Chapter 16 variable pay can be viewed as an attraction tool. Which plan would keep you motivated; profit sharing, gain sharing, group or individual incentives? Explain why.

Information:

Variable Pay

Variable pay by definition is a variable cost. It refers to all forms of ongoing cash compensation besides base pay. In other words, it has nothing to do with an employees base pay. If profits are low or even worse, there are no profits then there will be no extra pay beyond base pay. Historically, pay has been viewed as an entitlement. If you went to work and did well enough to avoid being fired, you were entitled to the same size paycheck as everyone else. Pay-for-performance plans signal a movement away from entitlement toward pay that varies with some measure of individual or organizational performance.

The greater interest in variable pay can be traced to two trends. First, increasing competition from foreign producers forces U.S. firms to cut costs and/or increase productivity. Well-designed variable-pay plans have a proven track record in motivating better performance and helping cut costs. Second, the fast-paced business environment means employees must be willing to adjust what they do and how they do itnew technologies, new work processes, and new work relationships require employees to adapt in new ways. Failure to move quickly may result in lost market share. To avoid this scenario, compensation experts are focusing on designing reward systems that more closely link employee interests with the objectives of an organization.

Types of Variable Pay Plans

Individual Incentive Plans

Individual incentive plans offer a promise of pay for some objective, or pre-established level of performance. All incentive plans have one common feature: an established standard against which worker performance is compared to determine the magnitude of the incentive pay. For individual incentive systems, this standard is compared against individual worker performance. Because its often difficult to find good, objective individual measures, individual incentive plans dont work for every job.

Team Incentive Plans

When we move away from the individual incentive systems and start focusing on people working together, we shift to group incentive plans. A standard is established against which worker performance is compared to determine the magnitude of the incentive pay. The standard might be an expected level of operating income for a division. Or the measure might be more unusual. Despite an explosion of interest in teams and team compensation, many of the reports from the front lines are not encouraging.

One of the problems with team compensation is that teams come in many varieties (full-time teams, part-time teams, etc.). With so many varieties of teams, its hard to argue for one consistent type of compensation plan. A second problem with rewarding teams is called the level problem.

If teams are defined at the very broad levelthe whole organization being an extreme examplemuch of the motivational impact of incentives can be lost.

Conversely, if teams get too small, other problems arise. TRW found that small work teams competing for a fixed piece of incentive awards tend to gravitate to behaviors that are clearly unhealthy for overall corporate success.

Teams hoard star performers, refusing to allow transfers even for the greater good of the company. Teams are reluctant to take on new employees for fear that time lost to training will hurt the team.

Finally, bickering arises when awards are given. Because teams have different performance objectives, it is difficult to equalize for difficulty when assigning rewards.

The last three major problems with team compensation involve the three Cs:

Complexitysome plans are simply too complex.

Controlsome companies factor uncontrollable elements into the process of setting performance standards. Experts assert that this ability to foretell sources of problems and adjust for them is a key element in building a team pay plan. Key to the control issue is the whole question of fairness. Recent research suggests that this perception of fairness is crucial. With it, employees feel it is appropriate to monitor all members of the group.

Communicationsteam-based pay plans simply are not well communicated. Employees asked to explain their plans often flounder because more effort has been devoted to designing the plan than to deciding how to explain it.

Although there is much pessimism about team-based compensation, many companies still seek ways to reward groups of employees for their interdependent work efforts. Companies that do use team incentives typically set team performance standards based on:

Productivity improvements

Customer satisfaction measures

Financial performance

Quality of goods and services

Comparing Group and Individual Plans

A major question when deciding to use group or individual plans is when to use which? Individual incentives yield higher productivity gains, but group incentives often are right in situations where team coordination is the issue. One study found that changing from individual incentives to gain sharing rewards resulted in a decrease in grievances and a fairly dramatic increase in product quality. Things like the type of task, the organizational commitment to teams, and the type of work environment may preclude one or the other type of incentive plan.

When forced to choose a plan with greater productivity pep, experts agree that individual incentive plans have better potential forand probably better track records indelivering higher productivity. Group plans can suffer from what is called the free rider problem. According to this concept, certain team members do not carry their share of the work load. Yet, when the time comes to divide the rewards, they are typically shared equally. The end result may be turnover of the very group that is most costly to lose. Research on free riders suggests that the problem can be lessened through use of good performance measurement techniques. Specifically, free riders have a harder time loafing when there are clear performance standards.

Gainsharing & Profit Sharing

When we get beyond a small work team and try to incentivize large groups, there are generally two types of plans: gain-sharing plans & profit sharing plans.

Gain-Sharing Plans

Gain sharing looks at cost components and identifies savings over which employees have more impact. For example, reduced scrap, lower labor costs, reduced utility costs. Given that organizations are complex and require more complex measures, performance measures have expanded beyond traditional financial measures. For example, with the push for greater quality management, organizations could measure retention of customers or some other measure of customer satisfaction. Similarly, other measures include delivery performance, safety, absenteeism, turnaround time, and number of suggestions submitted.

Great care must be exercised with such alternative measures, though, to ensure that the behaviors reinforced actually affect the desired bottom-line goal.

Perceived fairness of the formulaone way to ensure the plan is perceived as fair is to let employees vote on whether implementation should proceed. This and union participation in program design are two elements in plan success.

Ease of administrationsophisticated plans with involved calculations of profits or costs can become too complex for existing company information systems. Increased complexities also require more effective communications and higher levels of trust among participants.

Production variabilityone of the major sources of problems in group incentive plans is failure to set targets properly. At times the problem can be traced to volatility in sales.

A good plan ensures that environmental influences on performance, which are not controllable by plan participants, should be factored out when identifying incentive levels. One alternative would be to set standards that are relative to industry performance. To the extent data are available, a company could trigger gain sharing when performance exceeds some industry norm. The obvious advantage of this strategy is that economic and other external factors hit all firms in the industry equally hard.

Profit Sharing Plans

Profit sharing continues to be popular because the focus is on the measure that matters most to the most people: a predetermined index of profitability. When payoffs are linked to such measures, employees spend more time learning about financial measures and the business factors that influence them. On the downside, most employees do not feel their jobs have a direct impact on profits. The trend in recent variable-pay design is to combine the best of gain-sharing and profit-sharing plans.

A company specifies a funding formula for any variable payout that is linked to some profit measure. The plan must be self-funding.

Dollars going to workers are generated by additional profits gained from operational efficiency.

Along with having the financial incentive, employees feel they have a measure of control. Such a program combines the need for fiscal responsibility with the chance for workers to affect something they can control.

Combination Plans: Mixing Individual and Group

Its not uncommon for companies to use both individual and group incentives. The goal is to both motivate individual behavior and to insure that employees work together, where needed, to promote team and corporate goals.

These combination programs start with the standard individual (e.g., performance appraisal, quantity of output) and group measures (e.g., profit, operating income).

Variable pay level depends on how well individuals perform and how well the company (or division/strategic business unit) does on its macro (e.g., profit) measures.

A typical plan might call for a 7525 split. Seventy-five percent of the payout is based on how well the individual worker does, the other portion is dependent on corporate performance.