Reward System:

Reward Systems are a critical part of any organization's design. How

well they fit with the rest of the systems in an organization has an
important impact on how effective the organization is and on the
quality of life that people experience in the organization. Over the past
decade, some new reward systems practices have become popular in
order to align reward systems with the important changes that are
occurring in the way organizations are designed and managed (Lawler,
1990; Schuster and Zingheim, 1992). This chapter begins by
considering the role of reward systems in an organization and how
reward systems in organizations can be designed. It then it focuses on
the fit between reward systems and the high-involvement approaches
to organization design which are becoming increasingly popular.
Finally, it considers the role of pay system change in large scale
organization change efforts.
The over-riding principle that will guide the discussion in this chapter
is that in order to be effective organizations must have congruence
among their various operating systems. Particular operating system
practices are neither good nor bad in the abstract. They must be
evaluated in the context of the other systems in an organization and
the business strategy of the organization. The business strategy
indicates what the organization is supposed to accomplish and how it is
supposed to behave. It specifies the kinds of performance and
performance levels the organization needs to demonstrate in order to
be effective. Thus, it is a critical guide for the design of the overall
organization structure as well as information systems, human resource
management systems, and of course, reward systems, to mention
some of the most critical systems in an organization.
Figure 1 depicts one way of thinking about reward systems in an
organization. It shows that their design needs to be driven by the basic
organization design and the management style of the organization
which in turn, needs to be strongly influenced by the organization's
strategy. Finally the figure shows that the reward system in
combination with the organization's design drives the performance of

the organization, since

organizational behaviors.

it

influences

critical

individual

and

The business strategy should be the foundation for identifying the

critical behaviors that the organization needs to demonstrate. This in
turn is shown as driving the design of the reward system. The
challenge here is to correctly identify those features of a reward
system which will produce the behavior that is needed to make the
strategy come alive in terms of individual and organizational behavior.
Three critical elements of the reward systems are identified in this
figure. The first is the core principles which the organization holds.
These core principles may be stated or simply implicit in the way the
organization operates. But, they are part of any organization and its
reward system. Examples of core principles are a belief in pay for
performance, a belief in secrecy about pay, and other fundamental
relatively long-term commitments that organization make in the area
of reward systems.
The reward system also is shown to be made up of process features
and structural feature. Process design features include such things as
communication policies , and decision making practices. These are
critical, because they reflect not only the overall management style of
the organization, but influence how well reward system practices will
be accepted, understood, and how much commitment there will be to
them.
Finally, reward systems include actual reward system practices and
structures. These are the features of reward systems that get the most
attention. They include pay delivery systems such as gain sharing
plans, profit-sharing plans as well as administrative polices and a host
of other specific organizational programs.
Reward systems are assumed to be effective to the degree that the
core principles, processes and practices are in alignment. This is
depicted in the figure by the arrows among the three elements. The fit
here is critical because organizations need to be consistent in what
they say and what they do. Violations of this consistency inevitability
leads to misunderstanding about how the reward system works, and

failure to motivate the proper or needed behavior. Later in the chapter

we will return to the issue of the critical design decisions that need to
be made concerning the core values, processes and structures. Before
these are discussed consideration needs to be given to how reward
systems in general, and pay systems in particular, can actually effect
individual and organizational behavior. This will serve to create a
foundation for the discussion of how to diagnose the current impact of
a reward system, and how to design one to produce particular
individual and organizational behaviors.

Objectives of the Reward System

The research on reward systems suggest that potentially they can
influence six factors which in turn impact organization effectiveness.
1. Attraction and Retention - Research on job choice, career choice
and turnover clearly shows that the kind and level of rewards an
organization offers influences who is attracted to work for an
organization and who will continue to work for it (see e.g. Lawler, 1973;
Mobley, 1982). Overall, those organizations which give the most
rewards tend to attract and retain the most people (Gerhart and
Milkovich, 1992). This seems to occur because high reward levels lead
to high satisfaction, which in turn leads to lower turnover. Apparently
this is true because individuals who are presently satisfied with their
jobs expect to continue to be satisfied and, as a result, want to stay
with the same organization. The objective should be to design a reward
system that is very effective at retaining the most valuable employees.
To do this, a reward system must distribute rewards in a way that will
lead the more valuable employees to feel satisfied when they compare
their rewards with those received by individuals performing similar jobs
in other organizations. The emphasis here is on external comparisons
because turnover means leaving an organization for a better situation
elsewhere. One way to accomplish this is to reward everyone at a level
that is above the reward levels in other organizations. However, this

strategy has two drawbacks. In the case of some rewards, such as

money, it is very costly.
Also, it can cause feelings of intraorganizational inequity because the
better performers are likely to feel inequitably treated when they are
rewarded at the same level as poor performers in the same
organization, even though they are fairly treated in terms of external
comparisons (Lawler and Jenkins, 1992). Faced with this situation, the
better performers may not quit, but they are likely to be dissatisfied,
complain, look for internal transfers, and mistrust the organization.

2. Motivation of Performance - When certain specifiable

conditions exist, reward systems have been demonstrated to motivate
performance (Gerhart and Milkovich, 1992; Lawler, 1990; Lawler 1971;
Vroom 1964). What are those condition? Important rewards must be
perceived to be tied in a timely fashion to effective performance.
Organizations get the kind of behavior that leads to the rewards their
employees value. This occurs because people have their own needs
and mental maps of what the world is like. They use these maps to
choose those behaviors that lead to outcomes that satisfy their needs.
Therefore they are inherently neither motivated nor unmotivated to
perform effectively; performance motivation depends on the situation,
how it is perceived, and the needs of people.

3. Skills and Knowledge - Just as pay systems can motivate

performance they can motivate learning and development. The same
motivational principles apply. Individuals are motivated to learn those
changes which are rewarded. As will be discussed later, a relatively
new approach to pay, skill based pay, has been developed to capitalize
on just this point. It allows organizations to strategically target the
learning its wants employees to engage in. This is in contrast to many
job based systems which indirectly do this by tying increased pay and
perquisites to obtaining higher level jobs.

4. Culture - Reward systems are one feature of organizations that

contribute to their overall culture. Depending upon how reward
systems are developed, administered, and managed, they 7 can cause
the culture of an organization to vary quite widely. For example, they

can influence the degree to which it is seen as a human resources

oriented culture, an entrepreneurial culture, an innovative culture, a
competence based culture, a fair culture, and a participative culture.
Reward systems have the ability to shape culture precisely because of
their important influence on communication, motivation, satisfaction,
and membership. The behaviors they cause to occur become the
dominant patterns of behavior in the organization and lead to
perceptions and beliefs about what an organization stands for, believes
in, and values.

5. Reinforce and Define Structure - The reward system of an

organization can reinforce and define the organization's structure
(Lawler, 1990). Often this impact of a reward system is not fully
considered in the design of reward systems. As a result, their impact
on the structure of an organization is unintentional. This does not
mean, however, that the impact of the reward system on structure is
usually minimal. It can have a strong impact of how integrated the
organization is and how differentiated it is (Lawrence and Lorsch,
1967). When people are rewarded the same way it tends to unite
them, when they are treated differently it can divide them. In addition,
it can help define the status hierarchy, and it can strongly influence the
kind of decision structure which exists. As will be discussed later, the
key features here seem to be the degree to which the reward system is
hierarchical and the degree to which is allocates rewards on the basis
of movements up the hierarchy.
6. Cost - Reward systems are often a significant cost factor. Indeed,
pay alone may represent over 50% of an organizations operating costs.
Thus, it is important in strategically designing the reward system to
focus on how high these costs should be and how they will vary as a
function of the organization's ability to pay.

Performance measures quantitatively tell us something important

about our products, services, and the processes that produce them.
They are a tool to help us understand, manage, and improve what our
organizations do. Performance measures let us know:

How well we are doing

If our processes are in statistical control
If we are meeting our goals
If and where improvements are necessary
If our customers are satisfied.

They provide us with the information necessary to make intelligent

decisions about what we do.
A performance measure is composed of a number and a unit of
measure. The number gives us a magnitude (how much) and the unit
gives the number a meaning (what). Performance measures are always
tied to a goal or an objective (the target). Performance measures can
be represented by single dimensional units like hours, meters,
nanoseconds, dollars, number of reports. number of errors, number of
CPR-certified employees, length of time to design hardware, etc. They
can show the variation in a process or deviation from design
specifications. Single-dimensional units of measure usually represent
very basic and fundamental measures of some process or product.
More often, multidimensional units of measure are used. These are
performance measures expressed as ratios or two or more
fundamental units. These may be units like miles per gallon (a
performance measure of fuel economy), number of accidents per
million hours worked (a performance measure or the companies safety
program), or number of on-time vendor deliveries per total number of
vendor deliveries. Performance measures expressed this way almost
always convey more information than the single-dimensional or singleunit performance measures. Ideally, performance measures should be
expressed in units of measure that are the most meaningful to those
who must use or make decisions based on those measures.
Most performance measures can be grouped into one of the following
six general categories. However, certain organizations may develop
their own categories as appropriate depending on the organization's
mission:

1. Effectiveness: A process characteristic indicating the degree to

which the process output (work product) conforms to
requirements. (Are we doing the right things?)
2. Efficiency: A process characteristic indicating the degree to which
the process produces the required output at minimum resource
cost. (Are we doing things right?)
3. Quality: The degree to which a product or service meets
customer requirements and expectations.
4. Timeliness: Measures whether a unit of work was done correctly
and on time. Criteria must be established to define what
constitutes timeliness for a given unit of work. The criterion is
usually based on customer requirements.
5. Productivity: The value added by the process divided by the value
of the labor and capital consumed.
6. Safety: Measures the overall health of the organization and the
working environment of its employees.
The following reflect the attributes of an ideal unit of measure:

Reflects the customer's needs as well as our own

May be interpreted uniformly
Provides an agreed upon basis for decision making
Is compatible with existing sensors (a way to measure it exists)
Is understandable
Is precise in interpreting the results
Applies broadly
Is economical to apply

Performance data must support the mission assignment(s) from the

highest organizational level downward to the performance level.
Therefore, the measurements that are used must reflect the assigned
work at that level.
All organisations measure performance to some extent. However, there
is a large disparity among organisations in terms of which performance
measures are used with many primarily focussing on financial

measures. There has however, been a general move away from

financial measurement since the early 1980's. This was accelerated in
the 1990's and 2000s by the worldwide acceptance of business
excellence models and performance measurement frameworks that
address all stakeholders' needs.
Performance measurement is one of the cornerstones of business
excellence. Business excellence models encourage the use of
performance measures, but in addition and more importantly, they
consider the design of performance measurement systems to ensure
that measures are aligned to strategy, and that the system is working
effectively in monitoring, communicating, and driving performance. A
recent report presented by the Performance Measurement Association
(PMA) on one of the new performance measurement frameworks, the
Balanced Scorecard, demonstrated the popularity of this particular
method. The PMA presented evidence that 39% of FTSE 100 companies
were actively using the scorecard, and other researchers have reported
that between 40% and 60% of Fortune 1000 companies have
attempted to implement the Balanced Scorecard. With the movement
away from financially based measurement systems only gaining
momentum in the early 1990s this represents a significant change in
organisational practices in such a short space of time.

Challenges Associated with Performance Measures:

The performance measurement revolution has seen a move away from
the problems of past measurement systems. Five common features of
out-dated performance measurements systems were:
Dominant financial or other backward-looking indicators
Failure to measure all the factors that create value
Little account taken of asset creation and growth
Poor measurement of innovation, learning and change
A concentration on immediate rather than long-term goals

The focus in performance measurement is now on achieving a

balanced framework that addresses the issues described above.
Examples of these new frameworks are Kaplan and Nortons Balanced
Scorecard, Skandias navigator model and the Performance Prism.
Others recommend that the results sections of business excellence
models should be used to generate a balanced set of performance
measures.
There are a number of challenges that are faced when designing an
effective Performance Measurement System, these include the
following:
How to measure non-financial performance
What measures to choose and why
How to use them - what to do with the results
Who should be responsible for using the results
How and to whom, to communicate the results
The resources needed to consider the above and design and
deploy the measurement system
There are other major requirements that an organisation needs to
consider before an effective performance measurement system can be
designed or installed. Apart from lower level measures that may be
vital for the operation of processes, all measures need to be chosen to
support the attainment of specific performance or behaviour identified
by the organisation's leaders as important or necessary to work
towards the organisational goals. This being the case, there must be
clearly defined goals/objectives and strategies chosen to reach them
before measures can be chosen to support their attainment. Similarly
the key processes, drivers of performance, and the core competencies
required by employees need to be identified before effective
performance measurement can be achieved.