Which do you recommendshould Vitality Health:

Revert to not having a performance management program/process?

Revise the current performance management program/process?

Explain why you recommend this specific course of action, providing three details from the case which you believe support your recommendation.

Additionally, if you are recommending Vitality Health revert to not having a performance management program, what specific recommendation(s) would you make on how they would be able to keep their workforce focused on achieving high performance?

If you are recommending Vitality Health revise the current performance management program, what specifically would you recommend be revised?

Finally, how would you recommend Vitality Health roll-out your recommendations to the company? Provide a specific approach given the case content.

Performance Management at Vitality Health Enterprises, Inc. The Health and Vitality of Vitality Health Enterprises James Hoffman, the newly appointed vice president of Human Resources of Vitality Health Enterprises, was pleased when he saw an early preview of the earnings figures for the fourth quarter of 2011. But he knew better than to relax. Competition in the personal care products sector was cutthroat, and complacency was a recipe for obsolescence and loss of market share, particularly in cosmetics and nutraceuticals. Vitality was riding high on a six-quarter string of strong revenue growth that had surpassed analyst expectations. However, as emerging markets represented a growing portion of business revenues, the company was becoming increasingly exposed to volatility and uncertainty and, without prompt corrective action, would soon be poised to trip over its own feet. The cost of research and development continued to climb, and Hoffman feared that the chain of success was allowing employees to relax, leading to a culture of ineffective performance management. There were even whispers of discontent from the marketing team about a growing number of missed product launches. Hoffman knew that Vitality had recently struggled to maintain its position as an industry leader in innovation and he worried about the slow but notable increases in employee turnover, especially among the highly talented research scientists. Without their expertise, Vitality couldn't remain vibrant much longer. The CEO, Beth Williams, had the same concerns. Hoffman thought about the meeting he'd just had with Williams, remembering her directions: I want you to take the lead on the new Performance Management Evaluation Team New product R&D has slowed and the competition will kill us if we don't get those product engineers motivated. I need to know that this new performance management system is generating the outcomes we expected. And, Jim, I want you to present this information to the Board at their next meeting "The Board?" Hoffman had said. "I'll restart the Evaluation Team and get the data, but it seems a little ambitious to tell the Board about what's happening when we don't have clear results yet. Besides, I've only been with the firm for two months. "If the performance system is working, we shouldn't have anything to hide, right?" Williams had answered, smiling. "Just make sure you bring some solid analysis or the Board may question whether it's worth the ongoing investment. By the way, if this goes well, this could mean a lot for you professionally here at Vitality. The meeting's at the end of the month. That gives you four weeks." From Brains to Beauty Vitality Health Enterprises, Inc., was founded in 1987 in Ames, Iowa, when the wife of Hikaru "Fred" Kikuchi complained that she couldn't find cosmetics of the quality she'd enjoyed before immigrating from Japan. Sensing an opportunity, Kikuchi, a 42-year-old prosperous, serial entrepreneur, leveraged family contacts back in Japan to begin importing small quantities of eye, face, lip, and nail products to the United States. Operating at first out of his garage and later from a small rented warehouse, Kikuchi marketed the products to his neighbors and local organizations including volunteer, educational, athletic, and community associations typically staffed and joined by women. Within three months, Kikuchi's promotions and the resulting word of mouth had yielded more than $15,000 in sales. Kikuchi realized that he'd uncovered an impressive business opportunity. For the next two years, Kikuchi grew the company until import tariffs and finished product supply constraints forced him to re-examine his business model. In late 1989-after months of study, negotiations, and capital equipment purchases-Vitality established its own manufacturing facility in Ames to alleviate its dependency on rebranded Japanese products. Kikuchi hired a senior cosmetics chemist from Japan to create distinctive product formulas and an experienced manufacturing engineer to run the factory. Business started slowly as the management team trained their newly hired staff of scientists and product engineers on both proper product formulations and the idiosyncrasies of the U.S. market. By the summer of 1991, business had grown to $3 million per year, and Kikuchi was able to complete the vertical integration process, cutting the apron strings that tied him back to his Japanese finished-goods suppliers. In late 1994, Vitality signed a distribution agreement with several leading pharmacy retailers to get Vitality's products on the shelves throughout the United States and Canada. With its cosmetics entering mainstream markets throughout North America, Vitality turned its attention to expanding and strengthening its brand image and increasing consumer awareness of its products. As Vitality continued to grow, Kikuchi moved the company headquarters from Ames to nearby Des Moines to take advantage of the better infrastructure, proximity to airports, and the private capital markets in the city. Leveraging these benefits to attract private investors, Kikuchi launched the company into the global markets in 1995, opening talks with retailers in countries around the Pacific Rim, including Taiwan, China, and Japan. Asian consumers were an important target market for cosmetics manufacturers, and Kikuchi felt that, by leveraging Vitality's unique supplier connections and technological superiority, it could gain and sustain stronger advantages in these expanding markets where greater spending per capita made the consumer base more attractive. While expansion brought new challenges and opportunities to the young company, Kikuchi stayed true to Vitality's original vision by matching the corporate strategy to one of his favorite, ancestral sayings: Outer beauty can only be achieved as inner harmony is reached. In keeping with this axiom, Vitality acquired HerbaPure Nutraceuticals in 1997 in the hope of harnessing economies of scope in marketing, distribution, and product development and expansion. Vitality changed its name to Vitality Health Enterprises, which allowed the company to capitalize on the relationship between external beauty and internal wellness, deepening brand loyalty and pushing into a new, related businesses and previously untapped segments of the consumer market. The HerbaPure purchase also enlarged product distribution to specialty health and nutrition retailers, as well as to smaller, regional pharmacies across the United States. Of the acquisition, Kikuchi said: By bringing HerbaPure Nutraceuticals into our family, we can now offer a full range of health, wellness, and beauty products to a broader set of consumers. We develop their inner beauty and help it shine out, and our new company name reflects this holistic approach to wellbeing Building on the investment frenzy of the late 1990s, Vitality floated its IPO in order to raise capital to strengthen its position after the acquisition of HerbaPure and to fuel further expansion. While valuations came in lower than expected, Vitality raised enough cash to push growth into western Europe and double down on Japan and China-respectively its top market and its top growing market-by focusing on the higher quality of its products over the competition By late 2007, Vitality Health had grown to nearly 7,000 employees, with over three-quarters of the global manufacturing, distribution, engineering/R&D, and corporate workforce located in and around the company headquarters in Des Moines. The other roughly 1,500 employees were located in nine global offices representing markets in Asia, Southeast Asia, and Europe. Each regional office was composed of corporate divisions similar to those at the Des Moines headquarters, including finance, general administration, IT, operations, human resources, communications/PR, market research, compliance, and sales & marketing In mid-2008, the global economic crisis brought relative stagnation to Vitality's growth. In the face of level earnings, rising material costs, and growing concerns about Kikuchi's personal health, he and the Board decided it was time to bring fresh blood into the executive suite. Vitality recruited Beth Williams, the global VP of skincare products at personal care giant Barstow & Wyden. Williams brought a disciplined operational mindset and was known throughout the industry for reducing global production costs by 12% during her three years at the helm of B & W Beauty. The Board liked her no-nonsense approach and her willingness to tackle difficult issues head-on-a notable contrast to Kikuchi's more conciliatory management style. By bringing in a new CEO, Vitality sought to leverage new ideas to revitalize the company and launch it into a new era of growth. Working off the Fat In the first quarter of 2009, in the face of slackening discretionary spending across the global economy and disappointing earnings (see Exhibits 1a and 1b for select financial results), Vitality began rolling out its new business strategy. In addition to instituting a number of cost-cutting measures, Williams organized a committee to review the policies and methods for tracking the performance goals of all non-sales and non-executive employees from across the entire company. From her experience with B & W, Williams knew that consolidating departments and streamlining administrative and operational inefficiencies would help to ensure that a company was maximizing its performance capability at all levels. If Vitality was going to become a more nimble and competitive global organization, it would also need a coherent performance management systema system that held employees accountable for their actions and incentivized strong employee performance by offering thoughtfully designed compensation packages, including salaries, bonuses, and equity opportunities in the form of options. Over the next four months, the Performance Management Evaluation Team (PMET) studied the evaluation and rewards system, employing internal and external benchmarking, focus groups, and employee interviews. The PMET discovered that the performance management system presented problems for the approximately 2,500 professional staff of mostly scientists and engineers and their product managers who worked in teams in the Des Moines R&D labs. First, it had 13 different rating levels (from A to E including pluses and minuses). Unfortunately, this rating system opened the way for managerial abuses. In particular, the PMET discovered that many managers, when worried about offending their employees, gave almost everyone a C or a B, provided few Dor A ratings, and very rarely gave Es. This resulted in a somewhat homogenous ratings spread that failed to sharply distinguish performers from nonperformers (see Exhibit 2 for 2008 performance review rating distributions). Managers rarely gave A ratings for fear of upsetting a sense of teamwork and egalitarianism within the R&D groups, which left top-performing employees feeling slighted. And, since performance ratings were used to determine merit-based wage increases and other rewards, employees also felt undervalued financially, recognizing that they received similar rewards as their less-productive coworkers. A lab technician noted: I do good work for this company but I see nothing special for it. Sometimes I think I would be better off just coasting like some of the Ivy League guys. You know, the product engineers. They seem to produce next to nothing but still get the same ratings as me and my team members. Sometimes even better. This frustration was compounded by the point system Vitality used for salary calculations and performance-based raises. Each position had a base-level monthly salary that was modified upward along a pay policy line depending on the number of "job evaluation points" associated with the position. The formula was: Pay policy line = Base Salary + (Job Evaluation Points * Increase per Point) For 2009: f(x) = $2900 + (Job Evaluation Points"$9.06) Individual salaries were further modified by a comparative ratio, or "compa-ratio," based on individual performance in the company. For example, a position assigned 500 job evaluation points would have a target monthly salary of $7,430. If an employee had a compa-ratio of 90%, his or her 2009 monthly salary would be $6,687. Actual compa-ratios ranged between 80% and 125% of the target salary, and merit increases to compa-ratio tended to decrease on a percentage basis as an employee climbed through the range. For example, an employee with a compa-ratio of 85% might receive an increase of 5%-7% while an employee with equal performance but a compa-ratio of 110% would receive an increase of only 2%-3% (see Exhibit 3 for a more detailed description of Job evaluation points and compa-ratios). This meant that employees with consistently higher performance sometimes even received smaller raises than their less-productive colleagues. One lab scientist explained: I cracked the code for the latest generation of Ocucream (Vitality's leading anti-aging eye cream] and what do I get? A pat on the back and a 2% raise. If you go just down the hall you'll find two guys who get 5% just for showing up. I can't tell what else they've done all year. In an effort to retain top employees, Vitality benchmarked compensation to keep the pay policy line at about the 75" percentile with regard to their compensation peer group. This method produced actual compensation figures that averaged 7% 8% higher than the competition. One apparent benefit of the heightened pay was low turnover; however, the system focused on the pay stability of a flat salary and made little to no provision for bonuses or alternative forms of compensation. This meant that tenure with the company would inevitably result in a high salary, regardless of overall performance. While no one had directly complained about their individual paycheck, the system itself made it difficult to identify and reward top performers and equally difficult to identify and terminate low performers. The net result was that the little turnover that did occur tended to happen among more productive scientists and product engineers. Some of these employees, feeling underappreciated for their efforts, left the company for brighter job prospects. In response to these issues, Williams instructed the PMET to evaluate and revise the performance management system and then restructure Vitality's compensation practices to be better aligned. Her stated purpose was to find a better way to identify and reward top performers in order to keep "A" players in their positions and accelerate company growth by attracting new top talent. A related objective was to identify lower performers in order to coach them up or steer them out. In short, Williams wanted to motivate and direct improved performance throughout the company. This would involve assessing the attributes of specific jobs and how they connected to Vitality's strategic goals, as well as revising the evaluation criteria and tools used by managers in performance appraisals and in determining remuneration allocations. It also would require the development of new compensation tools beyond simple annual salary adjustments. Revitalizing the Performance Management System: June 2009 Six weeks later, in June 2009, Williams signed off on the new performance management system. The then-current head of HR sent a company wide email indicating that, after careful review by the PMET committee and Williams's endorsement, a new performance management and incentive system would be rolled out immediately. The new system would become the basis for the annual performance reviews going forward. Few details about the new system were provided in the initial communication, only that the revised system would more aptly "recognize" the contributions of high-performing employees. Two weeks after the announcement, HR sent an email to all directors and managers with a link to an online guidebook with details about the new performance management system through VitalNet, Vitality's employee intranet site. Managers were instructed to follow-up with their HR Generalists with questions, should any arise. The system would institute a forced distribution model of performance rankings, shifting from an absolute ranking system to a relative one. Instead of being measured solely against predetermined standards in which "everyone could win," employees were now rated with respect to one another. The PMET made this change to eliminate a key problem: the bulk of employees were receiving high rankings even when their department was failing to meet development and production goals and time-to-market schedules. The change required differentiation among employees on the basis of performance. The actual targets were set according to the following chart: Ranking Category Top Achiever (T) Achiever (A) Low Achiever (L) Unacceptable (U) Target 10% 75% 12% Constraints Max of 14% Min of 70% Min of 7% No Minimum 3% There was also a fifth category, Not Rated, for employees who were too new to the company or their position to receive an accurate rating. In the case of recent intra-company transfers, the protocol was for the previous manager to generate a performance review in conjunction with the new manager. The idea was that, with fewer ranking categories, it would be easier to determine which category each employee fit into. To further clarify the ratings process, the Evaluation Team researched the core competencies and key duties of the different jobs and job families at Vitality, codifying responsibilities and measures for each job class. In conjunction with these metrics, managers were instructed to develop specific goals with their individual employees and use those goals as a secondary component in the performance management process. In turn, managers themselves were to be rated on their performance in meeting staffing needs, their effectiveness in training, development and employee relations, their clarity in communication, and their implementation of corporate initiatives. All performance reviews were to be conducted at the start of the calendar year and delivered to employees in conjunction with the annual goal-setting process in January. This timetable put the entire company on the same review cycle in order to better measure collaborative efforts and to limit the effect of external factors on the relative rankings. Compensation was also adjusted by the new program. Rather than relying solely on salary increases, the new plan incorporated a system of performance-related short- and long-term cash and equity bonuses. The goal was to incentivize top talent to stay in order to "vest" and receive payout on some of their bonus compensation. The new plan also allowed for limited stock options to upper levels of management and directors as an incentive to successfully implement the new performance management system. Turning Back the Clock on Performance: December 2011 For the next two years, Vitality's new performance management system operated in an indefinite trial period as a surprise rebound in global sales and a weak dollar drove international growth and sent revenues to record levels. Toward the end of the fourth quarter in 2011, however, Williams decided it was time to review the new performance management process and see if it was actually achieving results and, in particular, if it was identifying top performers in order to distribute financial rewards appropriately and keep star players on board. Williams appointed Hoffman to head the reformation of the Performance Management Evaluation Team, dubbed PMET2. Hoffman quickly enlisted several other key company leaders and a few of the HR generalists from his small department to assist him. PMET2 compared performance rankings data for reviews done in early 2009 (covering 2008 performance) and in early 2011 (covering 2010). (See Exhibit 2 for ranking distributions). They found a definite shift in the distribution of rankings. The next step was to find out if the new distribution was meaningful In addition to reviewing the rankings data, PMET2 also sent survey questionnaires to all Vitality employees to elicit evaluations of the PMET1 system. Responses to the employee surveys indicated that just over half of the affected employees preferred the new system (54%) while nearly a third preferred the old system (31%) with the remainder indifferent between the two systems (15%). However, through the process of surveys and focus groups with employees and managers, some serious concerns came to light. Managers felt the new system made it more difficult to discuss performance with employees because the yearly review process was tied so closely with merit increases. With the added burden of compensation on the table, managers felt employees were more defensive and less open to coaching. Managers also worried that some employees were less likely to perform duties outside their job description because those responsibilities weren't part of their review and, therefore, were less likely to be rewarded. In the same vein, some managers were unwilling to spend the necessary time and effort on effectively implementing the process because they felt it was an under-rewarded task that simply detracted from their other, more important duties. Anonymous survey feedback said: It's not worth my time. It would be great for my team but there are too many fires to put out. Especially now that I have to do all of them in January. I've got more important, more productive things to do. Finally, some managers felt the forced distribution system was too rigid. If their team pulled together and had a record year, they were still left with the same allotment of Top Achiever rankings to give to their employees. Hoffman was quick to note that the opposite was also true: a failing department would still have a number of Top Achiever rankings. He wondered if there was a way to counter that issue. Through the course of the review, PMET2 also uncovered some managerial dissembling. The most common practice was for managers to automatically assign a Not Rated ranking to any employee who had been in the group for less than a year, regardless of actual performance. In doing so, managers were able to save the higher rankings for their veteran employees. Another problem that surfaced with a handful of managers was that they continued to submit uniform rankings, rather than following the new guidelines, forcing HR to change the rankings to fit the distribution curve. In effect, these managers avoided differentiating between their employees and left the process up to people who were less familiar with the individual situations of the employees. One manager noted: Who am I to pick between these guys? They're all good at their jobs. I don't want to pick winners and losers just to satisfy some arbitrary curve. I'm gonna do the same thing I always did. If it's that important to HR, let them decide. Alternatively, managers would submit rankings that fit the curve but then lie and tell their employees they had submitted something higher. When confronted about the practice, one of the managers told Hoffman: You don't know what it's like to be the bad guy around here. No one wants to be that. I'll play your rankings game but I've got to play theirs too. Finally, some managers would rotate the highest rankings between their employees from one year to the next. Some did this to avoid the relatively unrewarded time and effort of performing effective reviews, but some did it simply to avoid angering their teams. Rather than identifying top talent, these managers simply tried to maintain uniform rankings over time, ensuring that no employee was left behind, but also that no employee was identified and rewarded as a top performer. Among employees, the comments ranged the spectrum of both positive and negative. Some of the most common themes were: A big issue is that people are used to being rated against the job and its requirements, not against each other. Some people are having trouble adapting. On the plus side, the forced distribution has made managers actually make some decisions. If nothing else, I've heard about some interesting discussions about performance. Where was the training on all these changes? I think I remember seeing an email but that's about it. Can someone explain to me what's supposed to be happening? The company shouldn't force distribution at either end of the scale, low or high. If there isn't a "true" Top Achiever in the department, one shouldn't be picked just to fit the target. I don't like how, if the whole team does great, only a couple of us can get rewarded for it. If everyone does well, we should all see it on our reviews. The concerns raised valid points, points that Hoffman knew the PMET should address (See Exhibit 4 for more employee and management comments on the performance management system). The Future of Performance Management at Vitality Health Hoffman sat back and sighed in the fading light of the late afternoon. After four weeks of research, interviews and debate, the Evaluation Team was no closer to a real conclusion than they had been at the beginning. On the one hand, review of the performance rankings data indicated that the new performance management system was a step in the right direction. On the other hand, the negative comments, especially those from managers, worried Hoffman and some of the other Evaluation Team members. He wondered if the company had missed the mark again by forcing managers to rank scientists and lab engineers like marketing and corporate associates, or if there was a better way to evaluate performance and distribute rewards. Hoffman knew that, if the system wasn't yet the best it could be, Williams was going to expect a list of improvements or changes for the Board to review. Hoffman wasn't about to fumble such a big assignment so soon after accepting his new role. With Williams's warning about needing the Board's approval weighing heavy on his mind, Hoffman knew his choices were to update the Performance Management System or possibly update his rsum. Hoffman thought about the Board meeting scheduled for the next afternoon. He and the Evaluation Team had crafted a proposal but, in the end, the final say was still his. He paused to call his wife and let her know he'd be working late that night. Then, rolling up his sleeves, he started into the reports one final time. Exhibit la Vitality Health Select Financial Results: Income Statement 2011 (expected) 2010 2009 $ $ 2,498.6 462.2 2,036.4 2,202.6 390.3 1,812.3 1,907.1 349.1 1,558.0 680.6 1,020.9 600.5 900.8 Period Ending (in millions, USD$) Total Revenue Cost of Revenue Gross Profit Operating Expenses Research Development Selling General & Administrative Non-Recurring Total Operating Expenses Operating Income or Loss Income from Continuing Operations Other Income (Expense) Net Earnings Before Interest And Taxes Interest Expense Income Before Tax Income Tax Expense Net Income 538.5 807.8 11.4 1.357.7 1.701.5 1.501.3 334.9 311.0 200.3 (10.0) 324.9 10.0 314.9 102.0 (13.5) 297.5 13.5 283.9 97.9 186.1 (9.4) 190.8 9.4 181.4 65.9 115.5 212.9 $ Exhibit 1b Vitality Health Select Financial Results: Balance Sheet 2011 (expected) 2010 2009 $ 330,0 $ 36.8 Period Ending (in millions, USD$) Assets Current Assets Cash and Cash Equivalents Net Receivables Inventory Other Current Assets Total Current Assets Long-Term Investments Property Plant and Equipment Goodwill Intangible Assets Other Assets Total Assets 416.5 45.3 160.6 137.1 759.5 164.0 74.5 605.4 226.4 32.3 151.4 74.1 484.2 214.2 161.1 119.4 165.6 1,419.8 191.6 161.1 112.1 208.1 1,278.3 113.7 161.1 117.4 195.9 1,072.4 $ $ $ $ $ $ 304.6 41.0 270.2 39.9 214.6 50.7 345.5 Liabilities Current Liabilities Accounts Payable Current Portion of Long-Term Debt Other Current Liabilities Total Current Liabilities Long-Term Debt Other Liabilities Total Liabilities Stockholders' Equity Common Stock (1,308,921 shares at $1.00 par value) Retained Earnings Treasury Stock Capital Surplus Total Stockholder Equity Total Liabilities and Equity 154.7 96.9 597.1 310.1 190.6 102.5 603.2 265.4 173.5 95.2 534.1 $ $ $ 1.3 1,241.7 (748.1) 327.9 822.7 1.3 1,074.5 (683.1) 282.4 675.2 1,278.3 1.3 924.2 (621.2) 233.9 538.3 1,072.4 $ 1,419.8 $ $ Exhibit 2 Performance Management Ranking Distributions (2008 and 2010) 2008 Performance Management Rankings Ranking # of Employees Average Pay Increase by Compa-Ratio 80-95 95-110 110-120 120+ 8.2% 7.8% 5.8% 3.5% 18 6.2% 5.2% 5.0% 4.5% 210 2282 1813 1054 Distribution 0.29% 0.25% 2.91% 31.63% 25.13% 14.61% 15.68% 7.58% 1.03% 0.40% 0.49% 0.00% 5.8% 4.1% 3.4% 3.5% 1.2% 0.0% 0.01% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% A A- B+ B B- C+ C C D+ D D - E+ E Exhibit 2 (continued) 2010 Performance Management Rankings # of Ranking Employees Distribution Top Achiever (T) 799 11.07% Achiever (A) 5401 74.86% Low Acheiver (L) 747 10.35% Unacceptable (U) 114 T 1.58% Not Rated (NR) 93 1.29% Average Pay Increase by Compa-Ratio 80-95 95-110 110-120 120+ 12.1% 10.3% 7.7% 7.3% 5.5% 2.9% 1.5% 3.6% 0.0% 80.00% 60.00% 40.00% 20.00% 0.00% TAL UNR Exhibit3 Salary Calculations Salaries are based on a combination of job characteristics (as measured by "job evaluation points") and cumulative merit (as measured by performance ratings over time). Job evaluation points are determined by individually evaluating each position in terms of the three "job evaluation factors": required technical knowledge, required problem-solving skills, and level of accountability. Numerical scores are assigned to each factor according to standardized, companywide guidelines, and the sum of these scores defines the job evaluation points for each position in the organization. Job evaluation points are then converted to a "control point" (roughly an average monthly salary) using a salary-line formula. For example, the 2009 salary-line formula was: Control Point = $2900 + $9.06*(Job Evaluation Points). Thousands Salary Control Line Job Points Target Salary 0$ 2,900.0 100 $ 3,806.0 200 $ 4.712.0 300 $ 5,618.0 400 $ 6,524.0 500 $ 7,430.0 600 $ 8,336.0 700 $ 9,242.0 800 $ 900 $ 11,054.0 1000 $ 11,960.0 $2.0 0 100 200 300 400 500 600 700 800 900 1000 Thus, a mid-level employee at Vitality Health with 500 job evaluation points had a 2009 control point of $7,430 per month. The salary-line formula implies the hierarchical structure of wages in the organization, since higher corporate positions are typically associated with more job evaluation points. Actual salaries can range from 80% to 125% of the control point based on an employee's "compa- ratio." Compa-ratio is calculated as the employee's current salary divided by the current market rate as defined by the company's competitive pay policy. For example, an employee at Vitality Health with 500 job evaluation points and a compa-ratio of 90 would have a 2009 monthly salary of $6,687 (90% of $7,430). An employee's compa-ratio goes up each time he/she gets a merit increase, and falls whenever the salary-line formula is moved upward (holding salaries constant). Compa-Ratio Ranges (Assumes 500 Job Evaluation Points) Compa-Ratio 80-95 95.01-110 110.01-120 Lower Bound $ 5,944.0 $ 7,059.2 $ 8,173.7 Upper Bound $ 7,058.5 $ 8,173.0 $ 8,916.0 The salary line itself is recalibrated up or down each year with respect to the competitor companies in Vitality Health's peer group in order to maintain a level at 75% of the group median. This means pay between 7% and 8% higher than most of their competitors. Exhibit 4 Feedback for the New Performance Management System The following is a sample of comments that Hoffman and the PMET gathered through interviews, focus groups, and from the open-ended portion of employee engagement surveys. I know I've thought about leaving. I haven't put my resume out or anything... [T]he point is, it's tiring to do so much work and not bring anything home to show for it. I just want what I've earned. I think this new system is a step in the right direction. The Achiever category simply covers too many people. There's no way to show an employee he's at the high end or low end. I used to remember my anniversary by when my performance review came around. Seriously. In any case though, I don't think my boss spends much time on it now that he has to do everyone's in the same month. I don't mind the new system but the timetable was better before Labels are a problem. People were in the middle before, but they didn't know it. It's the discovery that they're in the middle that is unsettling to them. The old system had more gradations. You could "move someone through with small rewards." Can't do that as well now. We will have a future problem if we continue to get rid of people who aren't performing well. Very soon, we'll need to begin to get rid of people who are solid performers-but just not as good as others. This will cause a major morale problem. Another problem is the labels. Get rid of them and go to a full ranking of people. This is a recipe for a significant problem between line and staff people. When the division is doing very well in meeting its financial goals, most of the higher ratings are given to the line. There aren't any left over for staff people who may be performing just as well. On the flip side, more staff people get higher ratings during a bad year. Last year, many of staff performed superbly, but couldn't give them ratings that reflected that because the line had done well. Forced distribution is inappropriate. Last year our group had the best year ever, but, because of the rest of the division's performance, higher ratings were "used up." How can you reward people in a situation like this where they deserve it but are excluded from higher ratings because there are only so many to go around? It becomes very demotivating to people who performed extremely well. The whole thing is ridiculous. I'm not being judged on the job I do anymore. Now I'm being judged based on the job everyone else does. How backwards is that? I could work at the same level every year and be a star if my team falls flat or fall flat if my team is a star. Performance Management at Vitality Health Enterprises, Inc. The Health and Vitality of Vitality Health Enterprises James Hoffman, the newly appointed vice president of Human Resources of Vitality Health Enterprises, was pleased when he saw an early preview of the earnings figures for the fourth quarter of 2011. But he knew better than to relax. Competition in the personal care products sector was cutthroat, and complacency was a recipe for obsolescence and loss of market share, particularly in cosmetics and nutraceuticals. Vitality was riding high on a six-quarter string of strong revenue growth that had surpassed analyst expectations. However, as emerging markets represented a growing portion of business revenues, the company was becoming increasingly exposed to volatility and uncertainty and, without prompt corrective action, would soon be poised to trip over its own feet. The cost of research and development continued to climb, and Hoffman feared that the chain of success was allowing employees to relax, leading to a culture of ineffective performance management. There were even whispers of discontent from the marketing team about a growing number of missed product launches. Hoffman knew that Vitality had recently struggled to maintain its position as an industry leader in innovation and he worried about the slow but notable increases in employee turnover, especially among the highly talented research scientists. Without their expertise, Vitality couldn't remain vibrant much longer. The CEO, Beth Williams, had the same concerns. Hoffman thought about the meeting he'd just had with Williams, remembering her directions: I want you to take the lead on the new Performance Management Evaluation Team New product R&D has slowed and the competition will kill us if we don't get those product engineers motivated. I need to know that this new performance management system is generating the outcomes we expected. And, Jim, I want you to present this information to the Board at their next meeting "The Board?" Hoffman had said. "I'll restart the Evaluation Team and get the data, but it seems a little ambitious to tell the Board about what's happening when we don't have clear results yet. Besides, I've only been with the firm for two months. "If the performance system is working, we shouldn't have anything to hide, right?" Williams had answered, smiling. "Just make sure you bring some solid analysis or the Board may question whether it's worth the ongoing investment. By the way, if this goes well, this could mean a lot for you professionally here at Vitality. The meeting's at the end of the month. That gives you four weeks." From Brains to Beauty Vitality Health Enterprises, Inc., was founded in 1987 in Ames, Iowa, when the wife of Hikaru "Fred" Kikuchi complained that she couldn't find cosmetics of the quality she'd enjoyed before immigrating from Japan. Sensing an opportunity, Kikuchi, a 42-year-old prosperous, serial entrepreneur, leveraged family contacts back in Japan to begin importing small quantities of eye, face, lip, and nail products to the United States. Operating at first out of his garage and later from a small rented warehouse, Kikuchi marketed the products to his neighbors and local organizations including volunteer, educational, athletic, and community associations typically staffed and joined by women. Within three months, Kikuchi's promotions and the resulting word of mouth had yielded more than $15,000 in sales. Kikuchi realized that he'd uncovered an impressive business opportunity. For the next two years, Kikuchi grew the company until import tariffs and finished product supply constraints forced him to re-examine his business model. In late 1989-after months of study, negotiations, and capital equipment purchases-Vitality established its own manufacturing facility in Ames to alleviate its dependency on rebranded Japanese products. Kikuchi hired a senior cosmetics chemist from Japan to create distinctive product formulas and an experienced manufacturing engineer to run the factory. Business started slowly as the management team trained their newly hired staff of scientists and product engineers on both proper product formulations and the idiosyncrasies of the U.S. market. By the summer of 1991, business had grown to $3 million per year, and Kikuchi was able to complete the vertical integration process, cutting the apron strings that tied him back to his Japanese finished-goods suppliers. In late 1994, Vitality signed a distribution agreement with several leading pharmacy retailers to get Vitality's products on the shelves throughout the United States and Canada. With its cosmetics entering mainstream markets throughout North America, Vitality turned its attention to expanding and strengthening its brand image and increasing consumer awareness of its products. As Vitality continued to grow, Kikuchi moved the company headquarters from Ames to nearby Des Moines to take advantage of the better infrastructure, proximity to airports, and the private capital markets in the city. Leveraging these benefits to attract private investors, Kikuchi launched the company into the global markets in 1995, opening talks with retailers in countries around the Pacific Rim, including Taiwan, China, and Japan. Asian consumers were an important target market for cosmetics manufacturers, and Kikuchi felt that, by leveraging Vitality's unique supplier connections and technological superiority, it could gain and sustain stronger advantages in these expanding markets where greater spending per capita made the consumer base more attractive. While expansion brought new challenges and opportunities to the young company, Kikuchi stayed true to Vitality's original vision by matching the corporate strategy to one of his favorite, ancestral sayings: Outer beauty can only be achieved as inner harmony is reached. In keeping with this axiom, Vitality acquired HerbaPure Nutraceuticals in 1997 in the hope of harnessing economies of scope in marketing, distribution, and product development and expansion. Vitality changed its name to Vitality Health Enterprises, which allowed the company to capitalize on the relationship between external beauty and internal wellness, deepening brand loyalty and pushing into a new, related businesses and previously untapped segments of the consumer market. The HerbaPure purchase also enlarged product distribution to specialty health and nutrition retailers, as well as to smaller, regional pharmacies across the United States. Of the acquisition, Kikuchi said: By bringing HerbaPure Nutraceuticals into our family, we can now offer a full range of health, wellness, and beauty products to a broader set of consumers. We develop their inner beauty and help it shine out, and our new company name reflects this holistic approach to wellbeing Building on the investment frenzy of the late 1990s, Vitality floated its IPO in order to raise capital to strengthen its position after the acquisition of HerbaPure and to fuel further expansion. While valuations came in lower than expected, Vitality raised enough cash to push growth into western Europe and double down on Japan and China-respectively its top market and its top growing market-by focusing on the higher quality of its products over the competition By late 2007, Vitality Health had grown to nearly 7,000 employees, with over three-quarters of the global manufacturing, distribution, engineering/R&D, and corporate workforce located in and around the company headquarters in Des Moines. The other roughly 1,500 employees were located in nine global offices representing markets in Asia, Southeast Asia, and Europe. Each regional office was composed of corporate divisions similar to those at the Des Moines headquarters, including finance, general administration, IT, operations, human resources, communications/PR, market research, compliance, and sales & marketing In mid-2008, the global economic crisis brought relative stagnation to Vitality's growth. In the face of level earnings, rising material costs, and growing concerns about Kikuchi's personal health, he and the Board decided it was time to bring fresh blood into the executive suite. Vitality recruited Beth Williams, the global VP of skincare products at personal care giant Barstow & Wyden. Williams brought a disciplined operational mindset and was known throughout the industry for reducing global production costs by 12% during her three years at the helm of B & W Beauty. The Board liked her no-nonsense approach and her willingness to tackle difficult issues head-on-a notable contrast to Kikuchi's more conciliatory management style. By bringing in a new CEO, Vitality sought to leverage new ideas to revitalize the company and launch it into a new era of growth. Working off the Fat In the first quarter of 2009, in the face of slackening discretionary spending across the global economy and disappointing earnings (see Exhibits 1a and 1b for select financial results), Vitality began rolling out its new business strategy. In addition to instituting a number of cost-cutting measures, Williams organized a committee to review the policies and methods for tracking the performance goals of all non-sales and non-executive employees from across the entire company. From her experience with B & W, Williams knew that consolidating departments and streamlining administrative and operational inefficiencies would help to ensure that a company was maximizing its performance capability at all levels. If Vitality was going to become a more nimble and competitive global organization, it would also need a coherent performance management systema system that held employees accountable for their actions and incentivized strong employee performance by offering thoughtfully designed compensation packages, including salaries, bonuses, and equity opportunities in the form of options. Over the next four months, the Performance Management Evaluation Team (PMET) studied the evaluation and rewards system, employing internal and external benchmarking, focus groups, and employee interviews. The PMET discovered that the performance management system presented problems for the approximately 2,500 professional staff of mostly scientists and engineers and their product managers who worked in teams in the Des Moines R&D labs. First, it had 13 different rating levels (from A to E including pluses and minuses). Unfortunately, this rating system opened the way for managerial abuses. In particular, the PMET discovered that many managers, when worried about offending their employees, gave almost everyone a C or a B, provided few Dor A ratings, and very rarely gave Es. This resulted in a somewhat homogenous ratings spread that failed to sharply distinguish performers from nonperformers (see Exhibit 2 for 2008 performance review rating distributions). Managers rarely gave A ratings for fear of upsetting a sense of teamwork and egalitarianism within the R&D groups, which left top-performing employees feeling slighted. And, since performance ratings were used to determine merit-based wage increases and other rewards, employees also felt undervalued financially, recognizing that they received similar rewards as their less-productive coworkers. A lab technician noted: I do good work for this company but I see nothing special for it. Sometimes I think I would be better off just coasting like some of the Ivy League guys. You know, the product engineers. They seem to produce next to nothing but still get the same ratings as me and my team members. Sometimes even better. This frustration was compounded by the point system Vitality used for salary calculations and performance-based raises. Each position had a base-level monthly salary that was modified upward along a pay policy line depending on the number of "job evaluation points" associated with the position. The formula was: Pay policy line = Base Salary + (Job Evaluation Points * Increase per Point) For 2009: f(x) = $2900 + (Job Evaluation Points"$9.06) Individual salaries were further modified by a comparative ratio, or "compa-ratio," based on individual performance in the company. For example, a position assigned 500 job evaluation points would have a target monthly salary of $7,430. If an employee had a compa-ratio of 90%, his or her 2009 monthly salary would be $6,687. Actual compa-ratios ranged between 80% and 125% of the target salary, and merit increases to compa-ratio tended to decrease on a percentage basis as an employee climbed through the range. For example, an employee with a compa-ratio of 85% might receive an increase of 5%-7% while an employee with equal performance but a compa-ratio of 110% would receive an increase of only 2%-3% (see Exhibit 3 for a more detailed description of Job evaluation points and compa-ratios). This meant that employees with consistently higher performance sometimes even received smaller raises than their less-productive colleagues. One lab scientist explained: I cracked the code for the latest generation of Ocucream (Vitality's leading anti-aging eye cream] and what do I get? A pat on the back and a 2% raise. If you go just down the hall you'll find two guys who get 5% just for showing up. I can't tell what else they've done all year. In an effort to retain top employees, Vitality benchmarked compensation to keep the pay policy line at about the 75" percentile with regard to their compensation peer group. This method produced actual compensation figures that averaged 7% 8% higher than the competition. One apparent benefit of the heightened pay was low turnover; however, the system focused on the pay stability of a flat salary and made little to no provision for bonuses or alternative forms of compensation. This meant that tenure with the company would inevitably result in a high salary, regardless of overall performance. While no one had directly complained about their individual paycheck, the system itself made it difficult to identify and reward top performers and equally difficult to identify and terminate low performers. The net result was that the little turnover that did occur tended to happen among more productive scientists and product engineers. Some of these employees, feeling underappreciated for their efforts, left the company for brighter job prospects. In response to these issues, Williams instructed the PMET to evaluate and revise the performance management system and then restructure Vitality's compensation practices to be better aligned. Her stated purpose was to find a better way to identify and reward top performers in order to keep "A" players in their positions and accelerate company growth by attracting new top talent. A related objective was to identify lower performers in order to coach them up or steer them out. In short, Williams wanted to motivate and direct improved performance throughout the company. This would involve assessing the attributes of specific jobs and how they connected to Vitality's strategic goals, as well as revising the evaluation criteria and tools used by managers in performance appraisals and in determining remuneration allocations. It also would require the development of new compensation tools beyond simple annual salary adjustments. Revitalizing the Performance Management System: June 2009 Six weeks later, in June 2009, Williams signed off on the new performance management system. The then-current head of HR sent a company wide email indicating that, after careful review by the PMET committee and Williams's endorsement, a new performance management and incentive system would be rolled out immediately. The new system would become the basis for the annual performance reviews going forward. Few details about the new system were provided in the initial communication, only that the revised system would more aptly "recognize" the contributions of high-performing employees. Two weeks after the announcement, HR sent an email to all directors and managers with a link to an online guidebook with details about the new performance management system through VitalNet, Vitality's employee intranet site. Managers were instructed to follow-up with their HR Generalists with questions, should any arise. The system would institute a forced distribution model of performance rankings, shifting from an absolute ranking system to a relative one. Instead of being measured solely against predetermined standards in which "everyone could win," employees were now rated with respect to one another. The PMET made this change to eliminate a key problem: the bulk of employees were receiving high rankings even when their department was failing to meet development and production goals and time-to-market schedules. The change required differentiation among employees on the basis of performance. The actual targets were set according to the following chart: Ranking Category Top Achiever (T) Achiever (A) Low Achiever (L) Unacceptable (U) Target 10% 75% 12% Constraints Max of 14% Min of 70% Min of 7% No Minimum 3% There was also a fifth category, Not Rated, for employees who were too new to the company or their position to receive an accurate rating. In the case of recent intra-company transfers, the protocol was for the previous manager to generate a performance review in conjunction with the new manager. The idea was that, with fewer ranking categories, it would be easier to determine which category each employee fit into. To further clarify the ratings process, the Evaluation Team researched the core competencies and key duties of the different jobs and job families at Vitality, codifying responsibilities and measures for each job class. In conjunction with these metrics, managers were instructed to develop specific goals with their individual employees and use those goals as a secondary component in the performance management process. In turn, managers themselves were to be rated on their performance in meeting staffing needs, their effectiveness in training, development and employee relations, their clarity in communication, and their implementation of corporate initiatives. All performance reviews were to be conducted at the start of the calendar year and delivered to employees in conjunction with the annual goal-setting process in January. This timetable put the entire company on the same review cycle in order to better measure collaborative efforts and to limit the effect of external factors on the relative rankings. Compensation was also adjusted by the new program. Rather than relying solely on salary increases, the new plan incorporated a system of performance-related short- and long-term cash and equity bonuses. The goal was to incentivize top talent to stay in order to "vest" and receive payout on some of their bonus compensation. The new plan also allowed for limited stock options to upper levels of management and directors as an incentive to successfully implement the new performance management system. Turning Back the Clock on Performance: December 2011 For the next two years, Vitality's new performance management system operated in an indefinite trial period as a surprise rebound in global sales and a weak dollar drove international growth and sent revenues to record levels. Toward the end of the fourth quarter in 2011, however, Williams decided it was time to review the new performance management process and see if it was actually achieving results and, in particular, if it was identifying top performers in order to distribute financial rewards appropriately and keep star players on board. Williams appointed Hoffman to head the reformation of the Performance Management Evaluation Team, dubbed PMET2. Hoffman quickly enlisted several other key company leaders and a few of the HR generalists from his small department to assist him. PMET2 compared performance rankings data for reviews done in early 2009 (covering 2008 performance) and in early 2011 (covering 2010). (See Exhibit 2 for ranking distributions). They found a definite shift in the distribution of rankings. The next step was to find out if the new distribution was meaningful In addition to reviewing the rankings data, PMET2 also sent survey questionnaires to all Vitality employees to elicit evaluations of the PMET1 system. Responses to the employee surveys indicated that just over half of the affected employees preferred the new system (54%) while nearly a third preferred the old system (31%) with the remainder indifferent between the two systems (15%). However, through the process of surveys and focus groups with employees and managers, some serious concerns came to light. Managers felt the new system made it more difficult to discuss performance with employees because the yearly review process was tied so closely with merit increases. With the added burden of compensation on the table, managers felt employees were more defensive and less open to coaching. Managers also worried that some employees were less likely to perform duties outside their job description because those responsibilities weren't part of their review and, therefore, were less likely to be rewarded. In the same vein, some managers were unwilling to spend the necessary time and effort on effectively implementing the process because they felt it was an under-rewarded task that simply detracted from their other, more important duties. Anonymous survey feedback said: It's not worth my time. It would be great for my team but there are too many fires to put out. Especially now that I have to do all of them in January. I've got more important, more productive things to do. Finally, some managers felt the forced distribution system was too rigid. If their team pulled together and had a record year, they were still left with the same allotment of Top Achiever rankings to give to their employees. Hoffman was quick to note that the opposite was also true: a failing department would still have a number of Top Achiever rankings. He wondered if there was a way to counter that issue. Through the course of the review, PMET2 also uncovered some managerial dissembling. The most common practice was for managers to automatically assign a Not Rated ranking to any employee who had been in the group for less than a year, regardless of actual performance. In doing so, managers were able to save the higher rankings for their veteran employees. Another problem that surfaced with a handful of managers was that they continued to submit uniform rankings, rather than following the new guidelines, forcing HR to change the rankings to fit the distribution curve. In effect, these managers avoided differentiating between their employees and left the process up to people who were less familiar with the individual situations of the employees. One manager noted: Who am I to pick between these guys? They're all good at their jobs. I don't want to pick winners and losers just to satisfy some arbitrary curve. I'm gonna do the same thing I always did. If it's that important to HR, let them decide. Alternatively, managers would submit rankings that fit the curve but then lie and tell their employees they had submitted something higher. When confronted about the practice, one of the managers told Hoffman: You don't know what it's like to be the bad guy around here. No one wants to be that. I'll play your rankings game but I've got to play theirs too. Finally, some managers would rotate the highest rankings between their employees from one year to the next. Some did this to avoid the relatively unrewarded time and effort of performing effective reviews, but some did it simply to avoid angering their teams. Rather than identifying top talent, these managers simply tried to maintain uniform rankings over time, ensuring that no employee was left behind, but also that no employee was identified and rewarded as a top performer. Among employees, the comments ranged the spectrum of both positive and negative. Some of the most common themes were: A big issue is that people are used to being rated against the job and its requirements, not against each other. Some people are having trouble adapting. On the plus side, the forced distribution has made managers actually make some decisions. If nothing else, I've heard about some interesting discussions about performance. Where was the training on all these changes? I think I remember seeing an email but that's about it. Can someone explain to me what's supposed to be happening? The company shouldn't force distribution at either end of the scale, low or high. If there isn't a "true" Top Achiever in the department, one shouldn't be picked just to fit the target. I don't like how, if the whole team does great, only a couple of us can get rewarded for it. If everyone does well, we should all see it on our reviews. The concerns raised valid points, points that Hoffman knew the PMET should address (See Exhibit 4 for more employee and management comments on the performance management system). The Future of Performance Management at Vitality Health Hoffman sat back and sighed in the fading light of the late afternoon. After four weeks of research, interviews and debate, the Evaluation Team was no closer to a real conclusion than they had been at the beginning. On the one hand, review of the performance rankings data indicated that the new performance management system was a step in the right direction. On the other hand, the negative comments, especially those from managers, worried Hoffman and some of the other Evaluation Team members. He wondered if the company had missed the mark again by forcing managers to rank scientists and lab engineers like marketing and corporate associates, or if there was a better way to evaluate performance and distribute rewards. Hoffman knew that, if the system wasn't yet the best it could be, Williams was going to expect a list of improvements or changes for the Board to review. Hoffman wasn't about to fumble such a big assignment so soon after accepting his new role. With Williams's warning about needing the Board's approval weighing heavy on his mind, Hoffman knew his choices were to update the Performance Management System or possibly update his rsum. Hoffman thought about the Board meeting scheduled for the next afternoon. He and the Evaluation Team had crafted a proposal but, in the end, the final say was still his. He paused to call his wife and let her know he'd be working late that night. Then, rolling up his sleeves, he started into the reports one final time. Exhibit la Vitality Health Select Financial Results: Income Statement 2011 (expected) 2010 2009 $ $ 2,498.6 462.2 2,036.4 2,202.6 390.3 1,812.3 1,907.1 349.1 1,558.0 680.6 1,020.9 600.5 900.8 Period Ending (in millions, USD$) Total Revenue Cost of Revenue Gross Profit Operating Expenses Research Development Selling General & Administrative Non-Recurring Total Operating Expenses Operating Income or Loss Income from Continuing Operations Other Income (Expense) Net Earnings Before Interest And Taxes Interest Expense Income Before Tax Income Tax Expense Net Income 538.5 807.8 11.4 1.357.7 1.701.5 1.501.3 334.9 311.0 200.3 (10.0) 324.9 10.0 314.9 102.0 (13.5) 297.5 13.5 283.9 97.9 186.1 (9.4) 190.8 9.4 181.4 65.9 115.5 212.9 $ Exhibit 1b Vitality Health Select Financial Results: Balance Sheet 2011 (expected) 2010 2009 $ 330,0 $ 36.8 Period Ending (in millions, USD$) Assets Current Assets Cash and Cash Equivalents Net Receivables Inventory Other Current Assets Total Current Assets Long-Term Investments Property Plant and Equipment Goodwill Intangible Assets Other Assets Total Assets 416.5 45.3 160.6 137.1 759.5 164.0 74.5 605.4 226.4 32.3 151.4 74.1 484.2 214.2 161.1 119.4 165.6 1,419.8 191.6 161.1 112.1 208.1 1,278.3 113.7 161.1 117.4 195.9 1,072.4 $ $ $ $ $ $ 304.6 41.0 270.2 39.9 214.6 50.7 345.5 Liabilities Current Liabilities Accounts Payable Current Portion of Long-Term Debt Other Current Liabilities Total Current Liabilities Long-Term Debt Other Liabilities Total Liabilities Stockholders' Equity Common Stock (1,308,921 shares at $1.00 par value) Retained Earnings Treasury Stock Capital Surplus Total Stockholder Equity Total Liabilities and Equity 154.7 96.9 597.1 310.1 190.6 102.5 603.2 265.4 173.5 95.2 534.1 $ $ $ 1.3 1,241.7 (748.1) 327.9 822.7 1.3 1,074.5 (683.1) 282.4 675.2 1,278.3 1.3 924.2 (621.2) 233.9 538.3 1,072.4 $ 1,419.8 $ $ Exhibit 2 Performance Management Ranking Distributions (2008 and 2010) 2008 Performance Management Rankings Ranking # of Employees Average Pay In