What factors determine whether a firm offers a piece-rate or a time-rate compensation system?

There are several factors that determine whether a company uses a piece-rate compensation system or a time-rate one. Among those factors is the risk of quality being sacrificed in deference to the employees’ incentive to maximize output. Another is the recognition that piece-rate compensation systems do not free employers from compliance with minimum-wage and overtime laws. Service-sector and sales jobs are most likely to benefit from the piece-rate system, as they are divorced from the production side of the equation.

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There are multiple factors that go into determining whether a company will use a piece-rate compensation system or a time-rate one.

One important factor is state law, although most of the states approach labor wages the same way, with California being an exception. Piece-rate compensation systems, especially in California, do not absolve businesses from compliance with minimum-wage requirements, and therein lies the wrinkle in determining the best system for individual companies.

A company that chooses to use a piece-rate system, in which employees are compensated on the basis of output or productivity irrespective of the number (within the usual, regulated forty-hour work week) of hours an employee is “on the clock,” is still required to ensure that employees receive no less than what their compensation would be if payed on the basis of number of hours worked. A company determining the best system to use in compensating employees, therefore, has to calculate the labor costs associated with a time-rate system whether or not management prefers a piece-rate system.

Another factor that goes into determining whether to use a piece-rate compensation system or a time-rate system is the nature of the product or service associated with a business. Some products lend themselves to a compensation system tied to individual productivity and some do not.

A compensation system predicated solely or predominantly upon output is obviously placing a premium on the number of units sold. When employees, especially on a production line, are paid under such a system, the employees’ priority obviously becomes producing the greatest number of units possible—the goal of the enterprise. Quality, however, can easily be sacrificed at the altar of expediency. Prioritizing quantitative output at the expense of quality can and often will destroy a company. Businesses using a piece-rate system, then, understand that quality control considerations have to be part of the equation.

Another factor in determining the optimal wage system involves what is called “rest and recovery,” or down-time periods. This refers to lulls between spurts of activity. Clearly, a business owner prefers to compensate employees on the basis of productivity, which tilts the equation toward the piece-rate compensation system. The problem from the fair-wage standards perspective, however, is that employees who produce the requisite number of units—the number of units required to meet demand—may find themselves with down-time during which they are not producing anything.

Additionally, state labor laws usually require that employees be given breaks throughout the day. Employers may not like paying workers who are idle, but they usually have no choice, as labor laws require that employees receive no less than the minimum wage were the hourly-wage system used. Employees, therefore, are paid whether they are idle or hard at work.

In conclusion, choosing between the two systems is not as easy as simply calculating cost of production versus cost of compensating employees for the number of hours worked. When the costs associated with paying idle workers, ensuring that no full-time employee receives less then what what they would be paid under an hourly-wage system, and considerations of overtime-related costs are all factored in, the calculations become increasingly complicated.

If there is one area in which piece-rate compensation systems are almost always used, it is the area of sales, especially for high-value single-unit items like automobiles. Car salespeople are typically paid commissions for each unit sold. There is an incentive, therefore, for salespeople to be as productive as possible.

Because the product was produced elsewhere under an independent system (i.e., automotive assembly lines located far from the dealership), qualitative factors are not involved and individual salespeople are required to have arrangements with customers signed off on by sales managers, ensuring that the product is not being sold too cheaply—something that would cut seriously into the salesperson’s commission anyway. Back at the automobile assembly plant, however, the choice between the two compensatory systems remains as it was.

Last Updated by eNotes Editorial on January 13, 2021
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