The Peter Principle Tested

The Peter Principle is the observation that if people are good at doing their jobs they will be promoted. It follows that eventually everyone will be doing a job that they are not good at (otherwise they would have been promoted). The Peter Principle is tongue in cheek but it’s stuck around because it has an element of truth. Alan Benson, Danielle Li, Kelly Shue have put the principle to the test (summary here) by looking at promotions and performance of some 40,000 sales workers across 131 firms. Sales workers are a good place to look for the principle in action because it seems natural to promote the best sales people yet the best sales people do not necessarily make the best managers.

Figure One summarizes the main result: The best sales people as measured by sales revenue are more likely to be promoted (top) but their value added as managers actually declines in their (pre-promotion) sales revenues (bottom). The result isn’t difficult to believe, the best sales staff do not necessarily make the best managers, the best football players do not necessarily make the best coaches, the best professors do not necessarily make the best deans. But the result is deeper than this point because it raises questions about management. How can firms motivate top sales performers without promoting them to positions for which they may not be suitable? If sales revenue isn’t a good metric for manager potential, what is? The authors write:

We provide evidence that the Peter Principle may be the unfortunate consequence of firms doing their best to motivate their workforce. As has been pointed out by Baker et al. (1988) and by Milgrom and Roberts (1992), promotions often serve dual roles within an organisation: they are used to assign the best person to the managerial role, but also to motivate workers to excel in their current roles. If firms promoted workers on the basis of managerial potential rather than current performance, employees may have fewer incentives to work as hard.

We also find evidence that firms appear aware of the trade-off between incentives and matching and have adopted methods of reducing their costs. First, organisations can reward high performers through incentive pay, avoiding the need to use promotions to different roles as an incentive. Indeed, we find that firms that rely more on incentive pay (commissions, bonuses, etc.), also rely less on sales performance in making promotion decisions. Second, we find that organisations place less weight on sales performance when promoting sales workers to managerial positions that entail leading larger teams. That is, when managers have more responsibility, firms appear less willing to compromise on their quality.

Our research suggests that companies are largely aware of the Peter Principle. Because workers value promotion above and beyond a simple increase in salary, firms may not want to rid themselves entirely of promotion-based incentives. However, strategies that decouple a worker’s current job performance from his or her future career potential can minimise the costs of the Peter Principle. For example, technical organisations, like Microsoft and IBM have long used split career ladders, allowing their engineers to advance as individual contributors or managers. These practices recognise workers for succeeding in one area without transferring them to another.

Designing incentives is much more complicated than the carrot and the stick especially when workers contribute to firms in difficult to measure, multi-dimensional ways.

(fyi, our textbook, Modern Principles offers an introduction to incentive design).

Comments

Indeed “There are some mistakes it takes a PhD to make”
http://perkurowski.blogspot.com/2017/05/whut-you-goin-to-do-when-lefty-starts.html

+1
if you add up the
peter principle + too much gender ideology/sociology + big financial incentives+ too much virtue signaling + suppression of free speech in the academy = you get pre-adolescent children getting sex hormones

we predict this will go down as one of the really bad/harmful ideas
of the decade!

+1

Lotta purty talk here!

Fortunately, I have been vaccinated.

Regressing toward the mean after exceptional run of sales. YAWN

Failed socialist countries: Venezuela/Cuba, Succeful socialist countries: Denmark, Norway, France
Failed capitalist countries: Argentina/Moroco/Turkey, Succeful socialist countries: USA, Canada (with free health care)

It depends on the definition of "socialist", but for most USA people it seems that any country with public health care and Unemployment benfits and any redistribution systems is "socialist" (i.e. all europe+canada)... but they keep looking to the 2 worst of all, it's dangerous to look the other countries, it may defied they beliefs

> technical organisations, like Microsoft and IBM have long used split career ladders, allowing their engineers to advance as individual contributors

that is ... until age 36 or so:
https://www.forbes.com/sites/marenbannon/2019/04/10/the-biggest-bias-in-tech-that-no-one-talks-about/#3c87b1a362e3

At my previous company (mega-cap tech firm) most of the Principal Engineers were above 35, Senior Principal Engineers were above 40, and Fellows above 45. There was plenty of career advancement on the technical track beyond age 36.

> Senior Principal Engineers were above 40, and Fellows above 45.

What percentage actually became fellows?

Let's go to high schools and tell kids that if they learn STEM they can have lucrative careers that in some cases last well into their 40s.

What’s your point about percentages?
Not many people become exec VPs; would you expect more techs to become Fellows?

+1

The H1b visa makes it easier to dump older, more expensive workers and replace them with young indentured servants. The green card is the ultimate carrot. 🥕

It is called capitalism, EdR. You sound like a socialist who hates profits.

That's why you support replacing H1B visas with an equivalent number of regional visas or nationwide visas that don't lock people into a single employer, right?

Well, the basis for the visa is that there is a specific job (compiler designer for example) that can't (after reasonable demonstrated effort) be filled by an American citizen. Not that the total US market or a US regional market needs an additional 5,000 generic software testers (perhaps at some price/quality point).

I think the split career trajectory is the interesting solution here. Obviously it requires careful communication, and consciously elevating the status within the group of top performers, but not managers per se. Pulling that off in reality is tricky.

The best example that I can think of is the English legal profession. Top barristers are highly sought after, highly esteemed, and very well remunerated. But their daily diaries, forward bookings, accounting, and negotiated fees are generally managed by Clerks, who can have no formal education at all. I think strictly speaking clerks are employed by a barrister, but in effect they manage the barrister - but nobody cares who the clerk is in social circles, it's the star barrister who holds the status.

"Because workers value promotion above and beyond a simple increase in salary, firms may not want to rid themselves entirely of promotion-based incentives."

Really? Do everybody wants to be a manager?

I think that the underlying problem is that managers don't want anyone under them to earn more money than they do, and that is often, but not always, reflected in pay.

The best people in sales should earn more in commissions than managers several rungs above them, they're really that valuable. In many places, they do. However, it's not unusual for some managers to get together and try to "fix" the compensation schemes so that this is no longer true. What inevitably happens is that the best sales guys leave and take their clients with them.

Which Peter Principle, when reduced to a pithy quote?

This one? - 'Sometimes I wonder whether the world is being run by smart people who are putting us on or by imbeciles who really mean it.'

This? - 'In a hierarchy, every employee tends to rise to his level of incompetence.' (Clearly, there must be the Cowen Exception, otherwise CEOs would be the most incompetent people in a company, assuming that this Peter Principle is pyramidal in action.)

This? - 'Work is accomplished by those employees who have not yet reached their level of incompetence.'

Or this? - 'As individuals we tend to climb to our levels of incompetence. We behave as though up is better and more is better, and yet all around us we see the tragic victims of this mindless escalation.' (Oops - seems like the Cowen Exception was already rejected, based on an appeal to common reality.)

99% of references to the Peter Principle is to the second one. What a weird thing to be pedantic about.

Or, what a weird thing to reduce what was written in a satirical book titled The Peter Principle to a single quote. Which emphasizes the importance of observation 1, actually.

"What a weird thing to be pedantic obsessed about."

Which pretty well captures 75%+ of clockwork_prior's posts.

The Peter principle is probably why he got fired.

Even after a detailed explanation of not being fired from any GMU job, you persist in the need to believe. Something that remains a matter of abiding and irrational faith, for some reason.

Or to quote from that two week old exchange - 'Yep, a fascinating need.' https://marginalrevolution.com/marginalrevolution/2019/04/tax-returns-should-not-be-made-public-information.html

No one here believes you. Your behavior is one of a scorned, I mean fired, ex-employee.

The alternative explanation is that you developed an unhealthy obsession with this website for no reason at all, which reflects even more poorly on you than the current explanation of an embittered ex-employee who trolls the comment section believing he's exacting some sort of revenge. I mean, that's pathetic, but at least it makes sense.

He could easily release his CV and LinkedIn.

Or release it to a neutral party, like Caplan or Russ Roberts

He won’t.

Why residualized sales? This means that this relationship is dependent upon specification choice. Given the incentives in the academic economics profession (to "get results") I'm skeptical of a main result that is visually displayed only in residualized form. If there is just a store-fixed effect or hours-worked adjustment or something, that would make sense, but I would be highly skeptical if they threw in a ton of worker-characteristic controls and such.

" How can firms motivate top sales performers without promoting them to positions for which they may not be suitable? "

This is the real issue and it's not limited to sales. I remember my uncle explaining this dilemma to me at his firm. They had an engineer they didn't want to lose, but hey didn't want to promote him to management because his engineering skills were far more valuable. I think they wound up creating a new category for him.

They do this in tech a lot. Make then 'architects' or something. Sometimes with more pay than their manager - which makes them feel a lot better about no being a manager.

A lot of those guys don't want to be managers - worrying about budgets, recruiting, personnel issues, patent filings, getting the test facilities or manufacturing capacity that you are going to need in 12 months, etc. are not viewed as a reward, and many of them are not particularly good at it. They are interested in the technology and (if you are lucky as their manager) the projects.

I don't know why more firms don't follow suit and just reward their best technical people as much, or more, than their management.

Big tech firms are really leading the way in this. There is a recognition that a good individual contributor is just as valuable as a good manager. The tech career path at my former employer roughly mirrored the management path:

Associate Engineer -> Senior Associate Engineer -> Engineer -> Senior Engineer -> Staff Engineer -> Senior Staff Engineer -> Principal Engineer -> Senior Principal Engineer -> Fellow -> Senior Fellow

In broad therms, a Senior PE was roughly equivalent to a VP both in salary and status. A Senior Fellow was roughly equivalent to an Executive VP along the same vectors. Honestly there is some feeling that those who go into management simply couldn't cut it as engineers.

My girlfriend works for a health insurance company. It blows my mind to see the deference given to managers in that field. Unlike in tech there is notable deference given to management whether deserved or not. I completely agree that this old-school thinking needs to end. Tech gets plenty wrong, but this is something they got right.

Something similar happened to my father, an engineer. They promoted him to manager and offered him an office, but he preferred having a desk in the big room of desks (they didn't even have cubicles, just rows and columns of desks in a big room) where the engineers were doing their actual work and presumably wandering from desk to desk to consult with one another.

And he didn't like being a manager so when the project was finished and he moved to another one, he asked to be moved back to being an engineer, which they did.

What I don't know is if they gave him fancy senior engineer titles or salary bumps even though he wasn't a manager. I'm guessing probably yes, or he would've gritted his teeth and stayed in management.

Motivation, intelligence and experience are factors. Organizations spend a lot of money on assessment devices like Myers Briggs and ignore it when hiring. Wonderlic is used by the NFL and I am not aware of its use elsewhere. Experience is often blurred by bias.

Many examples exist of employee performance contributing mightily to a department with the manager reaping the rewards. An excellent manager may have many reporting to them being paid more.

Ideally you would choose a brutal up-or-out system, but this is possible only if your company works in some niche industries where you can attract the best and more ambitious people. It used to be management consulting and banking, now more and more tech, VC and hedge-funds.

In our group we move people laterally, for example from sales to operations or special projects, or to another entirely different business unit. Either they thrive, so we can promote them to higher, more complex positions, or not. In these cases, we have a frank conversation and we tell them what they should have already realized, they are better at what they used to do. They choose if going back to the previous position for good, or leave the group. We sometimes lose a good specialist, but we retain a good share of them without having to bullshit them continuously to maintain them motivated, which in the long term is a poison to the culture of the organization.

This was one benefit of the old defined benefit pension system. Employees could be compensated with deferred cash, and would also be attached to the company with golden handcuffs. That way, long tenured employees did not require as much ever-escalating pay raises and promotions to be satisifed.

Also, this article possibly inverts the causal relationship on promoting high performers to management. Sometimes, it is not that the company has a seat it needs to fill, in fact it is that they have a person they need to promote, so they create a "management" role for them - in order to justify the pay raise.

There is a limit to how much a company is willing to pay for direct non-supervisory work. And a limited imagination on how to do it. Higher earners must have "direct report" headcounts and "span of control" to justify the pay, in other words, high earners must be managers. Which is conveniently difficult to directly measure pay-to-payback relationship.

Technicians on the other hand, have a visible ceiling where it no longer makes sense to pay them for making widgets all day, even if they are really good at it.

One way out for non-supervisory tecnicians is to become a consultant to your former employer. They won;t pay you a salary above a certain wage, but they might pay you double or triple that on an hourly basis as an independent expert.

Note that this result doesn't actually show that promoting the top performing salespeople is bad, since the motivational impact of the promotions is not measured. It may be that the motivational factor outweighs the manager quality factor.

This is pretty common knowledge, especially as to salespeople, though I guess it's nice to have it confirmed.

What should I read if I'm interested in learning more about incentive design?

Alex, I say this with kindness: your ideas and thinking are marvelous, but your run-on sentences drive me up a wall. I've been reading this blog for 15 years and I keep thinking you'll fix this, but you never do. And I keep thinking I'll get used to it, but I am beginning to think I never will.

I realize this is a character flaw in me, but when an otherwise good idea is expressed with poor grammar, I discount that idea by at least 20 percent. My brain just stops engaging with the idea.

I must be being dim today. Can you cite an example of his bad grammar?

"The result isn’t difficult to believe, the best sales staff do not necessarily make the best managers, the best football players do not necessarily make the best coaches, the best professors do not necessarily make the best deans." Those are four independent clauses separated by commas. (The English have always been more relaxed about grammar than their transatlantic cousins... you'd have been unlikely to notice.) This is hardly the worst mistake Alex has made, of course.

True, but he could have fixed the sentence by adding "but" before "the best sales staff," and "nor do" before "the best professors." I found it easy to imagine those words added to the line as I read it.

No. The word "but" does not belong there. The examples don't make the result hard to believe, they support it.

"Poor grammar" seems harsh to me though I'll grant you that it's rather slack. Do criticise this version:-

The result is plausible: the best salesmen needn't make the best managers, nor the best footballers the best coaches.

Quite why it's worth fussing about such examples of the bleedin' obvious is a different matter.

The company that I work for does a pretty good job of creating split career paths that allow people in most positions to either advance in their field of expertise (with most job positions having between 3 and 7 steps of seniority and the top couple being extremely difficult to attain and very well compensated) or move into a management track with commensurate increases in pay and responsibility. This is probably the best option overall for a large organization, but it does create a couple problems.
1. Increases along the expertise ladder frequently become much more a matter of seniority, rather than actual expertise and willingness to contribute. Except for the top couple rungs, which only admit a limited number of people, movement is much less meritocratic than on the management track.

2. It reduces mobility and silos expertise. As one advances, the likelihood of another department having the budget to justify allowing a high-ranking engineer, for instance, to transfer over is remote. Other firms for which I've worked had either official or ad hoc generalized positions (usually some variant of 'project manager') which were paid out of a central budget so that the person's time and expertise could be applied as needed.

That's still better than turning great engineers into acceptable managers because that's the only path to higher pay and status.

It's important to bear in mind that management jobs are not always either respected or desired in some firms, particularly professional services firms.

In management consultancies where I have worked, Deloitte for an example, Managing Partner was a kind of short-straw type of position. Yes, it had prestige, but a lot of administration and internal politics, which many of the professional staff were not at all keen about.

This can also be true for doctors, lawyers, researchers and academics. Management is equated with administration, and administration in considered boring or inferior to professional practice.

So, the way to motivate staff is
1. pay
2. enjoyment and quality of work
3. promotion

Not infrequently, sales reps make more than their managers. And that's ok. Many sales reps -- and their management -- are well aware that the things which make them good at sales make them bad at management. Not everyone is destined to take a step up, or indeed, desires it.

Yup, and the sales guy is on the golf course at 10:00 am on a Friday, with his foursome of clients/buddies, bitching about the manager who insists on a receipt for the lunch and drinks afterwards.

I've observed something different. The best, most productive workers are often shipped off to a remote location (out of mind, out of sight) or forced out of the company by a petty, jealous manager who feels threatened. It's the slow, less productive worker - more docile and complacent - who does just fine.

Michael, of The Office, is a good example for the Peter principle

Some take a more cynical view of the whole question:
https://www.ribbonfarm.com/the-gervais-principle/

Perhaps it's also time to have another look at Parkinsons Law(s)

Parkinson's Laws are great. I love the one about how no organization ever gets its perfect office building until it is in decline. It reminds me of Apple's newly opened $5 billion headquarters building that Apple top management spent much of the last decade working on rather than new products,

It seems that those who are aware of it either dismiss it as satire or just ignore it. It really should be taken as a serious look at organisational behavior, both private and gov. It'll be interesting if the new Amazon HQ pans out the same.

Right. "Parkinson's Laws" is a wonderful little book. Lots of ideas for empirical researchers to test ...

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