Finance: It pays to offer the right incentives

When the practice of profit-related pay (PRP) is brought to a close at the end of this month, it will not be missed just by the 2.5 million workers who have been receiving its annual tax-free cash bonuses. Their employers, too, will mourn the passing of an initiative that has basically enabled them to award their workers pay rises at the Government's expense.

This is because Nigel Lawson, when he was Chancellor of the Exchequer, was apparently so convinced of the merits of employees sharing in the success of the organisations they worked for, that he created a system whereby businesses could receive a proportion of their profits free of tax, provided they satisfied certain Inland Revenue criteria.

Long before the Blair government decided to end this tax relief from the end of this year, the system was discredited and open to abuse. But the conviction that workers are more productive if they share in the success of their organisations is so widespread that Gordon Brown is in the process of carrying on the principle by encouraging share ownership for all employees.

Some experts doubt whether the latest scheme will work much better. Harry Hicks, tax partner with the accountancy firm Baker Tilly, believes the rules being proposed for these share schemes will be so complex that the system will be less attractive than the one it is designed to replace, leaving the Government paying "lip service to the concept of profit-sharing".

Others have a more general concern. For them, the problem is that improving performance relies on a lot more than giving employees a share of the spoils.

In the just-published book Paying for Contribution, Michael Armstrong and Duncan Brown, two highly-regarded experts on employee remuneration, chart how organisations are drifting away from relying on performance- related pay alone to support the achievement of business goals towards what they regard as a more holistic approach.

This involves taking account of such matters as individuals' competence as well as performance; paying for skills and behaviours supporting the success of the individual and the organisation, and rewarding a combination of organisation, team and individual performance, rather than concentrating on an individual's efforts.

Paying for contribution, as they term this approach, should "form part of an integrated and strategic approach to reward", say Mr Armstrong and Mr Brown, who are consultants. It is one thing to say this and another to make it happen - as one car company in their book shows. Faced with very low margins on new cars and a large proportion of their pay dependent on commission, "sales staff were directly and strongly encouraged to act in a way which conflicted with the company's business strategy", they write. The company's strategy was to deal with fierce competition by seeking to sell fewer more expensive models, a plan that was supposed to be achieved through a combination of strong products, teamwork and excellent customer service in the dealerships as the basis for building long-term relationships with customers.

In practice, sales staff could make a decent living only if they competed with each other to get customers and then went for the "quick sale" on higher-margin aspects, such as financing. This company saw the problem and in 1996 took steps to align the staff's incentives with the company's business objectives. The level of individual performance pay in the monthly contributions was reduced, base pay was increased and related to the skills and competencies required by sales staff dealing with affluent customers and a new annual bonus scheme related to individual and team performance was introduced.

Other businesses are following suit. In addition to taking greater account of the general business agenda and strategic issues, organisations are adopting many practices to satisfy the increasingly diverse needs of their employees and themselves.

A report earlier this year by the consultancy Business Intelligence showed how organisations as varied as the Midland Bank arm of HSBC and the industrial company DuPont were offering employees benefits to help them cope with the "work/life balance", while the likes of Bass Brewers and the cereals company Kellogg's were concentrating on linking pay to individual capability and performance.

Unfortunately, the development of what is known in some quarters as "strategic compensation" is undermined by the ways in which such plans are implemented. In particular, says Mr Brown, the effectiveness of many reward strategies is limited by "an over-reliance on top-down communication and a lack of consultation before introducing new ideas".

In the same way as employees showed enthusiasm for profit-related pay only when it was demonstrated that there was little risk of their income declining, so those being subjected to the new approaches to pay are concerned about what is in it for them.

Chris Ashton, author of the Business Intelligence report, says advisers and successful practitioners "emphasise that the involvement of employees in rethinking compensation, designing programmes, delivering change and evaluating the outcomes is of critical importance".