Chapter 1 The Pay Model McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. 2-1 Unit Topics Compensation: Definition Forms of Pay A Pay Model 2-2 Perspectives of Compensation Society’s Views Stockholders’ Views Employees’ Views Managers’ Views 2-3 Perspectives of Compensation (cont.) Society Considers pay as a measure of justice Benefits as a reflection of justice in society Stockholders Using stock to pay employees creates a sense of ownership and improves performance Linking executive pay to company performance supposedly increases stockholders' returns 2-4 Perspectives of Compensation (cont.) Managers Major expense Used to influence employee behaviors and to improve the organization's performance 2-5 Perspectives of Compensation (cont.) Employees Major source of financial security Return in an exchange between employer and themselves Entitlement for being an employee of the company Reward for a job well done 2-6 Perspectives of Compensation (cont.) Incentive and sorting effects of pay on employers’ behaviors Incentive effect - degree to which pay influences individual and aggregate motivation among the employees Sorting effect - effect that pay can have on the composition of the workforce 2-7 What is Compensation? Compensation refers to all forms of financial returns and tangible services and benefits employees receive as part of an employment relationship 2-8 Exhibit 1.4: Total Returns for Work 2-9 Forms of Pay Base wage It is the cash compensation that an employer pays for the work performed Some pay systems set base wage as a function of the skill or education an employee possesses 2-10 Forms of Pay Merit pay/cost-of-living adjustments Merit increases are given in recognition of past work behavior Cost-of-living adjustments give the same increases to everyone, regardless of performance 2-11 Forms of Pay (cont.) Incentives (variable pay) Tie pay increases directly to performance Do not increase base wage; must be reearned each pay period Potential size of the payment will generally be known beforehand Are one-time payments, and do not permanently increase labor costs May be long-term (stock options) or short-term 2-12 Forms of Pay (cont.) Benefits Income protection (Medical insurance, retirement programs, life insurance, and savings plans) Work/life balance (vacations, jury duty, financial planning, referrals for child and elder care, telecommuting, nontraditional schedules, nonpaid time off) Allowances 2-13 Forms of Pay (cont.) A present-value perspective shifts comparison of today's initial offers to consideration of future bonuses, merit increases, and promotions Relational returns from work (nonfinancial returns) have a substantial effect on employees’ behavior 2-14 Forms of Pay (cont.) Network of returns is more likely to be useful if bonuses, development opportunities, and promotions all work together 2-15 A Pay Model Three basic building blocks: Compensation objectives Policies that form the foundation of the compensation system Techniques that make up the compensation system 2-16 Compensation Objectives Guide the design of the pay system Serve as the standards for judging the success of the pay system 2-17 Four Policy Choices Internal alignment Compares jobs or skill levels inside a single organization Pertains to the pay rates both for employees doing equal work and for those doing dissimilar work 2-18 Four Policy Choices (cont.) Pay relationships within an organization affect employee decisions to: Stay with the organization Become more flexible by investing in additional training Seek greater responsibility 2-19 Four Policy Choices (cont.) External competitiveness Focus – pay comparisons with competitors Pay is ‘market driven’ Objective: To ensure that pay is sufficient to attract and retain employees To control labor costs to ensure competitive pricing of products/ services 2-20 Four Policy Choices (cont.) Employee contributions Directly affects employees’ attitudes and work behaviors Management Focus - right people get the right pay for achieving the right objectives in the right way 2-21 Chapter 2 Strategy: The Totality of Decisions McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. 2-22 Chapter Topics Similarities and Differences in Strategies Strategic Choices Support Business Strategy Support HR Strategy The Pay Model Guides Strategic Pay Decisions 2-23 Chapter Topics (cont.) Developing a Total Compensation Strategy: Four Steps Source of Competitive Advantage: Three Tests “Best Practices” versus “Best Fit”? Guidance from the Evidence Virtuous and Vicious Circles 2-24 Exhibit 2.1: Three Compensation Strategies 2-25 Similarities and Differences in Strategies Different strategies within the same industry Different strategies within the same company 2-26 Strategic Choices Strategy refers to the fundamental directions that an organization chooses A strategic perspective focuses on those compensation choices that help the organization gain and sustain competitive advantage 2-27 Exhibit 2.2: Strategic Choices 2-28 Support Business Strategy Pay systems should align with the organization's business strategy Based on contingency notions When business strategies change, pay systems should also change 2-29 Exhibit 2.3: Tailor the Compensation System to the Strategy 2-30 The Pay Model Guides Strategic Pay Decisions Five strategic compensation choices: Objectives Internal alignment External competitiveness Employee contributions Management 2-31 The Pay Model Guides Strategic Pay Decisions (cont.) These decisions, taken together, form a pattern that becomes an organization’s compensation strategy Stated versus unstated strategies 2-32 Developing A Total Compensation Strategy: Four Steps Step 1: Assess total compensation implications Step 2: Map a total compensation strategy Step 3: Implement strategy Step 4: Reassess 2-33 Exhibit 2.6: Key Steps in Formulating a Total Compensation Strategy 2-34 Step 1: Assess Total Compensation Implications Business strategy and competitive dynamics – understand the business Changing customer needs Competitors’ actions Changing labor market conditions Changing laws Globalization Competitive dynamics can be assessed globally 2-35 Step 1: Assess Total Compensation Implications (cont.) HR strategy: Pay as a supporting player or catalyst for change? Pay strategy is influenced by how it fits with other HR systems Pay can be a supporting player, as in the high-performance approach Pay can take the lead and be a catalyst for change 2-36 Step 1: Assess Total Compensation Implications (cont.) Culture/values A pay system reflects the values that guide an employer's behavior and underlie its treatment of employees Social and political context Context refers to legal and regulatory requirements, cultural differences, changing workforce, demographics, expectations etc 2-37 Step 1: Assess Total Compensation Implications (cont.) Employee preferences How to better satisfy individual needs and preferences Choice People do not understand the alternatives; too many choices confuse them Challenging to design and manage 2-38 Step 1: Assess Total Compensation Implications (cont.) Union preferences Union preferences for different forms of pay and their concern with job security affect pay strategy Unions' interests can differ Compensation deals with unions can be costly to change 2-39 Step 2: Map a Total Compensation Strategy A strategic map offers a picture of a company’s compensation strategy based on the five choices in the pay model Clarifies the message the company is trying to establish with its compensation system Maps do not tell which strategy is the “best”; provides a framework and guidance 2-40 Exhibit 2.8: Contrasting Maps of Microsoft and SAS 2-41 Steps 3 and 4: Implement and Reassess Step 3 Involves implementing the strategy through the design and execution of the compensation system Step 4 Recognizes that the strategy must change to fit changing conditions Involves periodic reassessment 2-42 Sources of Competitive Advantage: Three Tests Is it aligned? Does it differentiate? Does it add value? Calculate the return on investment (ROI) 2-43 “Best Practices” versus “Best Fit”? Best Practices Assumptions: A set of best-pay practices exists Practices can be applied universally across all situations Results in better performance with almost any business strategy Best Fit A company is more likely to achieve competitive advantage if the pay system: Reflects company’s strategy and values Is responsive to employees’ and unions’ needs Is globally competitive 2-44 Guidance from the Evidence Internal alignment Pay differences among internal jobs can affect results External competitiveness Paying higher than the average paid by competitors can affect results Employee contributions Performance-based pay can affect results 2-45 Guidance from the Evidence (cont.) Managing compensation All dimensions of the pay strategy need to be considered Compensation strategy Embedding compensation strategy within the broader HR strategy affects results “What practices pay off best under what conditions” is an important question to be answered 2-46 Virtuous and Vicious Circles A study concluded that how you pay matters as much as how much you pay Studies conclude that performancebased pay that shares success with employees improves employee attitudes, behaviors, performance – especially when combined with highperformance practices 2-47 Virtuous and Vicious Circles (cont.) Performance-based pay can be the best practice under right circumstances 2-48