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Pay-for-Performance

Plans

Chapter

10

Screen graphics created by:

Jana F. Kuzmicki, PhD

Troy State University-Florida and Western Region

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1. Discuss reasons for the popularity of pay-for-performance reward plans.

2. Describe the key differences among thecategories short-term, team-based, long-term

of pay-for-performance plans.

3. Identify the advantages and disadvantages ofindividual incentive plans.

4. Explain why an organization might choose agroup rather than an individual incentive

system.5. Clarify the criteria involved in determiningwhich type of group incentive plan best fits anorganizations objectives.

6. Identify the advantages and disadvantages of

group incentive plans.

Learning ObjectivesAfter discussing Chapter 10, students should be able to:

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Chapter Topics

What Is a Pay-for-performance Plan?

Does Variable Pay Improve Performance

Results? General Evidence

Specific Pay-for-performance Plans:

Short Term

Team Incentive Plans: Types

Explosive Interest in Long-term

Incentives

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Pay for performance plans signala movement awayfrom

entitlements.

Pay will vary with some measureof individual, team, or

organizational performance.

What Is Pay-for-Performance?

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Purposes of Pay-for-Performance

Attain strategic goals

Reinforceorganizational norms

Motivateperformance at individual,

group, andorganizational levels

Recognizedifferential employee

contributions

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Obstacles to Pay-for-Performance

Difficulties in specifying andmeasuring

job performance

Problems in identifying valuedrewards

Difficulties in linking rewards to job

performance

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Overview: Pay-for-Performance Plans

Types ofplans

Exhibit 10.1: Useof Different Variable-

Pay-Plan Types

Exhibit 10.2: Basevs. Variable Pay

Increasing interest in variablepay

Competition fromforeign competitors

Fast-paced business environment

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Exhibit 10.1: Use of DifferentVariable-Pay-Plan Types

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Exhibit 10.2: Base vs. Variable Pay

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Pay-for-Performance Plans: Short Term

Merit Pay

Lump-Sum Bonuses

Individual Spot Awards

Individual Incentive

Plans

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Issues: Rewarding PerformanceWith Merit Pay Increases

Expense

Improving employee andorganizational performance

Permanence

Individual focus

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Managing Merit Pay

Improve accuracyofperformanceratings

Allocateenough money to trulyreward

performance

Make sure sizeofmerit increase

differentiates across performance levels

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Lump-Sum Bonuses

Increasingly used substituteformerit

pay

Not built into basepay

Viewed as less ofan entitlement than

merit pay

Less expensive than merit payover the

long run

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Exhibit 10.3: Relative CostComparisons

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Exhibit 10.4: Customer Service BonusScheme

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Individual Spot Awards

Viewed as highlyormoderatelyeffective

Typically awardedforexceptional

performance

Special projects

Exceptional performance

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Overview: Individual Incentive Plans

All or a portion of an individuals payis tied

toemployeeperformance

Offer a promiseofpayfor someobjective,pre-established level ofperformance

Common feature- An established

standard against whichemployeeperformanceis

compared todetermine

magnitudeofincentivepay

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Exhibit 10.5: Individual Incentive Plans

Method of Rate Determination

Units of productionper time period

Time period per unitof production

(1) (2)

(4)(3)

Straight piecework

plan

Standard hour plan

Bedeaux plan

Halsey 50 - 50 method

Rowan plan

Gantt plan

Taylor differential

piece-rate system

Merrick multiple piece-

rate system

Pay constant function

of production level

Pay varies as functionof production level

Relationship

between

production level

and pay

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Exhibit 10.7: A Straight Piece Rate Plan

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Exhibit 10.9: Advantages of

Individualized Incentive Plans

Substantial contribution to: Raiseproductivity,

Lowerproduction costs,

Increaseearnings ofworkers.

Less direct supervision required tomaintainreasonable levels ofoutput than under

payment by time.

Systems ofpayment byresults (if accompanied

byimprovedorganizational andworkmeasurement) enable labor costs to be

estimatedmore accurately than underpayment

by time.

Helps costing and budgetary control.

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Greater conflict mayemerge between employees seeking tomaximizeoutput andmanagers concerned aboutdeteriorating quality levels.

Attempts tointroduce new technologymay beresisted byemployees concerned about impact on production

standards. Reducedwillingness ofemployees to suggest new

production methods forfearof subsequent increases inproduction standards.

Increased complaints that equipment is poorlymaintained,

hindering employeeefforts toearn largerincentives. Increased turnover among newemployees discouraged by

unwillingness ofexperiencedworkers to cooperatein on-the-job training.

Elevated levels ofmistrust between workers andmanagement.

Exhibit 10.9: Disadvantages ofIndividualized Incentive Plans

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Exhibit 10.10: Lincoln ElectricsCompensation System

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Improveorganizational performance

Useorganizational measures

Measuredperiodically

Overview of Team Incentives

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Exhibit 10.11: A Sampling ofPerformance Measures (1 of 2)

Customer-Focused Measures

Time to Market Measures

On timedelivery

Cycle time

Newproduct introductions

Customer Satisfaction

Measures

Market share

Customer satisfaction Customer growth and

retention

Account penetration

Financially-Focused Measures

Value Creation

Revenue growth

Resource yields

Profit margins

Economic value added

Shareholder Return

Return on invested capital

Return on sales / earnings

Earnings per share

Growth in profitability

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Capability-Focused Measures

Human Resources

Capabilities

Employee satisfaction

Turnoverrates

Total recruitment costs

Rateofprogress on

developmental plans

Promotabilityindex

Staffing mix/head-count

ratio

Other Asset Capabilities

Patents and copyrights

Distribution systems

Internal Process-FocusedMeasures

Resource Utilization

Budget-to-actual expenses

Cost allocation ratios

Reliability / rework

Accuracy / errorrates

Safetyrates

Change Effectiveness

Programimplementation

Teamwork effectiveness

Service / qualityindex

Exhibit 10.11: A Sampling ofPerformance Measures (2 of 2)

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Balanced Scorecard Approach

Uses a constellationofmeasuresPinpoints areas ofsuccess

Indicates areas toimprove

Categoriesofmeasures

Financial results

Process improvements

Customer service

Innovation

Forces discussions about priorities among

different measures

Outcome Objectives with different weights in

term

sof

impor

tance

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Exhibit 10.12: Types of Variable Pay Plans:Advantages and Disadvantages

Cash Profit SharingStock Ownership or

Options

Balanced Scorecard

Productivity / Gain-

SharingTeam / Group

Incentives

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Exhibit 10.13: The Choice BetweenIndividual and Group Plans

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Team Compensation:Issues and Problems

Manyvarieties of teams

Level problem

Complexity

Control

Communication

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Gain-Sharing Plans

Employees earn

bonuses tied to unit-

wideperformance as

measured by a

predetermined,

gainsharing formula

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KeyElements in Designinga Gain-Sharing Plan

Strength ofreinforcement

Productivity standards

Sharing the gains

Scopeof theformula

Perceivedfairness of theformula

Easeof administration

Production variability

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Types of Gain-Sharing Plans

Scanlon PlanDesigned to lower labor costs without

lowering level ofa firms activity

Incentives arederived as a function ofratio

between labor costs and sales valueofproduction (SVOP)

SVOP includes sales revenue andvalueofgoods in inventory

Rucker PlanRatiois calculated that expresses valueof

production requiredforeach dollarof totalwage bill

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Types of Gain-Sharing Plans (Coninued)

Implementation of Scanlon/Rucker PlansTwomajor components arevital to

implementation and success

Productivity norm

Effectiveworker committees

Improshare

Standardis developed that identifiesexpected hours required toproduce anacceptable level ofoutput

Any savings arising fromproduction ofagreed-upon output in fewer than expectedhours is shared byfirm andworkers

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Exhibit 10.14: Three Gain-Sharing Formulas

Total standard

value hours

Value addedNet sales (plus

or minus

inventories)

Denominator of

ratio (output

factor)

Actual hoursworked

Labor costPayroll costsNumerator ofratio (input

factor)

ImproshareRucker PlanScanlon Plan(Single ratio volume)

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Exhibit 10.15: Examples of a Scanlon Plan

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Profit-Sharing Plans

Focus Predeterminedindex ofprofitability

Employees receive annual bonus or

shares in company based upon company-wideperformance

Paidin cash or

Deferredinto a retirement plan

Issue

Employees may not feel their jobs directly

impact profits

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Earnings-at-Risk Plans

Success sharing planEmployee basepayis constant

Variablepayincreases in successful years

Noreduction in basepay and novariablepay

in poorly-performing yearsRisk sharing planEmployee basepayvaries

Basepayoften reducedin poorperformance

years Rewards typically higher than success-sharing

plans in high-performance years

Shifts part ofrisk ofdoing business fromcompany toemployee

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Exhibit 10.16: Group Incentive Plans:Advantages and Disadvantages

Advantages

Positiveimpact on

performanceof about

5-10%/yr.

Easeofmeasurement

Cooperation valued

Support of teamwork

Increases

participation in

decision-making

Disadvantages

Lineof sight lessened

Increased turnover

Increasescompensation risk to

employees

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Exhibit 10.17: Example of GroupIncentive Plan - GE Information Systems

A team-basedincentivewith links toindividual payouts

Team andindividual performance goals

are setIf team hits its goals, teammembers earn

theirincentiveonlyif they also hit their

individual goals

Teamincentiveis 12% to15%ofmonthly

basepay

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Exhibit 10.17: Example of GroupIncentive Plan - Corning Glass

A gain-sharing program (goal sharing)where75%ofpayout is basedon unit

objectives such as:

Qualitymeasures

Customer satisfaction measures

Production targets

Remainderis basedon Cornings return

on equity (ROE)

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Exhibit 10.17: Example of GroupIncentive Plan - 3-M

Operates with an earnings-at-risk plan

Basepayfixed at 80%ofmarket

Employees have a set ofobjectives to

meet forpay tomove to100%ofmarketAdditionally, thereis a modest profit

sharing component

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Exhibit 10.17: Example of GroupIncentive Plan - Saturn

Earnings-at-risk plan where basepayis93%ofmarket

Employees meet individual objectives to

capture at-risk componentAll teammembers must meet objectives

for any to get at-risk money

Aprofit sharing component is basedon

corporateprofits

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Exhibit 10.17: Example of GroupIncentive Plan - Du Pont Fibers

Earnings-at-risk whereemployees receivereducedpayincreases over5 years,

resulting in 6% lower basepay

Ifdepartment meets annual profit goal,employees collect all 6percent

Variablepayout ranges from0 (reach less

than 80%ofgoal) to12% (150%of goal)

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Long-Term Incentive Plans

Employee Stock Ownership PlansEmployee Stock Ownership Plans

(ESOPs)(ESOPs)

Performance Plans (PerformancePerformance Plans (Performance

Share and Performance Unit)Share and Performance Unit)

BroadBroad--Based Option Plans (BBOPs)Based Option Plans (BBOPs)

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Exhibit 10.18: Long-Term Incentives andTheir Risk/Reward Tradeoffs

Level One: Low

Risk/Reward

Time-basedrestricted

stock

Performance

acceleratedrestricted

stock

Stock purchaseplan

Level Two: Medium

Risk/Reward

Time-vested stock

option

Performance-vested

restricted stock

Performance

accelerated stockoption

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Level Three: High

Risk/Reward

Premium-priced stock

optionIndexed stock option

Performance-vested

stock option

Exhibit 10.18: Long-Term Incentives andTheir Risk/Reward Tradeoffs

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Conditions for Effective VariablePay-for-Performance Plans

Plan is clearly communicated

Plan is understood

Rewards areeasy to calculate

Employees participatein administering plan

Employees believe they are being treated

fairly

Employees believe they can trust companyand they have security

Rewards are awarded as soon as possible

afterdesiredperformance

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Implications of VariablePay-for-Performance

When a substantial portion ofpayis tied toperformance, that portion becomes variable-can go upordown - based upon individual,group, or companyperformance

Natureofauthorityrelationships and status inorganization might change

Employees will demand andoperation ofsystems might requireincreased sharing ofinformation

Variablepay-for-performance systems willcreate heightenedpressureforperformance andcost containment within organization - pressurewill comefrommanagers andemployees