Reward Systems are a critical part of any organization's design. How well they fit with
the rest of the systems in an organization has an important impact on how effective the
organization is and on the quality of life that people experience in the organization.
Over the past decade, some new reward systems practices have become popular in
order to align reward systems with the important changes that are occurring in the way
organizations are designed and managed (Lawler, 1990; Schuster and Zingheim, 1992).
This chapter begins by considering the role of reward systems in an organization and
how reward systems in organizations can be designed. It then it focuses on the fit
between reward systems and the high-involvement approaches to organization design
which are becoming increasingly popular. Finally, it considers the role of pay system
change in large scale organization change efforts.
The over-riding principle that will guide the discussion in this chapter is that in order to
be effective organizations must have congruence among their various operating
systems. Particular operating system practices are neither good nor bad in the abstract.
They must be evaluated in the context of the other systems in an organization and the
business strategy of the organization. The business strategy indicates what the
organization is supposed to accomplish and how it is supposed to behave. It specifies
the kinds of performance and performance levels the organization needs to
demonstrate in order to be effective. Thus, it is a critical guide for the design of the
overall organization structure as well as information systems, human resource
management systems, and of course, reward systems, to mention some of the most
critical systems in an organization.
Figure 1 depicts one way of thinking about reward systems in an organization. It shows
that their design needs to be driven by the basic organization design and the
management style of the organization which in turn, needs to be strongly influenced by
the organization's strategy. Finally the figure shows that the reward system in
combination with the organization's design drives the performance of the organization,
since it influences critical individual and organizational behaviors.
The business strategy should be the foundation for identifying the critical behaviors that
the organization needs to demonstrate. This in turn is shown as driving the design of the
reward system. The challenge here is to correctly identify those features of a reward
system which will produce the behavior that is needed to make the strategy come alive
in terms of individual and organizational behavior.
Three critical elements of the reward systems are identified in this figure. The first is the
core principles which the organization holds. These core principles may be stated or
simply implicit in the way the organization operates. But, they are part of any
organization and its reward system. Examples of core principles are a belief in pay for
performance, a belief in secrecy about pay, and other fundamental relatively long-term
commitments that organization make in the area of reward systems.
The reward system also is shown to be made up of process features and structural
feature. Process design features include such things as communication policies , and
decision making practices. These are critical, because they reflect not only the overall
management style of the organization, but influence how well reward system practices
will be accepted, understood, and how much commitment there will be to them.
Finally, reward systems include actual reward system practices and structures. These are
the features of reward systems that get the most attention. They include pay delivery
systems such as gain sharing plans, profit-sharing plans as well as administrative polices
and a host of other specific organizational programs.
Reward systems are assumed to be effective to the degree that the core principles,
processes and practices are in alignment. This is depicted in the figure by the arrows
among the three elements. The fit here is critical because organizations need to be
consistent in what they say and what they do. Violations of this consistency inevitability
leads to misunderstanding about how the reward system works, and failure to motivate
the proper or needed behavior. Later in the chapter we will return to the issue of the
critical design decisions that need to be made concerning the core values, processes and
structures. Before these are discussed consideration needs to be given to how reward
systems in general, and pay systems in particular, can actually effect individual and
organizational behavior. This will serve to create a foundation for the discussion of how
to diagnose the current impact of a reward system, and how to design one to produce
particular individual and organizational behaviors.
Objectives of the Reward System
The research on reward systems suggest that potentially they can influence six factors
which in turn impact organization effectiveness.
1. Attraction and Retention - Research on job choice, career choice and turnover
clearly shows that the kind and level of rewards an organization offers influences who is
attracted to work for an organization and who will continue to work for it (see e.g.
Lawler, 1973; Mobley, 1982). Overall, those organizations which give the most rewards
tend to attract and retain the most people (Gerhart and Milkovich, 1992). This seems to
occur because high reward levels lead to high satisfaction, which in turn leads to lower
turnover. Apparently this is true because individuals who are presently satisfied with
their jobs expect to continue to be satisfied and, as a result, want to stay with the same
organization. The objective should be to design a reward system that is very effective at
retaining the most valuable employees. To do this, a reward system must distribute
rewards in a way that will lead the more valuable employees to feel satisfied when they
compare their rewards with those received by individuals performing similar jobs in
other organizations. The emphasis here is on external comparisons because turnover
means leaving an organization for a better situation elsewhere. One way to accomplish
this is to reward everyone at a level that is above the reward levels in other
organizations. However, this strategy has two drawbacks. In the case of some rewards,
such as money, it is very costly.
Also, it can cause feelings of intraorganizational inequity because the better performers
are likely to feel inequitably treated when they are rewarded at the same level as poor
performers in the same organization, even though they are fairly treated in terms of
external comparisons (Lawler and Jenkins, 1992). Faced with this situation, the better
performers may not quit, but they are likely to be dissatisfied, complain, look for
internal transfers, and mistrust the organization.
2. Motivation of Performance - When certain specifiable conditions exist, reward
systems have been demonstrated to motivate performance (Gerhart and Milkovich,
1992; Lawler, 1990; Lawler 1971; Vroom 1964). What are those condition? Important
rewards must be perceived to be tied in a timely fashion to effective performance.
Organizations get the kind of behavior that leads to the rewards their employees value.
This occurs because people have their own needs and mental maps of what the world is
like. They use these maps to choose those behaviors that lead to outcomes that satisfy
their needs. Therefore they are inherently neither motivated nor unmotivated to
perform effectively; performance motivation depends on the situation, how it is
perceived, and the needs of people.
3. Skills and Knowledge - Just as pay systems can motivate performance they can
motivate learning and development. The same motivational principles apply. Individuals
are motivated to learn those changes which are rewarded. As will be discussed later, a
relatively new approach to pay, skill based pay, has been developed to capitalize on just
this point. It allows organizations to strategically target the learning its wants employees
to engage in. This is in contrast to many job based systems which indirectly do this by
tying increased pay and perquisites to obtaining higher level jobs.
4. Culture - Reward systems are one feature of organizations that contribute to their
overall culture. Depending upon how reward systems are developed, administered, and
managed, they 7 can cause the culture of an organization to vary quite widely. For
example, they can influence the degree to which it is seen as a human resources
oriented culture, an entrepreneurial culture, an innovative culture, a competence based
culture, a fair culture, and a participative culture. Reward systems have the ability to
shape culture precisely because of their important influence on communication,
motivation, satisfaction, and membership. The behaviors they cause to occur become
the dominant patterns of behavior in the organization and lead to perceptions and
beliefs about what an organization stands for, believes in, and values.
5. Reinforce and Define Structure - The reward system of an organization can
reinforce and define the organization's structure (Lawler, 1990). Often this impact of a
reward system is not fully considered in the design of reward systems. As a result, their
impact on the structure of an organization is unintentional. This does not mean,
however, that the impact of the reward system on structure is usually minimal. It can
have a strong impact of how integrated the organization is and how differentiated it is
(Lawrence and Lorsch, 1967). When people are rewarded the same way it tends to unite
them, when they are treated differently it can divide them. In addition, it can help
define the status hierarchy, and it can strongly influence the kind of decision structure
which exists. As will be discussed later, the key features here seem to be the degree to
which the reward system is hierarchical and the degree to which is allocates rewards on
the basis of movements up the hierarchy.
6. Cost - Reward systems are often a significant cost factor. Indeed, pay alone may
represent over 50% of an organizations operating costs. Thus, it is important in
strategically designing the reward system to focus on how high these costs should be
and how they will vary as a function of the organization's ability to pay.
Performance measures quantitatively tell us something important about our
products, services, and the processes that produce them. They are a tool to help us
understand, manage, and improve what our organizations do. Performance measures
let us know:
How well we are doing
If our processes are in statistical control
If we are meeting our goals
If and where improvements are necessary
If our customers are satisfied.
They provide us with the information necessary to make intelligent decisions about
what we do.
A performance measure is composed of a number and a unit of measure. The number
gives us a magnitude (how much) and the unit gives the number a meaning (what).
Performance measures are always tied to a goal or an objective (the target).
Performance measures can be represented by single dimensional units like hours,
meters, nanoseconds, dollars, number of reports. number of errors, number of CPR-
certified employees, length of time to design hardware, etc. They can show the variation
in a process or deviation from design specifications. Single-dimensional units of measure
usually represent very basic and fundamental measures of some process or product.
More often, multidimensional units of measure are used. These are performance
measures expressed as ratios or two or more fundamental units. These may be units like
miles per gallon (a performance measure of fuel economy), number of accidents per
million hours worked (a performance measure or the companies safety program), or
number of on-time vendor deliveries per total number of vendor deliveries.
Performance measures expressed this way almost always convey more information than
the single-dimensional or single-unit performance measures. Ideally, performance
measures should be expressed in units of measure that are the most meaningful to
those who must use or make decisions based on those measures.
Most performance measures can be grouped into one of the following six general
categories. However, certain organizations may develop their own categories as
appropriate depending on the organization's mission:
1. Effectiveness: A process characteristic indicating the degree to which the process
output (work product) conforms to requirements. (Are we doing the right
2. Efficiency: A process characteristic indicating the degree to which the process
produces the required output at minimum resource cost. (Are we doing things
3. Quality: The degree to which a product or service meets customer requirements
4. Timeliness: Measures whether a unit of work was done correctly and on time.
Criteria must be established to define what constitutes timeliness for a given unit
of work. The criterion is usually based on customer requirements.
5. Productivity: The value added by the process divided by the value of the labor
and capital consumed.
6. Safety: Measures the overall health of the organization and the working
environment of its employees.
The following reflect the attributes of an ideal unit of measure:
Reflects the customer's needs as well as our own
May be interpreted uniformly
Provides an agreed upon basis for decision making
Is compatible with existing sensors (a way to measure it exists)
Is precise in interpreting the results
Is economical to apply
Performance data must support the mission assignment(s) from the highest
organizational level downward to the performance level. Therefore, the measurements
that are used must reflect the assigned work at that level.
All organisations measure performance to some extent. However, there is a large
disparity among organisations in terms of which performance measures are used with
many primarily focussing on financial measures. There has however, been a general
move away from financial measurement since the early 1980's. This was accelerated in
the 1990's and 2000’s by the worldwide acceptance of business excellence models and
performance measurement frameworks that address all stakeholders' needs.
Performance measurement is one of the cornerstones of business excellence. Business
excellence models encourage the use of performance measures, but in addition and
more importantly, they consider the design of performance measurement systems to
ensure that measures are aligned to strategy, and that the system is working effectively
in monitoring, communicating, and driving performance. A recent report presented by
the Performance Measurement Association (PMA) on one of the new performance
measurement frameworks, the Balanced Scorecard, demonstrated the popularity of this
particular method. The PMA presented evidence that 39% of FTSE 100 companies were
actively using the scorecard, and other researchers have reported that between 40%
and 60% of Fortune 1000 companies have attempted to implement the Balanced
Scorecard. With the movement away from financially based measurement systems
only gaining momentum in the early 1990’s this represents a significant change in
organisational practices in such a short space of time.
Challenges Associated with Performance Measures:
The performance measurement revolution has seen a move away from the problems of
past measurement systems. Five common features of out-dated performance
measurements systems were:
Dominant financial or other backward-looking indicators
Failure to measure all the factors that create value
Little account taken of asset creation and growth
Poor measurement of innovation, learning and change
A concentration on immediate rather than long-term goals
The focus in performance measurement is now on achieving a balanced framework that
addresses the issues described above. Examples of these new frameworks are Kaplan
and Norton’s Balanced Scorecard, Skandia’s navigator model and the Performance
Prism. Others recommend that the results sections of business excellence models
should be used to generate a balanced set of performance measures.
There are a number of challenges that are faced when designing an effective
Performance Measurement System, these include the following:
How to measure non-financial performance
What measures to choose and why
How to use them - what to do with the results
Who should be responsible for using the results
How and to whom, to communicate the results
The resources needed to consider the above and design and deploy the
There are other major requirements that an organisation needs to consider before an
effective performance measurement system can be designed or installed. Apart from
lower level measures that may be vital for the operation of processes, all measures need
to be chosen to support the attainment of specific performance or behaviour identified
by the organisation's leaders as important or necessary to work towards the
organisational goals. This being the case, there must be clearly defined goals/objectives
and strategies chosen to reach them before measures can be chosen to support their
attainment. Similarly the key processes, drivers of performance, and the core
competencies required by employees need to be identified before effective
performance measurement can be achieved.