Focused vs. Consolidated Measures in Performance Pay Systems

Article excerpt

Abstract

Two types of incentive pay plans both have long histories and have been widely adopted by business organizations. One type is the one-dimensional plan that includes sales commissions and production piece-rates. The second type is group plans that include profit sharing and gainsharing. Problems and issues are inherent in both approaches and are discussed. A solution to these problems is described that includes the use of the "Performance Matrix" and "Profit-indexed Performance Pay. An important issue in the design of performance pay systems is whether the payout measures should be focused (one-dimensional) or balanced (multi- dimensional) through consolidation. Examples of focused measures are sales commissions and piece-rate plans. Examples of consolidated measures are profit sharing and gain sharing.

PROBLEMS WITH INCENTIVE PLANS BASED ON FOCUSED MEASURES

Focused plans pay incentives on one performance measure. Sales commissions typically pay a percentage of revenue or gross profit above a threshold performance level. Similarly, piece rates pay per unit of production and, in some cases, include a threshold performance level. Early in my consulting career, I helped implement a number of sales commission and piece rate plans in banks. The piece rate plans were for tellers and back office clerical employees. The application of piece rates in a bank was, and is, novel. The results were consistently remarkable.

My first application was for 'proof operators' who encode checks and deposits. The baseline 'items per hour' was 950. We eliminated the operator's base wages and instead paid them per item processed. Errors were counted as multiple items and subtracted from the item count to produce a 'net item' count. The net item count increased to over 3 100 items per hour, (a 326% gain) where it remained for some fourteen years. As a sidelight, turnover had been over 300% and dropped to zero. Further, the supervisor volunteered to become an operator again, and the operators then managed the department.

I repeated this success in several other banks, and with other clerical job positions. However, over time it became apparent that piece rate was a flawed plan. First, as the jobs I applied the plan to became more complex, it became evident that paying incentives on one measure often significantly reduced performance in other critical job results such as timeliness, accuracy or projects. Further, employees on a piece rate plan became quite uncooperative. Employees would come in early and take items from the in-basket to ensure they had plenty to do. Some employees hid items in their desks. As you would expect, employees were reluctant to train new employees, attend meetings, or help out in other areas. The Lincoln Electric Company is one of the best-known piece rate plans. When you enter the plant, there is a large sign posted that states, "no one can begin work before 8:00 A.M.".

The problem of ignoring non-incented job responsibilities extends to sales commissions as well. I have been in hundreds of organizations over the past 25 years and consistently hear the same complaints about sales commission plans. Commissioned sales people become just as independent as do employees on a piece rate plan. They also steal sales leads from other sales people and invade each other's sales territories. Further, revenue-based plans may encourage sales people to discount products and services, which has an adverse effect on the profit margin of the organization. They may sell to customers who can't pay, they make promises the operations group can't deliver, and they may be excessive in their travel and entertainment expenditures.

A larger issue, though, is that employees in these types of plans tend to focus on the specific performance pay measure and ignore their organization's overall mission. This is a two-pronged problem. It is quite possible for focused plans to award significant payouts to employees when the total organization is not profitable. …