May 3, 2014

Productivity

Piecework and time-based form of payment. Advantages and Disadvantages

By Alexander Sergeev

The evolution of forms and systems of remuneration reflects the long search for a balance of interests of employers and employees. The form of payment is an important element in implementing its reproductive and incentive (motivational) function. And it is crucial not only in terms of the wages per se but also regarding how it is calculated.

Let’s consider the problem that exists since the appearance of wage labor: How to pay in the best way?

The two basic forms of wages are piecework and time-based. Multiple payment systems are created using the combination of these two key forms. In different periods of industrial civilization, one of them prevailed and the other one was less popular.

Wages have various functions that can be implemented with the help of the systems based on the piecework or time-based forms of payment. Furthermore, we must distinguish an appropriate form of payment for the employee from the one for the employer. Their interests may coincide in some situations, but sometimes they can be the opposite. An essential function of wages for the employee is reproductive one and for the employer the incentive function of wages is of great importance.

Which of the two forms of remuneration is better and more effective in a modern market economy?

The Pros of Piecework Pay

At a glance, the piecework form of payment fully meets the interests of the employee and the employer. Earnings depend on the number of products made ​​(sold) or services delivered, or put simply, on the labor results and productivity. This direct relationship between the results of labor and remuneration is a real advantage of the piecework form of payment.

The employer’s interests are successfully met because, without additional control, employees are interested in increasing the company’s production. If employees reduce efforts for any reason, they decrease their wages. Consequently, the employee’s risk is higher than the risk of the employer. If we consider that the piecework form of payment attracts the workers willing to work hard and intensely, it can be perceived as a sort of market signal of the desire of the employee to work productively.

The employees’ interests are satisfied as they have a real opportunity to increase earnings by working harder and increasing labor productivity. In addition, the piecework form of payment can be applied to almost any employee, regardless of their reputation, health or documents. The employer’s risk is small in such cases: the employee gets some equipment (basket, box, bag, etc.) and earns as much as performs.

The piecework form of payment implies that the utility of employees depends on their abilities. The research of the American economists indicates that the productivity of workers with the piecework form of payment is higher than with the time-based.

Yet, the number of workers with the piecework form of payment has rapidly declined since the middle of the 20th century in most developed countries. For example, in 1950-70, their share in the U.S. decreased from 70 to 30%, in France (since the early 60s ) it dropped from 40 to 15%. Why so?

The Cons of Piecework Pay

The fact is that the piecework form of payment causes a number of disadvantages for both employees and employers:

  • Neglecting external factors. It can be difficult for the employer to take into account factors that are beyond the control of the employee but affecting production (illness, equipment failure, disruptions in supply, weather conditions, etc.). It must be taken into account that the increase in the production of the workers with the piecework form of payment depends not only on their own efforts and skills; it is also determined by other factors  – technical, organizational, economic training, and the workplace per se. An employee’s performance depends on the work of engineers, support workers, and many other professionals, which is nor reflected in the piecework payment form.
  • Overlooking soft skills. There is also a problem of correlation between employee efforts and the employer’s goals. Not every aspect of employment is observable or measurable. How to measure, for example, honesty, courtesy, friendliness, good manners, devotion to the interests of the company? Establishment of any evaluation criteria can lead to the fact that the employee will strive to improve aspects that meet the criteria, ignoring other aspects of the job not measured quantitatively.
  • Losing quality for the sake of quantity. A serious disadvantage of piecework pay for the employer is a danger that, in the pursuit of the quantity of production, workers will not pay attention to its quality. Costs for quality control of products (services) may negate the savings on the other forms of control.
  • Losing the team spirit. The piece-rate pay links the earnings of employees with their individual performance, ignoring the work of the department, unit or organization as a whole, which affects the collective motivation and group work. As a result, the sense of belonging to a community gets weaker; the success of colleagues and the overall performance of the company becomes unimportant for the worker. They have no incentive to achieve results in the long run the only thing that matters is the current salary. One consequence of this is the high turnover of the staff.
  • Damaging equipment. Excessive haste of workers leads to incorrect usage, equipment failures, breaches of safety standards, an increase in injuries, and overuse of raw materials. Some companies abroad even require the use of earners’ own tools or machines at work.
  • Vague output norms. It’s not easy to set reasonable standards of output norms, especially when reviewing them during the introduction of new equipment. This is especially actual for industries with frequent changes of products and technology.
  • Uncertainty. Most of them have a natural aversion to risk and having financial obligations associated with the regular cost (accommodation fees, food expenses, etc.) prefer greater certainty of earnings. In this regard, the transition to the piecework pay requires leveling the differences in wages that compensate workers’ worries about possible fluctuations in their earnings. This brings additional costs to the employer. By the way, this also explains why workers with piece-rate pay have higher wages than the ones with the time-based form of payment.
  • Decreasing the pay rate. When companies use piecework pay, employees often face the so-called “ratchet effect”.  A worker produces more output than the company expects. The manager connects this with the fact that the work is not too difficult, and therefore, the pay rate is too high. That’s why the manager can decide to decrease the rate.
  • Judging quality subjectively. When using the piecework form of payment, it is difficult to measure an individual output. If the quantitative aspects of work can be measured objectively, the quality often requires subjective judgment. If only a part of the functions performed by the employee can be measured objectively, then the unmeasured functions will be ignored. In this case, group incentives are more appropriate.

Many companies are increasingly adopting group rewarding instead of the individual one. Group piecework pay allows to closely integrate the interests of the employee and the employer by means of linking collective earnings to the performance of the company. Yet, there is still a “free-rider problem”, which means that the laziness of some workers is compensated by the diligence of others. This certainly doesn’t contribute to the motivation of the latter.

This problem can be easily resolved in small groups. But what if the team is rather big, and some employees are not sure about the diligence and performance of others? The creation of the atmosphere of belonging (to the interests of the organization) can help in this situation.

The managers should be properly rewarded for the performance of their departments. But here comes the problem of measurement: What period should be evaluated? Foreign experts believe that it is better to take into the results over the past few years. It is also recommended to link the leader’s wages to the cost of the company shares, bringing together their interests with the interests of shareholders.

Time-based pay

The wide usage of the time-based form of payment is explained by many factors, the most important of which is the scientific and technological progress, amending the technology and the organization of the production. The division of labor and specialization becomes deeper, skill requirements rise, especially in the service sector. More often it is difficult or impossible to distinguish and quantify the results of the individual employee work from the general results. The manufacturing process is often strictly regulated. Sometimes there is no possibility of increasing the output and sometimes it is not even necessary, especially if the increase in output can lead to poor quality or if the company solves the problem of saving material resources.

An important advantage of the time-based form of payment for the employer is reducing of quality control cost. In this case, it’s easier to form a sense of belonging to the interests of the entire organization of the employee (corporate patriotism). It reduces staff turnover and such models of staff motivation that “work” only while long-term cooperation of the employee and the company can be used.

Time-based form of payment is a guarantee of relatively stable earnings to the employee. The team in which time-based form of payment is used, is usually more cohesive as it has less staff turnover and the economic interests of some workers rarely confront the interests of others .

But it also has a lot of problems. The employee actually receives the money for the presence at the workplace, he has no incentive to productive work. There is a need to overseer, who controls the labor process and the volume of output. But it is very expensive, reduces the possibility of specialization. The observer must have sufficient information. Sometimes detailed control can be simply impracticable. Supervisors may conspire with those workers whom they have to control, so they also are to be controlled.

In the conditions of perfect competition the companies that use the piecework form of payment, as well as the time-based form of payment, will receive the same, normal profit. While firms that use time-based form of payment, will be unable to pay the costs of control (the value of their profits would be lower than normal and they go bankrupt), and the costs will be covered by the workers from their wages. By the way, it is another explanation of the lower earnings of the employees with the time-based form of payment. The choice of the form of payment system may depend on the costs of control: the companies with high costs would prefer the piecework form of payment, and firms with low costs will choose time-based one.

Using time-based form of payment, i.e. payment only for the presence at the workplace, the employer bears the risk of fluctuations in the performance of the employee. A productive worker increases profit of the company, non-productive – on the contrary, but the wages they have are the same. It’s more difficult to link the work to the final result. In addition, workers can put their own interests above the interests of the consumer, which in the long run can bring harm to the company.

Resume

The piecework form of payment in its pure form is reasonable when a person works independently and produces a homogeneous product. In today’s integrated and highly mechanized production, which uses mainly intellectual labor rather than physical, it is a rare situation. Nevertheless, the piecework form of payment is used in light industry and trade. It can be successfully used in mass production, where workers perform simple repetitive tasks, since in this case it is easy to measure the results of their work and put a payment in direct dependence on the output. The piecework form of payment is used if it is necessary to encourage the workers to further increase production volumes, if there are quantitative indicators of production, which the workers are able to increase.

In the spheres related to the provision of services the time-based form of payment is often effective, because it is difficult to determine the scope of services provided to customers by the individual employee. Time-based form of payment is reasonable in such circumstances when the employee can’t influence the growth of the production. With this form the labor of leaders, engineers and technical workers is paid. Time-based form of payment is effectively used today in the remuneration of highly qualified professionals working in services (lawyers, psychiatrists), the final result of the activities of which affects their professional reputation.

The form of payment is an important element in implementing its reproductive and incentive (motivational) function. And important is not only the amount of wages, but also how and by what rules it is formed.

Managers should consider advantages of each form of payment and the possibility of the negative effects and to use the form, that allows to intelligently combine the interests of the employees and the organization.

 

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