Pay for Performance Systems and Incentive Types

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LESSON: 27

Pay for performance (PFP):
Learning Objectives:
1. Understand the determinants of PFP systems.
2. Identify the critical variables related to the selection of the most appropriate PFP
system.
3. To know the different kinds of Pay incentives.

Do you know the concept ‘ Pay for Performance’?
Now let us study what it is…
The PFP system put more employees pay at risk and do indeed loosen the relationship
between assignments and pay levels. The term PFP is a little mix leading since many
incentive systems now award something other than pay for desired performance.
Objective:
• To understand the determinants of effective PFP systems.
• Identify the critical variables related to the selection of the most appropriate PFP
system.
• Review the evidence on the effectiveness of different PFP system.
• Determine the relative advantages and disadvantages of the various PFP systems.

Can anybody tell what could be the determinants of Effective PFP systems?
1. Worker value outcomes (Money and Prices)
2. Outcome is valued relatively to other rewards.
3. Desired performance must be measurable.
4. Worker must be able to control rate a output.
5. Worker must be capable of increasing output.
6. Worker must believe that capability to increase exists.
7. Worker must believe that increased output will result in receiving a reward.
8. Size of reward to sufficient to stimulate increased effort.



9. Performance measures must be compatible with strategic goals for short and
long terms.

Could anybody guess what are the problems in PFP programmes?
Some studies indicate that the majority of employees question the integrity of their
PFP system.
There are many potential problems with PFP system. They are as follows:
• Poor perceived connection between performance and pay.
• The level of performance pay is too low relative to basic pay. The cost of
more highly motivating programmes may be prohibitive.
• Lack of objective, countable results for most jobs, requiring the use of
performance rating.
• Faulty performance appraisals systems, with poor cooperation from
managers, leniency bias in the appraisal and the systems change.
• Union resistance to such systems and to change in general.
• Poor connection between PFP outcomes and corporate performance
measures.

How do you select a PFP system?
In designing a PFP system three major questions should be asked.
1. Who should be included in PFP system?
2. How will performance be measured?
3. Which incentives will be used?

1. Who should be included in PFP system: In general all goups should be
included in a PFP system; with one critical condition i.e. The PFp system should
be developed with specific groups and conditions in mind. Many companies
have different PFP systems for various classes of employees. Some companies
have reward system that are compatible with the culture that attempts to
minimize the distance between people at different levels in the organizational
hierarchy.



2. How will performance be measured: Performance can measured on the basis
of different organizational policies. We will discuss these methods in the later
half of this unit.
3. Which incentive will be used: Incentives are used on the basis of Merit-Pay
plans. They are
1. Use a bonus system in which merit pay is not tied to basic salary.
2. Maintain a bonus ranging from 0 to 20% for lower pay levels and from
0 to 40% for higher pay levels.
3. Take performance appraisal seriously. Hold raters accountable for the
appraisal and provide training.
4. Focus on key organizational factors that affect the pay system.
Information systems and job design must be compatible with the
performance measurement system.
5. Include group and team performance in evaluation. evaluate team
performance wherever appropriate and base part of individual part of
merit pay on the team evaluation.
6. Consider special awards separately from and annual merit merit
allocation that recognizes.

PAY INCENTIVES
Now friends, we shall discuss about various pay incentives which will be provided by
different organization, before that can any one tell, What are the different types of incentives
which are given to employees.
An Incentive or Reward can be anything that attracts a employee’s attention, stimulates him
to work; Other words it can define as “an incentive scheme is a plan or programme to
motivate individual or group performance.
In other terms, incentives are also called as ‘payments by results’.
Incentives are paid in addition to wages and salaries. Incentives depend upon productivity,
sales, profit, or cost reduction efforts.

Now, let us also see the different incentive schemes.

There are: (i) Individual incentive schemes, (ii) Group incentive programs and (iii) other
incentive schemes.



Individual incentives are applicable to specific employee performance. Where a given task
demands group effort for completion, incentives are paid to the group as a whole. The
amount is later divided among group members on an equitable basis and other incentive
schemes such as...

Fringe Benefits: These include such employee benefits as provident fund, gratuity, medical
care, hospitalization, accident relief, health and group insurance, canteen, uniform, recreation
and the like.

Perquisites:
These are allowed to executives and include company car, club membership, paid holidays,
furnished house, stock opinion schemes and the like. Perquisites are offered to retain
competent executives.

Non-monetary benefits:
These include challenging job responsibilities, recognition of merit, growth prospects,
competent supervision, comfortable working conditions, job sharing, and flextime.

Rewards:
People join organizations expecting rewards. Firms distribute money and other benefits in
exchange for the employee’s availability, competencies and behaviours.

Types of Rewards:
1. Membership and seniority-based rewards: Benefits an employee receives depend on
firm which he or she joins. An MBA taking up a job in Wipro or Infosys gets more
benefits than the boy or girls who joins a state government undertaking.
In the same firm, a senior employee receives more benefits than his or her junior
employee. Advancement, pay raises, retirement benefits and perquisites depend on
seniority of an employee.

2. Job Status-based Rewards: Every firm rewards employees for the status of the jobs
they are holding. Firms use job evaluation system, which helps establish differentials
in status of jobs. Status differentials are used as the basis for establishing
salary/wages differentials. Jobs that require more skill and effort have more
responsibility and have difficulty working conditions would have more value and
consequently would be place in higher pay grades. Firms that do not use job
evaluation system still reward job status based on pay survey information about the
labour market.
A supervisor will receive higher rewards than a purchasing assistant as the job of the
former enjoys better status than a letter. It has move value to the organisation (calculated
by the job evaluation system or pay survey) and therefore employees in that job receive
more status-based rewards in the orgn. High status jobholders are also rewarded with
more perquisites.

This incentive programme usually provides monetary rewards, but may also include a
variety of non-monetary rewards or prizes.



Features of incentive plan:
• These incentive plans usually consist of both monetary and non-monetary elements.
• The timing, accuracy and frequency of incentives are the basis of a successful
incentive plans.
• These plans should be properly communicated to employees. So this will encourage
individual performance, provide feedback and encourage redirection.

TYPES OF REWARDS/INCENTIVES
We have seen what is an incentive, now we will discuss what are the types of incentives
provided by the organizations,
An incentive or reward can be anything that attracts a employee’s attention, stimulates him to
work; Other words it can define as “an incentive scheme is a plan or programme to motivate
an individual or group performance.
This incentive programme usually provides monetary rewards, but may also include a variety
of non-monetary rewards or prizes.

The Rewards are classified into two:
* Direct compensation
* Indirect compensation

* Direct Compensation: - It includes the basic salary or wage that the individual is entitled
for his job; this include overtime work, holiday premium, bonuses based on performance etc.
* -*Indirect Compensation: It includes protection programmes; pay for time not worked,
services and perquisites. But these are maintenance factors rather than reward.

Incentive (Structure of incentives)



INTRENSIC EXTRINSIC

• Participation in Decision Direct Indirect Non financial
making Compensation Compensation Compensation
• Greater job freedom and • Basic wage or • Protection • Preferred
direction salary programme furniture
• More responsibility • Overtime and • Pay for time not • Preferred
• More interest in work holiday worked lunch hours
• Opportunities for premiums • Services • Assigned
personal work • Performance perquisites parking space
• Diversity of activities sharing • Business
• Stock option cards
• Own
secretary

Summary: The PFP system must support the competitive strategy and values of the
organisation. It the strategy emphasizes entrepreneurial activity and independent effort,
individual PFP system become increasingly important and effective. Incentive systems must
be compatible with organizational values. Openness and trust are necessary if employees are
to accept the standards and believe in the equity of the rewards.

The bottom line remains that for any PFP system to work, rewards valued by the worker
must be clearly linked to outcomes valued by internal and, most important, external
customers. Virtually all the research on high performance work systems supports the view
that proper PFP systems can help to create and sustain a competitive advantage when the
focus is on organisations that follow academic guidelines for development and maintenance,
PFP systems look a winner.

Article--1

FOR FURTHER READING: September 2003: Aon Consulting



Compensation Article
Paying for Performance: Easier Said Than Done

"Pay-for-performance" is typically one of the top goals of nearly every organization. What most
employers are thinking of when they talk about pay-for-performance is a base salary program that truly
differentiates awards based on performance. However, the vast majority of organizations and their
employees are dissatisfied with the programs that purport to provide performance-based rewards. Why is
this so and what factors are key to a successful program?

1. Little agreement or common language exists within the organization regarding what is meant by
pay-for-performance. Many equate it with what is known as merit pay, or the differential
distribution of base salary increases based on individual annual performance. Others consider
any variable ("incentive") pay program to fit within this definition. While either of these
definitions may relate to pay-for-performance, only when the organization agrees on a common
understanding of the purposes and processes associated with pay-for-performance is there any
hope of developing and implementing an effective design.

2. Organizational leaders are often unable to reach consensus on how such a program will help
support organizational performance or help managers better lead and develop their people. The
best programs are treated as organizational effectiveness tools and not as administrative
procedures that have to be carried out because "HR said so."

3. Most performance-based reward processes are based on performance management processes that are
flawed, irrelevant, or administrative in nature, and whose primary purpose is to determine salary
increases. A successful performance management process must help communicate and build individual
and organizational value, should not be experienced as burdensome, and requires well-trained managers.
In addition, the program must strongly differentiate the amount of increase and/or the level of pay
between average and extraordinary performers. If, in economically stressful times, salary increase money
is lacking, mechanisms of incentives, spot bonuses, and non-cash recognition become even more
important

4. Often compensation programs––pay-for-performance included––are viewed as fully formed solutions
(e.g., put in a new performance management process, attach a merit pay "matrix," and, voilá, you have
an effective program). Or design a new incentive plan with the right metrics, and you will have both the
desired performance and associated rewards. In truth, the effectiveness of a compensation program is
more dependent on the following factors than on the specific design:
.
Up-front alignment processes––which ensure that any new designs support the business objectives and
cultural values of the organization and, to the extent possible, incorporate management and employee
input.

Effectiveness and speed of the implementation––the extent to which affected employees understand
the compensation program and buy into it, managers are properly trained, and the new processes fit
with the organization's administrative and technology systems.

5. Pay-for-performance is often viewed in a piecemeal fashion. An effective performance management
process must be viewed holistically––as more than a mechanism to deliver pay increases. As such, it
requires ongoing communication, feedback, and true developmental action planning, as opposed to a
once-a-year required meeting.
If you translate pay-for-performance into making your heaviest investment of resources (money and
time) in your top performing/ contributing people and/or your high potentials, it is clear that the total
reward offering —both the tangibles and intangibles––defines the ability of an employer to attract,



reward, and retain its key people. Compensation can be a potent tool for retaining important contributors
but only in the context of an integrated total reward package that supports a winning business strategy.
In summary, pay-for-performance programs will thrive only within a true performance culture that is
supported by across-the-board organizational commitment. Such a commitment requires inculcation of
everyone in the culture, a clear and fully understood definition of what performance means, and an
emphasis on performance not only within HR processes but also strategically and operationally––all of
which are supported by effective, ongoing management training and employee development.
####
Aon Consulting FORUM September 2003

Article: 2
Meyners pays for performance
Abstract:
Meyners & Co. had to successfully increase employees' commitment to the firm's overall
marketing and revenue growth goals. To accomplish this the firm designed and
implemented a pay-for-performance system in July 2002. The new compensation
program includes a yearly salary increase that reflects a cost-of-living adjustment
(COLA) and three bonus pools. It calls for the firm to evaluate employee performance in
three areas: core values, core competencies and meeting goals. Early indications are
that the individualized evaluation process is a motivating employee. For core-value
assessments, Meyners uses a peer-to-peer input that results in a thorough, well-
rounded evaluation. For meeting goals, each employee and supervisor creates a win-win
agreement that includes specific performance numbers or other measures to meet. For
firms thinking about undertaking a similar effort, professionals at Meyners say to keep
The following pointers in mind: 1. Prepare to take time. 2. Frequent
communication is paramount. 3. Have adequate administrative support.

It was no small feat for Meyners and Co.'s leadership to offer employees nonstop support and
guidance while both management and staff refined the firm's core values and worked out
what behaviors demonstrating them would consist of at different levels of the workplace
hierarchy. As productive as the process was, it was only the foundation. Next, Meyners had
to successfully increase employees' commitment to the firm's overall marketing and revenue-
growth goals. To accomplish this firm designed and implemented a pay-for-performance
system in July 2002.

The new compensation program includes a yearly salary increase that reflects a cost-
of-living adjustment (COLA) and three bonus pools. It calls for the firm to evaluate
employee performance in three areas: core values (workplace behavior), core competencies
(business skills) and meeting goals (performance-measures win-win agreements). Early
indications are that the individualized evaluation process is a motivating employee. Janet



McHard, CPA and manager in the litigation and business valuation services department, says
the new system helps underscore what the firm values. If you contribute, not only will your
efforts be recognized, but also "you'll be compensated for having worked hard to meet those
goals," says McHard. "This system puts my job destiny in my hands. It removes the
uncertainty of: 'If I do a good job, will anyone know?' From my perspective, that's the coolest
thing about it." Here's how it works

EVALUATING EMPLOYEE BEHAVIOR

Meyners's core values-which employees across the board had developed, defined and
adopted-clarify the firm's goals, standards of etiquette and many other aspects of day-to-day
work. Those values-collaboration; commitment to maintain self, team, firm and customer
balance; commitment to quality and responsive customer service; commitment to the greater
good; continuous and never-ending improvement; creativity; fun; innovation; integrity;
mutual respect, honesty and trust; profitability and risk taking-represent the organization's
behavioral and interactive norms. The firm's new performance evaluation System measures
how staff members live up to them as they work with peers, managers and subordinates.

For core-value assessments, which take place during an employee's anniversary month,
Meyners uses "360-degree" feedback. The process includes peer-to-peer input that results in
a thorough, well-rounded evaluation. It works this way: To evaluate a staff member (the
subject), his or her supervisor selects four individuals who regularly work with that person,
who has a say in which four are chosen. Each subject selects two additional evaluators, one
who work inside his or her department and one from another section. Using a form that
describes what living a particular core value consists of at that person's level in the firm, the
six people "grade" the staff member. For instance, for the value "commitment to maintain
self, team, firm and customer balance," a level-one-employee action would be: "Takes
appropriate time away from work (including lunch, vacation, breaks) as needed."

Each evaluator then rates how successfully the subject has lived the value by checking one of
three ratings: "Needs mentoring" (individual is not meeting expectations); "lives the core
value" (he or she is meeting expectations) or "role model" (he or she has clearly and
consistently surpassed expectations). The results are tabulated and electronically scored. To
encourage candor, subjects and supervisors do not see individual evaluators' ratings but
instead see a summary of the results in each area. The human resources clerk coordinates the
process and maintains and files the evaluation records.

Employees receive a core-values bonus based on the percentage of possible points they earn
on the evaluation. For example, someone who earns 70 points out of a total of 100 possible
points gets 70% of $1,000 (the predetermined maximum), or a bonus of $700. The executive
committee sets the baseline bonus, which is linked to the employee's staff level, years with
the firm and responsibilities. Employees feel they get credit for a range of professional
interactions under the new system (see exhibit 1, page 43).



TECHNICAL AND BUSINESS SKILLS

To help Meyners focus on its profitability goals, consultant Coral Rice of the Growth
Partnership (TGP)-who has worked on the firm's growth program from the beginning-used
information collected in an earlier phase to develop a list of general categories for core
competencies. Those competencies represent the specific job-related skills employees need to
"get results now and develop the firm's ability to get better results in the future," she says.
The general categories are

• Client development.
• Client management.
• Business management.
• Technical expertise and work quality.
• Personal participation and professional development.
• Leading and developing others.
• Administration.

At all levels, the first step for each department was to determine its core competencies for
every position. To do this, staff members revised their job descriptions and listed specific
tasks associated with every competency according to the categories. The core competencies
for comparable jobs managing, for example-are very similar, but they differ based on specific
departments and other duties.

Each department chose its own approach to the process of expressing the competencies for
each of its positions. Janet McHard was on the management team in the litigation and
business valuation department and helped develop the competencies for the positions of
principal, director, manager, senior accountant and staff accountant. "In each area we
developed performance-based competencies or core criteria" and listed 6 to 10 bullet points
for each position, McHard says.

As an example of how the client-development competency differs according to employee
level,

* For senior managers (level three), the competency is: "Take a leadership role in firmwide
marketing efforts."

* For senior staff (level two), the competency is: "Develop prospective client relationships as
skills allow" (see exhibit 2, at left).

* For staff (level one), the competency is: "Recognize prospective client relationships and
seek ways to develop them."

Steve Comeau, JD, director of litigation and valuation services, says that while the process of
defining competencies and job duties for each position took more than six weeks of drafts,
meetings and discussions with everyone in the department, the time was well spent. The
process not only clarified what the firm expected individuals to do, but it was "helpful in
getting the group on the same page," says Comeau. He believes that having everything down



on paper simplifies the process of determining promotion eligibility and helps with recruiting
and hiring people.

The core-competencies evaluation process is similar to a traditional supervisor-employee
performance review. On the employee's anniversary, the supervisor completes job
performance forms that will be the basis of the evaluation. Supervisors rate employees on the
six-part scale: "Far above expectations," "Above expectations," "Meets expectations,"
"Below expectations," "Far below expectations" and "Not applicable." Employees receive a
core-competencies bonus based on the percentage of possible points they earn on the
evaluation multiplied by the employee's predetermined bonus (bonus x percentage), just as
they receive for their core-values evaluation. As part of the annual core-competencies review,
the employee and supervisor discuss the individual's development plan, which includes goals
for professional development, such as earning a special certification, and pinpoints skills to
strengthen or develop, such as writing and public speaking.

HITTING THE NUMBERS OR WIN-WIN AGREEMENTS

Core competencies are specific skills and duties employees must be able to perform well to
meet the firm's profitability goals, says Rice. Each employee and supervisor creates a win-
win agreement that includes specific performance numbers or other measures to meet.
Tailored to each individual, the win-win agreement is "the product of the consensus of
management and the employee," Comeau says. "It's a way to make personal and professional
growth part of daily and long-term activity," he says

For example, a competency to "participate in departmental strategic objective teams," might
result in a "win-win" goal with a measurable element such as: "Participate in the (name of
team) with 90% attendance." Another example: For the competency "pursue/accomplish
professional certification," a win-win agreement goal might be: "Obtain CVA certification no
later than 12/31/03."

The goals in win-win agreements may be similar for people in comparable roles, but the
actual numbers or measures likely will differ. Many targets will be tied directly to the
profitability of the firm and have to do with generating income. The supervisor and the
employee specify the measures and numbers based on what each thinks is possible.

Partners and managers have win-win agreements that deal directly with the firm's financial
performance as well as department and individual goals. For instance, a partner may agree to
bring in a certain dollar amount of business in his department. Or a staff accountant may
agree to take a set number of courses toward a certification by a certain date. This increases
the employees' professional capabilities as well as those the firm has to offer clients.

If the firm shows a profit at the end of the calendar year, employees who achieve 75% of the
total possible points available in the win-win agreement are eligible for a bonus. Each
department determines profitability goals during the annual budget process based on their
billable hours, revenue goals and anticipated expenses.

The partners who make up the executive committee approve the departmental budgets in
November to coincide with the start of the profitability bonus year, which runs from



November through October. In December the executive committee meets to allocate the
profits among all the stakeholders. The committee determines a gross allocation for each
department. How well a department met its profitability goals determines how much of the
profits it will be allocated. The department heads use agreed-on organizational criteria and
their own judgment to allocate that profit to the employees.

LIGHT AT THE END OF THE TUNNEL

Although the hard numbers for measuring the effects of the new pay and evaluation system
aren't in yet, Meyners's litigation services partner Thomas Burrage, CPA, says it has
improved morale and increased commitment to the firm's goals. The overhaul of its
compensation and performance process-sensitive issues for employees-will continue to
require time, effort and patience on the part of the entire firm as it plays out.

For firms thinking about undertaking a similar effort, professionals at Meyners say to keep
the following pointers in mind.

Prepare to take time. Meyners has invested a substantial amount of time to define values,
core competencies and goals as well as to analyze and describe exactly what is expected of
employees. Burrage says the firm has spent "thousands of hours" in meetings to come up
with the core values, define the job descriptions and explain each part of the process to staff.
Because the performance evaluation system is well defined and staff members understand
what is expected of them, "ultimately, the process is going to be automatic and simple to
use," says Comeau.

Frequent communication is paramount. Instituting a new pay-for-performance system has
required constant communication because the change involves people's money-and extends
into every aspect of work life. "Until you understand the process and the system, it appears
complex," says McHard, so we keep answering the questions that come up. Meyners has
done this through FAQ sheets, posters and meeting after meeting. Under the old system,
salary increases were "some percentage" of an employee's salary, says a Meyners document
explaining the new three-part pay-for-performance plan. "While the increase was intended to
reflect past performance, it often was difficult to assess performance accurately and
consistently throughout the firm."

Employees are particularly sensitive when it comes to salary, says Burrage. "Any time you
modify someone's compensation system, you have to work hard to reassure them you aren't
taking anything away," he says.

Have adequate administrative support. Because many more people are involved in giving
evaluations-especially of core-values performance-and because each employee gets three
evaluations-core values, core competencies and the win-win agreement-there is a great deal
of work involved to keep track of evaluation dates, distribute and tabulate the various forms
and calculate the bonuses. The firm has hired a human resources clerk who does this and
attends to other compensation and payroll duties involving the new pay-for-performance
process. Prior to the new process, a senior administrative professional had handled many
such duties, but Meyners created a new position to handle the growing amount of HR-related



work as the company grew. The firm uses an HR computer program to process the
evaluations.

Develop measurement systems. The firm would like to measure many things-such as the
number of referrals shared between departments-but it has found the most important things to
measure have been the various goals outlined in win-win agreements. "You need to have the
systems in place to measure the things you hold people accountable for," says Comeau (see
"Accountability by Numbers,"

THE PAYOFF

Comeau believes the new pay-for-performance system sends a strong message to employees
that the firm cares about them as well as profits. "The new system takes a global approach to
giving incentives for behavior. It's not just about dollars," says Comeau. "The process
identifies behavior that not only helps us make money but also evolve as a firm-and get better
professionally and personally at every level," he says. "It's about the future as well as the
present."

For the next stage of the firm's development, says Burrage, Meyners will determine specific
marketing strategies and train staff to carry out duties to support and reach the firm's business
goals.

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Pay for Performance Systems and Incentive Types