Internal competition at work: Worth the trouble?

January 25, 2012, 5:45 PM UTC

FORTUNE — You would never hear a management consultant advise a company to create a more cutthroat environment. “You know what we need here? Fear. More backstabbing.”

No, collaboration seems to be the word of choice for management experts and informed CEOs alike. “Collaboration is fundamentally the best approach towards management,” says Michael Serino, executive director of Human Capital Development at Cornell’s Industrial and Labor Relations School. Whether it’s accurate or not, most people in business today tend to believe that collaborative work delivers better results.

And yet, several Fortune 500 companies foster competitive internal environments. Consulting companies and law firms are famous for this. They tend to have an “up or out” promotion model — everybody wants to make partner, and after a certain point, people either move up to those coveted positions or they are encouraged to find employment elsewhere.

Take Goldman Sachs (GS). Every couple of years, the company promotes roughly a hundred employees to partner. It’s a big deal — those select few receive a significant raise in salary and equity in the company. But there are fewer than 500 partners out of 35,000 employees at the firm. People are weeded out on the way up, and though it’s rare, they can even get de-partnered once they reach the top.

Other companies have implemented hiring practices that would seem to spur internal competition. Former GE  CEO Jack Welch was known for championing a “forced ranking” system. Top GE (GE) executives would rank employees by performance, and they generally let the bottom 10% go. PepsiCo is also known for having a high churn rate among employees. “It seems to work for them,” says Mark Jaffe, president of executive search firm Wyatt & Jaffe, adding that the people who survive the system carry that cachet with them when they look for other jobs.

That can help mitigate the negative effects of an up-or-out model, such as having your staff feel terrified of losing their jobs. “If you think about McKinsey, it has always been an example of ‘up or out,’ but ‘out’ is not such a bad place,” Serino says. People who leave often get good offers elsewhere. He adds, “The rules of the game are very clear to everybody coming in. It’s up or out, ranked performance, it’s, ‘go go go.’”

Still, there is a down side to the competitive environment. For one, employees who feel pitted against one another can devote valuable time and energy trying to figure out how to outshine their peers, instead of trying to figure out how to best contribute to projects, says Serino.

Also, there’s strong evidence that some employees perform worse just knowing they’re going to be ranked. In a controlled study of a randomized group of employees at Amazon’s crowd-sourcing website Mechanical Turk, Wharton professor Iwan Barankay found that participants who knew they were ranked were generally less productive than those who didn’t, and that’s especially true for people who found out that they performed worse than their peers. The news didn’t motivate them, they just checked out.

But companies can actually use a competition to encourage a collaborative environment, says Dick Grote, chairman and CEO of Grote Consulting. Grote has worked with PepsiCo (PEP), and he says management there bases 40% of an employee’s annual bonus on how well he or she helps promising colleagues develop their careers at the company. People will collaborate when they’re ranked on how well they work with others, Grote says.

Grote claims that one of the benefits of forced ranking and other competitive measures is that it compels managers to actually assess their employees, which many top executives don’t do well.

But there are other options. There’s nothing that says firms have to be structured to encourage everyone to strive for partner. “In an up–or-out model, the best consultants in the world get pushed out,” says Dan Reardon, CEO of global consulting group North Highland.

Reardon’s firm takes a different approach, and allows good consultants to keep their jobs as consultants, while other people focus on responsibilities that typically fall to partners, such as sales. Also, Reardon says, all employees, not just partners, have equity in the company. “Part of the core of our culture at North Highland is to have more camaraderie. We want everybody focused on client success, not individual success.”

Culture is actually the most important factor when considering whether or not to encourage competition. Executives are always looking around for the best practices out there, says Serino, and some could consider forced ranking: “It’s easy to become enamored of perceived success, but then when you try to transplant it, it potentially can get botched.”

While there are ways to take the edge off of a business that has a fiercely competitive environment, it’s very difficult to turn a company that isn’t cutthroat into one that is. And given the benefits many companies are finding from focusing on collaboration, you probably wouldn’t want to anyway.

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