Strategic Compensation Systems

Compensation Strategy
The Compensation strategy defines the organizations remuneration goals & objectives, & describes what the organization will reward employees for, & on what basis

Compensation System Strategic Choices

1. Importance of External Equity 2. Link Between Compensation Plan and Overall Strategic Plan 3. Merit Pay Raises (Performance) or Across-the-Board raises 4. Level of Pay Secrecy 5. Internal Equity 6. Intrinsic and Extrinsic Rewards

External Environmental Variables

Nature of the Competition Nature of the Labor Market Government Regulations

1. Nature of the Competition

When an organization has many competitors or want to go for overall cost leadership strategy When an organization has few competitors or has adopted differentiation strategy

2. Nature of the Labor Market

Two important issues are: Labor supply & demand issue The wage levels that competitors are paying to their employees

3. Government Regulations
Minimum wage law Workers compensation Act COLA

Internal Environmental Variables

Corporate Strategy Management Philosophy The Type of Job
Variety of Tasks Location of Tasks Individual or Team

Productivity

1. Corporate Strategy
The compensation system must be designed to support the corporate strategy of the organization. There should be a tie between the compensation system & the developmental stage of the organization ( the six organizational stages along with compensation plans are shown )

Strategic Pay and The Organization Life Cycle

Revenues or Market Share

Growth Phase

Pay Mix

Base Pay Incentives Benefits

Start Up Low High Low

High Growth Maturity Competitive Competitive High Competitive Low Competitive

Stability High Low High

Decline High None High

Renewal Competitive High Low

SOURCE: George Milkovich and Jerry Newman, Compensation, 2nd ed. (Homewood, IL:EPI/Irwin, 1987), p. 16.

2. Management philosophy
Management philosophy is the value it places on its human resources. It is reflected by relationship between management & line employees

3. The Type of Job

A Job covers various factors such as:
Variety of Tasks Location of Tasks Individual or Team

Expatriates pay structure Goal sharing program

4. Productivity
Ratio of outputs (product or service provided by the company) to inputs (cost in terms of labor, capital, materials & machinery)

Strategic Compensation Option

1. Pay Level Policy 2. Pay structure policy 3. Intrinsic & Extrinsic rewards

1. Pay Level Policy

Pay level is the average wage rate paid for a specific group of jobs. Pay level policy refers to how an organizations pay level compares with its competitors pay level External Equity: The degree to which an organization wages are competitive with those of its competitors Wage and Salary Surveys
Pay Level Policy Options
Lead Lag Match

Wage & salary Survey

1. 2. 3. 4. 5.

DEF: a report of the current wage or salary earned by incumbents holding jobs in variety of organizations Major concerns:
Selecting which jobs should be examined Defining relevant labor markets Selecting firms to be surveyed Determining information to be asked Determining data collection techniques

Pay level policy options

Lead
Employers pay higher wages than the average wage paid in the labor market

Lag
Employers pay lower wages than the average wage paid in the labor market

Match
Employers pay matches the market wage rate

2. Pay Structure Policy

i. ii. iii. iv. v. vi.

Following areas are covered in pay structure policy: Pay ranges Internal Equity Job Evaluation Pay grade Broad banding Wage Compression

i. Pay ranges
Definition: The range of wages allowed by a specific wage classification and the amount of overlap between the ranges An organization must decide maximum or minimum pay for any job or set of jobs in the pay structure.

Internal equity & Job Evaluation

Internal Equity: Setting wage rates that conform to the jobs internal worth to the employer Job Evaluation: A formal process by which management assigns wage rates to jobs according to some pre established formula. Compensable Factors are:

Skills Required by the Job Responsibility for People and/or Equipment Effort Required Working Conditions

Pay grade, Broad banding & Wage Compression

Pay grade: A group of jobs that have the same classification with respect to pay Broad banding: The collapsing of job clusters or grades of positions into a few wide bands, which creates a flatter organizational structure. Wage Compression: Pay situation arising when new hires are brought in at about the same salary as or a higher salary than the current employees

Extrinsic Vs Intrinsic Rewards

Introduction

Types of Reward Plans

Intrinsic versus Extrinsic Rewards Intrinsic rewards (personal satisfactions) come from the job itself, such as:
pride in ones work feelings of accomplishment being part of a work team

Types of Reward Plans

Intrinsic versus Extrinsic Rewards Extrinsic rewards come from a source outside the job
include rewards offered mainly by management Money Promotions Benefits

Types of Reward Plans

Financial versus Nonfinancial Rewards Financial rewards include:

wages bonuses profit sharing pension plans paid leaves purchase discounts

Nonfinancial rewards emphasize making life on the job more attractive; employees vary greatly on what types they find desirable.

Types of Reward Plans

Performance-based versus Membership-Based Rewards Performance-based rewards are tied to specific job performance criteria.

commissions piecework pay plans incentive systems group bonuses merit pay

Membership-based rewards such as costof-living increases, benefits, and salary increases are offered to all employees.

Pay for Performance

1. Pay for Performance 2. Executive Pay and Pay for Performance 3. Pay for Performance at Individual and Group Level

1. Pay for Performance

Def: Employees who are more productive are more valuable to the organization & should be rewarded for their superior performance. Problems: 1. Determining & quantifying work standards 2. Traditional mindset of employers 3. Problem due to external equity

Pay for Performance (Cont.)

Implementation needs: 1. Who decides 2. Who benefits Slam dunk: some one from the top ordered someone below to implement a pay for performance system

Executive pay & pay for performance

1. Perks: Non cash compensation in form of special
benefits or privileges e.g. paid life insurance, club memberships, company cars, interest-free loans, free financial legal and tax counseling

Golden parachute: protect executives when a

merger or hostile takeover occurs by providing severance pay or a guaranteed position.

Stock options: The right to buy a certain

number of shares at a set price sometime in future

Deferred bonuses paid to executives over

extended time periods, to encourage them to stay with the company.

Pay for performance at individual and Group level

1. 2. 3. 4. 5. 6. 7.
Base pay Merit pay Incentives Gain sharing plans Profit sharing plans Commissions Stock ownership plans

Base pay
The basic cash received for the work performed, adjusted for the individuals skill, education, experience or some other attribute.

2. Merit pay

Based on the level of individuals performance in the past year to some standard performance.

Problems:
1. Dose not increase productivity because of the small difference of raise between outstanding & poor performers 2. Poor understanding of relation between pay & performance

Considerations:
1. 2. 3. 4.
Not apply to professionals Not apply to intrinsic motivated employees Not apply to teams Enforce the system

3. Incentives
Straight piece work plan: A type of
individual incentive plan that pays a constant amount for each unit that is produced

Standard hour plan: A type of

individual incentive plan that ties pay to standard amount of time it takes to perform, a service or complete a task.

Incentives (cont.)
Skill based pay: A form of incentive
based pay wherein employees are paid for the skills they possess, not just the skills they performed

Stay Bonuses: A variety of cash bonuses

and other inducements that firms offer to keep valued workers on the payroll during cooperate reorganizations or closedowns

4. Gain Sharing plans

Scanlon Rucker Improshare

Other plans

Profit sharing plans Commissions Stock ownership plans

Profit Sharing Plans

Profits are typically distributed: in cash deferred until a future time (retirement, severance, or disability), or paid in the combination of two methods

Advantages & Disadvantages of Profit Sharing Plans

Advantages
1. Incentive formula is simple & easy to communicate 2. Pay is variable because the plan pays only when the firm is profitable. 3. It promotes interest in the overall financial health of the company for both management & line employees

Disadvantages
1. Many employees fail to see the linkage of their performance to organizational performance 2. The connection between performance & reward is blurred when payout is deferred for many years

Commission
Commission plans are typically developed for sales employees Types of commission plans: Percentage of sales Combination of salary & commission Examples Real estate, departmental stores, banks

Advantages & Disadvantages of Commission Plans

Advantages
1. Commissions reward performance 2. Easy to communicate & administer 3. Allow fluctuation in pay

Disadvantages
1. High variability in pay from one period to next generate lower organizational commitment 2. Emphasis on sales may cause employees to pay less attention to non selling duties

Stock ownership plans

These plans are offered to top & middle level employees Types Classic stock option Restricted stock option

Strategic approach to Compensation

1. Growth mode 2. Retrenchment mode