What are the factors that have encouraged the spread of incentive or performance-linked pay? Drawing on examples of the implementation of performance-related payment systems, assess the advantages and the risks associated with these payment systems for both employees and organizations.
Traditionally, pay was seen as a price of the labour by the interaction of demand and supply in the labour market. However, more recently pay has become a more strategic element in an organisation. Human Resource Management has several debates on the fact that employees form a competitive advantage in an organisation and it is this very fact that has made pay a crucial element (Wilkinson and Redman, 2011). Although time based pay and seniority based pay has been prevalent in the UK for several decades, in the international arena with variable pay systems on the rise, UK required a shift as well. This shift was towards performance related pay. The performance of employees at an organisation has been important since a very long time; this can be proven due to the fact that performance appraisal methods have been prevalent in almost all sectors. However, since the last few years a major concern for human resource managers has been to relate performance to personnel management. This new trend gave rise to the concept of performance management which has surpassed the traditional appraisals systems wherein performance was reviewed only once a year.
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The term performance management grew popular as the employers’ concern regarding organizational performance had increased tremendously. Employers’ have certain expectations from their employees and most of the time performance is judged through the achievement of specified targets. Therefore, performance management in recent years has seen a shift wherein the wider objectives of the company are kept in mind to review performance of each individual (Bach, 2009). To describe what performance management entails of, Armstrong and Baron(2005) have rightly stated that through performance management it is possible to have a shared vision for the company; employees are told about what is expected from them; specific targets are set and how people can achieve them is explained, through this method employees are motivated to work as they receive regular feedback and can monitor their own performance.
Before moving on to the various factors of PRP, it is important to understand its true meaning. Performance Related Pay is a method of payment through which an individual’s performance is assessed on a more regular basis in a more systematic way. PRP focuses on twin objectives, it helps in imbuing motivation within the employees and it helps in driving an organizational change within the company (Wilkinson and Redman, 2011;Marsden and French, 1998). Lawson(2000) defines performance related pay as a pay progression system wherein individuals are assessed based on preset goals; where there is a direct link between employee performance and reward; the link between pay and performance is based on different criteria; a system which believes that organizational performance increases when pay and performance is linked as employees are motivated to work more to achieve more rewards.
Based on performance related pay (PRP), there are three major types of remuneration systems. The first type is called competence based pay which generally means that individual employees are rewarded on the basis of their performance. This pay can be either added to their base salary or be given in the form of an increment to their pay scale. The second type of PRP is in the form of a bonus. Bonuses are often given after certain targets are achieved; this is particularly famous in the sales department. The third type of pay although is not conventional however seems to work, is a collective bonus which is given after reviewing the performance of a group. This is particularly interesting as it does not hinder the team dynamics and a collective work environment is also produced (Bach, 2009).
Although performance related pay has existed in spirit since 1940, however, it has evolved ever since. The changes that are noticed today are a shift from mere evaluations of personal skills to a more organizational objective. PRP schemes are now used in the public sectors and can be noticed in all types of job sectors. Although integrated in the public sector, PRP is noticed more in the private sector. Bailey, Marriott and Perkins (2017) in a study confirm this fact and state that although incentive pay systems and variable pay systems have come about, the method of performance appraisals still looms large. The most common way to assess performance is through individual goals followed by team based goals. However, very few companies actually include salary changes to performance. It was noticed in the survey done by CIPD in 2017 (Bailey, Marriott and Perkins, 2017) that for PRP schemes to work in practice; the HR department must be competent in defining the goals, objectives and rewards for the plan. An interesting development was that although companies do wish to employ new schemes, they are at the same time unwilling to get rid of performance appraisals altogether. Having understood the basic tenets of performance related pay system, it is important to get an in depth understanding of the same. The following section discusses about the factors around PRP and the risks and benefits of PRP with the help of a few examples.
Having understood the ‘what’ of Performance Related Pay, it is now important to know the ‘why’ as well. Why have organizations shifted their focus on such schemes is a question that has been explored extensively. With the ever rising levels of competition for skills, the competitive advantage among firms is the employee. This strategic importance of employee to distinguish a company from the rest has given rise to the introduction of ‘New Pay’. High levels of employee motivation has been found due to changes in the pay system, therefore competitive advantage in terms of skills of individuals is one of the major factors for the advent of PRP schemes (Bach, 2009).Pay systems are varied due to other factors as well. PRP schemes are most prominent when firms wish to segregate employees in terms of personal skills and reward them. This helps in increasing motivation on an individual basis. A very important factor why PRP may be used is cost. The cost to company can be monitored before and after the schemes are applied and it is possible that such pay systems can ultimately save money for the company (Wilkinson and Redman, 2011). It is argued by many authors that the highlighting factor that encourages companies to adopt PRP schemes actually begins when the other traditional schemes begin to fail. When problems such as bias from line managers in performance reviews, deteriorating appraisal quality and improper goal setting exist, the companies tend to fall onto payment schemes that can solve these issues. PRP is the solution to these problems as it is a combination of a pay system with an effective monitoring environment (Marsden and French, 1998).
As mentioned before, competitive advantage stands to be the most important factor in applying PRP schemes. Organizations are willing to review their pay packages to new pay systems if it translates to good recruitment and the retention of the right people. White and Druker,(2000) suggest that the factors that have institutionalized new norms in pay systems are as follows- it is possible that certain firms were required to adopt new strategies due to political or legal pressure for example, in the case of public sectors. Environmental pressures may need the firm to imitate the strategies of their rival firms. It may also be the case that a reputed institution like CIPD reports studies wherein the new pay systems seem to be working for most firms, which encourages the other companies to adhere to same policies. Such factors led companies to adopt the non-conventional form of performance management through PRP. A few examples of firms and sectors that have applied these schemes have been discussed below which will help gain an insight into the practical approach towards performance based rewards.
In a case study of Solar Press Inc. in Illinois, USA, bonus systems were looked into. The bonus systems in the company had been reviewed thrice in a period of six years. The first bonus system revolved around rewards given to teams after they achieved certain targets and produced a certain quantity of goods. The teams were so focused on achieving their targets that their quality checks were degraded and half of the equipment broke down. The team had lost its cooperation and even if a few people came up with new ideas, they did not wish to reveal them in fear of losing personal bonuses. Finally, Solar Press decided to do away with the old system and came up with a way to reward everyone for minimum targets achieved and their individual performance. Therefore, it is noticed how PRP schemes and team bonuses may look attractive in the beginning ends up causing harm in some cases (Posner, 1989; Abbott and Kleiner, 1992). It is important to understand the sector, the vision and the culture of the company before applying the schemes. What works for one company will not necessarily be a success story for the others.
A similar case happened with General Health Inc. where in the introduction of PRP schemes cost more money to the company. The company had set up a bonus scheme with targets that specified that if targets were hit, the employees will each receive an extra month’s pay. The plan worked so well, that the company started losing out on money in paying for the extra salaries. Apart from this as the company grew in number and stature, it required new machinery and equipment and had to hire new staff to maintain the ever-growing business. Although fruitful in the beginning, the company grew closer to losses by the end (Abbott and Kleiner, 1992). This example proves that although PRP scheme may be effective, it is important that along with the application, regular checks and monitoring is equally important.
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England’s National Health Service (NHS) also applied PRP schemes during the 1990’s. A study done by Corby et al.,(2003) through the method of interviews of staff and managers suggested that although competence based pay was approved of, however, majority of the staff did not accept them in practice. Managers were of the view that there is a direct link between pay based and performance and patient care, which improved or will improve eventually. They believed that the staff was now more focused towards their work and believed that the New Pay schemes had improved their skills. This case study clearly shows that a consensus among the staff and the managers is an essential part for the PRP plans to work.
Performance Related Pay for teachers in England was introduced in 1861. It was believed that if the students’ performance was linked to the pay of the teachers, there might be an improvement in their teaching skills and ultimately, it would be the students who would benefit. However, studies show contradictory results regarding rewards for teachers’ performance. Financial rewards for teachers’ is not the most attractive option as a few teachers’ do it out of the passion for teaching rather than monetary benefits. PRP is often known to retain staff, but in case of teachers it is noticed that the decrease in turnover due to the introduction of PRP can be balanced out by the increase in turnover of teachers who do not receive any rewards (Chamberlin et al., 2002;Jacobson, 1995;Richardson, 1999). It is therefore important to keep in mind the sector in which PRP is applied. Although, it is known to widely acceptable in financial sectors and the sales department which are more target oriented, the public sector jobs like that of a teacher or a doctor may not be dependent on financial incentives. This data also varies across countries, where it was noticeable that in the USA, the teachers did respond to incentive plans, but in the UK, such plans were not welcomed as much.
Performance Pay schemes are adopted in companies because it is proven to have a few benefits. From the employee’s point of view, PRP can provide an incentive to the employee which in turn can motivate the individual to work, it is a way to recognize talent within an organisation which is seen to improve with such schemes and it is also a successful method of recruitment and retention of staff, as employees work towards achieving their goals. Suff, Reilly and Cox (2007) have suggested that from the firms’ point of view PRP shemes help in developing a cultural change within the organisation which is more performance focusses, this in turn helps the organization to growe and achive its targets. Apart from the frims’ growth, such schemes create a motivational factor for individuals who wish to improve and can increase their productivity. It is a method to identify poor performance and come up with solutions easily which will not cause a drain to the company in the future.
Although there may be many benefits associated to PRP schemes, every coin has two sides. It has been noticed that performance based pay in some cases can diminish commitment and trust. This was noticeable in a study done by Marsden and Richardson in 1994 for a period of five years at the Inland Revenue. They found out conclusively that through the scheme, the staff had lost willingness to work and did not wish to cooperate. Such schemes are known to destroy team working abilities within an organisation, which happened in the case of Inland Revenue as well. Similar studies done at NHS and Employment Service also demonstrated the same results (Marsden and French, 1998). The concept of fairness seems to be eroded with the introduction of PRP schemes and employees grow a feeling of distrust towards the organization. The whole premise of PRP is to improve motivation, however it is noticed that to some extent PRP may do just the opposite, as most employees wish to push themselves to a certain limit to earn the reward (White and Druker, 2000). They do not have an internal motivation or job satisfaction towards the job and do not wish to spend more time at the workplace if it is not rewarded in some or the other way. Therefore, in a way performance related pay although advantageous in many aspects can cause to be a bane for firms. Though welcomed by employees, the PRP schemes have been bad mouthed due to the way it is implemented, which is often seen as unfair and improper to the workers. Due to the continuous reviewing process of payment schemes which is required in the case of PRP, the firm loses stability within the contract, which is supposed to be binding. Also, in a way firms end up losing money through the application of incentive schemes as the cost of consulting and monitoring increases (IPD, Performance pay survey, 1998)
After having understood about the risks and benefits associated with PRP schemes, it is important to discuss the way forward for them. It can be said with utmost certainty that PRP schemes work best when organizations and employees work hand in hand to improve productivity. For this reason, the role of HR professionals needs to grow. They should define the objectives of the organization and explain the plans to the employees, new ideas need to be implemented for damage control when plans begin to fail and proper monitoring as well as reviewing of plans need to be done on a regular basis (Bailey, Marriott and Perkins, 2017). Performance Related Schemes would best work when there is effective planning and the company provides training programs for the operation of the scheme. Proper communication and transparency is necessary for the success of any plan and it is the same in the case of PRP as well. No type of scheme is a panacea for all corporate ills and it is found that different PRP schemes work in different organizational settings. Therefore, the key issue for managers would be to pick out the best scheme which fits the company (Suff, Reilly and Cox, 2007).Although it was seen that individual performance based schemes do exist, it was noticed how such schemes can foster a negative team working environment. This hinders the functioning of a company. Therefore, in the future the team based bonus schemes will be more on the rise. There have been very contrasting opinions regarding PRP, where at one end the criticisms are many, it cannot be ignored that it is the most effective way to monitor performance in an organization. It goes without saying that PRP schemes are here to stay for the long haul.
List of References
- Abbott, J. and Kleiner, B.H. (1992) 'Incentive Pay: Not just for top management', Work Study: MCB University Press, vol. 41, no. 2, March.
- Adnett, N. (2003) 'Reforming teacher's pay:incentive payments, collegiate ethos and UK policy', Cambridge journal of Economics, pp. 145-157.
- Armstrong, M. and Baron, A. (2005) 'Managing performance', CIPD.
- Bach, S. (2009) Managing Human Resources, Wiley-Blackwell.
- Bailey, D.M., Marriott, and Perkins, J. (2017) 'Reward management:focus on pay', CIPD survey report, December.
- Chamberlin , , Wragg, , Haynes, and Wragg, C. (2002) 'Performance related pay and the teaching profession: a review of literature', Research papers in education, vol. 17, no. 1.
- Corby, S., White, , Millward, L., Meerabeau, and Druker, J. (2003) 'Finding a cure? Pay in England's National Health Service', Employee Relations, vol. 25, no. 5, pp. 502-516.
- 'IPD, Performance pay survey', Chartered Institute of Personnel and Development (1998).
- Jacobson, S. (1995) 'Monetary Incentives and the Reform of Teacher Compensation: A persistent organizational dilemma', International Journal of Educational Reform, pp. 29-35.
- Lawson, P. (2000) 'Performance related pay in strategic reward systems'.
- Marsden, D.W. and French, S. (1998) 'What a performance: Performace related pay in the public services sector for economic performarmance'.
- Perkins, S.J., White, G. and Jones, S. (2016) Reward management:Alternatives,consequences and context, 3rd edition, CIPD.
- Posner, B.G. (1989) 'If at first you don't succeed', vol. 11, pp. 132-134.
- Richardson, R. (1999) 'Performance-related pay in schools: an assessment of the Green Papers'.
- Salaman, G., Storey, J. and Bilsberry, J. (2005) Strategic Human Resource Management: Theory and practice, 2nd edition, Sage Publications.
- Suff, P., Reilly, P. and Cox, A. (2007) 'Paying for Performance: New trends in performance related pay', IES Research Networks.
- White, G. and Druker, J. (2000) Reward management: A critical text, Routledge.
- Wilkinson, A. and Redman, T. (2011) Contemporary Human Resource Management, 4th edition, Pearson Eductaion UK.
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