Strategic Human Resource Management. Performance-Related Pay Systems - Essay Example

?Performance-Related Pay Systems Elective Module: Strategic Human Resource Management Introduction Within a modern business environment, employers must balance the needs of the business with the requirements of the employees. Human Resource Management (HRM) is an important aspect of this, where employers organise and develop strategies for working with their employees. Many employees work inefficiently, as they have no desire to perform well for the company. This comes from the fact that what is good for the company is not necessarily the same as what is best for the employee. Businesses are generally aiming to make the highest profit possible, while employees are working for the money that they need to live. Performance-related pay is a system in which the company attempts to align the interests of the employees with the interests of the business, by providing employees with incentives to work hard. The exact form of the system differs substantially between different companies, with some offering commission-based pay, some paying employees a certain rate per unit produced and others paying based on team performance. There are many other variations of performance-based pay and it is a popular means of increasing overall output for a business. Performance-related pay is common in Britain and has been used for government employees as well as many large companies . However, despite the popularity of the system, current research is questioning whether performance-related pay is actually effective. Evidence suggests that this may be a mechanism that is useful in some circumstances, and counterproductive in others. The need for performance-related pay In the standard work environment, people work because they need the money, not because they have a strong loyalty for the company. While some individuals may strive to put in effort to make sure that they perform well and that they are an asset to the company, most are content with doing the minimum that is required of them. Because the success of the company does not directly affect their pay check, most people have no interest in how well the business does. Research suggests that compensation is the most effective driver of motivation, behaviour and attitude within the workplaces. While forms of compensation vary, money has been shown to be the most influential . Consequently, the money that employers pay their staff members plays a crucial role in maintaining relationships and the development of motivation. Pay is an essential component of the relationship between employer and employee. For the employer, it is an important component of the costs of the company and is used for bringing in new talent as well as maintaining the current labour force. For the employee, pay is used as a way of paying for living expenses, and also represents how valued he is by the employer. A person who receives a higher wage feels that what they do is important, and may put in more effort as a result. In contrast, people who feel that they are being underpaid often do not work hard, and tend to have low morale which further decreases productivity. The traditional method of wage distribution has been non-performance-related, and pay increases have been related to a range of aspects, such as minimum wages, seniority, the cost of living or the need to retain staff. However, this system does not encourage skill development or employees to work at their maximum potential. Additionally, under this system pay rises were often associated with promotions. This can be difficult, as a person must be promoted in order to receive a pay rise and the number of positions present in a company is limited. Increasing an individual’s pay acts to reinforce positive behaviour, making it more likely that the behaviour will be repeated. Within a company, there are often many individuals that perform the same role, however they differ in terms of knowledge, experience and performance . For a business to remain competitive, it is important that their employees work to their maximum potential. Performance-related pay is used as a way to motivate employees to perform better and is based on two assumptions. The first is that the performance-related incentives will improve the effort and motivation of employees and the second is that these increase will result in increased performance . Thus, performance-related pay has the potential to provide many benefits to the company and to significantly increase its competitiveness. Types Individual systems can be further broken down into different ways of pay. A common method is for employee’s pay to place them in different tiers of performance, with each tier paying a different amount. The tiers may be based on output, efficiency or some other measure of performance. An alternate form of performance-related pay is commission. This is particularly common as a reward mechanism used for sales people. There are many different forms of commission, but often it will be where the person is paid a certain percentage of their sales. In some cases employees may be paid solely by commission, and other businesses pay a combination of commission and normal pay. Another form of performance-related pay is organisation-wide incentives. Here, it is not the productivity of the individual that makes a difference to their pay, but rather how everyone in the team operates. For example, one way of implementing this strategy would be to provide a bonus to all employees when the company hits a certain milestone, such as number of items produced or a particular ranking. Informing the employees of what they are working towards and the associated rewards can help to boost productivity and provide an incentive to employees. One benefit of this method is that it reduces competition among staff and promotes teamwork, as the incentive is available to all. However, this type of system also allows for some people to take advantage and let other people do the hard work. An intermediate approach is team-based incentives, where employees are allocated into different teams, and incentives are provided based on the overall productivity of the team rather than the individual. There is more accountability in a team environment than at the level of the entire organisation, and consequently it is harder for an individual to take advantage of the effort of others. Team-based incentives can help to motivate employees and promote hard work. However, this can create strong competition and tension between teams, often making between-team transfers difficult, as high performing teams do not want to risk the presence of someone who will make it harder for them to accomplish their goal. A different approach is gain-sharing. This is a system of performance-related pay that can occur at the level of the individual, team or entire organization. Here, the productivity gains of the company are directly shared with the company. This allows employees to see direct benefits to their work. However, it can be frustrating if only some staff members work hard towards this goal, as all benefit from it. This is a very effective model from the perspective of the business, as it ensures that the costs never outweigh the benefits, and they do not have to pay high incentives in times where the company is making low profits. Profit-sharing is a similar model however here the amount that the employees receive is directly related to the company profit and is calculated from a formula previously determined by the employers and the employees. The advantage of this is that it is a very transparent system and employees know exactly what to expect. Objectives of performance-related pay Performance-related pay is an attempt to align the interests of the employee with that of the business. In a non-performance-related pay system, employees are often interested in investing as little effort as possible and as a consequence, motivation and performance can be low. The implementation of performance-related pay is assumed to improve motivation and performance of employees by the provision of incentives . Thus, the overall objective of the system is to motivate employees, ultimately resulting in a higher output for the company and greater profits. The system needs to be balanced in a way that the costs of the incentives are outweighed by the financial benefits of increased performance. Strengths and weaknesses of performance-related pay Strengths There are many benefits to performance-related pay systems. They have the potential to increase the overall productivity of the company and of individual employees, as well as increasing employee morale and loyalty . As employees become more motivated, their performance increases. As a result, the company is able to gain more productivity from its current employees rather than train new staff and renegotiate contracts. Another strength of the system is that it allows employees and businesses to renegotiate their relationship and its terms. This allows employers to redefine the standards of performance that they expect, and the employees to fight for better pay and conditions. Renegotiation is an important aspect of performance-related pay that is often underestimated. . Additionally, performance-related pay systems are strongly related to economic environment, and this allows employers to fine-tune the amount employees get paid based on the strength of the economy. Weaknesses Performance-related pay can be a difficult system to use as it involves a significant time investment by the company. One of the most important aspects of performance-related pay is determining how the individual is performing. This can often be time consuming and it is important that the business evaluates performance correctly, or there is the risk of employees feeling that they are being unfairly treated. Appraisal is a commonly used method of employee evaluation. This commonly involves the employee being supervised for a predetermined length of time and their performance being evaluated fully or in part as the result of this appraisal . Performance may also be determined through factors such as, how many units are produced, how long is spent working with clients or how many items are sold (such as in a commission-based system). One weakness of performance-related pay systems is that there are many cases where the performance of one employee comes at the cost to another’s performance. For example, many car salesmen are employed under a system of commission, where they get a certain amount per car sold. This results in multiple employees competing with each other for customers, and can result in tension within the workplace. Many methods of performance-related pay are based on the productivity of either individuals or teams. Measuring productivity can be time-consuming in many situations and as a consequence, some models and businesses make use of a degree of self-reporting. As the income of the individual is directly related to the figures that they report, there is an incentive for employees to exaggerate their performance. Another area where the system fails is where it is applied to a complex job but uses only one or a few measures of performance. This can give an incorrect measure of performance and does not take into account quality. In many cases, this acts to increase the speed at which people work, but decrease the quality of the end product, as performance is measured by production only. This can result in dissatisfaction and frustration by many employees, as many who feel that they are performing well are not recognised, and not rewarded, under the system. Additionally, using one or a few measures of performance can be misleading as these may be affected by external factors. For example, people who are subject to a commission-based pay system see a decrease in their pay when the economy is performing badly and less people are purchasing products. However, the effort that they put into their work has not decreased, and many times has increased. Consequently, they can feel disheartened and angry with the company. A performance-related pay system is only effective if it is fair and the employees recognise it as such. It is important that employees are treated equally, and that there is no evidence of favouritism . If employees feel that they performance is not the only measure driving their pay then they can become resentful and decrease their productivity. For example, if an appraisal is the means used to assess someone’s productivity then a poor relationship between the appraiser and the employee may result in a bad outcome, even if the employees productivity is high. If the system is implemented effectively, then it can be successful and result in a substantial increase in productivity. However, it can be difficult to obtain the desired balance between the needs of the business and the employees. Effectiveness of performance-related pay Research indicates that performance-related pay is effective in some circumstances, but not in others. Performance-related pay is based on the assumptions that it will increase effort and motivation and that this in turn will increase productivity. However, this link is not always true . There are many external factors that can decrease the productivity of individuals or teams, and the use of a performance-related pay system means that this adversely affects their pay. For example, a system that bases pay on the number of units produced means that if a shipment of parts is late, then employees cannot produce their desired amount of product and may suffer a decrease in pay as a result. Employees respond to changes in different ways. Regardless of how well designed and how effective a performance-related pay system is, some employees will be happy with it, and others will resent it. This can be mitigated in part by the provision of goals and appraisal for employees who are happy with the new system. However, regardless of this, there will always be some people within the company for whom the system is not effective . In 2004, a performance-related pay system was introduced for family practitioners in the National Health Service (NHS) in Britain. The system made use of 146 distinct indicators of quality based on the organisation of care, the experience of patients and clinical care for specific chronic diseases. This scheme resulted in a substantial increase in performance and also increased the income of many practitioners. However, it is important to note that the quality of care was already increasing in the United Kingdom prior to the introduction of the program, thus it was not solely responsible for the effects observed . A similar effect was observed for healthcare quality in hospitals in the United States. Here, the use of a performance-related pay system resulted in improvements in quality and performance from 2.6% to 4.1% across two years . However, while performance-based pay systems appear to be successful in the healthcare industry, the same is not true in teaching. There has been a significant interest in linking the performance of teachers to their pay, but despite numerous attempts, this approach has generally met with failure. One problem with linking teacher performance to pay is that it is often difficult to determine what makes one teacher more effective than the other. Consequently, there are few approaches that teachers can take to become more effective, resulting in disillusion and frustration with the process. Research suggests that this problem may be specific to factors related to public schools, as similar attempts in the private school sector have met with significantly more success. . How effective performance-related pay is appears to depend on the type of company that is incorporating it. High-risk companies that incorporate a performance-related pay system fare significantly worse than low-risk companies that use the same system. Additionally, high-risk companies that use this system tend to do worse than similar companies that do not . The systems within the company also play a significant role in whether the method is successful. For example, if the union has a negative approach to this mechanism, then it can be very hard to implement. Generally, being aware of the cultural factors and demographics of the employees can help substantially. Some businesses may benefit most from team-based mechanisms, others from individual ones and some from schemes that operate at the level of the organisation. Whatever mechanism a business chooses to incorporate, it is important that it is carefully evaluated, as many performance-related payment systems are not successful. Performance-related pay has been shown to be effective in many situations, and is widely used. However, the results of research suggest that performance-related pay is effective when the employees are engaged in repetitive tasks. However, when tasks require creativity, problem solving or higher mental functions performance-related pay has been shown to decrease productivity rather than increasing it . Conclusion Within businesses, the desires of employees are often significantly different from that of their employers. While employers seek high production, employees do not generally have loyalty to the overall outcomes of the company. This disparity means that many employees often do not work at their full potential and consequently the productivity of the company itself is lower than it could potentially be. Performance-related pay systems have been introduced as a means of bypassing this problem and these have met with varying success. While in many cases these systems are able to motivate employees and significantly increase their productivity, in some industries and types of work it has the opposite effect. In jobs where there is a significant amount of thought involved it can be difficult to actively measure performance, and quality of work is often not considered. This results in people who are working hard and producing high quality products or services not being recognised or paid accordingly. This results in discouragement which can decrease productivity. In the healthcare industry, performance-related pay systems have been shown to be an effective way of increasing performance. However, the application of this system to teachers in public schools has been ineffective. Performance-related pay systems have many limitations and must be carefully considered before it is implemented in any business. While this can be successful in some situations, research indicates it is not as universally beneficial as is generally perceived. References Ariely, D., Gneezy, U., Loewenstein, G. & Mazar, N. (2009). Large Stakes and Big Mistakes. Review of Economic Studies, 76, 451-469. Ballou, D. (2001). Pay for Performance in Public and Private Schools. Economics of Education Review, 20, 51-61. Bloom, M. & Milkovich, G. T. (1998). Relationships among Risk, Incentive Pay, and Organizational Performance. Academy of Management Journal, 283-297. Boice, D. F. & Kleiner, B. H. (1997). Designing Effective Performance Appraisal Systems. Work Study, 46, 197-201. 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