Compensation and Benefits Unit 5

Unit 5 Incentive Schemes: Pay for Performance

Structure:
5.1 Introduction
Objectives
5.2 Types of Incentive Schemes
Income varying in the same proportion to output
Earnings varying proportionately less than output
Earnings varying proportionately more than output
Earnings differing at different levels of output
5.3 Wage Incentive Plans
Incentive plans for blue collar workers
Incentive plans for white collar employees/workers
5.4 Pre-requisites of Effective Incentive Schemes
5.5 Merits and Demerits of Incentives
5.6 Pay for Performance Plans
5.7 Summary
5.8 Glossary
5.9 Terminal Questions
5.10 Answers
5.11 Case Study

5.1 Introduction
In the earlier unit, you studied about the compensation strategy at micro
level, concept of internal and external equity, the methods, process and
problems of job evaluation, etc. In this unit, you will gain an in-depth
understanding of incentive schemes with a focus on the concept of pay for
performance.
An organisation must attract and retain productive employees in order to
succeed. To meet this objective, an organisation must develop incentive
plans, also termed as Performance Incentive Plans, that help motivate
employees in exceeding their expectations and result in firm’s growth.
In this unit, you will learn the types of incentive schemes when the income
or earnings are same, less, more or at different levels of output. You will
also learn about the wage incentive plans for blue and white collar workers
and the prerequisites for effective incentive schemes. Next, you will study

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merits and demerits of incentives. The unit will wind up with the pay for
performance plans.
Objectives:
After studying this unit, you should be able to:
• recognise different types of incentive schemes
• describe the wage incentive plans and its types
• list the pre-requisites of an effective incentive scheme
• identify the merits and demerits of incentives
• explain pay for performance plans

5.2 Types of Incentive Schemes

Before discussing about the types of incentive schemes, you must know
what is exactly meant by incentives. Incentives are monetary emoluments
paid to an employee in acknowledgment of their enhanced performances
aiming at motivating the performance of individuals and groups in the
organisation.
Such plans are usually constructed around monetary bonuses or incentive
pays but they also include non-monetary benefits like rewards, awards,
prizes etc. International Labour Organisation (ILO) has referred these
programs as payments by results. Wages and salaries are usually fixed in
nature but incentives typically differ from employee to employee and even
from time to time for same employee.
A wage incentive scheme can be defined as a payment method for an
acceptable quality of work done over and above the quantity or standards
specified by the organisation.
Example: Firms like Godrej, Mastek and Boyce have been able to
successfully link their rewards to performance based learning. Even
companies like Pfizer, Siemens have been able to meet their productivity
and performance targets by linking their rewards to shop floor workers’
performance.

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I see where we're going

"Here is and I believe
our we can get there.
Business
Plan"

I understand it.

I see how it links

to the business plan.
"Here is I understand what
our I am to contribute.
Incentive
Plan" It means a lot to me.

Source: http://www.vladvisors.com/compensation-information/Sustained-
Performance-article.aspx
Figure 5.1: Designing Organisation Incentive Plans

Figure 5.1 shows that after analysis of gap between the firms’ overall
business plan and its incentive plans for employees, two main types of
incentive plans, namely, short-term and long-term, are designed.
Figure 5.2 shows you the different types of wage incentive plans used by an
organisation to calculate the total earnings of an employee, explained in
detail in the later part of this unit.

Wage Payment Plan

Time Rate System Piece Rate System Wage-Incentive System

Time-based Approach
Productivity-based
Approach

Halsey Plan Rowan Plan Emerson Plan Bedaux Plan

Taylor Plan Merrick Plan Gantt Plan

Source: http://www.transtutors.com/homework-help/industrial-management/wage-
incentive-plans/types-of-wage-incentive-plans.aspx
Figure 5.2: Types of Wage Payment Plans

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Case Let

BancoSol
BancoSol, one of the leading microfinance banks in Bolivia, has adjusted
its staff incentive scheme for lending staff in response to the country’s
financial crisis in 2002. The scheme focuses on the portfolio quality and the
monthly bonuses of loan officers is determined by six performance
indicators to which different weights are allocated as reflected in the table
below.

Performance indicator Weight in the "bonus formula"

Portfolio Stock 20%
Client Stock 20%
Provisions 15%
Past Due Loans 20%
Delinquent Loans 10%
Write Offs 15%

The table below shows the extent to which BancoSol could increase its
loan portfolio quality. Of course, this achievement cannot only be attributed
to the changes in the bank’s staff incentive scheme, but the incentive
scheme has definitely supported this development significantly.

July 02 July 03 July 04

% Portfolio growth 9% 7% 20%
Portfolio at Risk 15% 9% 6%
% Provisions growth 2% – 2% – 3%
% Growth past due 8% – 34% – 15%
% Growth past due clients 4% – 49% – 27%
% Growth Write Off 3% – 32% – 57%
Source: http://www.microfinancegateway.org/gm/document-
1.9.29429/3532_file_Staff_Incentives_Scheme_Toolkit_0504.pdf

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5.2.1 Income varying in the same proportion to output

This scheme of providing income in proportion to output reflects that any
gains or losses resulting directly from a worker’s output accrue to him or her.
In contrast, when the worker is paid by the hour, day or month, all gains or
losses occurring from changes in his output accrue to the employer.
The success of this type of incentive requires that the measurement of
standard and individual outputs must be extremely accurate. The straight
piece-work and the standard hour systems are the two popular incentive
schemes which come under the first category. In the straight piece-work
method, the rate per unit of output is fixed, and the total earnings of a
worker are arrived at by multiplying the total output by the rate per unit.
Example: Let us take the example of an employee working in a
pharmaceutical company. If the rate per unit is ` 25 and the total output of an

employee is 100 units, his or her earnings will be 100 × 25 = ` 2500.00.

In the standard hour system (also called 100 per cent gains-sharing); the
standard time in terms of hours is fixed for finalising a job. The computation
of rate per hour is then executed. A worker is paid for a standard time or
less. He or she is paid the same wages if he or she takes more than the
standard time, unless he or she is guaranteed time wages. On the other
hand, when time wage is guaranteed, the worker gets the wages equal to
time consumed multiplied with time rate.
Example: Let us take example of an employee working in a tool
manufacturing firm. His working details are as below:
Standard time = 10 hrs.

Rate per hour = ` 15

Case (i)
Time taken = 8 hrs.
Earnings = 10 × 15 = ` 150.00

Case (ii)
Time taken = 12 hrs.
(a) Earnings if time wages are not guaranteed

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= 10 × 15 = ` 150

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(b) Earnings if time wages are guaranteed

= 12 × 15 = ` 180

5.2.2 Earnings varying proportionately less than output

Four allied but different systems (see figure 5.3) fall in this group, namely,
Halsey, Rowan, Barth, and the Bedaux possessing a common feature that
time is used as the measure of output and bonus is paid on the time saved.
These schemes are termed as ‘gain sharing schemes’ as they provide
benefits to both the employer and the employee. These systems are often
used in cases where it is impossible to accurately measure the employee’s
output or there is a difficulty in standards setting.

Source: http://www.headscratchingnotes.net/2012/02/suggestion-schemes-wage-
incentive-plan/
Figure 5.3: Types of Plans on the Basis of Earnings Less than Output

Halsey system
Halsey system, developed by F.A. Halsey, provides for the fixation of a
standard time for the completion of the task. You can say that in this system
for the work done in correct time or more, the actual time-rate is paid. Thus,
the minimum wage is guaranteed even if the output falls below the standard.
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On completion of job less than the fixed standard time, the employee
receives a bonus payment at his time-rate for a specific percentage of the
time saved. This percentage may vary anywhere from 30 per cent to 70 per
cent, but usually it is fixed at 50 per cent.
Example: Rohan is working in XYZ Ltd Company which is into beverage
production. His company pays him using Halsey Plan. You can calculate his
total wages with the given information using Halsey system as:
Standard Time (S) = 10 hrs
Time Taken (T) = 8 hrs

Wage Rate (R) = ` 20 per hour

Bonus = 50%
Total Wages (W) = T X R + 50% (S-T) X R
= 8 X 20 + 50/100 X (10-8) X 20 = 160 + 20 = 180
Rowan system
Under this system again a standard time is provided for a job, and bonus is
similarly paid for any time saved. But it is different from the Halsey plan in
terms of bonus compilation. The premium calculation is enacted on the
basis of the proportion which the time saved bears at standard time. Thus,
you can say that if a worker does work in six hours against 10 hours
standard, the wages payable in six hours will be wages plus 40% of wages
as bonus.
Example: Using the earlier example you can calculate the total wages of
Rohan if his firm would have used Rowan Plan instead of Halsey as:
Total wages (W) = T X R + [T X R X Time Saved/ Standard Time]
= 8 X 20 + [8X20X2/10]
= 192
Bedaux point system
Under this system, the standard time set is divided into a number of points
at the rate of one minute per point. The bonus is calculated at 75 per cent of
the points earned in excess of 60 per hour.
Thus, if the standard time is 10 hours and if the worker completes the job in
7 hours and if his hourly rate is 0.96 money units, the standard number of

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points for completing the job will be 600 points in 7 hours. His bonus,
therefore, will be 75 per cent of 180 × 0.96/60 which is equal to 2.16 money
units.
If a worker does not reach the standard, he is paid at his time rate. This
system enables the management to record the output of any worker of the
department in units and know whether the production is up to the standard
that the management desires.
Example: Arun is employed in a firm where his working information is given
to you as:
the Standard time(S) fixed by firm in doing his job is 240 minutes, Actual
time (T) taken by him is 180 minutes and the Wage Rate (R) as ` 15 per
standard time. The additional information tells you that a worker who
completed the job in less than standard time is paid bonus which is 75% of
the wages for workers and 25% for foreman. Now using Bedaux system you
can calculate total wages as:
Total Wages (W) = S × R + 75% R × (S – T)
= 240X 15 + 75% X 15 X (240-180)
= 3,600 + 675
= ` 4,275

5.2.3 Earnings varying proportionately more than output

There are two methods in this category (i) the high piece-rate and (ii) the
high standard hour system. Under the first one, the wages of the worker are
designed in proportion to his or her output, just similar to straight piece-
work, but the increase in wages for each unit of output above the standard is
larger.
Example: Arun is employed as an operating worker in a firm where he is
paid according to high-piece rate. Thus, according to this system for each 1
percent increase in output above the standard, there may be a 4/3 times
increase in his earnings.
The main feature of these two schemes is that since direct labour costs per
unit increase for levels of output above the standard, the worker also shares
the earnings in overhead costs which result from an increased output. The

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amount of this share depends on the size of the increments in earnings

which are payable at different levels of output.

5.2.4 Earnings differing at different levels of output

These systems can be best explained by describing how earnings vary from
minimum to maximum at different output levels. It includes the Taylor’s
Differential Piece-Rate system, the Merrick’s Differential Piece-Rate system,
the Gantt Task system, the Emerson’s Efficiency system and the
Accelerating Premium system.
Taylor differential piece-rate system
As the name suggests, this system was introduced by Taylor with objectives
of giving sufficient incentives to workmen to motivate them to produce at
their full capacity, and to remove the fear of earning deductions. The
workers are provided with a single uniform rate which usually a higher rate
is enabling the workers to earn a good bonus.
A lower rate is used for those workers who do not meet the standards. For
the workers who do not meet standards, higher rates act as incentives by
motivating them to work more efficiently to achieve them one day.
Figure 5.4 clearly shows the working of the Taylor Differential Piece-rate
System.

Input: Differential wage rate (R1, R2)

Standard Production (P) Output (O)

Is NO
Wage = R1 * O
O>P

Yes

Wage = R1 * P+ (O – P) R2

Pay wages to the worker

Source: http://www.transtutors.com/homework-help/industrial management/wage-

incentive-plans/differential-piece-rate-system.aspx

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Figure 5.4: Taylor’s Differential Piece Rate System

Example: An individual M is working in a cloth manufacturing firm which

uses Taylor’s Differential piece rate system to calculate earnings of its
workers. You can now understand the calculation as given below:
Standard Output = 100 units
Rate per unit = ` 10
Differential applied:
120% piece rate at or above standard
80% of piece rate when below standard
Case 1: When output = 120 units

Earnings = 120 X 120/100 X 10 = ` 1440

Case 2: When output = 90

Earnings = 90 X 80/100 X 10 = ` 720

Merrick differential piece-rate system

This is a modification of the Taylor system, with three instead of two rates.
One large step is broken into two, so as to encourage new and average
workers. 83 percent of standard output is paid as straight piece rates at
which bonus of 10 percent of time rate is paid. Further, a 10 percent of
bonus is given on reaching the standard output. For outputs above the
standard, high piece-rates are paid.
Example: Mohan working in an iron crafting company receives earnings on
the basis of Merrick differential piece rate system. You can understand the
computation of his earning by observing his details mentioned below:
Standard output = 100 units
Piece Rate = ` 10

Straight piece rate is paid up to 83% of standard output, at which bonuses of

10% of time-rate is also paid. Further a 10% bonus id is given on reaching
standard output and for output above standard high-piece rate is paid.
Case 1: When output is 80 units
Efficiency = 80/100 X 100 = 80%

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Earnings = 80 X 10 = ` 800.00 (as efficiency is less than the standard

output. Therefore, only base piece rate is provided)

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Case 2: When output is 90 units

Efficiency = 90/100 X 100 = 90%
Earnings = 90 X 110/100 X 10 = 990 ( Since the earrings are greater than
standard output but lower than 100% therefore 110 percent base-piece rate
will be applicable)
Case 3: When output is 110 units
Efficiency = 110/100 X 100 = 110%

Earnings = 110 X 120/100 X 10 = ` 1320 (Since earnings exceed 100%, 120

percent of base piece-rate will be provided)
Premium and task bonuses
H. L. Gantt devised this system which is the sole one to provide earnings
equal to a bonus percentage multiplied with standard time. Fixed time rate is
guaranteed under this system and the output and time standards are well
estimated for performing an individual job.
The wages consisting of standard time and a bonus ranging between 20 to
50 percent of allowed time is paid to the worker who completes the job
either before or on standard time. However, when a worker does not meet
quantity on standard time, he is just paid the time rate and not bonus.
Bonus Percentage under Gantt Plan is reflected in table 5.1.

Gantt recommended that based on the nature of work, the bonus may vary
from 10% to 100% of the guaranteed wages as given below:
Table 5.1: Bonus Percentage under Gantt Plan

Nature of Work Bonus

Percentage
• Work not involving much physical labour with constant 10 – 15 %
and close attention
• Work in general machine shop or tool room 35 %
• Work involving constant use of eyes 30 – 40 %
• Heavy work including skill work 60 – 70 %
• Work requiring much physical labour or strain, ability to 100 %
work under unpleasant conditions and involving

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acceptance of responsibility
Example: You can understand the computation of earnings of a worker
using Gantt Plan by going through the following illustration.
Rate per Unit (R) = 30
Standard Time (S) = 16
Percentage of Premium = 1/3.
Therefore Earnings = R × S + P × R × S
= 30 × 16 + 1/3 × 30 × 16 = 640
Emerson’s plan
Under the Emerson’s plan, a standard time is set for individual job, and the
efficiency of individual employee is computed by dividing the time taken by
the standard time. Up to 67 per cent of efficiency, the worker is paid by time-
rate. Thereafter, a graduated bonus, which amounts to a 20 per cent bonus
at 100 per cent efficiency, is paid to the worker. Thereafter, an additional
bonus of one per cent is added for each additional one per cent efficiency.
Accelerating premium system
Under the Accelerating Premium system, the earnings of workers increase
with output, the rate of increase itself rising progressively with the output.
The worker receives a strong incentive to increase his or her output in order
to get increased earnings. But the accelerating premium systems are
complicated and are difficult to understand and implement.
Self Assessment Questions
1. _________________ are monetary emoluments paid to an employee
in acknowledgement of their enhanced performances.
2. ___________________ system provides for the fixation of a standard
time for the completion of the task.
(a) Rowan
(b) Halsey
(c) Bedaux Point
(d) Standard hour
3. Under the Bedaux Point system, the standard time set is divided into a
number of points at the rate of one minute per point. (True/False)

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4. ________________ system was introduced with objectives of giving

sufficient incentive to workmen to motivate them to produce at their full
capacity, and to remove the fear of earning deductions.
5. ___________________ system is the sole one to provide earnings
equal to a bonus percentage multiplied with standard time.

Activity 1
Assume that you are the HR Manager of your organisation who has been
instructed to appoint an area sales manager. While planning his package
for the said designation, mention which all incentives like bonuses,
vacation pay, stock options or awards, etc. you will be using as his
incentive plan to keep him motivated.

5.3 Wage Incentive Plans

Blue collar jobs can be defined as the jobs in which workers perform manual
labour and get hourly wages in return. Mining road or rail construction,
building of houses or ships and labourers working in manufacturing units are
some of the examples of such jobs. On the other hand white collar jobs are
the one performed by personnel working in clerical, administrative and
management jobs. They are generally performed by higher educated people
and they get a fixed salary for performing such jobs. Blue-collar workers
perform labour jobs and typically work with their hands. The skills necessary
for blue-collar work vary by occupation. Some blue-collar occupations
require highly skilled personnel who are formally trained and certified.
White-collar workers usually perform job duties in an office setting. They are
highly skilled and formally trained professionals, who provide professional
services to clients.
You will learn that wage incentive plans can be categorised as plans for
(i) Blue-collar workers; and (ii) White-collar workers. A specific tailor made
incentive plan must be derived to meet the heterogeneous and separate
needs of each of these categories of employees. Therefore, correct
measurement of performance for the purpose of incentive payment is very
important.
Example: At Maruti Udyog, on one hand, the Sales manager gets a pay
including basic salary plus incentive equal to ` 71,167 per month. On the

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other hand, in the same company a casual worker get ` 7,000 per month
and a permanent worker say a Junior Associate-1 gets a pay ranging
between ` 15,000 to 17,000 per month.

Source: http://www.sajhrm.co.za/index.php/sajhrm/article/downloadSuppFile/323/495
Figure 5.5: Incentive Payouts – Percentage of Market Average

The figure 5.5 shows you the incentive payouts observed in Indian industry
calculated on the basis of percentages of market averages.
5.3.1 Incentive plans for blue collar workers
Short-duration incentive plans for blue collar employees may be broadly
classified into three categories:
1. Plans below which an additional incentive rate is in proportion to the
additional production.
2. Plans below which the additional incentive is proportionate at a lower
rate than the increase in production.

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3. Plans under which incentives rates are proportionately higher than the
rate of increase in production.
Incentive plans are acknowledged as premium plans as they proffer a
premium for remarkable performance.
Example: At MSIL Plant in Manesar, a permanent worker earns ` 8, 000 as
a fixed wage component which starts differing with the seniority and level of
skill of the workers, and reaches up to a maximum of ` 14, 000-15,000 per
month for senior workers.
5.3.2 Incentive plans for white collar employees or workers
You can understand this incentive plan with the help of a detailed analysis of
sums paid to salesmen of a firm. Sales commission is usually provided as
incentives to salesmen for achieving sales targets. A recently conducted
study reflects that among all the firms surveyed, 75 percent of them paid
salesmen on the basis of incentive plans. The unsupervised nature of sales
work, the market tradition and the motivating role of incentives in meeting
sales target can be accounted as a reason behind such incentive policy
formulation.
There are a number of incentive plans for sales staff broadly categorised
into three basic types of plans known as straight salary plan, straight
commission plan and combination plans.
The straight salary method though not an incentive plan provides the
salesman pay on weekly, monthly, or on yearly basis. The benefit of this
plan is that it helps the salesmen know in advance their earnings and (ii) the
expenditure on salesmen is also known in advance.
Under the straight commission, the salesmen are paid on the basis of sales
affected i.e. solely for the results they have achieved. This plan thus attracts
high performance by salesmen.
Under the combination method of salary and commission, salesmen not
only get salary but also a commission in proportion to the sale achieved.
The benefits of this method include relieving salesmen from financial
worries, greater command over its salesmen and a huge salary component.

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In many organisations, the managers are paid bonus. The overall corporate
results are generally used as a measure to provide bonuses to top
management.
Self Assessment Questions
6. ________________ is usually provided as incentives to salesmen for
achieving sales targets.
7. In a ________________ method the payment to executives is done on
weekly, monthly and yearly basis.
(a) Straight salary
(b) Straight commission
(c) Combination of these methods
(d) None of the above
8. Incentive plans are acknowledged as ________________ as they
proffer a premium for remarkable performance.

Activity 2
Conduct a survey in your organisation for any five blue and white collar
personnel and study their incentive structure in detail. Also critically
analyse the differences in their incentive structure if any.

5.4 Pre-requisites of Effective Incentive Schemes

You can conclude by now that for all firms a well-designed system of wage
payment can yield a number of advantages. But it is also true that to realise
these advantages there must be some safeguards known as pre-
requisitions of effective incentive plans.
These pre-requisites are as under:
1. The workers’ co-operation is mandatory in execution of incentive
schemes. The co-operation is required in respect of methods adopted
for analysis of result or output on basis of which payment is done, the
setting wage rate methods for different work categories and pre-
requisites relating to job security, earnings and dispute settlement
regarding work standards.
2. The incentive scheme must be influenced by scientific work
measurement like the standards set must be practical and inspiring. In

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addition, the employees must be provided with necessary resources to

meet these standards.
3. All indirect staff like foremen, helpers, supervisors, and canteen staff
charge hands etc. should also be roofed under incentive schemes.
4. A management commitment to oversee the outlay and schedule the
proper administration of plans should be formed.
5. An incentive plan should be first planned properly and then implemented
carefully to achieve desired results as mentioned in Figure 5.6 below.
Example: A car manufacturer while designing incentive plan will provide
incentive award to individuals working in dealership than the direct
employer.

Decide on
preferred
Identify Scheme alternatives for Develop Establish
Identify leading Parameters and Scheme Detailed implementation
practices provide Parameters Scheme infrastructure
alternatives (incl. scheme
instrument)

Support business Manage Share Mitigate market risk Provide Administrative

objectives Dilution Ease

Accounting/Tax/Legal Fair in all growth Manage Expense Provide

Support Retention Environment scenarios Efficiency Communication Ease

Source: http://www.gulfbanksssp.com/Common/HomePages/design_lti_program.html
Figure 5.6: Designing of an Incentive Plan

Self Assessment Questions

9. ________________ of workers is mandatory for successful
implementation of incentive plans.
10. The incentive schemes must be based on scientific work
measurements. (True/False)
11. An ________________ should be first planned properly and then
implemented carefully to achieve desired results.
(a) compensation plan
(b) incentive plan
(c) wage rate

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(d) None of the above

5.5 Merits and Demerits of Incentives

Now let us discuss various merits and demerits of Incentives.
Merits
You will find that the principal advantage of incentives is that it induces and
motivates employees to achieve high efficiency and superior output. Fixed
remuneration does not act as a motivator for workers to yield improved
results rather it removes panic of insecurity from employees’ mind.
Incentives result in enhancement of earnings which have helped employees
in improving their standard of living. Instances show that wages have
exceeded two to three times as contrasted to the time-rated wages because
of incentives.
Firms can bring down their per unit as well as total cost of production using
incentives as increase in productivity will lead to a larger output for given
inputs bringing down the total and unit cost of production.
The further benefits of incentive payments are: reduced command, greater
equipment utilisation, reduction in scrap and time lost, condensed turnover
and absenteeism and augmented output. Furthermore, systems of
imbursement by results would facilitate the application of cost control
techniques like standard costing and budgetary control.
Example: The Indian assembly line industries have been able to achieve
remarkable enhancement in performance and also provided an option of
self-financing to its employees through the use of incentives like bonuses,
performance incentives, stock options, awards, vouchers, gifts etc.
Demerits
The quality of products may show tendencies to get worse if steps are not
taken for timely quality maintenance through checking and inspection
involving added costs.
A firm may face difficulties related to introduction of new methods or
machines as employees may oppose them out of their fear that the new
piece of bonus rates set may yield lower earnings or that such introduction
will slow their work rate.

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In addition, a jealousy may arise between employees for the reason that
some may earn more than others.
One of the biggest complexities in incentive systems is fixing of piece or
bonus rates. Rate fixing involves fair and accurate judgement in which there
is always an error risk. Small rates will make workers disappointed and they
will be under pressure to work very hard. Soaring rates may slacken their
efforts at times and employer may not take the option of revising the rates
because earnings are too high.
Firms can also face difficulty in determining standard performance. Firms
usually use the average of past year’s performance for this purpose.
Most of the problems of financial incentives arise either from the
inadequacies of the particular system or from incorrect application and
insufficient control. In western countries, as also in India, it has now been
realised that economic gain is no longer a source of motivation and that
greater emphasis should be placed on non-economic factors.
Self Assessment Questions
12. The principal advantage of incentives is that it induces and motivates
employees to achieve high efficiency and superior output. (True/False)
13. One of the biggest complexities with the incentive systems is setting of
_______________.
14. The problems of financial incentives arise either from _____________.
(a) System inadequacies
(b) Incorrect application
(c) Sufficient control
(d) Both (a) and (b)

5.6 Pay for Performance Plans

In this section, you will learn about pay for performance. Pay for
performance is also known as variable performance linked pay or contingent
pay. Variable performance in the pay is a financially measurable reward
paid to an individual based on his overall performance.
This measure includes the cumulative performance of the individual, his
strategic business unit and that of the organisation. Contingent pay includes

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payment related to individual’s presentation, his skills and competencies,

contribution, or to the team or organisational performance.
Example: Whirlpool’s pay plans are driven by both short and long-term
focus and almost tied to enhancement in stockholder value.

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Table 5.2: Types of Variable Pay Plans

Individual Group/Team Organisation-Wide

• Piece rate • Gainsharing • Profit sharing
• Sales commissions • Quality • Employee stock options
improvement
• Bonuses • Cost reduction • Executive stock options
• Special recognitions • Deferred compensation
(trips, merchandise)
• Safety awards
• Attendance bonuses

Source: Compensation and Reward Management, 1st Edition, B.D Singh, Excel Books

Variable Pay can be linked to individual, team, and organisational

performance as reflected in table 5.2. Such pay plans aim at providing
tangible rewards to workers for exceeding normal performance and are
based on the following assumptions:
• Some jobs contribute more to firm’s success than others.
• Some people perform in a superior way than others.
• Such employees must get more reward
• A segment of a few employees’ total compensation should be contingent
on performance.
Advantages of variable pay
• It supports team work
• It promotes open lines of communication
• It is related to continuous involvement of employees
• It synchronises rewards with key business priorities
• It relates profit earning capacity with compensation

Example: Table 5.3 given below uses the merit incentive pay scheme for
differential performance recognition and rewarding. In this system, first the
result-oriented merit rating procedures are determined followed by
identification of job factors and related improvements, scale of reward
formulation and communication on basis of monetary rewards. Here, sales
promotion, realisation of outstanding, goodwill calls etc are identified as job
factors.

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Table 5.3: Scale of Distributing Incentive Opportunity Point

Job Factors Scale Values
1 2 3 4
1. Sales tasks 0 3 6 10
2. Realization of 0 1.8 3.6 6
outstandings
3. Goodwill calls, etc. 0 1.2 2.4 4
Source: Compensation and Reward Management, 1st Edition, B.D Singh, Excel Books

On the basis of these job factors, the merit rating is than allotted to every
employee as reflected in the next table 5.4.
Table 5.4: Definition of a Point on the Merit Rating Scale
1 2 3 4
Unsatisfactory Satisfactory Fair Good
Sales target not Sales target 3% above sales 5 per cent above
achieved achieved achieved sales achieved

Source: Compensation and Reward Management, 1st Edition, B.D Singh, Excel Books
Table 5.5: Teams and Pay for Performance
Type of Team Pay for Performance
Parallel Use gainsharing or other business unit plant to reward
savings. Use recognition reward plan for teams, as
appropriate.
Production and Use team bonuses or business unit bonuses if teams are
service interdependent. Use individual bonuses that are based on
peer evaluations.
Project Use bonuses based on project success. Also, use profit-
sharing and stock plans.
Management Use team or business unit bonuses. Also use profit-sharing
and stock-based plans.

The above table 5.5 shows you the various pay for performance done at
team levels. It also shows you the types of teams and the types of pay for
performance used for each team.
Factors affecting successful variable pay plans
Numeral elements that can cause the success of Pay for Performance Plans
are:
1. Availability of adequate financial resources.

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2. Consistency with firm’s culture

3. Evidently alienated from base pay
4. Unmistakably communicated
5. Performance results connected to payouts
6. Current and restructured plans
7. Assessable performance
8. Clear and comprehensible plan details
9. Results in desired behaviours
10. Linked to organisational goals.
Latest Incentive Plan
Following are the latest Incentive Plans:
1. Sales Incentive: Remuneration offered to a salesperson for exceeding
some predetermined sales goal. Sales incentives are offered by
manufacturers as part of a promotion for the sale of their goods. The
incentive may be in cash, or it may take the form of a special prize, such
as a trip to an exotic or exciting vacation place. Choosing the right sales
incentives to motivate a team can be challenging. On the one hand, they
need to be exciting enough to motivate a sales force to change their
behavior, or at least point it in a certain direction. On the other hand,
they also need to fit within an organization’s budget and not cost so
much that they cancel out the benefit of holding a sales contest in the
first place. Incentives can come in a number of different flavors, all of
which can be effective.
2. Delivery Management/Project Management: Incentive plans are, by
definition, designed to motivate employees to behave in ways that align
with business goals. The obvious case is a product sales professional
working towards a revenue based incentive. The business goal is to
sell, and it motivates to that end. In order to generate a laser focus for
your project delivery team, similar to a sales team trying to hit their
numbers, requires an incentive plan directly tied to desired
outcomes. For example, desired business outcomes may be:
™ Drive customer loyalty – Whether it is the life of a project or the
support afterwards, here again, the mission is not to spend more
time with customers. No CXO would judge their own customer
satisfaction by a measure of how much time they spend in

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meetings. Rather, looks at the primary measure of customer

satisfaction, whether that be survey results, or a similar measure.
™ Prepare for future growth: Focusing on hours billed is counter to this
goal. Preparing for future growth can only be done with activities
such as generating IP, mentoring others, and attending training.
This type of incentive mix can drive an employee to work towards X hours
per week, within a tolerance, or any variation thereof. The accelerator
(curve) drives this motivation. A cap can be used to limited bonus to Y%
attainment unless they meet other gates, such as pre-sales activity.
Accelerators and caps are important components of incentive structure that
drive behaviour.
With respect to the issue of perceived total compensation, the potential for
increased compensation is provided by pay bonus. This might be coupled
with the explanation that, "We don't want employees 'working to work'. We
want employees working towards the goals of the business." Optimally,
there would be a way to structure it so that the potential for total
compensation is greater than it would be otherwise. If all projects go
perfectly, there should be additional budget available for compensation, for
example. That would not be the case, per se, if staff all worked 80 hours
per week, without net impact to revenue-generating activities. Of course, if
a customer is paying for hours, that generates revenue; but that has to be
the core mission of the project. The mission may be to get seats deployed,
keep customers happy, and/or drive future growth.
Self Assessment Questions
15. Variable performance in the pay is a financially measurable reward
paid to an individual based on his overall performance. (True/False)
16. Variable Pay is compensation linked to _____________ Performance.
17. The _________________ pay scheme provides another method of
recognising and rewarding differential performance.
(a) Merit incentive
(b) Standard hour time
(c) Straight method
(d) Straight commission

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5.7 Summary
Let us recapitulate the important concepts discussed in this unit:
• A wage incentive scheme can be defined as a payment method for an
acceptable quality of work done over and above the quantity or
standards specified.
• Income in proportion to output reflects that any gains or losses resulting
directly from a worker’s output accrue to him.
• In income less than output, four systems namely, Halsey, Rowan, Barth,
and the Bedaux possess a common feature that time is used as the
measure of output and bonus is paid on the time saved.
• The high piece-rate and the high standard hour system are used to
provide incentives when earnings are more than proportion to output.
• Wage incentive plans may be discussed as plans for (i) Blue-collar
workers and (ii) White-collar workers.
• To realise the advantages of incentive plans there must be some
safeguards known as pre-requisitions of effective incentive plans.
• Increased motivation, productivity, earnings, lower organisational cost,
reduced supervision etc are some of the advantages of incentive plans.
• Variable performance in the pay is a financially measurable reward paid
to an individual based on his overall performance.

5.8 Glossary
Blue collar workers: These are workers performing manual labour tasks.
Incentive: It is the monetary benefit paid to employees in recognition of
their enhanced performances.
Time-rate system: It is a wage payment system in which workers are paid
according to time.
Variable Pay: It is a financially measurable reward paid to an individual
based on his overall performance.
Wage Incentive: It is a payment method for an acceptable quality of work
done over and above the quantity or standards.
White collar personnel: These are personnel performing administrative,
managerial and professional tasks.

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5.9 Terminal Questions

1. What do you understand by incentives? Explain using examples.
2. What are the methods used to provide incentives to workers when their
earnings vary less than proportion to output.
3. Compare and contrast Taylor’s and Merrick’s differential piece rate
systems.
4. List down the advantages of an Incentive Plan.
5. Critically analyse the concept of pay for performance.

5.10 Answers
Self Assessment Questions
1. Incentives
2. (b) Halsey
3. True
4. Taylor differential piece-rate
5. Premium and Task Bonus
6. Sales commission
7. (a) Straight salary
8. premium plans
9. Co-operation
10. True
11. (b) Incentive plan
12. True
13. Piece and Bonus rates
14. (d) Both a and b
15. True
16. Individual, team and organisation
17. (a) Merit incentive

Terminal Questions
1. Incentives are monetary emoluments paid to an employee in
acknowledgment of their enhanced performances. For more details,
refer to section 5.2.
2. Four systems namely, Halsey, Rowan, Barth, and the Bedaux are used
as the measure of output when earnings vary less than proportion to

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output and bonus is paid on the time saved. For more details, refer to
section 5.2.2.
3. The Taylor’s differential piece rate system uses a single uniform rate
usually a higher one enabling the workers earn a good bonus. A lower
rate for workers not meeting the standards is used. On the other hand,
Merrick differential piece rate system focuses on three instead of two
rates. For more details, refer to section 5.2.4
4. Increased motivation, productivity, earnings, lower organisational cost,
reduced supervision, etc. are some of the advantages of incentive plans.
For more details, refer to section 5.5.
5. Variable performance in the pay is a financially measurable reward paid
to an individual based on his overall performance. For more details, refer
to section 5.6.

5.11 Case Study

Air India
A CAG report with CNN-IBN says that Air India has been rewarding
employees despite the airline's poor financial health with ` 1500 crore being
paid yearly in performance linked incentives. So, the 10-day strike by Air
India pilots comes as a blessing to the airline, which will not need to pay out
April salaries, stemming a large amount of red on the balance sheet. In
1999, Air India introduced performance linked pay, hoping to improve
productivity and efficiency.
The evaluation parameters were far below the average in other airlines.
Despite this, Air India hiked incentives in 2005, and again in 2008. A CAG
audit shows airline profitability and load factor were not even considered
while evaluating performance. The audit says incentives paid were between
62 per cent and 919 per cent of salary and government guidelines say it
cannot exceed 50 per cent.

Air India paid out ` 473 crore in incentives, nearly ` 300 crore of this going to
officers. A struggling management recommended that halving performance
linked incentives would save Air India ` 600 crore. General Secretary ACEU
Arun Malhotra said, “Fifteen per cent of the employees are getting 85 per

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cent of the salaries. So, their wage bill put together in such a way that they
get 85 per cent of the entire ` 4000 crore, which is around

` 3400 crore. About ` 600 crore is what 85 percent employees get. So it is a

darker side of Air India.”
In comparison with other airlines Air India spends the most on its 40,000
odd employees, the wage bill along over Rs 3000 crore. But the productivity
is not commensurate. It is the lowest employee cost per revenue passenger
kilometres. A 2009 competitive survey by international rating agency Skytrax
termed Air India outdated, apathetic, grudging and unpleasant Today, of a
yearly wage bill of ` 3000 crore, half is paid out as performance linked and
flying allowances. As a former officer famously said while Air Indians get
richer, Air India gets poorer by the day.
Questions
1. What are the problems in this case?
2. Why are the incentive plans of Air India not able to raise its employees’
productivity?
3. What suggestion would you like to provide Air India to improve its
employee productivity by bringing about modifications in its incentive
plans?
Source: http://ibnlive.in.com/news/performance-incentive-plan-killing-air-
india/151519-3.html

References:
• B. D. Singh (2007). Compensation and Reward Management. Excel
Books Pvt Ltd.
• Armstrong, M. (2006). Handbook of Human Resource Management,
Kogan Page. 10th Edition.
• Robinson, S. L. & Rousseau, D. M. (1994). "Violating the psychological
contract: Not the exception but the norm" Journal of Organizational
Behavior 15, pp 245-259.
• Milkovich G. T. & Newman J. M. (2005). Compensation Management.
Tata McGraw Hill.
E-References:

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• http://www.slideshare.net/WelingkarDLP/hrm2-chap6wages-salary/
Retrieved on 17th July 2012, Time: 3:00 PM.
• http://www2.ie.psu.edu/Freivalds/courses/ie327new/WAGE.htm/
Retrieved on 17th July 2012, Time: 3:06 PM.
• http://www.scribd.com/doc/52978924/89/Types-of-Wage-Incentive-
Plans/ Retrieved on 18th July 2012, Time: 10:11 AM.
• http://www.svtuition.org/2010/08/incentive-wage-plans.html/Retrieved on
18th July 2012, Time: 11:44 AM.

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