Compensation
an Element of Strategy Management
p. 1
The Pay Model
 Pay matters
 It matters what you pay for
 It matters how you pay
p. 2
The Pay Model
 Economic and social pressures are forcing
managers to rethink how people get paid and
what difference it makes.
 Organizations provide individuals with money
and other benefits in return for their
availability, capacity and performance.
 Traditional approaches to compensation are
being questioned.
p. 3
The Pay Model
 For organization, the challenge becomes to:
– Plan
– Direct
– Organize
– Coordinate and control financial resources
– Attract
– Retain and motivate the necessary workforce
– Ensure the response that will allow the organization to
meet its objectives.
p. 4
Hierachy of Needs
 Using Maslow’s terminology (1954), for the individual,
the importance of compensation is directly related to
his or her needs
•
•
•
•
•
Physiological
Safety
Belonging
Self-esteem
Self-actualization
as well as the relative importance of these needs.
 In brief, although compensation is not the only benefit
an employee gets from the exchange with the
organization, it still remains one of the major one.
p. 5
MASLOW’S HIERARCHY OF NEEDS
Self-Actualization
Need for development, creativity and achievement
High level of autonomy & maturity
Meditation
Deepen know-how & culture
Personal development
Continuous training & own development
Being consulted and listen to
Givesadvices on work directions
Able to manage conflicts
Decides as a group
Be autonomous
Ego
Need for self-esteem, power, recognition, prestige
Develop autonomy
Be recognized and appreciated
Earn respect of others
Express opinions
Be different
Well recognized & appreciated work activities
Express specific competencies
Varied and innovated tasks
Managerial empowerment
Be appreciated and acknowledged
Taking part in objective settings
Social
Need for being loved, belonging, inclusion
Feeling dependant
Obtain a social status
Be integrated in a group
Knowledge of information
Being able to express ideas
sharing
Belonging to the community
as a whole, as well as to sub-group
within the community
Security
Need for a safe environment
Need for safety
Sense of living in
a fair and just society
Built a secure living environment
Taking car of its health
Living in a non-threatening area
Job stability
Being informed
Be supported
whenever necessary
Physiological
Physical survival needs
Water, food
Sleep, warmth
Exercise
Shelter
PRIVATE LIFE
Decent compensation
Working in acceptable
environmental conditions
PROFESSIONAL LIFE
p. 6
Society
 Most employers believe that how people are paid
• affects people’s behaviors at work
• which affect an organization’s chances of success.
Compensation systems can help an organization
achieve and sustain competitive advantage.
 Sometimes differences in compensation among
countries are listed as a cause of loss of jobs from
more developed, higher-wage economies to less
developed ones.
Therefore, understanding productivity differences
among international locations is crucial.
p. 7
Society
(cont’d)
 Some consumers may view increases in compensation
as the cause of price increases. They may not believe
that higher labor costs are to their benefit.
 Economic realities are relevant to compensation
management.
– an organization’s capacity to pay
– its industrial sector
– as well as geographic location
 are all key factors that must be considered.
p. 8
Society
(cont’d)
 An organization’s economic reality is not static
– Today’s decisions about compensation will have an impact on
the organization’s financial health for many years and,
generally, this impact is difficult to reverse.
 Employees have varied needs and view them
differently
– The challenge for the organization therefore is to adopt
compensation policies and programs that maximize
employee motivation.
 Compensation is also status, both within the
organization and in society.
p. 9
Society
(cont’d)
 Supervisors consider it important to be paid more than
their subordinates, and on a different basis.
 The same applies to the various perquisites an
organization provides to certain employees.
– Often, what counts with such benefits is not their monetary
value but rather the prestige and status they confer.
 Organization and individuals pursue different
objectives by means of compensation.
p. 10
Society
(cont’d)
 For the organization
– the exchange is designed to recruit and retain the
necessary labor, and to elicit employees behavior that
will enable it to fulfill its mission.
 For individuals
– the objective may come down to satisfying needs.
These may differ considerably from one individual to
another and may also change with time.
 Compensation is a contribution for the
organization, a reward for the individual.
p. 11
Stockholders
 To stockholders, executive pay is of special
interest.
 Linking executive pay to company
performance is supposed to increase
stockholders’ wealth.
 Unfortunately, this does not always happen.
p. 12
Management
 For managers, compensation influences their success
in two ways:
1. It is a major expense.
– Competitive pressures, both internationally and
domestically, force managers to consider the
affordability of their compensation decisions.
– Labor costs can account for more than 50 percent of
total costs.
– Unlike other production factors, the organization
cannot calculate the cost-effectiveness of this
investment with the same degree of accuracy.
p. 13
Labor Costs
p. 14
Management

For managers, compensation influences their success
in two ways:
2. In addition to treating pay as an expense, a manager also
uses it to influence employee behaviors and improve
organization performance.
The way people are paid affects
–
–
–

the quality of their work;
their attitude toward customers;
their willingness to be flexible, learn new skills, or
suggest innovations.
People may become interested in unions or legal action
against their employer based on how they get paid.
p. 15
The Importance of Compensation
 Impacts an employer’s ability to attract and retain
employees.
 Ensure optimal levels of employee performance in
meeting the organization’s strategic objectives.
 Compensation’s components
• Direct compensation in the form of wages or salary
– Base pay (hourly, weekly, and monthly)
– Incentives (sales bonuses and or commissions)
• Indirect compensation in the form of benefits
– Legally required benefits (e.g., Social Security)
– Optional (e.g., group health benefits)
p. 16
The Elements of Compensation
p. 17
The Elements of Compensation
 Organizations regularly adjust pay. This is
done by taking into account many factors,
such as :
– changes in the economy
– the amount of the changes made by other
organizations in the community or similar labor
market
– the organization’s ability to pay
– as well as any increase in an employee’s performance
or year of service
p. 18
The Elements of Compensation
 Sometimes a hardship premium is added to
the base pay i.e.
–
–
–
–
–
–
–
–
overtime premium
premiums working with hazardous goods
shift premium
premiums working under difficult situation
distance premium
call-back premium
weekend/holiday work premium
standby premium
p. 19
Cash Compensation – Base
 Base wage is the cash compensation that an
employer pays for the work performed.
 Base wage tends to reflect the value of the
work or skills and generally ignores
differences attributable to individual
employees.
p. 20
Cash Compensation – Merit Pay/COL adjustments
 Merit pay increases are given as increments to the base pay
in recognition of past work behavior.
– Some assessment of past performance is made, with or
without a formal performance evaluation program, and the
size of the increase is varied with performance.
– Thus, outstanding performers could receive an 8 to 10
percent merit increase 8 months after their last increase,
– whereas an average performer may receive, say, a 3 to 4
percent increase after 12 or 15 months.
 In contrast to merit pay, cost-of-living adjustments give
the same percent increase across the board to everyone,
regardless of performance.
p. 21
Cash Compensation – Incentives
 Incentives tie pay increases directly to performance
 However, incentives differ from merit adjustments.
– First, incentives do not increase the base wage, and so must
be re-earned each pay period.
– Second, the potential size of the incentive payment will
generally be known beforehand.
 Whereas merit pay programs evaluate
– past performance of an individual
– and then decide on the size of the increase
the performance objective for incentive payments is
called out very specifically ahead of time.
p. 22
Cash Compensation – Incentives
 Incentives can be tied to :
–
–
–
–
the performance of an individual employee
a team of employees
a total business unit
or some combination of individual, team, and unit
 The performance objective may be :
–
–
–
–
–
–
expense reduction
volume increases
customer satisfaction
revenue growth
return on investments
or increases in total shareholder value
 the possibilities are endless.
p. 23
Long-Term Incentives
 Long-term incentives are intended to focus employee
efforts on multiyear results.
 Typically they are in the form of stock ownership or
options to buy stock at specified, advantageous prices.
 Stock options straddle the categories of cash
compensation and benefits.
– Some argue that they are not compensation at all, that they
are more accurately described as an ownership share
granted by owners to employees.
 The idea behind stock options is that employees with a
financial stake in the organization will focus on longterm financial objectives:
– return on investment, market share, return on net assets,
and the like.
p. 24
Benefits – Income Protection
 Benefits, including
– income protection
– work/life balance services
– and allowances
are also part of total compensation
 Some income protection programs are legally required.
Different countries have different lists of mandatory benefits
–
–
–
–
medical insurance
retirement programs
life insurance
and savings plans
are common benefits. They help protect employees from
the financial risks inherent in daily life.
 Because the cost of providing benefits has been rising, they
are an increasingly important form of pay.
p. 25
Benefits – Work/Life Focus
 Programs that help employees better
integrate their work and life responsibilities
– include time away from work (vacations, jury duty)
– access to services to meet specific needs
– i.e.drug counseling
– financial planning
– referrals for child and elder care
– Working hours
– and flexible work arrangements.
p. 26
Benefits – Allowances
 Allowances often grow out of whatever is in short
supply.
– Housing and transportation allowances are frequently
part of the pay package.
 Companies that resist these allowances must come up
with other ways to attract and retain talented
employees.
– In many European countries, managers assume that a
car will be provided
p. 27
Perquisites
 There are various forms of perquisites (perks).
 They tend to be tax effective even though they are becoming
less and less attractive due to some tax harmonization
(especially in Europe).
 Some organizations provide
–
–
–
–
–
–
cars for certain employees (very popular in the UK), parking
Meals
tuition fees
financial advice
employee’s assistance programs
tax effective representation allowances.
p. 28
Total Earnings Opportunities
 Compensation decisions have a temporal effect.
– Say you have a job offer of $50,000.
– If you stay with the firm five years and receive an annual
increase of 4%, in five years you will be earning $60,833 a
year.
– The expected cost commitment of the decision to hire you
turns out to be $331,649 in cash.
 If you add in an additional 25% for benefits, the
decision to hire you implies a commitment of over
$400,000 from your employer.
p. 29
Total Earnings Opportunities
 A present-value perspective shifts the comparison of
today’s initial offers to consideration of future bonuses,
merit increases, and promotions.
 Sometimes a company will tell employees that its
relatively low starting offers will be overcome by larger
future pay increases and bonus payouts.
 In effect, the company is selling the present value of
the future stream of earnings.
p. 30
Non-financial Returns
 There is no doubt that non-financial returns from work
have a substantial effect on employees’ behavior
• Relational returns from work as
–
–
–
–
recognition and status
employment security
challenging work
and opportunities to learn
are other factors affecting people’s decisions about work.
p. 31
Non-financial Returns
 Other relational forms might include
– personal satisfaction from successfully facing new
challenges
– teaming with great co-workers
– receiving new uniforms, and the like.
Such factors are part of the total return, which is a
broader umbrella than total compensation.
 Compensation is only one of many.
p. 32
Employment Relationships
 Organizations that pay low cash compensation and offer low
relational returns are in the “workers as commodity”
category.
These organizations view labor as input into the production
process. In the United States, employers of migrant workers
may offer this type of deal.
 Organizations that offer both high compensation and high
relational returns may be characterized as cult-like.
Microsoft, Medtronic, and Toyota are examples.
The strong commitment to the organization shows in the
words and actions of employees: “being at the center of
technology”, having an impact on the work, working with
smart people, the sheer volume of opportunities, shipping
winning products, beating competition.
p. 33
Employment Relationships
 Some organizations offer a “family” relationship: high
relational and low transactional returns.
Starbucks is an example; one writer calls it the
“touchy-feely coffee company”.
 Finally, there are the “hired guns”—all-transactional,
“show-me-the-cash” relationships.
Brokerage houses, real estate firms, and auto
dealerships fit this category.
p. 34
Employment Relationships
p. 35
Compensation Management Model
 Compensation techniques and practices are not
developed in the abstract. They are founded on a set
of objectives and policies based on
– the nature of the individual,
– the organization or the environment in which individual and
organization evolve.
 Objectives are what the organization is trying to
achieve through various compensation systems
 Policies are the foundation for managing such a system
 Techniques and practices represent the means
available to the HR specialist for achieving the desired
results in accordance with developed policy.
p. 36
Compensation Management Model
p. 37
Objectives
 Setting compensation objectives is important for two
reasons:
1. the objectives are guides for developing necessary policies
and practices
– wishing to motivate the workforce to improve
productivity should consider using merit increase
and various performance bonus systems.
– wishing to emphasize workforce stability, more
weight on the fix portion of cash compensation,
offering relatively high salaries in comparison to its
reference market.
2. objectives are ideal criteria for assessing the effectiveness
of practice.
p. 38
Objectives
 The relative importance assigned to each objective
may vary from one employer to the next and from one
job category to the next.
• In diversified organizations, objectives may even
vary from one unit to the next.
 Because of the multiplicity of these objectives, not all
can be achieved; compensation management always
involve a compromise. These compromises
represent strategic choices.
p. 39
Policies
Four Policies
 Every employer must address the policy decisions :
–
–
–
–
(1)
(2)
(3)
(4)
internal alignment
external competitiveness
employee contributions, and
management of the pay system.
These policies are the foundation on which pay systems are
built. They also serve as guidelines for managing pay in
ways that accomplish the system’s objectives.
p. 40
Policies - Internal Alignment
Internal Alignment
 Internal alignment refers to comparisons
among jobs or skill levels inside a single
organization
 Jobs and people’s skills are compared in
terms of
their relative contributions to the organization’s
business objectives
p. 41
Policies - External Competitiveness
External Competitiveness
 External competitiveness refers to compensation
relationships external to the organization:
– comparison with competitors.
 Increasingly, organizations claim their pay systems are
market-driven, that is, based almost exclusively on
what competitors pay
p. 42
Policies - External Competitiveness
Employee Contributions
– How much emphasis should there be on paying for
performance?
– Should one programmer be paid differently from
another if one has better performance and/or greater
seniority?
– Or should there be a flat rate for programmers?
– Should the company share any profits with
employees?
– With all employees?
p. 43
Policies - Management
Management
 Ensuring that the right people get the right pay for
achieving objectives in the right way. The system will
not achieve its objectives unless it is properly
managed.
•
Are we able to attract skilled workers?
•
Can we keep them? Do our employees believe our pay system is
fair?
•
Do they understand what is expected of them?
•
Do they understand how their pay is determined?
•
How do the better-performing firms, with better financial returns
and a larger share of the market, pay their employees?
•
Are the systems used by these firms different from those used
by less successful firms?
•
How do our labor costs compare to those of our competitors?
p. 44
Techniques - Internal Consistency
Internal Consistency
 An organization trying to ensure internal consistency in
compensation must :
• first analyze and describe its jobs, then either :
– evaluate the jobs
– do a competency & skill job assessment
– a maturity curve approach (applicable for certain group
of professionals)
p. 45
Techniques - Competitiveness
Competitiveness
 An organization interested in making its pay
competitive must first define its labor market Domestic
and international for senior management).
 Having selected the market or markets, the next step
is to collect information about the various elements of
compensation.
–
–
–
–
–
–
Base salary?
Total Cash?
Working time?
Time off?
Benefits?
Other perks and allowances?
 Once the survey or surveys have been done, the
organization must determine the level of compensation
in relation to the market.
p. 46
Techniques - Employee Contribution
Employee Contribution
 An organization that wishes to recognize the
contribution of its employees may use techniques and
practices that vary according to what contribution it
wishes to emphasize
–
–
–
–
individual performance
group performance
years of services
training
 The organization must develop an employee
performance appraisal system and determine criteria
for measuring individual performance
p. 47
Compensation Management Model
p. 48
Example: The Strategic Compensation Decisions
Facing Starbucks
1.
Objectives: How should compensation support
business strategy and be adaptive to the cultural and
regulatory environment?
Starbucks objectives:
•
•
•
Grow by making employees feel valued.
Recognize that every dollar earned passes through
employees’ hands.
Use pay, benefits, and opportunities for personal
development to help gain employee loyalty and become
difficult to imitate.
p. 49
Example: The Strategic Compensation Decisions
Facing Starbucks (continued)
2.
Alignment: How differently should the various types
and levels of skills be paid within the organization?
Starbucks:
•
De-emphasize differences.
•
Use egalitarian pay structures, cross-train
employees to handle many jobs, and call
employees partners.
p. 50
Example: The Strategic Compensation Decisions
Facing Starbucks (continued)
3.
Competitiveness: How should total compensation
be positioned against our competitors? What forms
of compensation should we use?
Starbucks:
•
Pay just slightly above other fast-food employers.
•
Provide health insurance and stock options for all
employees (including part-timers).
•
Give everyone a free pound of coffee every week.
p. 51
Example: The Strategic Compensation Decisions
Facing Starbucks (continued)
4.
Contributions: Should pay increases be based on
individual and/or team performance, on experience
and/or continuous learning, on improved skills, on
changes in cost of living, on personal needs, and/or
on each business unit’s performance?
Starbucks:
•
Emphasize team performance and shareholder
returns.
•
For new managers in Beijing and Prague, provide
training opportunities in the U.S.
p. 52
Example: The Strategic Compensation Decisions
Facing Starbucks (continued)
5.
Administration: How open and transparent should
pay decisions be to all employees? Who should be
involved in designing and managing the system?
Starbucks:
•
As members of the Starbuck’s “family,” our
employees realize what is best for them.
•
Partners can and do get involved.
p. 53
Outcome
 Too often, case studies, benchmarking studies of best
practices, or consultant surveys are presented as
studies that reveal cause and effect
They are not
Just because the best-performing companies are using
a practice does not mean the practice is causing the
performance.
IBM provides an example of the difficulty of deciding whether a
change is a cause or an effect. For a long time IBM pursued a nolayoff policy. Clearly, that policy did not cause the value of IBM stock
to increase or improve IBM’s profitability. Arguably, it was IBM’s
profitability that enabled its full-employment policy.
p. 54
Outcome
 Compensation research often attempts to answer
questions of causality.
• Does the use of performance-based pay lead to greater
customer satisfaction, improved quality, and better
company performance?
Causality is one of the most difficult questions to answer
and continues to be an important and sometimes
perplexing problem for researchers.
 Compensation techniques and practices sometimes
prove to be so fascinating and complex that we lose
sight of their objective.
This is one of the greatest risks facing the
compensation professional. The technique
becomes an end in itself.
p. 55
Outcome
 In contrast to the past
• today’s compensation specialist should not only master
the content of various techniques in the field,
– but should also be a management expert
– have an in-depth knowledge of the nature of the
organization and the environment in which it operates
p. 56
Best Fit vs Best Practices
 A strategic perspective on compensation takes the
position that how employees are compensated can be
a source of sustainable competitive advantage.
 Two alternative approaches are highlighted:
• A “best fit” / contingent business strategy /
environmental context approach; and
• A “best practices” approach.
 The “best fit” approach presumes that one size does
not fit all. The art of managing compensation
strategically involves fitting the compensation system
to the different business and environmental conditions.
p. 57
Best Fit vs Best Practices(continued)
 The best practices approach assumes that there exists
a universal, best way.
• The focus is not on the question of what the best strategy
is, but how best to implement the system.
• Agreement on what are the best practices does not exist.
 The four-step process for forming and implementing a
compensation strategy includes:
• Assessing conditions
• Deciding on the best strategic choices following the pay
model
• Implementing the strategy through design of the pay
system
• Reassessing the fit
p. 58
Best Fit vs Best Practices(continued)
 Recent studies have begun to research what aspect of
the compensation system really does matter, but the
answer is still fuzzy.
 An essential point is that the deal (the employment
relationship) includes both transactional and relational
forms of compensation.
 It is the total deal, the relationship with people, that
makes an organization successful.
p. 59
Current Compensation Trends
p. 60
Profile of the Individual
 Cash reward level and perception varies based on
the following criteria :
• The age and experience of the incumbent
• The level of education
• The geographical location
• The market sector
p. 61
Profile of the Individual
 Age and Experience factors
• Starting career with basic education
–
–
–
–
High supply market
Low bargaining level
Straight salary approach (except sales jobs)
Salary levels usually established by collective agreements
• Starting career with professional education
– Same as above, however with a better bargaining level
– Salary levels are less confined
p. 62
Profile of the Individual
 Age and Experience factors
• Mid career with basic education
–
–
–
–
Competitive market
Still low bargaining level unless acquired new specialized skills
Straight salary approach (except sales jobs)
Salary levels usually established by collective agreements
• Mid career with professional education
–
–
–
–
–
High demand for high performers
Top reward environment
Salaries highly negotiable
Cash incentive highly utilized
Deferred incentive considered
p. 63
Profile of the Individual
 Age and Experience factors
• End career with basic education
– Highly competitive market
– Little bargaining level unless acquired highly specialized skills
– Some Cash incentive opportunities
• End career with professional education
–
–
–
–
–
–
High demand for top performers
High visibility
Lower bargaining power
Salaries less negotiable
Cash incentive highly utilized
Deferred incentive highly considered
p. 64
Geographical Location
 Salary levels and job opportunities for qualified
employees
North America
Europe
Eastern Europe
Asia Pacific
Latin America
ME
Africa
Salaries
Opportunities
+++++
++++
++
++
++
+++
+
+++
++
+++
++++
+++
+++
++
p. 65
Market Sector
 Salary aggressiveness
Salary levels
Financial/Trading
Pharma/Bio medical
Oil/Chemicals
Fast Consumer Goods
High Tech/Telecom
Industrial Goods
Services
+++++
++++
++++
++++
+++
++
++
p. 66
How to motivate employees
 To remunerate managers in a competitive way
based on their responsibilities as well as their
individual performance
• Establish a coherent salary structure (external equity)
• Create an internal equity within a competitive market
environment
• Establish a link between individual performance and the job
requirement
p. 67
Reward System
Reward System
Job Analysis
Benefits
Job Description
Managing Base
Pay
Jpb Evaluation
Variable Pay
Recruitment
Selection & Hiring
Training & Dev’mt
Career planning
Working
conditions
Long-term
Incentives
Recognition
Awards
Perf. evaluation
HR Planning
p. 68