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Healthy Turnover?

In a 2000 letter to General Electric shareholders under the heading of "People," Jack Welch heralded the 20-70-10 rule. This evaluation system made it policy to terminate or put on notice the bottom 10% performers in GE's management ranks.

In theory this ranking system requires honest feedback by managers and forces a continual renewal by infusing new talent to the enterprise. Many companies have followed GE's lead, implementing forced ranking systems as a way to weed out poor performers. Let's explore the idea of "healthy turnover" in the context of such techniques as forced ranking.

Who are the poor performers? Many companies go to great lengths to set up evaluation systems to identify poor performers. Forced ranking is one of the latest techniques. By 2005, as many as one-third of all companies were using some form of this tool as a way to not only terminate or put on notice low performers but to recognize their "A players."

Certainly, management should be interested in performance. Unfortunately, managers have no good ways to measure individual performance. Managers, as we have established in previous articles, should pay attention to results. If results are not being attained, it is important to find out why. But time spent evaluating performance, a subjective evaluation at best, is not likely to address underlying problems affecting results. Often the issues addressed in so-called performance reviews are based on behaviors observed that may or may not impact performance.

Is targeted (forced) turnover healthy? Assuming that poor performers could be identified, should they be fired? One rationale for turning over "low performers" is that of managing talent acquiring and adding more talented people to the workforce and recognizing the very top people. But consider that turnover has an average cost of about 1.5 to 2 times annual salary, counting both the actual cost of hiring and the loss of productivity from losing a person's knowledge and skill. Usually, getting these top people will cost a lot more money than the people you are replacing.

About a decade ago, McKinsey, a famous management consulting group, made its case for the need to hire the top talent. Their prototype company was... Enron. Finding the most talented people based on skill, experience or perceived past performance (often judged by results) will guarantee no more than costing more money.

Can a unit, division, or company succeed with "ordinary people?" The answer is that they must. By Welch's definition about 80% of the people are no better than ordinary. Also consider the concept of the bell curve where the middle distribution (those with about the same abilities) accounts for 68% of the employable population. The war for talent can be vicious with the winner paying a hefty premium. However, there are some VERY successful companies that have low turnover and whose "performance management" practices don't include forced ranking. One example is SAS, Inc., the largest private software company in the world.

SAS's workforce, mostly programmers and sales staff, often work less than 40-hour weeks unheard of in the software industry. Also unlike most in the industry, SAS does not use piece rate pay systems for its salespeople. Although they are able to create some niches, SAS competes against many large competitors seemingly a recipe for working long hours.

This workforce is extremely productive. Just a few years ago 80% of Fortune 500 companies used SAS software (97% of Fortune 100). From 1986 to 1998, SAS averaged 20% growth per year; the lowest growth year was 15%. Despite paying no stock options, no commission on sales for account representatives, and simply paying competitive salary for all workers, turnover runs about 3-4%. Another company that has been very successful using similar practices is Southwest Airlines.1

Low turnover for many units or companies can be healthy. Furthermore, the war for talent can be an expensive proposition even though acquiring the talent does not guarantee performance or required results; that is, ordinarily competent people in the right system can succeed spectacularly. Finally, forced ranking systems are not a panacea for improving the management systems and practices that enable competent workers to perform well. On the other hand, forced turnover made some sense at GE because they routinely carried a surplus of managers whose skills exceeded their positions. In next month's article we will explore when turnover is actually healthy and should be planned for by companies.

1From Hidden Value by Charles O'Reilly III and Jeffrey Pfeffer (2000)

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