Break the Link Between Pay and Motivation

Pay-for-performance (PFP) compensation systems were invented in the industrial age to drive individual performance — and despite research showing that this approach is ill suited to much of the knowledge work performed in organizations today, the practice persists as the norm.1

Compensation systems remain stuck in the past for several reasons. The first is, essentially, inertia: Companies have been using PFP for decades, and the best practices disseminated by compensation consultants usually derive from it. Additionally, most leaders are either not aware of the research on PFP or dismiss it as unreliable. Finally, leaving PFP behind and taking the leap required to design and implement a new compensation system can be a fearful prospect, given the potential impact on performance and results as a consequence of getting it wrong.

However, organizations may have more to lose by failing to move beyond PFP. We conducted a large-scale experiment with a target-independent compensation system. The results point to a strong business case for leaving PFP behind.

The Dysfunctional Elements of PFP

For the past 50 years, academics such as Edward L. Deci and Jeffrey Pfeffer, and pundits such as Alfie Kohn and Daniel H. Pink, have been arguing that PFP is inherently dysfunctional.2 This stems from two primary sources.

First, PFP is focused on narrowly defined outcomes, such as the number of sales closed, but it ignores the ways in which those outcomes are produced. This introduces the possibility that chance — or, worse, unethical behavior — will be rewarded and that the quest to achieve the promised reward will undermine other desirable behaviors, such as teamwork and collaboration.

Second, PFP provides the extrinsic motivation of financial reward, but it ignores powerful and beneficial intrinsic motivators, such as the joy of the task itself, a sense of contributing and belonging to a team, and personal development. (See “Shifting Thinking on Motivation and Compensation.”) Financial rewards prompt employees to pursue specific targets and avoid activities that do not lead directly to achieving those goals. PFP suppresses intrinsic motivation, leading at best to compliance — and it fails to nurture an enduring employee commitment to or identification with the company. In the long run, this lowers overall performance.

For all of the dysfunctions it can generate, PFP has its uses. It can drive superior performance when jobs offer little or no opportunity for intrinsic motivation. When jobs are monotonously simple or volume-driven, extrinsic motivation provides a focal point for employee effort and behavior.3 But PFP undermines the performance of work that requires people to explore complex problems, develop creative solutions, and achieve qualitative results that cannot be fully specified in advance.4 Moreover, when performance targets become obsolete, such as when production lines shut down and sales crashed during the initial round of COVID-19 lockdowns, PFP loses its motivational power because it cannot deliver the rewards that it promised.

Seeking Alternatives to Pay-for-Performance at Hilti

Leaders at Liechtenstein-based Hilti Group, which offers products and services to the construction industry, have had their own misgivings about the effectiveness of PFP and whether its focus on individual performance is out of step with the company’s collaborative culture.

The family-owned company employs more than 30,000 people, 70% of whom sell its products and services directly to contractors on construction sites in 120 countries. Hilti has a decentralized structure, and the country organizations maintain their own sales forces. As the range and complexity of the company’s portfolio of products and services have grown, so has the challenge for its salespeople. Initially, they simply offered the company’s products to as many contractors as possible within their assigned territories. But as Hilti fully penetrated its sales territories, continued growth demanded that the company win a greater share of contractor wallets. To that end, the company increased customization and added new digital solutions, but those moves also led to more complex sales, longer sales cycles, and a solution-based selling approach. Today, Hilti’s salespeople are more akin to consultants. Often, they specialize in the needs of specific industries and collaborate with colleagues, field engineers, customer service personnel, and team leaders to satisfy customer needs.

Sales compensation at Hilti has been based on a pay-for-performance system that is tailored, within centrally established guidelines, to local needs. But PFP’s focus on individual sales performance and volume is increasingly out of step with the company’s strategy and culture. Accordingly, in 2018 Hilti’s management asked us to propose and test a new sales compensation system that would be better aligned to its needs.

We reviewed the company’s market organizations globally and identified a country organization in Eastern Europe that was well suited to the rigorous study of an intervention involving a new compensation system. At the time, the country organization’s 190 salespeople received 65% of their salary in fixed compensation and 35% in variable compensation, on average. But there were problems with this system.

Management was investing a significant amount of time and energy in setting compensation targets that were both fair and motivational. Longer sales cycles and the team effort required to close deals made it difficult to attribute sales to individual salespeople. Moreover, the questions of when and how to adjust the targets were frequently debated and contested. Despite management’s efforts to address these problems using various formulas, setting targets for bonuses posed a chronic challenge that frequently resulted in dissatisfaction within the sales force.

The compensation system had also become too complex due to management’s efforts to use it to drive an ever-increasing number of organizational priorities. Many salespeople did not understand their compensation payout or what actions it was meant to incentivize, rendering the entire system ineffective as a motivational tool.

Another issue was that salespeople were turning to tactical behaviors to close the sales needed to earn their monthly bonuses. These behaviors diluted the organization’s sales strategy, which was aimed at investing the time needed to establish and nurture long-term, value-based customer relationships.

And finally, salespeople were unhappy with the variability in their compensation. Long sales cycles caused a high degree of fluctuation in monthly sales compensation, which sometimes left salespeople unable to meet their living expenses.

A New Compensation System

On Jan. 1, 2019, the country organization selected for the experiment launched a new sales compensation system that did not link rewards to preset targets.5 Under the new system, the pool for fixed sales compensation increased to 97% of the average total payout for the entire sales force in the previous two years. Individually, salespeople receive a like percentage in fixed salary, with small variations based on tenure and performance. This change was intended to signal greater trust in salespeople; to better support the stretch targets, operations, and practices necessary to exploit the full potential of a sales territory; and to encourage knowledge sharing and long-term strategic behaviors.

The new compensation system also expanded the existing structure for advancement for salespeople from three levels to seven levels based on tenure and performance to give them a longer-term career path.

Additionally, the country organization extended the use of gamelike competitions from individual salespeople to sales teams. These quarterly competitions, which were funded with the remaining 3% of the overall sales compensation pool, featured nonmonetary rewards, such as vouchers for family dinners and amusement parks.

To evaluate the results produced by the new target-independent compensation system, we conducted four online surveys of the sales force over 17 months (starting with a baseline survey before the new system was announced) and interviewed salespeople and their managers. We also used company records to track each employee’s sales data and results and their top- and bottom-line financial impact; employee turnover; and employee satisfaction scores. We recorded the following results.

Enhanced sales results. Initially, sales results under the new system gave us pause. In 2018, the last year under the old PFP system, net sales growth was 14.4%; in 2019, under the new target-independent system, net sales growth slowed to 11.1%. But these numbers did not account for the country’s construction market, which is highly cyclical and began to slow in 2019. When we compared sales growth in relation to market growth, we discovered that the country organization outperformed the market by a factor of 1.4 in 2019 — fully twice the rate of 2018.

Additionally, when we analyzed the sales results of the most extrinsically motivated salespeople, as identified in our four surveys, they still outperformed the average net sales growth rate of the organization. This allayed concerns that the performance of salespeople who were most motivated by performance bonuses would falter under the new compensation system.

Lower turnover. Despite a tight labor market, turnover within the sales force decreased by more than 4% under the new pay scheme in 2019 compared with turnover in 2018 under the PFP system.

Higher employee satisfaction. The entire country organization reported significant improvements in its annual employee satisfaction scores in 2019, which were higher than in the previous five years. While this result is likely attributable to a combination of efforts, there was a uniform and significantly disproportionate improvement in satisfaction with compensation and recognition within the sales force. Satisfaction with compensation within the sales force increased by 19%, compared with a 9% increase across the entire workforce in the annual scores.

Additionally, our surveys found that the perception of compensation fairness within the sales force increased significantly. From 2018 to 2020, the perception of fairness among salespeople increased by 15%.

Greater work effort. Fears that the new compensation system would result in a slackening of sales effort did not materialize. Our surveys recorded a linear increase in self-reported work effort of 7% from 2018 to 2020. Perceptions of coworker loafing rose by only 2% over the same period.

Based on the above results, the country leadership team became convinced that the target-independent compensation system was outperforming the PFP system. In 2021, the team made a modification to the system by replacing the nonmonetary awards in the team competition with monetary rewards, believing that bolstering competition in this way would not result in negative outcomes or hinder collaboration.

Meanwhile, several other country organizations within Hilti introduced their own target-independent compensation systems. At the corporate level, Hilti’s leaders are revising the global guidelines on compensation, and the Hilti Lab for Integrated Performance Management at the University of St. Gallen has launched a follow-up project to determine whether the results are transferable across cultures and contexts and to further measure the impact of target-independent pay on sales force productivity.

Are You Ready to Jettison PFP?

Our research suggests that target-independent compensation systems can be superior to PFP systems in organizations that rely heavily on knowledge work and collaboration, under certain conditions.

First, the organization should have attained a certain level of cultural maturity as evidenced by employees’ high levels of trust in leadership and the talent development process. The culture should also be performance-driven, with challenging goals and metrics that are used for performance accountability and improvement.

Second, a target-independent compensation system should incorporate several essential design choices. (See “Design Principles for a Target-Independent Compensation System.”) Establishing the right level of fixed salary is a particularly crucial choice: It needs to be competitive in the market and convincingly signal management’s trust in employees.

Third, the successful implementation of a new compensation system requires the full support of senior leaders, who must commit not only to making the instrumental changes but also to fully accepting the underlying behavioral assumptions regarding the desirability of intrinsic motivation. In addition, the new system must be aligned with all current programs and processes. For example, at Hilti, there was a special bonus plan in the summer that needed to be discontinued without thwarting the underlying need to bolster sales during vacation season.

Finally, management must communicate extensively to convey its trust in employees and its performance expectations. Without a bonus system to make performance expectations obvious, leaders have to pick up the slack.

The payoffs for these efforts are clear. At Hilti, a target-independent pay scheme bolstered intrinsic motivation, satisfaction with pay, and, ultimately, employee performance, without giving rise to free-riding, ugly competition, cost challenges, and layoffs in times of crisis. Intrinsic motivation seems to provide access to the vast untapped potential of employees, boosting both performance and well-being. Target-independent pay also serves as a lever to transform the focus of leaders from computational command-and-control to behavior-driven performance management. We believe that if your company does complex knowledge work, this is a compensation system that can pay off for you, too.