Group and Individual Incentive Compensation Strategies and the Tracking of Human Capital

Executive Summary

Group bonus incentive programs and individual variable compensation strategies can increase the level of organizational productivity. The success of such strategies is contingent on tracking human capital. The synthesis of these two factors, financial incentive pay and tracking human capital, is contingent on open forms of management and quantifying performance standards.

The purpose of this paper is to steer the management of an organization with over 100 employees at a variety of salary levels to increase productivity through compensation strategies. Specifically, this paper will seek to incorporate research findings on variable compensation strategies into a new set of compensation strategies for this organization. The first research finding shows that group bonus incentive programs are an important way of increasing productivity within employees that receive a similar pay grade. These types of bonus incentive programs can be risky if individual parameters for productivity are not established. A second research finding shows that individual variable pay incentives can increase productivity for low challenge and low investment jobs. Fixed pay wages can increase productivity for high challenge jobs. A third research finding suggests the importance of implementing a rating system that quantifies the levels of productivity that can be rewarded with incentive bonuses. This rating system is best if it quantifies human capital above other productivity standards.

Sharing gains can incentivize teamwork and bolster individual performance standards, but certain considerations must apply. This paper seeks to identify those considerations through an analysis of how each research finding will affect the organization, as well as research finding-specific recommendations for the implementation of a new set of compensation strategies. Open and honest management practices help decrease employee dissatisfaction. Integrating low challenge positions into the decision-making process also helps, but only if periodic evaluations are concurrent priorities. As job complexity increases these considerations don’t apply as strictly for low complexity positions. Individuals who prove their worth within an organization through variable pay incentive gains should be rewarded with increased job complexity and a higher fixed wage. Employee dissatisfaction due to subjective senses of worth are realities that must be confronted through these strategies. Quantifying human capital is an important way to track objective standards, decreasing subjective employee dissatisfaction.

Introduction

Compensation strategies aim to provide fair and comprehensive pay to employees, incentivize productivity, and establish parameters for organizational growth. It is no surprise, then, that low paid workers in low challenge positions have a high turnover rate and lack the same level of loyalty or investment that higher-paid workers receive. Fixed pay plans are generally necessary to retain skilled workers in positions of a high challenge as the employee’s individual production has a greater effect on organizational productivity than lower-skilled, lower challenge positions. It is the goal of this paper to recommend to the management of an organization of 100 employees at different salary levels the implementation of a group-based incentive program, an individual variable pay program, and a system of tracking human capital.

Employee perceptions of self-worth are largely subjective. Therefore, motivation to increase productivity must speak to employees at the individual level. Compensation, the primary incentive for employee participation, is an important tool that can be used to extrapolate that primary incentive into more focused levels of productivity. In an important look into incentive strategies, Balkin and Logan (1988) concluded that “a company’s pay system, if planned effectively, is a communication tool that reinforces desired employee behaviors and attitudes” (p. 25). While the specificity of a compensation strategy will be dependent on the nature of the organization’s work, it must be focused. Just as a well-organized compensation strategy can increase employee productivity, an ambivalent approach can just as easily create unintended miscommunication.

The purpose of this paper is to focus on compensation strategies at the group and individual levels in order to steer gains in productivity. Motivating employees to increase productivity by pandering to individual characteristics is ideal, but the resources required for this would be substantial. Instead, recommendations to management are made to implement compensation strategies that can reward individual and small group productivity to foster competition, increase individual upward mobility through promotions, and create a framework for quantifying an objective level of employee worth. Increasing individual motivation requires a strong emphasis on tactile goal constructs and managerial characteristics like volition, disposition, and an understanding of employee task characteristics. The communication of these types of considerations is embodied in the compensation strategy.

Indirect communication through compensation is powerful, but quantifying the intended levels of productivity is necessary to incentivizing performance. Bonus incentive programs at the group and individual levels are a direct form of rewarding productivity, however incentive programs produce winners just as they produce losers. Employees who do not receive incentive bonuses due to low productivity will retain their subjective sense of worth. This potentiates a negative view of the organization, future performance, and workplace social problems. An impartial set of standards for rewarding productivity can establish an objective understanding of an employee’s worth.

Research Findings

Group bonus incentive programs are gainsharing, variable pay plans that provide a distinct incentive to groups of employees for increased productivity in some quantifiable way. In an evaluation of Large Group Bonus Plans (LGBP) Schuster and Hoffman (2011) found significant improvements in the overall productivity of businesses after the implementation of LGBP. In one case study, they found that the success of such plans is oftentimes contingent on employees having a stake in the decision-making process (Schuster and Hoffman, 2011). Success was also contingent on an ongoing evaluation process. When applied in the correct format with proper considerations it seems that gainsharing plans at the group level can increase productivity and connect employees more intimately with the company, fostering loyalty.

Incentivized compensation packages don’t necessarily meet the requirements of all organizations. Balkin and Logan (1988) found that compared with bureaucracies and other forms of traditional hierarchical organizations, group-based variable compensation systems apply best to entrepreneurial organizations. They found that this was largely due to entrepreneurial-minded employees favoring a flat structure of pay grades where the ability to rise within the company was based on a small group or individual performance.

Group bonus incentive programs offer potential increases in job performance and organization productivity, but they must be implemented in a way that synergizes employee and managerial incentives. In the case study analysis of two industrial-production companies, Gross and Duncan (1998) found that “Partners in Performance” programs effectively linked pay to productivity among groups of workers (p. 47). The implementation of such programs, though, was a function of how open and honest management was with their employees. Employees, it seemed, responded well to the adoption of decision-making responsibilities.

Analysis: Sharing gains can incentivize employees to work together in a more productive manner. Management within this company should make note of case studies of group bonus incentive plans that have shown an increase in the productivity of business following the implementation of such an incentive program. The cost of production can go down if group incentive programs are implemented within a population of similarly compensated employees. Management should also note that the inclusion of employees in the decision-making process of implementing a group bonus incentive can add significant value to the first few months of the program. Open and honest management and periodic evaluations are also necessary components of a successful group-based incentive program.

Variable pay is some form of direct incentive pay that isn’t an agreed-upon the fraction of base pay. Variable pay can act as an incentive to drive performance by offering direct increases in pay. A common example is a commission-based pay structure. Miceli (2000) states the utility of variable pay structures in that they quantify performance. In order to more aptly quantify that performance, they found that successful plans have a framework that considers the current market pay, performance measures, payout formulas, frequencies of payouts, and leveraging ability (Miceli, 2000). The more competitive the market, the greater the importance to quantify performance measures.

The difference between fixed pay and variable pay systems lies in the incentive provided to the employee, coupled with the level of challenge inherent to the employee’s performance requirements. Madhani (2010), in a realignment study of fixed and variable pay structures in sales organizations, showed that human resource departments with quantifiable tracking systems relied more on variable pay and less on a fixed pay. This was indicative of the “salesperson’s opportunity cost of time” (Madhani, 2010, p. 491). If the salesperson feels their opportunity costs could be maximized within a different variable incentive program they will more likely join a close competitor or decrease their performance before they retain a high level of performance in hopes of future incentives. Well measured variable pay programs can function as performance-enhancing strategies, but they can also work as a form of upward mobility in an organization, recognizing high performing employees who will, in turn, receive a fixed pay salary upon retention and promotion.

Analysis: When an employee’s job complexity, institutional knowledge, and job skill increase variable pay decreases as an incentive. Management for this company should note that subjective worth increases when performance standards are quantified, making it worth an objective norm. Variable pay incentivizes performance when the challenge presented by the job task is relatively low, giving an employee reason to move ahead of his or her constituents. When that employee becomes skilled and able to take on more challenging job tasks variable pay will become less of an incentive. If this company implements such a program it is imperative that such employees are rewarded beyond individual incentives. Quantifying performance standards is an important way to identify those employees, and to establish the objective norms of work performance. Retaining high performing employees is an obvious benefit to organizational success, and it can act as a self-reinforcing mechanism to drive performance standards at the lower levels of the organizational hierarchy.

Group based incentive programs and individual variable compensation strategies can be risky if they aren’t implemented and tracked properly. Wright (2011) attempts to quantify human capital in order to make use of tracking mechanisms. Emergence is cited as an important concept to understanding true human capital, as well as the individual’s effect on organizational functioning. Emergence considers how the aggregate of individual human capital and potential capabilities plays into the measurement of organizational success. This is best accomplished by looking at the individual, social, and task-oriented context at all times (Wright, 2011).

Various case studies have shown that measuring certain parameters can create statistically significant increases in organizational productivity. Huselid (1995) showed that much of that productivity is due to a large decrease in employee turnover, which is a very costly problem in both financial and operational senses. His work showed that such a drop in turnover correlated to quarterly increases in revenue sales, and “the magnitude of the returns for investments in High-Performance Work Practices is substantial” (Huselid, 1995, p. 667). Measurable variables that are important include turnover, productivity, gross rate of return on assets, employee skills and organizational structure, and other systematic risk assessments.

High-performance work systems are operational landscapes that aim to increase productivity at the organizational level by fostering human capital at the individual level. R. Takeuchi, Lepak, Wang, and K. Takeuchi (2007) state that high-performance work systems generate a high level of collective human capital by fostering the group dynamic. These systems have certain characteristics that self-perpetuate productivity. Three important characteristics are: decentralization of the decision-making process, reduced status distinctions, and extensive sharing of financial and performance-based tracking data.

Analysis: The risks associated with implementing variable compensation and group bonus incentive plans is largely a product of individual employee dissatisfaction during periods of low productivity. Management for this company should understand that an employee’s worth is largely subjective and decreases in variable incentives during organizational low points will reflect on that subjective sense of worth. Tracking human capital is a way for this company’s management to layout objective standards of performance, and in order to maximize the return on investment for these types of incentive plans an organization must implement a performance-based tracking system. Quantifying human capital has shown to be a successful way of maximizing variable compensation strategies, and this indicates the importance of management-oriented periodic evaluations and open streams of communication. These are proven sources of support when implementing group bonus incentives and variable pay strategies.

Recommendations

Recommendation 1: The implementation of a group-based incentive program is designed to increase productivity by incentivizing workplace collaboration. A group-based incentive program should be implemented within a group of employees based on the same pay grade, with a focus on gainsharing. Incentives to groups should be linked to decreased cost of production and/or increased sales, and the specific measures of performance (which will depend on the work involved) should be tracked quarterly to allow for a return on the intended savings in production. 10% of savings should be allocated to this incentive program. Furthermore, open management techniques like postings of productivity reports and frequent employee-management communication should be primary goals.

Recommendation 2: Individual variable pay incentives, much like group bonus incentive plans, are not only a good way to increase general workplace productivity, but they can also identify high performing workers that could succeed with higher challenge jobs. An individual variable incentive program should be implemented in this company within the largest population of employees at a similar pay grade. Base pay should be decreased, and the remainder should be allocated to individual variable incentives over the first four months of the program. After the first four months, the incentive allocation should come from increased productivity and/or sales. If productivity does not increase this strategy should be reconsidered, however individual incentives should be awarded on a monthly basis to track the early success of the strategy. Upon identifying those employees within their individual incentive plans, or within the group based structure recommended under Research Finding 1, those individuals should be rewarded with high challenge jobs as resources and availability allow. Upon reaching high challenge positions the variable pay incentive should be replaced with a higher fixed wage. This will act to retain such individuals by establishing value without sacrificing a large fraction of labor costs. The variable pay incentives help to quantify that process.

Recommendation 3: The incentive-based compensation strategies offered in the first two research findings have the potential for successful outcomes, but the performance standards must be tracked. Quantifying human capital is an important and accurate way of determining objective performance standards. The primary goal for this company should be creating internal benchmarks for performance standards instead of using external industry-wide benchmarks. In order to do that human resource management should be tasked with the tracking of three standards: the percentage of employees trained in product knowledge, the percentage of employees completing sales training, and the percentage of employees who see compensation linked to customer service. The performance expectations should be organized, insightful, and published in a public workplace forum. The publication of such trends will create an environment in which workers will have less room to use subjective determinants as a form of tracking their own performance. They will be bound by standards of performance, and if those standards are quantified with human capital in mind the rights and well-being of the employees won’t be sacrificed.

Conclusion

Group bonus incentive plans and individual variable compensation programs can be effective strategies for increasing employee productivity. In low paying positions case studies and theoretical analyses have shown that incentive-based compensation programs fostered competition and increased productivity (Gross et al., 1998). This is generally understood to be a quality of entrepreneurial spirit. By fostering such competition and rewarding low paid workers in low challenge positions, organizations can identify employees with the highest levels of worth. These employees can then be placed in higher complexity positions, rewarded with a fixed pay. This will retain high functioning workers and incentivize individual and group-level performance.

Specific recommendations have been made to realize the importance of these research findings. It is recommended that group-based incentive programs should be rolled out within a population of employees at a similar pay grade, and performance standards should be quantified quarterly under a general gainsharing platform. It is also recommended that an individual variable pay program be implemented within the lowest skilled employee group to increase performance and to identify employees capable of higher-skilled work. Finally, it is recommended that the tracking of human capital runs concurrently of these incentive compensation programs with a focus on product knowledge, sales training, and customer service.

An incentive program for low pay grade workers increases entrepreneurial spirit and fosters productivity, but only if the program is coupled with proper tracking mechanisms. Tracking quantifiable levels of human capital justifies individual bonuses and group performance standards. This doesn’t just produce better workers; it establishes important parameters of human worth. Low paid workers in low challenge positions won’t see themselves as expendable units of an organization’s toolbox. They will see themselves as producers who are paid more for good work. This will foster productivity, decrease worker turnover, and allow an organization to identify its best employees.

References

Balkin, D. B., & Logan, J. W. (1988). Reward policies that support entrepreneurship. Compensation and Benefits Review, 20(1), 18-25.

Gross, S. E., & Duncan, D. (1998). Case study: Gainsharing plan spurs record productivity and payouts at Ameristeel. Compensation & Benefits Review, 30(6), 46-50.

Huselid, M. A. (1995). The Impact of Human Resource Management Practices on Turnover, Productivity, and Corporate Financial Performance. The Academy of Management Journal, 38(3), 635-672.

Kuhn, K. M., & Yockey, M. D. (2003). Variable Pay as a Risky Choice: Determinants of the Relative Attractiveness of Incentive Plans. Organizational Behavior and Human Decision Processes, 90(2), 323-341.

Madhani, P. M. (2010). Realigning fixed and variable pay in sales organizations: An organizational life cycle approach. Compensation & Benefits Review, 42(6), 488-498.

Miceli, M. P. (2000). Contextual determinants of variable pay plan design: A proposed research framework. Human Resource Management Review, 10(3), 289.

Schuster, M. H., & Hoffman, D. (2011). Evaluating large group bonus plans. WorldatWork Journal, 20(2), 16-31.

Takeuchi, R., Lepak, D. P., Wang, H., & Takeuchi, K. (2007). An empirical examination of the mechanisms mediating between high-performance work systems and the performance of Japanese organizations. Journal of Applied Psychology, 92(4), 1069-1083.

Wright, P. M., & McMahan, G. C. (2011). Exploring human capital: Putting ‘human’ back into strategic human resource management. Human Resource Management Journal, 21(2), 93-104.

Balkin, D. B., & Logan, J. W. (1988). Reward policies that support entrepreneurship. Compensation and Benefits Review, 20(1), 18-25.

Gross, S. E., & Duncan, D. (1998). Case study: Gainsharing plan spurs record productivity and payouts at Ameristeel. Compensation & Benefits Review, 30(6), 46-50.

Schuster, M. H., & Hoffman, D. (2011). Evaluating large group bonus plans. WorldatWork Journal, 20(2), 16-31.

Kuhn, K. M., & Yockey, M. D. (2003). Variable pay as a risky choice: Determinants of the relative attractiveness of incentive plans. Organizational Behavior and Human Decision Processes, 90(2), 323-341.

Madhani, P. M. (2010). Realigning fixed and variable pay in sales organizations: An organizational life cycle approach. Compensation & Benefits Review, 42(6), 488-498.

Miceli, M. P. (2000). Contextual determinants of variable pay plan design: A proposed research framework. Human Resource Management Review, 10(3), 289.

Huselid, M. A. (1995). The impact of human resource management practices on turnover, productivity, and corporate financial performance. The Academy of Management Journal, 38(3), 635-672.

Takeuchi, R., Lepak, D. P., Wang, H., & Takeuchi, K. (2007). An empirical examination of the mechanisms mediating between high-performance work systems and the performance of Japanese organizations. Journal of Applied Psychology, 92(4), 1069-1083.

Wright, P. M., & McMahan, G. C. (2011). Exploring human capital: Putting ‘human’ back into strategic human resource management. Human Resource Management Journal, 21(2), 93-104.