Strategic Compensation: A Human Resource
Management Approach
Tenth Edition
Chapter 3
Incentive Pay
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Learning Objectives
4.1 Explore the incentive pay approach.
4.2 Describe the differences between incentive pay
methods and traditional pay methods.
4.3 Explain the practice of individual incentive pay plans.
4.4 Summarize the practice of group incentive plans.
4.5 Describe the practice of company-wide incentive plans.
4.6 Summarize considerations when designing incentive
pay programs.
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Learning Objective 4.1
• Explore the incentive pay approach.
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Incentive Pay
• Compensation fluctuates according to:
– A preestablished formula
– Individual or group goals
– Company earnings
• Adds to base pay on a nonrecurring basis
• Controls costs
• Motivates employees through explicit goal setting
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Incentive Pay Assumptions
• Effective incentive pay systems are based on three
assumptions:
– Individual employees and work teams differ in how
much they contribute to the company, both in what they
do as well as in how well they do it
– The company’s overall performance depends to a large
degree on the performance of individuals and groups
within the company
– To attract, retain, and motivate high performers and to
be fair to all employees, a company needs to reward
employees on the basis of their relative performance
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Learning Objective 4.2
• Describe the differences between incentive pay methods
and traditional pay methods.
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Contrasting Incentive Pay with Traditional
Pay
• Traditional pay generally includes an annual salary or
hourly wage
– Increased periodically on a seniority or merit basis with
permanent increase to base pay
• Incentive pay generally
– Increases base pay on goal attainment with pay
increase nonrecurring
– Companies use incentive pay to reward individual
employees, teams of employees, or whole companies
based on their performance
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Cost Comparison: Merit Pay v s er us
Incentive Pay
Table 4-1 Permanent Annual Merit Increases versus Incentive Awards: A
Comparison (At the end of 2018, John Smith earned an annual salary of
$35,000.)
Cost of Cost of Cost of Cost of
Increase Increase Increase Increase
(Total Current (Total Current (Total Current (Total Current
Salary—2012 Salary—2012 Salary—2012 Salary—2012
Annual Annual Annual Annual Total Salary
Salary) Salary) Salary) Salary) under Total Salary under
Permanent Merit
Increase Incentive Award
Permanent (Percent Increase Annual (Percent
Increase Merit Incentive × Previous Increase × 2012
Year Amount (%) Increase ($) Award ($) Annual Salary) ($) Salary) ($)
2019 3 1,050 1,050 36,050 36,050
2020 5 1,802 1,750 37,853 36,750
2021 4 1,514 1,400 39,367 36,400
2022 7 2,755 2,450 42,122 37,450
2023 6 2,527 2,100 44,649 37,100
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Incentive Pay Categories
• Individual: these plans reward employees whose work is
performed independently
• Group: these plans promote supportive, collaborative
behavior among employees
• Company-wide: these plans tie employee compensation
to a company’s performance over a short time frame
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Learning Objective 4.3
• Explain the practice of individual incentive pay plans.
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Incentive Pay Measures (1 of 2)
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)
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Incentive Pay Measures (2 of 2)
Table 4-2 [continued]
Company-wide Incentive Plans
Operational Measures:
Customer satisfaction
Operational efficiency
Service/quality
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.
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Types of Individual Incentive Plans (1 of 2)
• Piecework plans: reward workers for every item produced
over a designated production standard
• Management incentive plans: award bonuses to
managers when they meet or exceed objectives based on
sales, profit, production, or other measures for their division
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Types of Individual Incentive Plans (2 of 2)
• Behavioral encouragement plans: employees receive
payments for specific behavioral accomplishments
• Referral plans: employees receive bonuses for
recruitment of highly qualified employees
• Spot bonuses: employees receive small monetary gifts
for outstanding work or effort during a reasonably short
time period
• Signing bonuses: monetary awards given to promote
recruitment and job offer acceptance
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Piecework Plans
• Awards based on individual production v s objective er us
standards
• Awards based on individual performance standards using
objective and subjective criteria
• Quantity and/or quality goals
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Calculation of a Piecework Award for a
Garment Worker
Piecework standard: 15 stitched garments per hour Hourly base 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: $0.75 per garment stitched per hour above
the piecework standard
Table 4-3 Calculation of a Piecework Award for a Garment Worker
Piecework Award
Guaranteed (No. of Garments Stitched
Hourly Above the Piecework Total Hourly
Blank Base Pay ($) Standard × Piecework Incentive Award) Earnings ($)
First hour 4.50 10 garments × $0.75 per garment = $7.50 12.00
Fewer than 15 stitched garments, thus
Second hour 4.50 4.50
piecework award equals $0
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Individual Incentive Pay Program
Advantages
• Helps relate pay to performance
• Promotes equitable distribution of compensation
• Instills an ownership mentality
• Compatible with America’s individualistic culture
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Individual Incentive Pay Program
Disadvantages
• May promote inflexibility
• Measurement problems
• May promote undesirable behaviors
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Learning Objective 4.4
• Summarize the practice of group incentive plans.
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Group Incentive Plans
• Reward employees for their collective performance
• Two types:
– Team based or small group
– Gain sharing
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Types of Teams
• Work (process) teams: refer to organizational units that
perform the work of the organization on an ongoing basis
– Ex: Customer service teams, assembly teams on
production lines.
• Project teams: consist of a group of people assigned to
complete a one-time project
– Ex: Engineers working on the construction of a bridge.
• Parallel teams (task forces): include employees assigned
to work on a specific task in addition to normal work duties
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Rewards Allocation Methods
• Equal incentive payments
• Differential payments based on contribution to goals
• Differential payments according to base pay
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Gain Sharing
• Incentives based on company performance in
– Increased productivity
– Increased customer satisfaction
– Lower costs
– Better safety records
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Gain Sharing Programs
• Most gain sharing programs have three components
1. Leadership philosophy
2. Employee involvement systems
3. Bonuses
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Gain Sharing Plans
• Three common forms:
– Scanlon plan
– Rucker plan
– Improshare
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Scanlon Plan
• Emphasis on teamwork
• Two-tiered cost savings suggestion system
• Production-level committees
• Screening committees
labor costs
• , Rewards =
SVOP
• Smaller Scanlon ratios show that labor costs are lower
relative to SVOP
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Rucker Plan
• Emphasizes employee involvement
• Uses a value-added formula to measure productivity (value
added/total employment costs)
• Larger ratios show that value added is greater than total
employment costs
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Improshare
• Measure productivity physically rather than in terms of
dollar savings
• Incentive to finish products
• Based on a labor hour ratio formula
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Comparison of Key Features
Feature Scanlon Rucker Improshare
Program goal Productivity Productivity Productivity
improvement improvement improvement
Basis for savings Labor costs Labor costs/raw Completing work
materials at or sooner than
costs/services costs production
standard
Employee Required Required NA
involvement
Type of Screening and Screening and NA
employee production production
involvement committees committees
Bonus payout Monthly Monthly Weekly
frequency
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Advantages of Group Incentives
• Companies can more easily develop performance
measures for group incentive plans than for individual
incentive plans
• Greater group cohesion
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Disadvantages of Group Incentives
• May lead to higher employee turnover because of the
free-rider effect
• Members may feel uncomfortable with the fact that other
members’ performance influences their compensation
level
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Learning Objective 4.5
• Describe the practice of company-wide incentive plans.
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Company-Wide Incentive Plans
• Rewards employees when company exceeds minimum
acceptable performance standards
• Two types
– Profit sharing plans
– Employee stock options
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Profit-Sharing Plans
• Current profit-sharing plans
– Award cash to employees typically on a quarterly or
annual basis
• Deferred profit-sharing plans
– Place cash awards in trust accounts for employees
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Profit-Sharing Formulas
• Fixed first-dollar-of profits formula
– Ex: 7% of corporate profits
• Graduated first-dollar-of profits formula
– Ex: 3% of the first $8 million of profits and 6% of the
profits in excess of that level
• Profitability threshold formula
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Distribution Methods
• Equal payments
• Proportional payments based on annual base earnings
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Advantages and Disadvantages of
Profit-Sharing Plans
• Advantages
– Enable employees to share in companies’ profits
– Allow companies greater financial flexibility
• Disadvantages
– Can undermine the economic security of employees
– May fail to motivate employees if they do not see a
direct link between their efforts and profits
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Employee Stock Option Plans
• Companies grant employees right to purchase share of
company
– Company stock
– Company stock shares
– Stock options
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Learning Objective 4.6
• Summarize considerations when designing incentive pay
programs.
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Incentive Pay Considerations
• Based on individual or group performance
• Acceptable level of risk
• Replace or complement traditional pay
• Performance criteria evaluated
• Appropriate time horizon for goals
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