We would like to summarize the defects of performance-based salary system. The performance-based salary system…

On January 19th, 2004, a radical criticism against the performance-based salary system was published. The book Fallacy of Performance-Based System -- Recommendation of Revival of Japanese Seniority System (Nikkei BP Publications, Tokyo: ISBN 4822243729; English translation is not available) is written by Nobuo Takahashi, author of Design of Adaptive Organizations: Models and Empirical Research (Springer Verlag, July 1987). He was born in 1957 and now Professor in Faculty of Economics of the University of Tokyo, specializing the management organization theories. Although most Japanese employees feel uncomfortable about the performance-based salary system that more and more Japanese companies introduce these days, we Japanese can't articulate the reasons of the feeling. This book proves the fallacy of the performance-based system with strict logic referring to historical fruits of various management theories, such as James Abegglen, Alfred Chandler, Edward Deci, Peter Drucker, Abraham Maslow, Edith Penrose, Frederick Taylor, Victor Vroom, etc… In this essay we would like to try to summarize the core argument of his criticism against the performance-based salary system.

The scope of Takahashi's definition of performance-based system is very wide. The performance-based system in this book means every concept that tries to measure the results in the past as objectively as possible or that tries to motivate people by the salary system linked with something that might be called 'results'. By defining the performance-bases system as widely as possible, Takahashi targets at the very wide range of the system named "performance-based system". We would like to see the defects of this system that are proved by him in the following paragraphs.

First of all, the short-term focus of performance-based system hinders every kind of changes because every change implemented in an organization lowers efficiency and productivity in the short term. But since the performance-based system requires the employees to achieve results within one fiscal year, nobody accepts such changes. The performance-based system demotivates people to change. The short-term focus also destabilizes the long-term career design of the employees. As a result, it demotivates people to think about the long-term future of the organization.

Secondly, by the implementation of this system, the employees tend to lower their objectives in order to make it easier to achieve the predefined results within one year. This means that nobody does his/her best any more. Regarding this defect, somebody might propose that the management should gradually elevate the employees' objectives year after year. But this means that, even if you achieve the elevated objectives, the salary per effort goes down every year. Frederick Taylor already proved nearly 100 years ago that, if the management elevates the objectives of employees, this results in the slowdown of the whole organization because their salary per effort continues going down whether they work hard or not. If the management doesn't elevate the objectives, the objectives will continue being set lower and lower every year.

In addition, as the objectives are set by the management in a top-down manner, the employees are not able to define their own objectives by themselves any more and their spontaneity and independence are damages in the long run. When the objectives were set by the field workers themselves, the process of objective definition was the bottom-up communication process. Through this process the management could recognize what are the most important topics in the field. But now that the performance-based system requires the top-down process of defining the objectives of employees, the important topics for the management are gradually separated from the actual condition in the field. This worsens the communication between the management and the field level. By the way, the competitiveness of Japanese companies mainly came from the sense of oneness between the management and the field. The performance-based system will damage this competitiveness year after year.

Thirdly, the performance-based system worsens the sectionalism and damages teamwork spirits in the long run. Under this system, the highest priority is to fulfill the predefined objectives. Since the objectives are defined in a top-down manner, the scope of the objectives tends to be limited within their own department. This means everybody focuses on the tasks restricted in his/her own department. In addition, if an objective requires the collaboration of other departments, it will be more difficult to fulfill it. So the employees try to minimize the interaction with other departments when they define the objectives. Thus, in the process of defining objectives, the interaction between the departments continues decreasing year after year. This damages another competitiveness of Japanese companies, i.e. sense of oneness of the whole company.

Fourthly, the performance-based system is a less efficient motivation system than Japanese seniority system. This system tries to differentiate the evaluation of every employee. But the employees who should be really differently evaluated are very few. Most employees constitute the middle layer of the evaluation that doesn't have to be evaluated so accurately. Only the employees on the top or bottom layer must be evaluated very closely because the evaluation of top layer affects the top management of the whole company and that the evaluation of bottom layer determines who should leave the company. The intense scrutiny of middle layer employees contributes almost nothing to the efficiency of the whole organization. The increased workload caused by this unnecessary scrutiny in the evaluation simply doesn't pay. So the performance-based system is an very inefficient methodology. On the contrary, Japanese seniority system tries to differentiate only the top and bottom layer employees and to give the middle layer employees a small salary increase every year that can be calculated automatically based on the age.

In addition, the performance-based system needs the wider difference of salary than Japanese seniority system to differentiate the employees. In Japanese seniority system, it is defined that the employees at the same age should be paid equally. As this equal base concept exists, only a tiny salary difference, such as 1,000 yen, is enough to evoke strong competitive spirits between the employees at the same age. Japanese seniority system makes the best use of rivalry among the employees at the same age. On the other hand, in the performance-based system, it is defined that every employee is paid differently based on the performance results every year. Therefore, in order to make the employees recognize the difference from the others, it needs much larger difference than Japanese seniority system. This might cause a vicious circle. The wider the difference of salary is becoming, the less sensitive the employees is becoming to the difference. The stronger the stimulation for motivation becomes, the weaker the effectiveness of stimulation becomes. And this system can't make a good use of rivalry among the employees. This might results in the long run that the performance-based system requires much more financial resources to motivate excellent employees than Japanese seniority system.

Regarding the fourth defect of the performance-based system, there is another argument. Once an employee is evaluated as low, it is very difficult to motivate this employee to recover from there because of his/her reputation in the organization. The other employees are not positively evaluated by helping this employee to recover. So the low evaluation tends to perpetuate under the performance-based system, even if it happens only one time. If we suppose that most employees who are evaluated as low at least one time remain lowly evaluated, the company has more non-working human resources year after year. The performance-based system is extremely weak in maximizing the potential capability of as many employees as possible.

Fifthly, the performance-based system erodes the managers' sense of responsibility for their subordinates. This system has already various sophisticated and so-called objective methodologies to evaluate the employees. Only if the managers follow the predefined procedures, they can get the evaluation results of each subordinate to some extent. Under the name of objectivity, the performance-based system detaches the evaluation process from the daily impressions that the managers get from how their subordinates are working. The more sophisticated the evaluation methodologies become in order to exclude subjective elements from the evaluation process, the less sense of responsibility the managers have in evaluating subordinates. In addition, the objectivity of evaluation method might reduce the possibilities of communication channels between managers and subordinates. The objective evaluation is not always an appropriate evaluation.

Sixthly, by the performance-based system, the company loses the motivation to foster young employees. Under this system, fostering young employees increases the following risks for the company. On the one hand, it might increase the labor costs of young people because the company has to define the salary mainly based on the results. In Japanese seniority system, the company could hire large amount of young people at very low labor cost because the salary was linked mainly with the age. But now under the performance-based system, the company has no excuse any more for holding down the young employees' salary. For example, some Japanese companies already decided to differentiate the starting salary of new employees based on the capability. This increases the total labor cost. On the other hand, by investing in fostering young people, the company might lose the excellent young employees at first. The performance-based system doesn't guarantee the employees the lifetime employment. So it will be less probable that excellent young people continue working in the company when compared with the situation before implementing the performance-based system. This means that the company becomes less motivated to invest in fostering young people. Under the Japanese seniority system, the company couldn't expect that the employees leave spontaneously. This fact motivated the company to invest in fostering the young employees as efficiently as possible in order not to waste the fixed labor cost. In addition, since the employees don't want waste time in fostering other employees under the performance-based system, the company can't rely on the on-the-job training that costs little additional money. Instead of OJT, the company has to install a section specializing in fostering the employees. The performance-based system requires more financial and human resources to train the employees than Japanese seniority system. Therefore, the performance-based system demotivates the company to foster the employees.

Seventhly, the performance-based system erodes its own fundamentals by separating the employee satisfaction from performance. Before implementing this system, the employee satisfaction was directly linked with the performance. Edward Deci named this situation 'intrinsic motivation'. In this situation, the employees could feel satisfied only the fact that he/she performed and achieved something. But the performance-based system separates the satisfaction from the performance. As Takahashi quotes in the book, Deci shows this by the following example of discriminated Jews. Just after World War I, a Jew opened a tailor in a small town in southern part of the United States. But poor little boys came to his shop and bothered him by shouting, "Kike! Kike!" One day he decided to pay 1 dime to each boy who insulted him and actually paid. The boys are satisfied with the payment and came to shout on the next day. The shop owner reduced the payment to 1 nickel. And on the next day, he reduced further to 1 penny. In the end, the boys stop shouting. This shop owner separated the boys' satisfaction of insulting Jews from the performance of shouting by introducing the payment. Once the performance gets linked with the satisfaction via payment (i.e. performance - payment - satisfaction), if the payment is stopped, people stop performing. The same thing happens in case of the performance-based system. Once performance gets linked via salary with satisfaction by implementing the performance-based system, the employees can't get satisfied only by fulfilling their tasks. They become to require the salary according to the performance. And if they can't get satisfied with the salary, they might stop performing, now that their satisfaction is disconnected with fulfilling the tasks. This means that the performance-based system has reduced the ways of satisfying the employees into the only one way, i.e. salary. This clearly increases the labor cost for producing the same results as before the implementation of performance-based system. The performance-based system make its only way of motivating people, salary, less and less effective by separating satisfaction from performance. Japanese seniority system had several ways to satisfy the employees and to motivate them to fulfill their tasks while the performance-bases system has the only one way to motivate people.

Decreases the effectiveness of salary as motivating instrument continuously.

Most of these defects can be solved with the implementation of Japanese seniority system. But Takahashi added one condition to the revival of Japanese seniority system. It is the appropriate operation. Takahashi shows the following three points for operating Japanese seniority system appropriately. Firstly, the managers should clearly explain their intention for fostering the subordinates. Secondly, the managers should pay maximum attention to assign as appropriate a job as possible to each subordinate by making maximum use of various human resource measures, such as periodical personnel reshuffle. Thirdly, the top management should always pay attention to every excellent employee who is supposed to be future top management. If it is impossible, such top management has to retire.

More and more Japanese companies introduce the performance-based system only because everybody does so. But if we think about the negative aspects of this system as shown above, the revival of Japanese seniority system itself can become a strong competitive advantage for every company. Why don't Japanese companies re-implement the seniority system in order to regain the long-term competitiveness?

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