Human Resources Chapter 11 Homework Types Individual Incentives Time and motion Studies Are Often

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

Chapter 11

USING PERFORMANCE-BASED PAY TO ACHIEVE STRATEGIC

OBJECTIVES

Opening Case: Managing Human Resources at the United States

Postal Service

New technologies and changing competitive pressures forced the USPS to implement

a market-driven and performance-based pay approach that helped it achieve

substantial increases in productivity and customer service. As USPS has repeatedly

changed its business strategy to address new challenges, so have its performance–

based pay practices changed. The goal is to set annual targets for performance that

employees can control directly. Their successful approach to performance-based pay

is due to the support of top-level managers, clear and specific performance targets,

rewards that are clearly linked to performance (and are large enough to make a

difference) and effective communication.

CHAPTER OUTLINE

I. THE STRATEGIC IMPORTANCE OF PERFORMANCE-BASED PAY

The most important reason for the increasing popularity of performance-based pay

plans is that managers believe that they can enhance the ability of an organization

to achieve its strategic objectives. Exhibit 11.1 shows the strategic value of

different types of pay.

A. Support Strategic Objectives

Performance-based pay helps align the goals of individual employees with the

goals of the organization. This is especially relevant for organizations that are

attempting to manage change and to diversify into new business lines.

1. Growth

When the strategic goal is growth, it’s reasonable to reward employees

2. Customer Service

Customer service may be enhanced by measuring customer service in

several different ways and then tying employee bonuses and other noncash

awards to performance to measurements of service.

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B. Manage Labor Costs

In order to deal with the problem of rising compensation costs that are unrelated

to improvements in employee performance, many companies are replacing

C. Attract, Retain and Motivate Talent

Performance-based pay can influence whether applicants apply for or accept a

position with a company, or decide to leave the company.

1. Attract

Start-up companies attract top talent while controlling costs by using

2. Retain

Once employees have been hired, performance-based pay can influence

3. Motivate

Effective performance-based pay creates strong instrumentality

II. PERFORMANCE-BASED PAY WITHIN AN INTEGRATED HR SYSTEM

It takes several HR practices working together to achieve highly effective employee

behaviors. Exhibit 11.2 shows how a performance-based pay system fits into an

integrated HR system.

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

A. Other HR Activities

1. Total Compensation

Performance-based pay supplements the base pay of employees. Base pay

2. Performance Management

Performance-based pay works best when there are appropriate and valid

performance measures and when the employee receives frequent feedback.

3. Recruiting and Retaining

Employees may be more attracted, motivated, and likely to stay at firms that

include performance based pay as part of their compensation and benefits

B. Organizational Environment

Performance-based pay is influenced by two aspects of the organizational

environment—namely, the business strategy and the company culture.

1. Business Strategy

Linking pay to the achievement of growth tends to improve growth; and

2. Company Culture

Through their participation and involvement in various aspects of the

company’s management activities, employees learn about the needs of the

business and its implications for their pay. At the same time, the

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

C. External Environment

Two external environmental components that have had a substantial effect on

use of performance based pay are technology and laws and regulations.

1. Technology

Performance-based pay practices are only as good as the performance

2. Laws and Regulations

Even otherwise successful pay practices will be considered as ineffective if

they lead to large lawsuits, huge fines, and a damaged corporate reputation.

Avoiding unfair discrimination and obeying relevant tax laws are particularly

Teaching Note: Point out to students that unions, in general, are very opposed

to performance-based pay. Why is this? Answer: Unions prefer an equality-

based pay system versus an equity-based system.

III. THE HR TRIAD

The roles and responsibilities of line managers, HR professionals, and employees

are summarized in The HR Triad feature “Roles and Responsibilities for Using

Performance-Based Pay to Achieve Strategic Objectives.”

1. Line Managers and HR Professionals

For many line managers and HR professionals, the roles and responsibilities

associated with performance-based pay include those associated with

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2. Employees

Most employees are eager to understand how their pay is determined,

so employers simply need to provide the information to them. Ideally,

IV. DESIGN CHOICES

Companies have different performance-based pay plans to fit their particular

circumstances and to achieve their strategies. One key choice is the extent to

which the company offers monetary rewards versus other types of outcomes that

employees may value. Most companies make an attempt to provide monetary

rewards for high levels of performance. Nonmonetary rewards such as career

development and recognition can also be tied to performance.

A. Types of Performance-Based Pay

The different types of pay plans are found in Exhibit 11.3.

Employers must decide among the level of guaranteed base pay, the

relationship of base pay to the market, the amount of performance pay, the

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

B. Rewards

Rewards come in all shapes and sizes, from a pat on the back to substantial

stock ownership

1. Which Rewards to Offer?

Besides cash, companies may give employees large prizes, direct stock

awards, stock options, or some combination of these. The mix will depend

As Exhibit 11.4 indicates, the more you move up the hierarchy, the greater

3. Who Gets the Reward?

4. When Is the Reward Given?

Delays in providing rewards diminish their effectiveness. However, by

Teaching Note: Ask students to weigh the benefits/costs of delaying rewards.

Which do they prefer?

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C. Performance Measures

Substantial research supports the conclusion that performance-based rewards

can greatly improve productivity, although some critics have expressed

reservations. Under some conditions, no effects or even detrimental effects

have been found.

1. What Gets Measured?

2. Level of Aggregation

Performance can be measured at the individual, work team, department,

plant, strategic business unit, or organization level. More objective

3. Multiple Measures

Using multiple measures can make up for the weaknesses of any single

4. Time Frame of the Measure

Finding the proper balance here is difficult. Rewarding for current service

and for learning skills needed in the future is both important and must be

recognized.

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Teaching Note: Short-term incentives for executives are particularly

problematic. Ask students their opinions on what the right “perspective” should

be for top team members. What should the balance between short- and long-

term incentives for this group be?

D. Linking Performance to Rewards

The strength of the link between performance and rewards is captured by the

V. IMPLEMENTATION ISSUES

Research supports the conclusion that performance-based pay can improve

productivity but can also have no effects or even has detrimental effects when

rewards are used ineffectively due to poor design and implementation, and not to

the negative psychological consequences of performance-based pay.

A. Evaluating Effectiveness

B. Gaining Employee Acceptance

Acceptance of a performance-based pay is often a major obstacle; especially

with variable-pay (pay-at–risk) plans. Exhibit 11.7 suggests steps for building

VI. RECOGNITION AWARDS

Recognition awards usually provide public recognition for employees’ achievements,

along with modest gifts to symbolize the company’s appreciation. Recognition

awards help create a positive work environment, motivate high performance, and

reinforce desired behaviors. Exhibit 11.9 shows the common goals of recognition

awards along with the percentage of firms that listed them.

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A. Spot Awards

B. Peer-to-Peer Awards

Currently the fastest-growing type of recognition program, peer-to-peer

C. Awards for Suggestions

To encourage more innovative ideas, many companies reward employees for

VII. MERIT PAY

Performance-based pay, traditionally the cornerstone of public and private

compensation systems, is best exemplified by merit pay plans that tie an

employee’s performance as measured by the supervisor’s appraisal to the

employee’s yearly raise. If implemented and administered properly, merit pay

practices result in top performers earning substantially higher salaries than poor

performers.

A. Performance Measures

B. Rewards

To reduce the cost of merit pay, employers can tie performance appraisals to

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C. Linking Performance to Pay

In a merit pay system, managers have a significant amount of discretion over

the size of pay increases given to employees. Some employers provide formal

VIII. INCENTIVE PAY

Unlike merit pay, which is a permanent increase, incentive pay is a one-time

A. Individual Incentives

1. Performance Measures

Common performance measures used to award individual incentives include

2. Effectiveness

Individual incentives get results, however, they increase competition among

workers and narrow employee focus to whatever is being measured.

3. Types of Individual Incentives

Time-and-motion studies are often used to determine how wages are tied to

output.

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

B. Team Incentives

Team incentives fall between individual and whole-organization plans such as

1. Advantages

➢ The presence of team members with a stake in the rewards creates

social pressure and evokes more vigorous and persistent behavior than

when individuals work alone.

2. Disadvantages

➢ Can create competition rather than cooperation among groups that may

or may not complement goal attainment.

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

C. Unit and Companywide Incentives

Incentives tied to unit or companywide performance are easier to relate to the

firm’s strategic goals, foster greater cooperation among all employees, and help

create an ownership mentality in employees. Two of the most popular

incentives used at these levels are gainsharing and profit sharing.

1. Gain Sharing

These plans motivate employees by rewarding them for becoming actively

involved in helping to reduce costs by eliminating wasted materials and

2. Profit Sharing

Introduced first at Gallatin glasswork factory in New Geneva, Pennsylvania

in 1794, these are systems under which the employer pays or makes

available to employees sums based on the profits of the business. The

benefit to companies is that they pay when they are most able to do so.

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

IX. PAY THAT PUTS EARNINGS AT RISK

Sales personnel and high-level executives frequently have their earnings placed at

risk. Some companies have pushed the notion of at-risk pay throughout the

organization. The two most common practices that put considerable amounts of

pay at risk are commissions and stock option.

A. Commissions

Commission payments are calculated as a certain percentage of the sales

price. About two-thirds of all salespeople receive commissions. It is important

for companies to ties their commission plans to the strategic objectives of the

firm. The most common sales measures are shown in Exhibit 11.14.

1. Straight Commission

Responsibility for generating personal income rests directly on the

2. Combination Approach

Over half of all sales compensation plans combine base salary and

B. Stock Ownership

Two approaches to building employee feelings of ownership are stock grants,

where stock is given to employees, and stock options, where employees may

buy future shares at current prices. The motivational power of these plans is

questionable because employees may not see the relationship between their

individual performance and the firm’s share price.

1. Stock Grants

Employee stock ownership plans (ESOPs) grant shares of stock to

employees as a means of long-term savings and retirement. The grants are

CHAPTER 11 Using Performance-Based Pay to Achieve Strategic Objectives

2. Stock Options

A stock option gives an employee the right to buy stock during a specified

time period or under other specified conditions. A broad-based stock option

plan gives most of a firm’s employees the right to buy some amount of stock

3. Stock Purchase Plans

Broad-based plans that allow employees to buy stock through the company,

X. CURRENT ISSUES

A. Ethical Considerations

Poorly designed pay practices can increase unethical behavior by employees and

lead to employees maximizing performance measures in ways that are detrimental

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B. The Shift toward Variable Pay

The use of variable pay is increasing as employers battle the entitlement

attitude of employees regarding pay. Seniority-based-pay gave way to merit

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QUESTIONS FOR DISCUSSION AND REFLECTIVE THINKING

1. Describe the strategic importance of performance-based pay.

Linking performance to outcomes that are valued by employees is important

2. From the perspective of employees, what are the major disadvantages

of the four major forms of performance-based pay (recognition, merit,

incentives, earnings-at-risk)?

The major disadvantage of merit pay systems is that they are often based on

subjective measures of performance that may lack validity. This approach

also gives managers a lot of discretionary power over the size of the merit

3. Debate the following assertion: If selection and placement decisions are

made effectively, performance differences among employees should be

relatively small; therefore, performance-based pay isn’t needed and may

even be disruptive.

While effective recruitment and placement should yield good employees, time

may be needed for them to get “up to speed”. The newest workers may not

4. What does it mean to put earnings at-risk? List the potential costs and

benefits of placing a substantial percentage of pay at risk for all

employees in the following types of organizations: a hospital, a

restaurant, a brokerage firm, and a fashion design house.

An earnings-at-risk plan sets a salary from which deductions are taken. The

employee is given the opportunity to minimize the amount of deductions taken

5. Describe the challenges associated with using team incentives. Do you

think these challenges differ for team bonuses versus team recognition

awards? Explain your opinion.

Team-based pay may produce unintended side effects such as competition

6. Do you think performance-based pay is more likely to cause employees

to behave unethically compared to paying a straight salary or wage?

Why, or why not?

7. Do you think the global convergence of broad-based variable pay

programs will continue? Explain your thinking.

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CASE STUDY: EVALUATING NONTRADITIONAL INCENTIVES

Ask students how they would use performance based pay to deal with the

developing disaster at the firm’s ski stores. The answers will vary but the

respondents may need to be reminded that there is general dissatisfaction on the

part of all employees – both those who are receiving performance based pay as

well as those who are not. All feel that their efforts are essential and those who

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VIDEO CASE STUDY: BRIGHT HORIZONS

Instructors: The following video case can be found on the companion DVD. The

video can be used in class as an introductory activity or a post-lecture activity, as

well as an online assignment for those students using CourseMate.

DISCUSSION QUESTIONS:

1. It was stressed that executives at Bright Horizons do not earn as much

they could in other industries. Do you think that the company is likely to

get the best possible talent if that is really true?

2. In covering the various forms of compensation available, Dan Henry

referred to the “cultural package.” What is that and how valuable is it?

3. Although the base pay for executives may be less than in other

industries, the firm has a program which enables them to obtain stock

ownership in the firm. Discuss how that might be the most desirable

compensation in the long run.

4. In discussing the firm’s “Rewards and Recognition” program, Dan

Henry pointed out that some people who are selected do not realize that

they have received recognition. Why did he say that and why did he feel

that was a good problem to have?

He indicated that people are constantly being thanked and shown