The four pillars of an improved performance management system

McKinsey found performance management is most effective when it features strong, consistent internal logic that employees understand.

As organisations weigh changes to performance management, they often struggle to understand what will yield the highest ROI, with leaders often forced to rely on anecdotal case studies from others’ experiences, according to McKinsey.

In a survey polling 1,000 employees across the globe, McKinsey found performance management is most effective when it features strong, consistent internal logic that they understand.

When it comes to building an overall framework for performance management, employees prefer consistency and simplicity. McKinsey found that approaching each element of performance management separately had lower effects on motivation to perform than doing it holistically.

Approaches with a coherent, connected framework across goal setting, performance reviews, feedback, and rewards correlated with the highest motivation to perform, McKinsey said.

Measurable goals

Goal setting has always been critical for improvement, with 7 in 10 respondents citing it as a strong motivator. However, the “what” and “how” of setting those goals are less definitive.

McKinsey revealed that employees felt more motivated when their performance goals included a mix of individual and team-level goals and when their goals were linked to their company’s.

The survey also suggested that the process of setting goals is just as important as the content of it. Employees tended to be more motivated when they were involved in the process and the goals were updated throughout the year to align with team and company priorities.

McKinsey’s survey suggests high returns when managers spend time throughout the year counselling employees on updates to align goals with current business priorities and articulating the connection between individual and team goals.

Performance reviews with skilled managers crucial to performance

As employers meet evolving employee expectations, many have adjusted their performance reviews by focusing on changes to ratings. 

From numerical scales like one through five, some have shifted to word-based systems like “underperforming” to “exceeds expectations”, or have ditched ratings altogether.

But the survey showed that different rating scales like those that measured results versus behaviour yielded negligible differences in how much motivation employees reported.

There was also no significant difference between receiving no rating and receiving a rating on a two-point scale or a three- or five-point scale.

Instead, employers may be overemphasising rating frameworks, overlooking the criticality of how ratings are given.

“Employees were significantly more motivated by performance reviews when they were offered by a skilled manager and reflected the individual achievement of a performance goal. This was especially true when managers were involved in setting goals and, therefore, well informed when it came time to assess performance,” said McKinsey.

Investment in manager training

The survey also underlined the impact of ongoing development discussion outside a review cycle.

Only 21% of respondents who had no development conversations felt motivated by their companies’ performance management, compared to 77% of those who received ongoing feedback.

McKinsey said manager training is critical in providing feedback, given that almost a quarter of employees said their managers had insufficient skills or capabilities to conduct their performance reviews.

At large companies, 3 in 10 cited this lack of skills. These companies in particular could designate more power and resources to middle managers– traditionally the most capable coaches within an organisation, McKinsey suggested.

Due to the taxing nature of giving and receiving feedback, some companies try to limit these exchanges to only once a year. However, given the benefit of regular feedback, McKinsey said managers could be equipped with the right tools such as generative AI by synthesising insights from colleagues who work closely with an employee.

Nonfinancial incentives give boost, too

Whilst McKinsey noted that money matters, it also said nonfinancial rewards like upskilling or development can play an important role in performance management strategies. 

The survey showed a strong relationship between employers’ use of both financial and non-financial rewards and employees’ perceptions of their personal motivation and performance improvement.

It also revealed that employees were more likely to think that their organisations’ performance management systems were improving company performance overall when nonfinancial rewards were used. Taken together, these findings suggest that nonfinancial rewards can serve as a critical booster for a performance management system’s success.

A separate McKinsey research said nonfinancial incentives should appeal to society, client, company, team, and self. Such incentives could include an immediate manager’s praise, an opportunity to lead a high-profile project, greater autonomy, or more workplace flexibility.

Like other aspects of an effective approach, McKinsey said nonfinancial incentives should be both frequent and explicitly tied to desired behaviours.

Economic volatility and new workplace norms have prompted employers to formulate the right performance management, and McKinsey suggests focusing on a cohesive overall design and effective execution.

As organisations consider approaches through goal setting, performance reviews, ongoing feedback, and rewards, McKinsey said companies must pay attention to the “what” and the “how” to motivate employees.