Financial/Incentives Techniques of Motivation:

Financial techniques refer to monetary rewards. Incentives are

nothing but the inducements provided to employees in order to
motivate them. There should be direct relationship between efforts
and rewards, financial reward should be substantial in value and must
be in parity with others.

Under -paying staff sends the message that your firm doesn’t value
their work. Money is not a prime motivator but this should not be
regarded as a signal to reward employees poorly or unfairly.

The financial incentives include:

1. Pay and Allowances:
It includes basic pay, grade pay, and dearness allowance; travelling
allowance, pay increments, etc. Good pay and allowances help the
organization to retain and attract capable persons.

However, good pay and allowances need not motivate all the people,
especially who are enjoying security of job in government
organizations and those for whom corruption is a way of life.

Some of the other issues are associated with bad attitudes, grievances,
absenteeism, turnover, poor organizational citizenship, and adverse
effect on employees’ mental and physical health.

2. Incentive Pay:
Incentive pay plans are meant to increase output, which can be
measured quantitatively. For incentive plan targets, the employees
must have confidence that they can achieve the targets.

3. Gain Sharing:
It is a reward system in which team members earn bonus for
increasing productivity or reduce wastages. To illustrate, if the wastage
is reduced from 5% to less the benefits may be shared equally with the
team.
4. Profit Sharing:
It means sharing of profits with the employees by way of distribution
of bonus. Profit sharing plan has its shortcomings – one, that it has
become a regular feature in government departments irrespective of
performance and two, it may have no relation with individual efforts.

5. Stock Options:
Many companies use employee stock options plans to compensate,
retain, and attract employees. These plans are contracts between a
company and its employees that give employees the right to buy a
specific number of the company’s shares at a fixed price within a
certain period of time.

Employees who are granted stock options hope to profit by exercising

their options at a higher price than when they were granted. In India,
stock options have primarily been used as a retention tool for a more
selective group of employees.

6. Retirement Benefits:
It includes the accumulated provident fund, gratuity, leave
encashment and pension. The provision of terminal benefits provides
assurance to employees during the service for their future

Wage Incentive Plans: Objectives, Advantages, Limitations

and Types!
Wage incentive refers to performance linked compensation paid to
improve motivation and productivity. It is the monetary inducements
offered to employees to make them perform beyond the acceptance
standards.

According to the National Commission of Labour “wage incentives are

extra financial motivation. They are designed to stimulate human
effort by rewarding the person over and above the time rated
remuneration, for improvements in the present or targeted results”.

Scott defines it as “any formal and announced programme under

which the income of an individual, a small group, a plant work force or
all the employees of a firm are partially or wholly related to some
measure of productivity output”.

Human and Nickerson define it in simple terms as “all the plans that
provide extra pay for extra performance in addition to regular wages
for a job”.

Objectives of Wage Incentive Schemes:

(i) To use wage incentives as a useful tool for securing a better
utilisation of manpower, better productivity scheduling and
performance control, and a more effective personnel policy.

(ii) To improve the profit of a firm through a reduction in the unit

costs of labour and materials or both.

(iii) To increase a worker’s earning without dragging the firm into a

higher wage rate structure regardless of productivity.

(iv) To avoid additional capital investment for the expansions of

production capacity.

Principles of a Good Wage and Salary Administration:

a. Simple and easy to understand.

b. Union management agreement.

c. Time standard must be fixed.

d. Reward must be proportional to the effort.

e. Complaints and grievances must be properly attended to.

f. The plans should not change frequently and must be tried out
continuously for some length of time.

g. Equity and fairness.

h. Workers must be made to understand the plan.

i. Method study must precede time standard.

j. There must be a min guaranteed payment.

Advantages of Incisive Plans:

Wage incentive plans benefit not only the employees but also the
employers.

a. Wage incentive plans provide an opportunity for hardworking and

ambitious workers to earn more.

b. It encourages employees to be innovative. They come out with more

efficient ways of doing work by overcoming the problems related to
productivity and wasteful practice.

c. Incentive plans help to improve discipline and industrial relations.

Effective incentive plan helps in minimizing absenteeism, accidents
etc.

d. The self motivation on the part of the workers to work hard and
improve performance so as to earn monetary rewards will reduce the
cost of supervision.

e. The scientific work study undertaken before introducing the

incentive plans helps in improving work flow, work methods etc.

f. The employees are encouraged to work as a team with mutual co-

operation as their activities is interdependent, and any obstruction on
the part of a worker can affect the output and rewards.
g. According to the National Commission on Labour, “wage incentive
is the cheapest, quickest and surest means of increasing productivity.”

Limitations:
a. Jealousy and conflicts among workers may arise when some
workers earn more than others.

b. Unless strict check and inspections are maintained, quality may

come under stake in the enthusiasm among workers to increase
productivity.

c. In the absence of a ceiling on incentive earnings, some workers may

spoil their health.

d. Strict vigilance becomes necessary to ensure that workers do not

disregard safety regulation.

e. The cost and time of clerical work increases in introducing and

administrating the incentive plans.

f. Whenever production flow is disrupted due to the fault of

management, workers insist on compensation.

Types of Wage Incentive Plans:

Following are the types of wage incentive plans.

They can be diagrammatically represented as below:

1. Straight Piece Rate Plan:
Under the straight piece rate plan workers are paid based on their
output. For example, if the piece rate is Rs. 4 per piece of the product,
then a worker who turns out 40 pieces/day earns Rs. 160 (Rs. 4 x 40)
as his wage for that day. Whereas another employee who produces 32
pieces/ day earns Rs. 128 (Rs. 4 x 32 pieces). Hence a fast worker
earns more compared to the slow worker.

Advantages:
i. Motivates the workers to increase their output.
ii. Simple and easy to understand.

iii. improve productivity.

Disadvantages:
i. No guaranteed minimum wage. This makes workers insecure.

ii. Great disparity of earning between slow and fast workers.

iii. Wastage might increase.

iv. Quality of production may suffer as the workers concentrate on

quantity.

v. Interpersonal relationship suffers due to jealousy and competition

to earn more.

vi. Enforced idleness like electricity failure or machine breakdown,

adversely affect earning of workers.

2. Standard Piece Rate with Guaranteed Minimum Wage:

Here the minimum guaranteed wage is fixed on hourly basis. A worker
gets the minimum fixed wage/day plus the incentive for the number of
pieces produced. To illustrate this, assume that there is 8 hour’s shift
the piece rate is Rs 4 and a minimum fixed wage of Rs 16/ hours (Rs
16 x 8 hours = Rs. 128 per day). The standard time/piece is 15 min.

Now, there are two workers A and B. (If worker A produces 25

prices/day then he earns: Rs. 128 (min. guaranteed wage) + Rs. 100
(Rs. 4 x 25 pcs) = Rs. 228/ day

If worker B produces 40 pieces / day then he earns Rs. 128 (min.

guaranteed wage) + Rs. 160 (40 pieces x Rs. 4) = Rs. 228/ day)

Advantages:
i. Min. guarantee improves sense of security.

ii. Disparity between slow and faster workers is reduced.

Disadvantages:
i. Demotivate faster worker.

ii. Slow workers get higher piece rate viz Rs. 5.12 (128/ 25).

Differential Piece Rates:

The shortcoming of the above mentioned incentive plans have given
way Differential piece rates. The differential piece rates are classified
under two heads viz. Individual incentive plans and Group incentive
plans.

Individual Incentive Plans:

The different plans here are discussed below:
(a) Halsey Plan:
The features of this plan are:
a. Min. wage is guaranteed.

b. Additional bonus is provided to workers who

Wage and Salary Administration 147 complete the job in less than the
“standard time”. Bonus is a certain proportion to the time saved. This
proportion is fixed at 50% in this plan.

The total wage is calculated as:

T x R + 50% (S – J) x R

Where J – time taken

R – Rate of wage

S – Standard time

50% – The bonus percentage.

Illustration:
S = 10 hours, J = 8 hours; R = Rs. 5 / Hr; Bonus = 50%

Φ = 8 x 5+(50/100) x (10 – 8) x 5
Φ = Rs. 45.

Advantages:
i. Guaranteed min. wage exists.

ii. Simple and easy.

iii. Dispensed with time consuming and costly process of work study.

iv. Management share a part of bonus on time saved.

Disadvantages:
i. Workers get only half of the benefit of their efficiency.

ii. If the worker’s rush through the job to save time, the quality may
suffer.

iii. Workers object management in sharing bonus on time saved.

iv. Sufficient incentive is not provided to fast workers.

(b) Rowan Plan:

This is a modified form of Hasley Plan, developed by James Rowen of
England. The Rowan Plan pays more than the Halsey Plan. This is
possible if a worker completes the task in half the standard time of the
task. If more than 50% time is saved then the bonus he earns
decreases.
Therefore, Total wage = J x R + [J x R x (Time saved/std. time)]

Illustration:
S = 10 hours; J = 8 hours; R = Rs. 5 / hrs.

Φ =8 x 5 + [8 x 5+ (2/10)]

Φ = Rs. 48

Advantages:
i. Minimum guaranteed wage exists.
ii. Both the employees and the workers share the benefits of time
saved.

iii. The efficient workers get bonus at diminishing rate if they save
more than 50% of the standard time. This checks over-speeding.

Disadvantages:
i. Incentive provided for fast worker is not sufficient.

ii. Workers dislike management sharing bonus of time saved.

(c) Gantt plan:

This plan was developed by Henry L. Gantt. Here standard time for
every task is fixed through time and motion study. Minimum time
wage is guaranteed to all workers.

A worker who fails to complete the task within the standard time
receives wages for actual time spent at the specified rate. Workers who
achieve or exceed the standard get extra bonus varying between 20%
to 50% of the hourly rate for the time allowed for the task.

Illustration:
(S) Suppose the standard time fixed for the job is 8 hours and (T) time
rate is Rs. 10 hours and the rate of bonus is 25%, then a worker who
completes the job in 10 hours will be paid Rs. 10 x 8 = Rs. 80. On the
other hand the worker who completes the job in 6 hours will be paid
Rs 100 (Rs. 80 + 25% of Rs. 80).

Advantages:
i. Minimum guarantee exists.

ii. Fast worker is paid bonus at higher rate proportional to their

output.

iii. Standard worker is paid 20% bonus.

iv. Part of bonus is shared by the organisation.

Disadvantages:
i. Sharing of bonus by organisation is resentment.

ii. Disunity among the slow and the fast workers.

(d) Bedeaux Plan:

This plan is developed by Charles E. Bedeaux in 1911. Here the
minimum time wage is guaranteed to all workers. The workers who
complete the job within or more than the standard time are paid at the
normal time rate.

Workers who complete the job in less than the standard time are paid
bonus, generally 75% of the wage for the time saved and 25% to the
foreman.

The wage rate is calculated as:

S x R + 75% of R (S – T)

Illustration:
S = 10 hrs; R = Rs. 5 / hrs; T = 8 hrs.

Then:

Φ = 10 x 5+ 75% (5) x (10-8)

= 50 + (3.75 x 2)

= 50 + 7.50

Φ = Rs. 57.50

Advantages:
i. Min. wage is guaranteed to all the workers.

ii. The foreman is motivated to the productivity as 25% of time saved

is paid to him.
iii. This plan is suitable in factories wherein a worker is expected to
perform different types of jobs.

Disadvantages:
i. Workers may resent sharing the bonus with foreman.

ii. Workers may find it difficult to understand the complete calculation

involved in this method.

(e) Emerson’s Efficiency Plan:

This plan was developed by Harrington Emerson. Here minimum
wage is guaranteed. Workers are paid different bonus rates as per
their efficiency level. Bonus is given at an increasing percentage
beyond the prescribed level of efficiency (usually 66.67%). Efficiency is
measured by comparing the actual time taken with the standard time.

Illustration:
S = 10 hrs, T = 8 hrs, R = Rs. 5 / hr.

Bonus = 10% upto 75 % efficiency

20% for 75%- 100%

30% beyond 100%

Φ = (T x R) + (percentage of bonus x T x R)

In this case, the efficiency level in (10/8) x 100 = 125% and,

Bonus at 30% is payable.

Total wage = 8 x 5 + (30/100) (8 x 5)

= 40+12

Rs. 51.

If worker A takes 16 hrs, then his bonus is nil.

If worker B takes 14 hrs, his bonus is (1/10) x 14 x 5.

If worker C takes 10 hrs, his bonus is (2/10) x 10 x 5.

If worker D takes 8 hrs, his bonus is (3/10) x 8 x 5.

Advantages:
i. Guaranteed time wage provides a sense of security to all the workers.

ii. It encourages healthy competition among workers.

iii. Bonus begins at 66.67% efficiency which is within the reach of

many workers.

Disadvantages:
i. There is little incentive after 100% efficiency level.

ii. The plan is not very flexible or selective.

iii. Employer may fix the standard time at a low level making it
impossible for most of the workers to earn bonus.

Group Incentive Plan:

In some cases like an assembly line production it is not possible to
determine the performance of an individual worker as several workers
jointly perform a single operation. In such cases it is desirable to
introduce a group incentive scheme. Here the bonus is calculated for a
group of workers and the total amount is distributed among the group
members in proportion to the wage earned by each.

(a) The Scalar Plan:

This is a group plan where the productivity of the entire work force is
taken into account. In this plan bonus is paid at the rate of 1 % for
every 1% rise in productivity. Workers are not paid the full amount of
bonus earned by them in the same month.
A certain percentage is set aside as a “Resource Fund” to take care of
fluctuation. At the end of the year, the balance remaining in the
“Reserve Fund” is also distributed.

(b) Priest Man Bonus Plan:

Here a committee of workers and management set the standard of
performance. A minimum wage is guaranteed to each worker. The
group gets bonus when actual output exceeds the standard. The group
supervisor also gets a share on the group bonus. This plan promotes
team spirit among employees.

Other Forms of Incentives:

Apart from the above mentioned incentive plans; there are also other
forms of incentives, especially for the white collared workers. They are
briefly discussed below.

Employee Stock Option Plan:

This is popularly known as ESOP. This is a form of incentive where the
employees are allotted the company share at a price below the market
price. When the company achieve better results, the market price of its
shares and the value of the employees’ shareholding rise.

This form of incentive plan is relatively new in India and is becoming

popular of late. IT is motivating to the employee, as (it enhances a
sense of belongingness to the organisation) shareholders are the
owners of the organisation.

Profit Sharing:
Prof. Seager defines profit sharing as “an arrangement by which
employees receive a share, fixed in advance of the profits”. Profit
sharing usually involves the determination of an organisation profits
at the end of the fiscal, year and the distribution of a percentage of the
profits to the workers qualified to share in the earnings. The main
objectives of profits sharing are to create unity of interest and the
spirit of co-operation.
The theory behind profit sharing is that management should feel its
workers will fulfill their responsibilities more diligently if they realize
that their efforts may result in higher profits which will be returned to
the workers through profit sharing.

In India this incentive scheme is not well received by both the

management and the workers. Committee appointed by the Govt. of
India suggested profit sharing as a method of ensuring industrial
peace and a step towards workers’ participation in management and
also suggested that 50% of the profit be shared among the workers.

Both the employers and the trade unions rejected this. The trade
unions prefer bonus to profits sharing as bonus is payable irrespective
of profit or loss under the Bonus Act 1965.

Fringe Benefits:
ILO describes fringe benefits as wages are often augmented by special
cash benefits, by the provision of medical and other services or by
payment in kind that form part of the cost for expenditure on the
goods in services.

In addition workers commonly receive such benefits as holidays with

pay low cost meals, low rent housing etc. such additions to the wage
proper are sometimes referred to as fringe benefits.

Fringe benefits involve a labour cost for the employer and are not
meant directly to improve efficiency. These add to the workers
standard of living. Hence benefits may be statutory or voluntary.

They improve motivation and morale of workers by satisfying their

needs and develops a sense of belonging and loyalty among workers.
They also improve the public image of the organisation.

INCENTIVES
Incentive schemes are one of the most popular and potentially effective forms of
benefits available for employees, particularly those involved in the sales process. These
schemes reward those who meet or exceed their targets, and provide a financial or non-
financial incentive to encourage high productivity. However, while there are numerous
benefits and advantages associated with these schemes, there are also significant
disadvantages that must be considered.

Advantages
Many of the advantages associated with introducing incentive schemes as benefits for
sales employees are self-explanatory. In the first instance, once employees are drawing
a salary there is frequently little reason for these individuals to work as hard as they
could. While sales employees would expect to lose their jobs if they repeatedly failed to
meet their targets, many employees coast through, fulfilling the minimum requirements
but failing to meet their true potential. However, introducing an incentive scheme can
encourage talented but unmotivated individuals to increase their productivity and
therefore increase he level of sales being produced for your company. Incentive
schemes may work on a commission basis, whereby employees are paid a proportion
of the value of each sale that they complete, or they may operate on a fixed rate basis,
with employees being remunerated in some way, over and above their salary, in the
event that they perform particularly well. As such, perhaps the most significant
advantage is the potential for greater turnover.

Incentive schemes can also help to create a climate of healthy competition within your
sales force. If you limit the number of employees who will receive remuneration through
your incentive scheme you can help to encourage competition amongst your staff,
which in turn creates a self-perpetuating increase in results.

Disadvantages
There are, however, a number of disadvantages associated with these schemes.
Primary amongst these is the potential for rifts between employees. If some feel that
they are being unfairly treated, this can actually have a negative effect on the
productivity of those individuals. Regardless of the increase in sales achieved by those
who are receiving the advantage of the scheme, this sense of iniquity can reduce the
productivity of the lower band of sales people to the extent that you may ultimately see
a net loss in sales.

Furthermore, if these schemes are not implemented in a fair and thoughtful way,
employees may feel that they are being taken advantage of. For example, you should
think very carefully if you are considering replacing part of your salary offering with an
incentive scheme; employees who don't perform sufficiently well may feel as if they are
taking a pay cut if you introduce this sort of arrangement, and their may be employment
contract issues to consider.
In order to take full advantage of the potential benefits of incentive schemes, and to help ensure
that you avoid the potential disadvantages, you should give careful thought to the specific
stipulations of the scheme. As such, you may wish to read the article offering advice on
implementing such a scheme, which is available elsewhere on this site

TIME RATES

Time Rate or Time Wage System is the most popular method of wage payment. Known by various
other names such as time work, day work, day wages and day rate, the payment is made on the basis
of attendance. Wages are paid to the workers on time basis irrespective of the quantum of production,
at a specified wage rate. The wage rate may be fixed on hourly, daily, weekly, fortnightly, or monthly
basis. Calculation of wages under this1 method of wage payment takes into account: (i) the time spent
by the worker and, (ii) the wage rate per unit of time fixed. The formula is:

Wages = Time spent x Wage rate per unit of time

For example, if a worker gets Rs.10 per hour, he works for 8 hours per day and has been present for
duty on 25 days during the month, his wages for the month on the basis of time rate system will be:

(25 x 8) hours x Rs.10 = Rs. 2,000

Thus the worker is paid on the basis of time and not on his performance or quantity of output.

Suitability of Time Rate System

The system may prove to be quite ideal is the following cases:

(i) Where quality of production is relatively more important than quantity, e.g., tool room, testing and
inspection, etc.

(ii) Where it is difficult to measure the performance precisely, e.g., the performance of indirect
workers, night watchman, gate-keepers, maintenance and repair work, etc.

(iii) Where output of the worker is beyond his control, e.g., where his speed of work is restricted by the
speed of machines or conveyor belts, or where his work is dependent upon the work done by other
workers.

(iv) Where close supervision of work is possible.

(v) Where the nature of work is such that there is no basis for incentive plan, e.g., night watchman.

(vi) Where production is intermittent on account of delays, power shut-down, etc.

Advantages

Important advantages of this system are the following:

(i) Simplicity - It is simple to understand and operate.

(ii) Economy - The system is economical. Records of labour are simple and less detailed. This means
a saving in overheads.

(iii) Quality output - The system results in better quality of output aim workmanship since workers are
in no hurry to complete the jobs.

(iv) Offers fixed minimum wage - The system offers a fixed minimum waggle the workers for a defined
period of time. They are assured of s earnings in spite of work stoppages or due to below par efficiency
cans by personal factors.

(v) Elimination of speeding - Speeding is eliminated as the security of minimum wage is ensured to
the workers. Speeding would have result in poor health of the workers and wastage of raw materials.

(vi) Equality and unity among workers - The system is generally preferred trade unions because
uniform rate of wage is given to workers irrespective of efficiency. It maintains unity among workers.

Disadvantages

Although the time rate system is a common system of wage payment and widely applied, yet it has the
following disadvantages:

(i) Unfair - As the wages are paid on the basis of time irrespective efficiency of the workers, there is no
correlation between the outputs an wage of a worker. The more efficient worker gets no extra reward
lord his efficiency. The wages of a beginner and an innovative and experience worker may be the same.

(ii) Discontent and Turnover - The system may cause discontentment among the efficient workers and
they may leave the organisation resulting labor turnover.

(iii) Reduction of efficiency - Efficient workers may become inefficient because they notice that the
inefficient workers also get the same wages.

(iv) Increased cost of production - The cost of production per unit is higher; there are direct incentives
to workers to work slowly which ultimately results in doing the incomplete work during overtime and
overtime wages are paid at higher rate. Workers also get wages for idle time which helps to increase
the cost of production per unit.

(v) Difficulty in preparing quotations - It is not possible to ascertain the exact labour cost per unit
because it will change if output falls or rises. So difficulty is experienced in sending the quotations for
tenders.

(vi) Conflict - The system may cause conflict between the management and workers since management
wants maximum output and workers want maximum wages. Such conflict may lead to serious
confrontation between management and workers.

(vii) Increased cost of supervision the system needs close supervision to ensure continuity of
operations which results in increased cost of supervision.

There are a few variations of the time rate system with a view to introducing an element of incentive
in the time wages. These methods are:

(a) High Wage Rate:

Under this wage system, a time rate of a worker is fixed at a higher level than the average wage rate of
the industry. The wage rate is fixed by hour or day. Higher rate is given to attract efficient workers.
Overtime is not permitted under this system. Stable working conditions are created to enable the
workers to achieve the standard output within the regular hours of work. Those who are not able to
achieve the standard are taken off the scheme.

(b) Graduated Time Rate:

Under this method, wages we paid at time rates which vary with changes in cost of living index. The
wage rate per hour or per day goes on changing with changes in the general cost of living index. This
system is preferred by the workers during the time of rising prices because their wages go on increasing
with increase in the cost of living index. In India, the basic wage rates normally remain fixed and the
worker is paid dearness allowance which rises with cost of living.

(c) Differential Time Rate:

Under this wage plan, different wage rates are fixed for different levels efficiency. Normal time rate is
paid to the workers up to certain percentage efficiency. The rate gradually increases beyond the
standard. Thus higher rates are giving to efficient workers in recognisation of their efficient
performance.

PAYMENT BY RESULTS
1. Incentive schemes, or Payment-by-result schemes, are one of the most popular and
potentially effective forms of benefits available for employees, particularly those involved in
the sales process. These schemes reward those who meet or exceed their targets, and
provide a financial or non-financial incentive to encourage high productivity. However, while
there are numerous benefits and advantages associated with these schemes, there are also
significant disadvantages that must be considered.

2. Advantages:

- Incentive scheme can encourage talented but unmotivated individuals to increase their
productivity and therefore increase he level of sales being produced for your company.

-Incentive schemes may work on a commission basis, whereby employees are paid a
proportion of the value of each sale that they complete, or they may operate on a fixed rate
basis, with employees being remunerated in some way, over and above their salary, in the
event that they perform particularly well.

-Incentive schemes can also help to create a climate of healthy competition.

3. Disadvantages:

-Potential for rifts between employees.

-Furthermore, if these schemes are not implemented in a fair and thoughtful way,
employees may feel that they are being taken advantage of.

PERFORMANCE RELATED PAY

 Performance related pay is a system where employers pay employees depending on
the quality of their work. In it simplest form, performance related pay is payment by
‘piece meal’. For example, a worker gets paid £1.00 per Kg of potatoes that they pick.

This piece meal payment is an effective way to give workers an incentive to work harder
and pick as many potatoes as they can. From the employers point of view it is relatively
easy to measure the marginal product of each worker and pay accordingly. The
employer can also ensure that employing workers is relatively profitable because they
only pay for the product they can sell.

Performance related pay in service sector

In many jobs outside manufacturing and farming, marginal product of workers is harder
to measure. If you work in retail, the output of a worker is less clearly defined and
dependent on how many customers come into the shop. However, a firm may try and
give performance related pay linked to the overall profitability of the individual shop.

This gives workers a sense that if they do a good job, they will share in the proceeds.

However, this performance related pay is likely to be only a small percentage of their
total pay. The firm will need to pay an hourly wage, (at least minimum wage). Then the
bonus for a good year will be only a small percentage of final take home pay. This may
be insufficient to affect incentives to work hard.

There is also a problem of free riding. If a firm employs many people, individual workers
may feel that if they slack and don’t work hard, it doesn’t matter because their effort has
only a small percentage impact on the overall profitability of the firm.

Also, many workers may be part time or temporary and not feel any connection to the
long-term profitability of the firm.

Often performance related pay is only given to managers and executives, who have the
biggest responsibility for determining the working conditions and atmosphere of the firm.
If managers are highly motivated to gain a performance bonus, this can affect the other
workers. However, the work of an executive is hard to measure because there are so
many variables which are not always clearly defined.

Advantages of performance related pay

1. Gives managers and workers an incentive to improve efficiency and productivity. This can lead
to lower costs and help the firm remain profitable and dynamic.
2. It gives workers a feeling of being tied to the fortunes of the company making it easier to
emphasise with cost cutting measures.
3. It can improve workers morale and loyalty if they feel their hard work is rewarded.

Disadvantages of performance related pay

1. Often the profitability of a firm may be out of the control of a manager. For example, general
market conditions may lead to fall in demand or it may be determined by the overall strength of
the product.
2. In many service sector jobs, it is very difficult to adequately measure productivity / success of a
worker. For example the output of teachers, nurses and doctors is difficult to measure in
numeric terms.
3. Profit related bonus payments may encourage risk-taking which leads to a chance of high profit
and high rewards. This is an issue in banking where generous bonus schemes encouraged
many managers to take risks (e.g. take on sub-prime mortgage) because if profitable, they
gained a large bonus, but losses would be absorbed by someone else (often taxpayer).
4. Profit related pay may distort effort into areas which increase profit in the short-term. If a
manager has a profit target, they may choose options which delay investment and take on the
easiest way to make profit. However, this can damage the company in the long-term because
investment is delayed and their may be a high turnover of staff.
5. The success of a job may not be necessarily related to profit or revenue, but whether the
manager is successful in treating workers fairly and maintaining awareness of social objectives
(e.g. decisions which impact on environment may conflict with profit motive). See objectives of
firms
6. Some have argued that high bonuses for executives is linked to the strong bargaining power of
executives. Top executives use bonus payments as a way to gain higher pay from firms, rather
than being linked to increased productivity. (understanding high pay for executives)
7. Some workers, classed as self-employed, such as delivery drivers are paid per delivery.
However, if roads are congested they may end up with less than the minimum wage. It may also
encourage bad driving, such as speeding. Paying per delivery and classing workers as self-
employed is a way for firms to cut costs and pay workers less overall.

Evaluation

 It depends how the scheme is set up. For example, in theory, some of the problems can be
mitigated by assessing performance on more metrics than profit and revenue – for example,
satisfaction of stakeholders.
 The best performance related pay schemes use a variety of measures. For example, part of pay
based on skills, duration in company, with performance related pay only linked to part of wage.
 Workers are motivated by many factors and bonuses are often not the biggest factor.
Performance related pay may create a competitive environment and dissatisfaction. The firm
may be better off trying to improve worker morale in other ways, such as listening to feedback
and improving work place environments.

Personal experiences of performance related pay

 Paperboy – £4 for a Sunday delivery. No hourly pay, the quicker you did job, the better the
hourly rate.
 Little Chef waiter / dishwasher – £3.00 an hour, no performance related pay. But, I don’t think a
performance bonus would have made any difference. I was interested in doing good job and
financial bonus wouldn’t have made any difference.
 Marking exam papers. Marking exam papers you get paid per script. In theory, there is an
incentive to work quickly and get job done, but there is also responsibility of trying to give
correct exam results for students. It’s hard to give performance related pay for marking. Though
some examiners got invited to do remarks which were paid at a higher rate.
 Teaching. I’m glad I wasn’t paid related to student exam results. Hard to measure productivity,
but head teachers definitely get to know reputation of a teacher, and perhaps the best are paid
higher wage to keep at a school.

PROFIT RELATED PAY

TO MOTIVATE EMPLOYEES Motivation of employees is clearly an important factor in the overall
performance of an organisation. Organisations would like their employees to work harder, and be
flexible. The link between reward schemes and motivation is a complex issue that is hotly debated in
both accounting and human resource-related literature. A well-known theory relating to motivation is
Maslow’s hierarchy of needs. Maslow stated that people’s wants and needs follow a hierarchy. Once the
needs of one level of the hierarchy are met, the individual will then focus on achieving the needs of the
next level in the hierarchy. The lower levels of the hierarchy are physiological, relating to the need to
survive (e.g. eating and being housed); once these have been met, humans then desire safety, followed
by love, followed by esteem, and finally at the top of the hierarchy, self actualisation, or self fulfilment.
Applying Maslow’s hierarchy of needs to reward schemes suggests that very junior staff, earning very
low wages will be motivated by receiving higher monetary rewards, as this will enable them to meet
their physiological needs. As employees become progressively more highly paid, however, monetary
rewards become relatively less important as other needs in the hierarchy, such 3 REWARD SCHEMES
JANUARY 2013 © 2013 ACCA as job security, ability to achieve one’s potential, and feeling of being
needed become more important. Herzberg argued that increasing rewards only motivates employees
temporarily. Once they become de-motivated again, it is necessary to ‘recharge their batteries’ with
another increase. A far better way to motivate employees is to ‘install a generator in an employee’ so
they can recharge their own batteries; in other words to find out what really motivates them. According
to Herzberg, it is the intrinsic factors in a job that motivate employees, such as ‘achievement,
recognition for achievement, the work itself, responsibility and growth or advancement.’ Giving greater
responsibility to employees, for example, can increase motivation. Perhaps the conclusion to be gained
from this is that monetary rewards alone are insufficient to motivate employees. Other factors such as
giving greater recognition and greater responsibility may be equally important, for example giving praise
at company meetings, promoting staff, and involving staff more in decision making.

QUICK REFERENCE
(PRP)

1. The situation in which the pay of employees is related to the profit made by the employer. The purpose is to
increase motivation, commitment, and effort by the workforce by ensuring that all staff have a positive stake in the
commercial success of the company. For such a scheme to be a success it must be believed in, valued, and
understood by all concerned. Staff must clearly understand that a bonus payment will be forthcoming if the
organization has a good year but will not be if the organization does not make profits. Above all, profit-related pay
should never be used as a means of cutting wage and salary bills. Its general effect is to put up wage and salary
bills and this legitimately raises the expectations of the individuals concerned.

Profit-related rewards are usually offered in one of two ways. The simplest of these is to allocate an amount from
the surplus generated by the organization and to share this out among employees. For maximum equality, this will
be as a percentage increase in all employees' salaries. The other approach is to offer shares in the organization;
the employees will thus become investors in their own future. In the UK, the Bell-Hanson Report (1989),
 researching 113 publicly quoted companies, found that profit-sharing companies out-performed others by an
average of 27% on returns on capital, earnings per share, and profit and sales growth. See also gain sharing;
profit-sharing scheme.

2. A former UK scheme enabling employees to be paid part of their salary tax-free; it was phased out in 2000–01.
Payments to employees under a registered scheme could be tax-free up to the maximum for the year. Show Less

From: profit-related pay in A Dictionary of Business and Management »

SKILL BASED PAY

CAFETERIA

Looking for a way to customize your benefits plan to the needs of your individual employees? A
cafeteria style benefits plan is an employee benefits plan that allows your employees to choose
among a variety of options to create a benefits package that best meets their needs and those of
their family.

Cafeteria style plans provide a special exception to federal income tax rules that apply to an
employee’s earnings.

In a cafeteria style plan, employees are allowed to select among a variety of nontaxable benefits
and cash.

Benefits to Employees
In a cafeteria style plan, an employee generally receives a certain number of dollars from the
employer to purchase particular components of a benefits plan. This enables employees to
purchase benefits, such as health insurance, with pretax dollars.

Cafeteria style plan options can include various levels of health insurance plans and other
insurance options such as short term and long term disability insurance, and group term life
insurance. 401(k) plan contributions for retirement, dependent care assistance, adoption
assistance plans, and contributions to Health Savings Accounts (HSAs) are several additional
benefits a cafeteria style plan can provide.

This provides employees with more take home pay and several additional benefits. The
advantage of a cafeteria plan is that employees have benefits plan options.

For example, a young employee with no health problems might opt to spend cafeteria plan
dollars on a minimal health plan.

An employee with four family members might choose to spend the cafeteria plan dollars o a
health plan with more comprehensive coverage. The employee without a family might choose
to spend his or her benefits dollars for investments in a retirement plan.

Regulation of Cafeteria Style Plans

Cafeteria plans are governed by Section 125 of the Internal Revenue Code. No matter the goal of
the employer’s cafeteria plan, the plans are, according to Gregory Boop,

“named after Title 26, Section 125 of the United States Code where 'cafeteria plans' are specifically
excluded from the calculation of gross income for federal income tax purposes.

"125 plans allow employees to contribute pretax dollars into the plan. Contributions toward plans are not
subject to federal, state, or social security taxes. The contributions are placed into an account the
employee can use to pay for allowed expenses (e.g., premiums for health insurance, dependent care costs,
medical supplies). Since no federal, state or social security taxes are taken out and the dollars are not
included as gross income, the employee saves anywhere from 27 - 50% on these purchases."
When the Employee's Choices Exceed the Amount of Money

In a typical cafeteria plan, an employee might exceed the number of dollars allowed by the
employer with the benefits plan choices he or she made.

In these cases, the employee pays a part of the premium for his or her chosen benefits, so the cost
to employers is lower.

For example, an employee with health problems or an employee who is age 55 and above might
choose to buy up to a more comprehensive health plan that covers more services.

Work with Benefits Professionals

In all cases, working to provide employees with a cafeteria style plan for benefits deserves the
assistance of a benefits plan professional who can advise the employer about options. Between
the complexity of the U.S. tax code and the predictable changes in laws, employers should
seek assistance.

Whether you are large enough to employee a compensation and benefits coordinator or you rely
on the assistance of trusted external advisors, I recommend getting advice. Employers should not
go this route on their own.

The complexity of the tax code is such that you need professional assistance to devise a cafeteria
plan that is legal and that benefits both the employer and employees.

Disclaimer – Please Note:

Susan Heathfield makes every effort to offer accurate, common-sense, ethical Human Resources
management, employer, and workplace advice both on this website, and linked to from this
website, but she is not an attorney, and the content on the site, while authoritative, is not
guaranteed for accuracy and legality, and is not to be construed as legal advice.

The site has a world-wide audience and employment laws and regulations vary from state to state
and country to country, so the site cannot be definitive on all of them for your workplace. When
in doubt, always seek legal counsel or assistance from State, Federal, or International
governmental resources, to make certain your legal interpretation and decisions are correct. The
information on this site is for guidance, ideas, and assistance only.