IV. Team Incentive Plans: Types
When we move away from the individual incentive systems and start focusing on
people working together, we shift to group incentive plans.
A standard is established against which worker performance (in this case, team
performance) is compared to determine the magnitude of the incentive pay. The
standard might be an expected level of operating income for a division. Or the measure
might be more unusual.
Despite an explosion of interest in teams and team compensation, many of the
reports from the front lines are not encouraging.
Failures of team incentive schemes can be attributed to at least five causes:
oOne of the problems with team compensation is that teams come in many varieties
(full-time teams, part-time teams, cross-departmental, temporary, etc.). With so
many varieties of teams, it is hard to argue for one consistent type of compensation
plan. Xerox has a gain-sharing plan that pays off for teams defined at a very broad
level, usually at the level of a strategic business unit. For smaller teams, primarily
intact work teams (e.g., all people in a department or function), there are group
rewards based on supervisory judgments of performance.
oA second problem with rewarding teams is called the “level problem.”
If teams are defined at the very broad level—the whole organization being
an extreme example—much of the motivational impact of incentives can be
lost.
Conversely, if teams get too small, other problems arise. TRW found that
small work teams competing for a fixed piece of incentive awards tend to
gravitate to behaviors that are clearly unhealthy for overall corporate success.
Teams hoard star performers, refusing to allow transfers even for the
greater good of the company. Teams are reluctant to take on new employees for
fear that time lost to training will hurt the team.
Finally, bickering arises when awards are given. Because teams have
different performance objectives, it is difficult to equalize for difficulty when
assigning rewards.
oThe last three major problems with team compensation involve the three Cs:
Complexity—some plans are simply too complex.
Control—some companies factor uncontrollable elements into the process
of setting performance standards. Experts assert that this ability to foretell
sources of problems and adjust for them is a key element in building a team pay
plan. Key to the control issue is the whole question of fairness. Recent research
suggests that this perception of fairness is crucial. With it, employees feel it is
appropriate to monitor all members of the group.
Communications—team-based pay plans simply are not well
communicated. Employees asked to explain their plans often flounder because
more effort has been devoted to designing the plan than to deciding how to
explain it. Conversely, the more transparent the plan, the more employees trust
management and respond positively to the incentive effects of the plan.
Although there is much pessimism about team-based compensation, many
companies still seek ways to reward groups of employees for their interdependent work
efforts. Companies that do use team incentives typically set team performance
standards based on:
oProductivity improvements (38 percent of plans)
oCustomer satisfaction measures (37 percent)
oFinancial performance (34 percent)
oQuality of goods and services (28 percent)
Exhibit 10.9 summarizes some of these measures.
Exhibit 10.10 outlines some measures that can be used if the corporate objective
is to reward short-term performance.
Historically, financial measures have been the most widely used performance
indicator for group incentive plans. Increasingly, though, top executives express
concern that these measures do a better job of communicating performance to stock
analysts than to managers trying to figure out how to improve operating effectiveness.
Group performance presents both problems and opportunities. Decisions
regarding these plans should focus on two areas.
As Exhibit 10.11 illustrates, decision should be taken as to which type of group
incentive plan best fits the organization objectives.
oManagement should even ask if an incentive plan is appropriate.
oRecent evidence, for example, suggests that firms high on business risk and those
with uncertain outcomes are better off not having incentive plans at all—corporate
performance is higher.
A. Comparing Group and Individual Incentive Plans
In this era of heightened concern about productivity, the authors are frequently
asked if setting up incentive plans really boosts performance. The answer is yes.
The authors are also asked which is better in a specific situation—group or
individual incentive plans. Individual incentives yield higher productivity gains, but
group incentives often are right in situations where team coordination is the issue.
One study found that changing from individual incentives to gain sharing resulted
in a decrease in grievances and a fairly dramatic increase in product quality.
As noted in Exhibit 10.11, things like the type of task, the organizational
commitment to teams, and the type of work environment may preclude one or the
other type of incentive plan.
Exhibit 10.12. provides a guide for when to choose group or individual plans.
When forced to choose a plan with greater productivity “pep,” experts
agree that individual incentive plans have better potential for—and probably
better track records in—delivering higher productivity.
Group plans can suffer from what is called the free rider problem.
According to this concept, certain team members do not carry their share of
the work load. Yet, when the time comes to divide the rewards, they are
typically shared equally. The end result may be turnover of the very group
that is most costly to lose.
Research on free riders suggests that the problem can be lessened through
use of good performance measurement techniques. Specifically, free riders have
a harder time loafing when there are clear performance standards.
B. Large Group Incentive Plans
When we get beyond a small work team and try to incentivize large groups, there
are generally two types of plans:
Gain-sharing plans—use operating measures to gauge performance.
Profit sharing plans—use financial measures.
C. Gain-Sharing Plans
Gain sharing looks at cost components of the income ledger and identifies savings
over which employees have more impact. For example, reduced scrap, lower labor
costs, reduced utility costs.
The following issues are key elements in designing a gain-sharing plan:
Strength of reinforcement—what role should base pay assume relative to
incentive pay? Incentive pay tends to encourage only those behaviors that are
rewarded. Tasks carrying no rewards are only reluctantly performed (if at all).
Productivity standards—what standard will be used to calculate whether
employees will receive an incentive payment? Almost all group incentive plans
use a historical standard.
A historical standard involves choice of a prior year’s performance to use for
comparison with current performance. But which baseline year should be
used? If too good (or too bad) a comparison year is used, the standard will
be too hard (or easy) to achieve, with obvious motivational and cost effects.
One possible compromise is to use a moving average of several years.
One of the major problems with historical standards is that changing
environmental conditions can render a standard ineffective. Care must be
taken to ensure that the link between performance and rewards is sustained.
This means that environmental influences on performance, which are not
controllable by plan participants, should be factored out when identifying
incentive levels.
Sharing the gains split between management and workers—part of the
plan must address the relative cuts between management and workers of any
profit or savings generated. This also includes discussion of whether an
emergency reserve (gains withheld from distribution in case of future
emergencies) will be established in advance of any sharing of profits.
Scope of the formula—formulas can vary in the scope of inclusions for
both the labor inputs in the numerator and the productivity outcomes in the
denominator.
Recent innovations in gain-sharing plans largely address broadening the
types of productivity standards considered appropriate.
Given that organizations are complex and require more complex measures,
performance measures have expanded beyond traditional financial
measures. For example, with the push for greater quality management,
organizations could measure retention of customers or some other measure
of customer satisfaction. Similarly, other measures include delivery
performance, safety, absenteeism, turnaround time, and number of
suggestions submitted.
Great care must be exercised with such alternative measures, though, to
ensure that the behaviors reinforced actually affect the desired bottom-line goal.
Perceived fairness of the formula—one way to ensure the plan is
perceived as fair is to let employees vote on whether implementation should
proceed. This and union participation in program design are two elements in
plan success.
Ease of administration—sophisticated plans with involved calculations of
profits or costs can become too complex for existing company information
systems. Increased complexities also require more effective communications
and higher levels of trust among participants.
Production variability—one of the major sources of problems in group
incentive plans is failure to set targets properly. At times the problem can be
traced to volatility in sales.
A good plan ensures that environmental influences on performance, which
are not controllable by plan participants, should be factored out when
identifying incentive levels.
One alternative would be to set standards that are relative to industry
performance. To the extent data are available, a company could trigger gain
sharing when performance exceeds some industry norm. The obvious
advantage of this strategy is that economic and other external factors hit all
firms in the industry equally hard.
Exhibit 10.13 illustrates three different formulas that can be used as a basis for
gain-sharing plans The plans are differentiated by their focus on either cost savings
(the numerator of the equation) or some measure of revenue (the denominator of the
equation).
Scanlon Plan
These are designed to lower labor costs without lowering the level of a
firm’s activity.
Incentives are derived as a function of the ratio between labor costs and
sales value of production (SVOP). The SVOP includes sales revenue and
the value of goods in inventory.
oRucker Plan
It involves a somewhat more complex formula than a Scanlon plan for
determining worker incentive bonuses.
Essentially, a ratio is calculated that expresses the value of production
required for each dollar of the total wage bill.
Implementation of the Scanlon/Rucker Plans
Two major components are vital to the implementation and success of a
Rucker or Scanlon plan.
A productivity norm— Development of a productivity norm requires
both effective measurement of base-year data and acceptance by workers
and management of this standard for calculating bonus incentives.
Effective measurement requires that an organization keep extensive
records of historical cost relationships and make them available to
workers or union representatives to verify cost accounting figures.
Effective worker committees/productivity committees/bonus committees
—The primary function of these committees is to evaluate employee and
management suggestions for ways to improve productivity and/or cut
costs.
Numerous authorities have pointed out that these plans have the best chance
for success in companies with competent supervision, cooperative
union-management attitudes, strong top-management interest and
participation in the development of the programs, and management open to
criticism and willing to discuss different operating strategies.
Similarities and Contrasts between Scanlon and Rucker Plans
Scanlon and Rucker plans differ from individual incentive plans in their
primary focus. Individual incentive plans focus primarily on using wage
incentives to motivate higher performance through increased effort. While
this is certainly a goal of the Scanlon/Rucker plans, they give more attention
and focus on organizational behavior variables. The key is to promote faster,
more intelligent and more acceptable decisions through participation. This
participation is won by developing a group unity in achieving cost savings.
Even though Scanlon and Rucker plans share this common attention to
groups and committees through participation as a linking pin, there are two
important differences between the two plans.
Rucker plans tie incentives to a wide variety of savings, not just the
labor savings focused on in Scanlon plans.
This greater flexibility may explain why Rucker plans are more
amenable to linkages with individual incentive plans.
Improshare
Improshare (Improved Productivity through Sharing) is a gain-sharing plan
that has proved easy to administer and to communicate.
First, a standard is developed that identifies the expected hours required to
produce an acceptable level of output. This standard comes either from
time-and-motion studies conducted by industrial engineers or from a
base-period measurement of the performance factor.
Any savings arising from production of the agreed-upon output in fewer
than the expected hours is shared by the firm and the workers.
D. Profit-Sharing Plans
Despite moderately positive results, profit sharing continues to be popular because
the focus is on the measure that matters most to the most people: a predetermined
index of profitability. When payoffs are linked to such measures, employees spend
more time learning about financial measures and the business factors that influence
them.
On the downside, most employees do not feel their jobs have a direct impact on
profits.
The trend in recent variable-pay design is to combine the best of gain-sharing and
profit-sharing plans.
A company specifies a funding formula for any variable payout that is
linked to some profit measure. The plan must be self-funding.
Dollars going to workers are generated by additional profits gained from
operational efficiency.
Along with having the financial incentive, employees feel they have a
measure of control. Such a program combines the need for fiscal responsibility
with the chance for workers to affect something they can control.
E. Earnings-at-Risk Plans
Management probably should not separate earnings-at-risk plans as a distinct
category. In fact, any incentive plan could be an at-risk plan.
Incentive plans falls into one of two categories:
Success sharing—employee base wages are constant and variable pay adds on
during successful years. If the company does well, the employees receive a
predetermined amount of variable pay. If the company does poorly, the
employees simply forgo any variable pay—there is no reduction in base pay.
Risk sharing—base pay is reduced by some amount relative to the level that
would be offered in a success-sharing plan.
These plans shift part of the risk of doing business from the company to the
employee. The company hedges against the devastating effects of a bad year by
mortgaging part of the profits that would have accrued during a good year. These
plans appear to be met with decreases in satisfaction with both pay in general and
the process used to set pay. In turn, this can result in higher turnover.
F. Group Incentive Plans: Advantages and Disadvantages
Group pay-for-performance plans are gaining popularity in today’s team-based
environment.
One factor with intriguing implications suggests that group-based plans,
particularly gain-sharing plans, cause organizations to evolve into learning
organizations.
Apparently the suggestions employees are encouraged to make (how to do
things better in the company) gradually evolve from first-order learning
experiences of a more routine variety (maintenance of existing ways of doing
things) into suggestions that exhibit second-order learning characteristics—
suggestions that help the organization break out of existing patterns of behavior
and explore different ways of thinking and behaving.
Exhibit 10.15 outlines some of the general positive and negative features of group
pay-for-performance plans.
G. Group Incentive Plans: Examples
All incentive plans can be described by common features:
The size of the group that participates in the plan
The standard against which performance is compared
The payout schedule
Exhibit 10.16 illustrates some of the more interesting components of plans for
leading companies.
V. Explosive Interest in Long-Term Incentive Plans
Exhibit 10.17 shows different types of long-term incentives and their definitions.
These plans are also grouped by the level of risk faced by employees having these
incentives, as well as the expected rewards that might come from them.
Long-term incentives (LTIs) focus on performance beyond the one-year time line
used as the cutoff for short-term incentive plans.
Recent explosive growth in long-term plans appears to be spurred in part by a
desire to motivate longer-term value creation.
oThere is very little empirical evidence that stock ownership by management leads to
better corporate performance.
oThere is some evidence, though, that stock ownership is likely to increase internal
growth, rather than more rapid external diversification.
All this talk about stock options neglects the biggest change in recent memory. As
of June 2005 companies were required to report stock options as an expense. Prior to
this date, they were (wrongly) viewed as a free good under old accounting rules.
A. Employee Stock Ownership Plans (ESOPs)
Some companies believe that employees can be linked to the success or
failure of a company in yet another way—through employee stock ownership
plans.
Despite some high-profile adoptions, ESOPs do not make sense as an
incentive.
The effects are generally long-term—how an employee performs today
won’t have much of an impact on the stock price at the time the employee
exercise his or her option. Nor does the employee’s working harder mean
more for him or her. Indeed, management can’t predict very well what
makes stock prices rise and this is the central ingredient in the reward
component of ESOPs.
Why then do about 9,500 companies have ESOPs covering more than 10
million employees with holdings of over $600 billion in the stock’s of their
companies?
The answer may well be that ESOPs foster employee willingness to
participate in the decision-making process. And a company that takes
advantage of that willingness can harness a considerable resource—the
creative energy of its workforce.
If we just look at the impact of ESOPs on productivity or financial
outcomes, leaving aside the positive effect on employee participation, the results
are very modest. ESOPs have little impact on productivity or profit.
Critics of ESOP argue that companies don’t use these programs
effectively. If more firms would combine ESOPs with high goal setting,
improved employee communication with management, and greater participation
in decision making by employees, maybe ESOPs would have more positive
results.
B. Performance Plans (Performance Share and Performance Unit)
Performance plans typically feature corporate performance objectives for a
time three years in the future.
They are driven by financial earnings or return measures, and they pay out
for meeting or exceeding specific goals.
C. Broad-Based Option Plans (BBOPs)
Broad-based option plans (BBOPs) are stock grants: a company gives
employees shares of stock over a designated time period.
The strength of BBOPs is versatility. Depending on the way they are
distributed to employees, they can either reinforce a strong emphasis on
performance (performance culture) or inspire greater commitment and retention
(ownership culture) of employees.
D. Combination Plans: Mixing Individual and Group
It’s not uncommon for companies to use both individual and group
incentives. The goal is to both motivate individual behavior and to insure that
employees work together, where needed, to promote team and corporate goals.
These combination programs start with the standard individual (e.g.,
performance appraisal, quantity of output) and group measures (e.g., profit,
operating income).
Variable pay level depends on how well individuals perform and how well
the company (or division/strategic business unit) does on its macro (e.g., profit)
measures.
A typical plan might call for a 75–25 split. Seventy-five percent of the
payout is based on how well the individual worker does, the other portion is
dependent on corporate performance.
An alternative might be a completely self-funding plan. These plans
specify that payouts only occur after the company reaches a certain profit target.
Then variable payouts for individual, team, and company performance are
triggered.