Merit Pay
A common method which has long been in existence is pay increases - in the form of increments, for example, for individual performance. Its workability and effectiveness depend on the existence of a suitable performance appraisal system, which has often been found to be lacking. Due to its integration into the salary, it is not lost due to poor performance later, and therefore may cease to be an incentive.
Incentive Payments
Lump sum payments (such as sales commissions) is another traditional method. It is not added to base pay. Usually the formula and the relationship between performance and the payment of the lump sum, are known beforehand.
Sales commissions may often have little to do with performance because factors such as product quality, brand name and price may contribute more to sales than the ability of the salesman to convince the buyers. Appraisals are less significant to this category since the criteria (e.g. sales figures) are statistical and no further measurement is needed.
Another traditional method of rewarding performance is piece rates. Unless related to a reasonable time frame within which the production should be completed, such rates would not be related to performance.
There are several weaknesses in certain types of incentive pay such as piece rates:
• it is not often easy to agree with workers on the standard required output
• frequent changes may be needed in the standard output due to technology changes, and this invariably leads to disputes
• factors other than individual performance affect output e.g. new work arrangements
• where team work is an organizational goal, individual incentives can be counter-productive
• piece rates can generate conflict and be divisive. Employees often wish to lower the standard output. Conflicts between different work groups occur when one group is dependent on another. There is a potential for conflict when norms have to be revised.
• piece-rates could be a disincentive to employees developing more productive work methods.Generally speaking, many incentive schemes are more appropriate to measurable repetitive tasks. They are not suitable for high technology and service activities requiring information-sharing, problem-solving and team work.
Group incentive schemes are of three types. Gain-sharing refers to a compensation system which divides between the employer and employees the results of improved performance consequent upon the better use of human resources resulting in productivity gains. Sharing is according to an agreed, pre-determined formula. A second type, namely, profit-sharing, gives employees a share of the profits. A third type is employee stock ownership plans (ESOPS). Sometimes bonuses are paid to individuals based on their own performance appraisal ratings. In the case of group incentives, the criteria could be either group or enterprise performance.
The necessity for objective criteria for distribution of the performance component of pay, and a clear relationship between what is paid and the criteria are important.
Productivity gain-sharing is practiced by the larger Japanese companies. Their system is based on the premise that basic to successful productivity enhancement in the long term is sharing productivity gains with employees by linking a part of earnings to productivity to achieve such multiple goals as
• increasing labour productivity
• improving employees' living standards
• strengthening employee commitment
• improving labour-management relations
• securing flexibility in labour costs
• maintaining corporate viability
In the Japanese system a part of productivity gains is shared with the employees through the collective bargaining process on whatever criteria are applied in collective negotiations, and part through the gain-sharing system. The amount distributed in recent years through the collective bargaining process and the gain-sharing system in manufacturing establishments with more than four employees has been about 35% of value added. In the 15 years previous to about 1993, the share allotted to labour remained stable. The two mechanisms - collective bargaining and joint consultation on gain-sharing - have supplemented each other, and have contributed to establishing a consensus on criteria for pay increases.
The component linked to productivity is paid in the form of a bonus, which in years before the recession, represented approximately 3-5 months' pay. About one-third of companies employing 30 or more persons have productivity-linked schemes. The percentage has been much higher in the larger companies.
Some companies combine productivity and merit rating. For example, a part of the increase may be a fixed amount to guarantee a fixed payment, while the other part is linked to productivity but distributed on a merit rating arrived at through the joint consultation system and reviewed annually.
Distribution of the productivity bonus may be direct to individuals, or first to the department or unit based on its performance level.
In Japan participation of employees in formulating and monitoring formulae has enabled them to:
• understand downturns and upswings in business cycles
• take a long-term view of growth
• be motivated through the opportunities offered them to influence the schemes
• achieve a common understanding of issues important to gain-sharing such as
1. concepts and measurement of productivity
2. the relationship between pay and productivity and past trends
3. estimates of labour costs and share
4. productivity improvement methods and targets
5. appraisal of the system
In general, gain-sharing systems are based on a participatory approach, and can be used to create or reinforce participatory practices. Evidence (e.g. in the U.S.A) indicates that such systems
• improve coordination, term work and knowledge-sharing
• satisfy social needs (through participation)
• focus on cost saving
• facilitate changes (e.g. in technology) needed to improve performance which are seen as being directly related to higher earnings
• result in expectations by employees of better management and planning
• result in contributions of ideas by employees.
Profit Sharing
These schemes are not related to an individual's performance, but are linked to the profits of an enterprise, a part of which is paid as a bonus to the workers. It may be a cash payment, or a deferred payment kept, for instance, in a special fund for a particular period. There are numerous types of schemes in existence. It has been estimated that by 1988 about half a million American firms were operating profit sharing schemes.
Long Term Incentives
Long term incentive plans are operated, especially for executives, both as an incentive to improved performance and in order to reduce fixed costs. Examples of such schemes are:
• share option plans to promote convergence of stockholder/executive interests
• bonus linked to long term performance (3-5 years) to encourage a focus on long term goals
In the 1980s stock ownership plans (ESOPs) in the U.S.A. normally included only executives, while in Japan they usually excluded executives. A lower rate of termination of ESOPs in Japan contrasted with a higher rate of terminations in the U.S.A.
Performance Bonus
This type of bonus can be based on individual or group performance. Where it is individual based, the payment would depend on performance ratings. Since the 1980s there has been in the U.S.A. an increase in union agreements substituting bonuses for traditional wage increases. In many countries performance bonuses are commonest for executive staff. It is estimated that in the U.S.A. about 97% of the large and 86% of the medium sized companies pay such bonuses to their executives. In
Western Europe the estimate is about 70% and in Singapore about 66%. As a percentage of base pay, the figure is highest in the U.S.A., though the variations are also large.
Some of the criteria for the success of such bonus payments are: group over individual performance, the existence of objective criteria for distribution, and the fact that such criteria are capable of measurement to ensure that what is paid is related to it.
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