2. What is a Pay-for Performance Plan?What is a Pay-for Performance Plan?
This is a movement away fromThis is a movement away from
entitlement and a movemententitlement and a movement
toward pay that varies withtoward pay that varies with
some measure of individual orsome measure of individual or
organizational performance.organizational performance.
3. Words you will hear when you think ofWords you will hear when you think of
Performance PlanPerformance Plan
4. Does Variable Pay ImproveDoes Variable Pay Improve
Performance Results?Performance Results?
The general evidence has shown those thatThe general evidence has shown those that
introduce variability into the level of payintroduce variability into the level of pay
receive, seem to have a positive impact onreceive, seem to have a positive impact on
performance if designed well.performance if designed well.
5.
6. Specific Pay-for-Performance Plans:Specific Pay-for-Performance Plans:
Short TermShort Term
MERIT PAYMERIT PAY
LUMP-SUM BONUSESLUMP-SUM BONUSES
INDIVIDUAL SPOT AWARDSINDIVIDUAL SPOT AWARDS
7. SHORT TERM – cont’dSHORT TERM – cont’d
• INDIVIDUAL INCENTIVE PLANSINDIVIDUAL INCENTIVE PLANS
• INDIVIDUAL INCENTIVE PLANS: Advantages andINDIVIDUAL INCENTIVE PLANS: Advantages and
DisadvantagesDisadvantages
• INDIVIDUAL INCENTIVE PLANS: ExamplesINDIVIDUAL INCENTIVE PLANS: Examples
8. MERIT PAYMERIT PAY
• A system linking increases in base pay to performanceA system linking increases in base pay to performance
evaluations.evaluations.
• The performance rating determines the percentage of increase toThe performance rating determines the percentage of increase to
the base pay.the base pay.
• Competitive, high performing employees benefit most from meritCompetitive, high performing employees benefit most from merit
pay.pay.
9. A merit pay system links increases in base pay (called merit increases) to how highly employees are rated on a
subjective performance evaluation. Consider the following typical merit pay setup:
Well Above Above Below Well Below
Average Average Average Average Average
Performance rating 1 2 3 4 5
Merit pay increase 6% 5% 4% 3% 0%
At the end of a performance year, the employee is evaluated, usually by the direct supervisor.
The performance rating, 1 to 5 in the above example, determines the size of the increase added into base pay.
This last point is important. In effect, what you do this year in terms of performance is rewarded every year you
remain with your employer.
By building into base pay, the dollar amount, just like the Energizer bunny, keeps on going! With
compounding, this can amount to tens of thousands of dollars over an employee’s work career.
10. LUMP-SUM BONUSESLUMP-SUM BONUSES
•DOES NOT AFFECT BASE PAY.DOES NOT AFFECT BASE PAY.
•BASED ON EMPLOYEE OR COMPANY PERFORMANCE AND PAIDBASED ON EMPLOYEE OR COMPANY PERFORMANCE AND PAID
AS AN END-OF YEAR BONUS EVERY YEAR AS IT IS EARNED.AS AN END-OF YEAR BONUS EVERY YEAR AS IT IS EARNED.
11. INDIVIDUAL SPOT AWARDSINDIVIDUAL SPOT AWARDS
• Someone alerts top management to exceptional performance……Someone alerts top management to exceptional performance……
12. INDIVIDUAL INCENTIVE PLANSINDIVIDUAL INCENTIVE PLANS
AdvantagesAdvantages
•Substantial impact raising productivity, lowering production costsSubstantial impact raising productivity, lowering production costs
and increasing earners of workers.and increasing earners of workers.
•Requires less direct supervision.Requires less direct supervision.
•Systems of payment by results enable more accurate estimation ofSystems of payment by results enable more accurate estimation of
labor costs than payment by time.labor costs than payment by time.
13. INDIVIDUAL INCENTIVE PLANSINDIVIDUAL INCENTIVE PLANS
DISADVANTAGESDISADVANTAGES
•Greater conflict may emerge between employees seeking toGreater conflict may emerge between employees seeking to
maximize output and managers concerned with deterioratingmaximize output and managers concerned with deteriorating
quality levels.quality levels.
•Employees concerned about impact on production standards mayEmployees concerned about impact on production standards may
resist attempts to introduce new technology.resist attempts to introduce new technology.
•Reduced willingness of employees to suggest new productionReduced willingness of employees to suggest new production
methods fearing subsequent increases in production standards.methods fearing subsequent increases in production standards.
14. INDIVIDUAL INCENTIVE PLANSINDIVIDUAL INCENTIVE PLANS
DisadvantagesDisadvantages
•Increased complaints on poorly maintained equipment, hindersIncreased complaints on poorly maintained equipment, hinders
employee efforts to earn larger incentives.employee efforts to earn larger incentives.
•Increased turnover among new employees discouraged by theIncreased turnover among new employees discouraged by the
unwillingness of experienced workers to cooperate in OJT.unwillingness of experienced workers to cooperate in OJT.
•Elevated levels of mistrust between workers and management.Elevated levels of mistrust between workers and management.
15. INDIVIDUAL INCENTIVE PLANSINDIVIDUAL INCENTIVE PLANS
EXAMPLE – Exhibit 10.10 Lincoln Electric’s Compensation PlanEXAMPLE – Exhibit 10.10 Lincoln Electric’s Compensation Plan
•Description of cultureDescription of culture Reservoir of trust. Long history of employment stability even during severeReservoir of trust. Long history of employment stability even during severe
economic downturns. Employees with 3+ years seniority are guaranteedeconomic downturns. Employees with 3+ years seniority are guaranteed
(on 1-year renewable basis) at least 75 percent full-time work for that year. In(on 1-year renewable basis) at least 75 percent full-time work for that year. In
exchange, employees agree to flexible assignment across jobs.exchange, employees agree to flexible assignment across jobs.
•Base wagesBase wages Market rate determined. Time study department sets piece rate so that averageMarket rate determined. Time study department sets piece rate so that average
worker can earn market rate.worker can earn market rate.
16. INDIVIDUAL INCENTIVE PLANSINDIVIDUAL INCENTIVE PLANS
• BonusBonus Board of directors sets year-end bonus pool as function of companyBoard of directors sets year-end bonus pool as function of company
(short term) performance. Employee’s share in pool is function of semiannual performance(short term) performance. Employee’s share in pool is function of semiannual performance
review (see below).review (see below).
• IncentiveIncentive Employees share in long-term company successes/failures in form of employeeEmployees share in long-term company successes/failures in form of employee
(long term) stock ownership plan (ESOP). Employees now own 28 percent of outstanding(long term) stock ownership plan (ESOP). Employees now own 28 percent of outstanding
stock shares.stock shares.
• Performance reviewPerformance review Employees rated on four factors: (1) dependability, (2) quality, (3) output, (4)Employees rated on four factors: (1) dependability, (2) quality, (3) output, (4)
ideasideas
and cooperation in comparison to others in department. To ensure against ratingand cooperation in comparison to others in department. To ensure against rating
inflation, the average score in department cannot exceed 100.inflation, the average score in department cannot exceed 100.
17. Team Incentive Plans: Types
• -When we move away from individual incentive systems and start
focusing on people working together, we shift to group incentive
plans.
• -It might be a work group or a department. Or it might focus on a
division of the whole company.
• -With the focus on groups, now we are concerned about group
performance in comparison against some standard, or level, of
expected performance.
18. Comparing Group and Individual Incentive Plans
-Setting up incentive plans really boost performance?
-Which is better: group or individual incentive plans?
19. Large Group Incentive Plans
•When we get beyond a small work team and try to incentivize
large groups, there are generally two types of plans.
•Gain-Sharing plans use operating measures to gauge performance
•Profit sharing plans use financial measures
•Earnings-at-Risk plans uses success sharing and risk sharing
20. Gain-Sharing Plans
Employees earn bonuses tied to unit-wide performance as measured by a
predetermined, gain sharing formula.
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
21. Types of Gain-Sharing Plans
• -Rucker Plan: Ratio is calculated that expresses value of
production required for each dollar of total wage bill
• -Scanlon Plan: Designed to lower labor costs without lowering
level of a firm’s activity. Incentives are derived as a function of
ratio between labor costs and sales value of production (SVOP)
• -Improshare (Improved productivity through sharing): Standard
is developed that identifies expected hours required to produce
an acceptable level of output. Any savings arising from
production of agreed-upon output in fewer than expected hours
is shared by firm and workers.
22. Profit-Sharing Plans
• Predetermined index of profitability
Employees may not feel their jobs directly impact profits
• The trend in recent variable-pay design is to combine the best of
gain-sharing and profit sharing plans
-the plan must self funding
-along with having the financial incentive, employees feel
they have a measure of control
24. Group Incentive Plans: Advantages and
Disadvantages
Advantages
1.Positive impact on organization and individual performance of about 5
to 10 percent per year.
2.Easier to develop performance measures than it is for individual plans.
3.Signals that cooperation, both within and across groups, is a desired
behavior.
4.Teamwork meets with enthusiastic support from most employees.
5.May increase participation of employees in decision-making process.
25. Group Incentive Plans: Advantages and
Disadvantages
Disadvantages
1.Line-of-sight may be lessened, that is employees may find it more
difficult to see how their individual performance affects their
incentive payouts.
2.May lead to increased turnover among top individual performers
who are discouraged because they must share with lesser
contributors.
3.Increases compensation risk to employees because of lower
income stability. May influence some applicants to apply for jobs
in firms where base pay is a larger compensation component.
26. Group Incentive Plans: Examples
All incentive plans can be described by common features:
1.the size of group that participates in the plan
2.the standard against which performance is compared
3.the payout schedule
27. Explosive Interest in Long-term Incentive Plans
Long-term incentives 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 longer-term value creations
Long-Term Incentive Plans
•Employee Stock Ownership Plans (ESOPs)
•Performance Plans (Performance Share and Performance Unit)
•Broad-Based Option Plans (BBOPs)
•Combination Plans: Mixing individual and Group
28. ConclusionConclusion
• Pay-for-performance plans can work. But the design and effectivePay-for-performance plans can work. But the design and effective
administration of these plans is key to their success. Having aadministration of these plans is key to their success. Having a
good idea is not enough. The good idea must be followed up bygood idea is not enough. The good idea must be followed up by
sound practices that recognize rewards can, if used properly,sound practices that recognize rewards can, if used properly,
shape employee behavior.shape employee behavior.
