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Finding the Right Method for Team Compensation

By Larry S. Carlton, DBA, SPHR   12/1/2004
 

Introduction

Human resource managers are responsible for designing total compensation packages that must simultaneously meet employee expectations of adequate compensation while achieving employer goals of containing labor costs and retaining a fully competent workforce. It may appear a simple matter to meet both objectives, but in practice the concept involves a complicated array of issues emerging from both within and beyond the workplace. HR managers need to consider the dynamics of social contracts, personality types, industry standards, employee expectations, competitive imperatives, cultural and national diversity, legal requirements and a myriad of other interrelated issues in order to fully meet organizational needs.

The purpose of this white paper is to simplify this maze by outlining some of the basic concepts in developing a team-based compensation package. In order to provide some framework in which to understand the dynamics of compensation development, the following topics will be explored:

  • Individual versus team compensation.

  • Types of teams.

  • Types of team compensation programs.

  • Examples of possible team compensation approaches.

In exploring the broad challenge of developing team compensation packages, a systematic approach to some of the underlying issues may help HR professionals come to terms with the many dynamics affecting effective integration of compensation policies with organizational strategic objectives. This paper will attempt to provide such a framework as a beginning approach to developing effective total compensation packages for team-based business units.

Individual Versus Team Compensation

While team-based organizational units are not new in the global workplace, they are becoming increasingly popular as business continues to evolve in a competitive transnational environment. Much has been written in the past two decades about the benefits of team orientation, especially in the wake of such popular approaches as Total Quality Management (TQM), ISO 900(x) certification and a myriad of other (albeit some unabashedly faddish) trends in organizational design. The element that ties all of these sometimes disparate organizational approaches is the imperative to remain competitive in an increasingly global market. American firms, in particular, have been undergoing a remarkable wave of reengineering efforts that have transformed the workplace in ways perhaps unimagined in past decades.

In some ways this transformation in the American workplace may seem remarkably “un-American.” After all, American culture and history are filled with examples of rugged individualism and the demand for the recognition of individual effort. On the other hand, teamwork is also highly regarded as the “way America works.”

Perhaps the ultimate example of how Americans resolve this apparent individual versus team dichotomy is the modern professional sports team. Individual players, often referred to as “superstars,” command stratospheric salaries and are afforded rarely paralleled adulation. Yet, even the top performers depend on the efforts of other team members in order to reach their remarkable achievements. A “superstar” receives numerous awards and a multimillion dollar salary for maintaining double-digit scoring averages, but would be hard-pressed to perform at a similar level without the blocking, rebounding and passing contributions of the other team members.

It is misleading, however, to carry the professional sports analogy too far in discussing business entities. It is therefore important to design company compensation packages based on a realistic comparison of real people working in normal jobs. According to Milkovich and Newman (2004, pp. 286-287), most employees believe that pay should somehow be tied to performance. The authors cite numerous studies supporting this idea. The challenge to HR professionals is in the design of compensation packages that recognize individual effort within the framework of developing team reward criteria.

Caudron (1994, p. 40) cites a common dilemma in establishing team-based pay systems: “Unfortunately, in most companies today the compensation system is based on paying employees for their individual performance. This makes it hard for workers to buy into the team concept. Why should they become team players if they are still going to be reviewed and paid based on individual merit?” She explains that in her research examples of group incentive plans are relatively rare. Even companies that have extensive experience in developing self-directed work teams have not significantly changed the compensation systems that support a team structure. She cites several examples of organizations that have attempted to switch to a team-based approach, explaining the difficulties of the transformation in each experience and what organizations continue to experience in the endeavor.

Milkovich (2002, pp. 309-311) outlines five typical causes for the failure of team-based approaches. First, there is great variety in team composition. Teams can be full-time, temporary, project-specific, cross-functional or can take a variety of other visages. The lack of standardization leads to lack of definition of what a team actually means.

Secondly, there is a “level problem.” This term defines the difficulty in determining optimum group size. Too large—and individuals are unlikely to see how their inputs can significantly affect group performance. Too small—and groups tend to engage in unwanted behaviors (such as hoarding best performers and resisting the introduction of new members). Additionally, it is difficult to design effective rewards for groups that have different objectives.

A third problem comes with the inherent complexity of the team compensation plan. In practice, developing team plans can become overly complicated in the effort to ensure equity-based performance. Perhaps because the typical American business culture is so deeply rooted in the idea of rewarding individual performance, some plans develop very complex equations to accommodate individual-within-the-group performance.

Fourth, there is the problem of team control. It is difficult to base team rewards on quantitative objectives when the achievement of those objectives depends on factors beyond the team’s control. For example, rewarding a farm-worker team on the basis of total bushels picked may be considered grossly unfair when the team is penalized for bad weather conditions.

The final common problem involves effective communication of the compensation plan. Most organizational design teams devote more time to developing the mechanics of the compensation plan than to explaining it to employees, with an accompanying confusion on the part of employees as to how the compensation plan actually works.

Types of Teams

Adding to the difficulty of determining team-based compensation policies is the underlying problem of defining exactly what a team is. Shonk (1992, p. 1) defines a team as “two or more persons who must coordinate their activities to accomplish a common goal.” While this definition may appear somewhat simplistic, focusing on the key term “coordinate” helps an HR manager grasp the concept. A highly integrated group of people who continuously coordinate their individual activities to achieve group objectives is one way to begin the process of defining teams. Shonk (1992, pp. 4-5) goes on to explore some reasons why team-based organizations are important. There are several compelling reasons why organizations adopt team structures, including increased quality, flexibility, coordination, productivity, employee satisfaction and development, and decreased costs.

More importantly, in practice, teams might take form of many structures, including (Shonk, 1992, pp. 27-31):

  • Suggestion teams are temporarily chartered to develop solutions to particular problems, but are usually not given authority to implement those solutions.

  • Problem-solving teams are similar to the above, but are often given at least limited autonomy in implementing the recommended solutions.

  • Semiautonomous teams usually have significant inputs into the planning, organizing and controlling functions affecting work unit issues.

  • Self-managing teams are fully responsible for managing their daily activities. These teams have great leeway in setting goals, allocating resources, hiring and replacing team members and recommending solutions to external problems.

It is apparent that the above teams are defined by the level of autonomy they have in addressing work-related issues. For managers, this is one approach to defining the structure of groups in order to allocate a fair compensation strategy for rewarding group results.

There are numerous other approaches to defining teams. Teams can be formed along functional lines, cross-functional alignment, geographic boundaries, product lines or other defined parameters. It makes sense, then, for the HR manager to help define a team approach that is germane to the type of work being done and to enlist the employees in determining what those parameters should be. One common theme in the literature of team development is the importance of enlisting employee inputs in determining team structure.

Another key component in developing team structure is alignment with corporate strategic direction. James Fairfield-Sonn of the University of Hartford highlights the importance of linking strategy to team development, regardless of the size of the company or the nature of its essential business. He cites two examples of companies with widely different structures. One is a manufacturing concern producing plumbing, heating and air conditioning supplies. The other is an entity providing residential rehabilitation services for inmates convicted of substance-abuse-related crimes. While radically different in basic structure and organization, both of these concerns redesigned the way in which work is accomplished by developing team-based structures aligned with basic strategic direction.

The author concludes with the observation that a team-based approach to complete work is neither inherently good nor inherently bad, but it is critically important to form teams made up of individuals who are convinced of the utility of team-based approaches and who have a clear understanding of how team achievement links to overall organizational goals.

Types of Team Compensation Programs

Just as it is difficult to clearly describe team components, it is similarly difficult to clearly determine how to best compensate teams. Milkovich (2002, pp. 308-309) asks the basic question of whether or not any incentive plan actually boosts performance. He determines that the answer is undoubtedly “yes,” but he is equally emphatic in describing the intrinsic difficulties of assigning fair distribution of group rewards to individual performance. He goes on to outline several quantitative approaches that have had some success in the business environment.

One such approach is the gain-share plan. In this construct, employees are rewarded when the team achieves some type of quantifiable performance gain. Often, this is tied to gains in profits. Other measures may include reduced waste and scrap, lower labor costs, increased market share, etc. According to Milkovich, some of the key elements of a gain-share plan include:

  • Strength of reinforcement, implying that incentive pay should be tied to behaviors that help achieve team objectives.

  • Productivity standards that are clearly defined and accepted by employees as fair.

  • Equitable share between management and employees, including provisions for emergency reserves to cover lean production periods.

  • Scope of the formula to ensure reasonably broad types of productivity and ensuring that counterproductive behaviors are not encouraged.

  • Perceived fairness that includes all reasonably involved contributors.

  • Ease of administration to preclude communication difficulties.

  • Production variability measures that account for production volatility.

Another approach to the problem is the Scanlon Plan. This approach is designed to lower labor costs without lowering the level of activity (Milkovich, 2002, pp. 313-314). Incentives are a function of payroll costs divided by net sales. The resulting figures are adjusted to provide a split between team members and the company, with provisions to provide some emergency reserves to compensate for periods of low productivity.

Similar to the Scanlon Plan is the Rucker Plan, which uses a more complex calculation to determine group productivity. In this plan, production bonuses are determined by the ratio between the total wage bill and the value of the total production. Bonuses are tied to the amounts over projected value of production that can be directly tied to the contribution of labor.

Improshare ( improved productivity through sharing) is a newer gain-share plan that Milkovitch says is easy to administer. Plan developers find a standard of production that reliably predicts the expected number of hours required to produce a predetermined output. Employees are rewarded for besting that standard in a 50/50 split with management.

Earnings-at-risk plans are still another approach to group incentives. Milkovich (2002, pp. 317-318) cautions against separating this approach from the others because, in a sense, all incentive plans are based on the risk that production will fail to meet expectations, with an accompanying drop in wage levels. However, it is also important to remark that there are a large variety of ways to tie performance gains to group activities that cannot be neatly categorized in one of the gain-share plans mentioned above.

From the above examples, it is easy to understand how complex the team compensation equation can be. For HR managers it is imperative to align all of the various components of a team-based structure to ensure that the essential elements of efficiency, equity and compliance are included in compensation development.

Examples of Previously Successful Team Compensation Programs

By now, it should be evident that there is tremendous variety in the way team-based compensation programs are structured and implemented. It is even possible to say that each company devising such a team-based plan is unique. Nevertheless, it is helpful to explore some actual examples of how different companies have implemented these strategies.

Zenith Electronics Corporation developed a pilot program to test a new compensation program based on project equity (The Management Roundtable, 1997). The initiative came as a result of a billion-dollar contract Zenith won to develop a system of delivering digital technology to consumers via a single in-home setup box. Devising a series of milestone-related incentives, each full- and part-time team member was given a specific number of “shares” that would eventually convert into substantial bonuses, providing the team reached each of its predetermined milestones. In addition, about 30 percent of the total available shares were reserved to reward particularly outstanding individual performance in meeting team goals. The company was careful to build flexibility in the pilot program to ensure that the incentive plan succeeded in motivating employees to keep performing at a high level, especially in light of the many changes that had to be made in response to changing customer requirements. In the end, the company met all of its objectives and is currently planning to expand on this initial success in future endeavors.

General Motors (GM) created a new set of team incentive programs in its Saturn Corporation subsidiary (Overman, 1995). The first of GM’s divisions organized completely along self-directed work teams, the company had great leeway in developing an entirely new (for GM) compensation program. The new plan was developed with base pay, risk pay and reward pay components. While base pay lags the competitive market, overall compensation can be substantially above the prevailing market rate. At its inception, risk pay was set at five percent of total compensation pay, but subsequently was increased to 10 percent. The company credits an extensive team training curriculum coupled with a general perception that the rewards system is fairly administered to the success of the novel program.

Sales organizations present unique problems to HR managers charged with developing a team-based compensation system. By long-standing tradition, most sales-oriented units are very closely aligned with an individual incentive plan. Wally Wood (1994) outlines some successful strategies sales forces have used to reengineer along team-based lines. Monroe Auto Equipment Co. in Monroe, Michigan, effectively implemented a 100 percent team plan for its sales force. The company “decided that freeloaders was a sales-management problem, not a sales-compensation issue” and pays each team member equally based on team performance.

At least at Monroe, this approach has proven successful: the company regularly secures the highest market share and margins within its territory. Another company, The Alexander Group, realized success by reengineering its sales force along customer lines. By redefining the customer base, the company was able to focus sales teams on the most likely targets for their medical products, with accompanying increases in team success. Wood cites several other examples of successful transitions of sales organization from individual to team-based compensation programs. He finds that companies ranging from small furniture outlets to behemoths like Hewlett-Packard can successfully make this transition, provided top management clearly explains the importance of the change and consistently applies the team-based formula.

So Now What?

Developing a team-based compensation plan is inherently difficult for many reasons. Foremost among these are overcoming traditional reliance on individual-based pay and the difficulties in devising formulas that accurately reflect individual contribution in a team environment. As with all compensation issues, it is critically important to meet the standards of efficiency, equity and compliance in establishing group performance plans. While this paper cannot claim to encompass all of the critical issues involved, it can serve to help HR professionals begin the arduous process of developing a team-based approach. Some common elements recur throughout the existing research material on this subject.

  • Team compensation must reinforce appropriate behaviors.

  • Team objectives must be unambiguously aligned with overall strategic goals.

  • Development of team compensation plans should coincide with other internal reengineering efforts that together reinforce the new team-based organizational structure.

  • There is no single “best way” to implement team plans. Each must account for a wide difference in corporate goals, ability to pay, environmental variables and more.

  • The organization leaders must have a strong conviction that these changes are necessary to achieve long-term organizational needs.

  • Lastly, and probably most importantly, the redesigned plan must be accurately communicated to all affected employees to ensure commitment and acceptance of the plan.

Bibliography

Cauldron, S. (1994, October). Tie individual pay to team success. Personnel Journal, 73(10), pp. 40-46.

Fairfield-Sonn, J. (Date undetermined). Moving toward a team-based organization: linking strategy and structure. Retrieved from http://blue.temple.edu/~eastern/fairnet.html .

Milkovich, G. T., & Newman, J. M. (2002). Pay for performance plans. In Compensation (7 th ed.), pp. 307-351. Boston: Irwin McGraw-Hill.

Overman, Stephanie. (1995, March). Saturn teams working and profiting. HR Magazine, 40(3), p.73.

Shonk, J. H. (1992). Team-based organizations. Homewood, Il: Business One Irwin.

The Management Roundtable. (1997). Zenith rewards key project team with project-based shares. Retrieved from http://navibar.mapnavibar.map.html

Wood, W. (1994, April). Reinventing the sales force. Across the board 31(4) , p. 24.

SHRM wishes to thank Larry S. Carlton, DBA, SPHR for contributing this paper. This paper is intended to provide general information and is not a substitute for legal or other professional advice.

Larry Carlton is an Associate Professor with the Extended Campus of Embry-Riddle Aeronautical University. He holds a B.S. and M.S. in Human Resources and a DBA. Mr. Carlton is Vice President of HR for Bio Tech Services, Inc. and the 2003/2004 President of the Sumter HR Management Association.

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