Module 3--Developing a Variable Pay Plan Phases 1 and 2: Pre-Design and Design Flashcards
What are the 3 phases of Plan Design?
Phase 1: Pre-Design
Phase 2: Design
Phase 3: Funding and Distribution
Phase 1: Pre-Design
Phase 1: Pre-Design
Activities that should be completed before you begin the design process include:
■ Considering internal and external factors
■ Obtaining management support
■ Identifying the design team
Phase 1: Pre-Design–Internal and External Factors
Internal and External Factors
Internal and external factors directly affect variable pay plans and should be considered in designing
the plan. Module 1 discussed some of these factors (business strategy, business life cycle, business
objectives). Additional factors include:
■ Internal Factors
* Organizational readiness / culture
* Costs / resource availability
* Timing
■ External Factors
* Labor market
* Competition
* Geopolitical
* Legal / regulatory
* Technology
* Best practices
Organizational Readiness – Four Cultures Types
An organization’s readiness to handle a certain level of pay variability can be viewed in terms of the
organization’s culture, and the extent to which that variability may be effective. Each organization
and sub-organizational unit operates somewhere within the matrix of the four cultures types.
■ Traditional / hierarchical – An organization places high value on its people, but employees’
ability to improve organizational performance may be limited. This culture may not be well-suited
to a variable pay plan, unless the objectives of the plan are primarily employee awareness of
measures important to the organization.
■ Job-focused / task-based – As with the traditional / hierarchical organization, a job-focused
/ task-based organization offers little opportunity for employees to affect organizational
performance. This factor, combined with a low value placed on people in the organization, may
make variable pay a poor fit without a change in culture.
■ Integrative / team-focused – This organization places a high value on people, with employees
having the ability to affect organizational performance. However, the strong culture could inhibit
a variable pay plan that places significant rewards on individual performance.
■ Individually measured – An organizational culture that places lower value on its people but
affords them the opportunity to affect organizational performance with an individually measured
focus may use individual incentives. However, in order to consider a recognition plan, a change in
culture may be required.
What is the VARIABLE PAY EFFECTIVENESS MODEL?
Variable Pay Effectiveness Model
The variable pay effectiveness model is one method for assessing the organization’s readiness for a
variable pay program.
■ Direction is defined by what the organization is attempting to accomplish and is reinforced by the
variable pay program.
* Business objectives may include teamwork, profit, customer satisfaction, internal quality,
productivity, etc.
* Business strategies’ external prevalence in the industry and internal alignment with
objectives will impact effectiveness.
* The culture of the organization affects the direction and plan design.
■ Power refers to how well the plan’s design reinforces its direction. Each of the highlighted
components below will vary in importance depending on the plan’s intent and design.
* Are employees aware of the plan?
* Does the plan have value to individuals and to the organization?
* How sensitive is the measurement to the contributions of employees and does the payout
directly correlate with performance?
* How much of the workforce is eligible to participate and/or actually receives a payout?
Example: A recognition plan for individuals (such as a spot award) can be powerful in awareness,
value and performance sensitivity, but lacking in participation, if only a few receive awards
during a year.
What are some issues to Consider when ti comes to Organizational Readiness?
■ Is the organization ready for a new or revised variable pay program?
Some issues to be considered in making that determination*:
* Will the organization be committed (or continue to be committed) to variable pay as a part of
total rewards?
* Can the organization measure the results on which rewards will be based?
* Is there an adequate level of employee trust?
* What is the employee perception of the market? How do employees view their company
against their peers?
* How will variable pay affect other pay programs?
* Does the workforce have the skills and knowledge necessary to achieve desired results?
* Will the organization be willing to share information on the objectives, measures and the
progress towards them?
* Is the organization willing to accept the risk and uncertainty of a potentially wide variance in
the possible payout?
* If applicable, how would the plan affect organized labor groups?
* Is the organization capable of accurately forecasting future performance on which rewards
will be based?
Costs / Resource Availability
Cost issues to consider prior to the design process include:
■ Implementation costs – Consider what the costs for communication and administration will be.
■ Funding – Broadly estimating plan costs will provide an idea of what funding will be required.
■ Compliance – Adding or revising programs may result in costs to comply with federal or state
regulations.
■ Support staff – A consideration often ignored, forgotten or miscalculated is the number of
support staff needed to effectively implement and administer the program.
TIMING
Timing
■ Impact of recent, current or upcoming events – Poor timing alone can ruin even a well-designed
variable pay plan. As you consider the high-level objectives of your plan, think about any recent,
current or upcoming events that may impact the appropriateness of implementing or revising a
plan. Here are some examples:
* Rolling out a new commission plan the day after the airing of a national news story
concerning the obsolescence of your company’s product line
* Distributing total rewards statements touting the competitiveness of the organization’s total
rewards program soon after the announcement that no profit-sharing incentives will be paid
for the year
* Announcing a major enhancement to the company’s management incentive plan, which will
increase managers’ target incentive amounts considerably, just days after a major costcutting
layoff is announced
* Rolling out a new plan after the company exceeded record sales could be perceived as an
attempt by management to unnecessarily reduce future rewards, especially if the changes
are perceived as unattainable.
EXTERNAL FACTORS
External Factors
■ Labor market
* The need to keep pace with the marketplace in terms of competitive wages / rewards
* Expectations based on location / demographics
■ Competition
* Plans industry / international competitors are using
* Cost-per-unit disadvantage relative to the industry
* Example: Two large competitors in your industry recently were in the news for exorbitant
bonus payouts. How might this affect your intention to roll out a new bonus plan
for managers?
■ Geopolitical
* Political relations in countries of business
* War / terrorism
* Product tariffs
* Foreign trade agreements
■ Technology
* Self-service Web sites
* Administrative software packages
■ Legal / regulatory
* Wage and hour laws
* Government mandates
* Governing bodies
* Tax
■ Best Practices
Obtaining Manage Support
Obtaining Management Support
■ Build a business case – Describe the business need this idea is addressing with preliminary
estimates on cost and payouts.
■ Determine buy-in early – Do not waste resources by working through an entire design process
until you determine whether a new plan or revision would even be considered. Sometimes,
financial, operational or cultural issues will not permit a variable pay plan or enhancement, no
matter how much of an improvement you believe it would make.
■ Begin at a high level – Generally, you will need some level of data and facts as you begin
floating ideas within the organization. It is more efficient to begin at a high level (identify broad
objectives, expected results or rough financial costs or gains) and then develop the nuts and bolts
of the plan as momentum increases. Initially, you should collect only as much information as the
decision makers in your organization require. You may only get one shot to pitch your idea, so you
need to be able to answer the level and detail of questions that are likely to be asked.
■ Utilize allies – There are those in positions of influence within an organization who will be more
supportive of HR / compensation initiatives than others. These allies can be extremely helpful in
gaining executive support for an idea and can serve as catalysts or champions for your cause.
■ Manage opposition – In any organization there are going to be those individuals who, no matter
what the change being proposed is, will adamantly oppose the change.
Identifying the Design Team
The organization may hire a consultant or design the plan using in-house experts. If a more
participative approach is desired, a plan design team may be formed.
■ Considerations for an in-house design team
* Design teams composed primarily of in-house members tend to produce programs that
have better alignment with an organization’s objectives and they generally have more
commitment to implementation.
* Team members can be instrumental in building trust and buy-in for a new plan.
* Can save substantial amounts of cash otherwise paid to consultants.
* Individuals may have difficulty finding time to participate due to pressing job
responsibilities.
* Expertise in plan design and implementation may not exist internally.
* Lack of strong management support for the team’s design proposal is a risk.
* Potential lack of creative thinking due to concerns the design team members feel about the
task. Their familiarity with the culture may stifle out-of-the-box ideas.
■ Advisory group alternative – A hybrid approach can be used when the concerns of using an
in-house team exceed the benefits. An advisory group can be created to represent various
perspectives of the organization, to provide reviews and to support implementation. An advisory
group is not involved in detailed design steps, but reviews the plan at key junctures and discusses
recommendations, creates excitement in anticipation of the new program and provides feedback.
The advisory group may be the final authority, or they may support the recommendation put forth
to senior management.
■ Develop a formal team charter – A charter identifies the team’s purpose, objectives, authority
and interaction with other interested parties. It defines the process or roadmap to guide their
actions in designing the plan.
■ Membership
* Cross-functional – The team should consist of six to 12 members representing all business
units affected by the plan and all levels of the organization. In a unionized work setting, the
participation of union leadership or employees should be addressed. Generally, effective
teams will include:
– Team leader (a respected mid-level manager)
– Finance representative
– First-line supervisors (2)
– Nonexempt representatives (2)
– IT representative (ad hoc as needed)
– HR
– Consultant (if one is retained)
* HR staff should not lead the team
■ Role of the design team
* Plan design – determine plan design, including selection of performance measures
* Approval – obtain senior management approval for the initial concept and final plan design
* Evaluation – determine how the plan will be evaluated
* Implementation – may participate in implementation of the plan
Phase 2: Design
The design of a variable pay plan is both a science and an art. The key is to have a basic process and
adjust it to the culture, objectives and specifics of the organization. Plan design includes:
■ Determining plan objectives and plan type
■ Defining eligibility
■ Selecting performance measures
Determining Plan Objectives and Plan Type
■ Directly address business objectives – As mentioned in Module 1, variable pay supports the
business objectives that are driven by business strategy. Keep the design of the plan on task by
clearly articulating the business objectives the plan will support or reinforce.
■ Limit the number of objectives – Generally three or less and no more than five plan objectives
should be defined for any one group of participants. Plans that are simple and easy to understand
are more apt to drive desired behaviors.
■ Use SMART objectives – Plan objectives should follow the SMART guidelines.
* Specific – Does it clearly state the tasks or activities to be done, along with the expected
outcomes or results?
* Measurable – Can it be assessed using some type of measure? Results must be quantifiable,
observable or verifiable.
* Attainable – Is it within the employee’s control to meet, challenge and reach with a stretch
in effort?
* Relevant – Is it related to business objectives or to individual employee responsibilities?
* Time-bound – Is there a clear timetable / deadline for performance to be achieved?
■ Select a plan type that supports objectives – Which category of variable pay (incentives,
bonuses, recognition) is best suited for our needs? Are the desired objectives achievable in one
year or less (short-term) or more than one year (long-term)? The type of plan that is chosen should
be one that best supports the plan objectives.
■ Examples
* Improve the productivity of the widgets division by implementing an incentive plan that will
share realized cost savings with plan participants.
* Drive higher levels of overall customer satisfaction through the introduction of a spot
recognition plan for call center employees.
* Ensure the timely rollout of a critical new product by offering current R&D employees
assigned to the product a retention bonus at year-end.
* Focus all employees on increasing operating income by implementing a profit-sharing plan.
Defining Eligibility
Defining Eligibility
Consider the following items when determining plan eligibility:
■ Level at which performance is measured – The level of measurement should support the plan
objectives. The level at which performance is measured (e.g., organization-wide, organizational
unit, team or individual incentive plan) will be a key factor in determining who to include
in the plan.
■ Participant line of sight – Can participants influence results?
■ Nonparticipants – In considering who to include, it is also important to consider who will not
be included.
■ Individual criteria – What individual criteria, such as employee status, performance rating or
eligibility in other plans, will affect the pool of eligible employees?
Level at Which Performance Is Measured
■ Organization-wide – Plans at this level measure and reward performance at the most
encompassing organizational level.
* Short-term plans can have organization-wide, organizational unit and individual elements.
The most common organization-wide short-term plan is a profit-sharing plan.
* Long-term organization-wide plans tend to operate independent of other variable pay plans
(e.g., stock option plans).
■ Organizational unit – An organizational unit may be defined as a unit that appears on the
organization chart. Plans at this level typically are short-term and focus on a variety of
workgroups, such as:
* Strategic business units (SBUs), departments, divisions, locations (sites)
■ Team – A team is a small number of people with complementary skills who are committed
to a common purpose. Often they share performance goals and hold themselves mutually
accountable. Types of teams include temporary, permanent, full time or part time. Plans for
teams tend to operate independently, recognizing the occurrence of an event, milestone, project
completion or outstanding contribution.
■ Individual – Individual plans exist in most organizations. They provide individuals with more
direct control / accountability for their variable pay.
Participant Line of Sight
■ Employee’s perception of influence – Line of sight is the employee’s perception of the degree to
which his or her contributions influence the performance measures being evaluated.
■ Short line of sight vs. long line of sight – Depending on how close the measures are to the
influence of the employee, line of sight can be short or long.
* Characteristics of a plan with a short line of sight include:
– A smaller number of plan participants (individual, work group, department, plant
/ location)
– Well-understood measures (scrap rate, productivity, turnaround time)
– Greater ability to affect the measure
– Short reporting periods (weekly, monthly, quarterly)
* Characteristics of a plan with a long line of sight include:
– A greater number of plan participants (organization-wide, large business unit)
– Measures that may be difficult to understand (profit, economic value added, EBITDA)
– Long reporting periods (yearly)
– Management may have greater faith in the accuracy and legitimacy of the measures.
■ Employee / management
The chart above illustrates the relationship between:
* The level at which performance is measured
* The degree to which employees believe they can influence and contribute to the result
* The degree to which management believes the measure will accurately reflect performance
The shorter the line of sight and the lower the organization level, the more faith the employee has in
the validity of the measurements.
The longer the line of sight and the higher the organization level, the more faith management has in
the accuracy and legitimacy of the measurement.
Nonparticipants
■ Nonparticipant effect on results – Are there employees not included in the plan who have a
direct role in the attainment of the plan objectives? Participants may be upset if actions by
nonparticipants reduce or eliminate payouts. On the other hand, nonparticipants may also be
unhappy if they are not allowed to share in the results.
■ Level of trust – Is trust level among all employees high enough to implement a plan for only
certain groups without disengagement of nonparticipants?
■ Payouts for “expected” behavior – Will some groups receive variable pay for behaviors which are
normal expectations for other groups?
* Example: a perfect attendance bonus for key operational groups during the holidays
■ Unintentional plan exclusions – Will criteria for an organization-wide plan exclude many or most
employees from an opportunity to receive an award?
* Example: A recognition plan that pays out 5,000 cash for any employee whose direct efforts
save the company more than 50,000 annually. In practice, only managers and above can
make decisions that would result in that level of savings.
Individual Criteria
Individual Criteria
When determining whether individual employees will be eligible for the plan, consider the following:
■ Employment status – full-time versus part-time
* Changes – status changes such as promotions / transfers into or out of eligible position /
team / department
* Departures – voluntary versus involuntary, retirement, layoffs, termination after the end of
the performance period but before the payout occurs
* Interruptions – interruption in employment such as medical or personal leave of absence,
long-term disability, military leave
■ Organization level – by job title, job grade or other organizational hierarchy
Note: This criterion may not account for the individual’s impact on company performance and
may put pressure on the job evaluation system.
■ Performance rating – poor performers, employees on probation or final notice
■ Eligibility for other plans – double payouts, competing plans, sales plans
■ Global, expatriate and union employees
■ Initial plan eligibility
* Upon first day of employment
* After successful completion of probationary period
* At the beginning of the next measurement cycle
Selecting Peformance Measures
■ Identify Performance Drivers
■ Establish Performance Measure
■ Determine if there are single or Multiple Measures
Identify Performance Drivers
As discussed in Step 1, a variable pay plan’s objectives should align with an organization’s business
objectives which are driven by business strategy. These plan objectives will guide what the plan’s
performance and measures of performance will be.
Establish Performance Measurements
It is important to decide what will work best in measuring a plan’s performance. In selecting
performance measures for a new plan, one should consider financial and non-financial measures and
how performance is currently measured for other programs in the organization.
■ Types of measurements
* Quantitative – lend themselves to precise definition and assessment (e.g., counting the
number of manufactured parts that meet specifications). With quantitative measures, there
usually is less room for variability of the data.
* Qualitative – require a greater degree of judgment. They are useful when evaluating
certain behaviors and results that require assessment based on observation and perception.
Qualitative measures do not have the same definitive and objective characteristics as
quantitative measures.
■ Performance measurement systems
* Balanced scorecard – focuses on financials (shareholders), customers, internal processes,
plus innovation and learning
* Business excellence model – combines results, which are readily measurable, with enablers,
some of which are not
* Shareholder value added – incorporates the cost of capital into the equation
* Activity-based costing and cost of quality – focuses on the identification and control of cost
drivers (non-value-adding activities and failures, respectively), which are themselves often
embedded in the business processes
■ Performance measurement systems (continued)
* Competitive benchmarking – involves taking a largely external perspective, often comparing
performance with that of competitors or other best practitioners of business processes
■ No one-size-fits-all approach
* Multiple, seemingly conflicting, measurement frameworks and methodologies exist because
they all add value. They provide unique perspectives on performance and offer managers a
different set of perspectives by which to assess the performance of individuals, teams and
organizations.
* Under some circumstances, one particular perspective will be exactly right for an
organization, whereas in another circumstance, it would be counterproductive. The key is to
recognize that there is no single best way to view business performance.
Quantitative Measures
■ Financial
* Volume / profit – usually comprises some variation of volume or profit
* Aggregate / end-result level – often are most useful at the aggregate, end-result level
* Limited interim process feedback – may not be as effective as operational measures in
providing interim process feedback needed for improvement
* Strong indicator of past performance – a strong indicator of past performance, but a poor
indicator of future performance
■ Operational – Operational measures are nonfinancial measures, such as on-time percentage,
percent defective or cycle time.
* Day-to-day data – may provide better data for making day-to-day improvements in
operations that could lead to improvements in monthly or quarterly sales volume. Examples
include: calls taken, net promoter scores, the accuracy of orders, efficiency of delivery or
customer satisfaction.
* Measure effectiveness – can be used to determine effectiveness across multiple functions
or processes
* Identify key processes – begin with the organization’s customers and work backward into
the organization to identify the key processes or work flows and associated measures
* Reflect value to customer – often transcend organizational boundaries and reflect the
extent to which the entire, end-to-end process adds value to the customer
Qualitative Measures
■ Behaviorally focused – Behaviors are the ongoing activities in which people engage to
produce results.
■ Emphasis on workflows, values and individual / group behavior
■ Different forms
* Anchored rating scale – defines as precisely as possible the characteristics of different
levels of performance
* Judgment – the expression of an opinion or perception, usually in a holistic or global fashion,
without significant detail or rationale required
Single vs. Multiple Measures
■ Single measure – plans based on a single measure of performance. The most commonly used
measure in a single measure plan is either financial-based or productivity-based.
* Financial – plans based on a financial measure such as profit. A similar profit measure may
be used at the business unit or group level.
Example: production department measured on profit (sales of department less labor /
materials / overhead costs)
* Productivity – plans designed to improve productivity and share a portion of the gains with
employees as a group. Primarily used in manufacturing, they have become less prevalent
as the modern marketplace requires a more balanced measurement for performance
improvement.
Example: production department measured on yield per ton of steel, labor cost or percent
of defects
■ Multiple measures – plans based on more than one measure of performance. A financial-based
measure typically accounts for at least one of the measures and provides funding for the plan.
Measures should be limited to 4.
■ Multiple measures (… continued)
* Plans may reflect several ways to measure performance against a single objective.
– Multiple financial objectives could be used: profit, revenues, return on sales, cash flow,
debt ratios
* Or plans may measure several objectives with a distinct measure for each.
Example of Multiple Measure Plan
In the example, the award amount is based on these measures:
1. Profit
2. Productivity
3. Customer satisfaction rating
Weighting Payout by Measure (page 9)
In multiple measure plans, different weighting can be given to each measure.
■ Different weighting for each measure – If the plan has more than one measure, different
weighting can be given to each measure.
■ Weighting should be based on business importance or financial value
■ Weighting can vary by organizational level – Adjusting the weight of goals by organizational
level can be an effective way to address line of sight differences while still using the same
measures for all.
- What activity would typically take place before designing the plan?
A. Selecting plan type
B. Defining eligibility
C. Obtaining management support
D. Determining plan objectives
C. Obtaining management support
- Which of the following best describes an internal factor that should be considered in
developing the plan?
A. Labor market
B. Competition
C. Technology
D. Costs / resource availability
C. Technology
- Which of the following best describes a step in the design phase?
A. Obtaining management support
B. Funding the plan
C. Defining eligibility
D. Assessing organizational readiness
C. Defining eligibility
- Which of the following items would most likely be considered in determining who would be
eligible to participate?
A. Participant line of sight
B. Past performance
C. Day-to-day data
D. Implementation costs
A. Participant line of sight
- Which of the following should be a primary driver of plan performance?
A. Labor market
B. Organizational readiness
C. Management support
D. Business objectives
D. Business objectives
- Which of the following is an example of a qualitative measure?
A. Turnover ratio
B. Anchored rating scale
C. Return on assets
D. Net income
B. Anchored rating scale
