1. Pay Plans & Rewards Management

2. Determining Pay Rates
Employee compensation refers to all forms of pay or rewards going to employees and arising from their employment.
It consists of 2 parts:
Direct financial payments
Indirect financial payments
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Instructor’s notes:
Employee compensation refers to all forms of pay or rewards going to employees and arising from their employment,1 and it has two main components:
direct financial payments (in the form of wages, salaries, incentives, commissions, and bonuses), and indirect payments (in the form of financial benefits like employer-paid insurance and vacations).
Direct financial payments Pay in the form of wages, salaries, incentives, commissions, and bonuses.
Indirect financial payments Pay in the form of financial benefits such as insurance, vacations and daycare.

3. Employee Compensation
Direct or Indirect compensation is given based on:
Increments of time
Hourly
Salaried
Performance
Piecework
Commission
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There are basically two ways to make direct financial payments to employees: on increments of time and on performance. Time-based pay is still most popular: Blue-collar workers get hourly or daily wages, for instance, and others, like managers or Web designers, tend to be salaried and paid by the week, month, or year. The second option is to pay for performance. Piecework is an example; it ties compensation to the amount of production (or number of “pieces”) the worker produces, and is popular as an incentive plan. For instance, you divide a worker’s hourly wage by the standard number of units he or she is to produce in one hour. Then for each unit produced over and above this standard, pay the worker an incentive. Sales commissions are another example of performance-based (in this case, sales-based) compensation. In this chapter, we explain how to formulate plans for paying employees a time-based wage or salary; subsequent
chapters cover performance-based financial incentives and bonuses, and employee benefits.
Several basic factors influence the design of any pay plan: legal, union, company

4. Factors Influencing Pay
Legal considerations
Union membership
Company policy
Competitive strategy
Equity
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5. Legal Considerations
The Labour act defines the minimum wage and employment conditions
Basic labor standards
Maximum hours
Safety/health standards
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Various laws specify things like minimum wages, overtime rates, and benefits. For example, the 1931 Davis-Bacon Act allows the secretary of labor to set wage rates for laborers and mechanics employed by contractors working for the federal government. Amendments provide for paid employee benefits. The 1936 Walsh-Healey Public Contract Act sets basic labor standards for employees working on any government contract that amounts to more than $10,000. It contains minimum wage, maximum hour, and safety and health provisions, and requires time-and-a-half pay for work over 40 hours a week.

6. Corporate Policies and Competitive Strategy
To remain competitive, compensation plans must reward strategy that furthers the firm’s strategy aims by asking:
What are our key competitive success factors?
What actions implement this competitive strategy?
What compensation program reinforces those behaviors?
What requirement should each pay element meet?
How well do the current reward programs match these requirements?
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The compensation plan should further the firm’s strategic aims—management should produce an aligned reward strategy. In other words, management should ask “how can I construct a total portfolio of reward programs that all link to both short and longer-term business success, drive shareholder value, encourage the behaviors that we need, and deliver true value to our employees?” IBM is a good
example. Gerstner’s aim at IBM was to install a new compensation plan that focused employees’ attention on productivity and competitiveness, rather than seniority.
Questions to ask:
1. What are the organization’s key success factors? What does the firm need to do to be
successful in fulfilling its mission or achieving its desired competitive position?
2. What are the behaviors or actions necessary to successfully implement this competitive
strategy?
3. What program should we use to reinforce those behaviors? What should be the purpose
of each program in reinforcing each desired behavior?
4. What requirements should each program meet to be successful in fulfilling its purpose?
What value should it deliver to employees, and how do we know it is valued?
5. How well do the current reward programs match these requirements?

7. Important Policy Issues
In writing the pay plan, ask the following:
Will we be a pay leader or a follower?
Will we emphasize seniority or performance?
What pay cycle?
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Exactly how the firm will use its pay plan to further its strategic aims will manifest itself in the firm’s pay policies. The HR or compensation manager will write the policies in conjunction with top management, in a manner that’s consistent with the firm’s strategic aims.
Whether to emphasize seniority or performance is another issue. Seniority-based pay may be advantageous to the extent that employees
perceive seniority as an objective standard. One disadvantage, though, is that top performers may get the same raises as poor ones.
Other policies usually cover the pay cycle, as well as how to award salary increases and promotions, overtime pay, probationary pay, and leaves for military service, jury duty, and holidays.

8. Important Policy Issues
How do we fix salary compression?
How should we compensate based on geography or overseas employees?
Is the pay rate equitable with rates in other organizations outside the firm?
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How to handle salary compression is another policy issue. Salary compression, which means longer-term employees’ salaries are lower than those of workers entering the firm today, is a creature of inflation. Prices (and starting salaries) go up faster than the company’s salaries, and firms need a policy to handle it. Constructing one is tricky. On the one hand, you don’t want to treat current employees unfairly or to have them leave with their knowledge and expertise. However, mediocre performance or lack of assertiveness, not salary
compression, may explain some low salaries. One policy is to give raises based on Geography also plays a policy role. Cost-of-living differences between cities can be considerable. For example, a family of four might live in Miami for just over $39,000 per year, while the same family’s annual expenditures in Chicago or Los Angeles would be over $56,000.
Last but not least, no one likes to think they’re paid less than they deserve. So equity, both external and internal, is crucial in determining pay. Externally, pay must compare favorably with rates in other organizations, or an employer will find it hard to attract and retain good employees. Pay rates must also be equitable internally: Each employee should view his or her pay as equitable given other pay rates in the organization.

9. Salary Inequities How satisfied are you with your pay?
What criteria were used for your recent pay increase?”
What factors do you believe are used when your pay is determined?
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When employees become aware of inequities in the pay system, disappointment and often conflict can result. Some firms therefore
maintain strict secrecy over pay matters. But online pay forums on sites like vault.com and easy access to salary data on sites like
Salary.com have made it easier for employees to judge if they’re being paid equitably.

10. Establishing Pay Plans
The 5 step process:
The salary
survey
Job
evaluation
Pay grade
grouping
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Step 1. The Salary Survey
It’s difficult to set pay rates if you don’t know what others are paying, so salary surveys play a big role in pricing jobs. Virtually every employer conducts at least an informal telephone, newspaper, or Internet salary survey. Employers use these surveys in three ways. First, they use survey data to price benchmark jobs, around which the firm then slots its other jobs, based on their relative worth to the firm. (Job evaluation, explained next, helps determine the relative worth of each job.) Second, employers typically price 20% or more of their positions directly in the marketplace (rather than relative to the firm’s benchmark jobs), based on a formal or informal survey of what comparable firms are paying for comparable jobs. (A dot-com firm might do this for jobs
Step 2. Job Evaluation
Job evaluation is aimed at determining a job’s relative worth. It is a formal and systematic comparison of jobs to determine the worth of one job relative to another and eventually results in a wage or salary hierarchy. The basic principle is this: Jobs that require greater qualifications, more responsibilities, and more complex job duties should be paid more highly than jobs with lesser requirements.25
Step 3. Group Similar Jobs into Pay Grades
Once it’s used job evaluation to determine the relative worth of each job, the committee can turn to the task of assigning pay rates to each job; however, it will usually want to first group jobs into pay grades. If the committee used the ranking, point, or factor comparison methods, it could of course just assign pay rates to each individual job.31 But for a large employer, such a plan would be difficult to administer, since there might be different pay rates for hundreds or even thousands of jobs. And even in smaller organizations, there’s a tendency to try to simplify wage and salary structures as much as possible. Therefore, the committee will probably group similar jobs (in terms of their ranking or number of points, for instance) into grades for pay purposes. Instead of having to deal with hundreds of pay rates, it might only have to focus on, say, 10 or 12.
Step 4. Price Each Pay Grade—Wage Curves
The next step is to assign pay rates to your pay grades. (Of course, if you chose not to slot jobs into pay grades, you would have to assign individual pay rates to each individual job.) You’ll typically use a wage curve to help assign pay rates to each pay grade (or to each job).
Step 5. Fine-Tune Pay Rates
Fine-tuning involves developing pay ranges and correcting out-of-line rates.
Instructor’s note:
In the film clip, the owner and manager did many things improperly. Ask students what they saw.
Answers will vary but should include:
They did not have data to present to the employee regarding her request.
The employee focused on her needs, not business reasons for her request for an adjustment.
The owner and manager needed to listen, take notes, commit to nothing except to get back with the employee at a later time when they had conducted more research.
Price pay grade-
wage curves
Fine tune
pay rates

11. 1. The Salary Survey
The salary survey is a survey aimed at determining prevailing wage rates which include:
Formal
Informal
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Salary survey
A survey aimed at determining prevailing wage rates. A good salary survey provides specific wage rates for specific jobs.
Formal written questionnaire surveys are the most comprehensive, but telephone surveys and newspaper ads are also sources of
information.
Benchmark job
A job that is used to anchor the employer’s pay scale and around which other jobs are arranged in order of relative worth.

12. Uses of Salary Surveys Benchmark jobs
Employers price 20% or more of their positions currently in the job market
Surveys collect data on benefits
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Employers use surveys to price benchmark jobs around which the firm slots other jobs
Employers price 20% or more of their positions currently in the job market
Surveys collect data on benefits such as insurance, sick leave, and vacations, as a basis for decisions about employee benefits

13. 2. Job Evaluation
Job evaluation is the formal and systematic comparison of jobs in order to determine the worth of one job relative to another
The comparison results in a wage or salary hierarchy
Compensable factors are fundamental elements of a job
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Jobs than require greater qualifications, more responsibilities, more complex duties are higher on the pay scale than jobs with less requirements.
Job evaluation is aimed at determining a job’s relative worth. It is a formal and systematic comparison of jobs to determine the worth of one job relative to another and eventually results in a wage or salary hierarchy. The basic principle is this: Jobs that require greater qualifications, more responsibilities, and more complex job duties should be paid more highly than jobs with lesser requirements.
Compensable Factors You can use two basic approaches to compare several jobs. First, you can take an intuitive approach. You might decide that one job is more important than another and not dig any deeper into why. As an alternative, you could compare the jobs by focusing on certain basic factors the jobs have in common. Compensation management specialists call these compensable factors.
They are the factors that establish how the jobs compare to one another, and that set the pay for each job.

14. Compensable Factors
Two approaches in comparing jobs – Intuitive or via compensable factors
Intuitive based on decision that one job is more important than another
Compensability determined arbitrarily but some metrics include:
Skill
Equal Pay
Act factors
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Know-how
Effort
Hay
Consulting
Accountability
Responsibility
Work
conditions
Problem
solving

15. Preparing for the Job Evaluation
Its mostly a judgmental process which requires cooperation among managers
Identify the need for the program
Get cooperation
Choose an evaluation committee who will do the evaluation
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Preparing for the Job Evaluation Job evaluation is mostly a judgmental process, one demanding close cooperation among supervisors, HR specialists, and employees and union representatives. The main steps include identifying the need for the program, getting cooperation, and then choosing an evaluation committee. The committee then performs the actual evaluation. Identifying the need for job evaluation should not be difficult. For example, dissatisfaction reflected in high turnover, work stoppages, or arguments may result from paying employees different rates for similar jobs.
Next (since employees may fear that a systematic evaluation of their jobs may actually reduce their pay rates), getting employees to cooperate in the evaluation is a second important step.
Next, choose a job evaluation committee. There are two reasons for doing so. First, the committee should include several people who are familiar with the jobs in question, each of whom may have a different perspective regarding the nature of the jobs. Second, if the committee is composed at least partly of employees, the committee approach can help ensure greater employee acceptance of the job evaluation results.

16. Job Evaluation Committees
Performs 3 main functions:
Identifies key benchmarks
Selects some compensable factors
Evaluate the worth of each job via one of the methods on the following slides
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The evaluation committee performs three main functions. First, it usually identifies 10 or 15 key benchmark jobs. These will be the first jobs to be evaluated and will serve as the anchors or benchmarks against which the relative importance or value of all other jobs can be compared. Next, the committee may select compensable factors (although the HR department will usually choose these as part of the process of determining the specific job evaluation technique the firm will use). Finally, the committee performs its most important function— actually evaluating the worth of each job.

17. Job Evaluation Method 1:Ranking
Obtain job information
Select raters and jobs
Select compensable factors
Rank jobs
Combine ratings
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Job Evaluation Methods: Ranking The simplest job evaluation method ranks each job relative to all other jobs, usually based on some overall factor like “job difficulty.” There are several steps in the job ranking method.
1. Obtain job information. Job analysis is the first step: Job descriptions for each job are prepared and are usually the basis for ranking jobs. (Sometimes job specifications are also prepared, but the job ranking method usually ranks jobs according to the whole job, rather than a number of compensable factors. Therefore, job specifications—which list the job’s demands in terms of problem solving, decision
making, and skills, for instance—are not as necessary with this method as they are for other job evaluation methods.)
2. Select jobs. It is often not practical to make single ranking for all jobs in an organization. The usual procedure is to rank jobs by department or in clusters (such as factory workers or clerical workers). This eliminates the need for direct comparison of, say, factory jobs and clerical jobs.
3. Select compensable factors. In the ranking methods, it is common to use just one factor (such as job difficulty) and to rank jobs based on the whole job. Regardless of the number of factors you choose, it’s advisable to explain the definition of the factor(s) to the evaluators carefully so that they evaluate the jobs consistently.
4. Rank jobs. The simplest way is to give each rater a set of index cards, each of which contains a brief description of a job. Then they rank these cards from lowest to highest. Some managers use an “alternation ranking method” for making the procedure more accurate. Here you take the cards, first choosing the highest and the lowest, then the next highest and next lowest, and so forth until you’ve
ranked all the cards. Table 11-3 illustrates a job ranking. Jobs in this small health facility are ranked from orderly up to office manager. The corresponding pay scales are on the right. After ranking, it becomes possible to slot additional jobs between those already ranked and to assign an appropriate wage rate.
5. Combine ratings. Usually several raters rank the jobs independently. Then the rating committee (or the employer) can simply average the rankings.
This is the simplest job evaluation method, as well as the easiest to explain. And it usually takes less time than other methods. Some of its drawbacks derive more from how it’s used than from the method itself. For example, there’s a tendency to rely too heavily on “guesstimates.” Similarly, ranking provides no yardstick for quantifying the value of one job relative to another. For example, job number 4 may in fact be five times “more valuable” than job number 5, but with the ranking system all you know is that one job ranks
higher than the other. Ranking is usually more appropriate for small organizations that can’t afford the time or expense of developing a more elaborate system.

18. Method 2: Job Classification
Rates categories of jobs into groups
Groups called classes if jobs are similar
Called grades if groups contain different jobs of similar difficulty
Example:
Grade 10 may deputy director and the managing director
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Instructor’s note:
GS-10 really might be a fire chief and a press secretary – wanted to make sure you’re paying attention!
Job Evaluation Methods: Job Classification Job classification (or job grading) is a simple, widely used method in which raters categorize jobs into groups. The groups are called classes if they contain similar jobs, or grades if they contain jobs that are similar in difficulty but otherwise different. Thus, in the federal government’s pay grade system, a “press secretary” and a “fire chief” might both be graded “GS-10” (GS stands for “General Schedule”). On the other hand, in its job class system, the state of Florida might classify all “secretary IIs” in one class, all “maintenance engineers” in another, and so forth.
There are several ways to categorize jobs. One is to draw up class or grade descriptions (similar to job descriptions) and place jobs into classes or grades based on how well they fit these descriptions. Another is to draw up a set of rules for each class (for instance, how much independent judgment, skill, physical effort, and so on, does the class of jobs require?). Then categorize the jobs according to these rules.

19. Method 3: Point The point method is more quantitative
Identifies compensable factors
The degree to which each of these factors is present
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Job Evaluation Methods: Point Method The point method is a more quantitative technique. It involves identifying (1) several compensable factors, each having several degrees, as well as (2) the degree to which each of these factors is present in the job. Assume there are five degrees of “responsibility” a job could contain. Further assume you assign a different number of points to each degree of each factor. Once the evaluation committee determines the degree to which each compensable factor (like “responsibility”) is present in the job, it can calculate a total point value for the job by adding up the corresponding points for each factor. The result is a quantitative point rating for each job.

20. Method 4: Factor Comparison
Factor comparison is a widely used method to rank jobs by a variety of skills and difficulties, then adding these to obtain a numerical rating for each job
With this method you rank each job several times—once for each of several compensable factors
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Job Evaluation Methods: Factor Comparison The factor comparison method entails deciding which jobs have more of the chosen compensable factors. The method is actually a refinement of the ranking method. With the ranking method, you generally look at each job as an entity and rank the jobs on some overall factor like job difficulty. With the factor comparison method, you rank each job several times—once for each of several compensable factors.

21. 3. Group Similar Jobs Into Pay Grades
A pay grade is composed of equally difficult jobs
Committee will assign pay rates to each job based on one of the job methods
Ranking method grades fall in to a point range
Point method grades fall within two-three ranks
Factor comparison grades pay rate range
Classification method puts into classes or grades
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Group Similar Jobs into Pay Grades
Once it’s used job evaluation to determine the relative worth of each job, the committee can turn to the task of assigning pay rates to each job; however, it will usually want to first group jobs into pay grades. If the committee used the ranking, point, or factor comparison methods, it could of course just assign the committee will probably group similar jobs (in terms of their ranking or number of points, for instance) into grades for pay purposes. Instead of having to deal with hundreds of pay rates, it might only have to focus on, say, 10 or 12. A pay grade is comprised of jobs of approximately equal difficulty or importance as established by job evaluation.

22. 4. Price Each Pay Grade -Wage Curves
Developing a wage curve involves the following:
Find the average pay for each pay grade
Plot the pay rates for each pay grade
Fit the line called a wage line through the points just plotted
Price the jobs
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Wage curve
The wage curve shows the pay rates currently paid for jobs in each pay grade, relative to the points or rankings assigned to each job or grade by the job evaluation.
Note the link to the figure shows pay rates on the vertical axis, and pay grades (in terms of points) along the horizontal axis. There are several steps in pricing jobs with a wage curve. First, find the average pay for each pay grade, since each of the pay grades consists of several jobs. Next, plot the pay rates for each pay grade. Then fit a line, called a wage line, through the points just plotted.

23. 5. Fine Tune Pay Rates
Pay ranges are a series of steps or levels in a pay grade, usually based on years of service
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Developing Pay Ranges Most employers do not pay just one rate for all jobs in a particular pay grade. Instead, they develop vertical pay (or “rate”) ranges for each horizontal pay grade. These pay ranges may appear as vertical boxes within each grade, showing minimum, maximum, and midpoint pay rates for that grade, There are several reasons to use pay ranges for each pay grade. First, it lets the
employer take a more flexible stance in the labor market. For example, it makes it easier to attract experienced, higher-paid employees into a pay grade if the starting salary for the lowest step may be too low to attract them. Pay ranges also let companies provide for performance differences between employees within the same grade or between those with different seniorities.

24. Pricing Managerial and professional Jobs
Goal is to attract and keep
Harder to quantify evaluation
Paid on basis of ability
More complex and stress incentives over evaluation
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Developing compensation plans for managers or professionals is similar in many respects to developing plans for any employee. The basic aim is the same: to attract and keep good employees. And job evaluation—classifying jobs, ranking them, or assigning points to them, for instance—is as applicable to managerial and professional jobs as to production and clerical ones. Job evaluation provides only a partial answer to the question of how to pay managers and professionals.
These jobs tend to stress harder-to-quantify factors like judgment and problem solving more than do production and clerical jobs. There’s also more emphasis on paying managers and professionals based on ability—based on their performance or on what they can do—rather than on the basis of static job demands like working conditions.

25. Compensating Managers
Top executives compensated by:
Base pay + guaranteed bonus
Short term incentives
Long term incentives
Perks
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Short term incentives are usually cash or stock bonuses for short term goals.
Long term incentives may include stock options for projects that drive up stock values.
Executive benefits and perks may include supplemental executive retirement plans, life insurance, and health insurance without a deductible or a coinsurance.
Instructor’s note:
Many answers are possible to the question in the slide. What might be interesting is to discuss if any of your students have had friends and family members who have had some unusual perks offered to them.

26. What Really Determines Executive Pay?
Company size and performance
Industry CEO average pay
May emphasize 25% performance incentive
Board sets CEO pay
Shareholders may affect pay
Complexity of the job
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What Really Determines Executive Pay? Salary is the cornerstone of executive compensation; it’s the element on which employers layer benefits, incentives, and perquisites—all normally bestowed in proportion to base pay. Executive compensation emphasizes performance incentives more than do other employees’ pay plans, since organizational results are likely to reflect executives’ contributions more directly than those of lower-echelon employees. Incentives equal 25% or more of a typical executive’s base pay in many countries, including the United States, United Kingdom, France, and Germany.

27. Compensating Professionals
Job emphasizes creativity and problem solving
Job evaluation is useful
Some disciplines result in 4-6 grades with a broad salary range
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Compensating non-supervisory professional employees like engineers and scientists presents unique problems. Analytical jobs like these emphasize creativity and problem solving, compensable factors not easily compared or measured. Furthermore, how do you measure performance? The professional’s economic impact on the firm often relates only indirectly to his or her actual efforts. For example, the success of an engineer’s invention depends on many factors, like how well the firm markets it. Employers can use job evaluation for professional jobs. Compensable factors here tend to focus on problem solving, creativity, job scope, and technical knowledge and expertise. Firms use the point method and factor comparison methods, although job classification seems most popular and focuses on market pricing and salary structure.
Most employers use a market-pricing approach. They price professional jobs in the marketplace as best they can, to establish the values for benchmark jobs. Then they slot these benchmark jobs and their other professional jobs into a salary structure. Each professional discipline (like engineering or R&D) usually ends up having four to six grade levels, each with a broad salary range.

28. Why Pay Employees by Skill Levels?
The differentiation may bring about satisfaction and a basis for discriminate action
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With more companies organizing around teams, job expectations change
Companies expect employees to rotate among jobs that require different skills
Often jobs overlap
Companies composed mainly of professionals need an alternative to evaluation based pay

29. Skill-based Pay versus Evaluation-based Pay
Competence testing
Effect of job change
Seniority and other factors
Advancement opportunities
SBP may increase productivity and lower labor costs over JBP
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Competence testing. With JBP, you receive the pay attached to your job regardless of whether you acquire the competence needed to perform the job.
With SBP, your supervisor must certify that you’re competent in the skills required by the job before you get a pay increase.
Effect of job change. With JBP, your pay usually changes when you switch jobs. With SBP, if you move up, you must demonstrate proficiency before getting a raise. Similarly, you can, for instance, fill in for a missing colleague in a lower paying job, but still receive your (higher-skill) pay.
Seniority and other factors. JBP systems often tie pay to time in grade or seniority. SBP pays for skills, not seniority.
Advancement opportunities. There tend to be more opportunities for advancement with SBP plans than with JBP plans because the company-wide focus on skill building fosters more development and more opportunities. Similarly, SBP enhances organizational flexibility because workers’ skills are applicable to more jobs and thus more portable.

30. Money and Motivation Incentives motivate workers
Taylor standardized a fair day’s work
Which led to the scientific management movement
Which in turn led to modern day HR practices
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Fair day’s work Frederick Taylor’s observation that haphazard setting of piecework requirements and wages by supervisors was not sufficient, and that careful study was needed to define acceptable production quotas for each job.
Scientific management The careful, scientific study of the job for the purpose of boosting productivity and job satisfaction.
enough to cause the firm to cut the piece rate.
One of Taylor’s great insights was in seeing the need for a standardized, acceptable view of a fair day’s work. As he saw it, this fair day’s work should depend not on vague supervisory estimates, but on a careful, formal, scientific process of inspection and observation. This need to evaluate each job scientifically led to the scientific management movement. Then, in the depression-plagued 1930s, scientific management gave way to the human relations movement and its focus on satisfying workers’ social—not just financial—needs. For many years, incentive plans declined in popularity.

31. Performance and Pay Competition, shareholder value, and turbulence
Businesses need an edge
Achieving employee satisfaction
Paying attention
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Competition, shareholder value, and turbulence characterize business today.
Businesses need an edge and motivated employees are that edge in intensely competitive markets.
Pay attention - one study showed that business turbulence was offset onto managers by using variable pay.

32. Types of Incentive Plans
Individual
Group
Profit sharing
Employee group
Variable pay
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As you probably know from your own experience, incentive plans can be classified in several ways. They can, for example, be classified by level. Individual incentive plans provide income over and above base salary to individual employees who meet specific individual performance standards. Group incentive programs pay all members when the group or team collectively meets its performance standard. 8 Profit sharing plans are generally organization-wide, and provide all or most employees with a share of
the company’s profits in a specified period. Plans can also be classified by employee group—such as plans for operating employees, sales employees, or managers.

33. Incentives for Operations Employees
Piecework
Straight piecework
Standard hour plan
All must guarantee minimum wage
Can create quality problems
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Piecework A system of pay based on the number of items processed by each individual worker in a unit of time, such as items per hour or items per day.
Straight piecework An incentive plan in which a person is paid a sum for each item he or she makes or sells, with a strict proportionality between results and rewards.
Standard hour plan A plan by which a worker is paid a basic hourly rate but is paid an extra percentage of his or her base rate for production exceeding the standard per hour or per day. Similar to piecework payment but based on a percent premium.
While still widely used, even industries that traditionally stressed piecework incentive plans, such as textiles, are reportedly moving to other plans. “People did work harder under these programs, but they posed problems. For one thing, they created quality problems,” says one expert. Firms also tend to be more interested in incentive plans “that focus on profitability and profitability-related accomplishments,” rather than just production volume, says another expert. More firms are therefore moving to the team incentive plans, gain sharing plans, and organization-wide incentive pay programs we’ll discuss later.

34. Incentives for Operations Employees
Team or group incentive plans
All members receive the pay earned by the highest producer
Members receive pay equal to the average pay earned by the group
All members receive the pay earned by the lowest producer
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Team or group incentive plan A plan in which a production standard is set for a specific work group, and its members are paid incentives if the group exceeds the production standard.
Team or group incentive plans pay incentives to the team based on the team’s performance.22 One way to do this is to set work standards for each team member and then calculate each member’s output. Members are then paid based on one of three formulas: (1) All members receive the pay earned by the highest producer, (2) all members receive the pay earned by the lowest producer, or (3) all members receive pay equal to the average pay earned by the group.
A second approach is to set an engineered production standard based on the output of the group as a whole: All members then receive the same pay,
based on the piece rate for the group’s job. This group incentive can use the piece rate or standard hour plan, but the latter is more prevalent.
A third option is to tie rewards to goals based on some overall standard of group performance, such as “total labor hours per final
product.” Doing so avoids the need for a precisely engineered piecework standard.

35. The Annual Bonus
A bonus is aimed at motivating short term performance with three issues to consider when awarding them:
Eligibility – based on job level and salary
Fund size – use a formula
Individual awards – based on performance
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Eligibility Most firms opt for broad eligibility—they include both top- and lower-level managers—and mainly decide who’s eligible in one of two ways. Based on one survey, about 25% of companies decide eligibility based on job level or job title. About 54% decide eligibility based on a combination of factors, including job level/title, base salary level, and discretionary considerations (such as identifying key jobs that have a measurable impact on profitability). Base salary level alone is the sole determinant in less than 3% of the companies polled.
Fund size formula
Some use a nondeductible formula. They use a straight percentage (usually of the company’s net income) to create the short-term incentive fund. Others use a deductible formula, on the assumption that the fund should start to accumulate only after the firm has met a specified level of earnings. Some firms don’t use a formula at all, but make that decision on a totally discretionary basis.
Other formulas used for determining the executive bonus fund are as follows:
1. Ten percent of net income after deducting 5% of average capital invested in business.
2. Twelve and one-half percent of the amount by which net income exceeds 6% of stockholders’ equity.
3. Twelve percent of net earnings after deducting 6% of net capital.
Individual Awards The third task is deciding the actual individual awards. Typically, a target bonus (as well as maximum amount, perhaps double the target bonus) is set for each eligible position, and the actual award reflects the person’s performance. The firm computes performance ratings for each manager, computes preliminary total bonus estimates, and compares the total amount of money required with the bonus fund available. If necessary, it then adjusts the individual bonus estimates.

36. Manager’s Performance Bonus
Bonus for managers is either individual or corporate performance based or both
Split it with part based on individual performance rest on corporate performance
Never give outstanding performers too little
Never give poor performers normal or average awards
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One question is whether managers will receive bonuses based on individual performance, corporate performance, or both. Here again, there are no hard-and-fast rules. Firms usually tie top-level executive bonuses to overall corporate results (or divisional results if the executive heads a major division). But as one moves farther down the chain of command, corporate profits become a less accurate gauge of a manager’s contribution.
Many firms tie short-term bonuses to both organizational and individual performance. Perhaps the simplest way is the split-award method, which breaks the bonus into two parts. Here the manager actually gets two separate bonuses, one based on his or her individual effort and one based on the organization’s overall performance.
Whichever approach you use, the rule is: Don’t pay outstanding performers less than their target reward, regardless of organizational performance, and pay them substantially larger awards than you do other managers. The company cannot afford to lose these people.

37. Long Term Incentives Stock options Different stock option plans
Performance plans
Cash plans
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Employers use long-term incentives to inject a long-term perspective into their
executives’ decisions. With only short-term criteria to shoot for, a manager could
boost profitability by reducing plant maintenance, for instance; this tactic might
catch up with the company two or three years later. Long-term incentives also
encourage executives to stay with the company by letting them accumulate capital
(usually options to buy company stock) that can only be cashed in after a certain
number of years—“golden handcuffs,” as some call them.
Firms don’t just use stock options for this: Other popular long-term incentives
(discussed below) include cash, stock, stock appreciation rights, and phantom stock.
Stock option
The right to purchase a stated number of shares of a company stock at today’s price at some time in the future.
Mega-option grants
Large, upfront grants in lieu of annual grants.
Different Stock Option Plans
The key employee program may go to a handful of top executives and provides significant economic incentives to motivate these people and to keep them on board.

38. Long Term Incentives (Cont.)
Other Plans
Stock appreciation
Performance achievement
Stock options
Performance Plans
Cash Versus Stock Options
Page
There are several other stock-related long-term incentive plans. Stock appreciation rights permit the recipient to exercise the stock option (by buying the stock) or to take any appreciation in the stock price in cash, stock, or some combination of these. A performance achievement plan awards shares of stock for the achievement of predetermined financial targets, such as profit or growth in earnings per share. With restricted stock plans, the firm usually awards shares without cost to the executive: The employee can sell the stock (for which he or she paid nothing), but is restricted from doing so for, say, five years. Under phantom stock plans, executives receive not shares but “units” that are similar to shares of company stock. Then at some future time, they receive value (usually in cash) equal to the appreciation of the “phantom” stock they own.
Traditional executive incentives (like stock options) often don’t build in any real risk for the executive, so the executives’ and the shareholders’ interests could diverge. The solution is to design the plan so that executives don’t prosper unless the company does. Performance plans are one means for doing so. They are “plans whose payment or value is contingent on financial performance measured against objectives set at the start of a multi-year period.”

39. Performance Plans Executives do not prosper unless the company does
Executives have some “skin in the game”
Value is contingent on financial performance
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Performance plans are one means for doing so. They are “plans whose payment or value is contingent on financial performance measured against objectives set at the start of a multi-year period.”
Use a plan where executives do not prosper unless the company does
Make executives have some risk to garner their reward – a multiyear bonus
So use plans whose value is contingent on financial performance measured against objectives set at the start of a multi-year period

40. Cash Versus Stock Options
Which do you think is a better motivator?
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A study by consultants McKinsey and Company suggests that stock options may be the simplest and wisest route. About half the companies surveyed had stock options only, and about half had performance-based plans in which managers were given cash bonuses for long-term performance.
A study by consultants McKinsey and Co found long-term cash and stock options had the same effect on a company
However stock options plans cost much less to implement so may be the preferred route
It recommends using measures that correlate with shareholder wealth creation, such as return on equity

41. Steps to a Compensation Package
Include external and internal issues
What are our long term goals?
How can compensation support them?
What defines the work culture and how can the package be molded to it?
What are our competitive challenges?
What are our specific business objectives?
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1. Define the strategic context for the executive compensation program, including the internal and external issues that face the company, and the firm’s business objectives. For example, ask: What are our organization’s long-term goals, and how can the compensation structure support them? What defines the organization’s work culture—its basic values regarding what people should and should not do—and how will the compensation program mold that culture? What competitive challenges do we face? What are our company’s specific business objectives—for example, growth in market share or expansion abroad—and how can the compensation program help push the company in that direction? And how will the executive compensation program fit into the organization’s overall pay strategy?

42. Steps to a Compensation Package (Cont.)
Shape components into balanced plan
Meet unique company and strategic needs
Legal and tax effective
Install a review and evaluation process
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2. Based on your strategic aims, shape each component of the executive compensation package (base salary, short-term incentives, long-term incentives, and benefits and perquisites), and then group the components into a balanced plan that makes sense in terms of these aims.
3. Create a stock option plan that gives the executive compensation package the special character it needs to meet the unique needs of the executives and the company and its strategy.
4. Check the executive compensation plan for compliance with all legal and regulatory requirements and for tax effectiveness.
5. Install a process for reviewing and evaluating the executive compensation plan whenever a major business change occurs.

43. Incentives for Salespeople - Salaries
Sales compensation can be salaried, commission-based or hybrid
Salaries make sense when job is primarily prospecting or servicing clients
Useful when relocating to new territories
Can de-motivate very productive workers
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Salary Plan
Some firms pay some of their salespeople fixed salaries (perhaps with occasional incentives in the form of bonuses, sales contest prizes, and the like). Straight salaries make particular sense when the main job involves prospecting (finding new clients), or when it mostly involves account servicing, such as developing and executing product training programs for a customer’s sales force or participating in national and local trade shows.

44. Incentives for Salespeople - Commissions
Pay only for results
Easy to understand and compute
Focus only on high volume items
May ignore non-selling aspects
Performance is a product of ability
May result in high turnover
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Commission Plan
Commission plans pay salespeople for results, and only for results. Under these plans salespeople have the greatest incentive, and there’s a tendency to attract high-performing salespeople who see that effort clearly leads to rewards.

45. Example - Auto Dealer Commissions
Insight into why auto salespersons behave the way they do:
Some are 100% commission based
Others get commissions and small base salary
Net profit of car
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Compensation for car salespeople ranges from a high of 100% commission to a small base salary with commission
accounting for most of total compensation. Commission is generally based on the net profit on the car when it’s delivered to the buyer. it encourages the salesperson to hold firm on the retail price, and to push “after-sale products” like floor mats, side moldings, undercoating, car alarms, and trunk-mounted CDs. Car dealers also use short-term incentives. For helping sell
slow-moving vehicles, the salesperson may be offered a “spiff”—a car dealer term for an extra incentive bonus over commission.

46. Professional and Non-managerial Incentives
Merit pay or a merit raise is any salary increase awarded to an employee based on individual performance
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This approach suffers from same problems that performance appraisals do and a modest correlation is seen between merit pay and performance.

47. Merit Pay Options
Lump sum raises are not cumulative; traditional raise is
Lump sum can be a bigger motivator
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Two adaptations of merit pay plans are becoming more popular. One awards merit raises in a lump sum once a year (making them, in effect, short-term bonuses for lower-level workers). The other ties merit awards to both individual and organizational
performance. Traditional merit increases are cumulative, but most lump sum merit raises are not. Therefore, the rise in payroll expenses can be significantly slowed.
Lump-sum merit increases can also be more dramatic motivators than traditional merit pay raises. For example, a 5% lump-sum merit payment to our $30,000 employee is $1,500 cash, as opposed to a traditional weekly merit payout of $29 for 52 weeks.

48. Incentives for professionals
Determining this type of incentive is challenging
Professionals are well-paid and driven
Keep highly motivated professionals by using:
Stock options and profit sharing
Better vacations
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Professional employees are those whose work involves the application of learned knowledge to the solution of the employer’s problems. They include lawyers, doctors, economists, and engineers. Professionals reach their positions through prolonged
periods of formal study.
Making incentive pay decisions for professional employees can be challenging. For one thing, firms usually pay professionals well anyway; for another, they’re already driven—by the desire to produce high-caliber work and receive recognition from colleagues. In some cases, offering financial rewards to people like these may actually diminish their intrinsic motivation—not add to it.

49. Organization Wide Variable Pay Plans
Variable pay plans include:
Profit sharing
Employee Stock Ownership Program (ESOP)
Scanlon or gain-sharing plans
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50. Profit Sharing Employees share in some part of profits In cash plans
Lincoln incentive plan
Deferred plans
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In cash plans are most popular with 15%-20% of profits given to employees
Lincoln Incentive plan gives all profits less taxes, dividends and a reserve as a large portion of pay
Deferred plans place proceeds in a tax exempt account to be used at a later time (retirement)

51. ESOP Builds a sense of commitment and ownership in company
Positive tax advantages for company and employee
Allows firm to borrow against stock held in trust
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Employee stock ownership plans are company-wide plans in which a corporation contributes shares of its own stock—or cash to be used to purchase such stock—to a trust established to purchase shares of the firm’s stock for employees. The firm generally makes these contributions annually in proportion to total employee compensation, with a limit of 15% of compensation. The trust holds the stock in individual employee accounts, and distributes it to employees upon retirement (or other separation from service), assuming the person has worked long enough to earn ownership of the stock.
ESOPs have several advantages. The company gets a tax deduction equal to the fair market value of the shares that are transferred to the trustee, and can also claim an income tax deduction for dividends paid on ESOP-owned stock.109 Employees
aren’t taxed until they receive a distribution from the trust, usually at retirement when their tax rate is lower. The Employee Retirement Income Security Act (ERISA) allows a firm to borrow against employee stock held in trust and then repay the loan
in pretax rather than after-tax dollars, another tax incentive for using such plans.

52. Scanlon Plan
An incentive plan developed in 1937 by Joseph Scanlon and designed to encourage cooperation, involvement, and sharing of benefits
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As currently implemented, Scanlon plans have the following basic features.
The first is Scanlon’s philosophy of cooperation. This philosophy assumes that managers and workers must rid themselves of the “us” and “them” attitudes that normally inhibit employees from developing a sense of ownership in the company. It substitutes a climate in which everyone cooperates because he or she understands that economic rewards are contingent on cooperation. A pervasive philosophy of cooperation must exist in the firm for the plan to succeed.
A second feature of the plan is what its practitioners call identity. This means that to focus employee involvement, the company must clearly articulate its mission or purpose, and employees must understand how the business operates in terms of customers, prices, and costs.
Competence is a third basic feature. The plan assumes that hourly employees can perform their jobs competently as well as identify and implement improvements, and that supervisors have leadership skills for the participative management that is crucial to a Scanlon plan.
The fourth feature of the plan is the involvement system. This takes the form of two levels of committees—the departmental level and the executive level. Employees present improvement suggestions to the appropriate departmental-level committees, which transmit the valuable ones to the executive-level committee. The latter then decides whether to implement the suggestion.
The fifth element of the plan is the sharing of benefits formula. The Scanlon plan assumes that employees should share directly in any extra profits resulting from their cost-cutting suggestions. If a suggestion is implemented and successful, all employees usually share in 75% of the savings. There are several conditions required for Scanlon plans’ success. They are usually more effective when the number of participants is fewer than 1,000. They are more successful when there are stable product lines and costs, since it is important that the labor costs/sales ratio remain fairly stable. Good supervision and healthy labor relations seem essential. And of course, it is crucial that there be strong commitment to the plan on the part of both workers and management, particularly during the phase-in period.
Philosophy of
cooperation
Identity
Competence
Involvement
system
Benefits sharing
formula

53. Gainsharing Eight basic steps:
A modern Scanlon type plan where cost savings are shared
Eight basic steps:
Establish plan
objectives
Payout must be
large enough to
motivate
Choose performance
measures
Choose form of
payout
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The Scanlon plan is one early version of what today we call a gainsharing plan. Gainsharing is an incentive plan that engages many or all employees in a common effort to achieve a company’s productivity objectives, with any resulting cost-savings gains shared among employees and the company. In addition to the Scanlon plan, other types of gainsharing plans include the Rucker and
Improshare plans. The basic difference among these plans is the formula used to determine employee bonuses.
1. Establish general plan objectives. These might include boosting productivity or lowering costs.
2. Choose specific performance measures. For example, use productivity measures such as labor hours per unit produced, or financial measures like return on net assets to measure employee performance.
3. Decide on a funding formula. What portion of gains will employees receive? In one study, employees received, by formula, an average of 46.7% of incremental gains; the remainder stayed with the company.
4. Decide on a method for dividing and distributing the employees’ share of the gains. Standard methods include equal percentage of pay or equal shares; however, some plans also modify awards based on individual performance.
5. Make the disbursement significant enough to get participants’ attention and to motivate their behavior. One expert suggests a potential of 4% to 5% of pay and a 70% to 80% chance of achieving the plan’s performance objectives as an effective combination.
6. Choose the form of payment. This is usually cash, but occasionally is common stock.
7. Decide how often to pay bonuses. Firms tend to compute financial performance measures for this purpose annually, labor productivity measures quarterly or monthly.
8. Develop the involvement system. The most commonly used systems include steering committees, update meetings, suggestion systems, coordinators, problem-solving teams, department committees, training programs, newsletters, inside auditors, and outside auditors.
Use a funding
formula
Decide bonus
frequency
Method for
distributing share
of gains
Develop
an involvement
system

54. Making Gainsharing Work
Use multiple measures
Productivity cost performance, product damage, customer complaints, shipping errors, safety, and attendance
Committed managers
Straightforward formula
Employee involvement
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Many firms use multiple measures to ensure employees don’t ignore important activities. For example, one firm chose seven variables (productivity, cost performance, product damage, customer complaints, shipping errors, safety, and attendance) and set specific goals for each (such as zero lost-time accidents, for safety). It attached specific monthly bonuses to each goal achieved.
Managers must be committed to the plan, since they’ll have to set and maintain team goals, foster an atmosphere conducive to team effort and cooperation, and reduce adversarial relationships between management and employees. financial formula should be simple and should measure and reward performance with a specific set of measurable goals and a clear allocation method. Employee involvement is vital. The partnership between management and employees requires two-way communication, rather than just goal setting and top-down directives.

55. At Risk Plans Some portion of weekly pay at risk
Exceed goals and get extra pay
Miss goals and lose some pay
Employees become committed partners
Relies on trust, respect, communication and opportunities for advancement
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At-risk variable pay plans are essentially plans that put some portion of the employee’s weekly pay at risk, subject to the firm’s meeting its financial goals. 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.

56. Why Incentive Plans Can Fail
Performance pay can’t replace good management
You get what you pay for
Pay is not a motivator
Rewards punish
Rewards rupture relationships
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 Performance pay can’t replace good management. Performance pay is supposed to motivate workers, but lack of motivation is not always the culprit. Ambiguous instructions, lack of clear goals, inadequate employee selection and training, unavailability of tools, and a hostile workforce (or management) are just a few of the factors that impede performance.
 You get what you pay for. Psychologists say that people often put their effort where they know they’ll be rewarded. But this also can backfire. An incentive plan that rewards a group based on how many pieces they produce may lead to rushed production
and lower quality. A plantwide incentive for reducing accidents may simply reduce the number of reported accidents.
 “Pay is not a motivator.”134 Psychologist Frederick Herzberg says that money only buys temporary compliance, and that as soon as you remove the incentive, the motivation disappears. Herzberg says employers should provide adequate financial rewards, and then build other, more effective motivators (like opportunities for achievement and psychological success) into jobs.
 Rewards punish. Many view punishment and reward as two sides of the same coin. They say “Do this and you’ll get that” is not very different from “Do this or you won’t get that.”
 Rewards rupture relationships. Incentive plans have the potential for encouraging individuals (or individual groups) to pursue financial rewards for themselves. Some performance appraisal systems may then make the situation worse—for instance, by forcing the ranking of employees or groups.

57. Why Incentive Plans Can Fail
Rewards can unduly restrict performance
Rewards may undermine responsiveness
Rewards undermine intrinsic motivation
People work for more than money
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 Rewards can unduly restrict performance. One expert says: “Excellence pulls in one direction; rewards pull in another. Tell people that their income will depend on their productivity or performance rating, and they will focus on the numbers.
Sometimes they will manipulate the schedule for completing tasks or even engage in patently unethical and illegal behavior.”
 Rewards may undermine responsiveness. When employees’ main focus is on achieving some specific goal like cutting costs, any changes or distractions make achieving that goal harder. Incentive plans can therefore mediate against change and responsiveness.
 Rewards undermine intrinsic motivation. There is considerable evidence that contingent financial rewards (incentives) may actually undermine the intrinsic motivation that often results in optimal performance. The argument is that financial incentives undermine the feeling that the person is doing a good job voluntarily.
 People work for more than money. As one observer recently put it, “People do work for money, but they work for meaning in their lives. In fact, they work to have fun.”

58. Implementing Incentive Plans
Get support
Use accurate measurement
Long and short view
Consider corporate culture
Comprehensive commitment oriented approach
Use common sense
Incentive linked to strategy
Effort linked to reward
Easily understood
Set effective standards
Standard is a contract
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1. Use common sense. Sometimes incentive pay doesn’t make as much sense. For example: when employees are unable to control quantity or output (such as on machine-paced assembly lines); when delays in the work are frequent and beyond
employees’ control; or (often) when quality rather than quantity is the main consideration. Therefore, in general, it makes more sense to use an incentive plan when there is a clear relationship between employee effort and quantity or quality of output, the job is standardized, the work flow is regular, delays are few or consistent, and quality is less important than quantity—or, if quality is important, employees can easily measure and control it.138
2. Link the incentive with your strategy. As at AmeriSteel and IBM, decide how the incentive plan will contribute to implementing the firm’s strategy and objectives.
3. Make sure effort and rewards are directly related. The incentive plan should reward employees in direct proportion to increased productivity or quality. Employees must also perceive that they can actually do the tasks required. The standard has to be attainable, and you have to provide the necessary tools, equipment, and training.
4. Make the plan easy for employees to understand. Employees should be able to calculate their rewards for various levels of effort.
5. Set effective standards. Make standards high but reasonable—there should be about a 60% to 70% chance of success. And the goal should be specific—this is much more effective than telling someone to “do your best.”
6. View the standard as a contract with your employees. Once the plan is working, use caution before decreasing the size of the incentive. Rate cuts have long been the nemesis of incentive plans.
7. Get employees’ support for the plan. Restrictions by members of the work group can undermine the plan.
8. Use good measurement systems. In the case of merit pay, for instance, the process used to appraise performance must be clear and fair if the plan is to be of any use.
9. Emphasize long-term as well as short-term success. For example, just paying assembly workers for quantity produced may be shortsighted: Longer-term improvements like those deriving from work-improvement suggestions are often equally important in increasing the firm’s value.
10. Take the corporate culture into consideration. Compensation experts recommend making the incentive plan consistent with the culture you want to create. For example, a consulting firm had difficulty getting its geographic divisions to share information and refer new business leads to each other. The company instituted a cross-selling commission system. Now employees in one division
can earn extra commissions by referring new business to another division better suited for the client. Over time, “this was enough to change the thought process from ‘me’ to ‘we.”
11. Adopt a comprehensive, commitment-oriented approach. From the employees’ point of view, incentive plans don’t exist in isolation. For example, trying to motivate employees with a new incentive plan when they don’t have the skills to do the job, or are demoralized by unfair supervisors or a lack of respect, might well fail. Therefore, it’s best to install the program within a framework of HR-related practices that promote employee commitment by making the company a place in which employees want to work and do feel like partners.