UNIT 4: INCENTIVE PLANS

Learner Outcomes:
Upon successful completion of this unit, learners will be able to explain:

1. Theoretical perspectives with applications to compensation

a. Vroom’s Expectancy Theory
b. Maslow’s Hierarchy of Needs
c. Adam’s Equity Theory
d. Herzberg’s Two-factor Theory

(i) Victor Vroom’s Expectancy Theory - is based on the premise that people evaluate the
expected behaviour against the reward or compensation that management is prepared to offer in
exchange for that behaviour. Vroom’s theory also suggests that motivation depends on
individual’s mental expectations about their abilities to perform tasks and receive desired
rewards. Expectancy theory is based on the relationship among the individual’s effort, the
possibility of high performance and the desirability of outcomes following high performance.
This theory is based on three beliefs – Valence, Expectancy, and Instrumentality.
 Valence – this refers to the emotional attachment the employee has to the reward whether
intrinsic or extrinsic. If the outcomes that are available from high effort and good
performance are not valued by an employee, motivation will be low.
 Expectancy – this examines employees’ capability and confidence in carrying out their
duties. Management examines what needs to be done to boost the confidence to carry out
such duties. Expectancy is the probability that putting effort into a task will lead to high
performance. For this expectancy to be high, the individual must have the ability,
previous experience and necessary tools, information, and opportunity to perform.
 Instrumentality – this refers to the perception of employees they will receive the reward
promised for the job performed. Management must fulfil the promised reward in a timely
fashion. expectancy involves whether successful performance will lead to the desired
outcome. If this expectancy is high the individual will be more highly motivated.
Expectancy theory assumes that employees will be motivated if they believe that:
 There is a positive correlation between effort and performance.
 A desirable reward will result from satisfactory performance
 The reward received will satisfy important need
 The effort invested will be worthwhile once there is a strong desire to satisfy the need.

(ii). Maslow’s Hierarchy of Needs

This is a fundamental part of the "emotional contract" between leaders and their teams: When
followers know they're being looked after by their leader, they'll usually give their best in return.
Maslow's Hierarchy of Needs is a popular way of thinking about people's needs. Published by
psychologist Abraham Maslow in his 1943 article, "A Theory of Human Motivation," this
theory contends that as humans strive to meet our most basic needs, we also seek to satisfy a
higher set of needs.
Maslow presents this set of needs as a hierarchy, consisting of: Physiological/bodily needs;
Safety needs; Love/belonging needs; Self-esteem; Self-actualization (the desire to be "all that
you can be").

The theory argues that the most fundamental level starts with the physiological need for food,
water, and shelter. This is followed by security and social needs. Maslow believed that the
higher-level needs, such as self-esteem and self-fulfillment, could only be met after the lower-
level needs had been satisfied.

Understanding the Theory

Maslow's hierarchic theory (see figure 1) is often represented as a pyramid, with the lower levels
representing the more fundamental needs, and the upper levels representing the growth/being
needs, and ultimately the need for self-actualization.
According to the theory, the higher needs in the hierarchy become evident only after all the
needs that are lower down in the pyramid are met.
These levels are:

Level 1: Physiology, Body

Physiological needs are biological needs and include the needs for oxygen, food, water, shelter,
etc. They are the basis for the hierarchy and are the strongest needs because if a person were
deprived of all needs, the physiological ones come first in the person's search for satisfaction.

Level 2: Security
According to Maslow, the need for security becomes evident only after a person's physiological
needs are met. While most adults are not acutely aware of security needs until a crisis arises, it is
important to understand this need and for managers to provide a safe workplace.

Level 3: Belonging, Social

Once the needs for safety are met, the need for a sense of belonging, one in which a give-and-
take relationship is nurtured, becomes evident. Maslow states that people seek to overcome
feelings of loneliness and alienation and managers must understand this to ensure employee
involvement, production, and motivation, etc.

Level 4: Self-Esteem
Once the first three classes of needs are met, the need for self-esteem can become dominant.
Because this includes the esteem a person gets from others, managers who understand this can
use this tool to help ensure employees and team members feel valued and respected, driving up
self-esteem.
This will positively impact the employee and the employee's motivation levels, productivity,
ability to work on a team and alone, etc. On the other hand, if these needs are not met, an
employee may become frustrated, feel inferior and worthless and he or she may withdraw.

Level 5: Self-Actualization
The need for self-actualization develops only after all of the foregoing needs are satisfied.
According to Maslow, self-actualization is a person's need to do that which he or she feels they
are meant to do. As a manager, it is important to help employees or team members find this,
otherwise the employee will become dissatisfied, restless, unproductive and may even look for
satisfaction elsewhere.

Applying the Theory

Maslow's Hierarchy of Needs is not so much a technique or process to use as an idea to have in
mind when you're thinking about how you meet a team member's needs (for example, during a
quarterly review). Managers often instinctively want to use salary raises as a way of motivating
team members. However, the reality is usually that they have a fixed "pot" of raises to offer to
their team members, and this often does not allow the rewards they want to give.
Maslow's theory is important for two reasons: Firstly, it points out that people's needs are not just
met by hard cash (which arguably addresses levels 1 and 2). People have many needs which have
to be met, and while people may be very well paid, they can still be unsatisfied if these needs
aren't met.

(iii). Adam’s Equity Theory

This theory proposes that people are motivated to seek social equity in the rewards they expect
for performance. The issue of equity is central to compensation management.
• It is an issue which preoccupies most employees in their dealings with each other and with their
employer.
• It explains the thought process an employee uses to determine the fairness of management
decision making, the core of equity theory says that individuals judge the fairness if their
treatment based in how others like them are treated. Employees make social comparisons to
others who are similarly situated in the organization.
• “Fairness is achieved when the return on equity is equivalent to the investment made...For
compensation then, we would define fairness as being achieved when the value of compensation
received is equivalent to the value of the Labour performed.
• Unfairness or inequity occurs when the value of the compensation received does not
correspond to the value of the Labour performed.

Federick Herzberg’s Motivation Theory – Two Factor Theory

Herzberg’s Motivation Theory model, or Two Factor Theory, argues that there are two factors
that an organization can adjust to influence motivation in the workplace.
These factors are:
 Motivators: Which can encourage employees to work harder.
 Hygiene factors: These won’t encourage employees to work harder but they will cause
them to become unmotivated if they are not present.

What is the Two Factor Theory?

Herzberg’s Theory of Motivation tries to get to the root of motivation in the workplace. You can
leverage this theory to help you get the best performance from your team.
The two factors identified by Herzberg are motivators and hygiene factors.

a. Motivating Factors
The presence of motivators causes employees to work harder. They are found within the actual
job itself.

b. Hygiene Factors
The absence of hygiene factors will cause employees to work less hard. Hygiene factors are not
present in the actual job itself but surround the job.
The impact of motivating and hygiene factors is summarized in the following diagram. Note that
you will often see motivators referred to as factors for satisfaction, and hygiene factors referred
to as factors for dissatisfaction.

Motivating factors include:

Achievement: A job must give an employee a sense of achievement. This will provide a proud
feeling of having done something difficult but worthwhile.
Recognition: A job must provide an employee with praise and recognition of their successes.
This recognition should come from both their superiors and their peers.
The work itself: The job itself must be interesting, varied, and provide enough of a challenge to
keep employees motivated.
Responsibility: Employees should “own” their work. They should hold themselves responsible
for this completion and not feel as though they are being micromanaged.
Advancement: Promotion opportunities should exist for the employee.
Growth: The job should give employees the opportunity to learn new skills. This can happen
either on the job or through more formal training.

Hygiene factors include:

Company policies: These should be fair and clear to every employee. They must also be
equivalent to those of competitors.
Supervision: Supervision must be fair and appropriate. The employee should be given as much
autonomy as is reasonable.
Relationships: There should be no tolerance for bullying or cliques. A healthy, amiable, and
appropriate relationship should exist between peers, superiors, and subordinates.
Work conditions: Equipment and the working environment should be safe, fit for purpose, and
hygienic.
Salary: The pay structure should be fair and reasonable. It should also be competitive with other
organizations in the same industry.
Status: The organization should maintain the status of all employees within the organization.
Performing meaningful work can provide a sense of status.
Security: It is important that employees feel that their job is secure, and they are not under the
constant threat of being laid off.

Upon successful completion of this unit, learners will be able to explain:

2. Types of incentives plans
a. Long term and short term Incentives
b. Individual and group
c. Types of group incentive Plans:
i. Scanlon Plan
ii. Rucker Plan
iii. Improshare Plan
iv. ESOP
d. Types of individual incentive plans:
i. Bonus
ii. Commission
iii. Piece rate
iv. Merit pay

What is an incentive plan?

Incentive plans are formal schemes designed to encourage specific actions and behaviors and
motivate individual or group performance.
Types of incentives plans

a. Long term and short-term incentive plans

Short-term incentives, also often referred to as annual incentives, are intended to compensate
employee for achieving the company's short-term business strategy based on achievement of
goals by the board compensation committee; while long term incentive plans are reward systems
designed to improve employees' long-term performance by providing rewards that may not be
tied to the company's share price.
b. Individual and Group Plans

Individual compensation plans define compensation that managers can award

to individual workers outside of the regular compensation cycle, such as a spot bonus or
education reimbursement that may be varied based on individual effort. Group compensation
Plans on the other hand a team-based incentives that are based on the collective effort of the
team.

Types of Group Incentive Plans:

Scanlon Plan: An incentive plan developed in 1937 by Joseph Scanlon and designed to
encourage cooperation, involvement, and sharing of benefits.
This is the most common gainsharing / bonus incentive plan and uses employee and management
information committees to gain cost reduction improvements. Scanlon Plans focus on the cost of
labour and encourage cooperation among employees. Savings are calculated by comparing the
sales value of production with employee costs. It is most appropriate for companies that have
”high touch labour" content and are often used in service industries where customer service
focus is essential to success.

Rucker Plan: A bonus incentive plan that also uses a committee system but has a far less
participatory structure. The Rucker Plan is based on the premise that the ratio of labour costs to
production value (actual net sales plus or minus inventory changes, minus outside purchased
materials and services) is historically stable. In other words, the savings gain is based on value
added, the increased value of goods at each stage of production and calculated by comparing
labour costs with sales minus the cost of goods sold. These plans are used mostly in the
manufacturing sector where costs are relatively stable over time and where the business wants to
reduce other costs in addition to labour.

Improshare Plan: An Improved Productivity through Sharing (Improshare) Plan involves

developing standards based on historical data. Bonuses are based upon the overall productivity of
the work team and it is the easiest of the gainsharing plans to understand and implement. The
standards developed form the operational baseline against which suggested improvements are
compared.
Savings are an indication of the change in the relationship of labour (inputs) to outputs via the
final product or service. Because the plan is based on performance standards, changes in sales
volumes, technology and equipment have minimal impact on the plan.

ESOP (Employee Stock Ownership Plan): Employee stock ownership plans are company-wide
plans in which a corporation contributes shares of its own stock—or cash to be used to purchase
such stock—to a trust established to purchase shares of the firm’s stock for employees. The firm
generally makes these contributions annually in proportion to total employee compensation, with
a limit of 15% of compensation. The trust holds the stock in individual employee accounts and
distributes it to employees upon retirement (or other separation from service), assuming the
person has worked long enough to earn ownership of the stock.

Types of individual incentive plans:

Bonus: Bonus pay is compensation over and above the amount of pay specified as a base salary
or hourly rate of pay. Bonuses are stated compensation amounts. They may vary for individual
employees and can be represented by a percentage or fixed amount (e.g., 4% of base salary or
$10,000). If the quota is not met, employees can earn a percentage of their bonus, which can help
to build and maintain staff morale.

Commission: is a fixed incentive amount offered for achieving a specific objective. In

commission plans, the total compensation amount will vary based on individual employee
performance. For example, sales teams are presented with a percentage (e.g., 6% of sales
revenue), which they will earn for every sale they make. Once employee reached their
performance target, this rate often increases to encourage over performance.

Piece Rate: is any type of employment in which a worker is paid a fixed piece rate for each unit
produced or action performed regardless of time. This is where the employee is paid on a piece-
rate pay system is being paid a set price for each unit of a product that they make, and the more
they produce the more they earn.

Merit Pay: merit increase or pay for performance, is performance-related pay. It provides
bonuses for workers who perform their jobs effectively, according to easily measurable criteria.
Merit pay is an approach to compensation that rewards the higher performing employees with
additional pay or incentive pay.
 Upon successful completion of this unit, learners will be able to explain:

3. Guidelines for Incentive Systems:

a. Organization culture and resources
b. Incentives tied to desired performance.
c. Current Incentive Plans
d. Plan payments/basic pay.

When designing an incentive system, it’s important to consider the following guidelines:
a. Organization Culture and Resources:

 Ensure that the incentive system aligns with the organization’s culture and values.
 Consider the resources available, including budget constraints and administrative
capabilities.

b. Incentives Tied to Desired Performance:

 Clearly define the performance metrics that incentives are tied to.
 Make sure these metrics are measurable, achievable, and directly related to the
organization’s goals.

c. Current Incentive Plans:

 Review and understand existing incentive plans to identify what works well and what
could be improved.
 Consider how new plans will integrate with or replace current ones.

d. Plan Payments/Basic Pay:

 Decide on the balance between fixed basic pay and variable incentive pay.
 Ensure that the total compensation is competitive and fair and motivates desired
behaviors and outcomes.

Remember, the effectiveness of an incentive system is largely dependent on how well it is

communicated to and perceived by the employees. It should be transparent, fair, and consistently
applied to maintain trust and motivation.
 Upon successful completion of this unit, learners will be able to explain:

1. Basic incentive plan for small business

Creating a basic incentive plan for a small business involves a few key steps to ensure it’s
effective and aligns with your business goals. Here’s a simplified guide to help you get started:
1. Define Clear Objectives: Determine what you want to achieve with the incentive plan.
This could be increasing sales, improving customer service, or boosting productivity.
2. Identify Key Behaviors: Decide on the behaviors that will contribute to these objectives.
For example, you might reward employees for upselling products or receiving positive
customer feedback.
3. Choose Incentive Types: Decide between monetary incentives like bonuses, profit-
sharing, and raises, or non-monetary incentives such as additional time off, flexible
working hours, or professional development opportunities1.
4. Set Measurable Goals: Establish clear, quantifiable targets that employees need to hit to
receive the incentive. This could be a sales target, a number of positive reviews, or a
project completion deadline.
5. Communicate the Plan: Make sure all employees understand how the incentive plan
works, what the rewards are, and how they can achieve them.
6. Monitor and Adjust: Keep track of the plan’s performance and be ready to make
adjustments if certain aspects aren’t working as intended.
7. Celebrate Achievements: When employees meet their goals, celebrate their success.
This not only rewards the individual but also motivates others.

Remember, the best incentive plans are those that are fair, transparent, and align with the
company’s culture and values. It’s also important to consider the preferences of your employees;
some may value recognition and professional growth opportunities over financial rewards.
Tailoring the plan to fit your team will increase its effectiveness and help you achieve your
business objectives.