Incentives

1. BASIC CHOICES

While incentive payment systems are common in the UK, there are millions of employees who do not receive this kind of reward and many employers who use them only in a limited way (often in the remuneration of senior managers). It is thus perfectly possible, and some would argue desirable, to recruit, retain and motivate a workforce by paying a simple, fixed rate of pay for each job in the organisation. There is other equipment in the HR manager’s toolkit which can be used to reward effort and maintain good levels of job satisfaction. The most fundamental question is therefore whether or not to use an incentive payment system at all. In the opinion of Sisson and Storey (2000, pp. 123-4) many organisations in the UK have introduced schemes in recent years for ‘ideological reasons’ as a means of impressing stock market analysts, reinforcing management con­trol or undermining established collective bargaining machinery. These, they suggest, are poor reasons which have generally met with little long-term success. Incentive schemes should only be used where they are appropriate to the needs of the business and where they can clearly contribute to the achievement of organisational objectives.

There is a long tradition in the academic literature of hostility to incentive schemes in general and those which focus on the individual in particular. In 1966, Frederick Herzberg argued that pay was a ‘hygiene factor’ rather than a ‘motivator’. He claimed that its capacity to motivate positively was limited, while it can very easily demotivate when managed poorly. It follows that there is little to be gained and a great deal to lose from the introduction of incentive schemes. Others (for example, Thompson 2000) have focused on the way that incentives are perceived by employees as tools of management control which reduce their autonomy and discretion. This, it is argued, causes resent­ment and leads to dissatisfaction and industrial conflict. A third source of criticism is the considerable additional costs which invariably mount up when organisations intro­duce incentive schemes. Cox (2006, p. 1493) labels these ‘costly side-effects’ and shows that they are both considerable and largely unanticipated at the time a new scheme is introduced.

A different school of thought argues in favour of incentives on the grounds that they reward effort and behaviours which the organisation wishes to encourage. As a result they not only are a fair basis for rewarding people, but also can enhance organisational effectiveness and productivity. Advocates of expectancy theory hold this position with their belief that individual employees will alter their behaviour (e.g. by working harder or prioritising their actions differently) if they believe that in so doing they will be rewarded with something they value. Hence, where additional pay is a valued reward, employees will seek it and will work to secure it. A positive outcome for both employer and employee is achievable provided the incentive is paid in return for a form of employee behaviour which genuinely contributes to the achievement of organisational objectives.

In addition, many reward specialists point to a significant sorting effect which leads employees who are willing and able to perform to a higher standard to be attracted to jobs in which their superior relative contribution will be properly rewarded. At the same time, it is argued, existing employees who perform relatively poorly are more likely to seek alternative employment than colleagues who perform well and are rewarded for doing so. Hence, over time, the quality of employees rises as a result of the presence of incentive schemes. Conversely, of course, it can be plausibly argued that employers who fail to recognise superior individual contribution in their payment systems are more likely to lose higher-performing people because they perceive themselves to be being inadequately rewarded for their skills and efforts.

The research evidence is patchy on the question of how far incentives actually lead to performance improvements at the organisational level. Some studies suggest a correla­tion between superior performance and some types of incentive scheme (e.g. Huselid 1995; Lazear 2000; Piekkola 2005; and Gielen et al. 2006), while others (e.g. Thompson 1992 and Pearce et al. 1985) have found no significant evidence of any link. In any case, as Corby et al. (2005, pp. 5-6) point out, there are very few published studies which focus on performance or productivity levels before and after the introduction of a new scheme. What we have are correlation studies which link superior organisational per­formance to the presence of incentive schemes, but no proof of any causal relationship. Much seems to depend on the circumstances. Incentives are not universally applicable, but can play a role in enhancing individual effort or performance where the conditions and scheme design are right. Problems occur when the wrong system is imposed, on the wrong people, in the wrong circumstances or for the wrong reasons.

Where an incentive scheme is used, the next choice relates to the way the scheme is to operate. There are two basic approaches that can be used: bonus payments and incre­mental progression. In the case of the former, the employee is rewarded with a single payment (possibly made in stages) at the end of a payment period. In the case of profit sharing it will often be an annual payment, while sales commission is usually paid monthly. Whatever the timing, the key principle is that the pay is variable. Good per­formance in one period is rewarded, but the same individual could earn rather less in the next if his or her performance deteriorates. Some writers refer to such systems as putting ‘pay at risk’, because earnings vary from period to period depending on how much incentive is earned. The alternative approach involves making incremental progression dependent on the individual’s contribution. The reward takes the form of a general pay rise over and above any cost of living increment being paid in a particular year. The incentive payment thus becomes consolidated into overall earnings and is not variable or ‘at risk’ after it has been earned.

Another basic choice concerns the extent of the incentive. In practice this is a decision of rather greater importance than the type of incentive scheme to be used, although it is given rather less coverage in the literature. There is a world of difference, in terms of cost and employee perception, between a scheme which rewards people with three per cent or four per cent of salary and one which pays a sum equivalent to 25 per cent. Studies undertaken in the USA, reported by Bartol and Durham (2000, p. 14), suggest that the minimum level of bonus or pay rise ‘necessary to elicit positive perceptual and attitudinal responses’ is between five per cent and seven per cent of salary. Piekkola (2005), in her studies of links between incentives and firm performance in Finland, found that a positive impact on productivity only began to kick in once the incentive exceeded 3.6 per cent of salary. Lesser payments are thus unlikely to provide meaningful incen­tives and will have only a peripheral impact. According to Hendry et al. (2000, p. 54) this has been a major problem for schemes introduced in the public sector where incentives have tended to be worth a maximum of only two per cent or three per cent of salary. Armstrong and Murlis (1998) offer the following advice:

As a rule of thumb, those whose performance is outstanding may deserve and expect rewards of 10% and more in their earlier period in a job. People whose level of performance and rate of development is well above the average may merit increases of between 7 and 9%, while those who are progressing well at the expected rate towards the fully competent level may warrant an increase of between 4% and 6%. Increases of between 0% and 3% may be justified for those who are not making such good progress but who are still developing steadily. Performance-related increases of less than 2-3% are hardly worth giving. Much also depends on current market movement and this affects expectations. (Armstrong and Murlis 1998, pp. 286-9)

The final choice concerns the level at which the incentive will be paid. Some schemes reward individuals for individual performance, others reward a group of employees or team for their collective performance. Finally there are schemes which share incentive payments out among all employees in the organisation or within individual business units. Team-based incentives have tended to get a better press in recent years than indi­vidual incentives, a major problem with the latter being their tendency to undermine teamworking in situations where it is an important contributor to competitive advan­tage (see Pfeffer 1998, pp. 218-20), but the different forms of incentive are by no means mutually exclusive. It is possible, for example, to reward a salesperson with three types of incentive, one from each level. The basic pay would thus be enhanced with commission calculated individually, with a performance-based payment made to all in his/her sales team to reflect excellent customer feedback, and finally with a profit-related bonus paid to all employees in the organisation. Indeed, the more recent research suggests that employers are increasingly mixing different types of incentive scheme so as to enable them to help meet a range of distinct organisational objectives. It is not at all uncommon, as a result, for more senior employees to have an opportunity to earn addi­tional income from three or four different types of bonus, some individual, some group based, some leading to a pay rise, others resulting in a one-off bonus payment. The schemes themselves also appear to be becoming increasingly sophisticated and admin­istratively complex (IDS 2005, p. 7; CIPD 2007, p. 15).

2. THE EXTENT TO WHICH INCENTIVES ARE PAID

There is conflicting evidence about how widespread incentive payments are in the UK and about whether or not they are becoming more or less common. Until 2005, each year the government’s New Earnings Survey selected a sample of over 100,000 employees from across the country and asked their employers to fill in a form outlining their earnings in the previous tax year. One of the questions asked was about incentive payments ‘such as piecework, commission, profit sharing, productivity and other incentives/ bonuses’. The survey results persistently showed that only around 15-20 per cent of employees were receiving such payments, most of which was accounted for by tradi­tional piecework or payment-by-results systems operated in manufacturing organisa­tions. The incidence of individual incentives paid to non-manual workers was low. Only around 10 per cent were recorded as receiving such payments in 2003 (Office for National Statistics 2003). The New Earnings Survey has now been superseded by the Annual Survey of Hours and Earnings (ASHE) which no longer includes a general ques­tion about incentive payments. Instead it simply records the amount of earnings that are comprised of ‘bonuses and commissions’ in each payment period (i.e. each week or month). As a result, data about annual bonuses and pay rises that are linked to per­formance criteria are not captured (Office for National Statistics 2006).

In any event, other surveys have long painted a rather different picture. The authors analysing the 2004 Workplace Employment Relations Survey (Kersley et al. 2006, pp. 190-1) concluded that around 40 of the workplaces in their sample operated either a payment by results or a merit pay incentive scheme, while 21 per cent operated some form of share-ownership scheme. Around 30 per cent paid profit-related bonuses to at least some employees. Even allowing for a strong degree of overlap between schemes as a result of employers operating different payment systems simultaneously, these figures suggest that incentive payments form at least some part of some peoples’ reward pack­ages in a majority of UK workplaces. The 2004 Employment Relations Survey also found evidence of substantial growth in the incidence of individual performance-related payment systems since the previous survey conducted in 1998.

The CIPD’s annual survey of reward practice covers a much smaller sample of employers, but it too suggests both high usage of incentives in the UK and considerably increased usage of incentives over recent years. In 2007 70 per cent of CIPD’s respond­ents reported using ‘cash-based/incentive plans’. Sixty-four per cent used individual- based schemes, 27 per cent used team-based schemes, while 53 per cent used schemes that ‘are driven by business results’. While such approaches are used by a sizeable minority of employers in the public and voluntary sectors, it is in the private sector that activity is focused.

It is not easy to reconcile the diverse results produced by these surveys. One possibil­ity is that the different results may reflect the different samples used. The ONS New Earnings Survey covered workplaces of all sizes, including the very smallest, while the others tend to focus on somewhat larger employers. It could therefore be the case that incentive schemes are largely used in bigger firms with more sophisticated management practices. Another possibility is that a high proportion of the schemes in operation reward employees with performance-based incremental payments (that is, a pay rise) rather than a one-off annual or monthly bonus. These would not have been picked up by the New Earnings Survey, which asks specifically about the amount of incentive pay­ment received in the previous tax year. A further possibility is that many of the schemes in operation only apply to senior managers and not to the generality of staff. Either way, there is clear evidence of growth in the extent to which employers make use of incentive payment systems.

Source: Torrington Derek, Hall Laura, Taylor Stephen (2008), Human Resource Management, Ft Pr; 7th edition.