Alas, in practice, performance evaluations too often result in the employee feeling unfairly judged and, in turn, demotivated. Bosses don't like doing formal reviews because they require much preparation and paperwork. Another disadvantage: bosses may feel an annual review can largely replace ongoing, just-in-time, informal feedback.
It is the latter, evaluating by walking around, that is usually most useful. Unless dealing with a remote workforce, the good boss spends a lot of time walking around among the supervisees, stopping to give attaboys/girls, and asking "How are things going?"
The boss might accept the typical "fine," or follow up with, for example, "Any way I can be of help to you?" Sometimes, the employee will ask for additional resources, which you may or may not want to give, but sometimes will elicit a request for your evaluation or guidance.
Whether or not you're evaluating by walking around, if you think there's a problem with an employee, unless s/he suffers from clearly too-high self-confidence and thus needs a wake-up call, start with tact and good listening. For example,
John, I've noticed that your reports (or whatever) haven't been great. Anything I can do to help, or is there something I need to understand that explains it?
Then listen carefully. Indeed, there may be a reasonable explanation. Then, if possible, instead of imposing a solution, let alone a punishment, it's wise to ask, "So what if anything do you propose we do?" Even if you don't fully agree or you doubt that will solve the problem, it's usually wise to say, "Fair enough. Let's try it." Your simply having raised the issue while being face-saving, not punitive, may be enough to sufficiently improve the employee's performance.
If that light hand turns out insufficient, you can always later offer suggestions, a structure for accountability, or if necessary, termination. It's usually wise to be punitive only if the aforementioned good-cop approach is unsuccessful--a confrontation often yields worse problems than it alleviates.
That said, many employers make the mistake of not cutting their losses early enough. In general, employers quickly know if it's wiser to replace an employee or to keep trying to get the employee to improve.
Unfortunately, today, dismissing an employee usually demands much stressful effort: months of written documentation of poor performance, and often contentious meetings to discuss an improvement plan with the employee. The whole process usually engenders defensiveness, may well hurt performance, and even cause the employee to sabotage your business and/or start legal action.
It's often wiser to try to counsel-out the employee, for example, "As you know it's been a bit of a struggle. You have real strengths (insert), which aren't made best use of on this job. How'd you like me to try to help you find a better-suited position in or perhaps outside the company?" Indeed, many people who perform poorly in one job could do better with different responsibilities or with a different boss or coworkers.
If You're Getting a Performance Review
Collect a goodie file: kudos, list of accomplishments, especially those that would build the bottom line. Send it to your boss in advance of your review, saying you hope these will be considered in the review.
Many employees exacerbate the effect of a negative evaluation by their response. Even if you're furious, don't respond right away. If you can muster up the restraint, say something like, "I appreciate the candid feedback. Of course, it's difficult to swallow so I'd like to take a few days to let it sink in." Then, with your reflexive anger likely reduced, you're more likely to respond wisely.
If you ethically can, say, "I'll work on it." If you can't, it's usually wise to respond gently, for example, "I thought my work has been better than that. Could you give me examples to help me better understand?" If you sense there is legitimacy to your boss's concern, you might ask the boss for a bit of help in improving. That would increase your boss's investment in you. I know it's not easy to stay on your A game when attacked, but it's usually worth trying to exercise restraint.
Employee evaluations are often dreaded by both employees and employers, but handled with delicacy and emphasizing just-in-time, informal, situation-specific feedback, dispensed in a positive face-saving way, performance review can be among the most beneficial components of a manager's job and of real benefit to employees.