Milkovich/Newman: Compensation, Ninth Edition

Chapter 10

McGraw-Hill/Irwin

Pay-forPerformance
Plans

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

STRATEGIC
POLICIES
ALIGNMENT

COMPETITIVENESS

CONTRIBUTION

STRATEGIC
OBJECTIVES

TECHNIQUES

Work
Descriptions
Analysis

Market
Surveys
Definitions

Seniority
Based

Evaluation/
Certification

Policy
Lines

Performance
Based

Merit
Guidelines

INTERNAL
STRUCTURE

PAY
STRUCTURE

INCENTIVE
PROGRAMS

EFFICIENCY
Performance
Quality
Customers

Stockholders
Costs
FAIRNESS

ADMINISTRATION

Planning Budgeting Communication EVALUATION

COMPLIANCE
10-2

Employee performance depends on three

general factors:
Employee performance = f (S,K,M)
where:
S = Skill and ability to perform task
K = Knowledge of facts, rules,
principles, and procedures
M = Motivation to perform

10-3

What Behaviors Do Employers

Care About?
How

do we get good employment prospects to

join our company?
How do we retain these good employees once
they join?
How do we get employees to develop skills for
current and future jobs?
How do we get employees to perform well on
their current job?

10-4

What Motivates Employees?

In the simplest sense, motivation involves three
elements:
1. what is important to a person, and
2. offering it in exchange for something
3. desired behavior

10-5

Components of a Total Reward System

1. Compensation
2.. Benefits

Wages, Commissions and Bonuses

Vacations, Health Insurance

3. Social Interaction
4. Security

Friendly Workplace
Stable, Consistent Position and Rewards

5. Status / Recognition

Respect, Prominence Due to Work

6. Work Variety

Opportunity to Experience Different Things

7. Workload

Right Amount of Work (not too much, not too little)

8. Work Importance

Is Work Valued by Society

9. Authority / Control / Autonomy Ability to Influence Others; Control Own Destiny

10. Advancement
11. Feedback

Chance to Get Ahead

Receive Information Helping to Improve Performance

12. Work Conditions

13. Development Opportunity

Hazard Free
Training to Learn New Knowledge / Skills / Abilities
10-6

Base Pay

Cost of Living
Increase

Merit Pay

Lump Sum
Bonus
Wage
Wage
Components
Components

Individual
Incentive

Success
Sharing Plans

Gain Sharing

Risk
Sharing Plans

Profit Sharing

10-7

The Fit Between People and Rewards

Person Characteristics

Preferred Reward Characteristics

Materialistic

Relatively more concerned about pay level

Low Self-Esteem

Low self-esteem individuals want large,

decentralized organization with little pay for
performance
Want more pay based on performance

Risk Takers

Individualists
Want pay plans based on individual
(I control my destiny) performance, not group performance

10-8

What Is Pay-for-Performance?

Pay for performance plans signal

a movement away from
entitlements
Pay will vary with some measure
of individual, team, or
organizational performance
10-9

Overview: Pay-for-Performance Plans

Use of Different Variable- Pay-Plan Types
Base vs. Variable Pay
Increasing

interest in variable pay

Competition from foreign competitors

Fast-paced business environment

10-10

Exhibit 10.1: Use of Different

Variable-Pay-Plan Types

10-11

Exhibit 10.2: Base vs. Variable Pay

10-12

Specific Pay-for-Performance Plans:

Short Term
Merit Pay
Lump-Sum Bonuses
Individual Spot Awards
Individual Incentive Plans

10-13

Merit Pay
A merit

pay system links increases in base pay

to how highly employees are rated on a
subjective performance evaluation
Issues
Expensive
Doesnt achieve the desired goal: improving
employee and corporate performance
Very small impact on performance.
10-14

Managing Merit Pay

Improve

accuracy of performance ratings

Allocate

enough merit money to truly reward

performance

Make

sure size of merit increase differentiates

across performance levels

10-15

Lump-Sum Bonuses
Increasingly

used substitute for merit pay

Employees

receive an end year bonus that does

not built into base pay

Viewed

as less of an entitlement than merit pay

because it must be earned by employees.

Less

expensive than merit pay over the long run

10-16

Exhibit 10.3: Relative Cost

Comparisons

10-17

Individual Spot Awards

Viewed

as highly or moderately effective

Typically

awarded for exceptional performance

Special projects
Exceptional performance

10-18

Exhibit 10.4: Customer Service Bonus

Scheme

10-19

Overview: Individual Incentive Plans

Offer

a promise of pay for some objective, preestablished level of performance eg Cellular

One car phone installation

Common

feature - An established standard

against which employee performance is
compared to determine magnitude of incentive
pay
10-20

Individual Incentive Plans: Types

Dimension

on which incentive systems vary

Method of rate determination

Specified relationship between production level and
wages

10-21

Exhibit 10.5: Individual Incentive Plans

10-22

Straight Piecework System

Rate

determination is based on
units of production per time
period, and wages vary directly
as a function of production
level.
Easily understood by the
worker and readily accepted by
them.

10-23

Standard Hour Plan

It

is a plan setting for the incentive

rate based on completion of a task
in some expected time period. Eg
automobile repair shop
It is practical than straight
piecework plans for long-cycle and
jobs that are non repetitive and
require numerous skills for
completion.

10-24

Bedeaux Plan

This

plan requires division

of a task into simple actions
and determination of the
time required by an average
skilled worker to complete
the action.
10-25

Taylor Plan
This

plan provides for variable

incentives as a function of units
of production per time period.
It provides for different piece
rates, depending on the level of
production relative to the
standard.
10-26

Taylor Plan
It

establishes two plans

One rate goes into effect when a
worker exceeds the published
standard for a given period of
time.
This rate is set higher than the
regular wage incentive level.
10-27

Taylor Plan

A second

rate is
established for
production below
standard, and this rate is
lower than the regular
wage
10-28

Merrick Plan
In

this plan there is three piecework

rates:
High- for production exceeding 100
percent of standard
Medium for production between
83 percent and 100 percent
Low for production less than 83
10-29

Halsey 50-50 Plan

This

method derives its name from the

shared split between worker and
employer of any savings in direct
cost..
An allowed time is fixed for the
completion of a work and if work is
completed within the standard time
the savings is allocated between the
10-30

Rowan Plan

Plan

same as Halsey but

workers bonus increases
as the time required to
complete the work
decreases.
10-31

Gantt Plan
The

standard time for a task is purposely set at a

level requiring high effort to complete.
Worker failing to complete the task in the
standard time is guaranteed a pre-established
wage.
If task completed, earnings
120 % of the time saved.

are payed at

Hence workers earnings increase faster than

production whenever standard time is met .
10-32

Advantages of
Individualized Incentive Plans
Substantial

contribution to:

Productivity raise
Lower production costs
Workers earnings
Reduces

direct supervision to maintain

reasonable output levels

Enables

labor costs to be estimated more

accurately
Helps costing and budgetary control
10-33

Disadvantages of
Individualized Incentive Plans
Conflicts

may emerge between employees and

managers
Introduction

of new technology may be resisted

by employees

Reduced

willingness of employees to suggest

new production methods

Increased

complaints of poor maintenance,

hindering employee efforts to earn larger
10-34

(cont.)
Increased

turnover among new employees

discouraged by the unwillingness of experienced
workers to cooperate in on-the-job training

Elevated

levels of mistrust between workers and

management

10-35

Team Incentive Plans

Group

Incentive Plans focus on people

working together.
A Standard is established against which
group performance is compared to
determine the magnitude of the incentive
pay.
Team Incentive plans improved customer
satisfaction, raised sales performance and
lowered turnover rates.
10-36

Team Incentives
Improve organizational performance
Use organizational measures
Measured periodically

10-37

Team Compensation: Issues and

Problems
Many

varieties of teams

Level

problem

Complexity
Control
Communication
10-38

Company rewarding system

Company

set team performance

standards based on :
Productivity improvement
Customer satisfaction measures
Financial performance
Quality of goods and services etc

10-39

Gain-Sharing Plans

Employees

earn
bonuses tied to unitwide performance as
measured by a
predetermined, gain
10-40

Cont
Gain

sharing looks at cost

components of income ledger
and identifies savings like:
Reduced scrap
Lower labour cost
Reduced utility cost etc

10-41

How does Gain sharing work?

A Company

shares productivity gains with the

workforce.
Workers voluntarily participate in management
to accept responsibility for major reforms. This
type of pay is based on factors directly under a
workers control (i.e., productivity or costs).
Gains are measured and distributions are made
frequently through a predetermined formula.
Because this pay is only implemented when
gains are achieved and gain sharing plans do
not adversely affect company costs.
10-42

Example of Gain sharing formulas

Calculate

gain in hours

The actual hours worked

minus the expected hours
(for the given level of output)
equals the gain in hours.
10-43

When does Gain sharing work best

Works best when company performance
levels can be easily quantified.
Employee involvement significantly
enhances the effectiveness of incentive
pay.
When used simultaneously, productivity
gains from combining these techniques can
exceed gains achieved separately.

10-44

Key Elements in Designing

a Gain-Sharing Plan
Strength

of reinforcement
Productivity standards
Sharing the gains
Scope of the formula
Perceived fairness of the formula
Ease of administration
Production variability(setting targets)
10-45

Types of Gain-Sharing Plans

Scanlon

Plan

Ratio is calculated that expresses value of production

required for each rupee of total wage bill
Designed to lower labor costs without lowering level
of a firms activity
Incentives are derived as a function of ratio between
labor costs and sales value of production (SVOP)
SVOP includes sales revenue and value of goods in
inventory
10-46

Types of Gain-Sharing Plans

Implementation

of Scanlon/Rucker

Plans
Two major components are vital
to implementation and success
Productivity norm
Effective worker committees
10-47

Exhibit 10.15: Examples of a Scanlon

Plan

10-48

Types of Gain-Sharing Plans (cont.)

Improshare (Improved productivity through

sharing)
Standard is developed that identifies expected hours
required to produce an acceptable level of output
Standard fixed by time and motion study by
industrial engineers.
Any savings arising from production of agreed-upon
output in fewer than expected hours is shared by
firm and workers
10-49

Profit-Sharing Plans
An incentive based compensation program to
award employees a percentage of the company's
profits.
Profit sharing work best When company
earnings are relatively stable (or steadily
increasing).

Predetermined

index of profitability

Employees may not feel their jobs directly impact

profits

10-50

How does Profit sharing work?

The

company contributes a portion of

its pre-tax profits to a pool that will be
distributed among eligible employees.
The amount distributed to each
employee may be weighted by the
employee's base salary so that
employees with higher base salaries
receive a slightly higher amount of the
shared pool of profits. Generally this
10-51

Cont
The

trend in recent variable-pay design is to

combine the best of gain-sharing and profitsharing plans
The plan must be self funding
Along with having the financial incentive,
employees feel they have a measure of control
Eg. Airline give incentive based on reduction in lost
baggage.
10-52

Earnings-at-Risk Plans
Success

sharing plan

Employee base pay is constant

Variable pay increases in successful years
No reduction in base pay and no variable pay in poorlyperforming years

Risk

sharing plan

Employee base pay varies

Base pay often reduced in poor performance years
Shifts part of risk of doing business from company to
employee
10-53

Exhibit 10.16: Group Incentive Plans:

Advantages and Disadvantages

10-54

Example of Group
Incentive Plan - Saturn
Earnings-at-risk

plan where base pay is 93% of

market
Employees meet individual objectives to capture
at-risk component
All team members must meet objectives for any
to get at-risk money
A profit sharing component is based on
corporate profits
10-58

Group Incentive Plans: Examples

All

incentive plans can be described by common

features
The size of the group that participates in the plan
The standard against which performance is
compared
The payout schedule

10-60

Explosive Interest in Long-term

Incentive Plans
Long-term

incentives (LTIs) focus on

performance beyond the one-year time line used
as the cutoff for short-term incentive plans
Recent explosive growth in long term plans is
spurred in part by a desire to motivate longerterm value creation

10-61

Long-Term Incentive Plans

Employee Stock Ownership Plans
(ESOPs)

Performance Plans (Performance

Share and Performance Unit)

Broad-Based Option Plans (BBOPs)

10-62

Employee Stock Ownership Plan

(ESOP)
An

ESOP is a defined contribution

employee benefit plan that allows
employees to become owners of
stock in the company they work
for. It is an equity based deferred
compensation plan. Several
features make ESOPs unique as
compared to other employee
benefit plans.

10-63

How does ESOP work?

The

ESOP operates through a trust, setup by

the company, that accepts tax deductible
contributions from the company to purchase
company stock.

The

contributions made by the company are

distributed to individual employee accounts
within the trust.
10-64

Cont
The

amount of stock each individual receives

may vary according to pre-established
formulas based on salary, service, or position.

The

employees may cash out after vesting in

the program or when they leave the company.
The amount they may cash out may depend
on requirements.
10-65

Cont
When

an ESOP employee who has

at least ten years of participation in
the ESOP reaches age 55, he or she
must be given the option of
diversifying his/her ESOP account
up to 25% of the value. This option
continues until age sixty, at which
time the employee has a one-time
option to diversify up to 50% of
his/her account.

10-66

Cont
Employees

receive the vested portion of their

accounts at either termination, disability,
death, or retirement. These distributions may
be made in a lump sum or in installments
over a period of years.

If employees become disabled or die, they or

their beneficiaries receive the vested portion
of their ESOP accounts right away.
10-67

Companies offering ESOPs

PepsiCo
DuPont
Coca-Cola
Microsoft

etc
10-68

Overall Effectiveness of Alternative Reward

Plans
Type of Plan

Gainsharing

% of companies reporting
significant business result
impact
30

Team/small group
incentive

31

Individual incentive

20

Project incentive

29
10-69

Types of Variable Pay Plans: Advantages and Disadvantages

10-70

Types of Variable Pay Plans: Advantages and

Disadvantages-cont

10-71

The Choice Between

Individual and Group Plans

10-72

THANK YOU!!
10-73