1. Pay for Performance and Financial Incentives Chapter 12

2. The Origin of Financial Incentive In the 1800s, Fedrick Taylor popularized using financial incentives Taylor had a feeling that the employees had the tendency to work at the slowest pace and and to produce at the minimum acceptable level Such attitudes of employees was referred to as systematic soldiering by Taylor To overcome the problem, Taylor established the connection between pay and performance level He provided the incentives to the workers whose production exceeds predetermined standard

3. Linking Performance and Pay Today, it is a strategic imperative to link the performance to pay However, it is not an easy task and many pay for performance programs are ineffective Research shows that 83% of such programs are somewhat successful or not successful To establish effective programs, it is essential to understand the incentive theories and strategies

4. Motivation Theories: The Hierarchy Needs of Abraham Maslow Self-actualization Self-esteem Social Needs SecurityPhysiological Needs

5. Practical Implication of Maslow’s Theory Any guesses???????? Discuss with your neighbor! The appropriate answer will receive a bonus point!

6. Practical Implication of Maslow’s Theory People are motivated first to satisfy the lower-order needs Don’t try to motivate a person with a higher position who doesn’t have enough money to pay the bill

7. Motivation Theories: Motivators and Fedrick Herzberg Hygiene factors (extrinsic factors) Motivators (intrinsic factors) Better pay and working conditionRecognition, appreciation and providing challenging work These factors just keep the employees from becoming dissatisfied The best way to motivate a person is to provide with motivator factors Adding more of these factors will not generate extra motivation for the employees Adding more of these factors will enrich the job and get the employees further motivated

8. Practical Implication of Herzberg’s Theory Any Guesses???

9. Practical Implication of Herzberg’s Theory Relying exclusively on extrinsic factors is risky Incentive plan should include the intrinsic factors along with extrinsic factors

10. Motivation Theories: Expectancy Theory and Victor Vroom Vroom’s Expectancy Theory ◦ A person’s motivation to exert some level of effort is a function of three things:  Expectancy: that effort will lead to performance.  Instrumentality: the connection between performance and the appropriate reward.  Valence: the value the person places on the reward. ◦ Motivation = E x I x V  If any factor (E, I, or V) is zero, then there is no motivation to work toward the reward.  Employee confidence building and training, accurate appraisals, and knowledge of workers’ desired rewards can increase employee motivation.

11. Types of Incentive Plans Pay-for-performance plans ◦ Individual focus  Any plan that ties pay to individual productivity or profitability, usually as one-time lump payments. ◦ Organizational focus  A team or group incentive plan that ties pay to some measure of the firm’s overall profitability.

12. Individual Incentive Plans Piecework Plans  Straight piecework - A fixed sum is paid for each unit the worker produces - Employees are paid under an established piece rate standard  Standard hour plan - The worker gets a premium equal to the percent by which his or her work performance exceeds the established standard.

13. Pros and Cons???

14. Individual Incentive Plans (cont) Pros of piecework ◦ Easily understandable, equitable, and powerful incentives ◦ Organizations will not suffer if the employees work at a slower pace Cons of Peicework ◦ Quality problems caused by an overriding output focus ◦ Resistance to change (e.g. introducing new technologies) ◦ Switching from job to job

15. Individual Incentive Plans (cont’d) Merit Plan ◦ With merit pay, a firm provides the employees with financial incentives based on their individual performance ◦ It applies to white-collar employees ◦ Benefit?????

16. Individual Incentive Plans (cont’d) Merit pay options ◦ 2 options: 1. Annual lump-sum based on individual performance: annual merit raises that do not make the raise part of an employee’s base salary. Benefits- -The pay increase is not baked into the employee’s salary -You pay for a specific period of time

17. Individual Incentive Plans (cont’d) Merit awards ◦ 2 options: 2. Awards based on individual and organizational performance: Merit awards tied to both individual and organizational performance Benefits- -Company performance and employee performance is taken into account -This approach is more effective

18. Lump-Sum Award Determination Matrix (an example) To determine the dollar value of each employee’s incentive award: (1) multiply the employee’s annual, straight-time wage or salary as of June 30 times his or her maximum incentive award and (2) multiply the resultant product by the appropriate percentage figure from this table. For example, if an employee had an annual salary of $20,000 on June 30 and a maximum incentive award of 7% and if her performance and the organization’s performance were both “excellent,” the employee’s award would be $1,120: ($20,000 × 0.07 × 0.80 = $1,120).

19. It’s your turn! ◦ If an employee had an annual salary of $30,000 and a maximum incentive award of 9% and if her performance and the organization’s performance were both “good,” How much will the employee receive?

20. Answer: $1,620: ($30,000 × 0.09 × 0.60 = $1,620).

21. Incentives for Salespeople 3 options are available- 1. Salary Plan - To provide with a fixed amount of money in the form of salaries Pros -It is easy to calculate the salary -It is easy reassign the employees Cons - Demotivate potentially high-performing salespeople

22. Incentives for Salespeople (cont.) 2. Commission plan ◦ Pay is only a percentage of sales Pros-  Keeps sales costs proportionate to sales revenues  Easy to compute and understand  Easy to attract the competent salespeople Cons-  May cause a neglect of non-selling duties  The effect of economic boom and recession  Can create wide variation in salesperson’s income  Can increase turnover of salespeople

23. Incentives for Salespeople (cont.) 3. Combination plan ◦ Pay is a combination of salary and commissions, usually with a sizable salary component (70% base salary and 30% incentive) Pros: ◦ Plan gives salespeople a floor (safety net) to their earnings and still provides an incentive for superior performance Cons: ◦ Plans tend to become complicated, and misunderstandings can result

24. Which plan is better? Any guesses?

25. Incentives for Managers and Executives In addition to the salary, managers receive (a) short-term and (b) long-term incentives Short-term incentives With short-term incentive plans, 96% of the incentives are provided in cash (e.g. bonus) The percentage size of bonus usually depends on the positions -Top level executives: 80% of the base salary - Managers: 30% of the base salary - Supervisors: 15% of the base salary -

26. Incentives for Managers and Executives (cont.) Long-term incentives With long-term incentive plans, 48% of them are paid in stock A stock option is the right to purchase a specific number of shares of company stock at a specific price during a specific period of time Long term plan is designed to reward and motivate management for long-term corporate growth Employees are less likely the to leave the organization when they have the company share

27. Team and Organization-wide Incentive Plans With team incentive plans, incentives are paid to the team based on team’s performance The aim is to foster the teamwork or to make sure you have all your team Piecework standards are avoided here For example, if the firm reached 100% of its goals, the employees as the teams share is about 5% of the of the improvement

28. Team and Organization-wide Incentive Plans (cont.) Pros - Foster team planning and problem solving - Collaboration - Japanese organizations have the tendency to apply team plan in order to reduce jealousy and make the members indebted to one another Cons ( Levi Strauss installed a team incentive plan and found the following problems) - Some employees worked harder than others did - The faster ones soon slowed down, production declined and Levi’s ended up closing its US factories

29. Team and Organization-wide Incentive Plans: Profit Sharing They are plans in which all or most employees share of the firm’s annual profits Usually 15% to 20% of annual profits A Classic example- John Lewis partnership Research shows that profit sharing plans positively affect the performance of the employees Such plans boost productivity and morale

30. Team and Organization-wide Incentive Plans: Scanlon Plans Scanlon plan (Joseph Scanlon, 1937) This plan has been established to foster employee commitment by synchronizing the company’s goal with those of the employees. This plan is consisted of 5 features: ◦ Philosophy of cooperation  No “us” and “them” attitudes that inhibit employees from developing a sense of ownership in the company ◦ Identity  Employees understand the business’s mission and how it operates in terms of customers, prices, and costs ◦ Competence  The plan depends a high level of competence from employees at all levels ◦ Involvement  Employees should be encouraged to get engaged and provide with improvement suggestions ◦ Sharing of benefits formula  If a suggestion is implemented and successful, employees share in 75% of the savings

31. Calculation: Scanlon Plan If the the sales are $600,000, raw material costs should be $300,000 (50% of the sales). Assume the firm implements suggestions that result in raw material costs of $250,000 in a month when sales were $550,000. How much will the employees receive for the suggestion?

32. Answer By law, the raw material costs should have been $275,000 (50% of the sales). However, it turned out to be $25,000 due to the implementation of suggestion. As such the organization saved $25,000 ($275,000-$250,000). As such, workers would get $18,750 (75% of the savings) and organization should receive $6,250 (rest of the amount)

33. Team and Organization-wide Incentive Plans: At-Risk Pay plans At-risk variable pay plans are plans that put some portion of the employee’s weekly, monthly or yearly pay at risk ◦ 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.

34. 5 Building Blocks to Effective Plans 1. Does it make sense to use incentives here? - Use the incentive plans when: a. Motivation is the problem b. The job is standardized c. Work flow is regular 2. Link the incentive with your strategy a. Link the incentive to behavior that is critical to achieving strategic goals Example, Sun Microsystem’s incentive program to support customer satisfaction goals

35. 5 Building Blocks to Effective Plans (cont.) 3. Make sure the program is motivational - How would you do that? - Recall Victor Vroom’s theory - To make the program motivational, there should be a link between performance and reward, and reward should be attracted 4. Set complete standards - Take both quality and quantity into account - Don’t pay for quantity only if quality is an issue 5. Be Scientific - Don’t waste money on incentive that looks logical but may not be contributing top performance - Gather evidence and analyze the effects of incentive plan to determine whether the plans are effective

36. Thank you!