Variable Pay Programs

The current human resource management practices are geared to achieving

advantage in the competitive market. 'People' can provide competitive
advantage through increased productivity, innovation and by accomplishing
strategic goals. The organisations can achieve these key objectives through
well-designed variable pay plans.

Organisations can choose from a basket of variable pay plans. The choice of
the plan, however is influenced by a number of strategic considerations that
include among others, plan feasibility, clarity of objectives and organisational
culture. The article illustrates a number of variable pay programs and
evaluates them from the standpoint of their applicability, advantages,
disadvantages, etc.

Annual Incentive & Bonus Plans

Companies to reward employees for the achievement of annual results use
annual incentive and bonus plans. These plans are also known as "short
term" incentive plans to distinguish them from other incentive plans that
reward performance over a longer period of time.

Progress is often measured periodically throughout the year. Some times

partial pay out of the incentive is provided if incremental progress is occurring
during the year. Companies use the annual incentive plans to:
• Match competitors plans to ensure employee retention
• Keep prices competitive by keeping fixed overheads as low as possible
• Attract key employees from the competition
• Increase productivity to more than offset the cost of the plan
• Right-size the staff by reducing manpower
• Focus employee attention on innovation and customer service
• Link rewards to the business plans and company culture
• Respond to employee desire to be involved and to share the results of
their efforts

The types of annual incentive plans include improved discretionary plans,

formula plans, profit sharing plans and mixed or variable plans.

The advantages of these plans include, among others, reduced labour costs,
ability to attract and retain employees, enhanced team spirit etc. The
disadvantages of these plans stem from a number of risks such as increased
cost in the event productivity improvement are not realised, morale problems
if incentives are not payable due to poor corporate performance, rewarding
the wrong behaviour, etc.

Small Group Incentive Plans

Small group incentive plans are designed to reward the performance of
groups in achieving specified goals. These plans apply some of the principles
 of broad-based incentive to small groups, such as work teams or
departments. The performance criteria used in small group incentives are
those, which the group can directly influence. The rewards for performance
can be cash, merchandise, travel, plaques, recognition, etc. Companies use
the small group incentive plans to:
• Increase efficiency
• Encourage team work
• Respond to both internal pressures to extend incentive deeper into the
• organisation and improve quality as well as external pressures to be
• More competitive and control cost.

The types of small group incentive plans are categorized in terms of their
measures, such as financial measures, production measures, goal
achievement measures and quality measures.

The advantages of small group incentive plans include improved productivity,

improved teamwork, ease of administration, visible link between pay and
performance, etc. The disadvantages of these plans include possibilities of
improvements by one group getting offset by poor performance by another
group, reduced emphasis on individual performance, implicit pressure on high
performers to slow down, etc.

Individual Incentive Plans

The individual incentive plans include those in which both the payments and
the performance criteria are based on individual rather than group information.
These plans are implemented with the objective of increasing the
performance of individuals. Companies use the individual incentive plans to:
• Foster the goal of realizing return for the money paid to employees by
differentially rewarding the highest performers.
• Achieve the goals of better quality products and more customer
responsiveness by focussing employee's efforts on activities that drive
these outcomes.
• Recognise and reward individuals with high performance, promoting
internal pay equity and developing company identity.

The individual incentive plans can be categorized according to the way

performance goals are set. There are three general methods used to set
performance goals, which include improvement over past performance,
improvement relative to some external market comparator, and performance
relative to strategically set goals.

The advantages of annual incentive plans include improved productivity,

quality and service, rewarding the high performers and introduction of variable
costs into the pay program. The disadvantages of these plans are that they
may encourage destructive competition. These plans are also expensive to
design and can be cumbersome to administer.
Gain-sharing Plans
Gain-sharing is a pay system that measures improvement in performance,
calculates the net financial results of those improvements and then shares
those financial results with the employees who contributed to them. Gain-
sharing plans are supported by a system of employee involvement in Which
employees actively participate in improving their own performance and the
performance of the larger group in which they work. Companies use the gain-
sharing plans to:
• Promote work environment in which employees see improved
productivity as beneficial to them, thus enabling worker productivity goals
and management productivity goal to become congruent.
• Create job enrichment opportunities for employees
• Provide a structure within which employees can work together to become
responsive to customer needs
• Offer a vehicle to employees for more involvement and more pay without
increase in net operating cost.
• Help companies become more competitive by entering into a partnership
with their employees in which both partners win.

The advantages of gain-sharing plans include increased productivity,

improved quality, reduced labour cost, better union management relation,
improved employee morale, improvements in customer satisfaction, etc.

The types of gain-sharing plans include Scanlon plans, Rucker plans,

Improshare plans and custom plans.

Scalon Plans are named for Joseph Scalon, who was instrumental in
developing the first known example of what we now call a gainsharing plan.
Scalon plans calculate gains based on reductions in standard costs. This plan
rely heavily on employee participation through a system of committees, to
solicit, develop, evaluate and implement suggestions related to improving the
productivity of the work unit.

Rucker Plans are named for Allan Rucker, whose research in the 1930's
showed a stable relationship between the value of production and the value
added by labor. Rucker plan calculates gains based on a value-added
formula.

Improshare Plans are based on a formula developed by Mitchell Fein, which

measures gains as a reduction in standard hours developed through
engineered standards during a base period. These plans do not as a rule
involve the employees in their design, implementation, or administration.

Custom Plans are made with formulas that are customised to the strategic
objectives of the company implementing them. Custom gain-sharing plans
formulas fall into three general types: financial, non-financial and mixed.
These plans may incorporate measures of quality or service in addition to
dollar savings.

Skill & Knowledge Based Pay Plans

Skill based pay is a pay system in which employees are paid based on the
number of skills they can perform. The skills are grouped into skill blocks,
which are usually smaller than jobs, so that a traditional job may represent 1 -
5 skill blocks. The skill blocks may represent horizontal skills or vertical skills.

The skill based pay plans are used by companies to:

• Increase employee flexibility by creating a multi-skilled work force
• Facilitate flatter organizational structures that are organised into work
teams.
• Offer participating employees a richer and more varied work setting.

The skill based pay plans are categorized according to whether incentives are
paid for vertical skill blocks or horizontal skill blocks or a combination of
vertical and horizontal skill blocks.

The advantages of skill based pay plans include flexible / multi-skilled work
force, enhanced commitment on the part of employees through job
enrichment and a higher sense of job security. These plans are also reported
to have led to decreased turnover and absenteeism and lower payroll costs
resulting from lower staffing levels. The disadvantages include high
administrative cost, possible conflict of these plans with traditional job
evaluation system and the dangers of pay compression.

Spot Award Programs: Spot bonuses are typically awarded for

accomplishments or performance which are neither recurring nor
readily measurable by a standard. Most often they are used to
recognize exemplary performance. The bonuses themselves are often
modest. The percentage of employees receiving spot bonuses is also
modest, typically 2-3 per cent. Companies use the spot bonuses to:
• Effectively reinforce a company's values, objectives and direct
behaviours towards the achievement of key roles.
• Recognize exemplary individual performance
• Promote individual employee initiative
• Improve employee morale and productivity.

The types of spot awards programmes are distinguished by three variables

including targeted recipients, award determination and types of awards
(Monetary vs. Non Monetary).

The advantages of spot award programmes include selective recognition,

ease of administration and flexibility. The disadvantages include
disappointment among employees who don't receive the spot award, internal
inequities and tendency on the part of managers to give spot awards to the
same employees in consecutive years.
Technical Achievement Award Programs: Technical achievement awards
are designed to reward and recognize employees for significant
technical accomplishment. They can be formal programmes, such as
patent royalty arrangement, or informal programmes, such as monetary
or non-monetary recognition for significant discoveries. Companies use
the technical achievement award programs to:
• Provide recognition and ongoing motivation
• Encourage employees to obtain patents
• Build teamwork
• Maintain some project control.

The technical achievement programs fall into one of the three categories,
namely recognition award, bonuses, and royalties. The advantages of these
awards include encouraging desired innovation, providing sustained
motivation in a cost-effective manner, etc. One possible disadvantage is that
these awards ultimately do not promote innovation but only commercially
viable advances. This might discourage the talented innovators and
potentially drive them away from the organisation.

Key Contributor Programmes: Key contributor awards are designed to

retain key personnel by linking pay to their continued employment for a
specified period of time. These programs may involve the use of
restricted cash or stock grants to employees who normally would not
be eligible for such awards. Companies use the key contribution
awards to:
• Retain key personnel
• Ensure an innovative culture and present ongoing challenges
• Motivate the best and brightest

The key contributor awards are of two types. The programs are designed
either to retain key personnel or recognize and reward achievements. The
advantages of the awards include retention by the organisation of critical
skills, aligning the financial interest of the individual with the organisation,
providing incentive to the individual to perform at the highest levels, etc. The
disadvantages stem from the possibility that the awards may me viewed as
giveaways by shareholders and that the participating employees may use the
potential pay outs to bid up the offers of employment from competitors.