GCSE / Level 2 Revision Notes

People management - Ways to pay employees and management

There is no doubt that most people are motivated (at least in part) by the financial rewards they gain from their work. So, getting employee pay right (often referred to as the “remuneration package”) is a crucial task for a business. 
Why is pay important?

• It is an important cost for a business (in some “labour-intensive” businesses, payroll costs are over 50% of total costs)
• People feel strongly about it
• Pay is the subject of important business legislation (e.g. national minimum wage; equal opportunities)
• It helps attract reliable employees with the skills the business needs for success
• Pay also helps retain employees – rather than them leave and perhaps join a competitor

Because pay is a complex issue, there are several ways in which businesses determine how much to pay:

• Job evaluation / content; this is usually the most important factor.  What is involved in the job being paid?  How does it compare with similar jobs?
• Fairness – pay needs to be perceived and be seen to match the level of work
• Negotiated pay rates – the rate of pay may have been determined elsewhere and the business needs to ensure that it complies with these rates.
• Market rates – another important influence – particularly where there is a standard pattern of supply and demand in the relevant labour market.  If a business tries to pay below the “market rate” then it will probably have difficulty in recruiting and retaining suitable staff
• Individual performance – increasingly, businesses include an element of “performance-related” reward in their pay structures.

Structuring the financial package

With so many methods of pay available, how should a business decide to structure the pay package it offers to employees, and what rate of pay should it use?

The starting point is usually to find out what the “market rate” is. Factors that help determine the market rate for a job include:

• Whether the skills that are required are widely available
• The overall level of unemployment in the employment “catchment area”
• Whether the job requires specialised (or even highly specialised) skills

There are several ways in which a business can obtain data on market rates:

• Local employment agencies & job centres
• Job adverts
• Industry associations (who often perform annual surveys of pay in an industry)

The next question is – should the business pay MORE or LESS than the market rate? Factors to consider here include:

• Does the business need above-average employees (e.g. salesmen with an industry reputation for being strong performers)
• Does the business need trained employees or is it prepared to invest in training beginners?
• Are the skills wanted by the business needed urgently (in which case – the business would probably want to pay more)
• Do factors affecting the mobility of labour need to be addressed – e.g. are there transport problems that need to be solved (e.g. pay for a rail season ticket) or relocation allowances to be offered to encourage new employees to move home?

The third important question is how to structure the remuneration package. 

• Should employees be paid on the basis of time spent working (e.g. time-rates) or the amount they produce (e.g. piece rates) or some other measure of performance?
• Should the remuneration package be a combination of approaches (e.g. some basic pay per month + a commission-related incentive)?

In deciding the answers to these questions, a business should try to construct a pay structure that is simple (to help employees understand it), logical and fair

Time-rate pay

Time rates are used when employees are paid for the amount of time they spend at work.  This is the most common method of payment in the UK.

The usual form of time rate is the weekly wage or monthly salary. Usually the time rate is fixed in relation to a standard working week (e.g. 35 hours per week).  The employment contract for a time-rate employee will also stipulate the amount of paid leave that the employee can take each year (e.g. 5 weeks paid holiday).
Time worked over this standard is known as overtime.  Overtime is generally paid at a higher rate than the standard time-rate – reflecting the element of sacrifice by an employee.  However, many employees who are paid a monthly salary do not get paid overtime.  This is usually the case for managerial positions where it is generally accepted that the hours worked need to be sufficient to fulfil the role required.

The main advantages of time-rate pay are:

• Time rates are simple for a business to calculate and administer
• They are suitable for businesses that wish to employ staff to provide general roles (e.g. financial management, administration, maintenance) where employee productivity is not easy to measure
• It is easy to understand from an employee’s perspective
• The employee can budget personal finance with some certainty
• Makes it easier for the employer to plan and budget for employee costs (e.g. payroll costs will be a function of overall headcount rather than estimated output)

The main disadvantages of time-rate pay are:

• Does little to encourage greater productivity – there is no incentive to achieve greater output
• Time-rate payroll costs have a tendency to creep upwards (e.g. due to inflation-related pay rises and employee promotion

Piece-rate pay

Piece-rate pay gives a payment for each item produced – it is therefore the easiest way for a business to ensure that employees are paid for the amount of work they do. Piece-rate pay is also sometimes referred to as a “payment by results system”.

Piece-rate pay encourages effort, but, it is argued, often at the expense of quality. From the employee’s perspective, there are some problems.  What happens if production machinery breaks down?  What happens if there is a problem with the delivery of raw materials that slows production?  These factors are outside of the employee’s control – but could potentially affect their pay.

The answer to these problems is that piece-rate pay systems tend, in reality, to have two elements:

• A basic pay element – this is fixed (time-based)
• An output-related element (piece-rate).  Often the piece-rate element is only triggered by the business exceeding a target output in a defined period of time

Commission

Commission is a payment made to employees based on the value of sales achieved. It can form all or (more often) part of a pay package.  Commission is, therefore, a form of “incentive pay”.

Commission, like piece-rates, is a reward for value of work achieved.  In most cases, the employee is paid a flat percentage of the value of the good or service that is sold.

The rate of commission depends on the selling price and the amount of effort required in making the sale.
For example, commission rates could range from 5% where the product sells easily (e.g. household goods sold door-to-door) to 30% where the effort is substantial.

The main advantage of commission from an employee’s point-of-view is that it enables high performing sales people to earn huge amounts.

The main advantage to the employer is that the payroll cost is related to the value of business achieved rather than just the amount produced.  After all, businesses exist to sell goods and services for profit – not just to make things.
However, there are several drawbacks with using commission payments:

• Sales people may cut corners to make sales (e.g. not explain the product or service in enough detail to potential customers) – i.e. customers are misled & missold
• High commission earnings enjoyed by some of the sales team may be resented elsewhere in the business – particularly if the sales actually depend on a team effort
• It is difficult to change what proves to be an over-generous commission structure without upsetting and demoralising the sales team
• Once commission payments have been made, the sales force may lose some motivation until they begin to focus on the next payment (which might be up to 12 months away)

As a result of the above disadvantages, most businesses that use commission as an incentive payment method offer a basic pay plus a moderate commission level.  In this way, if sales and profits justify the change, the commission rate can always be increased slightly.

Performance related pay

Performance-related pay is a financial reward to employees whose work is considered to have reached a required standard, and/or above average

Performance related pay is generally used where employee performance cannot be appropriately measured in terms of output produced or sales achieved.

Whilst the detail of real performance-related schemes varies from business to business, there are several common features:

• Individual performance is reviewed regularly (usually once per year) against agreed objectives or performance standards.  This is the performance appraisal
• At the end of the appraisal, employees are categorised into performance groups – which determine what the reward will be
• The method of reward will vary, but traditionally it involves a cash bonus and/or increase in wage rate or salary

Performance-related pay has grown widely in recent years – particularly in the public sector. This is part of a movement towards rewarding individual performance which reflects individual circumstances.
There are several problems with performance-related pay:

• There may be disputes about how performance is measured and whether an employee has done enough to be rewarded
• Rewarding employees individually does very little to encourage teamwork
• There is doubt about whether performance-related pay actually does anything to motivate employees.  This may be because the performance element is usually only a small percentage of total pay

Fringe benefits

Fringe benefits are financial benefits that are not paid out directly in cash (or cash equivalents such as shares).
Examples of these include:

• Company cars
• Discounted season tickets
• Health insurance
• Pensions
• Holiday and other entitlements to take time off work
• Childcare provision
• Staff uniforms
• Staff discounts

Benefits in kind have become a much more popular and widespread form of remuneration. This is partly because businesses pay less tax on providing them, but also because they cause a business less hassle and can help to differentiate the remuneration package.

Profit sharing

Profit sharing refers to any system whereby employees receive a proportion of business profits. Profit sharing is generally accepted as having many advantages, providing that all employees are able to participate.  Key advantages include:

• Creates a direct link between pay and performance
• Creates a sense of team spirit- helps remove ‘them and us’ barrier between managers and workers if all employees involved
• May improve employee’s loyalty to company
• Employees more likely to accept changes in working practices if can see that profits will increase overall