Study Notes on Incentives
Incentives
Introduction to Incentives
Definition: Incentive pay is compensation linked to and based on performance, rather than base pay.
Performance Metrics: Incentives can be tied to the performance of individuals, groups/teams, and/or organizational performance.
Negotiating Job Offers
General Tips for Negotiation
Be Enthusiastic: Show excitement about the offer but maintain composure; losing your cool can cost you income.
Understand Objectives: The company's aim is to minimize costs; your aim is to achieve a salary that meets or exceeds the middle of their proposed range.
Long-term Financial Impact: Negotiating pay can lead to thousands in additional income, especially because raises are often based on base pay.
Consider Total Compensation: Evaluate salary, benefits, bonuses, rate reviews, and promotional opportunities.
Know Your Worth: Research through websites, colleagues, and recruiters to determine your market value.
Salary Guidelines
Handling Expected Salary Questions: Develop a strategy for discussing your expected salary on applications and interviews.
Rough Rules of Thumb:
$30,000 jobs: Typically hourly and non-negotiable.
$40,000 to $85,000 jobs: Negotiation range is generally $2,000 to $5,000.
Jobs over $85,000: Typically have greater flexibility due to required training or experience differences.
Consider Beyond Salary
Evaluate salary and benefits as a total package, noting that excellent benefits can compensate for a lower salary.
Benefits to Consider: 401K, Pension, Vacation, Health Care, etc.
Information about benefits should be accessible from hiring managers, company websites, or HR representatives.
Negotiating Tips
Initial Offer: Companies usually extend the first pay offer. Do not accept it immediately; take time to evaluate.
Restate Your Value: When negotiating, clarify your contributions or values to the company, and know your worth beforehand.
Request More: If the company does not adjust pay, consider asking for alternatives, such as an extra week of vacation.
If Pay is Unsatisfactory: Politely ask if you can get back to them, reevaluate how much you want the job versus the offered salary.
Rejecting Offers
Maintain Professional Relationships:
Remember your network helped you receive the offer.
The company invested time and resources in you.
Rejecting offers should be done gracefully to keep doors open for future opportunities.
Key Reminders:
Stay classy, gracious, and grateful when declining an offer.
Accepting Offers
Action Steps:
Set a start date and complete any required tests or paperwork without broadcasting your new role initially.
Once confirmed, submit a formal resignation letter to your current employer, cooperating for a smooth transition.
Address potential counteroffers from your current employer.
Thanking Contributors: Acknowledge everyone who assisted you during the job search (e.g., HR recruiter, potential bosses).
Designing Incentive Plans
Objectives of Incentive Plans
Organizations often tie pay to performance for four primary reasons:
To recognize and reward high performers.
To motivate individuals to achieve corporate goals.
To improve overall productivity.
To move away from an entitlement culture.
Assumptions Behind Incentive Pay
Certain individuals are more productive than others.
Higher performing employees should earn more to avoid errors of omission.
Some jobs significantly contribute to the success of the organization.
Key Considerations for Designing Incentive Plans
Before establishing an incentive pay plan, consider the following:
Employee preferences (cultural and personal differences).
Amount of rewards available for high performance.
Methods to effectively motivate individuals in their roles.
Objectivity of the evaluation process that determines the rewards.
Steps for Designing Incentive Plans
Identify Goals: Determine what actions or behaviors the organization is incentivizing (e.g., safety, performance).
Budget: Assess the financial implications of the pay program to ensure a positive ROI.
Differentiation of Rewards: Ensure rewards reflect performance distinctions and are not uniform across all employees.
Influences of Incentive Plans
Incentive plans can positively impact:
Individual Performance.
Team Performance.
Organizational Performance.
Additional areas such as customer service, quality and quantity of production, teamwork, attendance, safety, revenue growth, market share increase, cost reductions, and productivity improvements.
Performance Measurement and Goal Setting
Incentive plans should focus on measurable outcomes that align with the business strategy and performance expectations.
Rewards need to be fair and should be grounded in comprehensive performance metrics.
Types of Incentives: Short-Term vs. Long-Term
Short-term Incentives: One-time rewards to motivate short-term outcomes (< 1 year), commonly used to drive immediate performance.
Long-term Incentives: Designed to motivate behaviors that enhance company value over an extended period (> 1 year), often related to factors such as share price and organizational health.
Pay for Individual Performance
Merit Pay: Compensation based on specific individual performance metrics.
Variable Pay Plans: Incorporate a risk component in base pay that can be supplemented by performance returns.
Spot Awards: Immediate recognition for very specific desirable behaviors or achievements.
Extrinsic vs. Intrinsic Motivation:
Extrinsic Motivation: Comes from outside the individual (e.g., performance bonuses).
Intrinsic Motivation: Derived from enjoyment or interest in the task itself.
Conditions for Effective Individual Incentives
Individual performance must be identifiable.
There must be a desire for competitiveness among employees.
The organizational culture must emphasize individualism.
Spot Bonuses
Utilization: Approximately 35% of companies implement spot bonuses; 74% find them effective.
Awarded for exceptional performance, extraordinary effort, or completion of special projects.
Larger institutions often utilize formal methods; smaller companies may be more casual.
Examples include Eastman's Employee Team Recognition and Chairman’s Awards, typically issued in cash or equivalent value rewards.
Individual Rewards Beyond Cash
Skill-based Pay: Compensates employees for their proficiency and knowledge depth.
Recognition Awards: Acknowledge specific achievements such as safety measures or service milestones.
Alternative Rewards: Non-cash incentives that supplement traditional pay and comprise aspects like telecommuting and flextime.
Group Incentive Plans
Purpose: Align teams’ goals with organizational objectives and motivate teams to achieve collective targets.
Examples:
Gainsharing: Employees receive a share of productivity improvements – Scanlon plans for implementing cost-saving suggestions and Improshare for productivity growth.
Group Incentives: Designed to reward collective outputs, cost savings, or quality improvements based on team performance against set standards.
Advantages of Group Incentive Plans
Potentially improve organizational and individual performance by 5-10% annually.
Simpler to create performance metrics compared to individual plans.
Encourages cooperative behavior within and across teams.
Generates enthusiasm for teamwork among employees.
Enhances employee involvement in decision-making processes.
Disadvantages of Group Incentive Plans
Reduced visibility regarding individual contributions and their impacts on payouts (line-of-sight issues).
Possible turnover of top individual performers who feel they are under-compensated due to shared rewards.
Increased financial insecurity due to variable earnings linked to team productivity.
Challenges Leading to Group Plan Failure
Team Variety: Difficulties defining what constitutes a team.
Team Size Impact: Large teams may result in motivational loss and social loafing; small teams may develop dysfunctions.
Complexity: Complications can diminish line-of-sight regarding performance.
Control: Questions of how much control a team has over their outcomes (referencing Eastman's compensation system).
Communication: Ensure team members can articulate how they are compensated and the rationale behind it.
Organizational Incentive Plans
Goal: Align employee objectives with those of the organization, rewarding performance at the organization level.
Types:
Organizational Pay for Performance Plans: Provide short-term rewards based on organizational performance versus targets, exemplified by profit-sharing.
Employee Stock Ownership Plans (ESOPs): Trusts established by employers to hold company stock for employee ownership.
Performance Measurement Focus in Organizational Plans
Performance measures can be customer-focused, time-to-market, capability-focused, and other integer measures that gauge effectiveness across different operational metrics.
Profit Sharing in Organizational Plans
Primary Objectives
To enhance productivity and organizational performance.
To attract and retain talent.
To boost quality standards and employee morale.
Drawbacks of Profit Sharing
Necessitates disclosure of financial results to participants.
Year-to-year profit variance can complicate perceptions of fairness.
Profit outcome may not directly correlate with employee effort.
Stock Options in Organizational Plans
Mechanics of Stock Option Plans
Grant employees the right to buy a fixed number of shares at a set price for a limited duration.
Illustration: The opportunity to purchase 1,000 shares at $17/share, assuming market price rises.
Profit Calculation Example:
Purchase of shares at $17 vs. market price of $87, yielding significant potential profit.
Example Calculation of Stock Option Profit
Scenario:
1,000 options to purchase at $17/share.
Sell price rises to $87/share after exercising the options.
Calculation:
Purchase Cost: $1,000 x $17 = $17,000.
Sale Revenue: $1,000 x $87 = $87,000.
Net Gain: $87,000 - $17,000 = $70,000.
Employee Stock Programs and Risk
ESOP Definition: Programs through which employees acquire substantial ownership in their organization.
Advantages:
Preferential tax treatment for income generated by ESOPs.
Employees are motivated by their stakes in the company.
Disadvantages:
Associated risks with employee investments in failing companies (e.g., case of ENRON).
Special Situations in Incentive Plans
Executive Compensation Elements
Base salary.
Bonuses and performance-based pay.
Long-term incentives like stock options and performance shares.
Additional perks (perquisites).
Severance packages.
Sales Incentive Program Considerations
Key design decisions for sales incentive programs include:
Eligibility determination within the sales team.
Balancing salary and incentives to achieve desired compensation levels.
Formulating the structure for calculating incentives based on performance metrics.
Clarifying sales recognition and co-sales attribution.
Specifying the duration of the sales cycle.
Common Pitfalls in Incentive Program Decisions
Errors of Omission: Failing to acknowledge deserving awards.
Errors of Commission: Incorrectly awarding undeserving individuals.
Managing Incentive Systems
Performance Feedback and Evaluation
Technological tools increase tracking efficacy for performance metrics.
Evaluate incentive plan effectiveness through participant and administrator feedback.
Successful incentive programs should yield improved performance outcomes and utilize feedback for continuous improvement.
Effectiveness of Incentive Pay
Positive Impact: Well-designed incentive pay plans can lead to significant improvements in performance metrics (individual, group, corporate).
Cost Benefits: May lower overall operational costs.
Risks of Poorly Designed Plans
Inadequate payouts for expected work may create errors of omission among high performers.
Setting unachievable or overly simple goals.
Utilizing outdated metrics or overwhelming participants with numerous metrics.