Week 2 D2

4.3 INDIVIDUAL INCENTIVES

4-3 Summarize five types of individual incentive pay plans.

Individual incentive pay plans are most appropriate under three conditions. First, employees’ performance can be measured objectively. Examples of objective performance measures include:

Number of units produced—an automobile parts production worker’s completion of a turn signal lighting assembly

Sales amount—a Mary Kay Cosmetics sales professional’s monthly sales revenue

Reduction in error rate—a word processor’s reduction in typing errors

Second, individual incentive plans are appropriate when employees have sufficient control over work outcomes. Factors such as frequent equipment breakdowns and delays in receipt of raw materials limit employees’ ability to control their performance levels. Employees are not likely to be diligent when they encounter interference: Chances are good that employees who previously experienced interference will expect to encounter interference in the future. Employees’ resistance threatens profits because companies will find it difficult to motivate people to work hard when problem factors are not present.

TABLE 4-2 Typical Performance Measures for Individual, Group, and Company-wide Incentive Plans

Individual Incentive Plans Quantity of work output Quality of work output Monthly sales Work safety record Work attendance

Group Incentive Plans Customer satisfaction Labor cost savings (through gain sharing plans) Materials cost savings Services cost savings (e.g., utilities)

Company-wide Incentive Plans Operational Measures:

Customer satisfaction Operational efficiency Service/quality

4.3 Individual IncentivesTOC/Annotation

4/15/20, 8:50 PM Page 1 of 7

Safety/occupational injury Financial Measures:

Revenue Earnings per company stock share

Operating income Revenue growth

Note: Measures such as safety records and customer satisfaction can be measured on an individual, group, or company-wide basis according to a company’s objectives.

Third, individual incentive plans are appropriate when they do not create a level of unhealthy competition among workers that ultimately leads to poor quality. For example, a company may create unhealthy competition when it limits the number of incentive awards to only 10 percent of the employees who have demonstrated the highest levels of performance. If the company judges performance according to volume, then employees may sacrifice quality as they compete against each other to outmatch quantity. In addition, under an incentive plan that rewards quantity of output, those employees who meet or exceed the highest standard established by their employer may be subject to intimidation by workers whose work falls below the standard. Unions may use these intimidation tactics to prevent plan standards from being raised.

Defining Individual Incentives Individual incentive plans reward employees for meeting such work-related performance standards as quality, productivity, customer satisfaction, safety, or attendance. Any one of these standards by itself or in combination may be used. A company ultimately should employ the standards that represent work that an employee actually performs. For instance, take the case of telemarketers. Customer satisfaction and sales volume measures indicate telemarketers’ performance. Tardiness would not be as relevant unless absenteeism was a general management problem.

Managers should also choose factors that are within the individual employee’s control when they create individual performance standards. Furthermore, employees must know about standards and potential awards before the performance period starts. When designed and implemented well, individual incentive plans reward employees based on results for which they are directly responsible. The end result should be that excellent performers receive higher incentive awards than poor performers.

Types of Individual Incentive Plans There are five common types of individual incentive plans:

Piecework plans

Management incentive plans

Behavioral encouragement plans

Referral plans

Spot bonuses

10 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04lev1sec11#ch04end10)

4/15/20, 8:50 PM Page 2 of 7

PIECEWORK PLANS Companies generally use one of two piecework plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss337) .

The first, which is typically found in manufacturing settings, rewards employees based on their individual hourly production against an objective output standard and are determined by the pace at which manufacturing equipment operates. For each hour, workers receive piecework incentives for every item produced over the designated production standard. Workers also receive a guaranteed hourly pay rate regardless of whether they meet the designated production standard. Table 4-3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04lev1sec3#ch04tab03) illustrates the calculation of a piecework incentive.

Companies use piecework plans when the time to produce a unit is relatively short, usually less than 15 minutes, and the cycle repeats continuously. Piecework plans are usually found in such manufacturing industries as textiles and apparel.

Quality is also an important consideration. Companies do not reward employees for producing defective products. In the apparel industry, manufacturers attempt to minimize defect rates because they cannot sell defective clothing for the same price as nondefective clothing. Selling defective clothing at a lower price reduces company profits.

TABLE 4-3 Calculation of a Piecework Award for a Garment Worker

Piecework standard: 15 stitched garments per hour Hourly base pay rate awarded to employees when the standard is not met: $4.50 per hour That is, workers receive $4.50 per hour worked regardless of whether they meet the piecework standard of 15 stitched garments per hour. Piecework incentive award: $0.75 per garment stitched per hour above the piecework standard

Guaranteed Hourly

Base Pay ($)

Piecework Award (No. of Garments Stitched above the Piecework Standard × Piecework

Incentive Award)

Total Hourly

Earnings ($)

First hour

4.50 10 garments × $0.75/garment = $7.50 12.00

Second hour

4.50 Fewer than 15 stitched garments, thus piecework award equals $0

4.50

The second type of piecework incentive plan establishes individual performance standards that include both objective and subjective criteria. Units produced represent an objective standard. Overall work quality is a subjective criterion that is based on supervisors’ interpretations and judgments. For example, supervisors may judge customer service representatives’ performance to be higher when sales professionals emphasize the benefits of purchasing extended product warranties than when sales professionals merely mention the

11

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04lev1sec11#ch04end11)

4/15/20, 8:50 PM Page 3 of 7

availability and price of extended product warranties.

Economists argue that there are two advantages to companies of using piecework plans in manufacturing settings known as the incentive effect (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss211) and sorting effect (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss419) .

The incentive effect refers to a worker’s willingness to work diligently to produce more quality output than simply attending work without putting in the effort. To put this simply, employees earn much less under the piecework system than they would under a standard hourly pay system. Whereas employees are certainly expected to perform without an incentive (piece rate), research shows that incentives often are associated with higher employee performance.

The sorting effect addresses an employee’s choice to stay versus leave his or her employer for another job, presumably one without an incentive pay contingency. Specifically, a hardworking, highly skilled employee is likely to choose to remain employed under an incentive system because both diligence and skill presumably contribute to higher quantity and quality of output—thus, higher pay.

MANAGEMENT INCENTIVE PLANS Management incentive plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss264) award bonuses to managers when they meet or exceed objectives based on sales, profit, production, or other measures for their division, department, or unit. Management incentive plans differ from piecework plans in that piecework plans base rewards on the attainment of one specific objective, and management incentive plans often require multiple complex objectives. For example, management incentive plans reward managers for increasing market share or reducing their budgets without compromising the quality and quantity of output. The best- known management incentive plan is management by objectives (MBO).

In Chapter 3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch03#ch03) , MBO was presented as an outcome-oriented performance appraisal technique for merit pay systems. When MBO is used as part of merit pay systems, superiors make subjective assessments of managers’ performance, and they use these assessments to determine permanent merit pay increases. When used as part of incentive programs, superiors communicate the amount of incentive pay managers will receive based on the attainment of specific goals.

TABLE 4-4 A Sample Behavioral Encouragement Plan that Rewards Employee Attendance

At the end of each 3-month period, employees with exemplary attendance records will receive monetary incentive awards according to the following schedule. Note that the number of days absent does not refer to such company-approved absences as vacation, personal illness, jury duty, bereavement leave, military duty, scheduled holidays, and educational leave.

Number of Days Absent Monetary Incentive Award ($)

12

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04lev1sec11#ch04end12)

13

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04lev1sec11#ch04end13)

4/15/20, 8:50 PM Page 4 of 7

0 (perfect attendance) 250

1 200

2 100

3 50

4 25

BEHAVIORAL ENCOURAGEMENT PLANS Under behavioral encouragement plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss24) , employees receive payments for specific behavioral accomplishments (e.g., good attendance or safety records). For example, companies usually award monetary bonuses to employees who have exemplary attendance records for a specified period. When behavioral encouragement plans are applied to safety records, workers earn awards for lower personal injury or accident rates associated with the improper use of heavy equipment or hazardous chemicals. Table 4-4 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04lev1sec3#ch04tab04) contains an illustration of a sample behavioral encouragement plan that rewards employees for excellent attendance. Employees can earn $250 for perfect attendance during a three- month period. With perfect attendance for an entire year, employees can earn $1,000. Behavioral encouragement plans have the potential to save companies substantially more money than the cost of these awards. For example, frequent absenteeism in a company’s workforce could disrupt production goals and quality. Customers may respond by choosing to make purchases for better quality products from other companies. Loss of customer bases will have a negative impact on profitability and reputation that prompts prospective customers to choose alternate sources to purchase products.

REFERRAL PLANS Employees may receive monetary bonuses under referral plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss371) for referring new customers or recruiting successful job applicants. Companies commonly rely on referral bonuses to enhance recruitment of highly qualified employees, particularly when the supply of highly qualified individuals is low, or the company is experiencing explosive growth. HubSpot, the developer of inbound marketing software, recently experienced growth in excess of 80 percent. The company relies heavily on the work of talented software engineers and designers. In response to this substantial growth, HubSpot offered a $30,000 bonus to employees whose referral was hired as a software engineer or designer. This program expands eligibility to any individual regardless of employment status.

A successful referral usually means that companies award bonuses only if hired referrals remain employed with the company in good standing beyond a designated period, often at least 30 days. Referral plans rely on the idea that current employees’ familiarity with company culture should enable them to identify viable candidates for job openings more

14 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04lev1sec11#ch04end14)

4/15/20, 8:50 PM Page 5 of 7

efficiently than employment agencies could because agents are probably less familiar with client companies’ cultures. Employees are likely to make only those referrals they truly believe are worthwhile because their personal reputations are at stake.

SPOT BONUSES Many organizations today are providing spot bonuses for critical areas and talents. Spot bonuses (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss422) are relatively small monetary gifts provided to employees for outstanding work or effort during a reasonably short period of time. If an employee’s performance has been exceptional, the employer may reward the worker with a one-time bonus with an amount as low as $50. For certain professional jobs it is not unheard of for a highly productive worker to receive $5,000 shortly after a noteworthy achievement.

Advantages of Individual Incentive Pay Programs There are three key advantages of individual incentive pay plans. First, individual incentive plans can promote the relationship between pay and performance. As discussed in Chapter 1 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch01#ch01) , employees in the United States are highly motivated by earning money. Employees strive for excellence when they expect to earn incentive awards commensurate with their job performance.

Second, individual incentive plans promote an equitable distribution of compensation within companies (i.e., the amount employees earn depends on their job performance). The better they perform, the more they earn. Equitable pay ultimately enables companies to retain the best performers. Paying better performers more money sends a signal that the company appropriately values positive job performance.

A third advantage of individual incentive plans is their compatibility with such individualistic cultures as the United States. Because U.S. employees are socialized to make individual contributions and be recognized for them, the national culture of the United States probably enhances the motivational value of individual incentive programs.

Disadvantages of Individual Incentive Pay Programs Although individual incentive plans can prove effective in certain settings, these programs also have serious limitations. Supervisors, human resource (HR) managers, and compensation professionals should know about three potential problems with individual incentive plans.

First, individual incentive plans possess the potential to promote inflexibility. Because supervisors determine employee performance levels, workers under individual incentive plans become dependent on supervisors for setting work goals. If employees become highly proficient performers, they are not likely to increase their performance beyond their reward compensation. For example, let’s assume that management defines the maximum incentive award as $500 per month, which is awarded to employees whose productivity rates 15 percent above the performance standard. Employees who produce more than 15 percent above the production standard will not receive additional incentive pay beyond the $500. With this design, employees would not be motivated to further improve their performance.

Second, with merit pay systems, supervisors must develop and maintain comprehensive performance measures to properly grant incentive awards. Individual incentive programs

4/15/20, 8:50 PM Page 6 of 7

pose measurement problems when management implements improved work methods or equipment. When such changes occur, it will take some time for employees to become proficient performers. Thus, it will be difficult for companies to determine equitable incentive awards, which may lead to employees’ resistance to the new methods.

A third limitation of individual incentive plans is that they may encourage undesirable workplace behavior when these plans reward only one or a subset of dimensions that constitute employees’ total job performance. Let’s assume that an incentive plan rewards employees for quantity of output. If employees’ jobs address such various dimensions as quantity of output, quality, and customer satisfaction, employees may focus on the one dimension—in this case, quantity of output—that leads to incentive pay and thereby neglect the other dimensions.

Our focus has been on financial incentive awards. Companies may provide nonfinancial incentives to employees, including companies such as hotels that operate in a low-paying industry. Hotel chain Joie de Vivre Hospitality does just that. Several times a year, employees are given the opportunity to stay in any of the company’s hotels at no charge and to take full advantage of the amenities. By assuming the customer role, Joie de Vivre Hospitality employees can improve job performance because they gain a better understanding of their guests’ needs.

WATCH IT!

If your professor has assigned this, go to the Assignments section of mymangementlab.com (http://mymangementlab.com) to complete the video exercise titled Joie de Vivre Hospitality: Pay for Performance and Financial Incentives.

4/15/20, 8:50 PM Page 7 of 7