Pay-for-perfoomance plan

7/29/2019 Pay-for-perfoomance plan

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Pay-for-Performance Plan

WHAT IS PAY-FOR-PERFORMANCE-PLAN

Pay-for-performance plans signal a

movement away from entitlement….sometimesa very slow movement toward pay that varieswith some measure of individual ororganizational performance.

Many of the surveys on pay forperformance tend to omit the grandfather of allthese plans, merit pay.



Percent of companies with plan

Type of Plan 1996 1998 1999 2002 2007

Special Recognition plans 44 51 59 34 72Stock option plans 21 46 43 40

Individual incentive plans 17 35 39 38 49

Cash profit sharing 22 22 23 18 16Gain sharing plans 16 20 18 11 10

Team awards 13 17 15 8 32



The greater interest in variable pay probably

can be traced to two friends:

1. The increasing competition from foreign

producers forces American firms to cut costsand/or increase productivity.

2. Today’s fast-paced business environment

means that workers must be willing to adjustwhat they do and how they do it.



DOES VARIABLE PAY IMPROVE PERFORMANCE

RESULTS? THE GENERAL EVIDENCE

Pay-for-Performance plans, those that introduce

variability into the level of pay you receive, seem

to have a positive impact on performance if

designed well. Notice that we have qualified our

statement that variable-pay plans can be

effective if they are designed well.



SPECIFIC PAY-FOR-PERFORMANCE PLANS: SHORTTERM MERIT PAY

A merit pay system links increases in base pay

(called merit increases)to how highly employees are

rated on a performance evaluation.

Well Above Above Below Well Below

Average Average Average Average Average

Performance 1 2 3 4 5Rating

Merit pay 5% 4% 3% 1% 0%

increase



At the end of the performance year, the

employee is evaluated, usually by the direct

supervisor. The performance rating, 1 to 5 in theabove example, determines the size of the

increase added into base pay. This last point is

important.

Increasingly, merit pay is under attack. Not only is it

expensive, but many argue it doesn’t achieve the

desired goal: improving employee and corporate

performance. In a thorough interview of merit payliterature, though, Heneman concludes that merit

pay does have a small, but significant, impact on

performance.



High performance ratings are nearly always

statistically related to high merit increases and

the reverse holds too. Departments andstrategic business units with better merit pay

programs have higher subsequent

performance. And removal of merit payappears to result in lower subsequent

performance, as well as lower satisfaction

among top performance. A final argument for

merit pay centers on the sorting effect we

discuss throughout our sections on variable

pay impacts.



Lump-Sum Bonuses

Lump-sum bonuses (or awards) are thoughtto be substitute for merit pay. Based onemployee or company performance, employeesreceive an end-of-year bonus that does not buildinto base pay.

Individual Spot Awards

Technically, spot awards should fall underpay-for-performance plans. About 35 percent of all companies use spot awards. And animpressive 74 percent of companies in onesurvey reported that these awards were eitherhighly of moderately effective.



Individual Incentive Plans

these plans differ from the merit and lump

sum payments because they offer a promiseof pay for some objective, pre establishedlevel of performance.

When this reverse incentive plan (penaltyfor poor performance rather than reward forgood) was implemented, vehicle damagedropped 70%. This is but one of many studies

showing pretty conclusive evidence thatindividual incentive plans increaseperformance substiantially.



All incentive plans have one common feature:

an established standard against which worker

performance is compared to determine themagnitude of the incentive pay. For individual

incentive systems, this standards is compared

against individual worker performance.

1. The first dimension on which incentive system

vary is in the method of rate determination. Plans

set up a rate based either on units of production

per time period or on time period per unit of

production. On the surface, this distinction may



appear trivial, but, in fact, the deviations arise

because tasks have different cycles of

operation. Short-cycle tasks, those that arecompleted in a relatively short period of time,

typically have as a standard a designated

number of units to be produced in a giventime period.

2. The second dimension on which individual

incentive systems vary is the specifiedrelationship between production level and

wages.



there are four general categories of plans:

1. Cell 1: the most frequently implemented

incentive system is a straight piece work

system. Rate determination is base on units of

production per time period and wages vary

directly as a function of production level.

the major advantages of these types of

system:

it is easily understood by workers and perhapsconsequently, is more readily accepted than some

of the other incentive systems.



2. Cell 2

To relatively common plans set standards base on time

per unit and tie incentives directly to level of output.a. standard hour plans – is a generic term for plans

setting the incentive rate base on completion of a task

in some expected time period.

b. Bedeaux plans

3. A beadeaux plan provides a variation on straight

piecework and standard hour plans. Instead of timing

an entire task, a bedeaux plan requires division of a

task into simple action and determination of the task

required by an average skilled worker to complete its

action.



4. Cell 3

the two plans included in Cell 3 provide for

variable incentives as a function units of production per time period:

a. Taylor plan – establishes two piece work rates.

One rate goes into effect when a worker exceeds

the published standards for a given time period. A

second rate is established for production below

standard in this rate is lower than the regular

wage.



b. Merrick system – operates in the same wayexcept that 3 piecework rates are set:

1. high for production exceeding 100percent of standard.

2. medium for production between 83 and

100 percent of standard.3. low for production less than 83 percent

of standard.

5. Cell 4: the three plans included in cell 4provide for variable incentives linked to astandard expressed as a time period per unitof production.



The Halsey 50-50 method derives its name

fro the shared split between worker and

employer of any savings in direct cost.The Rowan plan is similar to the Halsey

plan in that an employer and employee both

share in savings resulting from workcompleted in less than standard time.

The Gantt plan differs from both the

Halsey and the Rowan plans in that thestandard time for a task is purposely set at a

level requiring high effort to complete.



INDIVIDUAL INCENTIVES PLAN: ADVANTAGES AND

DISADVANTAGES

This is a common problem with incentive plans:

• Employees and managers end up in conflict

because the incentive system often focuses only

on one small part of what it takes for the company

to be successful.

• Employees, being rational, do more of what theincentive system pays for.



ADVANTAGES AND DISADVANTAGES OF

INDIVIDUAL INCENTIVE PLANS

Advantages

1. Substantial impact that raises productivity, lower

production costs, and increases earnings of workers.2. Less direct supervision is required to maintain

reasonable levels of output under payment by time.

3. In most cases, systems of payment by results, if

accompanied by improved organizational and workmeasurement, enable labor costs to be estimated

more accurate than under payment by time. This

helps costing and budgetary control.



Disadvantages

1. Greater conflict may emerge between employeesseeking to maximize output and managers concernsabout deteriorating quality levels.

2. Attempts to introduce new technology may beresisted by employees concerned about the impacton production standards.

3. Reduce willingness of employees to suggest newproduction methods for fear of subsequent increasesin production standards.

4. Increased complaints that is equipment is poorlymaintained, hindering employee efforts to earn largerincentives.



5. Increased turnover among new

employees discourage by the unwillingness

of experience workers to cooperate in on-the-job training.

6. Elevated levels of mistrust between

workers and management.



INDIVIDUAL INCENTIVE PLANS: EXAMPLES

Even though incentive systems are less popularthan they used to be, there are still notable

successes. Most sales positions have some part of

pay based on commissions, a form of individual

incentive. Perhaps the longest-running success

with individual incentive, going back to before

World War I, belongs to a company called Lincoln

Electric.



TEAMS INCENTIVE PLANS: TYPES

When we move away from individualincentive systems and start focusing on peopleworking together, we shift to group incentiveplans. A standard is established against whichworker performance (in this case, teamperformance) is compared to determined themagnitude of incentive pay. Whit the focus ongroups, now we are concerned about groupperformance in comparison against some

standard, or level, of expected performance. Thestandard might be an expected level of operatingincome for a division.



Failures of team incentive schemes can beattributed to at least five causes

1. First, one of the problems with teamcompensation is that teams come with anyvarieties. There are even full-time teams thatare temporary. (e.g., cross-functional teamspulled together to help ease the transition into apartnership or join venture).

2. A seconds rewarding teams is called “levelproblem”. If we define teams at the very broad

level --- the whole organization being anextreme example --- much of the motivationalimpact of incentives can be lost.



3. The last three major problems with team

compensation involve the three Cs: complexity,

control, and communications.Some plans are simply too complex. Xerox’s

Houston facility had a gain sharing plan for teams

that required understanding a three dimensionalperformance matrix.

The second C is control. Praxair, a worldwide

provider of gases (including oxygen) extracted by

the atmosphere, works hard to make sure all its

team pay comes from performance measures

under the control of the team.



The final C is a similar factor in

compensation successes and failures:

communication. Team-based pay plans simplyare not well communicated. Employees asked

to explain their plans often flounder because

more effort has been devoted to designing theplan than to deciding how to explain it.



LARGE GROUP INCENTIVE PLAN

When we get beyond a small work team andtry to incentive large groups, there are generallytwo types of plans. Gain-sharing plans useoperating measures to gauge performance. Profitsharing plans use financial measures.

GAIN-SHARING PLANS

Employees share in the gains in these types of group incentives plans. With profit-sharingplans (surprise) the sharing involves someforms of profit.



The following issues are key elements in designing a gain-sharing plan:

1. Strength of reinforcement: What role should base payassume relative to incentive pay? Incentive pay tends toencourage only those behaviors that are rewarded.

2. Productivity standards: What standard will be used to

calculate whether employees will receive an incentivepayout?

3. Sharing the gains split between the management andworkers: Part of the plans must address the relative cutsbetween management and workers of any profit or

savings generated.4. Scope of the formula: Formulas can vary in the scope of

inclusions for both the labor inputs in the numerator andthe and the productivity outcomes of the denominator.



5. Great care must be exercised with such alternativemeasures, though, to ensure that the behaviorsreinforced actually affect the desired bottom-line

goal.6. Perceived fairness of the formula: One way to ensure

the plan is perceived as fair is to let employees voteon whether implementation should go forward. Thisunion participation in program design are twoelements in plan success.

7. Ease of administration: Sophisticated plans withinvolved calculations of profit or costs can becometoo complex for existing company information

systems.8. Production variability: One of the major sources of

problems in group incentive plans is failure to settargets properly.



Scanlon Plan Scanlon plans are designed to lower labor

costs without lowering the level of a firm’sactivity. Incentives are derived as a function of the ratio between labor costs and sales valueof production (SVOP). The SVOP includessales revenue and the value of goods andinventory.

Rucker Plan

The Rucker plans involves a somewhatmore complex formula than a Scanlon plan fordetermining worker incentive bonuses.



Implementation of the Scanlon/Rucker Plan

To major components are vital to the

implementation and success of a Rucker or Scanlonplan: (1) a productivity norm and (2) effective workercommittees. Development of a productivity normrequires both effective measurement of base-year dataand acceptance by workers and management of this

standard for calculating bonus incentives.

The second ingredient of Scanlon/Rucker plans is aseries of worker committees (also known asproductivity committees or bonus committees). This

primary function of these committees is to evaluateemployee and management suggestions for ways toimprove productivity and/or cut costs.



Similarities and Contrasts Between Scanlon

and Rucker Plans

Scanlon and Rucker plans differ from

individual incentives plan in their primary

focus. Individual incentives plans focus

primarily on using wage incentives to motivatehigher performance through increase effort.

While this is certainly a goal of the

Scanlon/Rucker plans, it is not the major focusof attention.



Improshare

Improshare (Improved Productivity

through Sharing) is a gain-sharing plan thathas proved easy to administer and tocommunicate.

Profit-Share Plans

Productivity was much higher in plans

where payouts were that year than in planswere payment was deferred. Also, these plansworked much better in smaller (less than 775employees) companies.



Earnings-at-Risk Plans

We probably shouldn't separate earnings-

at-risk plans as a distinct category. In success-sharing plans, employee base wages areconstant and variable pay adds on duringsuccessful years. If the company does well,

you receive a predetermined amount of variable pay. If the company does poorly, yousimply forgo any variable pay --- there is noreduction in your base pay, though. In a risk-sharing plan, base pay is reduced by someamount relative to the level that would beoffered in a success-sharing plan.



Group Incentives Plans: Advantages andDisadvantages

Group for pay-for-performance plans aregaining popularity while individual plans arestable or declining in interest. Apparently thesuggestions employees are encouraged to make(how to do things better in the company)

gradually evolve from first order learningexperiences of a more routine variety(maintenance of existing ways of doing things)into suggestions that exhibit second-order

learning characteristics --- suggestions that helpthe organization break out of existing patterns of behavior and explore different ways of thinkingand behaving.



Advantages

1. Positive impact on organizations and

individual performance of about 5 to 10percent per year.

2. Easier to develop performance measures thatit is for individual plans.

3. Signals that cooperation, both within andacross groups, is a desired behavior.

4. Teamwork meets with enthusiastic support

from most employees.

5. May increase participation of employees indecision making process.



Disadvantages

1. Line-of-sight may be lessened, that is employees

may find it more difficult to see how theirindividual performance affects their incentivepayouts.

2. May lead to increased turnover among top

individual performers who are discouragedbecause they must share with lessercontributors.

3. Increases compensation risk to employeesbecause of lower income stability. May influencesome applicants to apply for jobs in firms wherebase pay is a larger compensation component.



Group Incentive Plans: Examples

All incentive plans, can be describe by common

features: (1) the size of the group thatparticipates in the plan. (2) the standards againstwhich performance is compared, and (3) thepayout schedule.

Explosive Interest in Long-Term Incentives Plan

Long-term incentives (LTIs) focus on performancebeyond the one-year line used as the cutoff forshort-term incentive plans. Recent explosivegrowth in long-term plans appears to be spurredin part by a desire to motivate long-term valuecreation.



Employees Stock Ownership Plans (ESOPs)

Some companies believe that employees can belinked to the success or failure of a company in yet

another way --- though employee stock ownershipplans. At places like PepsiCo, Lincoln Electric, DuPont,Coca-Cola, and others, the goal is to increase employeeinvolvement in the organizations, and hopefully this

will influence performance.Performance Plans (Performance Share and

Performance Unit)

Performance plans typically feature cooperate

performance objectives for a time three years in thefuture. They are driven by financial earnings or returnmeasures, and they pay out for meeting or exceedingspecific goals.



Broad-Based Option Plans (BBOPs)

The latest trend in long-term incentives,

and probably the component of compensationgenerating the most discussion in recent

years, is broad-based option plans. BBPOs are

stock giants: The company gives employeesshares of stock over a designated time period.

The strength of BBPOs is their versatility.

Depending on the way they are distributed to

employees, they can either reinforce a strong

emphasis on performance or inspire greater

commitment and retention of employees.



Combination Plans: Mixing Individual and

Group

It’s not uncommon for companies to useboth individual behavior and to insure thatemployees work together, where needed, topromote team and corporate goals. Thesecombination programs start with standardindividual (e.g., profit, operating income).

Self-funding plan, often favored by CEOs

who don’t like to make payouts when thecompany loses money. These plans specifythat payouts only occur after the companyreaches a certain profit target.

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Pay-for-perfoomance plan