Pay for Performance and Financial Incentives

Chapter 12
The Origin of Financial Incentive
In the 1800s, Fedrick Taylor popularized using
financial incentives
Taylor had a feeling that the employees had the
tendency to work at the slowest pace and and to
produce at the minimum acceptable level
Such attitudes of employees was referred to as
systematic soldiering by Taylor
To overcome the problem, Taylor established the
connection between pay and performance level
He provided the incentives to the workers whose
production exceeds predetermined standard
Linking Performance and
Pay
Today, it is a strategic imperative to link
the performance to pay
However, it is not an easy task and
many pay for performance programs are
ineffective
Research shows that 83% of such
programs are somewhat successful or
not successful
To establish effective programs, it is
essential to understand the incentive
theories and strategies
Motivation Theories: The Hierarchy
Needs of Abraham Maslow
Practical Implication of Maslows
Theory
Any guesses????????
Discuss with your neighbor!
The appropriate answer will
receive a bonus point!
Practical Implication of Maslows
Theory
People are motivated first to
satisfy the lower-order needs
Dont try to motivate a person
with a higher position who
doesnt have enough money to
pay the bill
Motivation Theories: Motivators
and Fedrick Herzberg
Hygiene factors (extrinsic
factors)
Better pay and working
condition
These factors just keep the
employees from becoming
dissatisfied
Adding more of these factors
will not generate extra
motivation for the employees
Motivators (intrinsic
factors)
Recognition, appreciation and
providing challenging work
The best way to motivate a
person is to provide with
motivator factors
Adding more of these factors
will enrich the job and get the
employees further motivated
Practical Implication of
Herzbergs Theory
Any Guesses???
Practical Implication of
Herzbergs Theory
Relying exclusively on extrinsic
factors is risky
Incentive plan should include the
intrinsic factors along with
extrinsic factors
Motivation Theories: Expectancy
Theory and Victor Vroom
Vrooms Expectancy Theory
A persons motivation to exert some level of
effort is a function of three things:
Expectancy: that effort will lead to performance.
Instrumentality: the connection between
performance and the appropriate reward.
Valence: the value the person places on the reward.
Motivation = E x I x V
If any factor (E, I, or V) is zero, then there is no
motivation to work toward the reward.
Employee confidence building and training, accurate
appraisals, and knowledge of workers desired
rewards can increase employee motivation.
Types of Incentive Plans
Pay-for-performance plans
Individual focus
Any plan that ties pay to individual
productivity or profitability, usually as
one-time lump payments.
Organizational focus
A team or group incentive plan that ties
pay to some measure of the firms overall
profitability.
Individual Incentive Plans
Piecework Plans
Straight piecework
- A fixed sum is paid for each unit the
worker produces
- Employees are paid under an established
piece rate standard
Standard hour plan
- The worker gets a premium equal to the
percent by which his or her work
performance exceeds the established
standard.
Pros and Cons???
Individual Incentive Plans
(cont)
Pros of piecework
Easily understandable, equitable, and
powerful incentives
Organizations will not suffer if the
employees work at a slower pace
Cons of Peicework
Quality problems caused by an
overriding output focus
Resistance to change (e.g. introducing
new technologies)
Switching from job to job
Individual Incentive Plans
(contd)
Merit Plan
With merit pay, a firm provides the
employees with financial incentives
based on their individual
performance
It applies to white-collar employees
Benefit?????
 Individual Incentive Plans
(contd)
Merit pay options
2 options:
1. Annual lump-sum based on individual
performance: annual merit raises that
do not make the raise part of an
employees base salary.
Benefits-
- The pay increase is not baked into the
employees salary
- You pay for a specific period of time
 Individual Incentive Plans
(contd)
Merit awards
2 options:
2. Awards based on individual and
organizational performance: Merit
awards tied to both individual and
organizational performance
Benefits-
- Company performance and employee
performance is taken into account
- This approach is more effective
 Lump-Sum Award Determination Matrix
(an example)

To determine the dollar value of each employees incentive award: (1)

multiply the employees annual, straight-time wage or salary as of June
30 times his or her maximum incentive award and (2) multiply the
resultant product by the appropriate percentage figure from this table.
For example, if an employee had an annual salary of $20,000 on June
30 and a maximum incentive award of 7% and if her performance and
the organizations performance were both excellent, the employees
award would be $1,120: ($20,000 0.07 0.80 = $1,120).
Its your turn!

If an employee had an annual salary

of $30,000 and a maximum
incentive award of 9% and if her
performance and the organizations
performance were both good, How
much will the employee receive?
Answer:
$1,620:($30,000 0.09 0.60
= $1,620).
 Incentives for Salespeople
3 options are available-
1. Salary Plan
- To provide with a fixed amount of money in the
form of salaries
Pros
- It is easy to calculate the salary
- It is easy reassign the employees
Cons
- Demotivate potentially high-performing
salespeople
Incentives for Salespeople
(cont.)
2. Commission plan
Pay is only a percentage of sales
Pros-
Keeps sales costs proportionate to sales revenues
Easy to compute and understand
Easy to attract the competent salespeople
Cons-
May cause a neglect of non-selling duties
The effect of economic boom and recession
Can create wide variation in salespersons income
Can increase turnover of salespeople
Incentives for Salespeople
(cont.)
3. Combination plan
Pay is a combination of salary and
commissions, usually with a sizable salary
component (70% base salary and 30%
incentive)
Pros:
Plan gives salespeople a floor (safety net) to
their earnings and still provides an incentive for
superior performance
Cons:
Plans tend to become complicated, and
misunderstandings can result
Which plan is better?
Any guesses?
Incentives for Managers and
Executives
Inaddition to the salary, managers
receive (a) short-term and (b) long-
term incentives
Short-term incentives
With short-term incentive plans, 96% of the
incentives are provided in cash (e.g. bonus)
The percentage size of bonus usually depends on
the positions
-Top level executives: 80% of the base salary
- Managers: 30% of the base salary
- Supervisors: 15% of the base salary
-
Incentives for Managers and
Executives (cont.)
Long-term incentives
With long-term incentive plans, 48% of them
are paid in stock
A stock option is the right to purchase a
specific number of shares of company stock at
a specific price during a specific period of time
Long term plan is designed to reward and
motivate management for long-term corporate
growth
Employees are less likely the to leave the
organization when they have the company
share
Team and Organization-wide
Incentive Plans
With team incentive plans, incentives are
paid to the team based on teams
performance
The aim is to foster the teamwork or to make
sure you have all your team
Piecework standards are avoided here
For example, if the firm reached 100% of its
goals, the employees as the teams share is
about 5% of the of the improvement
Team and Organization-wide
Incentive Plans (cont.)
Pros
Foster team planning and problem solving
Collaboration
Japanese organizations have the tendency to apply
team plan in order to reduce jealousy and make the
members indebted to one another
Cons (Levi Strauss installed a team incentive plan
and found the following problems)
Some employees worked harder than others did
The faster ones soon slowed down, production
declined and Levis ended up closing its US
factories
Team and Organization-wide
Incentive Plans: Profit Sharing
They are plans in which all or most
employees share of the firms annual
profits
Usually 15% to 20% of annual profits
A Classic example- John Lewis
partnership
Research shows that profit sharing plans
positively affect the performance of the
employees
Such plans boost productivity and
morale
Team and Organization-wide
Incentive Plans: Scanlon Plans
Scanlon plan (Joseph Scanlon, 1937)
This plan has been established to foster employee
commitment by synchronizing the companys goal with
those of the employees. This plan is consisted of 5 features:
Philosophy of cooperation
No us and them attitudes that inhibit employees from developing a
sense of ownership in the company
Identity
Employees understand the businesss mission and how it operates in terms
of customers, prices, and costs
Competence
The plan depends a high level of competence from employees at all levels
Involvement
Employees should be encouraged to get engaged and provide with
improvement suggestions
Sharing of benefits formula
If a suggestion is implemented and successful, employees share in 75% of
the savings
Calculation: Scanlon Plan
Ifthe the sales are $600,000, raw
material costs should be
$300,000 (50% of the sales).
Assume the firm implements
suggestions that result in raw
material costs of $250,000 in a
month when sales were
$550,000. How much will the
employees receive for the
suggestion?
Answer
By law, the raw material costs
should have been $275,000 (50%
of the sales). However, it turned
out to be $25,000 due to the
implementation of suggestion. As
such the organization saved
$25,000 ($275,000-$250,000). As
such, workers would get $18,750
(75% of the savings) and
organization should receive
$6,250 (rest of the amount)
Team and Organization-wide
Incentive Plans: At-Risk Pay plans
At-riskvariable pay plans are
plans that put some portion of
the employees weekly, monthly
or yearly pay at risk
If employees meet or exceed their
goals, they earn incentives.
If they fail to meet their goals, they
forgo some of the pay they would
normally have earned.
5 Building Blocks to Effective
Plans
1. Does it make sense to use
incentives here?
Use the incentive plans when:
a. Motivation is the problem
b. The job is standardized
c. Work flow is regular
2. Link the incentive with your strategy
d.Link the incentive to behavior that is critical to
achieving strategic goals
Example, Sun Microsystems incentive program to
support customer satisfaction goals
5 Building Blocks to Effective
Plans (cont.)
3. Make sure the program is motivational
How would you do that?
Recall Victor Vrooms theory
To make the program motivational, there should be a link
between performance and reward, and reward should be
attracted
4. Set complete standards
- Take both quality and quantity into account
- Dont pay for quantity only if quality is an issue
5. Be Scientific
- Dont waste money on incentive that looks logical but
may not be contributing top performance
- Gather evidence and analyze the effects of incentive plan
to determine whether the plans are effective
Thank you!