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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
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(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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THANK YOUTHANK YOUfor this opportunity
to be with you
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