Incentives and Incentive Plans – Advantages and Disadvantages

Incentive Plans refer to performance-linked compensation or performance-based rewards paid to improve the motivation and productivity of employees.

Definition

An incentive scheme is a plan or program to motivate individual or group performance. An incentive program is most frequently built on monetary rewards (incentive pay or monetary bonus), but may also include a variety of non-monetary rewards or prizes.

Determinants of Incentives

The individual

Different individuals value things differently. A reward that is considered highly attractive by one employee may not be attractive to another. Managers need to develop incentive plans giving top priority to employee preferences and desires.

The work situation

There are four important elements of the work situation that affect incentives

  1. Technology
  2. Job satisfaction
  3. Feedback
  4. Equity
  5. Incentive plans can be classified into two categories:
  6. Individual incentives
  7. Group incentives

Individual Incentive Plans

Rewards tied to the performance of individual employees are known as individual incentive plans. Individual incentive plans may be based on time or output.Some popular individual incentive plans are:

  1. Piecework
  2. Standard hour plan
  3. Bonus
  4. Perquisites
  5. Commissions
  6. Stock options

1. Piecework

Compensation is based on the number of units produced.

Straight piecework plan – Employee is guaranteed a minimal hourly rate for meeting some pre-determined standard output

Differential piece rate – Employees whose production exceeds the standard output receive a higher rate for all their work than the rate paid to those who do not exceed the standard.

2. Standard hour plan

A standard time for completing a particular job or task is established. The worker is paid the standard rate even when he or she completes the job in less time than the standard time.

3. Bonus

An incentive payment is given to an employee beyond his normal base wage. Frequently given at the end of the year and does not become a part of the base pay. Provides employees with more pay along with the security of a basic wage.

4. Perquisites

Perquisites are incentives offered to highly talented and competent employees. They are reserved only for some employees.

5. Commissions

Commonly used in sales jobs Straight commission plan –the salesman is paid a percentage of the price of the item. Combined salary and commission plan – the salesman is paid a small salary and the rest is paid in the form of commission on the sales made.

6. Stock options

The employee is granted the right to buy a certain number of shares of the company’s stock at a given price by a specified date. If the stock price rises, the employee can make a significant profit when the option is exercised. If the stock price falls, the option is not exercised.

Examples of Individual Incentive Plans

Infosys has been rewarding its sales force as a unit. The better the company performs, the higher is the variable pays out for everyone regardless of the performance of individual accounts.

Infosys is planning to put in place a new individual incentive structure to reward its sales superstars seeks to reward top performers handsomely on the basis of the incremental revenue that they generate from their individual accounts and new logos won regardless of the company’s overall performance.

Group Incentive Plans

1. Group Incentive Plans

Earnings of a group are related to the performance of the group as a whole.  Purpose is to encourage teamwork and cooperation to attain high productivity or performance It is useful when it is difficult to measure each individual’s output and when teamwork is important.

Some group incentive plans are:

1. Productivity gain sharing plans

2. Profit-sharing plans

2. Scanlon plan

Attempts to stimulate production efficiency by allowing employees to share in labor and production cost savings through periodic bonus payments. The Scanlon plan is a well-known gain sharing plan. The main concept is to use pay to tie the goals of the individual to that of the organization

3. Profit-sharing plans

A part of the organization’s earnings is distributed to employees to supplement their usual wages or salaries. Used to encourage cooperation, boost morale, and increase employees’ financial security.

There are three types of profit-sharing plans:

1. Current distribution plans – A percentage of the profits is distributed in cash at intervals of one year or less.

2.Deferred distribution plans – A percentage of the profits is deposited in an irrevocable trust and credited to the accounts of individual employees at retirement or termination.

3.Combined plans – Combination of current and deferred distribution

Advantages of Profit-Sharing Incentives

  1. Improves productivity
  2. Creates a sense of responsibility among employees
  3. Industrial democracy is promoted as workers are treated as partners and not as mere wage earners
  4. A stable workforce is built because the chance of profit-sharing attracts and retains qualified workers

Disadvantages of Profit-Sharing Incentives

  1. Profit-sharing may lead to conflict between the employers and the employees
  2. Incentives are not guaranteed
  3. Employee morale dips when they do no not get additional earnings
  4. External factors beyond employee control may have a greater impact on the company’s profitability

Group Incentive Plans: Example

HCL introduced an “Engagement Bonus“ for its employees. Bonus for individuals is decided on the basis of team performance, including the performance of underperformers in the team.

Performance is linked directly to client engagement that the employee is working on in a team. The weakest link in the team decides the bonus for the entire team.

Advantages and Disadvantages of Incentives

Advantages of Incentives

  1. Employees are Motivated to work hard and perform to the best of their abilities to earn incentives.
  2. Employees are willing to assume Ownership when compensation and organizational objectives are linked.
  3. Employees think of more Innovative ways of doing work and avoid wasteful and unproductive practices.
  4. When payments to individuals are based on team results, incentives foster teamwork.
  5. Less supervision is required as workers are motivated to work hard. This reduces the cost of supervision.

Disadvantages of incentives

  1. Deterioration of quality as workers may increase output to earn incentives at the cost of work quality.
  2. Workers may overwork themselves, which can affect their health.
  3. Neglect of safety matters as workers resort to shortcuts and ignore safety regulations.
  4. Managements often face Resistance while revising standards and rates owing to changes in technology, work methods, machinery, and materials.
  5. Rivalry and conflicts may arise when one worker earns more than the other.