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Types of Incentives


An ‘incentive’ or ‘reward’ can be anything that attracts an employees’ attention and stimulates him to work. An incentive scheme is a plan or programme to motivate individual or group performance.

An incentive programme is most frequently built on monetary rewards (incentive pay or monetary bonus), but may also include a variety of non-monetary rewards or prizes. Incentives are needed to increase the productivity of the labourers as also to reduce cost per unit of labour. It is gainful for both the labourers as well as employers to give incentives.

The types of incentives can be studied under the following heads:-


1. Monetary or Financial Incentives 2. Non-Monetary or Non-Financial Incentives.

Some of the monetary incentives are:-

1. Dearness Allowance 2. Profit Sharing 3. Co-Partnership 4. Bonus.

Some of the non-monetary incentives are:-


(i) Job Security (ii) Competition (iii) Opportunity of Progress (iv) Justice (v) Workers Participation in Management (vi) Praise (vii) Knowledge of Results (viii) Leadership (ix) Paid Vacations (x) Lack of Fear (xi) Joint Consultation (xii) Constructive Tendency (xiii) Recognition (xiv) Delegation of Authority (xv) Pride in Work.

Additionally, few other types of incentives are:-

1. Individual Incentive Plans 2. Group Incentive Plans 3. Organization Level Incentive Plans 4. Incentives to Professional Employees.

Types of Incentives Provided to Employees: Monetary and Non-Monetary Incentives

Types of Incentives – Monetary or Financial Incentives and Non-Monetary or Non-Financial Incentives (With Advantages and Disadvantages)

An ‘incentive’ or ‘reward’ can be anything that attracts an employees’ attention and stimulates him to work. In the words of Barack and Smith, “An incentive scheme is a plan or programme to motivate individual or group performance. An incentive programme is most frequently built on monetary rewards (incentive pay or monetary bonus), but may also include a variety of non-monetary rewards or prizes.”


Incentives are needed to increase the productivity of the labourers as also to reduce cost per unit of labour. It is gainful for both the labourers as well as employers to give incentives.

These incentives can be given in various forms as shown hereunder:

Type # 1. Monetary or Financial Incentives:

Money is the determinant factor of all incentives. In order to increase the efficiency of the labourers, various financial incentives such as good wage, bonus, dearness allowance, and money related income items (free uniform, free medical assistance, free education, etc.) are very essential. Financial incentives impart self-confidence and give sense of security to the workers. They take more interest in work and produce more in the hope of getting still more monetary benefits.

These financial incentives also include such economic incentives as are given collectively to the employees. For example, dearness allowance, profit-sharing, bonus, equal wage rates, pension and annual increment based on ability, etc.

Detailed description of dearness allowance, profit-sharing, co-partnership and bonus is as follows:

I. Dearness Allowance:

Payment of dearness allowance is made to the employees under wages/pay packet. It is paid by the employers to the employees in order to provide relief to the latter against ever rising prices of consumer goods. Thus dearness allowance is given to the employees by way of compensation for rising prices or consumer price index.

This compensation is called dearness allowance. It is an important part of the wages paid to the employees. To-day, dearness allowance is given to all government and most of the private sector employees.

Initially dearness allowance was kept separate from the basic salary. The main reason for it was that rise in consumer goods prices was temporary and it was hoped that in future prices will revert back to their normal level. But prices went on rising and all measures to control them failed miserably. In this way, the system of payment of dearness allowance, whose initial nature was purely temporary, has to-day become an integral part of wages. System of payment of dearness allowance in different industries and sectors is different from one another.


In India, the system of payment of wages is not very old. Prior to World War-II, system of dearness allowance was restricted to cotton textile industries of Mumbai and Ahmedabad. It was during World War I that payment of dearness allowance was first made in India in Cotton Textile Industries. In 1939, the system gained importance.

Initially, dearness allowance used to be treated as an additional income of the workers. Gradually, this system was introduced in all industries (private and public) of India. Presently, payment of dearness allowance has become an integral part of wage payment.

Methods of Computation of D.A.:

Following are the methods of computation of dearness allowance:


a. D.A. linked with cost of living:

(i) D.A. linked to consumer price index (CPI).

(ii) D.A. linked to pay-slabs and consumer price index.

b. D.A. not linked with cost of living:


(i) Flat rate of D.A.

(ii) Graduated Scale of D.A.

(1) Dearness Allowance Linked to Change in Consumer Price Index:

In this method consumer Price Index is taken into account. Dearness allowance is paid in accordance with change in price index on point basis. Employees getting low rate of wages are paid more dearness allowance than the employees getting high rate of wages.


(2) D.A. Linked to Pay Slab:

Under this method, rates of dearness allowance vary with different pay-slabs. Dearness allowance increases more in case of minimum pay-slab and it increases less in case of maximum pay-slab.

(3) Flat Rate of D.A.:

Under this method all employees are paid dearness allowance at uniform rate, irrespective of consumer price index.

(4) Graduated Scale of D.A.:

Under this method also, consumer price index is not considered. Amount of dearness allowance increases with increase in pay but rate of dearness allowance goes on falling as the level of pay goes on rising.

Many factors influence determination of dearness allowance, such as, earning capacity of the industry, increase in productivity and consumer price index, etc. Besides, the bargaining capacity of the employees and trade unions also compels the industries for the payment of dearness allowance. Various industrial adjudications have also contributed significantly to the determination of dearness allowance.

Advantages of Dearness Allowance:

(i) Dearness allowance scheme is beneficial for maintaining normal standard of living of the workers.

(ii) Being linked to Consumer Price Index, dearness allowance automatically compensate loss in purchasing power of money wage due to price rise.

(iii) Being an integral part of the wage, dearness allowance implies rise in wage and this rise is of permanent nature.

Disadvantages of Dearness Allowance:

(i) Rise in consumer Price Index leads to corresponding rise in rate of dearness allowance. Consequently, wages paid to the workers also rise. But rise in wages is not accompanied by rise in productivity. As a result per unit cost of labour increases.

(ii) Dearness allowance, instead of being linked to the profitability of the industrial unit, has been linked to Consumer Price Index which is a different element.

(iii) Payment of dearness allowance is one of the causes of inflation.

(iv) Dearness allowance leads to increase in the inequality of income. This gives rise to mutual animosity among the workers culminating into industrial disputes.

(v) Dearness allowance causes rise in labour cost and hence rise in selling prices of the products.

Supreme Court’s Views on Payment of D.A.:

Supreme Court has laid down the following principles to regulate payment of dearness allowance:

(1) Capacity to Pay:

While making payment of dearness allowance, industry’s capacity to pay must be taken into consideration.

(2) Rates Prevailing in Comparable Concerns in the Region:

While determining dearness allowance, rates of total wages (basic wage + D.A.) in similar concerns in that region must be taken into account.

(3) Extent of Neutralization:

Leaving aside low-level of handloom workers, it is improper and irrational to completely neutralize cost of living by dearness allowance. Real wages that fall due to rise in general price-level must be compensated by corresponding rise in dearness allowance.

(4) Same Rate of D.A. for Different Classes of Workers:

Following the principle of equality, irrespective of the nature of the work of workers, those getting equal wages should be given equal dearness allowance.


(i) Dearness Allowance Scheme should be uniform in all the industries of a given region.

(ii) Consumer Price Index be determined region-wise, to calculate fall in the real income of the workers.

(iii) Partial neutralisation of rise in cost of living be effected. Full neutralisation gives rise to inflation.

(iv) A part of the dearness allowance be merged into the basic salary. It will benefit the workers by way of more provident fund and higher house rent and hence more economic security in future.

II. Profit Sharing:

Inspite of several schemes providing incentives with regard to payment of wages, differences still persist between the workers and the employers. With the development of Industrial Democracy, profit-sharing and co-partnership have been accepted as motivational forces for the workers. Profit-sharing and co-partnership have come into being in order to create a sense of satisfaction among the workers and to elicit co-operation from them in the field of industrial production.

This concept was first of all introduced in the Metropolitan Gas Company of America. Some scholars are of the view that this concept was put to practice for the first time in France. In 1840, French Painter Laclaire calculated that if a part of the profit is distributed among the workers, there will be economy in the use of raw material and tools and equipments used in production will be handled with care.

Meaning and Definitions of Profit Sharing:

Under Profit-sharing scheme, in addition to their regular wages workers are given a certain percentage of share out of profit.

(1) In the words of H.R. Seager, “Profit sharing is an arrangement entered into by which the employees review a share, fixed in advance of profits.”

(2) According to International Conference on Profit Sharing, Paris, 1899, “Profit Sharing is an agreement (formal or informal) freely entered into by which the employees receive a share fixed in advance of the profit.”

(3) In the words of Dr. Kimball 8c Kimball, “Profit sharing is a scheme, whereby a certain percentage of the profits is distributed at fixed intervals, usually annually or semi-annually, in some definite ratio to all employees who have been in employment of the firm for a stated term.”

(4) According to International Co-operative Congress, 1897, “Profit sharing is an agreement freely entered into by which the employees receive a share fixed in advance, of the profits.”

(5) According to I.L.O. wages a General Report, 1948, “Profit-Sharing is a method of industrial remuneration under which an employer undertakes to pay his employees a share in the net profits of the enterprise, in addition to their regular wages.”

(6) According to Robert, Profit-sharing is an independent agreement which may be written or oral and according to which the employed workers are given the right to get a share in the profit in addition to their ordinary wages, but not in loss.

Characteristics of Profit-Sharing:

Main characteristics of Profit-sharing arrangement are as under:

(i) Profit is shared between the workers and the employers in accordance with an agreement.

(ii) Share out of profit is in addition to the normal market rate of wages and is intended to provide inducement to the workers.

(iii) Preparation of the profit to be shared is pre-determined, the employer cannot change it later on.

(iv) Share of the profit paid to the workers is based on the net profit or dividend of the industrial unit.

(v) It is the profit that is shared between the workers and the employer and not the loss.

(vi) Labour-class alone is entitled to it and not the managerial-class.

(vii) Each worker, without any discrimination, gets share out of profit.

(viii) Individual ability of the worker is not taken into consideration while sharing profit.

(ix) Distributed share amount is either paid in cash or credited to the provident fund of the workers.

(x) All workers know their share in advance.

Forms of Profit Sharing:

Following method are used as basis for determining profit-sharing:

(1) On the Basis of Industry:

Under this system, surplus profit of different units of a given industry is collected and distributed equally among all the workers of that industry.

(2) On the Basis of Locality:

All units operating at one place collect their profits and distribute a given percentage of it among the workers of all units.

(3) On Industry cum Locality Basis:

Units of a given industry operating in a particular locality distribute pre-determined proportion of their profits among the workers.

(4) On Unit Basis:

Under this arrangement, profit of different units is worked out separately. Each unit distributes pre-determined share of its profit among the labourers.

(5) On Departmental Basis:

Under this arrangement profit of different departments of the industrial unit is worked out separately and distributed among the concerned departments.

(6) On Individual Basis:

Of the total profit, pre-determined share is taken out and distributed among the workers on the basis of their efficiency.

Merits of Profit Sharing:

(1) Industrial Peace:

Workers get more wages in the form of profit and remain contented. Relations between the management and workers improve and there is enhancement of co-operation and goodwill. As a consequence, there establishes industrial peace in the enterprise.

(2) Increase in Production:

On account of profit-sharing, worker works hard because profit fluctuates in proportion to his labour. Consequently, labourer endeavours to increase production by dint of hard work and dedication.

(3) Economy:

Labourers know that it is in their own interest to augment profit. As such, they work with extra care and dedication. They use machines, tools and raw material carefully so that there is no wastage. It brings down cost of production.

(4) Stability in Job:

Labourers remain satisfied with their work and employer and the rate of labour turn-over is the minimum. It imparts stability to their job and employer is also saved from botheration of selecting, recruiting, training etc. of new labourers.

(5) Reduction in Supervision:

Because of the vested interest of the labourers, they work honestly and with a sense of responsibility. Thus, supervision is no longer required.

(6) Industrial Democracy:

Profit-sharing helps establish industrial democracy. Labourer is not treated as a mere wage-earner but an equal partner in the progress of the industry.

(7) Increase in Income and Efficiency of Workers:

This arrangement raises the level of income of the workers as also their efficiency.

(8) Benefits to Society:

Workers work more honestly and with a sense of responsibility. It leads to more production with less cost, thereby benefitting both the society and the consumers. Consumer goods are available in the market at low price in large quantity and good quality.

(9) Benefits to Nation:

Nation stands to gain with industrial peace, higher standard of living of the workers and more production.

(10) Discipline and Responsibility:

All workers work with a sense of responsibility and co-operation. Evil like indiscipline does not spread among them.

Demerits of Profit Sharing:

(1) Lack of Relationship between Effort and Reward:

Under this system reward is given not on individual merit of the worker but collectively. Because of lack of correlation between effort and reward, it cannot be regarded as a good system.

(2) Uncertainty of Profits:

Share to the labourers is paid out of profit. Profit of the industry tends to fluctuate and sometimes there may be loss. On account of uncertainty of profits workers enthusiasm is dampened.

(3) Delay in Receipt of Reward:

Share of the profit (in case the firm earns profit) is decided at the end of the year. Non-receipt of the reward soon after doing the work adversely affects the efficiency of the workers. They have to wait for long for the reward.

(4) Not Suitable for Efficient Workers:

This system does not pay any attention to the individual efficiency of the workers. Since profit is paid to all labourers collectively efficient workers are not motivated to do more work.

(5) Opposition by Unions:

Trade unions oppose this system because it causes groupism between the labourers. Those who get share of the profit do not co-operate with those who do not get it. Consequently, hold of trade unions on the labourers grows weak; so much so that the very existence of the union is endangered.

(6) Opposition by Management:

Management too has its contribution to the increase in production and profit, like the labourers. But, the management is not entitled to any share of the profit. Opposition by management to the scheme is therefore quite natural.

(7) Opposition by Employers:

Employers oppose this system on the basis of its being one-sided. Labourers are entitled to get their share of profit but in the event of loss the whole of it is borne by the employer. The system is therefore unwarranted.

(8) Unrest among Workers:

Under this system, workers take profit as their right. During the period of depression when the amount of their share in profit falls they feel frustrated. Sometimes feeling of dissatisfaction culminates into strike or gherao, etc. This opens the gateway to industrial unrest.

(9) Moral Depression:

Sometimes it is possible that due to certain reasons there may not be any profit despite the best efforts and hard labour put in by the workers. It may be due to change in market conditions, inefficiency of the management or illegal purchases, etc. Under the circumstances labourers get no share of profit and they feel disappointed. It also affects their efficiency adversely.

(10) Unscientific Base:

There is no scientific base of profit sharing. Employer decides the share on his own. It provides no incentive to the workers because he so determines the share as to sub-serve his own interests.

III. Co-Partnership:

Co-partnership is, in fact, a developed form of profit-sharing. Co-partnership is based on the establishment of industrial democracy and workers participation in management. Under this scheme, in addition to profit sharing, workers also have their share in management and control.

In the words of Chapman, “Co-partnership implies both profit sharing and control sharing”.

In short, it can be said that co-partnership is the scheme by virtue of which workers become partners of the industry. It improves the status of the workers and they begin to take more interest naturally in the management of the organisation. As a consequence, operational efficiency of the workers increases and a sense of responsibility develops in them.


(i) To promote increasing productivity in the interest of industry, workers and society.

(ii) To make workers realize their importance in production and industry.

(iii) To meet the desire of self-satisfaction and self-identity of the workers.

(iv) To create a situation of industrial peace, good relations between the employees and the employer, and more co-operation between management and workers.

Characteristics of Co-Partnership:

(i) In addition to normal wages, the workers have the right to get share out of net profit of the enterprise.

(ii) The profit that the workers get in addition to their normal wages the same can be invested as capital in the industry.

(iii) Workers get the right to participate in management. Workers get this right either – (a) by purchasing share capital or (b) by forming workers co-partnership committee.

Merits of Co-Partnership:

(1) Advantages to Workers:

Workers enjoy three kinds of advantages under this system. First, as labourers they get wages; second, as shareholders they get dividend; and third, as co-partners they participate in management.

(2) Setting Up of Industrial Democracy:

Under this system, workers are no longer treated as a commodity but are given human treatment and are made partner in management. It helps in setting up Industrial Democracy

(3) Employee and Employer Relation:

On account of participation in management workers realize their responsibility. They have a feeling of self-respect. Both being partners in the control of industry, their mutual relationship becomes very close. It helps to solve their disputes. Workers work with dedication.

(4) Reduction in Supervision:

As co-partners, workers are motivated to ensure the success of the industry. They feel inspired and take keen interest in the work. Less supervision is called for and expenses on supervision go down.

(5) Industrial Development:

Under this system, profit is given to the workers in the form of shares which means increase in their savings. It also improves the financial position of the industry and makes industrial development possible.

(6) Other Benefits:

Co-partnership has all those advantages which are available to profit-sharing system. For instance, increase in production, economy, stability in job, discipline and responsibility, etc.

Demerits of Co-Partnership:

(i) This system can be operative only in Joint Stock Company.

(ii) Interference of illiterate workers in management proves hindrance in the progress of industry.

(iii) Workers cannot have effective control over industry because they cannot buy number of shares necessary for such control.

(iv) It reduces the mobility of workers.

(v) Workers are not free to invest the amount of profit anywhere else.

(vi) In the management class, workers status is the lowest. Thus, workers co-partnership in management is not so effective.

(vii) It weakens trade unions.

IV. Bonus:

To motivate the workers, payment of bonus is also quite significant. Bonus serves as monetary incentive and helps establish cordial relations between labour and management. From the view point of good labour-management relations, problem of bonus is also significant.

Payment of bonus to workers is prevalent in almost all industries. Bonus refers to that monetary payment which is paid to workers in addition to their wages as a reward for their good services.

It is paid out of the profit earned by the organisation. Workers treat bonus as an integral part of their wages. And it is because of this that payment of bonus gives rise to industrial problems.

Meaning of Bonus:

It is difficult to define bonus. It has been defined neither by the Payment of Bonus Act 1965 nor by any other Act. In simple words, bonus is a payment made to the workers, in addition to their wages, as a reward for special or additional services. It is thus an additional payment made to the workers for good work. It may be called an incentive bonus.

Payment of bonus is a significant problem. It has its effect on industrial relations and industrial development. It is therefore necessary to lay down certain principles to determine it.

In this context, it becomes necessary to pre-decide the following:

(i) Is bonus an ex-gratia payment? Does its payment depend upon the discretion of the employer?

(ii) Is bonus a deferred payment? Can workers claim it as a matter of right?

(iii) Is bonus a part of the profit of industry? Can workers demand it as a right?

Bonus as an Ex-Gratia Payment:

Payment of bonus has been presumed as an ex-gratia payment depending upon the sweet will of the employer. It is a wrong presumption. Even in the judgements delivered by Industrial Tribunals, bonus has not been accepted as an ex-gratia payment. Economists also do not subscribe to this presumption. Hence, it is concluded that bonus is not an ex-gratia payment.

Bonus as Deferred Payment:

In modern times, bonus has been taken as deferred payment which can be claimed by the workers as a matter of right. In one of its judgements delivered by Allahabad High Court in 1954, it was observed: There is no doubt that in modern times, bonus has clearly been accepted as such a deferred wage which is paid to the worker and which, as per the conditions of employment, can be demanded as a right.

In this way, this right of the workers is legally recognised. It is also considered to be based on social justice. Thus, payment of bonus to workers is a deferred payment and it does not depend on the discretion of the employer.

Bonus as a Dividend:

Profit earned by the industry is the result of joint efforts of the workers as well as management/employers. As such, both labour and capital have claim on the profit of industry. Just as capitalist/employer has claim on the profit of industry, in the same manner, labourers have also full claim on their share of profit. (This right has got legal and social recognition as well).

Calculation of Bonus:

How much bonus be paid to the workers? In this respect Labour Appellate Tribunal has developed a principle which has also been endorsed by the Supreme Court. As per this principle at first the gross profit earned by the industry is worked out.

Of it, provision is made for the following items:

(i) Provision for Deprecation

(ii) Reserve for Rehabilitation

(iii) Interest @ 6% on Paid-up Capital

(iv) Interest on Working Capital

(v) Income-Tax Provision

Aggregate amount of the above items (provisions) is deducted from the gross profit. Of the remainder, workers can demand fair amount as bonus.

The fact that workers can also put up demand for bonus when:

(i) Industry earns large profit due to the efforts and co-operation of the workers, and

(ii) Wages are less than the standard of living of the workers, has also been accepted.

Type # 2. Non-Monetary/Non-Financial Incentives:

Non-monetary incentives include all those non-financial, social and psychological factors for which employees get incentives for maximum and outstanding work. Non-monetary incentives play an important role in getting work with greater efficiency from the worker. For the workers monetary reward has great significance but of still greater importance is their interest in satisfying social and psychological needs.

Scholars are of the view that non-monetary incentives are as important as monetary incentives. For building up favourable production environment it is essential therefore to make increasing use of non-monetary incentives.

These non-monetary incentives are as under:

(i) Job Security:

Every employee wants his job to be stable and secure. Security of service inspires him to perform his duty efficiently.

(ii) Competition:

By encouraging spirit of competition among the employees, production can be increased. Competition is a non-monetary incentive. In order to activate it, some economic incentives are required e.g., bonus or rewards, etc. Competition should be encouraged among persons of equal capability.

(iii) Opportunity of Progress:

Every employee looks for an opportunity to make progress. It is therefore essential that everybody should get ample opportunities for advancement. It is possible that he may not be able to take advantage of the opportunity when it comes his way but he does hope for the opportunity. Every one prefers working on higher post to financial gain.

(iv) Justice:

An employee expects justice and fair treatment at the band of the employer. In matters of promotion or transfer etc., the management must play fair. Workers lose confidence in management when the latter exercises discrimination. Besides, their enthusiasm for work becomes weak.

(v) Workers Participation in Management:

Workers should have the right to participate in management of industry or to conduct the business and to give advice in matters of mutual interests. This will make them realize their importance and develop in them sense of responsibility. It has effect both on industry and production.

(vi) Praise:

Everybody likes that his good works be appreciated. It is the weakness of an ordinary person that he feels greatly flattered at his praise. It satisfies his ego. Praise has great motivational force. It constantly inspires the worker to take keen interest in the work and adds to his productivity.

(vii) Knowledge of Results:

On research Lindsley has concluded that acquired skill comes to a halt if follies and virtues are not brought to the notice of the persons concerned. Thus, the workers must be made aware of the results of the work being done by them so as to motivate them to produce still more.

(viii) Leadership:

Skillful leadership by the management in industrial establishment, improves labour-capital relationship and arouse a sense of confidence among the workers. Feeling of respect towards workers, showing interest in their personal problems, joining their social functions etc. by the management provide impetus to them. Consequently, workers get inspired to do more work diligently.

(ix) Paid Vacations:

Provision is made for paid vacations to the workers for excursion. It also adds to the efficiency of the workers.

(x) Lack of Fear:

More work can be extracted from the workers for some time by frightening them, but sometimes the situation takes an ugly turn. Fear gets transformed into opposition and opposition into retaliation. Spirit of retaliation culminates into unjust treatment which is detrimental to workers, employers and the nation. It is therefore necessary that workers must always remain free from a sense of fear.

(xi) Joint Consultation:

There should be liberal exchange of views and information between labourers and management. It makes employees aware of their responsibility, they have a feeling of co-partnership and they realize that their views and opinions carry weight. As a consequence, their devotion to work goes on increasing.

(xii) Constructive Tendency:

Management should create such situations as encourage the workers to show their constructive tendencies. Thus taking full advantage of the ability and skill of the workers, profits of the enterprise can be multiplied.

(xiii) Recognition:

Every employee wishes that his work be fully recognised, it should be useful and he should be indispensable to production process. It makes him conscious of his ability, efficiency, position and responsibility. Management should therefore give due recognition to all kinds of work performed by the worker so that they are inspired to do work with greater zeal.

(xiv) Delegation of Authority:

Workers get lot of impetus if given full responsibility and delegated authority to accomplish a given task. Delegation of authority reflects confidence of the management in the employees. This feeling inspires them to do more work qualitatively and quantitatively.

(xv) Pride in Work:

Those workers who have a sense of pride in work and in their organisation, they do their work with utmost diligence and integrity.

Advantages of Incentives:

Main advantages of incentives or inducements are as under:

(i) Increase in industrial productivity.

(ii) Check on labour turn-over and availability of stable labour-power.

(iii) Workers work with keen interest resulting in reduction of labour cost.

(iv) Incentives help establish industrial peace. There is fall in the number of strikes, gherao and lock-outs.

(v) Improvement in the moral and physical level of the workers.

(vi) Managers rely on the workers. There is thus saving in the expenses of supervision and control.

(vii) Helps in setting up of industrial democracy and welfare state.

(viii) Problem of absenteeism and late-coming comes to an end.

(ix) Workers engage themselves in achieving the goal with a sense of full co-operation.

Types of Incentives – 4 Important Types of Plans: Individual Incentive Plans, Group Incentive Plans, Organization Level Incentive Plans & Incentives to Professional Employees

1. Individual Incentive Plans:

Individual incentive plans are influenced by many factors such as technology, job tasks/duties and/or organizational goals. Incentive payments are determined by the number of units produced, by the achievement of specific goals, by productivity improvements or by availability of money.

i. Piece Work:

It is one of the oldest incentive plans. In straight piecework incentive plan, the employees receive a certain rate for each unit produced. Compensation is determined by the total number of units produced during a particular period, say, in a day or in a week. In differential piece rate plan employees whose production exceeds the standard output receive a higher rate for all the units they produce than the rate paid to those who are unable to exceed the standard.

Piece work plan succeeds when:

(i) Units of output can be measured easily,

(ii) The quality of the product is less critical,

(iii) The job is fairly standardized, and

(iv) A constant flow of work can be maintained.


(i) It is simple to calculate the compensation.

(ii) It permits the firm to predict its labour cost with considerable accuracy as the cost is same for each unit produced.


(i) It may lead to jealousy among the workers as efficient workers can do more work than others.

(ii) Those who care more for peer approval may not put more efforts.

(iii) Individual contributions are difficult to measure in all jobs and particularly in mechanized jobs.

(iv) Piece work system is inappropriate when quality is more important than quantity, technology changes often and productivity standards are difficult to measure.

(v) It does not help develop a conducive organizational culture as everyone is preoccupied with the incentive payment.

ii. Standard Hour Plan:

In this plan, payment is determined based on the completion of a job in a predetermined standard time. If employees finish their work in less than the standard time, their payment is still based on the standard time for the job multiplied by their hourly rate. (If the standard time to polish a particular equipment is 5 hours and if an employee finishes the work in 4 hours, then his/her compensation is calculated for 5 hours even though he/she has completed the task in 4 hours).

(i) Standard hour plans are common in service departments.

(ii) They are suited to long-cycle operations or tasks or jobs that are non-repetitive and require a variety of skills.

(iii) Though standard hour plans can motivate workers to do more work, employers must make sure that equipment maintenance and product/service quality do not suffer as workers tend to finish their work faster to earn additional income.

iii. Bonus:

Bonus is an incentive payment given to an employee in addition to one’s normal basic pay.

(i) It is, generally, given at the end of the year.

(ii) Bonuses provide employees with more pay for putting in more effort.

(iii) Employees still have the security of basic pay.

(iv) Bonus payments are common among managers, executives and workers.

(v) It is determined on the basis of cost reduction, quality improvement or performance criteria developed by the organization.

(vi) When some special contribution is to be rewarded, a spot bonus may be made. Spot bonus is made ‘on the spot’ usually for employee’s effort not directly related to performance standard.

(vii) Bonus plan is useful to retain and motivate over-burdened employees.

iv. Merit Pay:

This incentive payment is based on one’s performance. Those who perform better generally receive more merit pay. This is in addition to basic pay. The percentage of increase is attributable solely to performance. Merit raises can serve to motivate if employees perceive the raise is related to the performance required to earn it. It is essential that merit pay should be distinguishable from cost-of-living or other general increases.

Limitations of Merit Pay Plan:

(i) Merit raise may continue year after year even when performance declines and employees may see it as being an entitlement unrelated to their performance.

(ii) Managers’ biased evaluation of employee performance will create unpleasant reactions.

(iii) Definition and performance measurement may be vague without any guidance.

(iv) Employees may not be able to distinguish between merit pay and other types of pay increases.

(v) There may be lack of honesty and cooperation in fixing merit raises.

(vi) Money available for merit raises may be inadequate to satisfactorily raise all employees’ basic pay.

v. Lump-Sum Merit Pay:

To make merit pay more visible and flexible, lump-sum merit pay is advocated. In this plan employees receive a single lump-sum increase at the time of their review. It is not added to the basic pay. The main advantage is that employees are able to see a clear link between their performance and payment. Moreover, lump-sum payment is visible compared to the small amounts paid weekly or monthly.

Incentive Awards and Recognition:

Special contributions, achievements or service to the organization are often recognized through merchandise awards, personalized gifts, vacations, gift vouchers etc. Presenting tangible awards with the right message at the right time is an effective way of appreciating good performances. Research showed that non-cash incentive awards along with recognition program were more effective to motivate workers.

Sales Incentives:

As sales job requires drive and enthusiasm, the sales people must be highly motivated. That is why financial incentives are used for sales force widely. Incentives are important to elicit cooperation and trust from sales people as they are generally in the field away from the office.

Since there are wide differences among sales people incentive schemes get complicated. Generally, performance of sales-people is measured by the sales volume, the employees’ ability to establish new contacts, the enthusiasm to promote new products/services and the various forms of services provided to the customers.

Performance standards for sales people are difficult to establish as their performance is often influenced by many external factors such as economic/seasonal fluctuations, sales competition, changes in demand and the nature of sales territory. There are also problems of how to reward extra sales effort and the activities which do not directly or immediately contribute to sales.

Types of Sales Incentive Plans:

a. Straight Salary Plan:

It is a compensation plan in which sales people are paid for performing various duties that may or may not result in sales. It may not motivate sales people to put in sufficient effort to maximize the sales and it only enables them to provide services and build-up the good will.

b. Straight Commission Plan:

It is based on a percentage of sales. This plan provides maximum incentive and is easy to understand and calculate.


(i) Sales people will concentrate only on sales volume rather than on profits.

(ii) There are chances that after-sales customer service is neglected.

(iii) As sales fluctuate in different periods, trained sales people may quit during poor sales period.

(iv) To increase sales volume, salespeople may offer price concessions without the knowledge of the company.

c. Combined Salary and Commission Plan:

This plan includes a straight salary and a commission. It is the most widely used sales incentive plan. For example, if a sales person works under a 75/25 combination, he or she gets 75% of the basic pay and 25% of the sales value as commissions. The ratio of combination is decided by the company based on certain objectives.


(i) It combines the advantages of straight salary and commission plans.

(ii) This offers greater flexibility to help companies maximize profits.

(iii) This plan motivates the sales people to achieve specific company objectives and sales volume.

2. Group Incentive Plans:

As many tasks are executed by people as groups/teams, group incentive plans have become popular. Group plans help companies in cost reduction and total quality management.

(i) Benefits of improved efficiency realized by work teams or units can be shared by all the employees.

(ii) These plans encourage cooperation and team spirit among employees.

(iii) These plans are desirable when tasks are independent and measurement of individual performance is difficult.

i. Team Compensation Plans:

These plans reward team members with incentive bonus when the performance standards are met or exceeded.

Team incentive plans have become popular as:

(i) Production has become more automated,

(ii) Teamwork and coordination among workers have become more important, and

(iii) The contributions of those engaged indirectly in production or service has increased.

Steps Involved in Establishing Team Compensation:

Step 1- Setting performance measures- Improvements in efficiency, product quality or reduction in materials/labour costs are common benchmarks to base incentive payments. The same must be informed to the employee.

Step 2- Determining of the size of incentives- It is deciding certain percentage of sales as incentives.

Step 3- Establishing payment formula- The team bonus may be distributed to employees equally, in proportion to their basic pay or on the basis of their relative contributions. It is decided by the team members along with the manager.

Merits of Team Compensation:

(i) It builds team culture and improves team spirit through supporting group planning and problem solving.

(ii) Group cooperation enhances individual contributions.

(iii) It motivates employees through broadening the scope of their contributions.

(iv) Team compensation reduces jealousies among the employees as their contributions and payments are similar.

(v) Interpersonal competencies will improve through cross-training.

Limitations of Team Compensation: 

(i) There are chances that some individuals may feel that their contributions are higher than that of others.

(ii) There may be pressure from inefficient fellow workers to reduce performance of efficient workers to hide their inefficiency.

(iii) Payment formulas are usually difficult to understand.

ii. Gain Sharing Plans:

These are organizational plans to increase productivity or decrease labour cost and to share the gains obtained through higher productivity or reduced wastes with the employees.

(i) In contrast to profit sharing, where employees may not be able to link their contribution to profits, gain sharing focuses on savings such as reduced use of materials or less labour.

(ii) As the name suggests, employees share the gains obtained through savings.

(iii) These are based on mathematical formula comparing standard performance and actual productivity during a period of time.

(iv) The idea in gain sharing is that employees will improve productivity through more effective use of organizational resources.

(v) Productivity, is usually measured as a ratio of outputs to inputs. The common output measure are sales, units produced, labour cost saved, customers orders etc. Inputs frequently measured are materials, labour, energy consumed, inventory, purchased goods or services, total costs etc.

(vi) There will be higher productivity when higher output is obtained with less or equal input or when equal production output is obtained with less input.

Typically there are three gain sharing plans viz., Scanlon, Rucker and Improshare. While Scanlon and Rucker plans emphasize sharing of the savings resulting from cost reductions, Improshare is based on the volume of finished goods in a given period of time.

a. Scanlon Plan:

This plan was developed in 1937 by Joseph Scanlon, an official of United Steel workers Union. It is a bonus incentive plan using employee and management committees to gain cost-reduction improvements. The aim is to encourage improved employee productivity by sharing resulting financial gains with employees. The main thrust is that employees should offer ideas and suggestions to improve productivity and in turn, be rewarded for their constructive efforts.

Scanlon plan has following five basic features:

(i) The first feature is the Philosophy of cooperation. This philosophy assumes that managers and workers should work together and avoid the attitudes of “us” and “them” to develop a sense of ownership in the company.

(ii) Second feature is identity. That is, the company’s mission or purpose is clearly explained and the employees must understand how the business operates in terms of customers, prices, costs etc. This helps employees focus their efforts.

(iii) Third feature is competence. This plan demands a high level of competence at all levels.

(iv) Fourth is involvement system. This is achieved through two committees, viz., shop and screening committees. The purpose of ‘shop’ committee at departmental level is to solicit suggestions, follow up on suggestions, discuss suggestions with employees and implement suggestions. Screening committees at executive level evaluate suggestions, review performance to determine bonus, oversee entire plan and keep top management informed.

(v) Fifth feature is sharing of benefits. Financial benefits are offered to all employees on the basis of an established formula. This plan assumes that employees should get a share of profits resulting from their cost-cutting suggestions/activities.

b. Rucker Plan:

Under this plan, the financial incentive is based on the historic relationship between the total earnings of hourly employees and the production value that employees create.

(i) Rucker plan, also known as share-of-production plan (SOP) normally covers production workers. But this can be extended to all employees.

(ii) In this plan also committees are formed to get and evaluate employee suggestions. But participating structure is less compared to Scan Ion plan.

Both Scanlon and Rucker plans prove that any management expecting to gain the cooperation of its employees in increasing productivity must allow them to become involved psychologically as well as financially in the organization.

c. Improshare:

In this plan bonuses are based on the overall productivity of the team.

(i) It improves productivity through sharing.

(ii) It uses a specific mathematical formula to determine employee bonuses.

(iii) While individual production bonuses are based on how much an employee produces above some standard, Improbonuses are based on the overall productivity of the work team.

(iv) Improshare output is measured by the number of finished products a work team produces in a given period of time.

(v) In this plan, both production (direct) employees and non-production (indirect) employees are included.

(vi) The bonus is based on productivity gains which result from reduction of time in production.

(vii) This plan also promotes interaction and support between employees and management.

Designing Effective Gain Sharing Plans:

(i) Enlisting management support in toto i.e., top, middle and lower- level management.

(ii) Including representatives from all groups affected by gain sharing effort viz., labour, employees and management.

(iii) Preventing any political game.

(iv) Making bonus payment fair, easy to understand, large enough to encourage future employee involvement and frequent.

(v) Establishing effective, fair and precise measurement standards.

(vi) Preparing the employees for the gain sharing reward system.

(vii) Launching the plan in a favourable business period.

3. Organization Level Incentive Plans:

(i) Organization level incentive plans include all the employees irrespective of teams/groups.

(ii) These incentives are based on the success of the organizations as a whole over a period of time, one year or above.

(iii) These plans aim to create a sense of owner- ship by encouraging a philosophy of coopera­tion and team work among all the members of the organization.

(iv) Common organization plans are profit sharing, stock options and employee stock ownership plans.

i. Profit Sharing Plans:

Profit sharing is any procedure by which the organization pays all regular employees some special amounts (current or past) based on the organization’s profit.

(i) These plans aim at giving employees the opportunity to increase their earnings by contributing to organization’s growth/profits.

(ii) The contributions could be improving product quality, reducing costs, improving work methods and building brand image in addition to increasing production.

(iii) Employees may feel more like partners and contribute more for the welfare of the organization as a whole.

(iv) The purpose of profit-sharing plan is to motivate employees for a total commitment instead of concentrating on a specific area/activity.


The drawback is that the profits shared could be due to climatic factors, economic conditions, inventory speculation etc., and need not be due to employees’ effort alone. Many a time profits will be less inspite of employees putting their maximum efforts due to other environmental conditions. Further, if a plan fails continuously for a few years, productivity and morale will decline.

ii. Stock Options:

Stock option plans give the employees the right to purchase a specific no. of shares of the company at a guaranteed price (option price) during a particular period. The employees can have the options to buy shares in the future at to-day’s price.

(i) Stock option programmes are a part of employee benefit scheme or a part of corporate culture.

(ii) The aim is to link employee effort to stock performance.

(iii) Some firms believe that stock option may motivate people as an incentive.

(iv) It is assumed that employees may play a partnership role.

(v) It is a popular way to boost morale of disinterested employees caught in mergers, acquisitions and downsizing.

(vi) Most options are given at the stock’s fair market value. Sometimes stocks are given and payment is received through payroll deductions.

(vii) When stock prices rise, employees stock plans can be financially rewarding to employees.

Inspite of the good intention of mutual benefit, employee stock options are criticized due to executive abuses and faulty accounting.

iii. Employee Stock Ownership Plans (ESOPs):

ESOPs are stock plans in which on organization gives shares to an established trust for the purpose of purchase of shares by its employees.

(i) The employer establishes an ESOP trust that qualifies as a tax- exempt employee trust.

(ii) In the stock bonus plan, each year the employer gives stock to ESOP or cash to buy outstanding stock.

(iii) The ESOP trust keeps the shares on behalf of the employees and informs the employees regularly about the value of their share account.

(iv) Allocation of shares to employees is based on seniority and/or employee salary.

(v) When employees leave the organization due to resignation or retirement they can either sell the shares to the organization or sell them in the open market if it is publicly traded.

(vi) The leveraged ESOPs are similar to stock bonus plan except that the ESOP trust borrows money from outside source (any bank or financial institute) to purchase stock and the organization makes payment to ESOP through pay roll deductions which in turn repays the lending institutions.

Advantages of ESOPs:

(i) ESOP gives employers certain tax and financial advantages.

(ii) Survey showed that ESOP-companies fared better than non-ESOP companies as ESOP served as an incentive to improve productivity.

(iii) As stock contributions are subsidised, the organizations can pay retirement benefits at a low cost.

Problems with ESOPs:

(i) ESOPs have significant risks for employees when they buy out shares of companies which are in poor financial conditions.

(ii) Poorly performing companies may not be able to pay back on retirement of employees.

(iii) ESOPs are not guaranteed by Govt.

4. Incentives to Professional Employees:

Professional employees such as engineers, scientists, advocates, doctors etc., cannot advance beyond a certain point of salary structure in some organizations unless they are willing to become administrators. Unfortunately, when they become administrators, their talents cannot be utilized. Under these circumstances they can be motivated through bonuses and merit increases.

The executive pay package for professionals basically consists of basic salary, short-term incentive/bonuses, long-term incentives/stock plans, benefits, perquisites and golden parachutes.

a. Basic Executive Salary:

It is reported that largest portion of executive pay is received in the form of long-term incentives, awards and bonuses and basic salary is only around 30-40%.

(i) Executive basic salaries are influenced to a great extent by market competition.

(ii) Comparisons are made in respect of organizational size, sales volume etc., to fix basic salaries of professionals.

(iii) Generally compensation committees decide the basic salaries based on published data and self-generated salary surveys.

b. Executive Short-Term Incentives:

(i) The main element of short-term incentives is annual bonus.

(ii) Bonus payment may be in the form of cash or stock. It may be paid immediately (in the same year), deferred for certain period or deferred till retirement.

(iii) Incentive bonuses are based on the contribution made by each individual.

(iv) There are many formulas to calculate the incentive such as a percentage of the company’s total profits, a percentage of profits in excess of a specific return, agreed-on profit level etc.

(v) Some organizations try operational yardsticks, to the traditional financial measures. These yardsticks called balanced score cards may measure components such as customer satisfaction, the ability to innovate, service/product leadership etc. Balanced score cards enable companies focus on building future economic value than be driven solely by short-term financial gains. This indicates exactly where the company is successful and where improvement is needed.

c. Executive Long-Term Incentives:

(i) The primary long-term incentives offered to executives are stock options.

(ii) The aim of offering stock options to executives is to have their fortunes linked to the performance of the company.

(iii) Stock options can serve to retain key executives when these options are linked to a specific period.

These plans may fail to bring in real performance if the compensation committees give additional options when performance declines. Further, stock option makes the shares of other stock holders less valuable.

d. Executive Benefits:

Though the benefit package offered to executives such as life insurance, health insurance, retirement plans, paid holidays etc., are similar to that of other employees, it may be broader in coverage and free of charge.

e. Executive Perquisites:

Perquisites or perks are non-monetary rewards given to executives. These are a means to show that executives are more important to the company. The status that comes with perks, such as chauffeur-driven car, independent rent-free residence, large office, private planes, membership of exclusive clubs etc., shows his/her position in the company and authority. Perks are a ‘badge of merit’. There will be tax savings as some perks are not taxed as income.

f. Executive Golden Parachute:

This is a benefit gained popularity in 1980s. It is a means to protect the executives in a merger or takeover. This incentive provides either a severance salary or a guaranteed position in the newly created (merged) company. These encourage top executives to stay with the company and fight the hostile takeover.

Though perks can facilitate company productivity by saving executive time or improving/maintaining executive health they are viewed as wasteful spending and overly lavish. To avoid any adverse comments, perks should be weighed against the added efficiency and managerial effectiveness they could generate.

Corporate compensation committees justify the lavish executive perks on the following grounds:

(i) To reward superior performance.

(ii) To compensate pressure and demanding situation.

(iii) To attract and retain good talents.

(iv) To create shareholders value.

(v) To reflect market trend.

However, there are strong resistance to lavish perks from employees, shareholders and stock holders.

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