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Variable Pay and

Incentive Scheme

Design

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This section covers the following key learning areas and outcomes:• Definitions and differences clearly understood

• The business case for implementing variable pay and incentive schemes

• Design considerations understood

• How to select the most appropriate scheme

• Common formulae used and main features of each scheme understood

• Typical incentive scheme headings - an aid to scheme design

• Lessons learned and critical success factors

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Vision

Mission

Strategic Objectives

Functional/operational strategy and objectives

HR Strategy

The Strategy Process

IR Strategy Reward Strategy HRD Strategy Personnel Strategy

Low base salaries High base salariesInternal equity External equityFew perks Many perksStandard fixed package Flexible packageNo Incentives Many incentivesNo employment security High employment securityHierarchical Flatter structuresIndividual pay Team payPay for input Pay for output

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Pay strategy may be a source of competitive advantage if:

� It really adds value in terms of improved company performance (economic value

created)

� It genuinely supports the attraction and retention of the right talent

� It is genuinely difficult to imitate – this latter does not imply that it should be

complicated. However, real sustained competitive advantage must come from:

� The way the organisation’s business strategy and compensation

systems fit together

� The alignment between strategy and other HR functions and

activities

� How effectively and consistently the systems are implemented

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SALARY STRUCTURE

•External Equity•Salary Survey•Union Negotiations

•Internal Equity•Job Grading

•Tax Law•Job Grades

Up to one year•Profit Share•Gainshare•Bonus•Commission

Over one year•Deferred Compensation•Share Schemes•Retirement Funds•EVA•“Rolling” Incentives•Value Added

Merit/PRPAllowances

POLICY•Attract•Develop/ Learn•Motivate•Productive•Loyal/ Retain

SBP, CBP, TBP.

1. Financial Awards

2. Non Financial Awards

FRINGE BENEFIT PERKS

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BASIC SALARY 1

LONG-TERMWEALTH

ACCUMULATION44

SHORT TERMINCENTIVES

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Components Of A Remuneration Structure

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Remuneration element and purpose

� Fair pay for a day’s work� Pays for overall job requirements, accountability, complexity of

tasks, and diversity of tasks� Safety net for emergencies� Provides special payments and programs that may set the

organsiation apart from others

Base Salary

Benefits / Perquisites

� Get results and successful execution of the strategic plan� Variable component to reward contribution to business plan

Short term and medium incentive

� Crucial in retaining employees� Focuses attention on longer term strategic imperatives

Long-term incentive

PurposeRemuneration element

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Pay Model

INDIVIDUAL ORGANIZATION

PERFORMANCE -BASED PAY

Pay for Results

Pay job for Job or RolePay for Competence

“Potential”Performance

Input

Output

InternalEquity

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Role Values

Reward Criteria

Reward Component

Pay For :

INPUTS

����Know the right things

����BASE SALARY

����Skills

THROUGHPUTS

����Behave the right way

����MERIT PAY

����Competencies

OUTPUTS

Achieve the right results

Demonstratesuccess

���� ����INCENTIVE PAY RECOGNITION

���� ����Results Accomplishments

Linking work value with rewards

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Industry (or product) Maturity

EMBRYONIC GROWTH MATURE AGING Common Strategies • Start up • New product

development

• Acquire market share

• Find new markets

• Consolidate position

• Find and protect market niches

• Become low cost producer

• Cost reduction

• Withdraw from unprofitable market segments

Industry Maturity

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Industry (or product) growth rate

Less emphasis on salary, benefits and perks; Attention to share options & long-term incentives; Stress on non-financial rewards (excitement of the new venture)

Continued emphasis on long-term incentives with increasing attention to ways to promote short-term results. Catch up with salary and benefits

Most attention focused on keeping salary and perks competitive; Reduced concern for long-term incentives; Bonuses oriented to productivity improvement

Benefits and salary are king; Very little attention given to long-term growth oriented incentives

EMBRYONIC GROWTH MATURE AGING Common Strategies • Start up • New product

development

• Acquire market share

• Find new markets

• Consolidate position

• Find and protect market niches

• Become low cost producer

• Cost reduction • Withdraw from

unprofitable market segments

Common Approaches to Compensation

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Remuneration and Corporate Life Cycle Stages

Overlapping programs

Above averageRichLayered plansAbove marketMature

Equity and cash plans (options & PUPs)

AverageAverage to above average

Total cash concept with unit variations

At/above marketEmerging

Combination share programs (2 to 3 plans)

AverageAverageMore formal and more closely tied to business plan

At marketGrowth

share optionsSignificantly below average

Minimal“Boilerplate” plansSomewhat below market

Initial public offering

Founders’ sharesNoneBasic medical insurance only

UnusualSubstantially below market

Startup

Capital and Wealth Accumulation

Perquisites and Special Benefits

BenefitsFormal Annual Incentives

Base SalaryCorporate Life-Cycle Stage

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General staff Remuneration strategy planning chart

���� Current system by itself cannot produce the desired objective �������� Current system produces the desired objective X Current system works against achieving the objectives

�������� P�������� P�������� PBonus scheme

�������� P�������� PReward competency acquisition (eligible grades)

�������� P�������� PWealth sharing (housing, share purchase)

�������� PDisclosure policy

�������� PSeamless Grades

��������xxx Award

��������xxx of the year

����Entertainment

����Personal Accident

��������Medical Aid

��������Retirement

��������������������Car scheme

������������PRP (Non-Unioin)

����������������Base Pay/Package

SCMWCMRole in SA

SocietyOrganisational Effectiveness

Differentiation / Value AddingCost leadership

Projects

Recognition

Motivate (achievement of strategic goals

RetainAttract

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Executives Remuneration Strategy Planning Chart

���� Current system by itself cannot produce the desired objective �������� Current system produces the desired objective X Current system works against achieving the objectives

�������� P�������� P�������� P3 year EVA

�������� PDisclosure policy

�������� PUniform grades

��������xxx Award

��������xxx of the year

����Entertainment

����Personal Accident

��������Medical Aid

��������Retirement

������������Car scheme

��������������������MS's share option scheme (remove)

����������������������������������������EIS (Execs)

������������PRP (Non-Unioin)

����������������Base Pay/Package

SCMWCMRole in SA

SocietyOrganisational Effectiveness

Differentiation / Value AddingCost leadership

Projects

Recognition

Motivate (achievement of strategic goals

RetainAttract

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Definitions and Differences

Clearly Understood

This guide on variable pay focuses on team rewards in the

form of STIs and LTIs. (The previous guide on PRP (performance-

related pay) focused on individual pay.

The most common forms of team rewards are normally described

under the headings of short-term incentives (STIs) and long-term

incentives (LTIs). There are many different definitions for these, but

broadly speaking, conventional wisdom describes them as follows:

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The Definitions and Reasons for PRP

PRP that applies to individuals is associated with salary structures,

grades and a performance and/or competence rating. This differs

from incentive schemes which are team or company-based as

these schemes are normally formula-driven and the payments are

once-off. In individual PRP schemes, a managerial rating often

translates into the size of a pay increase relative to the "purse" that is

available.

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Individual vs team based PRP

1. Typically formula-driven.

2. More often based on

quantitative measures.

3. Payments are usually once-off.

4. Payments can vary from

monthly to every three years.

1. Usually associated with

managerial assessment of

performance and/or

competence.

2. Based on quantitative and

qualitative measures.

3. Payment is often in the form of a

pay increase.

4. Payments are mostly annual.

Team PRPIndividual PRP

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Reasons Why Companies Implement PRP

• Strengthen the relationship between performance and reward.

• Drive company strategy implementation to individual level.

• Retain top performers by rewarding them for sustained superior performance.

• Send a clear message to non-performers (which is usuallyaccompanied by counselling and/or training).

• Institutionalise a performance culture within the company.

• Facilitate and necessitate performance contracting resulting inperformance reviews and assessments.

• Link the onerous salary and wage bill to the fortunes of the business.

• Differentiate reward in a defensible manner.

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The Mechanics of PRP

PRP is mostly driven by a performance management system.

Categories of performance management systems

The main categories of performance management systems are summarised in the table below. There are, of course, many others, some of which form subsets of these main categories.

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Types of System

Measures are devised typically for companies or SBUs under the four main headings of financial customers, learning and growth, and internal business processes. These can then be cascaded down to departments and individuals.

Balanced scorecard

Also has pre-determined factors which are generic and apply to all positions. The rating, however, is done by subordinates, peers and managers. These systems are often computer- based to cope with the administrative requirements of several raters.

360 deg.

Individual outputs or outcomes are agreed each year and are position-specific. Rating is usually on a “hit” or “miss” basis where the outcome was achieved or not, and is typically rated by your customer (internal or external).

Outputs (not activities) or outcomes

Usually has 10 to 20 pre-determined factors which are generic and apply to all positions. These are rated by your manager on a rating scale, e.g. 1 – 5 or 1 to 10.

Traditional

Brief descriptionType of system

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One Dimensional Merit matrix

An increase should not be given or a very small one given.

Below job requirements. The employee’s performance is below the standard requirements set. Little or no evidence exists of the employee’s competence.

1

Should receive a restricted increase, lower than the average increase.

Requires further development. The employee’s performance does not yet meet all the requirements set. Some evidence exists of the employee’s competence.

2

Deserving the percentage increment top management sets for the company in general.

Meets job requirements. The employee’s performance meets the requirements set. Tangible evidence shows that job KPIs have been met.

3

Should receive an above- average increase.

Exceeds job requirements. The employee’s performance exceeds the requirements set. Tangible evidence exists of the employee’s achievements.

4

Deserving of a special merit or merit increase.

Clearly outstanding. The employee’s performance is visibly outstanding on a sustained basis and far exceeds the requirements set. Tangible evidence exists of the employee’s ongoing achievements.

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Reward implicationPerformance descriptionScale point

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Performance Rating Distributions

It cannot be over-stressed that this is merely management information, and is to be used as a guideline to managing hard and soft raters. If one is using software, the actual distribution is calculated for the organisation and this can becompared to the desired distribution. It is then possible to identify hard and soft raters by specific departments. Software also allows flexibility in setting the scale score range.

Less than 10%Not yet competent (1)

Around 20%Developing (2)

Around 40%Effective (3)

Around 20%Very effective (4)

Less than 10%Outstanding (5)

Desired distributionDescription

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Guideline

The following is a guideline as to how the procedure could be followed, assuming an overall organisational salary increase percentage of 6 – 8%.

0%1

0 – 4%2

4 – 6%3

6 – 8%4

8% and above5

Percentage increaseScale point

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A More Sophisticated Matrix

A matrix like this accelerates pay increases for top

performers who are being paid at the bottom of the

pay scale (or compa-ratio of under 100). It

decelerates poor performers’ pay scale (or compa-

ratio of over 100).

20%14%10%6%0%Lower Quartile

16%12%8%4%0%Median

14%10%6%2%0%Upper Quartile

12%8%4%0%0%90th Percentile

54321Performance Score

Compa-Ratio

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Comparison – PRP and CBP

5. Facilitates integration of core, generic and individual competence.

5. Facilitates integration of individual, team and company objectives.

4. Competence profiles often stay the same for many years.

4. Targets may change from year to year.

3. Pay decisions are based by assessing behaviour against competence profiles.

3. Pay decisions are usually made by comparing results against targets.

2. Looks forward (competency predicts success)

2. Looks backwards (pays for results already achieved)

1. How work is done (behaviour)1. What work is done (results).

Competency-based payPerformance-related pay

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STIsThese are incentive schemes that reward superior performance over a period of one year. Typically, they reward "what happened" last year.The main examples of STIs are:

• Profit Sharing (PS)

• Gain Sharing (GS)

• Bonus Schemes (BS)

• Commission Schemes (CS)

LTIs

These are incentive schemes that "look into the future" and reward superior performance over more than one year. Typical examples are:

• Rolling Incentives (RI)

• Value Add Schemes (VAS)

• Share Schemes (SS)

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Difference between variable pay and

"pay at risk“

Link to pay at risk

With this concept, guaranteed pay is put at risk. In other words,

you may not be entitled to your total package if you do not

achieve certain hurdles.

Thereafter, you can earn your market-related package and, on

top of that, variable pay kicks in. This is shown diagrammatically

in Figure.

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Variable Pay, Fixed Pay, Risk Pay – The Link

AMarket-relatedTotal package

CRisk Pay

BMarket-relatedTotal package & Variable Pay

130

Variable Pay

Pay At Risk

Fixed Pay

Market Rate(Total Package)

50

100

280

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Design Considerations

This topic provides a comparison of application of variable pay and

guaranteed pay across the following variables:

• Position in the company

• Company's stage in its life cycle

• Industry

• Country

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GP : VP Differs By Level

Top

Mid

Low

50 : 50

70 : 30

80 : 20

(GP = Guaranteed Pay VP = Variable Pay)

R700k R700k

R300k R128k

R100k R25k

GP VP

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Industry/Product Maturity

EMBRYONIC GROWTH MATURE AGEING Common Strategies • Start up • New product

development

• Acquire market share

• Find new markets

• Consolidate position

• Find and protect market niches

• Become low cost producer

• Cost reduction

• Withdraw from unprofitable market segments

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GP : VP DIFFERS By Life Cycle

3

(STI = Short-term-incentives LTI = Long-term-incentives)

Low GP Med GP High GP High GP

High LTI High STI Med STI Low STI

Low STI Med LTI Med LTI Low LTI

Embryonic

Growth

MatureDecline

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GP : VP DIFFERS By Industry / Job

High GP : Low VP

85 : 15

E.g..: - Clerks

- Accountants

- Para-Statal

- Government

Low GP : High VP

50 : 50

E.g..: - Merchant Bankers

- Treasury

- Sales Clerks

- Dealers

- Stock Brokers

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Incentive Scheme Rules: Typical Headings

• Purpose

• Eligibility

• Determining the bonus pool

• Measurement Criteria / Modifiers/Trigger

• Limits of payout / clawback clause / how is it paid out - % of salary, equally, midpoint of payscale…

• Timing of payout

• Scheme administration

•Final arbitor

•Unhitching

•Earned in the conduct of core business

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Good Incentive Scheme Practice

The type of scheme chosen must align with employee “line of sight”i.e.

• Bonus scheme is common across all levels

• Bonus scheme can have any measures in it e.g. profit at the topend and specific controllable measures at the bottom end

Bonus SchemeCommission Schemes

Bonus Scheme Profit SharingSharesEVA

Bonus Scheme Gainsharing

TopManagement

Middle Management

General Staff

F

ED

CB

A

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Sec HrMin Shift Day Wk Month Qtr Yr YrsComponent

Sub-system

System

Unit

Site

BU

Company

MarketShareholders

CEO / Board

LineManagement

OperationalManagement

Teamleaders

IndividualWorker

Wastage (Yield)Production Volume

CostsQualitySafety

Equipment uptime, downtime & utilisation

ProfitabilityWorking Capital

Product Volumes & PriceProduct Mix

Equipment reliabilityProduction Cost

Maintenance Cost

Long Term Performance

Financial Structuring Mergers &

AcquisitionsStrategy FormulationProducts & markets

Alignmentof all performancemeasures to SHV

Operational Strategic

Time Frame of Measures

Tactical

Determining the right level

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Eligibility and participation level

FF

EE

DD

CC

BB

AA

Top Management/ Strategic Intent

Senior Management/ Strategy Execution

Middle Management/ Professional

Supervisors/Specialists

Operational

Basic Skills

80%

50%

30%

15% (30%-50% For Reps)

10%

8.3%

LEVEL % of PACKAGE (Market Averages)Incentive Scheme Base

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