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Compensation and incentives

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The topic of compensation and incentives includes the process of how salaries are set and by whom, the types of incentives being used, and the issue of compensation inequality.

A new perspective

In Teal Organizations, compensation is determined not only in a different way, but takes on a fundamentally different nature and level of importance. Typically these organizations exhibit the following general characteristics with regard to compensation:

  • People set their own salaries, with guidance from their peers.
  • There are no individual or team incentives, as incentives are seen to distract people from their inner motivation, and to skew behaviors.
  • While not necessarily explicitly attempting to create an egalitarian pay structure, it seems that in these organizations, people strive to reduce the sometimes extreme pay disparities witnessed in many sectors today. A special focus is to ensure that the lowest paid make enough to satisfy basic needs.  

In contrast, compensation and incentives in earlier stage organizations can be summarized as follows:

Red Organizations

In the Red paradigm, the prerogative of the boss is to freely, on a whim, decide to increase or reduce pay. There are no formal processes for negotiating on pay, nor any formal, documented incentive processes.

Amber Organizations

In the Amber paradigm, compensation is generally fixed and determined by a person’s level in the hierarchy (or other fixed status marker, such as the person’s type of university degree). There are no individual salary negotiations, no incentives. It’s “same work, same pay”.

Orange Organizations

In the Orange paradigm, there is some individual negotiation of base salary, and people generally fall into salary bands. A boss has some freedom to increase someone’s pay within that salary band. Orange believes strongly in individual targets and incentives. If people reach predetermined targets (that ideally belong to a cascaded system of targets or budget that builds up to strong creation of shareholder value), they will receive a hardy bonus. Strong differences in pay between top and bottom earners are seen as perfectly acceptable, as they reflect people’s merits and contributions.

Green Organizations

The Green paradigm believes in cooperation as much as in competition; individual incentives begin to make way for team bonuses. Attempts are made to reduce the difference between the highest and lowest earners in the workplace, for instance through a maximum multiple between the CEO pay and the median (or lowest) salary in the organization.

In practice

How salaries are set and by whom

In traditional organizations, compensation is typically determined according to the organizational hierarchy. Generally, a boss can decide on a pay raise for his subordinates, often subject to HR (or institutional) guidelines or approval. In self-managing organizations, in the absence of bosses, the process to determine salaries and other types of compensation must be reinvented using the power of peer input. It seems that there are two broad categories of systems: ranking-based systems and self-set (advice-based) systems. [Both of these can be used within hierarchical systems too. They don't depend on self-managing structures.]

Ranking-based systems

In certain companies, such as W. L. Gore or HolacracyOne, employees rank or evaluate the contributions of the peers they work with most closely. Based on this input, people are allocated to different salary bands - usually by an algorithm or an elected committee. People who are seen as contributing more will find themselves in the higher bands that earn bigger salaries; the more junior, less experienced colleagues naturally gravitate toward bands with lower salaries. The process is simple and easy to understand and it is generally seen as fair. When it’s not just one person (the boss), but many of an individual's colleagues informing the process, the resulting salary is likely to be a fairer reflection of that person's contribution.

Such systems can result in pay fluctuating (going up but also down) over the years, depending on people's contribution. In many countries, labor laws prevent salaries from going down, which requires adaptations to this method. For instance, the system could be used only to discern which colleagues should receive a pay raise. Alternatively, a system can be engineered using a low fixed salary, and allowing the fluctuations through individual bonuses that can go up or down.

Self-set (advice-based) systems

A more empowering version is one where people set their own salaries, calibrated by the advice process from their peers. In this case, generally once a year, people propose what salary raise they believe to be appropriate for themselves, and the justifications for their proposal. This input is reviewed by a number of peers (e.g. in an elected salary advice group) who give individual advice on that proposal, based on a calibration across colleagues. Individuals can then choose to follow the advice they have received or not, and their choice is made public. If it so chooses, the salary advice group can choose to declare a conflict and invoke the conflict resolution mechanism.  

The process cuts through much of the haggling, strategizing, complaining, and "sucking up" that happens when salaries are set by one's boss. If people are unhappy with their salary, they can simply raise it. And they will face the consequences of their choices, if they decide to place themselves too far outside their peers' advice. 

Use of incentives

In the Teal paradigm, people value intrinsic over extrinsic motivators. Once people make enough money to cover their basic needs, what matters most is that work is meaningful and that they can express their talents and callings at work. In the book Drive, Daniel Pink concludes from a great amount of research on the matter that in today’s complex work settings, incentives are mostly counterproductive, reducing rather than enhancing people’s performance.

The consequence is that Teal Organizations generally operate without explicit financial incentives at individual and team level. No one, not even sales people, has targets or incentives and there are rarely individual bonuses or stock options. Instead, at the end of very profitable years, some part of the profit will be shared with all employees (in some cases everyone receives the same fixed percent of base salary, in others everyone receives the same fixed amount). See also Ownership.

Compensation inequality

Without the use of bonuses and stock options, compensation inequality is automatically reduced, as a large share of the pay inequalities in today's Fortune 500 companies stem from the often extravagant CEO bonuses and stock options. Some organizations also strive consciously to limit inequality in the base salary. Some organizations, like AES and FAVI, have replaced hourly wages with monthly salaries for shop floor operators, erasing the distinction between blue- and white-collar workers. Everyone is compensated on the same principles. 

Frequently asked questions

When salaries are self-set, how can salary inflation be prevented?

The advice process (and if needed the conflict resolution mechanism) generally prevents a situation where one individual gets a raise that would be disproportionately high. But one might then ask "what prevents a sort of (even unconscious) collusion whereby everyone grants themselves big raises, thereby inflating the entire payroll of the organization to a degree where it might hurt shareholders or even the organizations purpose?" This doesn't seem to be a problem with the pioneering organizations that use self-set pay. Here is how they seem to go about it. 

  • In some organizations (such as Morning Star in California), everyone needs to benchmark their salaries to a market rate. They institute a rule of thumb, for example, that salaries shouldn't be higher than 110% of the industry average. They might support this with the arguments that if salaries are too high, this allows for less investment and future development, makes the organization less able to achieve its purpose or is unfair to the shareholders. 
  • Many of the organizations researched are very profitable, and pay out a lot in profit sharing (workers at FAVI typically make the equivalent of 17 or 18 months of salary this way). The idea, therefore, is to keep compensation in line with the industry, and when profits allow, top up the salary with profit sharing. This reduces the incentive to try and increase one's base salary, knowing also that in bad times, jobs are more secure if the base salaries aren't inflated.
  • Some organizations (like FAVI in the north of France) find it useful to have a simple rule of thumb for the organization overall: Revenues should break down into X% for salaries, Y% for material costs, Z% for investments so that a healthy P% of profit remains. Everyone seems to accept this rule as good common sense. This is the basis for what can be shared in profit sharing. If needed, the salary advice group could share these parameters with everyone upfront, for instance in years with low profitability.

Should we make all salary information transparent?

When some information is secret, it tends to generate rumors. For what reason would salary information be made a secret? Probably because of the idea that some people would be shocked by some of the information and claim the salary distribution is not fair.

From a Teal perspective, such discussions shouldn't be feared and avoided, but can be steered in productive ways. They can help bring to light unspoken issues and hidden grievances. They can help people grow as part of the process, in dealing with their relations to one another and to money. And perhaps, indeed, to correct some obviously unfair situations that might have slipped in over time.

For this reason, many organizations choose to make information totally public. (The social media app maker Buffer even publishes everyone's salary online). Some organizations, like the tomato-processing company Morning Star, have chosen to make the salary increase percentages public within the organization, but not the base salary. That might be an intermediary step towards full transparency for an organization to take.

What happens in times of crisis?

There are several documented examples of self-managing organizations where colleagues have voluntarily decided to temporarily reduce their salaries to weather a downturn so as to avoid having to lay-off staff. In self-managing organizations, all information tends to be public and there is generally a high level of maturity and literacy when it comes to financial matters. In a traditional organization, when revenues are down and the organization faces heavy losses, plans are often made secretly within HR for redundancies. In self-managing organizations, everyone sees the storm coming. Someone, at some point, calls in everyone (or in a large organization, might invite a cross-section of the organization) to a meeting to say: what do we do? From the group, solutions emerge, which in many cases simply come down to everyone agreeing to a temporary salary reduction (with often the highest salaries taking a higher percentage cut). 

Semco, the Brazilian firm that Ricardo Semler's bestseller Maverick made famous, has put in place a "voluntary risk program" to institutionalize such salary reductions to protect the organization in times of crisis (to which Brazil has been prone over the last several decades). Employees are offered the option of a risk salary program. They take a pay cut of 25 percent and then receive a supplement raising their compensation to 125 percent if the company has a good year. If the company does poorly, they only receive 75 percent of their salary. As the good years outweigh the bad, the deal is favorable to employees willing to take a risk.

How do these practices link with the three Teal breakthroughs?

Self-management

Self-set or ranking-based salaries are a key enabler to self-management: in traditional hierarchical structures, bosses decide on the salary raises and bonuses of their subordinates; in self-managing systems, it is necessary to upgrade to peer-based compensation mechanisms.

[And yet, self-set or ranking-based systems can also be implemented within traditional hierarchical structures. It can be a step towards ultimately replacing hierarchy with self-management. Within an organization where complete self-management isn't in the cards (for instance if the board of directors wouldn't accept that the organization let go of a pyramid structure), it can also be an important step to take some power out of the boss-subordinate relationship and create more of a team-based collaborative spirit.]

Wholeness

When there is one boss that decides over a person's salary, it's tempting to want to please that person, to conform to their expectations, to not speak one's truth. When it's not one person, but a great number of colleagues one works with who calibrate one's salary increase, most people naturally relax into showing up more truthfully. In this way, self-set or ranking based compensation mechanisms help colleagues show up more easily from a place of wholeness.

They also help us take an adult stance towards compensation. Traditional boss-subordinate relationship tend to push employees to behave like children and bosses like parents. Self-set or ranking based compensation systems also do away, almost instantly, with much of the strategizing, haggling and complaining around compensation, with everyone forced to take an adult-to-adult stance. 

Evolutionary purpose

[The link between evolutionary purpose and compensation practices can show up in times of crisis. There are several documented cases of self-managing where workers, in a severe downturn, choose voluntarily to reduce their compensations on a temporary basis to avoid lay-offs. In self-managing organizations, colleagues often often have a high level of financial knowledge and maturity, and choose to contribute to save their colleagues jobs and to maintain the organizations ability to pursue its purpose with all its skills and resources.]

[Teal organizations are built on the premise that individuals are primarily motivated, after attaining basic needs, by intrinsic factors such as the pursuit of purpose. Thus, they tend not to exhibit the primacy of compensation, including added incentives, typical in Orange or even Green.]

Concrete examples for inspiration

Here are some practical examples from organizations that have adopted self-set or ranking-based salary systems.

Self-set (advice-based) salary systems

Morning Star

Food processing - United States - 400 people - For profit

Salaries are self-initiated, calibrated by the advice given by an elected salary committee, and if needed, using the conflict resolution process.

If you work at Morning Star, then once a year, along with all your colleagues, you write a letter stating the raise in salary you believe to be fair for yourself and why. In an uneventful year, you are likely to stick with a cost-of-living adjustment. But if you feel you have taken on more challenging roles or made special contributions, you can choose a higher percentage. You back up the letter with the peer-based feedback you received from your CLOU colleagues (the people with whom you concluded one-on-one contracts a year earlier) and any relevant data on performance indicators you are responsible for.

You then share your letter with a handful of colleagues that were elected into a compensation committee (there is one such committee in each of the company’s four locations). The committee’s job is to review all the letters it receives, calibrate them, and provide feedback. It might tell you that you’ve been too humble about your accomplishments and that you should consider going for a bigger raise. Or it might tell you that, in comparison to your peers, the salary increase you granted yourself seems on the high side. The committee has only advisory power and cannot impose its decision, but the process to set salaries is understood to be part of Morning Star's "Gaining Agreement" process. If you choose to ignore the committee's advice for you to lower your salary raise, the committee can choose to enter into the Gaining Agreement process (a conflict resolution process) with you to create a space and time to explore in more depth where your and the committee’s assessments diverge and to help you and the committee reach agreement.

Morning Star’s experience is that people prove to be remarkably skillful at assessing a fair compensation for themselves. In any given year, roughly a quarter of people choose salary increases above the cost-of-living adjustment. Only a handful of people throughout the company receive feedback that they might have aimed too high. [1]

Buffer

Social media start up - Global - 40 people - For Profit.

Buffer practices radical transparency, and their process relies on self-set salaries using the advice process. 

Salary components

The process of setting one's salary at Buffer focuses on a formula with 5 components:

  • Base Component: A general base level for each type role
  • Location: Cost of living in each teammate’s city (they use Numbeo to help with this)
  • Family: An allowance for kids, parents, partners or other dependents
  • Journey: Journey correlates to expanded role, leadership, and how often the teammate is sought out for advice
  • Experience: Putting a value to the growth of skills and knowledge that teammates accrue over time


Advice Process

Each person has the ability to adjust each of these components to what feels fair for their case, using the formula as a general guideline. For example, for the location component, if you're in a C bracket but are traveling for several months through quite a few B cities, you might decide to go somewhere in between those two. 


Salary sounding board

A key element of this process is the “Salary Sounding Board.” This is a rotating group of team members whose role is to assist in finding an equilibrium for salary adjustments from a position of higher perspective.

The Sounding Board helps each salary adjustment find its equilibrium through various methods, which could change depending on the situation. Some approaches could include:

  • Suggesting team members who might provide a useful perspective on a salary adjustment and who might not have been sought for advice or been heard yet
  • Cultivating transparency through open discussions and advice
  • Encouraging honesty in the advice process, even when it may be challenging (for example, if someone feels that a salary adjustment is too high)
  • Sensing adjustments (or lack of adjustments) that feel out of equilibrium

The Sounding Board pays attention to how salary adjustments are proceeding across the entire company, to help the process stay healthy and encouraging while also balancing all perspectives and the overall financial wellbeing of Buffer.

Transparency

The compensation of every colleague in Buffer is public, not only to colleagues themselves, but even to the outside world.[2]

Realize!

Consulting - Netherlands - 4 partners - For Profit

Beautiful in-person conversation among partners to set their compensation.

In small organizations, the process to set salaries and get advice can involve everyone. All colleagues can come together for a meeting to discuss and honor their contribution and decide on the appropriate salary levels for every person in turn.

Realize!, a four-person partnership in the field of organizational development consulting based in Amsterdam, the Netherlands, sets salaries in this way. (Note: since this writing, Realize has changed structure and this process although it remains relevant and inspirational). Each quarter, the four partners come together for a much-anticipated discussion.

The meeting starts with a traditional business update―discussing client activity, prominent events, and key figures for the last quarter. Then comes the beautiful (and sensitive) part: each partner in turn shares his perspective on his contribution during the last quarter, including work he has done, projects he has led, and support he has given to others. While one partner speaks, the others can chime in to add any unreported contributions, offer praise, or ask a critical question. When the group is done and feels that everyone’s contribution has been heard and honored, each person pauses to reflect in silence about compensation. How could the earnings from the last quarter be shared among the partners in a way that reflects everyone’s contribution?

At some point, one partner breaks the silence with a proposal. Sometimes, the proposal feels just right and gets accepted on the spot. More often, it is a basis for a discussion: I feel my contribution here or your contribution there deserves a higher recognition. How exactly the cash will be split, the partners acknowledge, is ultimately not what this conversation is about. The discussion serves a higher purpose: making sure everybody feels his or her contribution is fully valued, that the inner and outer perspectives (what I know and what others perceive) are in sync. It is an exercise in openness, trust, and vulnerability. The four partners report that invariably they go into the discussion with some nervousness and leave the meeting with a deep sense of gratitude (and spontaneous collegial hugs) for being part of a partnership that operates from such deep levels of listening and trust.[3]

Elbdudler

Social media consulting - Germany - 34 people - For Profit.

People self-set their salaries based on 4 simple questions.

At Elbdudler, colleagues self-set their salaries using the 4 following questions to trigger reflection and self-calibrate: 

  • What do I need?
  • What's my market value outside of Elbdudler? 
  • How much do my colleagues earn?
  • What can the company afford to pay?

All salary choices are public. So far, no one has ever made an outrageous choice. If someone asks for a very high salary, colleagues can ask him or her to make a proposal how the company could earn more money. It's up to that person to make the plan happen.[4] 

Hanno

Digital design agency - Worldwide - 8 'shipmates' - For Profit.

Evolution of open salary setting from algorithm to advice process.

Summary

In September 2014, Hanno made the information about all team members' salaries openly available to the rest of the team.

After trialling an algorithm-based model, as of June 2015 Hanno has implemented a self-set salary model, with an advice process. In the words of founder Jon Lay: "As long as we have total financial transparency, respect for the individual, peer review and self-discipline in our process of setting salaries, employees can be trusted to set a salary which works for them and also their team."[5]

Process for self-setting salaries at Hanno

It works roughly like this:

  • To ensure financial transparency, all salaries are published to the team (aka 'shipmates').
  • There is an open briefing every 3-6 months on Hanno's financial status, which advises 'shipmates' on salary direction for the coming period - advice they are at liberty to challenge or ignore.
  • This is followed by rounds of feedback and discussion, before each 'shipmate' submits their proposed salary for the next 3-6 months to an Advisory Process.
  • After further feedback and discussion, each 'shipmate' may adjust (or not) their original proposal.
  • The new salaries are then also published to the whole team.
  • A salary proposal can only be rejected if it is felt there is a genuine risk that it will harm the interests of the company.

Drawbacks of the algorithm model at Hanno

The previous algorithm-based system (based on the Buffer model) used addition/multiplication factors based on Role, Expertise, and Location, as well as a Founder component. Hanno soon found that this model was often either tricky to apply, or produced results that seemed to work against their goals.

It was particularly difficult to adjust the weighting so that 'shipmates' were appropriately rewarded for both investing in personal growth (new skills/expertise) and delivering strategic business value (e.g. networking, business development). In addition, it proved difficult - in such a rigid model - to account for factors such as differing elements of Location, and to ensure that the company remained sufficiently attractive to 'shipmates' with dependents.

In addition, the Founder factor was considered unfair (even by the founder himself), especially as this role had power over the salary formula itself and was therefore somewhat immune from checks and balances.

Further information

Details of this journey and its further evolution are documented in Hanno's online logbook.[6] 

Ranking/Algorithm based systems

W.L.Gore

Industrial conglomerate - Global - 10.000 associates - For Profit.

Gore uses a ranking system, calibrated by two panels, to decide on salaries.

Contribution process

Once a year, within each team (typically groups of 10 people in roughly the same function), everyone ranks the others from 1 to 9 (contrary to Holacracy, you don’t rank yourself in the list) based on their past and expected future contribution. The process has been automated, and on the forms, people can add a comment next to every person, and additionally assess if they are a “high culture fit" or "low culture fit”.

A small committee (typically the leader, another leader, and HR) reviews the aggregate results in great detail, and in their discussion they can change the order. Say John ends up number 2 on the aggregate list, but that feels too high, and the committee member suspect that it's really a loyalty vote. They can decide to move John down to number 4.

When the committee is done, each sponsor shares feedback with their person. Never the exact place in the rank. But “at the top”, “middle” and “bottom”. (If one person is at the bottom for a while, discussion will happen: other role that fits better? Need for training? Or exit the company?)

Compensation process

A compensation committee follows in the footsteps of the contribution committee. It will plot the salary curve of the 10 people that were ranked and see if the salaries are in line with the contribution. If needed, the committee will make the appropriate changes.

Transparency

There is no transparency on salaries at Gore. If a person in the committee is being discussed, he or she will not see the data that pertains to him or her.

Incentives and profit sharing

At Gore, there are no incentives or bonuses. Everybody gets shares in the company as part of profit sharing. For example, someone making £50K in salary in the UK could make an additional £5K in shares. The profit sharing is proportional to the base salary (it is calculated based on this year's salary and the salary over the last 3 years in some formula). So if your unit loses lots of money or makes lots of it, it doesn’t change profit sharing, to reinforce the “all in the same boat” mantra.[7]


HolacracyOne

Consulting and Training - US - 12 partners - For Profit.

HolacracyOne, the small consultancy/training company behind Holacracy, uses a ranking mechanism, which feeds an algorithm that allocates colleagues to salary bands. 

Once a year, colleagues at HolacracyOne fill out a survey for all their colleagues, consisting of only two questions:

  • “This person contributes (much) more or (much) less than me.” (On a scale of -3 to +3)
  • “This person has a good basis to evaluate me.” (On a scale of 1 to 5)

A simple algorithm crunches through the answers and groups colleagues into a few salary buckets. The more experienced, knowledgeable, and hard-working people land in the higher buckets that earn bigger salaries; the more junior, less experienced colleagues naturally gravitate toward buckets with lower salaries.[8]

Valve

Software - US - 330 Employees - For Profit.

Valve uses a stack ranking system to determine compensation.

Valve is a leading video game developer and distributor.  Once a year, a designated group of employees (the group changes every year) interviews everyone in the company, asking for feedback on each individual that person has worked with over the past year (this information is used primarily for constructive feedback) and asking the employee to rank each member of his own project/product group on the following four metrics:

  • Skill level/Technical Ability
  • Productivity/Output
  • Group Contribution
  • Product Contribution

Each of these metrics is given equal weight in compiling a stack ranking of all the employees in a given group.  Once the intra-group ranking is done, the information gets pooled for the company as a whole and is used to determine compensation.  The system is based on a belief that these four metrics are the most appropriate for determining the "correct" compensation and that they in turn are best determined through a peer-based valuation process (which the company believes is less likely to be subject to bias given its flat organizational structure).[9]

Reducing pay disparities

Resources for Human Development (RHD)

Human Services - United States - 5,000 employees - Non-profit

RHD has put in place a number of practices to boost the lowest salaries and reduce pay inequality

RHD, a Philadelphia based non-profit, holds the principle that when there is room for salary increases, they should be disproportionately geared toward the lowest salaries first. The CEO’s salary is capped to a maximum of 14 times the lowest salary in the organization. One can argue about the multiple―is it too high or too low?―but RHD introduced a clever twist by capping the highest salary not based on the average or median salary, as many Green Organizations have started doing, but on the lowest. It’s now very much in the CEO’s and the leadership’s own interest to ensure that even the colleagues with the lowest qualification earn enough for a decent living. Next to this direct focus on entry-level salaries, RHD has set up a scholarship fund to offer staff members opportunities to pursue formal education and increase their earning potential. And it has instituted a companion currency, the RHD Equal Dollar, that allows lower-paid colleagues to increase their access to goods and services by trading with each other and with their local community.

Related topics

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Notes and references

  1. Source: Gary Hamel, “First, Let’s Fire All the Managers,” Harvard Business Review, December 2011, http://hbr.org/2011/12/first-lets-fire-all-the-managers. and interviews Frederic Laloux at Morning Star Self-Management Institute.
  2. Source: Courtney Seiter, colleague at Buffer, May 2015
  3. Source: Laloux, Frederic. Reinventing Organizations. Nelson Parker (2014), page 130.
  4. Source: http://www.mopo.de/geld/deutschlands-coolster-chef-er-laesst-mitarbeiter-selbst--ueber-ihr-gehalt-bestimmen,5066776,29007608.html
  5. Source: https://logbook.hanno.co/choose-your-own-salary/
  6. Source: https://logbook.hanno.co/choose-your-own-salary/
  7. Source: http://www.managementexchange.com/story/innovation-democracy-wl-gores-original-management-model and personal interview Frederic Laloux with Gore leader, April 2015
  8. Source: Interview Frederic Laloux with Tom Thomison, 2013
  9. Source: Valve Handbook for New Employees; 2012