358 PART 4 Compensating Human Resources

L*f Describe how orga nizations

recognize individual per{ormance.

Although most, if not all, employees vah'e pay, it is important to remember that

earning money is not the or-rly ."n on people try to do a good job. As we discuss in

"irr", Jt"pr"r, (r"" Chapters 4, B, u.rd 13), people also want interesting work, appre-

ciarion for their efforts, flexibility, and a sense of belonging to the work group-not

to menrion the inner satisfaction of work well done. There{ore, a cotnplete plan for

motivating and compensating employees has many components, from pay to work

design to ieveloping ^urrug"ri

so they can exercise positive leadership.- -ffri,tr regard to thL f"irr-tJrs of incentive pay, the preceding chapter described equity

,n.orv *hj.h explains how employees form judgments about the fairness of a pay structure. The same process uppti"t to judgments about incentive pay. In general,

"*JoV"., compare th"i. .ffoi* a.d rewards with other employees', considering a

;ffi ; be {air *h.rl th" rewards are distributed according to what the employees

conrribute. The rernainder of this chapter identifies elements of incentive pay systems'

We consider each option's ,t .rrgth, and limitations with regard to these princi" ples. The many kinds of incenlive pay fall into lhree broad categories: incentives

tl"f..a to inclividuai, group, or organizational performance.. Choices from these cat-

;;;;;;:h;rtd .onrid"., not o.,ly"their streng;hs and weaknesses,-,but also their fir *-irh ,h. organizarion's goals. The cfioice oflncentive pay '''ay

affect not oniy the

1"rr"1 of moiivation but"also the kinds of employees who are attracted to and stay

with the organization. For example, there is some evidence that organizatiols'"vith

team-based rewards will tend to attract employees who are more team-oriented' while rewards tied to individual performance make an organization more attrac-

rive to those who thlr-rk "r-rd

act independently, as individuals.? Gi,rett the poten-

tial impact, organizalions not only shouid u,eigh the stlengths and li'eaknesses in

,"i".,i"g ,yp.r"of incentive pay but also should measure the results of these progfams (see "Did You Know?").

Pay for lndividual Perfsrmane€ Organizations may reward individual performance with a variety of incentives:

o Piecework rates o Standard hour plans r Merit pay . lndividual bonuses . Sales commissions

Piecework Rates As an incentive to work efficiently, some organizations pay production

workers a

piecework rate, a *ug. U^"a on'the. u-our'tt they produce' The amount paid per

lrrit o ser ar a lev.l thit rewards employees for abo'e-average production volume' For example, suppose that on average, assemblers can finish 10 components

in an

hour. lf rhe organization wanrs to pay its average assemblers $8^p:t hour, it can pay

" p]"."*".f. ."i" of $B/hour dividea by 10 -components/hour,

o. $.80 per component'

A"-, "rr.*bl"r

who produces the average of 10 components per hour earns an amount

e.,rral ro $8 oer tro.r., i., assernbler *Lo prod.',.es 12 components in an hour would ;il^$.80;":.2, o, g9.60 each hour. Thii is an example of a straight piecework pl"i, U..""r. th" .*ployer pays the same rate per piece' no matter how much the r.vorker produces.

Piecework Rate

A wage based on

the amount workers produ ce.

Straight Piecework Plan

lncentive pay in which the employer PaYS the

same rate Per Piece, no matter how much

the worker Produces.


f {



itllr !1'Ol

l]ror e\ar :no

Ir l]tor( iales rmpl if the :ates have This :har

iiecg, ;erfor -'atisfa :ealize ri hile lonus irop a :oais r rrhers. :irl orgi .,rganiz


that ;s in ,pre-

-not i for vork

luity pay

eral, :lga yees

lms. nci- ives cat- r fit the

stay vith ted, rac- ten- sin ams

rsa pel me. ran pay

ent. )unt ruld ork the





F, :t: r+:

*: tt. :r.t :,ti

,9, g


:;:'i .t +!

:1 ,'i


* .i: dl i:

1; i:;r:


:; .il


;l a, :ll :,


,& &- :# tr ,:' ,.:

ln a recent survey of more than 75Q organizations in 66 countries, only one out of five said theY measure the return on investment {ROl} of incentive programs, but more want to move in that direc- tion. Companies that measure the

ROI of rewards tend to think of pay as an investment in human resources aimed at bringing out top performance. ComPanies that don't measure ROI tyPicallY think of pay as simplY a cost of doing business.

Source:iom McMullen, Reward Next Practices {Hay Group, August 2009). http://www. haygroup. com.

ls a current {ocus

Will be a focus in the {uture

4020 Percentage o{ ComPanies Measuring Rewards ROI

A variation on straight piecework is differential piece rates (also cailed nsrng and

faltingdifferentials), in;hi;h the piece rate depends on the amount produced' If the *orki, pio.l.,.es more than the standard output, the piece rate is higher' If the worker prodr1.", at or below the standard, the amount paid per piece is lower. in the preceding

"*"*p1", the differential piece rate could be $ I per component for components exceed-

ing 12 per hour and $.80 per component for up lo 12 components per hour' In one study, the lse of piece rates incfeased production output by 30 percent-

more than any'other rnotivational device evaluated.S An obvious advantage of piece rates is t1-re direct link between how rnuch work the employee does and the arnount lhe

employee earns. This type of pay is easy to understand and seems fair to many people,

lf they rhlnk the producrion standard is reasonable. In spite of their advantages, piece

rates are relativeiy rare for several ,"uro^r.9 Most jobs, including those of rlanagers'

have no physical output, so it is hard to develop an appropriate performance measure.

This type of incenrive is most suited for very routine, standardized jobs with output that is easy to measllre. For con-iplex jobs or jobs lvith hard-to-measure outputs' pieceu,ork plans do not apply very well. A1so, unless a plan is rvel1 designed to include p"rfo.malce standards, it may not reward employees for focusing on quality or cuslomer iatisfaction if it interferes r.vith the day's output. In Figure 12.1, the employees quickly realize they can earn huge bonuses by writing softu'are "bugs" and then fixing them, lvhile rvriting bug-free sofrware affords no chance to earn bouuses. More seriously, a

bor-rus based on number of faucets produced gives production rvorkers no incenti\re to

stop a manufacturing line to correct a quality-control problem. Production'oriented goul, ,ouy do nothing to encourage employees to iearn neiv ski1ls or cooperate with others. Therefore, individual incentives such as these may be a pool incentive in an organization that wants to encourage teamwofk. They rnay nor be helpful in an -rrganization rvith compiex jobs, ernployee empowerment, and team-based problem r,rlving.


Differential Piece

Rates lncentive pay in which

the piece rate is higher when a greater amount is produced.




& i* g sl g

360 PART 4 Compensating Human Resources

|: igure 1 ?. i How lncentives Sometintes "Work"

SOURCE: DILBERT: O Scott Adams/Dist. By United Feature Syndicate, lnc

$tandarcl llour Flan An incentive p{an that pays workers extra ior work done in less than a preset "standard


Standard Hour Plans Another quantiry-oriented incentive for production workers is the standard hour plan, an incentive plan that pays workers extra for work done in less than a preset


dard time." The organizatior-r determines a stairdard time to complete a task, such as tun-

ing up a car-engine. If the mechanic completes the work in less than the standard time, rhe mechanic receives an amount of pay equal to the wage for the fr-rll standard tirne. Suppose the standard time for tuning up an engine is 2 hours. If the mechanic finishes a tlne-up in 1% hours, the rnechar-ric earns 2 hours'u'orth of pay in i% hours. \X/orking

that fast over the course of a week could add significantly ro the mechanic's pair

In terms of their pros and cons, standard hour plans are much like piecer.vork plans. They encourage ernployees to work as fast as they can, but not necessariiy to care about quality or customer service. Also, they only succeed if employees want the extra

money more than they u'ant to work at a pace that feels comfortable.

Merit Pay Alrnost all organizations have estabiished sorle program of merit PaY-a systern of linking pay increases to ratings on performance appraisals. (Chapter B described the content and ,"rse of performance appraisals.) To make the merit increases consistent, so

they r.vill be seen as fair, many merit pay programs use a merit ina"ease grid, such as the

sample for Merck, the giant drug company, in Table 12.1. As the table sholvs, the deci' sioni about merit pay are based on two factors: the individual's performance rating and

the individual's compa-ratio (pay relative to average pay, as defined in Chapter 11)- This s],stern gives the biggest pay increases to the best performers and to those whose pay ls relatively lou, for their job. At the highest extreme, an exceptional employee earning B0 percent of the average pay for his lob could receive a 15 percent merit raise.

An employee rated as having "room for improvement" wor,rld receive a raise only if that employee was earning relatively low pay for the job (compa'ratio of .95 or less).

By today's standards, all of these raises are large, because they were created at a time

wher-r inflation rvas strong and economic forces demanded big pay increases to keep up r.vith the cost of living. The range of percentages for a policy used today would be iower. Organizations establish and revise merit increase grids in light of changing eco- nornic conditions. When organizations revtse pay fanges, employees have nerv compa-

ratios. A higher pay range would result in lower compa-ratios, car-Lsing employees to

l1ttr*rit Pay

A system of linking pay

increases to ratings on performance

a ppra isa ls.

l,:i:ri* -

Sample l\

il EX





SOURCE President

become it maker

Adn recent y age perf, 6 percer amoLlnt careef, tl on a yea shor.r's, c'

ever, ext ernploye raises gir.

raises for





Note: Experts

CHAPTER 12 Recognizing Employee Contributions with Pay 361

ii:i;ii- :,:. i Sample Merit lncrease Grid





(Exceptional within Merck)

{Merck Standard with Distinction)

{High Merck Standard}

{Merck Standard Boom for lmprovement)

{Not Adequate for Merck)

EX 13-1 5%

9-i 1




8-1 0



To maximum of range

j' ir-1:-li'c: Li" ?.

Ratings and Raises: Underrewardin g the Best


rour tan- tun- ime, ime. shes


lns. tare rtra

SOURCE: K. J. Murphy, "Merck & Co., lnc. (B)," Boston: Harvard Business School, Case 491-0A6. Copyright @ 1990 by the President & Feliows of Harvard College. Reprinted with permission.

becorne eligibie for bigger rnerit increases. An advantage of rnerit pa)' is therefore that rt rnakes tl-re reu'ard rnore valuable by relating it to economic coirclitior-rs.

A dlarvback is that cclnditior-rs can shrink the available range of increases. During recent years, budgets fol merit Lralr irlcreascs were about 3 to 5 percent of pa1,, so aver- age performers could receive a 4 percent raise, and top per{ormers perhaps as tnuch as 6 percent. The 2-pelcentage-point clifference, after taxes and other deductions, rvould alrrolrllt to only a feri' dollars a \\,eek on a salary of $40,000 per year. Over an entire career, the biggel increases for topr perforners can grow into a major change, but vier,r'ed on a 1,g21-ft-year basis, they are not much of an incentive to excei.10 As Figule 12.2 shc'rtt's, cotnpauies typically spread merit raises fairly evenly across all elnployees. Ho$'- ever, experts advise rnaking pay ir-rcreases twice as great for top perforners as for ar.erage etnployees-and not reu,arding the poor per{ormers with a raise at a11.11 hnagure if the raises given to the bottorn ilvo categories in Figr-rre i2.2 ir-rstead u,ent toward 7 percent raises for the top irerformers. Tiris t;'pe of elecision sigr-rals that excellence is ren'arded.

rof the ,so ,he :ci- nd 1).




Average Pay lncrease

Highest-Rated Workers

Next Highest Rated

Middle Rated

Low Rated

Lowest Rated

Note: Experts arlvise thaI the top category shou]d receive trsice as nuch as the ntiddle caleltorv.





o- a-