Compensation Systems

Difficulties Using Merit Pay

1 The incentive value of the reward offered may be too small to motivate performance. 2 The link between performance and rewards may be weak. 3 Merit raises are permanent increase in payroll costs. 4 Union contracts limit pay-for-performance decisions. 5 Managers may have limited personal control over organizational performance. 5 Managers maybe reluctant to distinguish between performance levels. 6 Performance appraisal definition anf guidelines may lack precision. 7 People may think their own performance is above average. 8 Merit pay runs contrary to intrinsic motivation in the work itself.

Pay Adjustment Matrix

A system for integrating appraisal rating and pay changes

Person-Based System

An employee's characteristics determine pay. Superior knowledge or skill mastery is rewarded. - Knowledge-based (e.g., scientists whose pay is based on knowledge in a field or domain) - Skill-based (e.g., machine operators cross-trained on a variety of production equipment) - Competency-based (e.g., professionals who excel at defined competencies) Disadvantages 1. Can be costly in terms of both administration and training 2. May result in higher pay rates 3. Skills/knowledge must be effectively used to provide the organization with an offset to the higher pay rates 5. May be more difficult to institute cost controls Advantages 1. works best where skill/knowledge levels are well defined 2. Encourages flexible and better-trained workforce 3. May reduce need for specialists 5. Allows for work teams that are highly interdependant

Single- or Flat Rate System

Each incumbent of the job has the same rate of pay, regardless of performance or seniority. eg: A newly hired factory worker may make $9/hour with a $0.50/hour raise after six months. All other factory workers earn $9.50/hour.

Compensation ratio

Employee's pay rate/ Pay range midpoint

Combination step-rate and performance structure.

Employees receive increases on a step-rate basis up to the job rate. Above the job rate, increases to higher steps are granted only for above-standard performance. This system requires adequate resources to develop and administer a performance appraisal system and communicate it to employees so that they understand how they can earn performance-based increases.

Geographic Pay Differentials

May pay differently because 1. Labor costs - change their base-pay to reflect different wage rates or factors that impact the cost of living in different geographic area 2. attract workers to certain locations 3. Foreign countries

Pay compression or salary compression

Occurs when there is only a small difference in pay between employees regardless of their experience, skills, level or seniority. How to counteract the effects of pay compression 1. Match the market pay rates for all employees, not just new hires 2. Provide other benefits to employees affected by pay compression 3. Continuously evaluate survey data and update pay ranges accordingly 4. Provide incentive plans for managers 5. Increase the amount of time off awarded 6. Provide longevity bonuses 7. Monitor salaries for inflation 8. Install a more aggressive merit pay program

Cost-of-living adjustment (COLA)

Pay adjustment given to eligible employees regardless of performance or organizational profitability; usually linked to inflation. Sometimes paid as lump sums

Productivity-based pay

Pay based on the quantity of work and outputs that can be accurately measured. Works best in assemble line work when 1. units of output can be measured 2. A clear relationship between employee effort and quantity of output exists 3. The job is standardized, the workflow is regular and delays are few or consistent 4. quantity is more important than quality 5. costs are known and precise Disadvantages 1. May sacrifice quality of work 2. May create inflexibility in the workforce because employees may want to stay with the job for which they are paid the most

General pay increase

Pay increase given to employees based on local competitive market requirements; awarded regardless of employee performance. Not linked to cost of living and will depend on the employer's ability to pay for compensation increases

Seniority increase

Pay increases tied to a progression pattern based on seniority. To the extent performance improves with time on the job, this method has the rudiments of paying for performance

Differential pay

Pay that is based on when the employee works (e.g., overtime pay, shift-pay differential) or where the employee works. This practice allows organizations to better control their labor costs and to tie performance and pay together. also have Time Based and geographic

Differential Piece-Rate Plan

Piece rate plan devised by Frederick W. Taylor that pays one rate for all acceptable units produced up to some standard and then a higher rate for all pieces produced if the output exceeds the standard.

Total Organization Compensation Expense

Salaries + Overtime+ Benefits+ Bonuses/ Total operating costs

Performance-based pay

Situation where an individual's performance on the job is the basis for the amount and timing of pay increases; also called merit pay or pay for performance. a common feature is that a form of measurement is established, goals are set, and compensation is linked to the measures of work quality or goals

Green-circle rates

Situations in which an employee's pay is below the minimum of the range.

Straight piece-rate system

The employee receives a base wage rate and is awarded additional compensation for the amount of output produced Advantage - Simple Disadvantage - does not reflect individual performance, seniority or skill differences

Time-based step-rate pay

The employee's pay rate is based on longevity in the job. Pay increases occur on a predetermined schedule. Advantages 1. Best suited to routine jobs where the qualifications of job incumbents increases with time 2. Enables an organization to reward long-term employment Disadvantages 1. Generally does not reflect the varying rates at which incumbents become proficient 2. Does not reflect performance differences, except for unsatisfactory performance 3. Can raise average pay levels over time even if performance is below average.

Direct Sales Compensation

Three ways 1. Straight Salary-least used 2. Straight commission 3. Salary plus commission and/or bonus -most used

Automatic step-rate pay structure

automatically pay scale is divided into several steps that are 3-7% apart. At set time periods, each employee with the required seniority receives a one-step increase

Incentive Pay

forms of pay linked to an employee's performance as an individual, group member, or organization member Stems form the theory that rewards drive behavior employees can influence the desired outcome employees must believe that the goals are achievable Short/Long term must drive financial success as well as be legally compliant Individual - piece-rate, commission, or other type of non cash reward - usually have the most significant impact on productivity Group - share in profit, team bonus Organization - Profit sharing and bonus programs tied to organizational goals. In order to be successful 1. competitive base salaries 2. stable management 3. Good communications 4.Reliable method for measuring results 5. Commitment form top down to communicate the plan and provide on going training and coaching.

Red-circle rates

payment rates above the maximum of the pay range

Step-rate with variability-based performance standards.

similar to the automatic system, but the size and timing of increases may vary if performance is substantially above or below standard. For example a capable employee could skip steps

Time-based differential pay

some employees receive time based pay or a different rate of pay based on when they work (keep in mid that any overtime premiums must be applied to the differential pay) Shift pay, emergency shift pay, premium pay (holidays) on call or call back, reporting pay (report even when there is no work), travel time pay (paid for travel even if time is outside of working hours) and overtime pay

Guidelines for Effective use of Merit Pay

1. Gain Executive buy-in 2.Align the merit pay system with organizational goals and culture 3. Develop accurate performance appraisal system that recognize proficiency 4. Train supervisors in the mechanics of the performance appraisal system 5.Tie meaningful rewards closely to performance 6. Use a wide range of increases to differentiate between performance levels Implement accountability measures

base pay systems

Develop and maintain a pay system that helps attract, motivate, and retain employees Most employees receive base pay in the form of hourly wage or salary

Executive Pay

Differ from employee plans in 2 ways 1. incentives usually account for a greater share of the executive's total direct compensation package. 2. Incentives are generally linked to the performance of the entire organization or the major business unit Types Annual salary Stock option plans Stock purchase plans Restricted stock grans Phantom stock Restricted Stock Units Performance grants

Lump-sum increase (LSI)

One-time payment made to an employee; also called performance bonus. Employees base wage rate is typically not adjusted by this increase this is an advantage for the organization because other types of pay linked to base pay are not impacted

Market Based Increase.

Organization need to attract and retain employees. Uses this approach to be competitive in attract new talent and retaining current employees. These salary increases are usually added to the base pay and may be called equity increases.