Skill-based pay makes sense to reward individual employees who know how to work. The idea is that employees with the same skills should deserve the same pay (Henry, 1987). The academic background and the acquisition of special skills of employees will be evaluated by managers or top management in order to determine their base salaries. Therefore the advantage of this system is that employees will be self-alerted to achieve self-improvement and search ways to perform their job more efficiently and effectively. Nevertheless in practice only some employees can improve their skills, which can lead to inequity of worker standardization and generate pressure in organizations. Besides, there is no easy way of determining how much a skill is worth, and skill assessment can often be difficult (Steers, 1975: 514).
Performance-related pay, sometimes addressed as merit pay, comparatively is very different from all the earlier incentive methods mentioned above, for the scheme connects itself to the evolution of Management by Objectives to a larger extent. The main goal for PRP is similar to profit-related bonuses, which is to achieve targets, but the particular aims are distinct—the former generally applies to targets relating to individuals whereas the latter tends to focus on groups or even a whole organization ( Cannell and Wood in IPM, 1992).
It is also called merit pay, for in the implementation of such scheme part or all of an employee’ basic payment raise is decided principally by the individual’s performance which is measured by a number of specific objectives (for instance, sales targets or customer satisfaction) (Marchington and Wilkinson, 2002).
PRP thrived well in the last decade and has been demonstrated repeatedly by piles of survey findings to receive support among employees engaged in various jobs in a wide range of organizations (Fletcher in IPM, 1993: 41). Nowadays, near two-thirds of organizations adopt this scheme as one of their main reward strategies. Even in the public sector, such as local government, the Civil service, and more recently, teachers (Marchington and Wilkinson, 2002). Although based on Armstrong’s article in People Management (2000), the teachers’ case seems to be an example of failure for applying PRP, yet he also suggested the potential benefits of implementing it, such as acting as a lever of change, improving individual and organizational performance and helping the organization to attract and retain people through financial rewards and competitive pay—the latter may accordingly largely reduce the so-called ‘golden handcuff’ effect which refers to poor performers staying with employers (1999).
In the book Incentive Pay Impact & Evolution (Cannell and Wood, 1992), PRP is argued to have all the strengths and none of the weaknesses of the other systems in theory. Then is it also invincible in practice?
As Kessler’s (1994) review pointed out, there is an important gap between assumptions and reality in those organizations which have introduced IPRP. This fact strikingly contrasts with the claims presented in books about the efficacy of PRP. In the following paragraphs an effort is made hopefully to discover those problematic issues concerning PRP’s effect on performance as well as the fairness of operating PRP scheme.
It is widely recognized that PRP is by far the most popular reward scheme which directly links the performance review with the reward review. The influence of PRP on performance, theoretically speaking, must be strong and straightforward. However, certain research into individual performance-related pay in the UK over the past decade has failed to show that such systems have an effect on performance (John Purcell, 2000). Thus, examining the causes of potential problems brought by PRP is necessary and unavoidable.
Firstly, pay fails to motivate. Though no one will deny the fact that money can buy things and services that human being need, there is no evidence for the assumption that people will be encouraged to work better by being paid more. As Frederick Herzberg indicated, too little pay can demotivate people, but it does not mean that more and more money is capable to generate their better performance. In his principle: the real motivation comes from the job, not things like money and the conditions under which they work. People works for satisfaction, for recognition, for pride and for more meaningful things in life, which is in particular applicable to those senior employees. When the salary is high enough, the excess money cannot make people do better.
Secondly, PRP could contradict to team-work performance. It is not difficult to understand that when people are exposed in a competitive surrounding with their colleagues and evaluated individually, great emphasis is more likely to be attached to their own performance goals, and their attention are more easily to be focused on individual targets rather than the team’s objective as a whole. Obviously, the possibility for employees to cooperate with and help each other is rather slim. As a result, less commitment and contribution will be involved in the teamwork as well as the organization.
Thirdly, PRP can undermine intrinsic interest in a task. It has long been realized that excessive stress on extrinsic motivation in the form of pay can be detrimental to intrinsic motivation(Deci, 1975). Studies have shown that intrinsic interest which results in optimal performance typically decreases when external reasons are presented for doing it. In fact, a series of studies, published in 1992 by psychology professor Jonathan L. Freedman and his colleagues at the University of Toronto, confirmed that the more incentive we are offered, the more negatively we will view the activity for which the bonus was received (Kohn, 1993: 62).
In short, PRP is inclined to reduce people’s enthusiasm about their work, the outcome of which is undesirable performance. Besides, PRP can lead to short-termism. In order to achieve quick profit, it is easy for people to have strong intention on short-term benefits instead of pursuing the accomplishment of long-term strategic goals. It seems that focusing on the former is more practical than striving for the latter.
As a matter of fact, nowadays a growing number of staff and managers have appeared to lose faith in applying PRP in practice. Apart from its adverse influence mentioned above, the major reason could be due to the difficulty in implementing performance appraisal, which, however, lies at the heart of PRP. According to the survey conducted by the Institute of Personnel and Development(IPD), one third of employees believes that their bosses merely regard appraisals as “a bureaucratic chore”, and one in eight managers would prefer to have a dental appointment instead of doing an appraisal (Hilpern, 2000).
Why does performance appraisal sometimes not work? In general, it is perceived as arbitrary, subjective and therefore lack of justice. The study of Inland Revenue staff found that 87 percent of the interviewees felt that “PRP has made staff question the fairness of appraisal system”; 63 percent believe that “a good appraisal is too often overruled by someone higher up”; 35 percent felt that “people get a good box marking not because of their performance but because managers want to reward their favorites” (Cannel and Wood, 1992: 90).
As it is shown in the above study, the outcome of assessment is mainly based on the subjective view of the appraisal, which can be easy to be changed in accordance with individual’s arbitrary will. And what makes the process much worse is that managers who are responsible to measure people’s performance are not well-trained and qualified enough to conduct such performance appraisals. Thus their judgments on subordinates are usually unconvincing. Certain figures generated from similar study indicate that manager’s ratings are often manipulated to suit different motives (Redman and Wilkinson, 2001). Longnecker et al.’s study of 60 senior managers also found that a variety of factors, other than the subordinate’s actual performance, influenced the ratings managers allocated their subordinates (Bach and Sisson et al., 2001: 252). For example, supervisors are reluctant to give unfavorable ratings to their subordinates since this will reflect their own poor performance as well.
Another difficulty which causes problems with performance appraisal is setting the objectives or criteria. Firstly unrealistic targets may be set by inexperienced managers. Some targets may be too easy while others are too difficult. Secondly, it is especially challenging for individuals to reach the organization’s objectives. That is to say some variability of macro environment is not controllable. Even if great endeavors have been made in work, there is still little likelihood for individuals to reach the organization’s objectives. For instance, in financial services the economic climate produces far more influence than individual effort, which can easily demotivate employees’ performance when it is in close relation with reward (Redman and Wilkinson, 2001). Thirdly, since jobs of each employee are not identical, and people vary considerably in their ability and motivation, it is impossible to find single universal criterion or target for managers to assess every one’s performance. Some managers tend to give everyone a similarly intermediate-high score of performance to make every one happy. The case in Finbank ( See Table 1) shows that around 90% of employees are assessed as “Fully Effective” and “Excellent” which are intermediate-high grades (Lewis, 1998). But in such cases, when every one has the same score of performance, there is no reward in fact. At the same time, since the employees cannot find a universal standard to compare their own work with other employees, they might think the appraisal is unfair to them even though it is fair.
To improve this situation, some organizations use 360 degree appraisal or some other methods to modify the appraisal system, but since the basic problem of appraisal is people, such modification cannot solve the problem thoroughly. As a result, the appraisal system not only works poorly in offering effective estimation of performance but also increases the administrative cost due to its complexity.
In the light of all the accounts above, PRP seems to work ineffectively in practice. A variety of difficulties derived from implementation of the scheme are identified and examined explicitly to show the evidence that PRP is deficient while being adopted to operate in reality. However, is it really so vulnerable and problematic in practice?
In the case, The Contract with Caesar ( Cannell and Wood in IPM, 1992), it showed clearly that when PRP was introduced to the senior executives in a firm, the objective was not to offer more monetary advantage for them but to lead them to focus on things which mattered to the business, and therefore, to improve the overall organizational performance. In this study, managers would be set targets and must understand that they had to achieve them. Thus, the adoption of PRP here “offered a positive balance—‘if you succeed, you’ll be paid more’—to its negative side—‘if you don’t deliver, you’re out’” (1992: 56).
Brown and Armstrong in Paying for Contribution (1999) claimed that there were almost as many studies implying PRP can reinforce and contribute to organizational and individual performance as those suggesting that it cannot. According to Lewis (1998), the key point lies in the employees’ intention. If both the principle and practice of PRP are generally agreed by employees, the motivation purpose will be achieved by the improvement of job performance and profitable organizational outcomes will follow. On the contrary, if such agreement doesn’t be met, then employees will not be motivated to perform their jobs effectively and consequently organizational outcomes will probably not occur (Marchington and Wilkinson, 2002).
After examining the most applicable payment schemes nowadays, what can be observed is that for each scheme there must be advantages and disadvantages in both theory and practice. There is no absolute evidence to support whether human resource management indeed only works well in theory but not in practice. Actually, in the light of our discussion, we found that the conclusions are balanced, which means for some theories they not only flourish in books but also effect well in real case studies. Time rates for instance, are generally applied in managerial and white-collar work, and PBR as well thrives in clothing industry and later on insurance business. Each scheme has its strengths in dealing with particular problems. Though weaknesses may be found while implementing the theory, the effectiveness in practice cannot be ignored. Besides, no theory is flawless, and even though there is, the implementation would generally not go as smoothly as the theory does. The critical reason behind this could be certain uncontrollable factor which varies hugely from place to place, time to time; that is—people.
No matter how perfect a theory might be, when it comes to people, there could be some problems occurring. As what has been mentioned above, in most schemes, such as PBR and PRP, the standards of performance are often disputed and not easy to be decided. The obvious key point lies in personnel. The same as what happened to the performance appraisal evaluation system, a major argument about the justice of appraisal arose from the managers who made those assessments and might not have done them fairly and effectively. Because of this, many defects occurred while implementing the schemes.
While more flaws may be uncovered, more improved human resource management theories would also be investigated and generated. Until now, there seem to be no theories in this field which can be proved to work perfectly well in practice, and such situation may still remain in the future. People changes; hence the study of human resource management must be varied and modified along with such fact. Does human resource management simply work well in theory but not in practice? The answer is uncertain and there are always more theories to come.
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