Guidelines for Effective Performance based Pay System

To be fair to employees, organisations should keep the following guidelines in mind while instituting merit-pay systems.

Establish high standards of performance, so that only the truly outstanding employees emerge as winners.

Develop accurate performance appraisal systems. The focus must be on job-specific, results- oriented criteria as well as employee behaviours.

Train supervisions in the mechanics of carrying out appraisals and offering feedback to employees in a proper way.

Tie rewards closely to performance.

Use a wide range of increases. Also, make pay increases meaningful.

10.6.3 Incentives

Fringe benefits are different from incentives. Incentives are paid in lieu of superior performance shown by an employee. It is like a reward paid for performance. They are paid as a means to attract, motivate and retain employees. Incentive pay plans can elicit strong feelings. Incentive pay plans is based on the philosophy that a fair day's work is not normally attainable without some proportion of pay being at risk because time based workers produce only about 50 to 60 percent of the output of incentive pay workers. Incentives can be broadly classified into financial and non-financial incentives. Financial incentives are the monitory benefits provided to employees for their superior performance whereas non-financial incentives are those incentives that satisfy social and psychological and esteem needs of an employee. They can be further classified into following types:

Notes _{Types of Incentive Plans}

1. Individual Level Incentive Pay Plans: This is the most popular form of incentive pay plan. In this type of plan, each person's output or performance is measured and the rewards the person receives are based upon this measurement. Clearly, this is the type of incentive pay plan most likely to establish a clear performance-reward relationship in the mind of the employee. The purpose of the plan is to increase the pace of work or the effort the individual is willing to contribute in order to receive higher rewards. The classic example of this type of plan is a piecework system, wherein the employee is paid a set amount for each unit of production. The organization expects to receive more output than it would if the employee were paid under a time-based system. In addition, the organization can easily track the labour cost associated with each unit of output.

One assumption of these plans is that the employee is an independent operator, that he or she alone can carry out all the activities required to achieve the performance measure. In this way, performance is a function of the employee's effort. The performance standard must be clearly defined and measurable if such a plan is to be useful. Also, the job must be relatively stable: the output required from the job should be consistent, and the inputs to the job should arrive in such a way that the employee can work continuously.

2. Group Level Incentive Pay Plans: Where it is impossible to relate output to an individual employee's efforts it may be possible to relate it to the efforts of the work group. If, in addition, cooperation is required to produce the desired output, then a group incentive plan may be the best alternative. Interdependence of work, then, is a major reason for choosing a group plan over an individual one. A group incentive plan can reward things that are very different from what an individual plan rewards, in particular: cooperation, teamwork, and coordination of activities. Where these are highly valued, a group plan is the most appropriate. As organizations become more complex and the production process more continuous, group incentive pay plans can be expected to become more popular. Group plans are also useful where performance standards and measures cannot be defined objectively. In a group setting, variations tend to average out, so no one gets as hurt by random variation or lack of continuity. Almost any individual plan can be adapted to a group setting. Thus the focus in group plans is still higher level of effort.

The primary disadvantage of the group plan is that it weakens the relationship between the individual's effort and performance. Where there is likely to be wide variation in the efforts of group members, a group incentive may lead to more intragroup conflict than cooperation. In group plans, it is also more difficult to monitor performance standards and measures. Finally, group norms play an expanded role, both positive and negative, in group plans. They are stronger and more controlling on the individual. Where the group norms are congruent with management's goals, this is a plus; but where the two differ, it can harm the chances of success of the incentive plan.

3. Plant and Organization-wide Incentive Pay Plans: Organization-wide plans are expanding under the name of gainsharing.

Organization-wide plans differ significantly from individual plans by rewarding different things. As indicated, most individual and group plans attempt to increase effort. Most organization-wide plans, however, reward an increase in organization-wide outcomes that directly affect the cost and/or profit picture of the organization. Usually, these plans reward increases in productivity of the plant or organization as measured by reduction of organizational costs, in comparison with some measured normal cost. Or they may reward increased output with the same or fewer inputs.

A major feature of organization-wide incentive pay plans is a change in the relationship between management on the one hand and employees on the other. Rather than the

Notes

traditional adversarial relationship between the two, most organization-wide plans require a high degree of cooperation. This is because both groups must focus on the desired cost savings and listen to the other party. Various types of organization level plans are: (a) Profit Sharing: Profit sharing is popular organization-wide programme that is often

classified as a gainsharing plan. This type of plan can be made much more simple than a cost-savings plan. Nor does it require the revolution in employee-management relationships that cost-savings plans do. With profit sharing, management hopes to change employee attitudes toward the organization without a concomitant change in managerial attitudes toward the employee. The idea behind profit sharing is to instill in the employee a sense of partnership with the organization. But most plans go beyond this and use profit sharing as a way to keep valuable employees and to encourage thrift in employees. Profit sharing plans are typically differentiated on the basis of when profit shares are distributed. Cash plans (known also as current- distribution plans) pay out profit shares at regular intervals. Deferred plans put the profits to be distributed in the hands of a trustee, and distribution is delayed until some event occurs. This type of plan is most often tied into a retirement system. Combination plans distribute a part of the current profits and defer the rest. Profit sharing plans vary widely in provisions concerning organization contributions, employee allocation, eligibility requirements, payout provisions, and other administrative details. Two-thirds of the plans define the contribution of the organization by a formula; in the balance, the board of directors determines the amount. Most formulas specify a straight percentage of before-tax profit, after reservations for stockholders and reserves. The amounts allocated to employees or their accounts are usually based on their compensation, but may also be influenced by their length of service, contributions, performance, or responsibility. In most plans, all full-time employees are eligible immediately or after a short waiting period, but a substantial minority of plans exclude union employees or are limited to specific employee groups. Payout provisions are usually determined by plan designation (cash, deferred, or combination), but deferred and combination plans are increasingly incorporating vesting provisions and payout under a wide variety of circumstances.

(b) Gain Sharing: This approach is broader than profit sharing. It is a more appropriate organization-wide incentive pay plans. The purpose of gainsharing is to tie the employee to the performance measures by which top management is judged and by which society defines a successful organization. Although clear performance-reward connections can be made in these circumstances, it is difficult to make a performance- effort connection.

A number of different performance measures can be used in gainsharing, but all share a common dimension: a baseline standard must be established to determine where the organization is at the present time. The value of improvements in future measures of performance is then shared with the employees. One set of performance definitions rewards reductions in costs or improvements in productivity.

The most popular gainsharing plan is the Scanlon Plan. In this plan, employees are paid a bonus if costs remain below pre-established standards. The standards have been set by studies of past cost averages. Ways to reduce costs are developed by a series of committees throughout the organization and a plant-wide screening committee that reviews and implements changes. Although Scanlon developed this plan in 1937, these committees took much longer to pay out profit shares at regular intervals as earned. Deferred plans put the profits to be distributed in the hands of a trustee, and distribution is delayed until some event occurs. This type of plan is ordinarily tied into a retirement plan. Combination plans distribute part of the profit share as earned and defer distribution of the balance.

Notes

Notes _{Two new concepts of incentive programmes are Broadbanding and Competency-} based pay. Organisations that follow a skill-based or competency based pay system frequently use broad banding to structure their compensation payments to employees. Broad branding simply compresses many traditional salary grades (say 15 to 20 grades) into a few wide salary bands (three or four grades). By having relatively few job grades, this approach tries to play down the value of promotions. Depending on changing market conditions and organisational needs, employees move from one position to another without raising objectionable questions, (such as when the new grade is available, what pay adjustments are made when duties change, etc.) As a result movement of employees between departments, divisions and locations becomes smooth. Employees with greater flexibility and broader set of capabilities can always go in search of jobs in other departments or locations that allow them to use their potential fully. Broad banding, further, helps reduce the emphasis on hierarchy and status. However, broad banding can be a little unsetting to a new recruit when he is made to roll on various jobs. Most employees still believe that the existence of many grades helps them grab promotional opportunities over a period of time. Any organisation having fewer grades may be viewed negatively - as having fewer upward promotion opportunities. Moreover, a number of individuals may not want to move across the organisation into other areas.

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Case Study

_{The Failed Job Change}

N

ikhil has joined as Director of an organisation during early March, 2001 in New Delhi, shifting from Calcutta. During the selection process, the committee duly considered his earlier pay package and has given him a proportionate rise in pay adding also the tax savings which he will accrue due to splitting of 50 per cent of his pay as reimbursement. He was happy for such compensation design, as his savings will be more in his new position. Within two weeks of his joining, government has issued a notification, declaring ceiling on all perquisites and bringing all reimbursements given as perquisites within the ambit of tax net. Nikhil raised this issue and asked for reprieve with upward revision of his compensation package. The company pleaded its helplessness as government orders are beyond their control and any revision at this stage will set a bad precedence to other employees of the organisation. He was told to continue and wait for the next revision after a year, when these issues will be taken care of.

Salary information in the company is not confidential. It is so transparent that even the lowest rung of the organisation knows what others get. Internally employees feel de- motivated when they find their pay raise is disproportionate to the pay raise of their bosses. The company has a system to give Diwali gifts to all in cash and kind. This is kept strictly confidential and nobody knows what others are getting. The Board approves the total amount for this purpose and distributes among employees, keeping in view their performance and hierarchy. Performance feedbacks are obtained from the structured performance appraisal system.

Nikhil was tipped off that he will be able to reduce his loss through the Diwali gift and hence he should not feel de-motivated at this stage. During early November, 2001, Nikhil received a sealed packet with a gift cheque of 10,000 and gift vouchers worth 20,000.

Notes

Next morning he received a phone call from the Chairman, who asked him to indicate his feelings when he met him in person during the afternoon. In between, Nikhil did a detailed computation in consultation with his Chartered Accountant and found that he cannot get him absolved from tax burden from this gift amount as he has to show this in 'other income category' and pay about 33 per cent towards tax. A visibly perturbed Nikhil decides to quit. He loses all hopes for re-negotiation and sends his three months' notice to the Chairman.

Questions

1. Do you think Nikhil is right in his stand?

2. What could be the alternatives for the organisation to reduce the pay gap? 3. Should the Chairman initiate any action to retain Nikhil considering his outstanding

contributions.

In document HUMAN RESOURCE MANAGEMENT (Page 169-173)