Chapter 10 Pay for Performance Plans IrwinMc GrawHill

Chapter 10 Pay for Performance Plans Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 1

Pay for performance plans signal a movement away from entitlements. Pay will vary with some measure of individual, team, or organizational performance. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 2

Purposes of Pay for Performance: • Attain strategic goals • Reinforce organizational norms • Motivate performance • Recognize differential employee contributions Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 3

Performance Pay Obstacles • Difficulties in specifying and measuring job performance • Problems in identifying valued rewards • Difficulties in linking rewards to job performance Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 4

• Base Pay Adjustments – General Increases – Merit Pay Plans – Lump-Sum Awards Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 5

Difficulties in Rewarding Performance with Base Pay Increases • • Economics Lack of flexibility Permanence Individual focus Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 6

Individual Incentives • Under a system of individual incentives, all or a portion of an individual’s pay is tied to their performance. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 7

Pay-for-Knowledge • Base pay, or pay progression, is tied to job knowledge: 1. Increased knowledge-based systems 2. Multi-skilled-based systems Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 8

Recognition Plans: • • • Celebrate Objectives Reinforce Extraordinary Performers Recognize Activities Reinforce Demonstrated Desired Behaviors Recognize Service Recognize Needs of Employees Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 9

Group Incentives • Improve Organizational Performance • Organizational Measures • Measured Periodically Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 10

Group Incentive Plans: • • • Balanced Scorecard Measures (Organization, Division, Department, Workgroup) Lead: Customer and Employee Satisfaction, Market Share Operational: Productivity, Quality, Cycle Time Lag: Profit, Return on Net Assets, etc. Pre-announced Performance-Reward Schedule Formula Driven Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 11

Gainsharing • Under gainsharing plans, employees earn bonuses tied to unit-wide performance as measured by a predetermined, gainsharing formula. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 12

Advantages of Gainsharing Over Other P-F-P Options • • It is based upon group, not individual performance. It encourages teamwork. It is based on macro-measures. It results in pay-outs relatively close in time to performance. It is based upon factors controllable by the group. It usually does not encourage destructive competition among teams. It promotes an employee / company partnership for improvement. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 13

Criteria for Gainsharing Formula • • • Fair to company Fair to employees Understandable Easy to administer Flexibility Helps to isolate problem areas Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 14

Small Group Incentives • Small group incentive systems are similar to gainsharing plans; but in this case, the bonus employees receive is based on the performance of a small group instead of an entire department, division, or plant. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 15

Profit-Sharing Plans • Employees receive an annual bonus or shares in the company based upon company-wide performance. • Employees are either paid in cash, or their earnings are deferred into a retirement plan. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 16

Team Incentives • Enabling Involvement • Rewarding Contributions • Project Measures Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 17

Advantages and Disadvantages of Group Incentive Plans • • • ADVANTAGES Positive impact Ease of measures Cooperation valued Teamwork Participation in decision-making Irwin/Mc. Graw-Hill • • • DISADVANTAGES Line of sight lessened Increased turnover Compensation at risk increased © The Mc. Graw-Hill Companies, Inc. , 1999 18

Example of Group Incentives: GE Information Systems • A team-based incentive with links to individual payouts • Team and individual performance goals are set • If the team hits goals, the team members earn their incentive only if they hit their individual goals. • The team incentive is 12% to 15% of base pay and is paid monthly. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 19

Example of Group Incentives: Corning Glass • A gain-sharing program (goal sharing) where 75% of the payout is based on unit objectives such as: – quality measures – customer satisfaction measures – production targets • The remainder is based on Corning’s return on equity (ROE) Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 20

Example of Group Incentives: 3 -M • • • Operates with an earnings-at-risk plan Base pay is fixed at 80% of market Employees have a set of objectives to meet for pay to move to 100% of market • Additionally, there is a modest profit sharing component Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 21

Example of Group Incentives: Saturn • Earnings-at-risk plan where base pay is 93% of market • Employees meet individual objectives to capture at-risk component • All team members must meet objectives for any to get at-risk money • A profit sharing component is based on corporate profits Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 22

Example of Group Incentives: Du Pont Fibers • Earnings-at-risk where employees receive reduced pay increases over five years, resulting in 6% lower base pay • If the department meets annual profit goal, employees collect all 6% • Variable payout ranges from 0 (department reaches less than 80% of goal) to 12% (150% of goal). Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 23

The Choice Between Individual and Group Variable Plans • • • Characteristics for decision: Performance measurement Organizational adaptability Organizational commitment Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 24

Characteristic: Performance Measurement Choose an individual plan when: • Good measures of individual performance exist. • Task accomplishment not dependent on performance of others. Irwin/Mc. Graw-Hill Choose a group plan when: • Output is group collaborative effort. • Individual contributions to output cannot be assessed. © The Mc. Graw-Hill Companies, Inc. , 1999 25

Characteristic: Organizational Adaptability Choose an individual Choose a group plan when: • Performance standards for • Individual individuals change to meet performance external environmental standards are stable. pressures on relatively • Production methods constant organizational objectives. and labor mix are • Production methods and relatively constant. labor mix must adapt to meet changing pressures. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 26

Characteristic: Organizational Commitment Choose an individual plan when: Choose a group plan when: • Commitment strongest • High commitment to to individual’s organization built upon profession or superior. sound communication of organizational • Supervisor viewed as objectives and unbiased and performance standards readily apparent. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 27

Long-Term Incentive Plans Employee Stock Ownership Plans (ESOPs) Performance Plans (Performance Share and Performance Unit) Broad-Based Option Plans (BBOP) Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 28

Other Long-Term Incentive Plans • Premium Priced Stock Options • Long-term Vest Stock Options • Indexed Stock Options • External Standards LTI • Career Grants Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 29

Conditions for Effective Variable Pay-for-Performance Plans • • • Plan is clearly communicated Plan is understood Rewards are easy to calculate Employees participate in administering the plan Employees believe they are being treated fairly Employees believe they can trust the company and that they have security • Rewards are awarded as soon as possible after the desired performance. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 30

The Serious Implications of Variable Pay-for-Performance • When a substantial portion of pay is tied to performance, that portion becomes variable - can go up or down - based upon individual, group, or company performance. This change is significant. • The nature of authority relationships and status in the organization might change. • Employees will demand, and the operation of the systems themselves might require, increased sharing of information. • Finally, variable pay-for-performance systems will create heightened pressure for performance and cost containment within the organization. This pressure will come not just from managers, but from employees themselves. Irwin/Mc. Graw-Hill © The Mc. Graw-Hill Companies, Inc. , 1999 31