Milkovich/Newman: Compensation, Ninth Edition

The Pay Model

Chapter 1

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
 Contrasting Perspectives of
Compensation
Society’s Stockholders’
Views Views

Employees’ Managers’
Views Views

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 Compensation: Definition
 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

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 Compensation: Definition (cont.)
 Society
– Pay as a measure of justice
 Gender pay gap in U.S., after adjusting for differences in
education, experience, occupation, has narrowed from 36
percent in 1980 to 13 percent in 2006
– Benefits as a reflection of justice in society
 ~46m Americans do not have health insurance (16% of
population)
 Proportion of Americans w/ private insurance 67.5% in 2007
– Job losses (or gains) attributed to differences in
compensation (see Ex. 1.1)
– Belief that pay increases lead to price increases

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 Exhibit 1.1 update: Hourly Compensation
Costs for Production Workers (2007 data)
United States $24.59 Austria 35.33
Belgium 35.45
Brazil 5.96 Czech Republic 8.20
Canada 28.91 ($2.83 in 2000)
Mexico 2.92 Denmark 42.29
Finland 34.18
Australia 30.17 France 28.57
Hong Kong 5.78 Germany 37.66
Japan 19.75 Hungary 7.91
South Korea 16.02 ($2.79 in 2000)
($8.23 in 2000) Ireland 29.04
Singapore 8.35 Italy 28.23
Sri Lanka 0.61* Netherlands 34.07
(comparable to China?) Norway 48.56
Taiwan 6.58 Poland 6.17
Portugal 8.27
Spain 20.98
Sweden 36.03
Switzerland 32.88
United Kingdom 29.73
Source: U.S. Department of Labor, Bureau of Labor Hourly compensation costs include (1) hourly direct pay and (2)
employer social insurance expenditures and other labor
Statistics, January 2009. taxes. 1-5
 Compensation: Definition (cont.)
 Stockholders
– Linking executive pay to company performance theoretically
increases stockholders' returns (see Ex. 1.2)
 Managers
– A major expense (labor expense can account for 50+% of
total costs)
– Used to influence employee behaviors and to improve the
organization's performance (see Ex. 1.3)
 Grocery store clerk pay (2005):
– Industry average: $12.28/hr
– Costco: $16
– Whole Foods $12.50
– Sam’s Club $12
– Wal-Mart $9.68
 Labor costs as % of total costs for grocery stores historically 15-18%;
today norm is 9-12%; warehouse stores 4-6%; Whole Foods 25%
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Labor Costs as a Percentage of Revenues,
Airline Industry
(8e)

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What Is Compensation?

Compensation refers to all

forms of financial returns
and tangible services and
benefits employees
receive as part of an
employment relationship

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Exhibit 1.4: Total Returns for Work

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 Forms Of Pay
 Relational returns
– Psychological in nature
 Total compensation
– Cash Compensation/ transactional
 Base wages
– Difference between wage and salary
 Merit pay/cost-of-living adjustments
– Merit increases – given in recognition of past work behavior –
adjustments to base
– Cost-of-living adjustments –same increases to everyone,
regardless of performance

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 Forms Of Pay (cont.)
– Cash Compensation/ transactional (cont.)
 Incentives/ Variable pay – tie pay increases directly to
performance
– Does not increase base wage; must be reearned each pay period
– Potential size generally known beforehand
– Long-term (stock options), and short-term

– Benefits
 Income protection (some are legally required)
 Work/life balance (includes pay for time not worked)
 Allowances (e.g., expatriates)

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 Exhibit 1.5: THE PAY MODEL

POLICIES TECHNIQUES OBJECTIVES

Work Descriptions Evaluation/ INTERNAL

ALIGNMENT
analysis certification STRUCTURE
EFFICIENCY
• Performance
• Quality
Market Surveys Policy PAY
COMPETITIVENESS definitions lines STRUCTURE • Customers
• Stockholders
• Costs
Seniority Performance Merit INCENTIVE
CONTRIBUTORS based based guidelines PROGRAMS FAIRNESS

COMPLIANCE
MANAGEMENT Costs Communication Change EVALUATION

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Exhibit 1.6: Pay Objectives at Medtronic
and Whole Foods

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 Four Policy Choices
Internal alignment
– Focus - Comparisons among jobs or skill levels inside
a single organization
– Pay relationships within an organization affect
employee decisions to:
 Stay with the organization
 Become more flexible by investing in additional training
 Seek greater responsibility
External competitiveness
– Focus - Compensation relationships external to the
organization: comparison with competitors
– Pay is ‘market driven’

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 Four Policy Choices (cont.)
 External competitiveness (cont.)
– Effects of decisions regarding how much and what forms:
 To ensure that pay is sufficient to attract and retain employees
 To control labor costs to ensure competitive pricing of products/
services
 Employee contributions
– Focus - Relative emphasis placed on employee performance
 Performance based pay affects fairness
 Management
– Focus - Policies ensuring the right people get the right pay
for achieving the right objectives in the right way

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 Listening to HR’s Critics
 Quantify people-management results into dollars
– Productivity of workforce
– Cost of vacant position
– Cost of keeping bad manager
– Dollar impact of hiring and keeping top performers vs.
average ones in mission-critical jobs
 Adopt “fact-based” decision-making
– Not “I think” or “I believe” but “I know” re: cause and
effect
 Causes of turnover
 What motivates workers to produce more
 Which HR actions can turn business unit around
 Source: Workforce Management, 7/31/06 1-16
 Evidence-based HR Decision-making
 Assumption that correlation implies causation pervades
decision making in human resources and pay plan design.
– Inferential issue: "The CEO drank Wild Turkey; the company
performed well; ergo, all CEOs should drink more Wild Turkey.
The company uses individual incentives; the company performs
well; ergo all companies should use more incentives.“
 "The first step is to know what the evidence says. Know the
research literature that pertains to your business. Diffusion
and persistence do not prove effectiveness.“
 “The goal is to transform human resources into the R&D
department for the human system, which is the most
important system in almost all organizations.”
– "In R&D, you go into the laboratory, you experiment and you keep
up with the research that others do. Can you imagine walking into
the R&D lab at a pharmaceutical company, asking the chief
chemist about an important new study and having him respond that
they don't keep up with the literature in chemistry?“
 Jeffrey Pfeffer, Stanford University, in Workforce Management, 11/3/08

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