compensation methods

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11

Compensation:Methods and Policies

McGraw-Hill/IrwinHuman Resource Management, 10/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

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Objectives

Understand how individual pay is determined.Define variable pay and discuss the various incentive

programs that can be used in such a system.Explain why merit pay may cause employees to

compete rather than cooperate.Recognize the significant changes in these

innovations and learn to differentiate among them: skill-based, knowledge-based, credential-based, feedback, and competency-based pay.

Describe issues such as secrecy, security and compression

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Introduction

A compensation system should be: SecureBalancedCost-effectiveAcceptable to employees

Three aspects of acceptability will be discussed: Whether pay should be secret Communication to achieve acceptability Employee participation in pay decision making

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Determination of Individual Pay

To determine individual pay: Management must answer these questions:

How should one employee be paid relative to another when they both hold the same job in the organization?

Should we pay all employees doing the same work at the same level the same?

If not, on what basis should distinctions be made? Seniority, merit, or some other basis?

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Most employers pay different rates to employees performing the same job based on: Individual differences in experience, skills, and

performance Expectations that seniority, higher performance, or

both deserve higher pay

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Reasons to pay different rates for the same job: Employees performing the same job make

substantially different contributions to goals A changed emphasis on important job roles, skills,

knowledge, and so onEmphasizes the norms of enterprise without having

employees change jobs (promotion) Without differentials, the pay system violates the

internal equity norms of most employees Recognizes market changes between jobs in the

same grade without overhaul the whole system

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Methods of Payment

Employees can be paid for:The time they workThe output they produceSkillsKnowledgeCompetenciesA combination of these factors

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Variable Pay: Incentive Compensation

Global competition and economic restructuring are requiring businesses to become more productiveReliance on outdated pay systems is holding

American businesses back Traditional pay systems do not effectively link pay to

performance or productivity Managers are increasingly using variable pay plans

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Variable pay is any compensation plan that: Emphasizes a shared focus on organizational success Opens incentives to nontraditional groups Operates outside the base pay increase system

Included in the calculations of variable pay are: Individual incentive awards Individual recognition awards Group and team awards Scheduled lump-sum awards

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To implement successful variable pay systems, companies must based their plans on:Clear goals Unambiguous measurements Visible linkage to employees' efforts

Key design factors include: Support by managementAcceptance by employeesSupportive organizational cultureTiming

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With variable pay, a percentage of an employee's paycheck is at risk If business goals aren't met, the pay rate will not rise

above the base salary Annual raises are not guaranteed The individual earns all or part of the bonus by

meeting objectivesPay returns to the base level the next year and the

employee must again compete for the variable reward

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Total compensation includes:Base payVariable payIndirect pay

Variable pay helps manage labor costs, but does not guarantee equitable treatment of employees Financial insecurity is built into the system As a result, productivity may actually decline

Paying employees on the basis of output is usually referred to as an incentive

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Merit Incentives

The most widely used plan for managing individual performance is merit pay A reward based on how well a job was done

Traditionally, merit pay results in a higher base salary after the annual performance evaluation Merit increases are usually spread evenly throughout

the subsequent year 80 to 90 percent of firms offer merit raises, but little

research has examined merit pay or its effects

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Merit Incentives

Advocates claim merit pay is the most valid type of pay increase Awards are directly linked to performanceRewarding the best performers with the largest

pay is claimed to be a powerful motivator This premise has two flawed assumptions:

Competence and incompetence are distributed in roughly the same percentages in a work group

Every supervisor is a competent evaluator

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Merit Incentives

Many merit pay systems fail due of three problems: Employees fail to make the connection between pay

and performance The secrecy of the reward is perceived as inequity The size of the award has little effect on performance

Merit plans can work where: The job is well designed The performance criteria are well delineate

and assessable

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Merit Incentives

Merit pay systems depend on a reward to produce an effect A promise of increased salary in exchange for a

promise to perform satisfactory future work Many existing merit plans are not clearly linked to an

individual's performance, so merit increases are not always viewed as meaningful

Merit pay focuses on the individualIt is more likely to cause employees to compete with

each other than to collaborate or share resources

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Individual Incentives

The oldest form of compensation is the individual incentive planThe employee is paid for units produced

Individual incentive plan takes several forms: Piecework Production bonuses Commissions

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Individual Incentives

Individual incentive plans are likely to be effective if: The task is liked The task is not boring The supervisor reinforces and supports the system The plan is acceptable to employees and managers The incentive is financially sufficient to induce

increased output Quality of work is not especially important Most work delays are under the employees' control

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Team Incentives

Individual incentives can be paid to teams of individuals Team incentive plans can reduce administrative costs

Reasons to choose a team incentive plan It is difficult to measure individual output Cooperation is needed to complete a task or project Management thinks this is a more appropriate

measure on which to base incentives

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Team Incentives

The Japanese use team incentives to foster group cohesiveness and reduce jealousyIn the United States, there may be a clash between

societal norms and group incentive systems For small-group incentives to be effective,

management must:Define its objectivesAnalyze the situationSelect the most appropriate group incentive

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Problems with Incentives

In individual and group incentive systems, competition can result in: Withholding information or resources Political gamesmanshipNot helping othersSabotaging the work of others

To minimize these problems, some organizations are using organization-wide incentive plans

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Organization-wide Incentives

Organization-wide incentives are more common than individual or group incentives

Payments are usually based on one of two performance concepts:

Sharing profits generated by the efforts of all employees altogether

Sharing money saved as a result of employees' efforts to reduce costs

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Organizationwide Incentives

Three approaches to incentive plans are used at the organizationwide level: Suggestion systemsCompany group incentive

plans (gain-sharing)Profit sharing

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Suggestion Systems

A formal method of obtaining employee advice about organizational effectiveness It includes some kind of reward based on the

successful application of the idea The key to success is employee involvement These programs are quite cost-effective

Suggestion systems can: Improve employee relations Foster high-quality products Reduce costsIncrease revenue

Suggestion systems are often administered by

the HR department

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Suggestion Systems

A successful suggestion system includes: Management commitment Clear goalsDesignated administratorStructured award systemRegular publicityImmediate response to each suggestion

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Gainsharing Incentive Plans

Gain-sharing plans are company-wide group incentive plans that use a financial formula to:Distribute organization-wide gains, andUnite diverse organizational elements in the common

pursuit of improved organizational effectivenessThrough cash bonuses, these systems share the

benefits of: Improved productivityReduced costsImproved quality

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Gain-sharing Incentive Plans

Gain-sharing incentive systems are exceptionally effective in enhancing teamwork in:Manufacturing organizationsService organizations

Commonly used gain-sharing plans: Lincoln Electric ScanlonRuckerImproShare

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Profit-Sharing Plans

Profit-sharing plans distribute a fixed percentage of total profit to employees in cash or deferred bonuses Profit sharing is not dominant in other industrialized

countries Profit-sharing plans are typically found in three

combinations: Cash or current distribution plansDeferred plansA combination of both

80% of the companies using profit sharing use the deferred option

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People-Based Pay

The bureaucratic job-based method of determining pay will not be used in the future The new designs will be people-based

Variants of people-based pay: Skill-based Knowledge-based Credential-based FeedbackCompetency-based

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Skill-Based Pay

Skill-based pay sets pay levels on the basis of:How many skills employees have, or How many jobs they can do

Expected positive outcomes include: Increased quality Higher productivity A more flexible workforce Improved morale Decreased absenteeism and turnover

When a new skill is added to an

existing job, the employee earns a pay increase by

mastering it

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Skill-Based Pay

Methods for defining individual skills: Direct observation TestingMeasurable results

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Knowledge-based Pay

Knowledge-based pay rewards employees for acquiring additional knowledgeApplies to both the current and new job Stretches the skill-based model to professionals,

managers, and some technical personnel A study compared two manufacturing plants

One used the job-centered pay design; the other a knowledge-based design

After 10 months, the pay-for-knowledge facility had higher quality, lower absenteeism, fewer accidents

The traditional plant had higher productivity

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Credential-based Pay

Credential-based pay rests on the fact that an individual must have:A diploma or license, or Pass one or more examinations from

a third-party professional or regulatory agency

Credential-based pay is more cut-and-dried than skill-based or knowledge-based pay

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Feedback Pay

Feedback pay is based on:Aligning pay with strategic business objectives Establishing a direct connection between the

jobholder and his/her part in accomplishing goals This design must conform to four principles:

Flows directly from strategic business goals Directly links employees' actions to these goals Provides sufficient opportunity for rewards to hold

employees' attention Is timely

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Issues in Compensation Administration

Managers must make policy decisions that involve the extent to which: Compensation will be secretCompensation will be securePay is compressed

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Pay Secrecy or Openness

There are degrees of pay secretiveness and openness In many organizations, pay ranges and individual

pay are open to the public and fellow employees (open system)

With the secret system, pay is known only to the employee, her/his superior, and HRM/payroll In some organizations, employees cannot discuss

pay matters and, specifically, their own pay

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Pay Secrecy or Openness

Opening up a system has costs and benefitsTo reduce the manipulative aura surrounding pay, a

company must share pay information with employees As firms post job openings, information on pay

becomes a critical decisionWhen deciding on secrecy or openness:

Determine what employees want to know about pay Decide if the information will harm or help the firm Weigh performance, interdependence, and causal

relationships

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Pay Security

Current compensation can motivate performanceSo can the belief that there will be future

compensation security Plans for providing this security include:

A guaranteed annual wage Supplementary unemployment benefits Cost of living allowances (COLAs) Severance pay Seniority rules Employment contracts

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Pay Compression

Occurs when employees perceive too narrow a difference between their pay and that of colleagues There is a narrowing gap between senior and junior

employees and between supervisors and subordinates Differentials of 10 percent or less are not unusualJunior employees are sometimes brought in at

salaries greater than those of their superiors The resulting low morale can lead to decreasing

productivity, higher absenteeism, and turnover To identify pay compression, compare salaries and

incumbents' years of experience with the company

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Pay Compression

Solutions for pay compression include: Reexamining how many entry-level people are

needed Reassessing recruitment Emphasizing performance instead of salary-grade

assignment Basing all salaries on longevity Giving first-line supervisors and other managers the

authority to recommend equity adjustments Limiting the number of new hires with excessive

salaries

compensation methods

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