Absolutely. If you can tell them what it is they need to do. But you've got to remember there's a whole bunch of other stuff that they may do as well. So that's the first thing. Should we? That's the first question. Should. Play out the thought experiment. Think about it.

[00:38:22] [SPEAKER_00] Don't jump on from that should we question. Look at the research. But just ask Claude or ask ChatGPT. You don't have to read research papers anymore. Say what research is there to tell us whether this problem that we need to solve can be solved with pay. Then can we? And that's the other hurdle. And that's the thing where you were alluding to. Can we measure performance? In the world where everyone's working with each other. In the world where we can't really carve up a team-based piece of work into individual contribution.

[00:38:50] [SPEAKER_00] We don't really know who did what. And if we did then is it fair to do that? Or are we just bringing in bias? And are we just going to reward familiarity and politics? You know, which happens so much in the corporate world. And then AI complicates it further. How much of that was the person? How much of that was just an AI agent delivering something that we don't really need to pay that person to do because they didn't really do it themselves? That deck looks great. Did they just prompt Claude to do that? I mean, do we reward them for the quality of the prompt they used?

[00:39:17] [SPEAKER_00] Or do we maybe just give the money to Anthropic because that was the platform underneath it? So that complicates it even further. But this is the direction of travel, I think, Ruth. Like, the direction of travel is getting harder and harder. Knowledge work is more and more prevalent and more and more complex and more and more collaborative. So it's getting harder, not easier, to attribute performance to individuals. And this is what leads us to the statistics around pay, the dissatisfaction around pay.

[00:39:43] [SPEAKER_00] When you look at the level of satisfaction around merit cycles is a good indicator. It's very, very low. Very few people believe it's fair and unbiased. When Gallup did a survey among CHROs of the Fortune 500, 2% felt that the performance management system was delivering and what it was supposed to be delivering. The closer you get to the people that actually administer the systems, the less confidence they have in the systems that are being used. Yet everyone keeps defaulting to these broken systems.

[00:40:11] [SPEAKER_00] So I'm turning around and saying, why do we keep doing what we know isn't working? Everyone's complaining about it all the time. Why do we keep turning to these broken systems? And I believe it's going to keep getting harder, not easier, to use these century-old systems.

[00:40:25] [SPEAKER_01] Well, that's a great probably stopping-off point, I think. I think my reflection on reading the book, and I have read a previous book as well, is it is just thought-provoking. Because we do tend to do the same thing every year, often as compensation professionals. And as you say, the environment in which we are trying to operate is getting harder. It's getting harder to understand what work is, like what the unit of work is.

[00:40:51] [SPEAKER_01] It's getting harder to understand what good looks like. It's getting harder also from a resource perspective in terms of the amount of money available. So I guess, you know, I thank you for coming, James, today to share all your thoughts. I'd encourage the audience to grab a copy of Close the Gap. Have a good read before you go into potentially your year-end process. And maybe think differently about how you might have the conversation with your executive team and your CFO about the right way to potentially allocate budget this year.

[00:41:21] [SPEAKER_01] Well, if you're not doing it for this year, like start the conversation now to think about how you might start to change things over the next 12 months. Any final closing words, James?

[00:41:32] [SPEAKER_00] Yeah, one thought, as you say, it is difficult because when you're surrounded by people that share this view that we should use pay and you get a lot of executives that have grown up and want to use pay in that Jack Welch type thinking of, you know, rank and yank and vitality curves and sack the worst and promote the best and all that. You know, it's quite pervasive. So I do think it's quite daunting. I find a lot of people actually agree in principle, but it's very daunting, the idea that we can change that. So what I would say to those people is you don't have to go all the way all at once.

[00:42:02] [SPEAKER_00] This is about directional change. You know, this is why, and that's why I settled on this title, Close the Gap. It's not, it's not, it really is closing the gap in a way. It's, we need to just, you know, break that. There's a gap between what people need for good work and what people are expected to do in exchange for that work. It's just moving in the right direction. So to me, if I was offered some advice, it would be think, well, think about the direction you're moving. Are you moving towards the conditions that the research tells us will bring out the best in people?

[00:42:30] [SPEAKER_00] Or are you moving towards systems of control and measurement? And are you trying to treat people like machines, which the research tells us will not bring out the best in people? So you can do small things, and that could be reducing the component of the individual bonus because everyone's complaining about it and say, hey, look, no one trusts it. Everyone's complaining about it for our company and in the literature and in Gallup surveys. Everyone complains that my performance can't be measured. So let's just reduce it. Let's take it from a weighting of 80%. Let's reduce that source of toxicity.

[00:43:00] [SPEAKER_00] And the final thing I'll say is don't be afraid to experiment. Companies experiment all the time with products and services in the market. Well, they'll test things and they'll fail. They'll be happy to fail. They'll go back. Don't be afraid to experiment with the working conditions for your people. So take a team. Find a team that's broken, that's struggling, that's complaining, that's really, really unhappy, and suggest something different. And so let's try it. Bring people along with that journey. Bring the people that are being subjected to those conditions on that journey with you. And say, you want to try something. You want your feedback.

[00:43:26] [SPEAKER_00] Because the Hawthorne studies that were conducted back in the middle of the 20th century showed that it wasn't bright lights or dim lights in the change productivity. It was the fact that people were being asked what they thought. That was the thing that improved productivity. Consult with people. Ask them what they need to get more out of their working lives. And then test things and run an experiment. And that's the way to get changed. And I come from a consulting world where you think change is top down. You get the CEO to sign off.

[00:43:55] [SPEAKER_00] Then you come up with all these big communication plans and roll it out to everyone at the same time. Reality is change happens laterally. Small changes that produce good results that ripple through the organization. And people become jealous of that. They don't become told what to do. They see something working and they say, well, maybe we should try that. So that's how change happens. Tiny changes in corners of the organization that demonstrate there is a different way of thinking. And that's the way I'd encourage people to think about positive change.

[00:44:21] [SPEAKER_00] Get people to agree to an experiment and use that as your demonstration of effectiveness.

[00:44:27] [SPEAKER_01] Well, thank you, James. Well, what did you think, audience? You can always get in touch with us here at coffee at payscale.com. Let us know what you thought. Where can they get hold of the book, James?

[00:44:38] [SPEAKER_00] All good bookshops as long as they're called Amazon. So it's available on Amazon. And it's in hardback and paperback and Kindle. I need to finish my audio book, but it will be on Spotify and it will be on Audible at some point fairly soon.

[00:44:51] [SPEAKER_01] Great. Well, thank you so much for joining us today and sharing your insights on the book and all the research that went into that. I hope you enjoyed that discussion. It's a topic that fascinates me. I'm interested to hear what you think. And if there's something else you'd like us to discuss on the podcast or if you'd like us to continue the discussion around performance-related pay, then as I said, get in touch at coffee at payscale.com. And thank you very much for listening.