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FORMS OF INCENTIVE PAY

Lump Sum Payments

If you carefully monitor survey data, you should be able to keep your base pay rates within reason. But how do you avoid having your base rates creep out of line as a result of annual increases?  You do that by substituting lump sum payments for some of the annual increases. A lump sum payment is a one-time cash payment equal to some percentage of base wages. For example, instead of giving a 4 percent annual increase, you give your employees a one-time cash payment equal to 5 percent of their annual pay.  The chief advantage of a lump sum payment over an annual increase is that, unlike an annual increase, it doesn't accumulate. You are not adding the 5 percent payment on each year in the future. The advantage for employees is that they get the payment all at once as one large check instead of having it spread out over the year.

Group Incentive Bonuses

Neither base pay nor lump sum payments are motivating. Group incentive bonuses are. Consequently, a major component of your compensation strategy should be to provide an opportunity to your employees to make substantial bonuses, provided their performance improves.  One of the most popular group incentives being adopted by large and small companies over the last five years is called gain sharing.

As its name implies, gain sharing is an incentive program whereby employees share in financial gains that come to their company as a result of their efforts. A formula for calculating gains is developed and then performance each month or quarter is compared to performance during some historical period or to some target performance. If current performance is better than the historical or target base, then again is made and the company and employees split the gain. Employees receive cash bonus payments in a separate check. In a manufacturing environment, the formula will often compare direct labor costs to the sales value of production.  In short, if employees produce more for lower labor costs then a gain is made and a bonus is paid. In a service environment
Employees might have targets or goals to meet on a variety of measures (such as customer satisfaction, service delivery times and/or operating costs). If they perform better than the targets then they earn bonus points that are worth so much in cash.

Gain sharing has been used in the United Stales since the 1930s and has been extremely successful. Four example, 80 percent of the companies adopting gain sharing have said it had a positive or very positive impact on performance (productivity, cost savings, improvement in customer service, and so on). Since gain sharing has been around a long time, a lot of books and articles exist to help you design your own company's gain sharing plan. For example, Maximum Performance Management, by Joseph H. Boyett and Henry P. Conn, contains detailed information about how to design and install a gain sharing plan.  Books and articles will explain standard gain sharing formulas that other companies have used and will point out other decisions you must make in designing a plan. Since there are some legal ramifications of gain sharing, such as ensuring compliance with the Fair Labor Standards Act, you should read some of the many books on gain sharing and have any plan reviewed by your accountant and attorney before you adopt it.

Profit-Sharing

Profit-sharing is similar to gain sharing in that employees have the opportunity to earn bonuses based upon company performance. In this case, you set aside a certain percentage (either a fixed amount or adjusted each year) of the profits of the company that will be paid to employees if certain annual profit goals are met or exceeded. Bonuses are paid out in cash, as a contribution to a retirement fund, or partially in cash and partially as a contribution toward retirement. Like gain sharing, profit-sharing has certain legal ramifications and you need to check out any plan with  your accountant and attorney.

The advantage of profit-sharing is that it ties any bonuses you pay to the actual profits of the company. Under gain sharing, you conceivably could be paying bonuses even when the company was not profitable or when profit goals weren't met. (The reason for this is that many gain sharing formulas do not include all costs.)  

The disadvantage of profit-sharing is that employees may make a bonus even when their performance didn't improve. Maybe the profits occurred because a new product line took off, the business economy improved, or you were able to raise prices. It is likely your employees had little, if anything, to do with these favorable developments. On the other hand, employees could work hard all year and not receive a profit-sharing bonus simply because the economy suffered a downturn, you decided to write off some receivables, or for any number of other reasons out of their control.  Finally, profit-sharing bonuses are normally not paid as frequently as gain sharing bonuses. Normally, profits are determined at the end of the year. Thus, employees may work hard all year without any clear assurance they will revive a bonus. You, and they, won't know until the books are closed at year end.

Pay-for- Knowledge

Gain sharing and profit-sharing address your need to establish some link between employee performance and compensation.  Since one way employees can improve performance is through teamwork, cooperation, and the willingness to be flexible in job assignments, gain sharing and profit-sharing  promote such behavior.  But what if employee flexibility is critical to your company?  The answer might be to design and install a pay-for-knowledge system.

Under pay-for-knowledge, employees are given the opportunity to earn supplements to their base pay if they can learn and retain skills in a variety of jobs or just increase their skill in one job, The value to your company comes from having multiskilled employees who are willing and able to perform any job you need them to perform. Usually under a pay-for-knowledge system, you define number of skill sets. Each skill set is worth a certain amount in additional base pay. For example, you might pay an additional fifty cents or one dollar per hour for each skill set an employee learns and can prove he or she retains. As in the case of the other innovative pay systems we have discussed, you need to read more about pay-for-knowledge (Maximum Performance Management includes a chapter on this pay system), and you should check out any system you design with your accountant and attorney.

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