In order to succeed, organizations must attract and keep their productive employees. A business has to establish incentive plans to meet these objectives. The purpose of incentive plans is to motivate employees to perform highly, exceed expectations, and expand the business. These plans make employees increasingly productive during a specific period. They also attract the right type of employees. For incentive plans to work, they must have achievable goals. If not, employee morale fades and the incentive plan becomes ineffective (Dessler, 2011). In the current difficult economic times, organizations are using incentive plans to utilize the limited resources to drive performance. Incentive plans have become a powerful tool for employers to differentiate employees, improve performance, and establish a clear connection between performance and reward in organization (Kohn, 1999). There are various incentive plans available to employers today. Two of the most notable ones include profit sharing and merit pay. This paper examines profit sharing and merit pay incentive plans and their advantages and disadvantages.
A profit sharing incentive plan provides employees with a direct and open feeling of ownership in the company profits. The amount and nature of incentives depends on the profit levels. Every employee receives a given percentage of the profits according to a predetermined formula for distribution. This incentive plan provides a firm link between the level of awards and the business performance. Profit sharing is a type of variable pay plan. When profit sharing is distributed as a portion of the annual pay, it leads to less money distributed to employees in positions of lower pay and higher amounts distributed to employees of higher compensation levels. This shows that more highly paid employees are tasked with managing the organization, taking risks, making decisions, and leading the other employees. The profit sharing incentive payments are only made when the company has registered profits for a specified time. There are various advantages of the profit sharing incentive plan (Dessler, 2011).
First, this plan lets everyone know that all employees are part of a close-knit team working together for a common purpose. The employees feel that they are rewarded equivalently and equitably to reinforce the shared service to customers. This is good for the company because employees are likely to get along well when they do not feel unfairly treated. Employees who get along are likely to improve the overall performance of the company. Employees begin to feel like the owners of the company and, therefore, become more accountable for their actions. The second advantage of profit sharing is that it leads to tax benefits for employees. If this incentive plan comprises a deferred cash feature, employees may contribute part of their annual salary to the plan. The participation amounts for employees are deposited into the deferred cash feature. This enables employees to get their contributions as subtractions from their individual Annual Adjusted Gross Income (AGI) (Dessler, 2011). Third, the profit sharing plan improves the profitability of companies. This happens if the contribution plans for companies are based on overall sales acquired from business operations. Employees are likely to work harder if they get the feeling that they can affect their future retirement benefits through improving company sales. Measures for cost cutting are also discoverable (Kohn, 1999). This also improves the company’s profitability.
The fourth advantage is increase company opportunities. As employees become involved with the operation of the company, new business opportunities and markets arise as employees suggest new ideas. Employees who feel that their fate lies with the company may find new product lines and markets to increase the business opportunities of the company. The fifth advantage is potential for better workers. With company expansion and growth comes the need to hire new employees who compensate for high profitability expectations of the company’s new operations. There may also be a need to find specialized employees who perform the tasks needed in the new business operations. Providing a profit sharing incentive plan to potential employees develops better hiring opportunities and competitive recruitment process.
Profit sharing plans also have disadvantages. One weakness is that employees cannot really see and sense how their work translates into profitability for the company. While employees enjoy obtaining the shared profits, they begin to feel more of entitlement rather than motivation. Employees begin to feel that they deserve the shared profits that they receive from the company. The result of this is that the motivation factor decreases and the plan become ineffective in raising employee morale (Dessler, 2011).
Merit pay incentive plans depend on compensation by rewarding employees who perform better than others do with added pay or incentives. This method is one of the best incentive plans available in business. This method has several advantages as well as disadvantages. The first advantage is that the plan helps employers differentiate between employees who perform highly and those who perform poorly. The employees who perform better than the rest are awarded accordingly. Secondly, merit pay enables the employer to differentiate the performance of the company in its entirety and that of the individual. This is advantageous because employees may perform well even though the company is not performing well as a whole. If some employees are letting the company down by performing poorly, it does not mean that the hardworking ones should go unrewarded. The third advantage is that employers are able to recognize individual performance.
There are several disadvantages of merit pay. First, it is very difficult to differentiate performance between employees 100% accuracy. This means that it is challenging to determine them employees who deserve the merit pay more than others do. Some of the contributions that should necessitate merit pay are also not measurable. This means that the manager’s opinion, which may be flawed, remains the only constant in determining who deserves merit pay. Secondly, the limitation of metrics as well as the ability of the employer to communicate what each employee contributes to the company is a great challenge. It is obvious that some supervisors/ managers communicate in a better way than others do. Even with All the existing limitations, merit pay remains the best opportunity for managers to ensure that their outstanding performers are retained in the company. High-performance employees may be greatly demotivated if they learn that poor performers are compensated on the same level as theirs.
Organizations use incentive plans to attract and keep effective employees in the company. Profit sharing plans provides employees with a direct and open feeling of ownership in the company profits. Merit pay incentive plans depend on compensation by rewarding employees who perform better than others do with added pay or incentives. Both of these incentive plans have advantages and disadvantages. However, merit plans are preferred because they ensure that employees that are more deserving are rewarded. Overall, organizations should consider using incentive plans to make their operations more effective and to keep the best employees.
Dessler, G. (2011). A Framework for Human Resource Management (6th ed.). Upper Saddle River, NJ: Prentice Hall. ISBN: 9780132556378.
Kohn, A. (1999) Punished by Rewards: The Trouble with Gold Stars, Incentive Plans, A's. Houghton, Mifflin Harcout. NJ.