About a decade ago, Microsoft famously ditched its controversial (and allegedly culture-killing) “stack ranking” employee review system.

Yet stack rankings, and other relative-ranking systems in which employees are rated against one another (often with the poorest performers seeing a pink slip), remain alive and well.

For one, they are relatively simple to execute: you can stack individuals in similar roles against one another and see who performs best. These systems also tend to provide strong performance incentives at low cost. “If I am forcing my team to compete with each other, I’m raising the bar for all of them,” as George Georgiadis, an associate professor of strategy at Kellogg, recently told Kellogg Insight.

And the benefits don’t stop there. But as Microsoft learned the hard way, there are also plenty of risks associated with relative-ranking systems. Today, we’ll explore some of these systems’ promises and pitfalls.

A useful buffer

Georgiadis explains that relative-ranking systems have a few less obvious (at least to this editor) benefits. For one, they provide a useful buffer against uncertainty about what constitutes good performance. Since any business operates under dynamic conditions, it can be difficult to know in advance what might help or hurt employees’ ability to execute or how a new product might fare in the market.

“If your salespeople are operating in a new territory or selling a new product, there’s a lot of uncertainty and you don’t know exactly what to expect,” Georgiadis says. “But if you reward people relative to each other, then those who sell the most will earn more.”

They offer an important benefit to employees, too. For example, imagine a pandemic hits and your salespeople can’t make their targets. If they are rewarded based on absolute sales, everyone’s compensation will plummet for reasons that have little to do with individual effort or talent. “But if they are ranked relative to their peers, this unexpected shock will filter out,” Georgiadis says.

Ruthless competition

And yet. The internal competition associated with relative ranking is not for everyone. It can push out otherwise excellent employees who are averse to the dog-eat-dog culture that can grow out of stack-ranking systems. It can also threaten teamwork: nobody wants their colleagues to succeed if that success comes at your expense!

It is possible to take this tendency into account when designing a relative-ranking system based on objective criteria. For instance, some companies rate employees on both their own individual performance and their broader team’s performance. But this can cause its own problems, leading to unbalanced team compositions where top performers gravitate to one another, leaving less-experienced employees without colleagues from whom they can learn.

Is it possible to get the best of both worlds: efficiency and competition as well as cooperation and mentorship? Maybe, but you will need to incentivize the precise kinds of cooperation and mentorship you want to see. “Ask yourself what you care about as a manager, what you want your team to do exactly, and then pay them to do that,” says Georgiadis. You can read the entire article in Kellogg Insight.