Ch30-Compensation Systems - 2019

Compensation Systems
Sections:
1. Overview of Compensation Systems
Chapter 30 2. Time-Based Pay Systems
3. Direct Wage Incentive Systems
4. Gain Sharing
5. Profit Sharing
Work Systems and the Methods, Measurement, and Management of Work

by Mikell P. Groover, ISBN 0-13-140650-7.
©2007 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
Employer's Compensation System
Equality cycle:
Fair day’s work  Fair day’s pay
Content and measurement system Reward system
The various forms of financial rewards and fringe
benefits provided to employees in return for their
services
 Components of compensation system:
1. Base pay
2. Variable pay
3. Fringe benefits
Two Basic Pay Systems
1. Time-based pay systems
 Employee is paid for the time worked
2. Incentivized pay systems
 Pay is based on the amount of work
accomplished or some other measure of
performance

Continuum of Pay Systems
Many pay systems are combinations of time-

based and incentivized schemes

Combination Pay Schemes
 Salesperson who is paid a base salary plus
commission for sales above a defined
minimum
 Production worker who earns an hourly wage
and also receives a bonus that is proportional
to his or her individual output
 Manager who earns a regular salary and is
also paid a bonus for achieving defined goals
of the organization

Three Components Examined
 A worker's total compensation usually consists
of three components:
1. Base pay
2. Variable pay
3. Fringe benefits

Base Pay
 Wage or salary paid to employee on a
regular basis
 Base pay = time-based component of total
compensation
 Base pay depends on:
1. Value of job in the organization
2. Value of individual to the organization
3. Laws of supply and demand in the labor
market

Variable Pay
 Usually based on some measure of
performance
 Variable pay = incentivized component of
total compensation
 Types:
1. Direct incentive systems – bonus paid in
direct proportion to output of worker or
group
2. Indirect incentive systems – based on
productivity improvement or profits

Fringe Benefits
 Social Security and Medicare
 Workers’ compensation
 Disability insurance
 Paid vacation
 Paid holidays
 Pension plan
 Life insurance
 Tuition reimbursement

Time-Based Pay Systems
 Employee is paid a specified rate for his or
her time
 Two categories:
1. Hourly pay systems – hourly rate for
amount of time worked
2. Salary systems – fixed amount paid at
regular intervals (e.g., weekly, monthly) for
services of worker

Hourly Pay Systems
1. Conventional hourly pay system – pay by the hours
worked, no direct measure of amount of work
accomplished
 Also called day work
 Reasons
 Infeasible to set time standards
 Random interactions with people
 Active/nonactive periods
 Little correlation of between the worker’s effort
and the output
2. Measured day work – work output is measured using
time standards and it may have an effect on the pay

Exempt vs. Non-Exempt Workers
Exempt, in the US practice, means exempt from
certain provisions of the regulations on the
worklife.
 Turkish law: 45 hours per week regular +
overtime
 US practice
 An exempt employee is not paid at time-
and-a-half for hours above 40 per week
 Salaried workers are usually exempt
 Hourly workers are usually non-exempt

Salary Pay Systems
 Exempt workers (usually)
 Qualifications for exemption: executive,
managerial, administrative, professional
employees, and salespersons who sell
outside of employer’s place of business
 Criteria for exempt status:
 High earnings level
 Supervision of workforce
 Work requires discretion and judgment
 Work requires advanced knowledge in
given field

Day Work Systems for the Non-Exempt
 Computation of wages (W) up to 40 hours per

week:
W = RhrHw
where Rhr = hourly rate, $/hr; and Hw = hours
worked, hr
 Wages for more than 40 hours per week:
W = RhrHw + 0.5 Rhr(Hw – 40)

Measured Day Work
Hourly pay system in which time standards are
used to measure the amount of work
accomplished by each employee
 Time standards are used for labor staffing,
production planning, work scheduling, cost
estimating, etc.
 But not for direct wage incentives
 Instead, time standards can be used to
determine a worker efficiency index to
evaluate workers (for periodic reviews, pay
raises)
Direct Wage Incentive Systems
 Wage or salary increases as work output
increases
 Examples
 Piece rate systems
 Sales commissions
 Management bonus plans
 Two basic categories:
 Individual incentive plans
 Group incentive plans

Individual Wage Incentive Plans
 Individual wage incentive plans pay each
worker according to his or her individual
output
 Categories:
1. Piecework plans
2. Standard hour plans
3. Bonus-sharing plans

Piecework
 Also called piece rate system
 Wage computed as follows:
W = Ru Q
where Ru = piece rate, $/pc; and Q = quantity
produced, pc
 Piecework systems were common before World
War 2
 No guaranteed base rate
 Workers have to produce to earn (value added
by the labour)
 Companies have to sell to earn (value added by
the capital owner)
Standard Hour Plan
 Operates like piece rate plan, but piece rate is
a time rate rather than a dollar rate
 Guaranteed base rate
 Wage computed as follows:
W = Rhr Hstd if Hstd > Hsh (1)
W = Rhr Hsh if Hsh  Hstd (2)
where Hstd = standard hours accomplished, hr;
and Hsh = shift hours, hr
 If (1), bonus B = Rhr(Hstd – Hsh)

Example: Standard Hour Plan
 Given: Worker is paid weekly, but his wage is
computed on a daily basis with Rhr = $10/hr on
a standard hour plan with guaranteed base
rate
In a three-day period, he produced 88, 96, and
110 units per day on a task with Tstd = 5.0 min
 Determine for each day: (a) worker’s wages,
(b) bonus if one is earned, and (c) direct labor
cost per work unit

Example: Solution, Part (a)
(a) Standard output quantity
Qstd = units/day
First day
W1 =
Second day, output =
W2 =
Third day,
W3 =

Example: Solution, Parts (b) and (c)
(b)
B1 = B2 =
B3 =
(c) Direct labor cost per work unit on each day

Cpc1 = / 88 = $ /pc
Cpc2 = / 96 = $ /pc
Cpc3 = / 110 = $ /pc

Wage vs. Output
Relationships
between wages and
output for hourly pay,
piecework, and
standard hour plan

Bonus-Sharing Plans
 Worker receives only a portion of bonus
 Remainder shared with (1) company or (2)
supervision and/or indirect workers
 Wage & bonus computed as follows if Hstd > Hsh
W = RhrHsh + pRhr(Hstd – Hsh)
B = pRhr(Hstd – Hsh)
where p = proportion shared by worker
 Typical p value 0.25 to 0.50

Bonus-Sharing Plans
Relationship
between wage and
output in a bonus-
sharing plan

Example: Bonus-Sharing Plan
 Given: Same data as previous example, but
the company uses a bonus sharing plan with
worker receiving 50% of the bonus (p = 0.5)
Rhr = $10/hr with guaranteed base rate
Determine for each day: (a) worker’s wages,
(b) bonus if one is earned, and (c) direct labor
cost per work unit

Example: Solution, Part (a)
(a) First day, worker produces 88 units and is paid
the guaranteed base rate
W1 = $10(8.0) = $80.00/day
Second day, worker produces 96 units
W2 = $10(8.0) = $80.00
Third day, worker produces 110 units
Hstd =
W3 =

Example: Solution, Parts (b) and (c)
(b) As in previous example, B1 = B2 = 0
Third day
B3 =
(c) Direct labor cost per work unit on each day
Cpc1 = / 88 = $0.909/pc
Cpc2 = / 96 = $0.833/pc
Cpc3 = / 110 = $0.780/pc

Bonus-Sharing Plans
1. Halsey Plan (typical p = 0.333)
 Started in late 1800s before direct time
study widely used
 Helped to to curb “runaway piece rates”
 Bonus shared with company
2. Bedaux Point System (p = 0.75)
 Bonus shared with supervisors and
indirect workers

Group Incentive Plans
 Each member of worker team receives the
same % bonus, based on output of the team
 Individual wages and bonuses may vary
according to job classification

Advantages of Group Incentives
 Easier to install and administer than individual
plans
 Group success requires cooperation and
teamwork
 This requirement encourages cooperation
and teamwork within the group

Disadvantages of Group Incentives
 No attention is paid to individual performance,
at least not officially
 Possible personnel problems if some
members loaf
 Group incentive plans do not provide as much
incentive for greater individual effort as
individual incentive plans

Objectives of a Direct Incentive Plan
1. To increase productivity for the organization
that sponsors it
2. To increase earnings for the workers who
participate in it
 Achieving both objectives provides a mutual
interest in the success of the incentive
system

Why Direct Incentive Plans Fail
 Conflicting objectives between workers and
organization
 Workers want to maximize their own wages
 Organizational objectives include higher
productivity, better quality, greater customer
satisfaction, higher profits
 Workers may not care about these
objectives

 Penalties for increasing productivity
 Increasing productivity means the same
amount of work is accomplished with fewer
workers
 Possible consequences:
 Less overtime
 Displacement to less desirable jobs
 Layoffs

 Emphasis on physical effort
 Incentive system rewards workers for
greater speed and effort
 Work harder, but not smarter
 Methods improvements may increase
productivity more than greater physical
effort

 Standards become eroded over time
 Learning curve phenomenon
 Worker learns task and becomes more
proficient and efficient at it
 Worker makes unofficial changes in
methods and conceals them

 Mixing day work and incentive work
 Some workers work on day work while
others work on incentive
 Jealousy because incentive workers earn
more
 Individual workers work part of the time on
day work and part on incentive
 Accounting of how much time spent in
each category is difficult
 Some companies pay average earned
rate (AER) to worker for day work
Incentive Plan Success Factors
 Clearly defined and documented incentive
policy
 Avoids workers trying to “beat the system”
 Easy to understand
 Plan should be stable
 Training of workers
 Training about incentive system
 Training in standard method

Incentive Plan Success Factors
 Link between effort and output
 Output must be measurable
 Otherwise there is no basis for determining
worker’s bonus
 Accurate time standards
 Maintenance of time standards
 Standards not allowed to erode over time

Alternatives to Direct Wage Incentives
 Gain-sharing plans
 Profit sharing plans

Gain-Sharing Plan
 Indirect group incentive plan in which
employees are encouraged to make
improvements that increase productivity and
reduce cost
 Company shares the benefits of those
improvements with employees through periodic
bonuses

Gain-Sharing Plans
 Intended to motivate not only high individual
effort but also to allow for
 Methods improvements
 Material savings
 Quality improvements
 Automation
 Working harder and smarter

Scanlon Plan
1. Philosophy of cooperation permeates the
organization
2. Workers involved in production committees
to study improvements
3. Formula for measuring productivity
improvements and sharing the benefits with
employees

Scanlon Plan
 Formula based on ratio of payroll costs in
defined base period (PCb) to net sales for
same period (NSb)
SBR = PCb/NSb
where SBR = Scanlon base ratio
 After base period, bonus calculated as follows
for any period i:
Bi = SBR (NSi) - PCi
 Bonus is shared 50-50 between workers
and company

Example: Scanlon Plan
 Given: Two year base period in which net sales
= $24,000,000 and payroll costs = $7,200,000.
In a subsequent three-month period, net sales
= $3,500,000 and payroll costs = $960,000.
 Determine: (a) Scanlon base ratio, (b) bonus in
three month period, and (c) cash amount
distributed to employees.

Example: Solution
(a) Scanlon base ratio:
SBR =
(b) Bonus for three-month period if the calculated
value is positive:
Bi =
(c) The $90,000 is divided 50%-50% between the
workers and the company
Of the 50% going to the workers ($45,000),
75% is distributed immediately as a cash
payment
Cash amount =

Other Gain Sharing Plans
 Rucker Plan
 Similar to Scanlon plan but instead of net
sales, the value added by labor is used in
the bonus formula
 Improshare (stands for “improved productivity
through sharing”)
 Similar to Scanlon and Rucker plans but
labor hours are used in the bonus formula
rather than dollar amounts

Profit Sharing
 Company pays to employees a share of its
profits
 Indirect group incentive plan
 Motivates employees to greater effort but
bonus not directly related to their own output

Profit Sharing Plans
1. Cash plans – profit bonus paid soon after
profits are determined
2. Deferred plans – profit bonus is credited to
an employee account that can be withdrawn
at retirement or severance
3. Combination plans

Profit Sharing Plans
 Factors that determine the size of each
employee’s share of the profit bonus:
 Annual wage or salary level
 Length of company service
 Proportion of total profit allocated to profit
sharing
 Size of the profit
 Problem: if company makes no profit, there is
nothing to share


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Compensation Systems

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Many pay systems are combinations of time-

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

 Computation of wages (W) up to 40 hours per

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

(c) Direct labor cost per work unit on each day

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

Work Systems and the Methods, Measurement, and Management of Work

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