The Effectiveness Of Pay For Performance Plans Essay Example
Motivation is always one of the central topics for discussion in management. Among the numerous ways of motivating employees, extrinsic rewards cause the most debates. The main reason for this is rather straightforward – pay and benefits represent two of the most important aspects in employment relationship (Hill, & McShane, 2008). There are several factors that influence financial rewards: job status, membership and seniority, task performance, and competencies. This paper will analyze the effectiveness of pay for performance plans, which have become increasingly popular over the last several decades.
Before proceeding with the actual analysis, it is important to define the most widespread types of pay for performance plans. The most basic forms of performance-based rewards date back to 20th century BC, as far as the Babylonian times. Within the context of modern management, these forms of rewards are called piece-rate systems (Hill, & McShane, 2008). Under such systems, workers are rewarded based on the quantity of produced units. For instance, payment of crop workers at Eurofresh in Arizona depends on the number of tomatoes they pick. A pure piece-rate plan generally provides no fixed, stable salary and pays employees only for their production volumes. Ballpark employees who sell soda and peanuts are often compensated this way. If they sell 35 bags of peanuts for $1 each, they receive $35. The more and harder they work, therefore, the more money they get. Obviously, within the framework of today’s business environment, such systems are hardly feasible. Their main limitation lies in inapplicability to many jobs (Robbins, & Judge, 2014). Surgeons receive significant compensation regardless of the outcomes of their patients. If they would be paid only on the condition of their patients’ full recovery, a severe deficit of surgeons would occur, as well as a number of potential unanticipated issues. For example, surgeons might start to avoid patients with terminal or complicated conditions. Hence, while incentives are undeniably motivating and relevant for certain jobs, the claim that they can be the only source of an employee’s pay is unrealistic.
The second, more progressive pay for performance model is merit-based plan. It pays for individual performance according to the performance appraisal ratings (Robbins, & Judge, 2014). Its main advantage is that the hardest workers who are considered to demonstrate outstanding results can receive bigger raises. When properly designed, merit-based plans enable employees to perceive direct connection between their rewards and their performance. Although they are intuitively appealing, merit pay plans contain several shortcomings. Firstly, they usually depend on annual performance appraisals and hence are only as effective as the performance ratings. Another major limitation is associated with fluctuations of the pay-raise pool based on economic or other conditions, which have a very vague connection with individual performance. A top university professor who performed excellently in research and teaching can be granted a pay raise of $300 due to a very small pay-raise pool. That can hardly be considered a pay-for-performance model. Lastly, unions generally oppose merit pay plans. Because of this nuance, a relatively low number of teachers are covered by merit pay. Instead of this, “seniority-based pay, where all employees get the same raises, predominates” (Robbins, & Judge, 2014, p. 126).
The third type of pay for performance model is bonuses. For many jobs, annual bonuses often represent a significant portion of total compensation. Performance bonuses’ incentive effects should be stronger than those of merit pay due to the fact that rather than rewarding a several year-old performance, bonuses pay for more recent accomplishments. During unfavorable times, companies can reduce bonuses to cut compensation costs. For instance, steel producer Nucor guarantees its employees only approximately $10 per hour, but often offers substantial bonuses. In 2006, Nucor’s average worker made about $91,000. When the recession started in 2009, employees experienced dramatic cuts in bonuses. Total pay had fallen by 40 percent (Byrnes, 2009). This situation is a vivid example of bonuses’ major downside: pay of employees is a lot more vulnerable to cuts. A serious problem can occur when bonuses constitute a large portion of total pay or when workers take them for granted.
The fourth type is the skill-based pay, also referred to as knowledge-based or competency-based pay (Hill, & McShane, 2008). It has a different approach from job-based pay, as the pay levels are centered on the number of skills an employee has or what variety of jobs they can perform. Employers benefit from skill-based plans due to increased workforce flexibility: staffing is much easier when skills of employees are interchangeable. Such plans also reinforce internal communication within an organization because people understand each other’s jobs better. A study by Mitra, Gupta, and Shaw (2011) discovered that across 214 companies, skill-based pay was associated with higher workforce flexibility levels, membership behaviors, positive attitudes, and productivity. There are some downsides, naturally. Employees can acquire all the skills required by the program, which might frustrate them because they are no longer challenged by an environment of growth, learning, and continual pay increases. Also, skill-based pay plans don’t take the actual level of performance into consideration, focusing on someone’s ability to perform a skill. Perhaps due to these weaknesses, a study of 97 U.S.-based companies that used skill-based plans revealed that 39 percent of them had moved to a more widespread market-based plans 7 years later (Robbins, & Judge, 2014).
Profit-sharing plans also represent a pay for performance plan. However, the pay is linked to organizational rather than individual performance. The compensation is distributed based on a certain established formula and largely depends on a firm’s profitability. On an organizational level, profit-sharing plans assumingly have a positive impact on employee attitudes, as they report a stronger sense of psychological ownership (Robbins, & Judge, 2014). The main shortcoming of these plans is connected to focus on organizational successfulness, putting little emphasis on individual performance. Within the framework of a profit-sharing plan it is hard to reward each employee’s individual contribution justly. Some people might have a feeling they have not been adequately rewarded because from their perspective they made a more valuable input than the other employees did.
Gain-sharing plans are relatively similar to profit-sharing plans. However, rather than accumulating bonuses based on team sales or profit, they are awarded for cost savings and improvements in productivity (Hill, & McShane, 2008). Therefore, employees can still receive bonuses even when their company is not profitable. Additionally, because the bonuses depend on productivity under the gain-sharing pay plans, hard workers are pushing weak performers to do a better job, which positively affects the whole group’s performance.
The final and largely widespread type of pay for performance plans is employee stock ownership plan (ESOP). Under this company-established benefits plan employees acquire company stock, usually at below-market prices, as a part of their benefits. Benefits and downsides of ESOPs are almost identical to those of profit-sharing plans, as they are highly similar in nature.
Therefore, it is possible to state that the effectiveness of pay for performance plans largely depends on the plan’s type, company’s size, industry, and managerial approach, and the way the plan is designed. Each type has its shortcomings and advantages, and is suitable for specific organizations and industries. In general, however, pay for performance plans can effectively improve organizational successfulness and the well-being of employees.
Robbins, S. P., & Judge, T. A. (2014). Essentials of organizational behavior (12th Ed.). New Jersey, NJ: Pearson
A. Mitra, N. Gupta, & J. D. Shaw. (2011). A Comparative Examination of Traditional and Skill-Based Pay Plans. Journal of Managerial Psychology, 26 (4), 278–296
Hill, C. W., & McShane, S. L. (2008). Principles of management. New York, NY: McGraw-Hill/Irwin
N. Byrnes. (2009, March 26). Pain, But No Layoffs at Nucor. Business Week. www.businessweek.com
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