The Decline of 'Piece Rate' Compensation in Manufacturing

In modern manufacturing... team work, planning, decision making, and problem solving ...may be required of workers, and all of these are harder to observe than the output of a single good.

The simplest form of pay-for-performance -- the piece rate -- has been in decline in manufacturing in recent decades. In Analyzing Compensation Methods in Manufacturing: Piece Rates, Time Rates, or Gain-Sharing? (NBER Working Paper No. 16540), authors Susan Helper, Morris Kleiner, and Yingchun Wang show that this change has come about with the adoption of modern manufacturing systems, in which firms produce a greater variety of products to a more demanding quality and delivery standard.

In years past, when it was common for workers to produce only one product, the owner of the firm would often monitor output and compensate workers using "piece rates." Under this form of compensation, workers' pay is based simply on the quantity and quality of their output. In modern manufacturing, though, team work, planning, decision making, and problem solving also may be required of workers, and all of these are harder to observe than the output of a single good. Therefore, managers may choose other types of compensation systems, such as time rates and gain sharing (where part of compensation is linked to quality-adjusted productivity). These systems, which may involve some variable pay, can in some settings lead to higher profitability and to greater satisfaction for the workforce.

In this study, the authors develop a theory of the type of compensation system that is appropriate for modern kinds of production, in which there is a high return to "multi-tasking," the same workers perform both easy-to-observe and hard-to-observe tasks, and just-in-time production entails a high cost of holding inventory. They also provide empirical evidence from six establishments within two firms that changed from a piece-rate method of pay to either time rates or gain sharing. Based on repeated visits, focus groups, interviews, and analysis of employee questionnaires and company performance, the authors are able to examine changes in compensation within both an auto parts company and a shoe manufacturer over a period of years. Their analyses suggest that moving away from piece-rate methods of pay for performance may enhance profits in both of the cases they examine. In addition, for production workers, changes away from piece rates enhance the new workers' attitudes toward teamwork and collaboration. These results suggest one reason why firms may have chosen to largely abandon piece-rate methods of pay in favor of time rates or gain sharing over the past 50 years.

This analysis shows the importance of distinguishing types of incentive pay: the authors find that modern manufacturing is consistent with either group incentive pay (such as gain sharing) or no incentives (such as hourly pay), but is not consistent with individual incentive pay (piece rates). They suggest that these results may hold for any form of production (not just for manufacturing) where it is productive to have the same employees perform both easy- and hard-to-observe tasks.

--Lester Picker