Pay for Performance

Merit Pay: Issues

-Expensive -Doesn't necessarily achieve the desired goal: improving employee and corporate performance

Managing Merit Pay

-Improve accuracy of performance ratings -Allocate enough money to truly reward performance -Make sure size of merit increase differentiates across performance levels

Incentive Plan Design

-Individuals -Groups

4 behaviors?

-Join -Stay -Develop job skills -Perform better

Factors impacting turnover

-Level of employee satisfaction with pay -Pay based on individual performance -Group incentive plans -Extent of pay at risk -Other rewards affect the decision to stay

Lump-Sum Bonuses

-Lump-Sum Pay -Increasingly used substitute for merit pay -Viewed as less of an entitlement than merit pay -Less expensive than merit pay over the long run

Disadvantages of Individualized Incentive Plans

-New technologies/ production methods may be resisted by employees -Increased turnover among new employees discouraged by the unwillingness of experienced workers to cooperate in on-the-job training -Mistrust between workers and management over production standards and product quality

Individual Incentive Plans

Pay for production relative to specific, standard objectives Two types: Piece Rate Standard Hour

Group Incentive Plans: Advantages

Performance improvements Ease of developing metrics Promotes teamwork and employee participation

Rucker Plan

Ratio based on value of production for each dollar of wage bill Employees get some percentage of the savings

Internal process-focused measures

Resource utilization Change effectiveness

A merit pay system

links increases in base pay to how highly employees are rated on a subjective performance evaluation

Differential Piece Rate (Taylor Plan)

lower rate for employees below standard, higher rate for employees above standard

Piece Rate Plans

pay for each unit produced/ action performed

Pay for performance

plans signal a movement away from entitlements --Pay will vary with some measure of individual, team, or organizational performance

Gainsharing

portion of gains an organization realizes from a group effort is shared with the group (e.g. improved productivity)

Straight Piecework

same pay for each unit

Gantt Plan

Base hourly wage + possible bonus of 120 percent of time saved for employees who exceed the standard

Individuals: Piece Rate & Standard Hour

Based on comparison to standard

Individuals: Merit & Lump-Sum Pay

Based on performance assessments

Scanlon Plan

Based on ratio of labor costs to sales value If improves, employees get bonus as a percent of the savings Employee submit suggestions for improvements

Group

Collaboration required Difficult to measure individual contributions Dynamic environment Union

Improshare

Compares current worker productivity in hours to historical work standards Pay savings back to workers on a weekly or monthly basis

Group Incentive Plans: Disadvantages

Difficult to connect individual effort to outcomes Turnover of top performers More pay at risk

Success sharing plan

Employee base pay is constant -Variable pay increases in successful years -No reduction in base pay and no variable pay in poorly-performing years

Risk sharing plan

Employee base pay varies -Base pay often reduced in poor performance years -Shifts part of risk of doing business from company to employee

Halsey Plan

Employee bonus = % of wage for time saved e.g, took one less hour, 50 % X 1 hour wage

Lump-Sum Pay

Employee receives bonus for ratings on performance assessment/or reaching other targets (not incorporated into base pay)- cash payout, does not affect base pay

Balanced Scorecard

Examines performance on multiple measures, e.g. -Customer focused -Financially focused Measures are related to strategic objectives Award pool based on achieving performance targets

Plant and Organization Incentive Approaches

Gainsharing Profit sharing Employee stock ownership plans (ESOP) Balanced scorecard Earnings at Risk

Team Based Performance Pay

High interdependence & Common output Based on performance standards: E.g. expected level of costs, customer feedback or standard production rate Often include: Extrinsic (e.g. bonus pay) and intrinsic (e.g. recognition) rewards

Rowan Plan

Hourly rate based on percent of standard E.g. completes in 85 percent of standard, gets paid 1.15 X regular hourly rate

Capability-focused measures

Human resource capabilities Other asset capabilities

Employee perceptions

If the incentive depends on individual performance, applicants find the company more attractive -Team-based incentives less attractive

Individual

Independent tasks Individual measures available and stable Non-union

Profit-sharing & ESOP

Long term focus Indirect relationship between individual performance and reward Variables beyond individual control

Role of Performance Pay

Strong evidence that pay for performance has a direct and, at times, substantial impact on firm performance

Advantages of Individualized Incentive Plans

Substantial contribution to: -Individual productivity -Lower production costs -Workers earnings Reduces direct supervision to maintain reasonable output levels Enables labor costs to be estimated more accurately than under payment by time

Multiple Piece Rate (Merrick Plan)

Three different rates for employees at 83 percent of the standard, between 84 percent and 100 percent, and above 100 percent

Customer-focused measures

Time-to-market Customer satisfaction

Individual Spot Awards

Typically awarded for exceptional performance -Special projects -Exceptional performance

Financially-focused measures

Value creation Shareholder return

Group Plans

Work Team Plant Organization

Profit-sharing

bonus pay based on total net profit for some period of time

Standard Hour Plans

bonus pay for performing task in less time than required by the standard

ESOP

employee stock ownership plan