Compensation Management

Incentive Meaning and Types of Incentive Schemes

Incentive Meaning – Incentives or payment by results are monetary benefits paid to workmen in recognition of their outstanding performance. They are defined as “variable rewards granted according to variations in the achievement of specific results”. Unlike wages and salaries which are relatively fixed, incentives generally vary from individual to individual, and from period to period for the same individual.

Incentive systems are an important part of organisational motivation and are central to helping managers understand the forces that drive the organisation. Incentive systems can encourage or discourage employee and work group behaviour. A good incentive system also encourages employees to be productive and creative, fosters loyalty among those who are most productive, and stimulates innovation. Incentives can be broadly classified as financial and non-financial incentives.

Types of Incentive Schemes

' Types of incentive schemes ' ' Types of incentive plans '

(1) Individual Incentive Plans

Individual incentive plans are widely accepted today and most of them contain provisions that encompass corporate and group objectives. But what makes them truly individual incentive plans is the fact that the actual awards to employees are differentiated based on individual performance criteria.

Types of Individual Incentive Plans Individual incentive plans are many and varied. The International Labour Organisation (ILO) classifies all the schemes of payment by result into following four categories –

(i) Earnings Varying in Same Proportion as Output – The chief characteristics of the schemes where incomes vary in proportion to output is that any gains or losses resulting directly from a worker’s output accrue to him or her (leaving to the employer any gains or losses in overhead costs per unit of output). In contrast, when the worker is paid. by the hour, day or month, all gains or losses resulting from changes in his or her output accrue to the employer. There are two incentive schemes under this category –

  • Straight Piece – Work
  • Standard Hour Plan

(ii) Earnings Varying Proportionately Less than Output – Four allied but different systems come in this group, namely, Halsey, Rowan, Barth, and Bedaux. The common feature of all these is that time is used as the measure of output and bonus is paid on the time saved, that is, the difference between the standard time- set for the job and the time actually taken. These plans are explained below –

  • Halsey Plan
  • Rowan Premium Plan
  • Barth Variable Sharing Plan
  • Bedaux Plan

(iii) Earnings Varying Proportionately More than Output – This category includes two methods –

  • High Piece Rate – Under this system, the earnings of the worker are in proportion to his or her output, as in straight piece-work, but the increment in earnings for each unit of output above the standard is greater. For example, for each one per cent increase in output above the standard, there may be a 4/3 times increase in earnings as compared to one per cent increase in earnings under the straight piece-rate system. The higher rates start applying after the standards have been reached. Similar logic applies to the high standard hour system.
  • High Standard Hour System – Under the high standard hour system, the rate per unit of time is higher. For example, there may be a 10 per cent increase in the time rate earnings of a worker for every one per cent increase in output above the standard.

(iv) Earnings Differing at Different Levels of Output – This group includes several schemes. These systems can be best explained by describing how earnings vary from minimum to maximum at different levels of output. Earnings for one part of the range may vary proportionately less than output and for another part proportionately more, or more usually in the same proportion as the output. Systems which fall under the category where earnings differ at different levels of output are as follows –

  • Taylor’s Differential Piece – Rate System
  • Merrick’s Multiple Piece – Rate System
  • Gantt Task and Bonus Plan
  • Emerson’s Efficiency Plan
  • Accelerating Premium System

(2) Group Incentive Plans

Group incentives are the incentive wage plans which motivate the group to produce more. The group might consist of a couple of individuals, an entire department, or an entire company. Group incentive plans are useful where the workers’ jobs are highly interrelated. Group incentive plans are intended to get employees to work as a collective unit. Types of group incentive plans are as follows –

(i) Priestman’s Production Bonus Plan – In this plan, a group of experts set the standard performance in terms of the number of units for the whole work to be carried out by a group within a specific period. Then, the actual performance of the group is measured and this performance is compared with the standard performance. When the actual performance exceeds the standard performance, the group members are entitled to a bonus computed on the basis of the excess production achieved by them. However, when the group’s performance is below the standard performance, they are paid on the basis of time rate without any bonus.

(ii) Cost Efficiency Bonus Plan – Under this plan, the organisation first determines the standard cost for the various elements of cost. These may be material cost, labour cost and overheads associated with production. Of course, an organisation may also decide the standard cost for the total cost of all these elements.

Next, it measures the actual cost incurred by the group in accomplishing the production goals or targets. Finally, the actual cost incurred by the group and the standard cost are compared to determine the savings in the cost achieved by the group. As per the cost efficiency plan, a predetermined percentage of the savings is distributed in the form of bonus to the employees.

(iii) Gainsharing Plan – Gainsharing matches an improvement (gain) in company performance to some distribution (sharing) of the benefits with employees. Usually, gainsharing is applied to a group or all employees, rather than an individual. Gainsharing focuses on the company’s most vital performance¬† metrics. Payout is often monthly or quarterly in gainsharing.

(iv) Towne Plan – This method considers the savings in labour cost alone for determining the rewards payable to the group. In the first step, the standard labour cost for the entire work is determined in advance. Then the actual labour cost for that work is measured and compared with the standard labour cost. Now, the saving in the labour cost is computed and a proportion of the saving in monetary terms is distributed to the group members. However, a part of the saving is usually given to the supervisors as a recognition of their role in cost saving. Of course, the organisation may get a share in the saving achieved in labour cost.

(3) Enterprise Incentive Plans

Enterprise incentive plans differ from individual and group incentive plans in that all organisational members participate in the plan’s compensation payout. Enterprise incentive plans reward employees on the basis of the success of the organisation over an extended time period-normally one year, but the period can be longer. It seeks to create a “culture of ownership” by fostering a philosophy of cooperation and teamwork among all the organisational members. Types of Enterprise Incentive Plans Types of enterprise incentive plans are as follows –

(i) Profit-Sharing Plan – The profit-sharing plans are based on predetermined economic sharing rules that define the split of gains between the company as a principal and the employee as an agent. For example, suppose the profits are x, which might be a random variable. Before knowing the profits, the principal and agent might agree on a sharing rules(x). Here, the agent will receive s(x) and the principal will receive the residual gain x-s(x).

(ii) Stock Options – Employee stock options are options granted by a company to its employees as a compensation for work. Stock options are opportunities for employees to purchase a specified number of shares of company stock in the future at a guaranteed price.

(iii) Employee Stock Ownership Plan (ESOP) – An ESOP is a defined contribution employee benefit plan that allows employees to become owners of stock in the company they work for. It is equity based deferred compensation plan. It is an alternative to selling the company to outside investors or to another company is to sell the company to its employees.

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