For a nonprofit, which is better: performance reviews or bonus system?
Let’s consider performance reviews first, as most managers believe it necessary, and sometimes useful, to conduct them.
In my view, the employee performance review system has a number of shortcomings. For one, postponing communication of feedback to an arbitrary date in the future; feedback needs to be timely in order to be helpful. Another is the emphasis on grading past performance rather than shaping future efforts.
We can, however, mitigate these two weaknesses. Reviews may be performed on a quarterly or monthly basis, rather than once-a-year. Achievement may be emphasized at the expense of past performance by incorporating employee-specific goals into the review, and communicating specific expectations to the employee at the beginning of each performance review period.
If goals and expectations are sufficiently detailed and quantified, responsibility for evaluation may be shifted from the manager to the employee (performance reviews are worthwhile only if the benefits realized exceed the cost—in time and resources—of performing them). Think of an airline schedule; at the start of the work day, specific flight departure times represent agreed upon expectations for all employees. When the day is finished, performance is evaluated with, of course, the actual departure time for each flight.
Now, one of the big advantages of utilizing this type of “before and after” performance review system is that the employee compiles the information over time, so very little management time is required. But the really cool thing about this system is that, when executed as outlined above, there is really no difference between a performance review and a bonus plan.
The purpose of both performance review and bonus plan systems is to: 1) compel staff to plan in advance the programs, projects, and major efforts to be carried out in the coming twelve months, break each into manageable pieces, and assign individual responsibility for execution; 2) keep employees focused on established priorities; and, 3) provide a basis for assessing, at the end of each evaluation period, how well each employee (and the entire organization) performed.
Success depends, in large part, on: 1) how well designed the system is; and, 2) how committed the employee is to the system, including how often he or she compares individual expectations to actual outcomes. The first–design of the system–tends to impact both performance review and bonus systems more or less equally. The second, however–employee commitment–can be significantly increased by using a bonus system. Moreover, bonus opportunities maintain employee commitment to the system over time.
How does one establish a method to measure individual performance? It’s not as difficult as it might seem, even in a nonprofit.
Consider that work activities are often either “input” based, or “output” based. An input is what an employee does, for example: make a phone call to a donor; write an op-ed; or, research educational performance for a state education system. An output (or outcome) is something that occurs as the result of an input: receive donor money; generate attendance at an event; or, visits to a website.
Employees may be evaluated on inputs or outputs, but the best approach is to utilize a combination of both. The variety of actions and outcomes which may be selected for performance evaluation may at first appear daunting, but there exists an established methodology for the process. Corporations have faced this same issue for years and now use what’s called a “balanced scorecard”.
Here’s a simplified example of a balanced scorecard which may be used for a development associate:
Here is a more complex example of a balanced scorecard developed for an employee bonus plan.
Here are two articles which explain in greater depth how balanced scorecard bonus plans may be utilized by nonprofit organizations. If you have difficulty finding a copy, contact me.
- “‘If the Shoe Fits’: Not-for-Profits Try Out New Compensation Plans” by Sally B. Bailey and Howard Risher, from Compensation and Benefits Review: v28 p47-57 My/Je 1996, © American Management Association, New York. All rights reserved. WBN: 9612203772007
- “Linking CEO Compensation to Organizational Performance” by David E. Strachan, and Lawrence G. Myslewski; Association Management v49 p63-4+ Ap 1997.
Staffing in One Lesson
If a window needs replacing, who might we call to perform the work? For most of us, the obvious answer is: “someone who has experience replacing glass windows.” Or better still, “someone who has experience replacing this particular type of window,” as an expert at home window repair might find replacing a large window on a multi-story office building beyond their expertise.
Experience
And so it is in staffing, where the only valid and accessible indicator of future success in a given job is past performance in the same or similar job. If an individual has experience at successfully performing “X,” then there is every reason to believe that they will be able to do “X” in the future. 
Candidates lacking this experience are far less likely to succeed and will require an extended period of on-the-job learning before they are capable of functioning quickly, consistently, and with few mistakes. Rule number one: individuals who have previously performed a given job successfully are qualified candidates for that same job in your organization.
This rule, however, must be further refined to take into account the depth of experience a candidate may possess. There is a significant difference in capability between an individual who has performed in a position for two years and another with fifteen, or twenty years of experience. There are often significant differences in the extent of experience even when candidates have the same title–one may oversee a department of a few employees, while the other may oversee multiple departments, managers and reports. Rule number two: an individual’s previous responsibilities should reasonably match those of the position to be filled, in both extent and degree..
Developing a Job Description
This raises an important question: “What is the level of capability required in a job?” Too often, the specifications for an employee seem to materialize out of thin air, with much attention given to the responsibilities and experience required, but little focus on overall workforce planning. Viewed in a broader context, the employees of an organization are the “machines” that get the work done, which is why employees are accurately referred to as “human capital.” In a manufacturing environment, the processing that must be performed defines the context of equipment use and purchasing decisions, as there are a variety of machines available to perform any process. For example, one could employ a small number of large, multi-function machines, or a larger number of small, dedicated machines, with numerous advantages and disadvantages to each option. The lesson here is that: 1) decision-making should focus on multiple, interrelated processes, not discrete machines; 2) a given process may be accomplished using different combinations of machines with differing capabilities. Staffing decisions should be approached in a similar way.
Workforce planning is best accomplished by identifying the processes to be performed and then determining the possible combinations of existing and obtainable labor power that can perform these processes. Each viable option is evaluated and compared in an effort to identify the most advantageous option. Inherent in the elaboration of a viable option is a description of a specific function or activity to be performed by each employee. This description defines the capability required of the employee–he or she must be capable of performing the activity described. Rule number three: the work to be accomplished requires discrete activities to be performed and these activities define the capabilities required of each employee.
Once the planning has been done and the qualifications required of the future employee are known, how does one go about finding viable candidates? It is a common complaint of hiring managers that qualified candidates are difficult to find. Yet, it is not really a candidate problem so much as a budget problem. With unlimited funds, a massive marketing campaign would surely generate more viable candidates than could be interviewed. What most for-profit companies have long known is that it costs money to generate a sufficient number of viable candidates and it costs even more money to fail to do so. Recruiting costs are simply budgeted, along with training and interviewing costs, as part of the outlay required to hire an employee. Although accurate figures are elusive, at least 50% of all positions are filled using advertising, with executive recruiters contributing about 35% of all employees. However, when one considers only salaried positions, the percentage filled by executive search firms is much higher than for advertising and the vast majority of all middle and senior level managerial positions (excluding those filled by promotion) are filled by search firms. Rule number four: executive search firms are the most cost-effective source of qualified candidates for salaried positions.
Maintaining focus during the interview
When the resume of a viable candidate is received, an interview should be promptly scheduled. An interview serves three purposes: 1) determine if the candidate has previously performed the same or similar work as required by the position they are being considered for; 2) evaluate the personality and veracity of the candidate; and 3) “sell” the candidate on working for your organization. One potential interview pitfall is a failure to stay sufficiently focused on the candidate’s work history. It is easy for a candidate to make sweeping assertions about their abilities and quite another to make statements of fact about what they have done at work over the past few years. The most desirable candidates are honest about their experience and comfortable with self-disclosure, but a clever and genial candidate may project an appearance of extensive experience, while avoiding discussion of specifics. Rule number five: candidates should be judged on their qualifications, not on their interviewing skills.
One of the major mistakes an employer can make is dragging the interviewing process out so long that all the good candidates get away. Anyone who has shopped for and purchased a home knows that the dogs stay on the market for months while the desirable houses are snapped up very quickly. Hiring managers should strive to come to a decision on a viable candidate within two weeks or less. If more than one interview is required, the second interview should be the last interview and all the decision makers must make themselves available to meet the candidate at that time. With each passing day, the likelihood increases that a candidate will receive and accept an offer from another employer, get a raise or promotion, or experience a change in personal circumstances that alters their employment search. Furthermore, a candidate’s enthusiasm about an opportunity cools with the passage of time and eventually transforms into disdain for an organization that is unable to make a timely commitment. Rule number six: desirable candidates will be lost if timely decisions are not made.
The Background and Reference Check
The most important step in the hiring process is reference checking. A thorough reference check must confirm the quantity and quality of a candidate’s previous experience and uncover any problems or concerns that the candidate may not have shared. Dates of employment must be verified as well as
specific qualifications essential to success in the position.
An online search should also be conducted with an eye toward discovering employment omitted from the resume, or other problematic issues, such as litigation or inappropriate public behavior (including online postings). Rule number seven: some people will say anything to get a job, so information provided by candidates must be verified and not accepted at face value.
Although mutual fund prospectuses warn, “Past performance does not guarantee future results,” when hiring, past performance is our best predictor of future performance. A thorough assessment of previous experience (through resumes, interviews, and reference checks) provides the information required to hire employees with the greatest likelihood of success.
Succession Planning and Leadership Development
To function in the long run, public policy think tanks must acquire highly-qualified leaders. As founders age, or senior managers leave the organization, the need to transfer leadership responsibility may become urgent. Moreover, new leaders bring fresh ideas and a variety of experience that can aid in expanding and strengthening the organization.
A loss of leadership will result in a stagnant or waning organization, yet many organizations are unprepared for the possibility that its top leader may become ill or disabled. A related problem is inadequate secondary management; leadership may be willing to delegate but lacks confidence that subordinates can handle the work. Similarly, if an organization has grown beyond the capabilities of its managers, further growth is jeopardized and new opportunities will languish unexploited.
An organization’s ability to produce results derives from its leadership and staff–its sole productive asset. The only way to improve the “product” of such an organization is by improving the quality of the employees, and the most essential employees are those who manage the organization. The better our employees are, and the more of them we have, the more output the organization can generate.
Employee Output
Research has demonstrated that there are enormous differences in the productive output of employees, and it is clear that high-quality (and highly-compensated) employees generate far more output per payroll dollar than average employees. Good employees are 50% more productive than average employees. Top employees are at least 2¼ times more productive than average (Hunter, Schmidt & Judiesch, 1990, Journal of Applied Psychology, among others).
Excellent Employees
The salary earned by an individual generally increases over time as they learn and gain experience; how far and how fast is a function, according to recent research, of general mental ability and conscientiousness (Schmidt & Hunter, 2004, Journal of Personality and Social Psychology). Individuals who posses these characteristics in abundance will be top performing employees who can learn quickly, function independently, and maximize output.
Increase in salary over time
Unfortunately, many organizations approach compensation from what might be called a “budget” perspective, where salaries are determined by what fits the budget rather then what must be spent to acquire an excellent employee. Arbitrarily limiting salaries creates a “natural selection of the unfit” where potential employees who are both excellent and experienced are too expensive for the organization to hire and current employees who are excellent will–once they gain experience–leave to earn a better living elsewhere. Only below-average employees will stay, since they have nowhere better to go.
Some individuals will accept lower pay in exchange for a more desirable or satisfying position–such as working for a think tank. The difference between what an individual could earn elsewhere and what they are willing to accept as a think tank employee has been referred to (by Larry Reed) as the “missionary discount.” Missionary discount notwithstanding, lower-paying organizations will lose good employees to those that pay better; many charitable and educational groups pay higher salaries than think tanks; and, as the employee’s financial needs and the salary discrepancy increase, the employee’s willingness to work for less may vanish (followed soon after by the employee).
Show me the money
Hiring and retaining excellent employees capable of becoming tomorrow’s leaders requires a financial investment. Where will the cash for this investment come from?
Spending less on current programs and cutting some of your least essential programs will free up cash for investing in leadership. These programs may be restored once revenue growth and improved efficiency are achieved. The organization should perform a cost/benefit analysis for each program and those whose benefit is less significant than the survival of the organization are candidates for reduction or elimination.
Increase revenue by asking donors and foundations to provide a “leadership development” grant that covers the cost of hiring a well-qualified leader. This requires a well-researched plan that itemizes the costs and the anticipated future benefits. Borrowing the money is an option too, particularly if it will be used to hire a fundraiser.
Solutions
Investing in excellent current employees is accomplished with direct monetary incentives and through leadership development. Salary and bonus are monetary incentives and excellent employees should be paid above-average salaries accompanied by generous opportunities to earn bonus tied to goal attainment. (For more on structuring bonus plans, see: Kaplan, Robert S.: “Strategic performance measurements and management in nonprofit organizations;” Nonprofit Management and Leadership, 11(3):353-370, Spring 2001; and “The Balanced Scorecard and Nonprofit Organizations;” Balanced Scorecard Report, December 2002, pp 1-4.)
Leadership development has an internal and an external component. Capable employees become leaders through practice and experience. Provide them with a specific project, set measurable goals, provide resources, and then get lost. Mentoring develops skills; micro-management does not. Practice must be supplemented by external training, the most important of which is formal training in an MBA program. Managers must be able to perform statistical analysis, manage information, construct and evaluate marketing plans, read accounting statements, and manage finances. Providing managers with employer-paid access to MBA courses will probably benefit the organization more than any other leadership development effort.
Investing in new employees is a constant requirement for growing organizations. Under-performing employees should be let go and replaced with high-performing, well-paid employees. The payroll will grow, but–due to the higher quality of employees–output and revenue will grow more.
Another Issue: Founder Flounder
Organization founders sometimes find it difficult to let go. One option is for the Board to create new positions and specify exact job responsibilities: the founder becomes President with a fundraising, PR, or research role, but no direct reports, and an Executive Director is hired to run organization.
Sometimes questions arise over compensating the founder in a new role, but there is a straightforward solution. Quantify the value of the founder’s contribution (aka: marginal contribution) by estimating what would be lost if the founder left. Place a dollar figure on this contribution, or estimate the cost to replace the founder. Compensation should be no more than the marginal contribution; or, if you prefer formulas: compensation <= marginal contribution.
