Corporate Partners Research Programme

Smart incentives
Stephen Bevan

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Contents
Smart incentives the pay ahead? 1. Understanding employee performance: does theory help or hinder? 2. Reward strategy 3. Cash 4. Non-pay rewards and recognition 5. Conclusions Bibliography 7 10 13 19 22 23

The Work Foundation Registered as a charity no: 290003 First printed July 2003 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the publishers. This publication may not be lent, resold, hired out or otherwise disposed of by way of trade in any form, binding or cover other than that in which is is published, without the prior consent of the publishers.

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Smart incentives the pay ahead?

With a decade of low inflation behind us and most employers having had experience of linking performance to reward we have witnessed a relatively stable period of practice in the pay and remuneration field. Most UK employers have tended towards conservatism in their remuneration practices despite the best efforts of pay consultants and commentators to persuade us that our organisations cannot survive without competencybased pay, or contribution-based pay, or total reward, or flexible benefits. However, this stability has not meant complete stagnation or poverty of ideas. There have been some subtle shifts in practice as well as growing concerns about current practice, which more and more employers have begun to articulate. These include: Equality: increasing anxiety over the stubborn 19 per cent gap between men and womens earnings in the UK, together with evidence that some pay systems are inherently discriminatory, has made employers considerably more cautious over radical changes to reward practice. With relatively little action on the collective bargaining front, trades unions are playing more frequently the equality card to exercise leverage over employer practice. Individual or team?: for many organisations there has been a growing unease backed up by empirical evidence particularly in the public sector that reward individualisation is failing to deliver the goods in the ways anticipated in the mid- to late 1980s. Many more organisations have introduced a team element to pay to reflect the way work is actually organised and allow collective effort to be incentivised and rewarded. Pay or non-pay?: increasingly cash as the sole form of reward is a thing of the past in many organisations. Growth in the use of non-pay reward and recognition schemes has

signalled an acknowledgement that employees both expect and respond to a greater plurality of rewards. Payout failure: some employees have had to adjust their expectations over total earnings because of low inflation and a falling equity market. Performance-related bonuses, profit-share schemes and employee share schemes have dramatically reduced their payouts in recent years. This has increased a sense of indignation among employees despite the risk-sharing natures of these arrangements and raised anxiety among employers. There have also been macroeconomic concerns that reduced levels of discretionary or windfall schemes will feed through to reduce consumer spending on luxury goods and services, such as cars and holidays. Changing bargaining focus: the days when collective bargaining was about pay alone are also gone. Complex deals are more common, with unions often concerned about improving wider conditions including leave, reductions in working time and improvements to work/life balance, and employers keen to link reward practices to wider organisational change by tying pay deals of at least one year to working practice modernisation.1 With significant regional differences in the cost of living, some voices2 have argued that pay deals, especially those covering public sector workers, should include more of a local or regional element. Unsurprisingly, some unions have interpreted this as heralding the end of national pay bargaining. Expect more developments here. Fat cat backlash: the dismay voiced by many over senior managers and directors reward packages in newly privatised utilities in the late 1980s and early 1990s has found an echo in recent indignation at the pay deals being offered to CEOs in some of the worlds largest businesses. Aside from the sheer magnitude of some of the payments being made, there has been considerable concern over the

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Bevan, S and Horner, L (2003) Long Term Pay Deals in the Public Sector, Public Services Unit Briefing Number 1, June, The Work Foundation, London. Brown, G (2003) Euro Announcement, House of Commons, 9 June: Oswald, A (2001) Setting Public Sector Pay More Sensibly by Region, Financial Times, 24 August.

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way some former executives have attracted significant payouts despite having presided over seemingly poor performing corporations. These incidents have prompted rebellion among some shareholders and a new climate of caution and transparency over reward. Reward or incentive?: frankly, many organisations are still confused over the distinction between rewards where the focus is on past performance and incentives with its focus on future performance. Rewards and incentives each have their own specific function, though it is still common to hear managers describe discretionary merit payments for past performance as incentives. Where the distinction is clearly understood it is possible to witness a burgeoning of often imaginative pay and nonpay incentive schemes being set up to encourage employees to deploy their talents and efforts in a direction determined by the employer. While these schemes are often no more than the dangling of well-calibrated carrots, they usually have the merit that both parties are aware of the rules of the game. As long as the carrot is not too far out of reach and judged to be worth striving for, shortterm performance gains can also result.

This report
Smart incentives takes a closer look at some of these developments. In particular, it examines the differences between pay and non-pay rewards, and those between rewards and incentives. It asks whether there is scope for real innovation in reward practice in the current climate and whether organisations are in the least bit strategic about rewards to promote and support transformations in organisational performance and productivity.

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1. Understanding employee performance: does theory help or hinder?

For decades, much of the debate among HR theorists and organisational behaviour gurus has focused on how to get more effort and performance from employees. However, casual observers, especially if they are practitioners, could be forgiven for thinking that, despite its elegance and sophistication, this debate has substantially missed the point. For example, the managing director of an SME with short order books, a cash flow crisis and an unsympathetic bank manager may not feel that intrinsic motivators and innovative job design should be at the top of her list of priorities. This might seem harsh, given that some of the strands of work below have become part of HR teaching orthodoxy in the Anglo-Saxon tradition. us understand how an individuals perception of their own competence and chances of success affects their willingness to attempt new tasks. The irony is, of course, that most practitioners have no real incentive to read all this stuff. Many still use reward as their primary motivational tool, almost to the exclusion of anything else, while some adopt the principles out of common sense.

1.1.1 Job design

Job design is one of the ways roles can be reconfigured to maximise the effect of intrinsic motivators. As Hertzberg6 said: If you want someone to do a good job, give them a good job to do. Writers such as Hackman and Oldham7 have since expended much effort to turn these ideas into practical rules for the design of jobs that are intrinsically motivating.

1.1 The theory

Motivation theories of variable empirical quality have characterised the thrust of mainstream debate in the field of worker performance. Some of the early work of the 20th century3 has been largely discredited or superseded. Later work by Frederick Hertzberg4 is generally considered more robust. He crystallised the distinction, for example, between intrinsic and extrinsic rewards. Here, he was able to differentiate between the characteristics of work that are intrinsically motivational (such as variety, challenge and control) and the external factors, such as pay, which are more instrumental or transactional in nature. He also encouraged us to consider that some job characteristics were motivators while others were only hygiene factors. For example, he argued that pay rarely motivates workers by itself, but that it had the capacity to destroy morale if it was perceived to be inadequate or unfairly distributed. Agency theory5 focuses on the factors that encourage individuals to stir themselves into action, while self-efficacy theory helps

1.1.2 Skill acquisition and deployment

Skill acquisition and deployment are at the heart of a massive body of work by people like Edwin Fleishman8 who took the reasonable view that much of the variability in worker performance is attributable to how competent they are. Work in this field breaks jobs down to their smallest components through job analysis, determines which skills are required to perform these tasks and assesses which of these skills are most amenable to learning, practice or training. The better the alignment between the competence of the worker and the task requirements of the post, the better the performance.

1.1.3 Employee commitment

One of the defining characteristics of human resource management (HRM) is its emphasis on the notion of

Taylor, FW (1911) The Principles of Scientific Management, Dover Publications: Maslow, A (1970), Motivation and Personality. New York, Harper & Row.
Hertzberg, F (1968) One more time: how do you motivate employees? Harvard Business Review (January-February), 5362.
Eisenhardt, K (1989) Agency Theory: An Assessment and Review, Academy of Management Review. 14(1): 5774.
6 Hertzberg, F (1968) One more time: how do you motivate employees? Harvard Business Review (January-February), 5362.
7 Hackman, J R and Oldham, G R (1980) Work Redesign Reading, Mass., Addison-Wesley.
8 Fleishman, E A (1972) On the relation between abilities, learning, and human performance American Psychologist, 27, 10171032.

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employee commitment. This work suggests that employees are more likely to exert effort on behalf of the organisation if they identify with its values and feel proud to be associated with it. Writers such as Meyer and Herscovitch,9 and Meuller, Wallace and Price10 have demonstrated that commitment, rather than job satisfaction, is strongly linked to employee performance and retention. More recently the concepts of discretionary effort11 and engaged performance12 have found their way into the language, though with only a fledgling empirical basis.

performance targets has been shown to be one of the most powerful influences on employee performance.

1.2 Pay
Notwithstanding the effort that has gone into theorising about, researching and modelling worker motivation, needs and drives, a significant proportion of line managers, practitioners and HR professionals still hold the view that employees work harder if you pay them more. So, how much weight should organisations give to reward as a strategic lever over employee performance? Reward has been described as the field of HRM that can boast the widest gap between rhetoric and reality. All too often reward strategy underpins grand plans for business improvement or cultural transformation only to collapse into underperformance or PR disaster. As Kessler14 has argued, reward policy and practice have been characterised less by clarity of purpose than by whim and ad hocery. To what can we attribute this spectacular and almost uniform record of under delivery? Is it that the concept of reward strategy is too grand, or conceptually flawed? Is it that employers fail to make the link between business strategy and reward strategy sufficiently explicit? Or does effective reward strategy design tend to collapse once it comes to be implemented on the ground? We will explore the answers to these questions in the next chapter.

1.1.4 Physical working environment

The impact of physical working environment on employee performance is a further area to come under scrutiny of those researching employee performance determinants. For many years, human factors researchers have looked in detail at the ergonomics of the workplace and what used to be called the man-machine interface. Now attention has turned to the wider impact that the use of space in the workplace has on both employees physical and psychological well-being and its impact on performance and productivity.13

1.1.5 Leadership and line management

The importance of effective leadership and line management as factors influencing employee performance has long been recognised. At one level, the need for employees to have a clear sense of organisational purpose and direction is an important task for leaders to perform. At another, the setting, monitoring and assessment of performance against objectives is an important task for line managers. Indeed, the setting and evaluation of clear

Meyer, J P and Herscovitch, L (2001) Commitment in the workplace: Toward a general model, Human Resource Management Review, 11, 299326. Meuller, CW, Wallace, JE and Price, JL (1993) Employee commitment: Resolving some issues, Work and Occupations, 19, 211236. 11 Bailey, T (1993) Discretionary Effort and the Organization of Work: Employee Participation and Work Reform Since Hawthorne, working paper, Teachers College, Columbia University, New York. 12 Hay Group, (2003) Engage Employees and Boost Performance, London. 13 Nathan, M (2002) The State of the Office: The Geography and Politics of Office Space, The Work Foundation, London. 14 Kessler, I (1995) Reward Systems in J Storey (Ed) Human Resources Management: A Critical Text, London, International Thomson Business Press.
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2. Reward strategy

Organisations frequently approach the process of adjusting their pay systems by seeking to put right: the features judged to not work properly; are proving unpopular or which nobody has ever really understood. If these are reward tactics, it is still rare to find an organisation that has a realistic reward strategy and that bears any serious scrutiny.

2.1 Coherence
Overarching coherence is implicit in the notion of reward strategy: that all parts of a reward strategy the underpinning reward philosophy, the pay structure, its market positioning and its progression rules join together in a mutually supportive way. In addition, we might

reasonably expect a reward strategy to support the business strategy from which it is derived. Other characteristics might include: Integration with other HR policies and practices eg performance management, training and development, career progression etc. An impact on the culture of the organisation and on the behaviour of individuals. High potential for individuals to gain a clear line of sight15: where reward lubricates the connectedness of individual efforts and improved corporate performance. For example, in Table 1 a business pursuing an innovation-led strategy to competitiveness might wish to encourage creativity, risk-taking and collaborative

Table 1: innovation-led strategy Employee role/behaviour creativity: seeking new solutions risk-taking behaviour medium-term focus collaborative and co-operative behaviour concern for quality and continuous improvement equal concern for process and outcomes high tolerance of ambiguity and unpredictability encouragement for learning and environmental scanning Reward policy thrust mix of individual and collective rewards use of soft performance measures, periodically monitored emphasis on medium-term performance use of learning and personal growth opportunities as a soft reward broad-banded and flexible pay structure high relative market pay Other HR policies broadly defined job roles cross functional career paths to encourage the development of a broad range of skills appraisal focusing on medium-term and collective achievement high investment in learning and development frequent use of teamworking

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Lawler, E (1990) Strategic Pay, San Francisco, CA, Jossey Bass.

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behaviour. To reinforce these behaviours, the firm may choose a mixture of collective and individual rewards focusing on medium-term performance, supported by broadly banded jobs, together with high investment in learning and development. Of course, differing business strategies will require alternative approaches to reward and HR. In Table 2 we see an organisation that has adopted a competitive strategy based mostly on cost reduction, demanding a short-term focus, risk-averse behaviour and predictability and standardisation of work practices. To achieve these characteristics it may adopt a narrow, rigid pay structure with a high proportion of employee earnings at risk. In support of this it might require training initiatives to deliver a short-term pay back and narrowly defined job descriptions.

2.2 Lack of coherence

All in all, having a reward strategy these days is somewhat of a tall order, as to conform the criteria it should:

support and be derived from the business strategy drive sustainable improvements in business performance bring about and reinforce cultural change integrate with the rest of HR policy and practice keep the paybill under control. Little wonder, then, that so many employers underperform in the design and delivery of a truly strategic approach to reward, if such a thing exists. One reason for this is that organisations commonly fail to get a strategic steer from the board on the: way it sees reward supporting business strategy delivery criteria by which it will judge reward strategy success. It is in the second area where serious ambiguities are often allowed to remain, and most often ambiguities around: Reward or incentive?: rewards focus on past performance and incentives focus on future performance. Despite this simplicity, many organisations get the two confused. It is important to avoid this confusion because a good deal of cash can be pumped into rewards in the expectation that they will have an incentive effect. Some

Table 2: cost reduction-led strategy Employee role/behaviour repetitive and structured tasks risk-averse predominantly short-term focus reliance on individual effort concern for quantity primary concern for results rather than process
need for predictability and standardisation focus on productivity improvement Reward policy thrust focus on individual rewards high proportion of earnings at risk emphasis on short-term performance narrow and rigid pay structure moderate relative market pay use of hard performance measures, frequently monitored Other HR policies narrowly defined job descriptions appraisal focused on short-term results task focused training with short-term pay back limited opportunities for progression and development

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performance pay schemes, for example, have consistently paid out four or five per cent increases for satisfactory performers, year on year. A dip in company fortunes might mean that the size of the merit pot from which such payments are made might fall dramatically meaning a satisfactory performer gets on one-and-a-half per cent. Amid the ensuing cries of wheres the incentive? it should be recognised that such merit payments are always only rewards rather than incentives. In practice, incentives are fundamentally different in character from rewards. They are formula-driven, they offer clarity upfront and they are based on a clear, transactional psychological contract between the organisation and teams or individuals. As ever, its always best to decide what the organisation needs before designing a scheme. Rewarding inputs or outputs?: many pay systems reward activity, or inputs, rather than outcomes. This is fine if inputs drive business success, though in most businesses it is outputs that do this. This is the primary objection to overreliance on competency-based and skill-based pay. Competencies are great for shaping training and development interventions, but their effectiveness in driving pay is questionable, not least for reasons of equity. Rewarding excellence or improvement?: some pay systems reward only people who achieve top results, creating performance rankings that target variable pay at the, say, top ten percent of performers. Other schemes set out explicitly to reward improvements in performance, no matter how low the baseline. The choice between these approaches depends partly on philosophy and partly on whether employers believe that they have an elite group that generates most of its value or whether a wider group of staff plays a part. Either way, the dominant approach requires a quite distinctive way of administering pay. Cash or non-cash?: it is now generally acknowledged that cash can only do so much to reward or incentivise staff to perform in the way employers want. A good way of deciding the mix of cash and non-cash elements to remuneration is to think hard about the kind of behaviour

and performance that needs to be incentivised, rewarded and sustained. Its then a simple case of tailoring the approach to the need. In the next two chapters we will look at both the cash and non-cash approaches, discussing what practitioners have found to be the most effective ways of deploying them.

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3. Cash
3.1 Paying for performance
Paying individuals or teams for their performance has become a central pillar of reward strategy in many UK businesses. Surveys have shown that between a half and two-thirds of organisations (in private and public sectors) have some form of performance-related pay for their staff. Individual-based performance-related pay (IPRP) linked to an appraisal scheme is an increasingly popular approach and tends to be focused on mostly managerial and white-collar employees. However, there are growing signs that it is permeating through to other groups and in some instances it has been introduced for manual workers. Employers appear to be attracted to PRP for several reasons. First, it is seen as a means of helping to influence or change the culture of the organisation. For example, by modifying behaviour through the appraisal system and making it more explicit that achieving objectives and targets is valued most. Organisational objectives such as the improvement of customer service, better quality and productivity can be pursued by this approach. PRP is being increasingly used, therefore, as a lever to promote organisational change and generate a new performancefocused company culture. Certainly in the public sector, this pursuit has been an explicit goal (eg the original Citizen's Charter talked of rewarding good performance and 'punishing bad'). Second, PRP is thought to introduce an element of pay bill flexibility in that it provides employers with another lever to control pay costs. In service-based organisations where labour costs can be between 60 and 70 per cent of total operating costs, such flexibility is desirable in circumstances where many companies are striving to be cost-leaders in highly competitive markets. Furthermore, in the search for solutions to the whitecollar productivity crisis, PRP is seen to play an important role in helping to ensure that increases in the wage bill are funded by increases in productivity. Third, this form of PRP emphasises the individual's contribution to business performance. This is appealing

In terms of remuneration, employers pay out cash to employees under two broad categories: 1. Basic Pay: in most organisations, something in the region of 95 per cent of their paybill is spent on basic pay. It refers to the core wages and salaries paid to employees. An important characteristic of basic pay is that it is almost always driven by the job the organisation wishes to be done. In setting the value of a post, an employer may wish to take account of some or all of the following. The value of this post in the marketplace. This market may be local, regional, national or international, or it may be occupational. The value of this post relative to other posts in
the organisation.
The extent to which the organisation has a system or hierarchy of posts within which postholders may move or progress. The extent to which the organisation wishes (or is required) to review basic pay in relation to the cost of living. 2. Variable pay: this typically makes up around five per cent of the paybill. It is an umbrella term that encompasses a range of approaches to distributing pay that reflects the contribution of an individual or team. Unlike basic pay, variable pay is usually intended to incentivise or reward contribution over and above the core requirements of the post. In many organisations, this has come to mean that a proportion of the paybill is allocated on a discretionary basis, often with line manager involvement. Variable pay can take the form of performance, merit or discretionary bonuses (usually not pensionable or consolidated into basic pay) or other awards such as increments, which move the employee through a grading structure by increasing their basic pay. In this chapter, we will discuss current practice in the distribution of variable pay, and the extent to which it can contribute significantly to performance improvement among employees.
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to many employers because it is seen to reinforce the relationship between the individual and the organisation rather than have this mediated by collective representative structures such as staff associations and trade unions. In this context, trade unions are often resistant to the introduction of PRP because it is seen as a threat to the values that underpin their workplace role. This may also be seen as aligned with the initial objective of changing the culture of the company. The emphasis on the individual is also prompted by a desire to ensure that those contributing most are rewarded more than those contributing least. Indeed, for some employers, the use of PRP to manage poor performers has been a significant factor. There are, of course, a host of other reasons put forward by employers, such as the need to offer PRP to recruit and retain good-performers. However, those outlined above tend to underpin the more recent interest in PRP and may help explain why many employers have been seduced by its appeal.

3.2 Forms of performance pay

There are three main kinds of performance pay. The first focuses on individual performance. The second on the contribution of work teams and the third links reward to the performance of the whole organisation. Let us examine each of these approaches in turn.

3.2.1 Individual PRP

This form of reward has received the most attention in recent years. This is primarily because of the debates that have raged about its philosophical and practical merits. Several approaches to delivering individual performance awards are commonly in use: Performance-related pay increases may be consolidated into basic pay until the maximum rate of pay for the grade is reached. If pay increases are consolidated, the rate and limits of progression through pay bands are usually determined by performance ratings that are often made at the same time as

performance appraisal. The increases may be made through incremental progression (eg up pay spines) or by a defined percentage. A pay matrix may be used to deliver performance increases in a conventional grading structure. Here, increases are based on an individuals appraisal rating and their position in the salary range, with smaller awards going to individuals higher up the pay range. This approach is based on the principle that the mid-point salary equates to the market rate, or rate for the job. This assumes that pay increases, at any given level of performance, should be lower for those whose salary is above the mid-point, since they are already receiving more than the market rate for their job. Performance increases may be paid as cash bonuses (often on a discretionary basis) for exceptional effort, special attainment, sustained levels of high performance or because the individual is at the maximum of their salary band. Usually these are paid as non-consolidated increases. They are rarely pensionable. These approaches frequently use annual line manager appraisals as the driver for assessment. They are often based on performance measures that are enshrined in objective setting and based on measurable results. Organisations increasingly are seeking to build into these assessments recognition of the competencies displayed by an individual, though these schemes may be vulnerable to challenge on equal opportunity grounds. Bonuses and incentives can be another element of variable pay. They are discretionary, formula-driven bonuses that are held out as a carrot to motivate people to desired performance and made to individual employees, teams or whole workforces. These payments are most often over and above the basic salary and are frequently non-consolidated and non-pensionable. The basis for paying them can vary. Some are contractual and relate to core working conditions, such as unsocial hours. Others, and more commonly in recent years, are attached to some kind of
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performance measure. These can include piece rates, productivity bonuses, performance-related bonuses, profit-related bonuses and incentive bonuses driven by formulae. An increasing number of organisations use non-consolidated bonus payments to reward employees who have reached the maximum of their pay range. If basic pay is intended to reflect the market rate that an employer attaches to a post, bonuses and incentives today represent extra payments made to individual postholders based on their efforts or results over-and-above the core requirements of the job. Linking individual performance with bonuses or incentives is frequently based on a number of assumptions about individual motivation and managerial capability. Chief among these assumptions are that: Employees will increase their effort or output in order to attain the reward on offer. Employees feel that the rewards on offer to be of sufficient value to them to incentivise extra effort. Employees are confident that the reward will still be on offer at the end of the period during which their individual performance is being measured. Organisations are able to establish and use clear and transparent measures of performance for all relevant employees, and apply these measures consistently. Individual rather than collective contribution is the primary driver of organisational performance (even in organisations where there is a strong emphasis on teamworking). Line managers have the time, commitment and competence to explain and administer bonuses and incentives effectively, transparently and consistently (and see the importance of doing so). Any performance improvement brought about by bonuses and incentives is sustainable over time. Bonuses and incentives will deliver sufficiently large pay increases to motivate and incentivise employees, even during periods of low inflation. There is considerable debate about whether these
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conditions have been sufficiently satisfied in many of the organisations that have embraced bonuses and incentives over the last decade. The debate has been particularly energetic in the public sector, where PRP has been widespread. There can be no doubt that PRP during times of low inflation has not been as effective as was originally hoped. The evidence suggests that most individuals find PRP at least a neutral influence on motivation, and most often a negative influence. Recent studies have shown that some PRP schemes are discriminatory. Some schemes combine the PRP or merit pay approach with individual incentives. This allows high flyers to reap superior reward, but ensures that team contribution is also kept in focus.

3.2.2 Team bonuses and incentives

Incentive bonuses also allow organisations to link the payment of a non-consolidated bonus payment to a group of employees if they collectively meet or exceed a predetermined performance target or goal. This approach has a number of advantages as it: allows the business to focus effort on high addedvalue performance (eg high margin activities) provides the facility to give high earnings increases to high performing teams allows within-year control of payroll costs by avoiding consolidation of bonuses into base pay encourages employees to see a direct link between their collective efforts, tangible business outcomes and reward. Quite often team bonuses are based on meeting or exceeding collective performance targets, like sales or profits. The operation of such schemes may not be without problems. For example, employees are often concerned that managers will move the performance goalposts part way through the year. For some employees, the performance measures they are chasing may also seem over complicated, remote from their influence or unattainable. In some case, line managers

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may not agree with the principles of team bonuses, which leads to underperformance. However, emerging evidence suggests that carefully constructed and simple team bonuses can significantly increase commitment and productivity. They can improve employee identification with the goals of the business and can incentivise improved collective effort and achievement. In general, team bonuses and incentive schemes should therefore seek to comply with the following design principles: Define the team. A pre-existing team is clearly better than a team artificially constructed for the purpose of a bonus. Agree the performance measures and set the baseline against which to track progress. Decide reward formula and type of payout. Will the payout be a flat rate sum or proportional to salary? Decide eligibility rules and how people who join or leave a team mid-year will participate. How about those on long-term sickness, or people who are underperforming? Set up a data and communication infrastructure. It is important to provide regular and detailed data on performance against the targets. Agree evaluation process. Know how success will be judged, and collect data that will help such a judgement to be made.

3.2.3 Organisation-wide incentives

Another mechanism for linking performance and reward can operate at the level of the whole organisation. These approaches are based on the principle that employees will exert effort if they feel they have a share of the spoils of organisational success. Financial participation of this kind concerns the involvement of employees in the financial success of the enterprise. It can take a whole host of forms, but most commonly it refers to one of three types of basic scheme: 1. Profit sharing, where a proportion of remuneration is tied to the profits of the organisation for the year.

2. Employee share ownership, where employees are rewarded with a number of shares in the employing company. 3. Share options, where the employee is given the possibility of purchasing at a future date a set number of shares at a price agreed initially. Depending on growth in the market value of the shares over the initial value, the option to purchase the shares may be exercised or not. These schemes may be seen discretely or combined with each other, for example profit bonuses may be invested in company shares. Some schemes are applicable to all employees; others are restricted to particular groups, such as senior executives or directors. The government has a number of reasons for promoting financial participation. One driver relates to economic performance. The advantage of employee financial participation is that it is a form of financial flexibility. It allows employers to see their wage bill rise and fall in line with business activity. This means that the pay bill adjusts to suit the exigencies of the business situation. Wages can be contained during lean times, but rise on the back of profits, but in a controlled way. Labour costs thus become more flexible, just as they do if the numbers employed varies with work demand. As organisations search for approaches to remuneration linked to the new business climate that both reward performance improvement and help keep the lid on payroll growth, more are turning to forms of incentive bonuses as a solution. A variety of bonus schemes have been in use for many years, but only recently have businesses and, more latterly, the public sector, begun to re-assess the value these schemes play in their reward strategies.

3.3 Cash bonuses and incentives in the UK: the state of play
Until relatively recently, bonuses and incentive schemes were confined to sales jobs and manufacturing environments. Now they are being used more extensively
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in the service and public sectors, reflecting growing interest in the use of bonuses and incentives among a wider group of employers. Key developments here include the following: Approximately two-thirds of employers in the UK pay some form of bonus to at least a proportion of their workforce. In 2001, just over three per cent of gross weekly earnings were made up by some form of bonus or incentive payment. While interest in team bonuses is growing, recent surveys show that between eight and 22 per cent of employers are using them with a proportion of their employees. Interest is particularly high in the Civil Service, where HM Treasury are keen to extend its use to incentivise delivery of targets. Traditional forms of bonus plan such as piecework and productivity-based schemes have been phased out in recent years in the UK as multi-factor bonuses have become increasingly prevalent. These schemes reward a variety of dimensions of performance, eg both sales volume and customer retention, in an attempt to ensure employees do not maximise performance on one measure to the detriment of others. Although still a minority pursuit, gainsharing schemes (in which employees share the benefits of costs and efficiency savings through formula-driven bonuses) remain a feature of reward in manufacturing organisations. Many unions, while initially sceptical of bonus and incentive schemes, have accepted their introduction as they have been used as a way of boosting earnings in a time of low inflation-related settlements. However, unions remain wary of these schemes becoming too embedded for two main reasons. First, they still prefer to see paybill increases being focused on basic pay rather than nonconsolidated payments. Second, such bonuses are only rarely pensionable and the higher the proportion of employees earnings made up by non-pensionable pay, the less unions like it.
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3.4 What works best?

The Work Foundation has been involved in the design, implementation and evaluation of reward and incentive schemes in both private and public sector organisations. In our experience, the ten keys to success include: 1. Clarity about the place of bonuses and incentives alongside other components of remuneration (base pay uplifts, individual PRP, share ownership etc). 2. Visible senior management commitment to the principle and practice of bonuses and incentives. 3. Clarity over the definition of a team for the purposes of team incentives. 4. Clear eligibility rules: especially rules governing poor performers in team bonus schemes. It is important to avoid concern over freeloaders. 5. Consultation during design. 6. Simple, objective and achievable (but stretching) performance measures. 7. Clear line of sight for employees: high level of awareness of how they can directly affect the measures that will determine their bonus. 8. Regular and reliable communication about progress on rewards. 9. Training for line managers in the operation of the scheme. 10. Monitoring and evaluation of the scheme against success criteria (cost; impact on performance, and on morale/motivation; perceived fairness, etc). While the operation of such schemes may not be without problems, bonuses and incentives can significantly increase commitment and productivity.

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4. Non-pay rewards and recognition

Most employees will also testify to the motivational power of a well-timed, genuine, non-patronising thank you from someone with status in the organisation whose opinion they value. Given the complexity of the reward and recognition schemes that exist in many UK organisations, it seems that the simplicity of this point is often lost. In some organisations, managers have to complete an online nomination form. This is then forwarded for consideration by a judging panel, which assesses the merits of each case and then sanctions the awarding of an officially endorsed thank you, often in the form of a token reward (vouchers, meals out, Air Miles etc). Employees usually need never be spoken to by his or her manager in this process a feature that far too managers view as an advantage. In practice, recognition schemes need to be carefully designed in order to ensure that they dont become overengineered and, therefore, too mechanistic. Ironically, the need to be transparent and demonstrably equitable (thus avoiding charges of favouritism and bias) can often push these schemes towards being very formulaic and inflexible. So, what factors need to be taken into account when designing and operating such a scheme, and to what extent are these approaches witnessing innovation?

4.1 Design and operation

An important stage is to locate any recognition scheme in the reward strategy thinking advocated earlier. What behaviours or aspects of performance is the organisation seeking to influence or improve? Is a non-pay approach the best way to achieve this? And is non-pay reward or incentive the best approach? Organisations usually consider recognition schemes as a means of: focusing employee performance and behaviour in a particular direction (eg improving customer focus, encouraging knowledge sharing) making a fuss of employees who exert special effort or behave in a way which demonstrates adherence to or

promotion of organisational values boosting employee satisfaction and morale by giving a public acknowledgement to the quiet but steadfast efforts of ordinary workers. This way the scheme can provide a lighter touch than formal, cash-based schemes and offer an appropriate level of acknowledgement close to the time that the behaviour or performance is exhibited. The kinds of recognition awards that employers distribute vary considerably. They include the following: Voucher schemes: these schemes use the purchasing power of the organisation or an explicit tieup with a commercial partner to offer preferential rates to employees. These can be exchanged for goods or services such as holidays or experiences like balloon flights or driving fast cars. Voucher schemes are treated as taxable benefits. Certificates, tokens and gifts: in some organisations a personal letter or email from the CEO sent to the employees home address, and that acknowledges an employees contribution can be a very powerful form of recognition. Of course, this only works in certain organisational cultures. Other forms of recognition include gifts like pens, umbrellas or certificates of special achievement. These are also used where the symbolism of acknowledgement is more important than the cash value. Discretionary awards: some employers are less prescriptive about the nature of the recognition awards they distribute, preferring to give line managers a pot of money which, within broad guidelines, they are encouraged to distribute among their direct reports. On the plus side, this approach can help tailor the needs and preferences of the individual to the nature of the award (driving lessons for a young colleague, theatre tickets for a colleague celebrating his wedding anniversary are examples quoted to us recently by some companies). Some managers decide to pool the pot and take the whole team out for a social or teambuilding event. On the downside, this approach runs the risk of being seen as
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unduly subjective, with managers being prone to distribute awards to their favourites or to the most visible members of the team. Some schemes use structured nomination processes to assess the merits of a proposed award and to build greater consistency and transparency into the distribution process. This means developing a set of criteria against which to assess nominees, deciding who will sit on the panel (usually bosses, but sometimes peers), and devising a rating or scoring system to differentiate between the nominees. Up to a point, this bureaucracy is necessary if the organisation is concerned to demonstrate that it wishes to recognise employees in an open and equitable manner. The consequence is that spontaneity is often the victim and employees have to wait solemnly for the white smoke to emerge from the nomination process, before taking receipt of their 25 book token.

4.2.2 Development: in a similar vein, some organisations recognise that their staff are keen to find time for personal or professional development that may not be directly work-related. Care needs to be taken that development opportunities, which might be legitimately regarded as an entitlement, are not dressed up as perks given to good performers. However, some firms are now sending colleagues on specialist conferences or providing short sabbaticals to employees for whom the opportunity to recharge their intellectual batteries is highly valued. 4.2.3 Knowledge-sharing: in some organisations, especially where a silo mentality has been tacitly rewarded over several years, economic and creative value can be released by encouraging greater knowledge sharing between employees. In Siemens Medical Systems in the US, for example, the problem was that many employees associated sharing knowledge with losing power. Thus, if a software engineer is the only one in a department who can perform a certain skill, s/he saw that as job security and didnt want to give that knowledge away. There was also a scheduling issue. Taking the time to share information or to coach someone in a new skill can be burdensome to busy employees. Employees saw no value in this sort of communication. To support the new environment, the company built three web-based knowledge-sharing tools through which employees could collect and disseminate useful information to the rest of the company. The first of these is People of Med, an online database of employee profiles that included each members contact information, experience, areas of expertise, and photograph. If theres a need for someone with a specific skill set, employees can search the database and instantly find out if there is someone in the company who fits their requirements. The second is Communities of Practice, an online meeting place where employees volunteer to host forums on specific topics, such as ISO 9001 certification challenges. Any employee interested in that topic can register and participate in conversations,

4.2 Anything new?

A few organisations are looking at the non-pay reward and recognition field through a slightly different lens, although innovation appears relatively rare. Some of the more interesting examples that appear in the literature include the following. 4.2.1 Time: some organisations are recognising that, for a growing proportion of employees, time has a significant value. Several large employers are looking at offering staff incentives to do different work, to achieve more or to behave differently by offering time flexibility or time banking. The Inland Revenue has, for example, been piloting a time-banking scheme in its Sussex offices that allows staff to receive one-and-a-half hours for every hour they work outside conventional hours to provide extended services to the public. They can then bank this time to be used when they find it most convenient, for example during long school holidays or to carry out voluntary work.
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and share materials that may be of value to the group. The third tool is the Knowledge Square, an online database filled with presentations, web sites, technical papers, specifications and other materials that might be of value to the company. Employees can search the database to quickly find information related to their area of interest. To encourage employees to take advantage of the knowledge-sharing opportunities, they receive bonus points every time they use one of the three tools. These can be used to purchase items from a gift catalogue that includes everything from T-shirts to vacations. In practice, the incentives were used to lubricate a change in behaviour. Once staff started using the web-based tools, the incentives became almost redundant as their intrinsic value was self-evident.

4.3 Overview
Non-pay reward and recognition schemes can be a powerful tool in the development of a climate where achievement is acknowledged and effort is incentivised. As long as their place in the overall reward strategy of the organisation is clear, and that the employer has a realistic view of what they can and cannot achieve, they can supplement cash-based pay schemes with considerable success. However, it is important to recognise that they only have a limited shelf life. This needs to be factored into their design, and such schemes need regular reviews is they are to be kept fresh and to avoid cynicism.

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5. Conclusions

If organisations are to be both smart and flexible over their use of rewards, it is important to get the following right. 1. Keep a strategic focus. Revising pay systems can be a cathartic process, which can cause a good deal of internal strife. This can be worth it if what you end up with is better, energising and creates a dynamic sense of purpose. Having a clear and short list of success criteria can help keep this focus on the things that matter to the organisation going forward, rather than allowing it to focus only on putting right the things people dont like or dont understand. 2. Avoid over-complicating things. It is so easy to become embroiled in the complexities and technical details of pay system design and to lose sight of the big picture. Many pay systems fail because they violate the simplicity principle. 3. Involve line managers. No matter how elegant the design of the pay system, if the folk who bear the brunt of making it work find doing so beyond their capability then it is dead in the water. 4. Maintain faith in the system. This means maximising transparency of the scheme, not just to meet legal and good practice requirements, but also to demonstrate that the organisation is acting in good faith. 5. Provide rewards that employees value. For both cash and non-cash rewards, employers need to examine the extent to which they are tailoring them to the needs of the individual or the team in question. The more an employee values the reward on offer, the more likely they will exert effort in order to attain it. This might be the most obvious statement of psychological basics, but it is also a principle that many pay systems happily violate. Pay systems have the dramatic potential to be one of the biggest positive influences on employee behaviour and performance. However, organisations placing reward at the foundation of their HR strategy need to ensure that this foundation can bear the weight of all that is built upon it.

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