By Boris Ewenstein, Bryan Hancock, and Asmus Komm; McKinsey & Company

What happens after companies jettison traditional year-end evaluations?

The worst-kept secret in companies has long been the fact that the yearly ritual of evaluating (and sometimes rating and ranking) the performance of employees epitomizes the absurdities of corporate life. Managers and staff alike too often view performance management as time consuming, excessively subjective, demotivating, and ultimately unhelpful. In these cases, it does little to improve the performance of employees. It may even undermine their performance as they struggle with ratings, worry about compensation, and try to make sense of performance feedback.

These aren’t new issues, but they have become increasingly blatant as jobs in many businesses have evolved over the past 15 years. More and more positions require employees with deeper expertise, more independent judgment, and better problem-solving skills. They are shouldering ever-greater responsibilities in their interactions with customers and business partners and creating value in ways that industrial-era performance-management systems struggle to identify. Soon enough, a ritual most executives say they dislike will be so outdated that it will resemble trying to conduct modern financial transactions with carrier pigeons.

Yet nearly nine out of ten companies around the world continue not only to generate performance scores for employees but also to use them as the basis for compensation decisions. The problem that prevents managers’ dissatisfaction with the process from actually changing it is uncertainty over what a revamped performance-management system ought to look like. If we jettison year-end evaluations—well, then what? Will employees just lean back? Will performance drop? And how will people be paid?

Answers are emerging. Companies, such as GE and Microsoft, that long epitomized the “stack and rank” approach have been blowing up their annual systems for rating and evaluating employees and are instead testing new ideas that give them continual feedback and coaching. Netflix no longer measures its people against annual objectives, because its objectives have become more fluid and can change quite rapidly. Google transformed the way it compensates high performers at every level. Some tech companies, such as Atlassian, have automated many evaluation activities that managers elsewhere perform manually.

The changes these and other companies are making are new, varied, and, in some instances, experimental. But patterns are beginning to emerge.

– Some companies are rethinking what constitutes employee performance by focusing specifically on individuals who are a step function away from average—at either the high or low end of performance—rather than trying to differentiate among the bulk of employees in the middle.

– Many companies are also collecting more objective performance data through systems that automate real-time analyses.

– Performance data are used less and less as a crude instrument for setting compensation. Indeed, some companies are severing the link between evaluation and compensation, at least for the majority of the workforce, while linking them ever more comprehensively at the high and low ends of performance.

– Better data back up a shift in emphasis from backward-looking evaluations to fact-based performance and development discussions, which are becoming frequent and as-needed rather than annual events.

How these emerging patterns play out will vary, of course, from company to company. The pace of change will differ, too. Some companies may use multiple approaches to performance management, holding on to hardwired targets for sales teams, say, while shifting other functions or business units to new approaches.

But change they must.

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