The Business Case for Performance Management Systems

The Business Case for Performance Management Systems A Handbook for Human Resources Executives and Managers Josh Bersin Principal Analyst January 2008 BERSIN & ASSOCIATES RESEARCH REPORT v.1.0

The Business Case for Performance Management Systems TABLE OF CONTENTS Introduction 4 What Is Employee Performance Management? 5 Performance Management Is Fundamental to Talent Management 7 The Business Case for Employee Performance Management 9 Three Categories of Business Benefits 9 1. Efficiency and Compliance (driven by HR) 9 2. Process Improvement (driven by organizational development) 9 3. Business Transformation (driven by business executives) and Business Performance 11 The Benefits of Performance Management Software 12 First-Generation Solutions (1980s 1990s) 12 Second-Generation Solutions (1999 2000s) 13 Third-Generation Solutions (emerging) 13 Defining the Benefits 15 Efficiency and Compliance Benefits 16 Process Improvement Benefits 17 Case in Point: Pep Boys 18 Case in Point: An Example 19 Business Transformation Benefits 19 Pay for Performance 20 Organizational Transformation 20 Improving the Leadership Pipeline 20 Improving Quality of Hire and Workforce Mobility 22 Building the Business Case: Factors to Consider 24 Process First, System Second 24 Consider the Type of Vendors to Evaluate 25

The Business Case for Performance Management Systems Focus on Ease of Use Adoption Is Key 25 Budget Time and Energy on Process Design 26 Budget for Change Management, Training, Communications, Monitoring and Governance 27 Obtaining the Funding Presentation to Upper Management 28 For More Information or Assistance Come Visit with Us in 2008 31 Join Our Research Membership Program 31 1 Appendix I: Figures Appendix II: Table of Figures 2 3 About Us 34 About This Research 34

The Business Case for Performance Management Systems 4 Introduction One of the fastest-growing segments of HR software today is the market for online employee performance management systems. Our current research estimates that this market will reach $409 million in 2008 growing by more than 25 percent per year. Today, there are more than 30 companies providing solutions in this rapidly growing market, each with unique and innovative solutions to address this segment. This research report is designed to help HR and line managers understand the business drivers and benefits of such systems to aid in the development of the business case and planning process for selecting and implementing such systems.

The Business Case for Performance Management Systems 5 What Is Employee Performance Management? The term performance management is well-known to HR managers. Traditionally, it refers to the process of establishing goals, assessing employees and implementing the annual performance appraisal process. The goal of performance management is to create a consistent, fair and equitable process for the establishment of performance standards across an organization. This process is fundamental to a high-performing organization because it establishes the way in which people are managed. Our research has found seven independent parts of performance management in most organizations. These include: 1. Development of indiviudual goals; 2. Alignment of goals across the organization; 3. Manager assessment of performance; 4. Employee self-assessment of performance; 5. Peer or 360 assessment of performance (also called multirater assessment); 6. Competency assessment (often called assessment of potential ); and, 7. Coaching and development, and related planning for future career positions. Each of these processes is complex and is performed in different ways by different organizations. While there are hundreds of books on how to conduct performance appraisals, ultimately performance management is management. It forms the basis for the way in which employees work with their managers every day. Our research has found that these seven processes form and enhance the relationship between managers and employees. Well-implemented performance management systems will reinforce and institutionalize your company s overall process of management. Unfortunately, in many organizations (approximately 70 percent), performance management itself is not a well-established, consistent process. Even in those that have a consistent process, it often tends

The Business Case for Performance Management Systems toward the annual appraisal leaving much of the other processes up to the whims of a manager. Our research shows that, despite the great importance of performance management in HR departments: Sixty-one percent of line managers do not feel that the process they have today is driving greater performance; Fifty-six percent of managers are not satisfied with the process; and, Fifty percent of HR managers are not happy with the process. 1 The biggest complaint from managers is that they are not given enough guidelines on how to assess people, and the biggest complaint from employees is that the process is not equitable and fair. (A consistent software-driven process, coupled with excellent training, can avoid these problems.) So in the vast majority of organizations, performance management is a work in progress. 1 For more information, High-Impact Performance Management: Comprehensive Industry Study: Market Analysis, Trends, Best Practices, and Vendor Profiles, Bersin & Associates / Josh Bersin, June 2006. Available to research members at www.elearningresearch.com or for purchase at www.bersin.com/perfmgt.

The Business Case for Performance Management Systems 7 Performance Management Is Fundamental to Talent Management Driven by today s competitive business environment and the changing demographics of the workforce, organizations of all sizes are implementing integrated talent management strategies. These programs are designed to improve the leadership pipeline, improve workforce skills, and increase retention and staffing to meet the needs of growing organizations. Our High-Impact Talent Management research illustrated how dramatically this shift is taking place. Almost twothirds of HR organizations are building integrated talent management strategies which look at HR processes as an integrated whole (not only as separate functional processes). Ultimately, however you define talent management, our research clearly shows that performance management is foundational it establishes the ground rules for conversations between managers and employees. How, for example, do you decide who gets the bigger raise? How do you decide who is promoted into a given position? How do you decide who to lay off during a downturn? How do you decide who should be given an opportunity to take on a challenging, business-critical new assignment? Everywhere you look, these talent management decisions are dependent upon the appraisal of an individual s performance, capabilities and potential. In most HR textbooks (and in many organizations), performance assessment is broken into the following two fundamental pieces. The What What did this person accomplish? What value is he / she delivering to the organization? Is he / she achieving his / her business objectives? The How How did this person achieve such results? What is his / her skills and competencies? How well are they aligned with our corporate values? 2 For more information, High-Impact Talent Management: Trends, Best Practices and Industry Solutions, Bersin & Associates / Josh Bersin, May 2007. Available to research members at www.elearningresearch.com or for purchase at www.bersin.com/hitm.

The Business Case for Performance Management Systems In most organizations, a performance rating is some combination of both of these. The what is typically used to establish compensation, and the how is used to establish promotability and development planning. But there is no hard and fast rule here. Some organizations weigh heavily toward the what (e.g., organizations with a very results-driven culture), and others weigh more toward the how (e.g., organizations with a more career-oriented culture). Again, our research clearly shows that, while performance-driven organizations do well in the short term, long-term value in organizations is driven much more by focusing on the how because these processes are used to help people develop, improve and move into the right jobs in the future. Our High-Impact Talent Management Framework (see Figure 1) illustrates how performance management forms the foundation of integrated talent management. Figure Figure 1: Bersin 1: Bersin & & Associates High-Impact Talent Management Talent Management Framework Framework HR Systems & Metrics Business Strategy Sourcing & Recruiting Sourcing Candidate Pools Assessment Employer Brand Recruiting Selection Talent Strategy & Planning Critical Talent Strategy Performance Management Goal-Setting Cascading Goals Self-Assessment Manager Assessment 360 Assessment Development Planning Competency Assessment Competency Management Onboarding Role-Based Curricula Content Development and Delivery Management Training Operational Training Target Metrics & Measurement Job Profiles Process Governance Career and Succession Management Calibration Meetings Talent Reviews HiPo Identification Career Planning Talent Migration Plan Corporate Values Leadership Curricula e- Learning Strategy Leadership Competencies Learning and Development Systems Strategy Leadership Development Formal Programs Stretch Assignments Executive Education Coaching Mentoring Job Rotation Assessment Evaluation Functional Competencies Coaching / Mentoring Programs Developmental Assignments Certification Programs Compensation Planning Base Compensation Plans Compensation Pay for Performance Short- and Long-Term Incentives Source: Bersin & Associates, 2007.

The Business Case for Performance Management Systems 9 The Business Case for Employee Performance Management Before discussing the importance of performance management software and the many benefits it provides, it is first important to discuss the business case for performance management itself. How does this process create business value? Three Categories of Business Benefits Generally speaking, there are three major business benefits from the performance management process. 1. Efficiency and Compliance (driven by HR) Legally Defensible Employee Management The first and foremost purpose for performance management is to create consistent, defensible performance standards for employees to help managers with the process of management. The process should create equity and alignment in compensation and promotional decisions, and in the legal defense of terminations. These benefits are legal mandates employers can be sued for undocumented decisions about compensation, termination and promotion without such a process. Compensation Optimization Without a performance management process (and system), many compensation decisions are made on an ad-hoc or personal-opinion basis, leading to overspending on salary increases, bonuses and other incentives. One of our research members found that, through the integration of a new performance management process (and system), the company saved more than $10 million per year on discretionary bonuses alone. 2. Process Improvement (driven by organizational development) Increasing Employee Retention There are many ways in which performance management increases retention. First, by having regular and clear goals and performance standards, employees feel

The Business Case for Performance Management Systems 10 more aligned with their managers and are much more likely to feel committed to the company. Second, the process itself (if welldesigned) encourages managers and employees to talk regularly about goals and development plans creating a more engaged manager and employee. Third, the process helps recruiters and prospective employees understand the company s culture and performance standards, helping to hire the right people who are most likely to succeed. Costs Associated with Losing Employees Data from Cornell University and Hewitt show that the cost of losing a single position is from 30 percent to 150 percent of the annual salary. In a firm with 40,000 full-time positions, the difference between a 15 percent turnover rate and a 25 percent turnover rate is more than $40 million annually. Improvement in Employee Engagement and Development By implementing a complete performance management process (one which includes development planning and coaching), organizations greatly improve the career development, skills and engagement of their employees. Our High-Impact Talent Management 4 research looked at 62 different talent management processes and found that the one which drives the highest level of business impact is coaching. Coaching describes the process of a manager listening, assisting and developing his / her people. A well-designed performance management process formalizes this ongoing relationship. Improving Efficiency and Effectiveness of Training Organizations spend between two percent and four percent of their payroll on training. These dollars go into a wide array of programs that are often changing every few months. The use of a welldesigned performance management process creates development planning as part of performance planning, aligned with the business strategy. It gives training managers the tools to often eliminate or redeploy 20 percent to 30 percent of their training budgets toward more urgent and needed programs. 3 Source: http://www.cornell.edu/research. 4 For more information, High-Impact Talent Management: Trends, Best Practices and Industry Solutions, Bersin & Associates / Josh Bersin, May 2007.

The Business Case for Performance Management Systems 11 3. Business Transformation (driven by business executives) and Business Performance Workforce Goal Alignment One of the biggest benefits of modern performance management is that it creates a process for common goal alignment across the workforce. Through the use of new performance management software, it is now possible to make sure that all employees have goals that are aligned with corporate goals. This gives employees, managers and executives new levels of visibility into their organizations enabling them to identify areas of misalignment and giving everyone information on how they can more easily help the business succeed. Increasing Employee Productivity and Performance Through the performance management processes, organizations can implement special programs (such as pay for performance, incentive bonuses and many others) that encourage employees to perform at higher levels. Organizations with well-established performance management programs (65 percent of organizations in our High-Impact Performance Management research 5 ) have 47 percent higher self-reported outcomes in creating a higherperforming workforce than those without well-established performance management processes. These benefits, when leveraged across an entire corporation, are tremendous. Improving the Leadership Pipeline The performance management process establishes the base for many talent management processes, as described earlier. It enables the company to find potential leaders more quickly and effectively, better develop these leaders, and identify successors to any and all critical job roles. Our research shows that the number one issue plaguing HR executives today is the hollowing out of their management and leadership pipelines. Only through a performance management process can these organizations identify and prepare the future leaders to fill these roles. 5 For more information, High-Impact Performance Management: Comprehensive Industry Study: Market Analysis, Trends, Best Practices, and Vendor Profiles, Bersin & Associates / Josh Bersin, June 2006. 6 For more information, High-Impact Talent Management: Trends, Best Practices and Industry Solutions, Bersin & Associates / Josh Bersin, May 2007..

The Business Case for Performance Management Systems 12 The Benefits of Performance Management Software Now let us look at the role of performance management software, and how it enhances and facilitates these three areas of benefit. First, it is important to understand the evolution of these systems. First-Generation Solutions (1980s 1990s) In the 1980s and 1990s, organizations implemented Microsoft Word- and Excel-based forms automation systems that focused on automating the completion of performance appraisal forms. Initially, these systems focused on making it easier for managers to complete appraisals and then later, tools were added to help managers write (i.e., writing assistants), maintain legal compliance (i.e., checkers for illegal or discriminatory statements) and compute ratings (i.e., tools to weight and check ratings for equity and accuracy). As Figure 2 shows, these systems focused heavily on facilitating the efficiency and compliance benefits of performance management. Figure 2: 2: The Evolution of Performance Management Systems Business Transformation Third Generation Process Improvement Second Generation Business Benefits Efficiency and Compliance First Generation Web-Based Performance Management Ongoing Employee Performance Management Forms Automation (Word and Excel Templates used once per year) (Web forms appraisal workflow used a few times per year) (Employee and Manager planning, decision-making, and networking tool used frequently) 1980s 1999 2000s 2007+ Source: Bersin & Associates, 2007.

The Business Case for Performance Management Systems 13 Second-Generation Solutions (1999 2000s) In the late 1990s and through the 2000s, the Internet enabled organizations to build highly networked online performance management systems. These were (and still are) essentially web-based forms automation solutions. They include easy-to-use web forms to help managers and employees develop goals, assess competencies, and develop feedback and performance plans. These systems help managers capture information from others (as well as other areas) in the organization to include in the performance plan. They include powerful charting and analysis tools to help compare employees to each other and to assist in succession planning decisions. Employees and managers gain visibility into goal development, achievement, competency gaps and other information across the organization. These second-generation solutions go far beyond efficiency and compliance and focus heavily on implementing and improving the entire process of managing people. They have become more and more indispensable in the process of integrated talent management. In fact, many of these systems are now highly integrated with recruiting, learning and compensation to help the organization implement a tightly connected process for integrated talent management (often called the talent management suite 7 ). Through tools (like goal alignment and enterprisewide goal transparency), these systems are now able to facilitate true business transformation, as we will discuss. Third-Generation Solutions (emerging) There is a new, third generation of these systems now emerging. Here, we call this systems for everyday employee performance management. Most second-generation systems (while very well-designed) are still based on forms and tabs, and are only used occasionally by employees (a few times per year). 7 For more information, Talent Management Suites: A Comprehensive Look at Integrated HR Systems, Bersin & Associates / Leighanne Levensaler, January 2008. Available to research members at www.elearningresearch.com or for purchase at www.bersin.com/tmsuite.

The Business Case for Performance Management Systems 14 These next-generation systems are designed to drive business transformation by encouraging use by everyone in a regular and daily way. They manage more than just goals and employee development plans these systems go forward to help employees manage all the decisions they make on a daily basis. The next-generation systems look more like Web 2.0 applications (e.g., Facebook) and are designed to work through seamless integration to office productivity tools (like Microsoft Outlook). This integration means that mangers can capture performance management feedback throughout the year in the online system, without ever having actually logged into the system. Other tools include collaboration and networking, as well as embedded decisionsupport tools like analytics and workforce planning. Figure Figure 3: Next-Generation 3: Next-Generation Employee Employee Performance Performance Management Management Solutions Solutions Source: Taleo, Inc., 2007.

The Business Case for Performance Management Systems 15 While such systems are still in their early stages, we believe they are the inevitable next step in this market and will help accelerate business transformation. Buyers should consider these third-generation systems and features as part of their long-term talent management systems strategy. Defining the Benefits As we look at the benefits of performance management software, we find that they map directly to the three business drivers of performance management itself. Figure 4: Three Levels of Business Benefits for Performance Management Systems Business Value Business Transformation Process Improvement Efficiency and Compliance Developing Standard Rating Model Automating Performance Appraisals Increasing Engagement and Retention through Feedback and Coaching Increasing Performance through Development Developing Standard Competency Model Improving Business Results through Goal Alignment Driving Performance Culture through Pay for Performance Improving Leadership Pipeline through Succession Planning Bus Exec Driver ROI = 5-10X OD Driver ROI = 2-4X HR Driver ROI =.5-2X Source: Bersin & Associates, 2007.

The Business Case for Performance Management Systems 16 Figure 5: Benefits of Performance Management Systems Category of Benefits Driver Typical Return on Investment Efficiency and Compliance HR 0.5 to 2 Times Investment Process Improvement Organizational Development 2 to 4 Times Investment Business Transformation Business Executives 5 to 10+ Times Investment Source: Bersin & Associates, 2007. Your organization will likely see benefits throughout this continuum. Your business case should focus on the areas in which there is the most urgency, awareness and need today and into the near future. Let us show some examples of benefits in each area. Efficiency and Compliance Benefits Any performance management software solution will provide many benefits in this area, including: Saving a manager s time with the appraisal process; Reducing errors in the performance management process; and, Saving the time of HR managers in consolidating and recording ratings. Such automation savings are typically small but often big enough to cost-justify a system. Today, these kinds of business cases are harder to justify, but you can build a business case on forms automation alone. If you consider that the system may save several hours per year across all managers in a large organization, the real savings can be very large. Imagine an organization of 5,000 employees that uses an ad-hoc paper-based approach to performance management. Even if forms are regularly used, there are many costs that can be saved. Imagine that 5,000 appraisal forms are filled out by hand and each is sent to HR. (In all likelihood, many will never make it to HR.) The human resources organization will typically encode these into an Excel spreadsheet

The Business Case for Performance Management Systems 17 to be used for compensation planning and this information will be redistributed to the employees for annual compensation planning. That forms collection, encoding and distribution process often takes four to six weeks (or longer), and rarely enables the organization to iterate and calibrate the appraisal ratings. These costs (including the cost of management time spent on paper processing) often approach the tens to hundreds of thousands of dollars. An even bigger driver here is the savings in potential legal exposure. If an employee sues an organization for discrimination in compensation or termination, the legal costs will be hundreds of thousands of dollars or higher. With a paper-based process, the organization may not have the right records available, or (even worse) the manager may have written something that is inappropriate or legally liable. Performance management software prevents such problems by including writing tips and communications archives between all managers and their employees. Our research finds that organizations easily realize a 50 percent to 200 percent return on investments (ROI) from efficiency and compliance. Process Improvement Benefits The second category of business benefits involves the improvement or adoption of important talent-related business processes. These benefits typically require the implementation of a second-generation system or a talent management suite. Consider, for example, the possible benefits of establishing a standard rating and competency model, and creating clearly aligned goals. Here, there could be tremendous financial benefits, such as: More equitably allocating compensation across employees, reducing total expense; Reducing compensation expense by not misallocating budget to employees who did not actually achieve goals; and, Reducing employees expectations for compensation by more clearly explaining performance standards. There are also significant, potential financial savings.

The Business Case for Performance Management Systems 18 Case in Point: Pep Boys One organization we spoke with (Pep Boys, a large automotive parts retailer) told us that the company saved more than $10 million in compensation expenses after the adoption of its new system simply because managers now felt less obligated to give out bonuses to employees who were not performing well. Prior to the use of the system, managers would hand out annual bonuses based on overall business objectives and general guidelines. After the new performance management process was put in place, managers were given clear bonus guidelines tied directly to local organizational business objectives. The result is far fewer bonuses and a far more performance-oriented process. Consider the benefits of creating an integrated process for employee development, aligned to corporate goals and competencies. First, such a system (as many pioneers in this market have seen) integrates the performance management process with the development resources in the company. Benefits include: Managers can more efficiently and easily assign the right development activities to employees; Training staff and dollars can be allocated to the most urgent and pressing development needs; HR executives and managers can assess the true value of their learning and development investments; Employees feel far more engaged because they can create their own development plan, using the support of your organization; and, Underutilized training programs and external programs can be cut or realigned. Since most companies spend between two percent and four percent of payroll on development (approximately $1,300 per employee on average across all employees in the U.S.), any savings or improvement in efficiency here can have large financial benefits.

The Business Case for Performance Management Systems 19 Case in Point: An Example Consider the potential savings in learning and development (L&D) spending. Most training organizations struggle to stay closely aligned with business needs. If a 5,000 employee-sized company spends two percent of its payroll on training, the total L&D budget will be around $5 million to $7 million per year. Organizations with well-defined performance management processes that are linked to development are typically 25 percent to 30 percent more efficient at allocating training dollars. This means the potential savings of $1 million to $2 million in efficient allocation of training programs. Do not underestimate the more intangible business value of integrated development planning. Organizations with integrated development planning processes can greatly: Improve their leadership pipelines; Reduce the need to hire external employees; and, Improve retention through career development programs. Many large organizations (e.g., Aetna, Seagate and Textron) have turned themselves around by focusing on the coaching and development aspects of performance management. 9 Business Transformation Benefits The third type of business benefits for performance management systems falls into the category of business transformation. Many of the newer performance management systems (including the next-generation solutions ) focus in this area. Here, the organization can use the system This information is based on our industry report, High-Impact Learning Organization, the report for which is available now with a new edition coming in 2008. For more information, please visit www.bersin.com/hilo. 9 In-depth case studies of Aetna, Seagate, Textron and others are available to Bersin & Associates research members. For more information on our research membership program, please visit www.bersin.com/membership.

The Business Case for Performance Management Systems 20 to develop and implement new, integrated performance-driven processes that align and drive behavior, improve business planning, and facilitate business performance improvement. Pay for Performance For example, do you have a pay-for-performance culture in your organization today? Can you motivate employees toward organizationwide goals (such as revenue growth, cost containment, customer satisfaction measures, or other important operational measures)? Such goal alignment is often the dream of a CEO. With today s new performance management systems, such goal alignment and direct computation of goal attainment is now possible. Organizational Transformation One organization with which we spoke (a large European bank) used its new performance management process to manage a large acquisition. These two banks (one Spanish and one English) had vastly different cultures, systems and products. The company used its performance management process to establish a set of operational goals that force all employees to work on common initiatives and programs vital to making the merger work. In the first year of this rollout, more than 85 percent of all employees were given goals that directly aligned with a set of mergerbased initiatives. The organization forced alignment with this process, creating tremendous benefits in process improvement. Of course even in this case, it is still up to the individual manager to create the ongoing support and environment to achieve such goals. But with such a goal alignment process, the directors and vice presidents can clearly see who is onboard and who is not. Improving the Leadership Pipeline Imagine an even bigger challenge. Today, our research shows us that the biggest challenge in organizations is the development of the leadership pipeline. 10 10 For more information, High-Impact Talent Management: Trends, Best Practices and Industry Solutions, Bersin & Associates / Josh Bersin, May 2007.