Chapter11-abb

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11 Compensation: Methods and Policies

McGraw-Hill/Irwin Human 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: Secure Balanced Cost-effective Acceptable 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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Determination of Individual Pay 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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Determination of Individual Pay 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 on Emphasizes 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 overhauling the whole system

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Methods of Payment Employees

can be paid for: The time they work The output they produce Skills Knowledge Competencies A combination of these factors

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Variable Pay: Incentive Compensation Global

competition and economic restructuring are requiring businesses to become more productive Reliance 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: Incentive Compensation

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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Variable Pay: Incentive Compensation

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 management Acceptance by employees Supportive organizational culture Timing

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Variable Pay: Incentive Compensation

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 objectives Pay returns to the base level the next year and the employee must again compete for the variable reward

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Variable Pay: Incentive Compensation

Total

compensation includes: Base pay Variable pay Indirect 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 performance Rewarding 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 delineated 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 individual It 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 plan The 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 jealousy In 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 objectives Analyze the situation Select 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 gamesmanship Not helping others Sabotaging 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 systems Company 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 costs Increase revenue

Suggestion systems are often administered by the HR department

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Suggestion Systems

A

successful suggestion system includes: Management commitment Clear goals Designated administrator Structured award system Regular publicity Immediate 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, and Unite diverse organizational elements in the common pursuit of improved organizational effectiveness

Through

cash bonuses, these systems share the benefits of: Improved productivity Reduced costs Improved quality

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Gain-sharing Incentive Plans

Gain-sharing

incentive systems are exceptionally effective in enhancing teamwork in: Manufacturing organizations Service organizations

Commonly

used gain-sharing plans: Lincoln Electric Scanlon Rucker ImproShare

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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 plans Deferred plans A 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 Feedback Competency-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 Testing Measurable results

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Knowledge-based Pay

Knowledge-based

pay rewards employees for acquiring additional knowledge Applies 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 secret Compensation will be secure Pay 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 benefits To 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 decision

When

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 performance So can the belief that there will be future compensation security

Plans

A

for providing this security include:

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 unusual Junior 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