Incentives Meaning, Definition, Prerequisites, Types

Table of Contents:-

  • What is Incentives in hrm?
  • Meaning of Incentives
  • Definition of Incentives
  • Prerequisites of Effective Incentive System
  • Types of Incentive Plans

What is Incentives in hrm?

Incentives or payment by results are monetary benefits provided to individuals to motivate and reward their performance. Incentives are variable rewards granted according to variations in achieving specific results. Unlike wages and salaries, which are relatively fixed, incentives generally differ from person to person and may also fluctuate over time for the same individual.

Meaning of Incentives

Incentive systems are an important part of organisational motivation. They are essential for managers to understand the driving forces within their organisation. These systems can either encourage or discourage employee and workgroup behaviour. A well-designed incentive system promotes employee productivity and creativity, cultivates loyalty among the most productive employees and stimulates innovation.  Incentives can be broadly categorized into financial and non-financial incentives, both of which contribute to the overall success of the organization.

Definition of Incentives

According to Kemmerer and Thiagarajan, “An incentive is something that influences people to act in certain ways. An incentive system is a collection of incentives and a set of procedures for using them. Organisations use incentive systems to motivate their employees”.

According to Burrack and Smith, “An incentive scheme is a plan or programme to motivate individuals for good performance. An incentive is most frequently built on monetary rewards, but may also include a variety of non-monetary rewards or prizes”.

Prerequisites of Effective Incentive System

An incentive plan or scheme must fulfil the following essential requirements to be successful:

1) Specific and Measurable Objectives

Incentive schemes must be identified with specific and measurable objectives to facilitate monitoring and control and to maintain momentum.

2) Simple to Understand

The scheme should be easily understood particularly by the workers. They should be in a position to calculate their earnings.

3) Simplicity in Administration and Inexpensive

The firm’s management should be able to administer the scheme with minimum effort and cost.

4) Guarantee Minimum Days’ Wages

While selecting an incentive scheme, it should be ensured that the same guarantees the day’s wages in case of circumstances beyond the control of workers.

5) Conformity with Labour Laws and Regulations

It should be ensured that the scheme does not violate the labour laws and other regulations in the country.

6) Minimisation of Labour Turnover and Absenteeism

The scheme should be attractive enough to make the workers come to work daily and remain in the organisation.

7) Motivation

Incentives provide a spur or zeal in the employees for better performance. It is a natural thing that nobody acts without an objective behind it. Therefore, the incentive scheme should be such that it motivates the workers to raise production.

8) Savings in Production Cost

The incentive scheme should result in savings in the cost of production.

9) Reward for Good Production

The incentive scheme should discourage spoilage and defective work and only reward good production.

10) Relationship with Effort and Efficiency

The scheme should be such that it should have a relationship with effort and efficiency.

11) Scientific Setting of Standards and Attainable Performance Levels

One of the requirements of a good incentive scheme is that the standards should be capable of being established on a scientific basis. This makes the norms objective. At the same time, such standards should be both realistic and achievable so that they may motivate employees to enhance their productivity.

12) Unlimited Earnings

The scope of increasing their earnings would make the workers put in greater efforts and as a result, production would rise.

13) Timely Payment of Incentive

Generally, the scheme should provide for the payment of incentives after the completion of work to serve as a motivational tool.

Types of Incentive Plans

Incentive plans can be broadly classified under the following categories:

1) Individual Incentive Plans

Individual incentive plans are widely accepted today, and most contain provisions that align with corporate and group objectives. But what makes them genuinely individual incentive plans is that the employee awards are differentiated based on personal performance criteria.

According to L.G. Magginson, “Individual incentives are the extra compensation paid to an individual for all production over a specified magnitude which stems from exercise of more than normal skill, effort or concentration when accomplished in a predetermined way involving standard tools, facilities and materials”

Types of Individual Incentive Plans

There are many and diverse individual incentive plans available.  The International Labour Organisation (ILO) has classified all payment schemes based on performance into the following four categories:

i) Earnings Varying in Same Proportion as Output

One key feature of schemes in which incomes vary based on output is that any gains or losses directly linked to a worker’s productivity are attributed to the worker. At the same time, the employer retains any gains or losses related to overhead costs per output unit. In contrast, when the worker is paid by the hour, day, or month, all profits and losses resulting from changes in their output accrue to the employer. There are two incentive schemes under this category:

a) Straight Piece-Work:  In this method, the rate per unit of output is predetermined, and a worker’s total earnings are calculated by multiplying the total output (measured in units) by the predetermined rate per unit.

b) Standard Hour Plan: A standard hour plan is an incentive pay plan which establishes a fixed unit of time for completion of a task or job.

ii) Earnings Varying Proportionately Less than Output

Four allied but different systems come in this group, namely, Halsey, Barth, Rowan, and Bedanx. A common characteristic among all these approaches is using time as a metric for output measurement, with a bonus awarded based on the time saved. This bonus is calculated as the difference between the predetermined standard time allocated for the task and the time taken to complete it. These plans are explained as follows.

a) Halsey Plan

 This plan was introduced by F. A. Halsey. Under the Halsey Plan, a predetermined time is set for the completion of a job, and the rate per hour is determined accordingly. Workers who take the standard time or more to complete the job will be compensated based on the hourly rate.

b) Rowan Premium Plan

The concept was initially introduced by D. Rowan in 1901 as a modification to Halsey’s Plan. This innovative approach calculates the premium based on a percentage of wages for the time worked and not for the time saved. As a result, workers are rewarded with additional bonuses. It is calculated by the following formula:

Bonus = Time Saved x (Time Taken / Standard Time or Time) x Allowed Hourly Rate

c) Barth Variable Sharing Plan

It does not guarantee the time rate. The worker’s pay is ascertained by multiplying the standard hour by the number of hours taken to do the job, taking the square root of the product and multiplying it by the worker’s hourly rate.

d) Bedaux Plan

Under this plan, each operation or job is quantified in terms of a specific number of standard minutes, referred to as Bedeaux Points or Bs. These points serve as a representation of one minute, derived through meticulous time and motion study analysis. Therefore, there are 60 “B’s” within one hour. Every job is assigned a specific number of Bs as a standard requirement. The hourly rate is also determined. In addition to their hourly rate, the worker is entitled to receive a bonus. According to the original plan, this bonus is calculated as 75 per cent of the points earned by the worker, provided that the number of points exceeds 60 per hour. Furthermore, the bonus is multiplied by one-sixtieth of the worker’s hourly rate. Workers who fail to meet their standards are compensated based on the time rate.

iii) Earnings Varying Proportionately More than Output

This type of category includes the following two methods:

a) High Piece Rate

In the High Piece Rate system, a worker’s earnings are directly linked to their output, similar to straight piece-work. However, what sets this system apart is that the increase in revenues for each output unit surpassing the standard is significantly higher.

For example, when output exceeds the standard by one per cent, earnings may increase by 4/3 times compared to a one per cent increase in revenues under the straight piece-rate system. The higher rates are applicable once the standards have been met. The same reasoning applies to the high-standard hour system.

b) High Standard Hour System

Under the high standard hour system, the rate per unit of time is higher. For example, a worker’s time rate earnings may experience a 10 per cent increase for every one per cent increase in the output above the standard. This system ensures that workers are incentivized to exceed the standard and achieve higher productivity.

iv) Earnings Differing at Different Levels of Output

This group includes various schemes. The best way to understand these systems is by describing how earnings vary from minimum to maximum at different output levels. The earnings within a specific range may go to a lesser extent than the output for some parts, while they may vary to a greater extent for others. Alternatively, earnings are likelier to vary in the same proportion as the output. The systems that fall under the category where earnings vary at different levels of production are as follows:

a) Taylor’s Differential Piece-Rate System (Developed by F. W. Taylor in 1880)

Under this system, two-piece rates are determined, i.e., a low piece rate for those who fail to attain the standard and a high piece rate for those who reach the standard or are above the standard. The efficiency of a worker may be determined as a percentage of either
(a) of the time allowed for a job to the actual time taken or
(b) of the actual output to the standard production within a specified time.
Here, the differential to be applied is 80% of the piece rate below standard and 120% above standard.

b) Merrick’s Multiple Piece-Rate System

It is an improvement over Taylor’s Differential Plan. According to this plan, three price rates for a job are fixed. None of these three-piece rates are fixed below the normal level. These three rates are applied in the manner explained as follows:

c) Gantt Task and Bonus Plan

This plan has been devised by H. L. Gantt and is the only one that pays a bonus percentage multiplied by the value of standard time. Under this system, fixed-time rates are guaranteed. Output standards and time standards are established for the performance of each job. Workers completing the job within the standard time or in less time receive wages for the standard time as well as a bonus which ranges from 20 per cent to 50 per cent of the time allowed and not the time saved. When a worker fails to turn out the required quantity of a product, he simply gets his time rate without any bonus.

d) Emerson’s Efficiency Plan

A standard time is set for each job, and the efficiency of each worker is determined by dividing the time taken by standard time. Up to 67 per cent of efficiency, the worker is paid by time rate. Subsequently, a graduated bonus is awarded to the worker, equivalent to 20 per cent of their salary when they achieve 100 per cent efficiency. Thereafter, an additional bonus of 1 per cent is added for each additional I per cent efficiency. 

e) Accelerating Premium System

These are the systems which provide a guaranteed minimum wage for output below standard. For low and average increases in the output above the standard, small increments in earnings are allowed Increasingly large earnings are conceded for above-average output, the increment being different for each 1% increase in output. Substantial earnings boosts are awarded for exceptionally high productivity levels. In this system, the production is pushed up higher and higher by discouraging low output and rewarding at increasingly effective rates higher outputs. Such schemes are generally adopted when a much higher output than what is currently obtained is to be achieved.

2) Group Incentive Plans

Group incentives refer to incentive wage plans which are designed to motivate a group of individuals to enhance their productivity. The group may comprise a few individuals, an entire department, or even an entire company. Group incentive plans are highly beneficial in situations where workers’ jobs are closely interconnected. Group incentive plans are designed to encourage employees to work cohesively as a team.

Types of Group Incentive Plans

Types of group incentive plans are given as follows:

i) Priestman’s Production Bonus Plan

In the Priestman’s Production Bonus plan, a team of experts establishes the benchmark performance in terms of the number of units to be completed by a group within a specific timeframe. This plan aims to incentivize and reward exceptional productivity among employees. Then, the actual group’s performance is assessed and compared to the standard performance. In cases where the real performance exceeds the traditional performance, group members are eligible for a bonus. This bonus is calculated based on the additional production the individuals involved accomplish. However, if the group’s performance falls below the standard level, they will be compensated based on an hourly rate without any additional bonuses.

ii) Cost Efficiency Bonus Plan

Under the Cost Efficiency Bonus Plan, the organization initially establishes the standard cost for various cost components. These may be labour costs, material costs and overheads associated with production. Indeed, an organization may also determine the typical cost for the overall expenses encompassing these elements. Furthermore, the subsequent step involves quantifying the precise costs borne by the collective in successfully attaining the predetermined production objectives or targets. Finally, the group’s actual incurred cost is compared to the standard cost to assess the cost savings achieved by the group. Per the cost efficiency plan, a predetermined percentage of the savings is allocated as bonuses for our valued employees.

iii) Gainsharing Plan

Gainsharing is a strategic approach that aligns the enhancement (gain) in a company’s performance with the equitable distribution (sharing) of the resulting benefits among its employees. Usually, gainsharing is applied to a group or all employees rather than an individual. Gainsharing focuses on the company’s most essential performance metrics. Payouts are typically distributed on a monthly or quarterly basis in gainsharing programs.

iv) Towne Plan

This method focuses only on the savings in labour costs when determining the rewards to be paid to the group. The process begins by establishing the standard labour cost for the entire project in advance. After that, the actual labour cost for the project is measured and compared against the typical labour cost. The resulting savings in labour costs are then calculated, and a portion of these savings is distributed to the group members in monetary terms. Notably, a portion of the savings is typically allocated to the supervisors to recognise their contribution to cost reduction. The organisation may also receive a share of the savings in labour costs.

3) Enterprise Incentive Plans

Enterprise incentive plans differ from group and individual incentive plans in that all organisational members participate in the plan’s compensation payout. Enterprise incentive plans are designed to reward employees based on the organisation’s success over an extended period, usually one year or even longer. It seeks to create a “culture of ownership” by promoting teamwork and cooperation among all the organisational members.

Types of Enterprise Incentive Plans

Types of enterprise incentive plans are given as follows:

i) Profit-Sharing Plan

Profit-sharing plans are established on pre-determined economic sharing rules, which clearly outline the distribution of gains between the company, acting as the principal, and the employee, serving as the agent. For example, suppose the profits are denoted by the variable ‘x’, which might be a random variable. Before knowing the actual profit amount, the principal and agent can establish an agreement regarding the distribution rules for ‘x’. In this scenario, the agent will be entitled to receive ‘s(x)’, while the principal will receive the remaining gain, ‘x – s(x)’.

ii) Stock Options

Employee stock options are a form of compensation given to employees by the companies for their work performance. Stock options are valuable opportunities for employees to purchase a specified number of shares of company stock in the future at a guaranteed price.

iii) Employee Stock Ownership Plan (ESOP)

An Employee Stock Ownership Plan (ESOP) is a defined contribution employee benefit plan that offers employees the opportunity to become shareholders in the company they are employed by. It is an equity-based deferred compensation plan. It is an alternative to selling the company to external investors or another company to sell the company to its employees.

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