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Integrating Performance Management and Rewards at Microsoft

May 25, 2012 | Stephen Miller, CEBS

last updated Nov. 18, 2013

Update: 'Stack Ranking' Ended at Microsoft

In November 2013, Microsoft Corp. announced it had ended its controversial "stack ranking" employee-review and compensation system, and no longer requires managers to grade employees against one another and rank them on a scale of one to five, as described below. The most contentious aspect of this approach was its targeted, or forced, distribution requirements, which meant managers were required to designate a small percentage of their direct reports as underperformers.

However, stack ranking is still championed at many companies, and in particular at technology firms.

To learn more, see the November 2013 SHRM Online articles "‘Stack Ranking’ Ends at Microsoft, Generating Heated Debate" and "Announcements on ‘Stack Rankings’ Touch Off Debate," which also discusses Yahoo's commitment to stack ranking.

Our report on stack ranking at Microsoft, posted in May 2012, appears below.

Microsoft Corp.'s pay-for-performance philosophy recognizes that top performers provide the highest value to the firm—and that they have the greatest opportunities in the external job market. With that in mind, Microsoft redesigned its performance management system and total rewards program, integrating the two systems to allow for simplified, transparent and differentiated rewards, explained J. Ritchie, the firm's corporate vice president for compensation, benefits and performance management, and Julie Tschida Brown, Microsoft's director of global compensation programs, during their presentation at the 2012 WorldatWork Total Rewards Conference in Orlando, May 21-23, 2012.

The pay mix at Microsoft has evolved significantly over time, Ritchie explained. Before 2000, management relied heavily on stock options as a dominant part of employee pay packages at a firm whose stock price was surging. After the 2000 dot-com bust, every Microsoft employee received a 15 percent increase in base pay, and equity as a percentage of overall compensation was reduced in favor of cash. In 2003, as the stock price stabilized at the maturing firm, management shifted equity compensation from stock options to restricted stock units (RSUs) that reward retention over time.

"As the stock price had risen, it made sense to give full shares" with a time restriction, Ritchie noted. Microsoft has mostly phased out stock options in favor of RSUs globally, he said.

Changes in compensation continued at the firm, and in 2006 a more flexible rewards system, dubbed MyMicrosft, was introduced. This system rewarded employees with merit pay increases, annual bonuses and RSUs, but it proved confusing and cumbersome for managers who had to determine separate increases in each of those buckets.

In response to these issues, in 2011 a simplified system was implemented companywide using an integrated approach. "We wanted to more clearly connect rewards to performance," explained Brown. "The aim was to reduce 'process' and improve the line of sight between employees contributions to the company's success and increases in compensation."

Added Ritchie, "we wanted to increase clarity with a single rating hard-wired to rewards" and to avoid "wasting managers' time weighing a 2.7 percent vs. 2.8 percent bonus."

Effective with 2011 performance reviews, employees receive one rating based on their manager's assessment and a calibration process (typically with managers one or two levels above the employee). The rating ranges from "1" (highest) to "5" (lowest). A "3" rating equals target compensation that is market competitive locally. Targeted distribution limits the percentage of employees in each rating category.

The single rating triggers increases in merit pay, bonus and RSUs, with the size of the increase tied to factors such as job family and discipline. This allows the company to target its compensation investment to those positions deemed most critical and to disciplines most significant to the company's success, such as engineering research and development.

Job Ratings and Rewards and Microsoft
	1 (highest)	2	3	4	5 (lowest)
Merit pay	$$$$	$$$	$$	$	--
Bonus	$$$$	$$$	$$	$	--
Restricted stock units	$$$$	$$$	$$	$	--

Performance Inputs

As explained by Ritchie and Brown, three inputs determine the single performance rating:

• What employees did during the year vs. their goals/commitments, relative to the achievements of their peers.

• The behavior used to achieve those results as reflected in feedback from peers and managers.

• Employees’ proven capabilities based on the above inputs plus their long-term performance record.

Microsoft being Microsoft, the company provides an interactive intranet portal that allows employees to see how their compensation would shift based on different performance ratings. The aim is to provide "clear, customized communications," said Ritchie.

As a result of the new system with its clearer line of sight, pay satisfaction among employees went up, Microsoft found, and employees and managers report that the quality of their discussions around pay and performance has improved.

Ritchie noted that an important aspect of the compensation system is to stay competitive. This means that when salaries are raised for new hires, including fresh college graduates, "compression is used to increase pay up the stack."

The goal is to "attract and retain key talent by delivering the highest compensation to the highest performing employees," Ritchie said. "We want to make certain we stay competitive for people who are performing the best for us."

Stephen Miller, CEBS, is an online editor/manager for SHRM.

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