Future of work: Paying employees for outcomes - the next step-change in organizational efficiency? 27/03/2010

Amidst the era of globalization, the outsourcing trend has exploded. The two primary motives driving companies to outsource are clear and well-recognized. The first is cost- source certain tasks to a firm that, due to cheaper labor, materials, or economies of scale, can perform them cheaper. 

The second is specialization - source certain tasks to a firm that, due to their experience or expertise in that niche, can perform them better. There are a host of secondary Benefits as well, but one of the most under-appreciated, and often under-utilized, is the groundwork that outsourcing provides for pay-for-solution relationships.

Rolls-Royce gets much of the credit for branding and popularizing pay-for-solution outsourcing over 20 years ago with their innovative ‘Power by the Hour’ jet engine maintenance contracts. Rather than charging their aviation customers separately for the engine, every maintenance visit, and each replacement component, RR guaranteed to provide an available and functional engine to their customers for a flat monthly fee. The idea is simple but ingenious. When considered more deeply, the former system actually incentivized RR to design an engine that would maximize the number of maintenance visits and replacement parts needed, and require quicker replacement. None of these incentives are in the interest of the customer. But with the PBH contract, RR’s incentives are flipped to align with the customer, who can now be assured that RR will do everything possible to provide a reliable engine with long life and minimal maintenance requirements, and be able to plan around a consistent monthly expense. And the offer of the contract itself enables RR to signal the quality of their product.

Though still not universal, so-called ‘performance-based-logistics’ have become a more and more popular outsourcing tactic since Rolls-Royce’s initial foray as a way to align incentives and keep contractors honest. The rationale is clear and the Benefits are significant and measurable. So why has this concept so rarely been applied to employees within firms? 

Performance-based pay may claim these Benefits, but yearly bonuses have oft been proven to serve more as ex-post rewards to incentivize employees to stay with the firm, rather than output-linked compensation.

While a number of Challenges clearly exist for more widespread usage of output-based employee compensation, the potentially extraordinary Benefits they could create both for employees and their firms, ought to warrant further exploration. This piece examines three such Benefits, while next month’s article will outline the major obstacles that must be addressed before output-based pay can begin yielding some of these fantastic Results.

There is a strong push these days for firms to offer more flexible work arrangements.  And well there should be. From the employee side, flexible work arrangements translate directly to a greater ability to plan around family and personal commitments, hopefully allowing personal and professional life to co-exist more harmoniously. For example, it helps open greater career possibilities for mothers and allows fathers to take on more of the child-raising responsibilities. 

But there are Benefits on the business side as well. When utilized correctly, flexible work arrangements can lower overheads by leading to smaller office space requirements, reduce machine downtime or increase hours of operation by enabling 24-hour work scheduling, and generally attract and retain better, happier, more motivated and committed staff due to the employee Benefits listed above.

Output-based pay can serve as the basis for the ultimate flexible work arrangements.  With pay only contingent on successful completion of the tasks that business value creation requires of you, then you become free to complete those tasks whenever, wherever, and however you’d like. No need to ask the boss to leave early or try and negotiate Fridays off. So long as the work is completed, everyone is happy. The shackles of office face-time could be cast off once and for all.

There is a saying in business that ‘what gets measured, gets managed.’ In other words, people care most about what they are being graded on, and will allocate their effort accordingly. While the rough performance evaluation criteria that now exist in virtually every company help a bit to focus effort on the correct metrics, money sends the ultimate signal. And many employees, especially within large organizations, know that at the end of the day their paychecks depend on showing up, and creating a vague illusion of contribution.

The result is an inordinate amount of time and office resources being spent on creating exactly this illusion. Office space and corporate internet bandwidth are two line items that see the biggest spike, but the effects trickle all the way down to office supplies and expense accounts.

If employees were compensated on the output they created, all of these extraneous expenses would be unnecessary and irrelevant. If structured correctly, pay-for-solution contracts would in fact incentivize employees to generate quality output with the fewest and cheapest inputs as possible.

One of the most infuriating frustrations for high-performing employees at most firms is to look around and see co-workers get paid multiples more for being more senior or for having successfully ‘politicked’ their way to the top, without ever having done any real work.

Paying employees for outcomes makes it far more difficult for these situations to occur. Paychecks will mimic real value creation within the firm and imperfections can be ironed out by adjusting the system and letting natural market forces work to the firm’s benefit. Even better, functions within the firm can be easily costed against market rates and outsourced if significantly underperforming.

So what are organizations waiting for?

But of course paying employees for outcomes is not a simple silver bullet. Many Challenges and obstacles must be addressed for such a system to work properly and do more good than harm. For example:

• What do you measure (especially in service and enablers roles)?
• How do you handle the variability of pay (people tend to rely on constant paychecks)?
• How do you protect against gaining the system?
• How do you resolving disputes?

Next month, the LBS Human Capital Network explores some of these Challenges, and brainstorms potential solutions.

The London Business School Human Capital Network organises another top event on Monday the 10th of May at 7:30pm at London Business School (register here: http://www.london.edu/event/do?eventCode=A10CLC1005LYNDA).

In the third masterclass of the London Business School Organisational Development Speaker Series, Lynda Gratton, professor of management practice at London Business School, will give insights in the Future of Work and Organisational Innovation in the Next Economic Cycle. 

Lynda Gratton is a global authority on the people's implications of strategy. Lynda leads Hot Spots movement (http://www.hotspotsmovement.com) – a management lab that helps companies, governments and non-for-profits to ignite organizational innovation. She actively advises blue-chip companies across the world and has published numerous books and articles.

Lynda Gratton is currently heading a global Future of Work Research Consortium (http://lyndagrattonfutureofwork.typepad.com) that brings together executives from around the world to engage in the on-going research about the future of work and adoption of innovative future proofed organisational practices. The consortium is observed by the Financial Times and the Economist.

The research focuses on several key topics:

1. Describing future trends, i.e. technological developments, globalisation of products, services and talent pools, changing patterns of demography, carbon neutrality

2. Profiling real world impacts, i.e. the likely impact of the four future trends on the day-to-day experiences of employees with both a 5 year and a 10 year horizon:

- Employees who spend much of their time working from home
- Descriptions of how people work in virtual teams
- The role a manager will play in a 2015
- How diversity will impact on work
- What employees across the world will want from work

3. Understanding organisational implications, i.e. describing how the day-to-day employee experiences will be contained and directed towards the strategic goals of the organisation:

- How organisations will be structured and the way in which decisions are made, information shared and resources allocated

- What the key role of leaders is likely to be and how this will impact on key leadership competencies. We will also consider how these future leaders can be identified and developed

- The key organisational development capabilities

- How the future will play out with regard to the people practices of the company, including reward mechanisms, engagement practices, training and development

- What the future will mean for the key people competencies, for example the key competencies and aspirations of talent pools

- What the culture, values, norms and behaviours will be most appropriate for the future

4. Building a Portfolio of Future Proofed examples, i.e. identifying and categorising against the six key organisational implications in a series of at least 30 real world examples of how organisations across the world have begun to create the future

5. Profiling the Adoption of Innovative Practices

Oxana is an independent organisational development consultant and Co-Chair of the LBS Alumni Human Capital Club. Oxana advises companies on best practices in organisational effectiveness, talent management and learning & development. Oxana completed her MBA at London Business School in 2006.