MNG 4105-

COMPENSATION &
BENEFITS
ACADEMIC YEAR 2020/2021
WEEK 2- PAY MODEL AND STRATEGY
THE PAY MODEL OF COMPENSATION

• Developed by G.T Milkovich and J.M Nemwan, the pay model of compensation helps
managers to structurally design and understand the compensation system for their
employees.
• The model consists of three main components: objective of the remuneration model, the
policy that is the foundation for the structure, and the techniques that link the policy to
the objectives.
THE PAY MODEL OF COMPENSATION

• The model defines compensation as a form of financial gain and tangible services and
benefits that employees receive as part of their employment.
BUILDING BLOCKS OF THE PAY MODEL
THE PAY MODEL : POLICIES

• The four policy choices are;

• Alignment (Internal Alignment)
• External Competitiveness
• Contributions
• Management
POLICIES- ALIGNMENT

• The focus of internal alignment is to compare jobs or the skill level inside a single
organization.
• Jobs and people skills are compared in terms of their relative contributions to the
organization’s business objectives.
• Pertains to the pay rates both for employees doing equal work and for those doing
dissimilar work.
POLICIES- ALIGNMENT

• Pay relationships within an organization affect employee decisions to:

• Stay with an organization
• Become more flexible by investing in additional training
• Seek greater responsibility
POLICIES- EXTERNAL COMPETITIVENESS

• The focus of external competitiveness is to compare compensation with those of

competitors.
• Pay is “market driven”.
• Effects of decisions regarding how much and what forms have a twofold effect on
objectives:
• To ensure that pay is sufficient to attract and retain employees.
• To control labour cost to ensure competitive pricing of products/services.
POLICIES- EMPLOYEE CONTRIBUTIONS

• The focus of employee contribution places emphasis on employee performance as it

directly affects employees’ attitudes and work performance.
• Performance based pay affects fairness: employees need to understand the basis for
judging performance in order to believe that their pay is fair.
POLICIES- MANAGEMENT

• The focus of management is to ensure the right people get adequate pay for achieving the
objectives of the organization.
• Managing compensation means answering the “So What” question. So what is the impact
of this policy, this decision?
PAY SYSTEM TECHNIQUES

• In order to comply with internal alignment, as the model shows, the techniques are skills
and work analysis. In order to meet the competition policy, surveys can be held and
market definitions can be created. The employee contribution is assessed based on
performance guidelines. When managing these remuneration plans, communication and
change are important factors.
• Techniques tie the four basic policies to the pay objectives.
OBJECTIVES OF THE PAY MODEL OF
COMPENSATION
• Ethics.
• Organizations care about how its results are achieved
• Managing pay sometimes creates ethical dilemmas
• Manipulating results to ensure executive bonus payouts, misusing statistics used to
measure competitors’ payrates, and shaving the hours recorded in employees’ time
cards are all too common examples of ethical lapses.
OBJECTIVES OF THE PAY MODEL OF
COMPENSATION
• Efficiency. Effective remuneration systems contribute to efficiency in the form of
improved performance, better quality, satisfied customers, or lower costs.
• Fairness. Fairness refers to designing and introducing a reward system that rewards
performance and meets the needs of the employees. Fairness is the foundation for healthy
work relationships, which means it’s important that employees are treated fairly and get a
salary that matches the work they do.
• Conformity. Compensation models have to conform to the requirements of various central
and national salary legislation and regulations.
SUMMARY OF THE PAY MODEL OF
COMPENSATION
• The Pay Model of Compensation by Milkovich & Newman gives a structured way of
how compensation systems should be organized. The model consists of three
components: objective of the remuneration model, the policy that is the foundation for the
structure, and the techniques that link the policy to the objectives.
COMPENSATION STRATEGY
STRATEGIC CHOICES

• Strategy refers to the fundamental directions that an organization chooses. An

organization defines its strategy through the tradeoffs it makes in choosing what (and
what not) to do.
• Corporate level: What business should we be in?
• Business unit level: “ How to gain and sustain competitive advantage?
• Functional level: “ How should total compensation help gain and sustain competitive
advantage?
• A strategic perspective focuses on those compensation choices that help the organization
gain and sustain competitive advantage.
STRATEGIC CHOICES
SUPPORT BUSINESS STRATEGY

• Pay systems should align with the organization's business strategy.

• Based on contingency notions: Differences in a company’s business strategy should
be supported by corresponding differences in its human resource strategy, including
compensation.
• Underlying premise: The greater the alignment (fit) between the organization and the
compensation system, the more effective the organization.
SUPPORT BUSINESS STRATEGY (CONT’D)

• Compensation systems can be tailored to:

• Innovator business strategy: Stresses new products and short response time to
markets.
• Cost cutter business strategy: efficiency focused strategy and stresses doing more
with less by minimizing cost, encouraging productivity increases and specifying in
greater detail exactly how jobs should be preformed.
• Customer-focused business strategy: stresses delighting customers and bases
employee pay on customer service.
TAILOR THE COMPENSATION SYSTEM TO THE
STRATEGY
Strategy
Innovator: Increase product
complexity and shorten
product life cycle
Cost cutter: Focus on
Efficiency
Customer Focused: Increase
customer service
Business Response HR Program Alignment Compensation System
• Product leadership • Committed to supple, • Reward innovation in
• Shift to mass risk-taking, innovative products and processes
customization people • Market-based pay
• Cycle Time • Flexible generic job
descriptions
• Operational excellence • Do more with less • Focus on competitor’s
• Pursue cost effective labour cost
solutions • Increase variable pay
• Emphasize productivity
• Focus on system control
and work specifications
• Deliver solutions to • Exceed customers • Customer satisfaction
customers expectations incentives.
• Speed to market • Value of job and skills
based on customer
satisfaction
STRATEGIC GUIDELINES FOR COMPENSATION
CHOICES
• Objectives: How should compensation support the business strategy and be
adaptive to the cultural and regulatory pressures in a global environment?
• Internal Alignment: How differently should the different types and levels of skills
and work be paid within the organization?
• External Competitiveness: How should total compensation be positioned against
competitors?
• Employee Contributions: should pay increases be based on individual and/or
team performance or experience and/or each business unit’s performance?
STRATEGIC GUIDELINES FOR COMPENSATION
CHOICES (CONT’D)
Management: How open and transparent should the pay decisions be to all
employees?
THE PAY MODEL GUIDES STRATEGIC PAY
DECISIONS
• Decisions based on the five strategic compensation choices of the pay model,
taken together, form a pattern that becomes an organization’s compensation
strategy.
• Stated versus Unstated Strategies
EXAMPLE: THE STRATEGIC COMPENSATION
DECISIONS FACING WHOLE FOODS
• Objectives: How should compensation support business strategy and be adaptive
to the cultural and regulatory global environment?
• Whole Foods objectives
• Increase shareholder value through profits and growth
• Go to extraordinary lengths to satisfy and delight customers
• Seek and engage employees who are going to help the company make money
EXAMPLE: THE STRATEGIC COMPENSATION
DECISIONS FACING WHOLE FOODS (CONT’D)
• Internal Alignment: How differently should the various types and levels ofskills and work
be paid within the organization?
• Whole Foods approach
• Store operations are organized around eight to ten self-managed teams
• Executive salaries do not exceed14 times the average pay of full-time employees
• All full-time employees qualify for stock options, and 94percent of the company's
options go to non-executive employees
EXAMPLE: THE STRATEGIC COMPENSATION
DECISIONS FACING WHOLE FOODS (CONT’D)
• External Competitiveness: How should total compensation be positioned against our
competitors? What forms of compensation should we use?
• Whole Foods approach
• Offer a unique deal compared to competitors
• Provide health insurance for all full-time employees
• 20 hours of paid time a year to do volunteer work
EXAMPLE: THE STRATEGIC COMPENSATION
DECISIONS FACING WHOLE FOODS (CONT’D)
• Employee 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 business unit’s performance?
• Whole Foods approach
• A shared fate- Assesses the performance of teams on a monthly basis.
• Top teams get incremental increases on hourly wages in the next pay period .
EXAMPLE: THE STRATEGIC COMPENSATION
DECISIONS FACING WHOLE FOODS (CONT’D)
• Management: How open and transparent should pay decisions be to all employees? Who
should be involved in designing and managing the system?
• Whole Foods approach
• No-secrets management: Every store has a book listing the previous year’s pay for
every employee including executives.
• Employees were granted the option to choose their health insurance rather than
having one chosen by management.
KEY STEPS TO FORMULATE A COMPENSATION
STRATEGY
STEP 1: ASSESS TOTAL COMPENSATION
IMPLICATIONS
• To cope with turbulent competitive dynamics, focus on what factors are important in the
business environment:
• Changing customer needs
• Competitors’ actions
• Changing labor market conditions
• Changing Laws
• Globalization
STEP 1: ASSESS TOTAL COMPENSATION
IMPLICATIONS (CONT’D)
• Culture and values
• A pay system reflects the values that guide an employer's behavior and underlie its
treatment of employees.
• The pay system mirrors the company’s image and reputation
STEP 1: ASSESS TOTAL COMPENSATION
IMPLICATIONS (CONT’D)
• Social and Political context
• Context refers to legal and regulatory requirements, cultural differences, changing
workforce, demographics, expectation.
• Affects compensation choices
• Governments are major stakeholders in determining compensation: Lobbying to
influence laws and regulations is also part of compensation strategies.
STEP 1: ASSESS TOTAL COMPENSATION
IMPLICATIONS (CONT’D)
• Employee and Union Preference
• How to better satisfy individual needs and preferences
• Offering more choice is one approach
• Pay strategies need to be adapted to the nature of the union-management relationship
• Unions interests can differ(i.e.protected retirement and health care plans)
• Compensation deals with unions can be costly to change
STEP 1: ASSESS TOTAL COMPENSATION
IMPLICATIONS (CONT’D)
• Prominence of Pay in overall HR Strategy: Supporting player or catalyst for change
• Pay strategy is influenced by how it fits with other HR systems
• Pay systems based on performance
• Pay can be a supporting player or a catalyst for change
STEP 2: MAP A TOTAL COMPENSATION
STRATEGY
• Mapping is used in marketing to clarify and communicate a product’s identity.
• Offers 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”, rather providing framework and guidance.
STEP 3: IMPLEMENT THE COMPENSATION
STRATEGY
• Involves implementing strategy through the design and execution of compensation.
STEP 4: REASSESS THE COMPENSATION
STRATEGY
• Reassess and realign, closes the loop and recognizes that the strategy must be changing to
fit dynamic conditions.
• Involves periodic reassessment.
SOURCE OF COMPETITIVE ADVANTAGE: THREE
TEST
SOURCE OF COMPETITIVE ADVANTAGE: THREE
TEST
• Alignment of the pay system with the organization’s business strategy
• Alignment of the pay strategy includes three aspects: (1) alignment with the business strategy; (2)
aligned externally with the economic and sociopolitical conditions; and (3) aligned internally with
the overall HR system.
• Alignment is probably the easiest test to pass.

• Differentiation of an organization’s strategy from its competitors.

• Advocates of the strategic approach propose that sustained advantage comes from how the pay
system is managed.
• While it may be easy to imitate any single pay practice of a competitor, the strategic perspective
implies it is the way pay practices fit together and fit the organization’s strategy that is hard to copy.
SOURCE OF COMPETITIVE ADVANTAGE: THREE
TEST
Does it add value?
• Since compensation is often a company’s largest controllable expense, the challenge is determining
how to calculate the return on investment (ROI) of different forms of pay.
• Trying to measure ROI for a compensation strategy implies that people are “human capital,” a view
that some people find dehumanizing. Viewing pay  as an investment with measurable returns
diminishes the importance of treating employees fairly
• Of all three tests, this one is the most difficult to “pass.
ADVANTAGES TO AN INNOVATION
COMPENSATION STRATEGY
• In products and services, first movers (innovators) have well-recognized advantages that
can offset the risks involved with high margins, market share, and mindshare.
• It is however, not known, whether such advantages accrue to innovators in total
compensation.
“BEST PRACTICES” VS “BEST FIT”

• Premise of strategic perspective (best fit):  If the design of the pay system reflects the
organization’s strategy and values, is responsive to employees and union relations, and is
globally competitive, the organization is more likely to achieve competitive advantage. The
better the fit, the greater the competitive advantage.
• Assumptions of best practices: (1) a set of best-pay practices exists and (2) these practices can
be applied universally across all situations. Based on these assumptions, several potential
outcomes exist.
• Using best practices results in better performance with almost any business strategy.
• Adopting best-pay practices allows an employer to gain preferential access to superior employees.
GUIDANCE FROM EVIDENCE

• There is consistent research evidence that the following practices do matter to the
organization’s objectives.
• Internal alignment: Smaller internal pay differences and larger internal pay differences can both be a
“best” practice.
• External competitiveness: Paying higher than the average paid by competitors can affect results.
• Employee contributions: Performance-based pay can affect results
GUIDANCE FROM EVIDENCE (CONT’D)

• There is consistent research evidence that the following practices do matter to the
organization’s objectives.
• Managing compensation: Rather than focusing on only one dimension of the pay strategy such as pay
for performance or internal pay differences, all dimensions need to be considered together.
• Compensation strategy: Embedding compensation strategy within the broader HR strategy affects
results. Compensation does not operate alone; it is part of the overall HR perspective
VIRTUAL AND VICIOUS CIRCLES

• Studies have reported that while pay levels (external competitiveness) differed among
these companies, they were not related to the companies' subsequent financial
performance.
• Performance-based pay works best when there is success to share.
• Performance-based pay that shares success with employees does improve employee
attitudes, behaviors, performance (coupled with the other “high- performance” practices).
• While in cases where organization performance declines, performance-based pay plans
do not pay off; with potentially negative effects on organization performance.
VIRTUAL AND VICIOUS CIRCLES

• Unless the increased risks are offset by larger returns, the risk-return imbalance will
reinforce declining employee attitudes and speed the downward spiral.
• These studies do seem to indicate that performance-based pay may be a best practice,
under the right circumstances.
REFERENCES

• https://www.toolshero.com/human-resources/pay-model-of-compensation/
• file:///C:/Users/DO4F68~1.E/AppData/Local/Temp/viewcontent.cgi.pdf
• https://gimmenotes.co.za/wp-content/uploads/2019/01/HRM3705-chapter1_studyunit1_.p
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• https://gimmenotes.co.za/wp-content/uploads/2019/01/HRM3705-chapter2_studyunit2_.p
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