Defining Individual Incentives

Individual incentive plans reward employees for meeting work-related performance

standards such as quality, productivity, customer satisfaction, safety, or attendance. When
managers created individual performance standards and implemented well, individual
incentive plans reward employees based on results for which they are directly responsible.

Types of Individual Incentive Plans

There are four common types of individual incentive plans:

1. Piecework plans
2. Management incentive plans
3. Behavioral encouragement plans
4. Referral plans

Piecework Plans

Generally, companies use one of two piecework plans. The first typically found in
manufacturing settings, rewards employees based on their individual hourly production
against an objective output standard. For each hour, workers receive piecework incentives
for every item produced over the designated production standard.

The second type of piecework incentive plan establishes individual performance standards
that include both objective and subjective criteria. Units produced represent an objective
standard and overall work quality is a subjective criterion.

Management incentive Plans

Management incentive plans award bonuses to managers when they meet or exceed
objectives based on sales profit; production, or other measures for their division
department or unit. Management incentive plans differ from piecework plans in that
piecework plans base rewards on the attainment of one specific objective and management
incentive plans often require multiple complex objectives.

Behavioral Encouragement Plans

Under behavioral encouragement plans, employees receive payments for specific

behavioral accomplishments, such as good attendance or safety records. For example,
companies usually award monetary bonuses to employees who have exemplary attendance
records for a specified period.
Referral Plans

Employees may receive monetary bonuses under referral plans for referring new
customers or recruiting successful job applicants. In the case of recruitment, employees can
earn bonuses for making successful referrals for job openings.

Advantages of Individual Incentive Pay Programs

There are three key advantages of individual incentive pay plan.

1) Individual incentive plans can promote the relationship between pay and
performance. Employees strive for excellence when they expect to earn incentive
awards commensurate with their job performance.
2) Individual incentive plans promote an equitable distribution of compensation
within companies. That is, the amount employees earn depends upon their job
performance. The better they perform, the more they earn. Ultimately, equitable pay
enables companies to retain the best performers.
3) Individual incentive plans is their compatibility with individualistic cultures

Disadvantages of Individual Incentive Pay Programs

Although individual incentive plans can prove effective in certain settings, these programs
also have three serious limitations.

1) Individual incentive plans possess the potential to promote inflexibility. Because

supervisors determine employee performance levels, workers under individual
incentive plans become dependent on supervisors for setting work goals. If
employees become highly proficient performers, they are not likely to increase their
performance beyond their reward compensation.
2) Individual incentive programs pose measurement problems when management
implements improved work methods or equipment. When such changes occur, it
will take some time for employees to become proficient performers. Thus, it will be
difficult for companies to determine equitable incentive awards, which may lead to
employees’ resistance to the new methods.
3) Individual incentive plans may encourage undesirable workplace behavior when
these plans reward only one dimension. Let’s assume that an incentive plan rewards
employees for quantity of output. If employees’ jobs address various dimensions
such as quantity of output, quality, and customer satisfaction, employees may focus
on the one din1ension--in this case, quantity of output that leads to incentive pay,
and thereby neglect the other dimensions.
Defining Group incentives
Group incentive programs reward employees for their collective performance, rather than
for each employee’s individual performance. Group incentive programs are most effective
when all group members have some impact on achieving the goal, even though individual
contributions might not be equal.

Types of Group Incentive Plans

Companies use two major types of group incentive plans:

 Team-based or small-group incentive plans. A small group of employees shares a

financial reward when a specific objective is met.
 Gain sharing plans. A group of employees, generally a department or work unit, is
rewarded for productivity gains.

Team-Based or Small-Group Incentive Plans

Team-based incentives are similar to individual incentives with one exception. Each group
member receives a financial reward for the attainment of a group goal. Teams or groups
may receive incentive pay based on criteria such as customer satisfaction, safety records,
quality, and production records. Companies allocate awards to each worker based on the
group‘s attainment of predetermined performance standards. Human resource experts
allocate rewards in one of three ways:

 Equal incentive payments to all team members.

 Differential incentive payments to team members based on their contribution to the
team‘s performance.
 Differential payments determined by a ratio of each team member’s base pay to the
total base pay of the group.

Gain Sharing Plans

Gain sharing describes group incentive systems that provide participating employees with
an incentive payment based on improved company performance for increased productivity,
increased customer satisfaction lower costs, or better safety records [15] Gain sharing was
developed so that all employees could benefit financially from productivity improvements
resulting from the suggestion system. Most gain sharing programs have three components:

 Leadership philosophy
 Employee involvement systems
 Bonus
Advantages of Group Incentives
The use of group incentive plans has two advantages for companies.

1) Companies can more easily develop performance measures for group incentive
plans than for individual incentive plans. There are obviously fewer groups in a
company than individuals. Thus, companies generally use fewer resources such as
staff time to develop performance measures.
2) Greater group cohesion is the second advantage associated with group incentive
plans. Cohesive groups usually work more effectively toward achieving common
goals than do individual group members focusing on the specific tasks for which
they are responsible.

Disadvantages of Group incentives

The main disadvantage of group incentive compensation is employee turnover. Company’s
implementation of group incentive programs may lead to turnover because of the free-
rider effect. Some employees may make fewer contributions to the group goals because
they possess lower ability, skills, or experience than other group members. In some groups,
members may deliberately choose to put forth less effort particularly when each group
member receives the same incentive compensation regardless of individual contributions
to the group goals. In any case, the free-rider effect initially leads to feelings of inequity
among those who make the greatest contributions to the attainment of the group goal. Over
time, members who make the greatest contributions are likely to leave.

Group members may feel uncomfortable with the fact that other members’ performance
influences their compensation level. Exemplary performers are more likely to feel this way
when other group members are not contributing equally to the attainment of group goals.
The lower performance of a few group members may lead to lower earnings for all
members of the group. Discomfort with group incentive plans is likely to be heightened
where incentive compensation represents the lion‘s share of core compensation.

Defining Companywide incentives

Companywide incentive plans reward employees when the company exceeds minimum
acceptable performance standards, such as profits or the overall value of the company
based on its stock price. Nowadays, companies use companywide incentive programs to
motivate employees to work harder for increased profits or increased company value to
owners.
Types of Companywide Incentive Plans
Companies use two major types of companywide incentive plans;

 Profit sharing plans. Employees earn a financial reward when their company’s profit
objective is met.
 Employee stock option plans. Companies grant employees the right to purchase '
shares of company stock.

Profit Sharing Plans

Profit sharing plans pay a portion of company profits to employees, separate from base
pay, cost-of-living adjustments, or permanent merit pay increases. Two basic kinds of profit
sharing plans are used widely today.

i. Current profit sharing plans award cash to employees, typically on a quarterly or

annual basis. This plan provides cash to employees as part of their regular core
compensation; thus, these payments are subject to IRS taxation when they are
earned.
ii. Deferred profit sharing plans place cash awards in trust accounts for employees.
These trusts are set aside on employees’ behalf as a source of retirement income.
Deferred profit sharing plans are not taxed until the employee begins to make
withdrawals during retirement.

Advantages of Profit Sharing Plans

The use of a profit sharing plan has two main advantages, one for employees and the other
for companies.

1) Profit sharing plans enable employees to share in companies’ fortunes. As

employees benefit from profit sharing plans, they will be more likely to work
productively to promote profits. Obviously, the upshot of enhanced employee
productivity is greater profits for companies
2) Companies that use profit sharing programs gain greater financial flexibility. Profit
sharing plans enables companies to use limited cash reserves where needed, such as
for research and development activities.

Disadvantages of Profit Sharing Plans

There are three main disadvantages associated with profit sharing plans.

1) Profit sharing plans may undermine the economic security of employees.

 2) Company’s excellent performers are likely to leave because employees will find it
difficult to predict their earnings, which will affect their saving and buying behavior
as company profits vary from year to year.
3) Profit sharing plans may fail to motivate employees because they do not see a direct
link between their efforts and corporate profits.

Employee Stock Option Plans

Under employee stock option plans, companies grant employees the right to purchase
shares of company stock. Company stock represents total equity of a company. Employee
stock options provide an incentive to work productively, with the expectation that
collective employee productivity will increase the value of company stock over time.

Two other basic kinds of stock plans are widely used today.

i. Employee stock ownership plans (ESOPs) place company stock in trust accounts for
employees. The purpose of ESOPS is similar to deterred profit sharing because these
trusts are set aside on employees’ behalf as a source of retirement.
ii. Stock compensation plans represent an important type of deferred compensation for
executives. Deferred compensation is supposed to create a sense of ownership,
aligning the interests of the executive with those of the owners or shareholders of
the company over the long term.