How should I pay you?

May 27, 2007 by

Most of our lives, we often act as employees, rather than employers. When the tables are turned, and we must hire others, we must consider the best payment structure.

Hourly Pay

One means of paying people is by the hour. This mode of payment works best in tasks in which workers have a uniform output per hour of work, and are highly interchangable. As output is proportional to the number of hours worked and not proportional to effort, this mode of pay compensates workers more extensively for producing greater levels of output. Hourly pay is also a good means of pay for temporary workers whose length of tenure with a firm is uncertain. Hourly pay is often seen in the food service industry, and in trades in which consumers hire tradesmen (by the hour) to do short-term tasks. Hourly workers are motivated to produce quality work by their desire to obtain more hours to work for the firm and by their intrensic drive for quality.

Salary with a Bonus

In some jobs, the effort level of the employee matters far more than the amount of hours that the employee has worked. For instance, if two people have been paid to create a marketing campaign, it is quite possible that a campaign produced by an employee that worked on it for 30 hours might produce more revenue than a campaign produced by an employee that worked on it for 40 hours. The quality of the campaign is not necessarily proportional to the time that has been invested in it. 

Salaried positions typically imply a long-term or definite-term relationship between the employer and the employee. A salary helps reduce the problem of the ambiguity caused by paying for the number of hours an employee has worked, when the number of hours worked does not determine the level of output. Salaried employees are motivated to produce quality work by their intrensic need for perfection, and by their fear of being dismissed from the company. Performance-based bonuses can be used to help align the incentives of salaried employees with the overall profit structure of the company. This is only effective if employees do not feel that their efforts are a drop-in-the-bucket. The more tightly a bonus can be linked to an individual’s performance, the more potent an incentive it will be.

Pay for Performance

Pay for Performance (P4P) is often a variation of salary-based pay. A portion of the employee’s salary is withheld on payday. Then, employees are paid the withheld amount based upon whether or not they, their group, or their firm has met its performance targets. This payment structure is in some ways superior to a salaried structure, as it directly aligns compensation with meeting company targets. However, it can cause trouble within a firm if employees place so much effort in meeting measured targets that they neglect to perform on unmeasured but equally important tasks. 

Milestone-Based Pay

When employees are external to the firm, and their time and effort cannot be readily observed, milestone-based pay is often preferable. Milestone-based pay is also often most effective in industries where measuring the time and effort of the employee is inconvenient. In a milestone-based payment scheme, it is pre-arranged how much the employee will be paid once critical tasks are completed. The employee is then paid over the duration of the project as each milestone is achieved. This form of payment is seen in project contracting. However, it is also seen in more mundane forms, such as in the payment of a barber. Before receiving a haircut, a customer typically negotiates the milestone’s specifications (the type of haircut). The barber then assesses the difficulty of reaching the milestone and offers a price. The barber is only compensated after the milestone is achieved, and often expects a performance-based bonus; a tip.

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2 Comments

  1. p.r.venkateswaran

    I think the hourly pay mode can only be effective in case of unskilled labour. The best way to stimulate skilled labour is to go for Performance based payscale.(P4P). P4P is clearly constructed and everybody knows why somebody is valued and paid higher than others. There will be no room for any kind of politics, internal or external.

  2. Parul Gupta

    This is an interesting article that summarizes the payment options currently prevelant in various industry. I feel that one important payment option is not mentioned here thats the deffered payment option like long term service bonus where in an employee is compensated for putting in some x years in the same company. Another benefit similar to this is the retirement or pension benefits.

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