Mapping the Compensation Strategy (Explanation of Terms)

Given below is a repertoire (inventory) of strategic pay choices which together constitute the
compensation strategy of a firm.

I) Compensation objectives / philosophy

How important is compensation in the overall HR strategy? Is it a catalyst, or support, or

playing a lead role?
More specifically, there could be three broad compensation objectives which could be given
different emphasis depending on the strategy of the company:

1. Labor costs:

a. b. c.

reducing labor costs;

keeping labor costs in line with industry levels; and staying in line with labor market
strategies.

2. Attraction/retention:

1. attracting highly talented new employees; and

2. retaining high performing/high potentials amongst current employees.

3. Motivation:

1. supporting flexibility in job assignments;

2. rewarding job performance;

3. motivating skills and knowledge acquisition; and

4. improving unit results.

In addition to these, there are two more compensation objectives which organizations may
pursue to varying degrees:

1. Fairness: Ensuring distributive, procedural, and interactional justice

2. Compliance: Ensuring compliance with the letter and the spirit of the law

II) Internal alignment.

1. a)   Jobs-Based Structure vs. Person-Based Structure (pay differences are based on

tasks performed vs. pay differences are based on skills possessed by the incumbents)

2. b)   Hierarchical vs. Egalitarian (there are large differences in pay as one moves up
the hierarchy vs. there are small differences in pay as one moves up the hierarchy)
 3. c)  Criteria used to determine differences in levels (e.g., responsibility, skill, effort,
working conditions, impact on cost, impact on innovation, span of control, etc.)

III) External competitiveness.

1. a)   Compensation level vs. Market pay (for a given job/skill set, the extent to which a
company pays with respect to market compensation; this is often expressed as a
percentile of the average market compensation)

2. b)   Cash vs. Benefits (represents the pay mix in terms of how much proportion of the
total compensation is paid in cash and how much is paid in non-cash benefits)

IV) Individual contributions

a) Fixed pay vs. Variable (the proportion of total compensation which is fixed i.e., dependent
on organizational membership and the proportion of the total compensation which is
variable, i.e., dependent on performance)

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2. b)   Individual vs. Aggregate Performance (the extent to which rewards are based on
individual performance vs. aggregate or team performance; also include the level of
aggregation i.e., team, department, function, & organization)

3. c)  Short term vs. Long term Orientation (the extent to which rewards encourage
short-term vs. long term orientation in performance)

4. d)   Frequency of rewards (monthly, quarterly, annual, two yearly, five yearly, etc.)

5. e)  Risk aversion vs. Risk taking (the extent to which rewards encourage maintaining

performance vs. taking risky bets in order to substantially increase performance)

6. f)  Qualitative vs. Quantitative measures (the extent to which performance is

measured

qualitatively e.g., through performance appraisal scores vs. quantitative performance

measures e.g., sales)

V) Management

a) Centralization vs. Decentralization (the extent to which compensation decisions are made
at head offices vs. other locations)
b) Participation vs. Nonparticipation (the extent to which line managers participate in
reward related decisions)

c) Open vs. Secret (the extent to which information about compensation structure, policies,
and actual salaries is openly available to employees vs. secrecy regarding compensation)
d) Bureaucratic vs. Flexible Pay Policies (the extent to which pay policies are fixed vs.
flexibility to accommodate special cases)
Tests a good compensation strategy...

A good compensation strategy is one which has the following characteristics:

Aligned

There are four kinds of alignment: 1. Internal consistency

2. Horizontal fit (with other HR practices)

3. Vertical fit (with business strategy)
4. External fit (with economic and socio-political conditions)

Differentiated

Does the pay system differentiate our organization from others.

Add value

Does the pay system add value to our business.

Source: (i) Gomez-Mejia, L. R., Berrone, P., & Franco-Santos, M. (2010). Compensation and
organizational performance: Theory, Research, & Practice. M. E. Sharpe. (ii) Milkovich, G.
T., Newman, J. M., & Gerhart, B. (2011). Compensation (10th edition). McGraw Hill.