Individual Incentive Schemes: Definition; Types; Example; Advantages And Disadvantages

1.1 Introduction

Performance/output-based method is an approach of rewarding employees pegged on their output levels. Under this classification, the approach is divided in to two main categories, namely;

a) Individual Schemes

b) Group Schemes

This article focuses on the individual-based kind of performance incentives only

1.2 Individual Schemes

Definition-1: As the name suggests, this method of rewarding focuses on individual employee versus his or her output level. In this case the reward level of compensation is directly related to the employee’s level of output. Such that the more one produces, the more the reward and the vice versa is true.

Definition 2: Individual incentive plan is a rewarding system to the performance of individual employees and the type of reward is pegged on the category of workers for which they are designed.

1.3 Applicability of Individual Incentive schemes

1. This method applies commonly where output is more associated to a particular worker or employee.
2. The scheme is structured in a manner that it is possible for either the employer or employee determine the amount of bonus thereof without difficulties.
3. Performance terms are fairly favorable to all workers such that the scheme is not discriminative as far as terms and conditions thereof is concerned.
4. No artificial or micromanaged conditions around the working environment of the worker and any time such condition occur which curtain any specific worker from effectively performing, then the employer should protect the worker.
5. The scheme works well where there is consensus from all parties concerned such as the workers, employers and the trade unions.
6. The scheme perpetuity should be well assured such that the rates, set earnings to be paid and other working conditions should be such that it is reasonable to guarantee its long existence.

Types Of Individual Schemes

Some of the examples of individual incentive schemes are as detailed below with their corresponding applicability/characteristics distinguishing them and the advantages and disadvantages thereof. These schemes are;

1. Merit-Based compensation scheme
2. Piece-Rate Incentive schemes
3. Bonus System
4. Differential Piecework

2.1 Merit-Based Compensation Scheme   

Definition: Merit-Based compensation scheme is an individual incentive scheme/method of rewarding employees with a higher performance history above what is expected or is normal production. The method is also referred to as incentive pay scheme or pay for performance.

2.1.1 How practical is merit-based incentive scheme?

To understand how merit-based incentive scheme for individual employee works, the following general steps are followed by the human resource department of the firm adopting this methodology.

2.1. 2 Steps of Actualizing Merit-Based Scheme

The following are the FOUR main steps of ensuring that the scheme is beneficial to the employees and the concerned organization.

STEP ONE: SETTING OF PERFORMANCE REVIEWING CRITERIA (i.e., BENCHMARK)

In this step, the human resource department lays down the rules of the game. Such that some measurement metrics are put in place so as to assess what is normal work load and what is classified as bonus workload. This objective is achieved through setting of performance review schedule which are either pegged on monthly, quarterly or yearly interval basis.

STEP TWO: SETTING OF THE WITH EFFECT DATES (i.e., With Effect From-w.e.f.)

The human resource needs to set the timeframe when the increment or additional reward is to be effected upon. This is made possible by putting in place the specific dates when the incentive scheme is effective and on the same breath, when its validity ends. All the concerned parties should be well aware of this timing to avoid any conflict of interest.

STEP THREE: WORKERS’ PERFORMANCE DATA COLLECTION

The human resource department has to correctly collect the relevant data to ensure that the computation of the incentive is pegged on correct information. This helps in avoiding cases of over or under incentive payments.

STEP FOUR: COMPUTATION OF THE INCENTIVE AMOUNT

After the human resource department has collected the data needed, it further establishes the amount to be paid by using the correct computation model. Once this is accomplished, then payment can be done accordingly. Some of the methods commonly used are a certain set percentage of their basic salary or pay rate already in existence. For instance, a 2.5% increase may be given to individual performers with may be individual performers who have outperformed the rest are paid something like 4%.

2.1.3 Advantages of Merit-Based Incentive Scheme

1. A firm enjoys quality output from the top professional workers. That is since the additional pay is anchored on how much one produces over and above the normal, this attracts those employees who have self-confidence that they can do a better job. Coincidentally those who are poor performers will not bother themselves and therefore the firm in question automatically avoids them.
2. Less friction/resistance between the management and the employees. Since this scheme is well framed, all the participating parties such as the employees, employers and the trade unions know what is expected. So, productivity is guaranteed.
3. Promotion of equity amongst employees. The employers use this system to rank employees in accordance to performance. Top performers are ranked highly and the low performing receive low ranking and of course payment of incentives are done as supposedly.
4. Accelerate achievement of company objectives. When companies tie compensation increases to accomplishing goals, they make their performance objectives to be actualized within the stipulated time frame.
5. Increased production efficiency. Although this method of incentive is output oriented, the workers are also keen on the quality of the output to avoid disqualification. This is commendable.
6. Enhance inter-competition. Healthy competition a rise amongst employees and this increases productivity in the organization and by extension increase profitability of the firm.

2.1.4 Disadvantages of Merit-Based Incentive Scheme

1. Killing of some employees’ morale. The aim of merit-based scheme is to promote the morale of the hard-working workers. Coincidentally, those who are not in a position to outperform may be disappointed.
2. Loss of greater opportunity cost. Instead of paying these incentives, may be such resources can give better results if invested elsewhere.
3. Suffer biasness. Since output is the key thing to how much an individual employee will take home, the human resource department may be tempted to allocate more assignments to the best workers leaving the average and lowly performing ones behind. This is a discriminative act at the work place.
4. Perceived favoritism: Employees who are not satisfied with their merit pay may feel like there is manager favoritism toward other employees, regardless of their performance reviews.
5. Managerial burden. Extra pay is always an extra liability to the firm for it entails extra cash out flow over and above the normal.

2.2 Piece-Rate Schemes

2.2.1 Definition

Piece-Rate is an individual incentive scheme/method where by workers are paid based on a constant or fixed rate per unit produced or are paid on piece rate basis with a guaranteed time rate if and only if he or she produces over and above the flat rate already set. The following illustration clarify this scenario.

2.2.2 Applicability of piece-rate incentive schemes

The big question which we need to ask ourselves is, why is this incentive method common amongst organizations and what makes it so practical? The following are some of the key points to success or applicability of this model.

i). It is characterized by jobs of repetitive nature and as result a worker knows precisely the expected outcome. Similarly, the employer knows what he/she expects from the employee.

ii). Accessibility of output quantity is possible. This is because there is always a devised method of measuring the output gotten.

(iii) Controllability of the output. The management is in a position to monitor and dictate the expected quality of output.

(iv) Rating of the output is possible. The human resource is in a position to fix an acceptable piece rate for the pieces to be produced. 

(v) The method of incentive is characterized by reasonability of the piece rate set. This makes it possible for the workers to attain the set levels of production and even exceed. 

vi) There is flexibility of the system which accommodates variances of the price levels in the market.

(vii) The system advocates for maintenance of time cards to make workers punctual and regular so that production may not slow down.

EXAMPLE

A worker is paid an agreed rate per unit for the number of units produced and where there are various categories of goods or products produced by one employee, then different set rates apply. For example, assume that a worker produced the following number of units during the working hours. Say 40 hours per week, as follows;

600 units of product X Piece time allowance 1.9 minutes/unit

300 units of product Y Piece time allowance 1.5 minutes/unit

150 units of product Z Piece time allowance 1.2 minutes/unit

If the piecework rate is $0.50 per minute produced, then the total incentive paid is;

(600*1.9) + (300*1.5) + (150*1.2) =82,140 hours

Total pay= 82,140*.50= $41,070

NB: The straight piecework may assume the following approaches;

1. Piecework with guaranteed day rates-this is where if the earnings from piecework fall below normal day rates, then there is a guarantee that, that days rate would be paid. This is playing safe when cases of other eventualities arise such as production delays, material shortages and machine breakdown.
2. In lieu of Bonus-in this case, the worker is normally covered by an incentive scheme whereby there is an option of the benefits being transferred to ordinary day work. In this case, the in lieu of bonus can be paid on top of the ordinary day rate or payment. This is commonly applied to other workers where the piecework incentive does not apply.

2.2.3 Advantages of Piece-Rate Incentive Schemes

1. Idle workers cannot be paid. The system does not advocate for the payment of who are idle or not worked or who are ghost workers.
2. Adoption of better production methods by the workers-the piece-rate incentive scheme prompts the workers to devise better production methods which benefit them and as a result, the productivity efficiency of the firm improves.
3. Enjoy economies of scale. Where the productivity is increasing, the average cost declines and this has an advantage of increased profitability.
4. Pricing of goods or services is made easy. With precise labor cost incurred, it becomes simple assign prices to the final output.
5. Less chances of machine or tool breakdown. The employees usually make good use of their tools or machinery with due diligence to avoid any kind of production stoppage. This helps in protecting them from their replacement which could imply cash outflow to the organization.
6. Minimum worker supervision. Less supervision is required because workers have the fear of not earning wages if they do not work as supposedly.
7. Occurrences of increased performance efficiencies may arise amongst the workers. The inefficient workers are motivated to become efficient by the already those employees who are enjoying the scheme. This generally increases the performance of the business.

2.2.4 Disadvantages of Piece-Rate Incentive Schemes

1. In cases where the rate of inducement is perceived by the workers as low as compared to other competing firms may not help in achieving the role of motivating the same employees in that organization.
2. Quality of the final product may be compromise-sometimes the quality of work done may be short changed with the number or level of production. This is disadvantageous to the organization.
3. Increase in the level of production may not guarantee enjoyment of economies of scale. This may be due to other arising logistics.
4. Health side effects-health problems amongst the workers may arise due to overworking without resting.

2.3 Bonus System

2.3.1 Definition

Bonus System is an individual incentive scheme/method which involves payment of extra amount on top of the worker’s salary. Of course, you know the reason why one will be paid a salary is because of the output one generates. But this system focuses more on one’s salary such that a higher salary implies more output but the focus will be indirectly to the salary level.

2.3.2 Classification of Bonus System

These bonuses may take diverse forms based on the nature of the objective being complied and accomplished. Those bonuses may be;

a).-Spot Bonus Incentive System

This occurs when an employee does something extra ordinary. Over and above what was expected. The system is referred to as spot because the payment is done spontaneously. There by then and may not follow any pattern.

b). Non-cash Bonus Incentive System

This incentive as the name suggests is not on cash basis. It is in other forms such as issuance of a trophy, certificate etc. For example, the incentive can be something like the employee of the year.

c). Referrals Bonus Incentive System

This system is pegged on extra payments as a reward to the already existing employee when he or she directs his or her employer to another resourceful employee who turns out to be an asset to the organization.

d). Signing Bonus Incentive System

A signing bonus is a system of bonus paid to new employees by the new employer for honoring that specific offer of a new job. Sometimes the pay may not be immediate for some logistical issues.

e). Milestone Bonus Incentive System

This is a commonly used bonus system in projects. The employer pays some cash to appreciate the employee for spearheading a specific project assignment to a certain level. It is also known as mission or task bonus.

f). Project Bonus Incentive System

In this case, the incentive is paid if and only if the project is completed at the end of the actual project assignment date. It is contrary to the milestone bonus where by the project is not yet complete. i.e., the worker is rewarded even when the project is still under Work in Progress (WIP).

g). -Attendance Bonus Incentive Scheme

 Attendance bonus is a reward given to workers who are efficient in reporting to the work place in time such that within a specific period of time, the attendance cuts above the rest. The reward is given on quarterly or yearly basis based on the organization’s budget.

k). Holiday Bonus Incentive Scheme

Holiday bonus is reward given to all employees especially during a certain holiday such as Christmas and may not necessary be in cash form. For example, it can be in form of shopping voucher or extension of a holiday tour to an employee.

l). -Annual Bonus Incentive System

Annual bonus is a reward given to all employees of a firm at the end of the financial period as a result of the firm making profits. The bonus may be tied to a certain level of performance goals.

m). -Longevity Bonus Incentive System

The reward is based on the time duration a certain employee(s) has remained with the organization. It is common to those employees who have served for the longest time. The reward may not necessarily be in form of cash.

n).-Commission Bonus Incentive Scheme

Commission bonus is a reward given to salesmen or salesperson on hitting beyond a certain level of sales volumes. In this case, over and above the normal or basic salary, the worker is paid a certain amount pegged on the level of sales beyond a certain point.

o). -Safety Bonus Incentive System

This is reward extended to workers who have hit the safety target of the organization and can be done on quarterly or yearly basis. This is common for example in factories or on transport businesses where precaution is key.

p). -Retention Bonus Incentive System

This reward is common where mergers or acquisition has taken place. In this case the reward is aimed at ensuring that the old employees in the former firms before merger are kept in the new company.

q). -Profit Sharing Bonus Incentive System

The incentives in this case are pegged on a certain percentage of company profit threshold reached or generated. This awarding can be done on quarterly basis, annually etc.

2.3.3 Advantages of Bonus Incentive System

1. Source of employee motivation-this rewarding system is a psyche to the workers and can really lead to increased output.
2. Firms get high caliber employees-the system ensures that the best workers are gotten to do good work.
3. Low rate of employee turnover-very few workers will leave the organization due to low payments. This assures the firm that no much investing in training new employees through induction processes.
4. The organization is forced to plan well-this planning entails setting of clear targets to be achieved which is an advantage to the firm for there is proper or optimal utilization of resources.

2.3.4 Disadvantages of Bonus Incentive System

1. Favoritism between workers and employers-sometimes employers may be tempted to show biasness to some employees and not others and this becomes source of disappointment.
2. Ineffective approach-sometimes this rewarding system may fail to work. This is because some employees may be less motivated by bonuses especially when they don’t benefit in the rewarding process.
3. Increased labor cost-of course any rewarding system is accompanied by cash out flow and if the cost exceeds the benefits, then it is uneconomical to the firm.
4. Lack of unity amongst employees-Disharmony may arise for there is an obvious inter-competition amongst employees. This may slow down productivity.

2.4 Differential Piecework Incentive System

2.4.1 Definition

Differential piecework incentive system is an approach which involves rewarding of the worker in a progressive manner such that the more active employees are paid more at higher levels of production while the less performing employees are equally paid less and less reward as long as production is declining.

This scheme was introduced by Tylor, the father of Scientific Management. The aim of this professor was to eliminate those workers who are not devoted to production or work.

Professor Tylor’s proposition was to ensure that the inefficient workers are done away with. He achieved this by setting very low rates of salaries and incentives such that such employees automatically fall off. For instance, the active workers, if the piecework can be set at eight (8) units for 8 hours duration at a rate of $1.00. But any production beyond the 8 units, is at a rate of $1.30. contrary, to the lazy workers, they may be paid $0.60 for any production beyond 8 units per day. So, the lazy workers are forced to quit their jobs.

The progressive approach uses a structure as follows;

Up to 100 units per day $0.5/unit

101 units up to 150 units per day $.80/unit

151 units up to 200 units per day $1.10/unit

2.4.2 Advantages of Differential Piecework Incentive System

1. Saves time-those workers who are active do their work within the stipulated period and this saves the organization’s time resources
2. Increased production efficiency-the system encourages improved productivity which is beneficial to the organization.
3. Cost effective-when the lazy employees are eliminated, they leave the active ones in place and they produce more than they are paid. This is economical.
4. Possible for the management to measure the value for money of work done-you see wage is directly linked to output and therefore, it is possible to avoid payments to workers which are unnecessarily leading to increased cash outflows.
5. Optimal utilization of the production tools/equipment- the employees will continuously engage the machines used for production such that no cases of idle machines.
6. No close employee supervision is needed. The firm management does not need to engage full supervisors for each employee is focused on what to achieve at the end of the day. So, the firm saves a lot of money they could have spent in engaging supervisors.
7. Cost control effectiveness-the firm will enjoy reduced production cost for this system advocates for increased employee efficiency.
8. Enhance planning and control management perspective-because each employee has his/her target to meet, this increases certainty to management in planning for the future activities.

2.4.3 Disadvantages of Differential Piecework Incentive System

1. Interrupts production-when weak workers are laid off, their contribution is eliminated and this adversely affects the overall production level of the business. Why am I saying this? We all know that even with loss making department, its closure may worsen the overall productivity of the organization as a whole. This is because there is that contribution element the loss-making department provide. So, similarly, the case of eliminating the weak or inefficient employees may not be a guarantee of full success.
2. Job insecurity-No provision for unavoidable circumstances on the side of the employee. So, if one becomes sick, there is a challenge of getting any earnings.
3. Low quality products arise-employees focus more on numbers and not the quality for they want to maximize their returns through bonuses.
4. The method is not appropriate for the beginners-the aspect of learning curve theory is key here because for a new employee, the system is not applicable for the learning process keeps on improving with time. That means in the early stages when the employee is producing lowly for he is not yet used to, his reward may turn to be unattractive.