Case Study: (Un) Justification Of Performance Evaluation
The leadership of a company that has affiliates across various geographies find themselves in a quandary even when the results are outstanding. It is prone to deal with situations such as providing a healthy salary rise to all its employees or to decide on the hike basis the performance of a given geography, the right formula for the hike and so on.
Mr. Srikant Amanaganti (Srikant), the President of Neptune Computers (Neptune) was examining the performance reports of different foreign affiliates to Neptune. This year, in spite of the pandemic, Neptune had accrued decent profits as their main line of business involved sales of personal computers (PC) and laptops. The gross sales revenue is 250 million USD, and thus, Srikant wanted to hand out a healthy salary raise to all the employees. He is thus reviewing the performance reports and salary recommendations submitted by the Global HR Head, Sameer Rosselini (Sameer).
Srikant noticed that all the eight foreign affiliates were assessed basis uniform financial criteria, such as after-tax profits and so on. Srikant observed that two of them had scored lower, while three of them were in between, and three had topped the list. Neptune engaged in intraaffiliated trade and its pricing policy of products and components was based on maximising company-wide profits after taxes. Neptune never hesitates in shifting its sourcing bases from one affiliate to another because it takes advantage of exchange rate fluctuations.
Srikant said, “Sameer, how to justify the salary increases? Is there a better way to evaluate the performance of each foreign affiliate? I want you to rework this; please take the support of our Financial Head, if needed…. for that matter, any help from an external expert is welcome too. We cannot reduce the salary enhancements for some affiliates on the basis of these numbers. Please remember, that we shifted the sourcing base in some cases”.
Sameer came back to his table and began reviewing his own work. Return on equity, after-tax profits, return on assets, profitability, expense items, customer base, profit margins, and revenue growth are the criteria used to evaluate the performance of affiliates. Then, he was reminded of Neptune’s pricing policy. He rubbed his forehead for a while and was thinking of criteria that is beyond numbers. But, everything was hazy. He called up his consultant friend for some help. The consultant visited Sameer and asked for a brief about Neptune to which Sameer responded.
Neptune is an international company that was started in the USA by a group of non-resident Indians and native USA citizens. The main line of business involved sales of personal computers and laptops which started in the late 1950. The gross sales revenue in the pandemic year is 250 million USD of which 55% of the total sales happened from laptops and PCs with a 70 percent of total profits.
Neptune has eight foreign affiliates, viz., India, Spain, Germany, France, Japan, England, Canada and the Philippines. Affiliates in England, Spain, and Germany are wholly owned subsidiaries, while those in India, Japan, France, Canada, and the Philippines are joint ventures with domestic companies where Neptune owns majority stakes in excess of 51%. The affiliates of England, Spain, and Germany were established in the late 1950s in anticipation of the unification of the markets of Europe into a unified common market. Most interest groups expected the European Union (EU) to flourish and to enrich all member countries.
In anticipation of this prospect, companies from North America and Japan were making huge direct investments mainly in England, France, Germany, and Holland. The Japanese subsidiary was set up in 1973 to keep an eye on the Japanese competitors and as a window to Japanese technology. The Philippines subsidiary was established around 1976 given the largest Englishspeaking population in Asia and thus ease of communication. The Spanish subsidiary was established in 1987 following the entry of Spain in to the EU since labour is cheaper in Spain. The German subsidiary was established in 1991 after the East and West Germany united. The Indian subsidiary was established after liberalisation around 1992- 93 because the labour is not only cheaper, but also skilled; international trade advantages provided by the government post liberalisation was an added advantage. After the establishment of NAFTA, the Canadian subsidiary was established in 1994.
The French and England subsidiaries imported components made by the Spanish affiliate for the assembly plants located in Mansfield and Liverpool. The Mansfield telephone company helped ease international correspondence; Liverpool had long established trade routes easing exports and imports. The French affiliate specialised in PCs while the England affiliate specialised in laptops. Laptops assembled in England and PCs imported from French were sold in the domestic English market and also to Scotland, Ireland, Finland, Denmark and Norway; Sweden was also a target market. Similarly, PCs from France were sold in French market as well as in many parts of Europe. Similar instances in other affiliates too. Coming to the Indian market, 40% of the components were sourced from the local suppliers and the rest were imported from the Spanish subsidiary. 80% of PCs and laptops were made by the Indian affiliate and were sold in the Indian market and the rest were exported to the neighbouring countries of India. It was Neptune’s long-term plan to make the Indian affiliate the principal source of its products for exports to South Asia and Middle East.
The markets in Canada and India were booming at 15-20 percent growth rate since last five years. The Spanish market is steady at a rate of 9 percent while the markets in Germany, France, England, Japan, and the Philippines are at a rate of 3-4 percent at the same time. Though the European market is recording a growth rate of 5.3 percent per annum, the company’s home base in the USA is growing at a steady rate of 7.5 percent a year. Overall, the growth rates are expected to remain at the same level in the coming future.
During the past five years (2015-20) annual inflation in these foreign affiliates is as follows:
The above numbers are derived using the price increase of a defined product basket.
The Japanese Yen, the Canadian Dollar and the Philippines Peso is depreciating against the US Dollar and the Indian rupee has appreciated over 4% against the US dollar and the Euro is appreciating as well. However, the Euro is expected to depreciate in countries with high COVID-19 threat. Competition for PCs and Laptops is intensifying in the USA, India and certain European markets. Almost every computer company is competing in the American, Asian, and European market and no single company is able to emerge as a leader. Nevertheless, IBM and Fujitsu are able to hold on to a share of 25-30% amidst this chaos.
Sameer paused and his consultant friend was busy taking notes. Sameer once again mentioned Neptune’s policy which encourages intra-affiliate trade and shifts its component sourcing base depending on the prevailing exchange rates. The consultant asked, “Sameer, so what is the problem?” Sameer showed him the financial analysis that had been done by him. The Consultant noticed some surprising figures. For instance, the US, Japanese, Philippines, and Spanish markets ranked lowest in the pre-selected financial criteria. England, France and Germany were in the middle. The Indian and Canadian markets ranked the best on the list. Sameer said, “Our President, Srikant says, I quote, “how can I justify to the USA, Japanese, Philippines, and Spanish subsidiary heads that they don’t deserve a bonus as the others do?” Sameer paused, and adjusted his voice, “My friend, is there any other way of evaluation that renders each affiliate’s performance as valid?
The consultant adjusted his voice and said, “Your President is right. There is something called Management Control in international strategies and operations. When both output measure availability and the knowledge of the transformation process are high, an organisation has the flexibility to use either output or behaviour. Thus, input control, behaviour control and output control are three aspects which you should be looking at. Since yours is an international company, problems of control can be many starting from geographic distances to language differences; cultural differences notwithstanding. Ok, Sameer, give me a week’s time, I shall come up with something with and beyond numbers.” Sameer was relieved and he firmly gave a hug to his friend.
Dr. Prageetha G Raju is an independent researcher. She has previously worked as Associate Professor-Business Management at the Symbiosis Law School, Hyderabad. She can be reached on firstname.lastname@example.org.
Analysis by Ravi Mishra, Senior Vice President-HR for Global Epoxy Business, Aditya Birla Group.
In a multi-locational organisation, it is very superficial to consider salary enhancements based on fiscal performance owing to the inter-linking of business processes. Neptune earned a whopping profit during the pandemic year. India and Canada were the top earners, followed by England, France and Germany and finally by the USA, Japan, Philippines, and Spain.
An organisation’s profitability depends on multiple variables and internal and external factors. When the business spreads to different geographies, it paves way for greater complexities and challenges while creating opportunities. However, there is no straight formula to judge the direct influence of individual performance on the overall profit as in the case of Neptune.
As Neptune’s President, Srikant’s views over the need to understand the business processes and enablers are very mature. Neptune is a great example to decipher the impact of collaboration to achieve business excellence. Companies from North America and Japan were hugely investing in England, France, Germany, and Holland to benefit from the unification and augmenting business affiliates in the EU, resulting in utilisation of funds from low to emerging markets. Most PCs and laptops made by the Indian affiliate were being sold in the Indian subcontinent.
The other key dimension to business is economic viz. inflation, business growth in different countries, GDP, valuation of currencies, cost of labour etc. Therefore, it is impossible to give credit to a one particular location for better profits. However, this is Neptune’s opportunity to celebrate and set an example of how every business affiliate collaborates with each other to maximise profitability on a shared objective.
Sameer needs to devise a formula to recognise salary enhancement as a monetary reward by creating a proper grid system. Employees must be delivered a message that they are one entity with a shared vision and mission. Salary enhancement can happen in two parts i.e. annual increment and variable pay.
Annual Increment / Fixed Compensation: One can go for normal annual increments based on benchmarked data on the basis of the business sector, geographical region and inflation. This must be little higher to motivate employees for the business performance being very good.
Annual Incentive Pay (AIP)/Variable Pay: In a simple way, Sameer can propose the following to the senior management team to decide the ratio for the weightages as under. 100% when the achieved business results are a 100% against the target. However, this year it is more than 100%, and hence, it is required to work out the distribution of surplus profit.
1. Overall Business Performance as a multiplier to all affiliates, may be 60%
2. Business Unit /Affiliate Performance 15% and
3. Individual Performance as 25% on standard rating at 3 on a 5-point scale.
Calculation of Coefficient for actual pay-out: Business performance X (Affiliate performance + Individual Performance)
Actual Variable pay out for the year = Target variable pay X Coefficient for the year
Considering Neptune’s performance this year, the coefficient will be higher than 1. Hence, employees should get the AIP/Variable pay more than their target variable pay.
An interesting part of this calculation is treating the overall business performance as a common multiplier to employees. This gives a strong message to focus on team performance, collaboration and thinking beyond the organisation’s geographical boundaries.
As the President of the company, Srikant must adopt a holistic approach wherein individual performance and group performance are valued in a balanced manner. Secondly, the focus is should be more on variable pay, and hence, it does not create the liability for the future in case the business environment undergoes a drastic change or is unsupportive and is likely to impact the future profitability.
Analysis By Kalpana Bansal Head - Competency Assessment and Development, Reliance Industries Ltd.
“It’s all about Money, Honey!” Organisations often jump through hoops trying to align compensation practices with industry benchmarks, input and output measures and other criteria. Fairness and equity become important principles in organisation stance and talent philosophy. However, reality and aspiration rarely intersect, and when it comes to dynamic things like talent markets, it is very difficult to reach an equilibrium.
Many elements of observed human behaviour fly in the face of the ‘rational’ behaviour assumed in traditional economics. Observations about people’s actions in matters of loss and gain, certainty versus uncertainty, fairness etc. differ from the view offered by traditional economics. Organisations use reward systems to create links to rewards for extrinsic motivation and encourage achievement of performance outcomes by driving motivation through financial rewards and recognition schemes.
The annual increment process marks a logical culmination to the actions of the previous year and provides an opportunity for re-alignment, resource planning and fresh goal alignment. While large organisations seek to smoothen this process with tools and mechanisms, the process continues to be fraught with challenges.
Kahneman and Tversky (1979) provided a conceptual framework for decisionmaking under uncertain conditions with their ‘Prospect Theory’. This theory brought to light how people weigh gains and losses while making decisions, and highlighted the concept of ‘good enough’, whereby, individuals consider options one by one and choose the one option that meets the lowest level of acceptance. It is difficult to come up with an optimum solution for a complex problem such as this where multiple attributes are intertwined. Oftentimes, the central rewards team or HR takes a ‘good enough’ decision basis here and now data.
There are no right or wrong answers to salary decisions. It is about what seems most workable at a point in time in the way of market dynamics. Inflation, geography and average increments all play a part in pegging the MSI figures for an incumbent. A differentiated talent strategy would consider these differences as well as role criticality, growth prospects and continuity of operations while planning geography-specific markers. However, the larger questions still loom ahead:
• How critical is talent in a particular geography?
• What are the implications of a differentiated talent strategy on salary revision norms?
• What would happen if the various factors resulted in inequity across geographies?
Any salary revision exercise invariably kindles in employees a sense of implicit unfairness. Richard Thaler has talked about actions by firms that make people angry. The notion of a perceived loss of increment could make employees resentful. He argues that when employees think the firm is taking away something to which they believed they were entitled; these actions get coded as losses (Thaler, 2015).
Complex spreadsheets aside, the philosophy of salary is what needs to be resolved. What are the key principles that would guide the decision of the organisation? Once the principles are clear, then geography, growth and other attributes just become data points that navigate outcomes. Complexity is never an answer to what is fundamentally an issue that touches the core of human values of fairness, equity, and justice. At the end of the day, complexity only disguises the lack of clarity and signals a lack of coherence.
The moment one segregates communication about evaluation from the evaluation itself and starts examining each of these issues with a dispassionate lens, the issues are simple:
• What can the organisation afford to pay in each geography?
• What are the right benchmarks to consider?
• How sustainable are these decisions in the medium to long term?
Like someone once said, “Wisdom consists of knowing how to distinguish the nature of trouble, and in choosing the lesser evil!”
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