Differentiation is something we talk about a lot. Yet there are subtleties that as a leader are very hard for me to wrap my brain around. On Differentiation Welch says:
“I just don’t like quotas in the boardroom or in the office. Winning
companies are meritocracies. They practice differentiation, making a
clear distinction between top, middle and bottom performers. This
system is candid and fair, and it’s the most effective way for an
organization to field the best team.” – Jack Welch, Winning, Pg 346
I tend to agree with that statement. Yet the word “meritocracies” even with the given Rand overtones leads us to believe people are paid fairly for the work they do. That just sounds right, doesn’t it? Pay people fairly for the work they do. ?
But economics suggests otherwise. Specifically the tournament theory of economics. In the Forbes article Why Your Boss is Overpaid Tim Harford explains:
The ugly truth is that your boss is probably overpaid–and it’s for
your benefit, not his. Why? It might be because he isn’t being paid for
the work he does but, rather, to inspire you. In other words, we work
our socks off in underpaying jobs in the hope that one day we’ll win
the rat race and become overpaid fat cats ourselves. Economists call
this “tournament theory.”
Or to have it explained by an economist, because that always clears things up, we have:
This explanation of wage differences in terms of relative performance is often called tournament theory. One place where this explanation should work is in contests with winners and losers. For example, consider two almost equally able gladiators fighting in the arena of ancient Rome. Small differences in ability (or luck) could result in a huge difference in reward–one could die and the other live.
Though gladiators are no longer part of our world, there are still cases in which winners matters a lot, and as a result, small differences in ability (or luck) can cause large differences in reward. The sports world has many examples.
Having started the company on 7k, for years I made sure I demonstrated the “boot strap” nature of business. I lived in a small house. Drove a civic. I am not of the personality to discuss my latest golf vacation to big sur (I don’t golf and I am not sure where big sur is, or if they have a golf course.) This works against me as a leader.
The theory goes that if you have a motivated employee. They believe in the company. They like what they are doing. And they look at the managers and the CEO and see them living below their means, driving sensible cars, that in fact this hurts the company. Good people will leave because they do not see the just rewards of the tournament.
So, according to the theory, it is not enough to differentiate your
people. That differentiation must be visible or in fact their is no
incentive to the others.
This also explains why your CEO talks about his thousand dollar car payment, brings up taking his car into the shop just to remind you he drives a Jag. Why he visibly takes time off to golf and jokes about it where you can hear. And why many pay packages are heavily laden with “performance pay” that is virtually unattainable. He does it for your benefit. And then asks you to come in on Saturday to catch up on work.
Office space basically is true. And why crack dealers live with their Mom because most of them can’t afford anything else!
For years I was not the highest paid person at the company. That is no longer the case. I finally got rid of the civic and purchased a Mercedes (don’t tell anyone but it was used). See, even now I feel compelled to justify a lower cost decision because that is how we built the company. We purchased at auction, we found creative ways to save and we sold like crazy.
So what to do with the young ones? The competitors have aggressive performance pay and hire two entry level people to “compete” for a more successful ones job. Is that the answer? As a leader I don’t like it and I know from experience that I was not a commission motivated employee at other jobs.
We have a system of profit sharing. Quite aggressive. But it does basically allow free loading. Certainly salary increases quickly differentiate the high performers from the low. But does in fact a balanced profit sharing program work at all? I just don’t know. Tournament theory says it likely doesn’t.
We have been having a content contest in the office. The idea is to encourage new helpful content that allows clients to help themselves. We all then receive higher profit sharing. Yet many in our wonderful company freeload. They benefit from others adding the content and don’t contribute.
Still thinking on this. Would love to hear your thoughts on tournament theory as well?
I think it all depends on what management wants to worry about. Many people have a competitive, acquisitive spark that will cause them to surge ahead for an upcoming promotion. Other people want to compete with themselves and build their skills. But you can’t have different pay systems for all your individuals. Every company needs to decide for itself the compensation system, communicate it constantly, and recognize its flaws. (Which you are doing and that’s great.) Consistency and caring will be remembered long after the profit sharing is paid.
Posted on May 6, 2008 at 8:35 am.
My first and recurring thought is the Dilbert quote that, “the promise of capitalism is that if you work hard you can make your boss rich.”
A more analytical thought is that if you pay management slots excessively to motivate lower slots in a organization’s hierarchy, that you are not eliminating freeloading, just relocating it up the management chain as a perk of earlier success.
Looking at my own experience, i see a different dynamic in action. In the company where I “made it” as a consultant, I made the owner of the company richer than he was before I joined the company. And I benefited the whole way. Land a big deal, get a bonus and his tailor came in and measured me for a custom suit. Have a year of good deals, and I got to keep my company van. Have another year, and I got his Lincoln when he got a new car.
I was very well motivated. By winning for him, I won. It worked that way as a principle in a startup as well. There was a visible payoff for my work. That is what these tournament theory companies are working towards.
I think where these companies miss the boat is that they create a zero-sum environment. For me to win, you must lose. The previous gladiator and tournament philosophies encourage this idea.
I prefer an environment where we all win together, or we all sink together. (Another lesson from building a start-up). Cooperation trumps competition. I recently participated in an exercise of two teams told to stack blocks. One scenario created competition between the teams, the other the teams were advised to cooperate. The cooperative teams stacked more blocks per person than the competitive ones. (Probably because in the competitive situation people began sabotaging other peoples’ stacks – and so they were limited by what size stack they could successfully defend).
This is supported in games theory as well – but beware of bozosity in players who can gain personal advantage by not cooperating. (Think along the lines of Plato’s prisoner’s dilemma.) The reason we don’t see cooperative structures very often in big companies is that it doesn’t scale well. Eventually players are brought in that will choose to gain at other’s expense.
Hence bozosity.
Sorry to ramble on like that – was a good place to go and think about what works and what doesn’t. I hope something in here provided more food for thought.
Posted on May 6, 2008 at 5:37 pm.
@Theresa you make a good point re “But you can’t have different pay systems for all your individuals”. I worked at a large computer company for a while and they did have two COMPLETELY different pay structures. Sales was punitive/reward for renewals and new biz. The rest (me) were more incremental organizational chart and tournament oriented.
We don’t do that at Schipul per se, but I have considered the dual compensation by personality option.
@crossmage – great comments! and the “bozosity” comments make me think of @guykawasaki ‘s talk last week at the HTC.
I would love to meet the CEO who gave you his car. That person really sounds like someone I could learn from. It is is hard to differentiate for top performers without demoralizing the 70% who are the majority of the company.
For example – employees get frustrated for lack of excess profit sharing (OK, me too, just saying). Yet when it comes to innovation, inventing new products, pushing forward, well, not so much. A minority of high performers yes. I almost think if surveyed 80% would say they are top 10%. I wonder if anyone has tested that? Hmmmm.
Last thought – if any schipulites are reading this I’d love to hear your comments. Even if just by email. You can always use an anonymous emailer if you are uncomfortable putting your name on it, right?
Mainly – I want to improve both my understanding of how to compensate people and how to retain great people even more than we already do.
Posted on May 6, 2008 at 5:48 pm.
Interesting post, Ed. Jeff reminded me of a chart he saw one time which tried to answer the question, can money buy happiness? The answer, as you might expect was–if you’re hungry or living under a bridge $10,000 can make you much happier, but at a certain point, more money doesn’t make you happier. I *think I’m at that point.
I look at upper management, imagine how much they might make, and think eh, I’ve already got at least two of everything, why would I want to put up with the things they put up with to have three of everything?
That probably means I’m (we’re) overpaid, but money has never been a big motivator for me. I grew up in a modest household, and now I often feel more guilty than proud of what we have. Does anyone really deserve all this?
Wanna get me to perform? Tell me what a good job I did on Project X in front of my peers, and I’ll work my a$$ off to get you to say it again about Project Y. (And I won’t feel one bit guilty about it.)
Posted on May 7, 2008 at 9:21 pm.
I think you address the reality of many companies. I also think you are citing one of the main reasons companies fall down once there is any bigger reason for unrest inevitably they start picking apart compensation.
I like the idea of performance based compensation though (almost impossible to fairly quantify in every organization). I have managed large task-based organizations with thousands of people and even though the performance measure wasn’t perfect, people understood the rational and performed well. I think not because of the comp package but because they felt that the comp was fair.
Also, it seemed to me that those with higher base salary among peers rarely showed significant differences in productivity than those of lower pay scale.
What I absolutely found to be true was that the better the work environment the more flexible employees were with their compensation and they became less fixated on what they were paid.
Great thoughtful piece, I really enjoyed it.
Posted on May 8, 2008 at 2:30 pm.
Ed: Great piece. Very thought provoking. As I read your overview, it seems that a conceivable deficiency in your current system is how the profit sharing gets paid out. Your suggestion that some can skate and still get their share of the profit share leads me to believe that you are not currently matching that payout with a parallel performance evaluation. I suppose there are countless ways you could calculate it, but one that is aligned with Welch’s ideals would be a 25/50/25 model in which the people rated in the top 25% get a bigger bonus, the middle 50% get an average bonus and the people rated in the bottom 25% get no bonus — and a strong message that their performance needs to improve.
Posted on May 12, 2008 at 3:30 pm.
My 2 cents is this ~ Most people are mediocre. Sad but true; not b/c they can’t many times, simply, b/c they won’t. However, as Ed intimated, it is these people who make up the bulk of your employees. Tadah!! Welcome to the most frustrating thing about the “services” business….the people. How does one motivate an otherwise unmotivated employee (assuming you recognize and terminate, layoff, downsize or kill the unqualified poor hire)? Answer, IMHO, you don’t. The secret isn’t in compensation, the secret is in training, team work, and sadly even in the inevitability of turn-over in the ranks of the mediocre. The higher pay and performance is a reward, whether salary, profit sharing, or commissions, for the performers that deserve the extra pay. Thus, the problem with a socialistic approach to pay is you disenfranchise the truly solid performers and, ultimately, you have nothing but the mediocre. As an entrepreneur, and sometimes friend, you want to help change your people and make their lives economically better…but I do not believe that can be done through ANY form of compensation ploy. As far as the tournament theory, I find it interesting, and can tell you in sales…it works…period. If a salesperson is not motivated by money, he needs to find a new career. I do not believe that it works in other areas as money is not the prime motivator for many, many people. That said…I am personally motivated by money, and control over my own financial well being (yes, admittedly, I am ultimately a salesperson)…and, coincidentally, I bought a new Jag not long ago. Incidentally, it costs way more than 1k a month
PS – I hate golf, takes way too long to play. Old and/or retired man’s game. I like paintball. Sometimes, I bring my non-money motivated people out to play paintball, or snow ski, or casino trip, etc. Whether I drove in a Jag or a Toyota is immaterial…we are out to have fun and build a team. As a side note, I think it is important for your staff to feel like there is economic stability to the organization and not that the boss is barely squeaking by financially. I bought my Jag and the Porsche before it used, b/c that is smart, but I believe it is a motivator to some, an indication of economic stability to others, and a damn fine ride in regardless! Great post Ed, thought provoking and interesting and hits at the heart of some of the common things owners struggler with daily…what decision should I make and whats the impact of said decision. Keep it up!
Posted on May 17, 2008 at 4:15 pm.
I should also say…it is in finding the unique differences in our individual staff members that we find out what motivates each of them to perform. Nothing replaces getting to know your people and letting them know you care. Granted, you still can’t push a wet noodle up a flight of stairs
Posted on May 17, 2008 at 4:19 pm.