Institute of Business Administration

University of Dhaka

H601: Compensation Management

Fall Semester, 2019
Lecture 9 & 10
 Today’s Lecture outline
Define & Discuss
External Competitiveness
External Competitiveness: Pay Level & Pay Mix
What Shapes External Competitiveness?
Consequences of Pay-level & Mix Decisions:
Guidelines from Research
Designing Pay Levels, Mix, and Pay Structure
Some Major Decisions in Pay-level Determination
Methods of Salary Surveys
Sources for Salary Surveys
Critical Pay Survey Problems
Theories of Wage Determination
Principles of Compensation Determination
 Compensation Strategy
Recognise what competitors for
comparable jobholders are paying in
relevant labour markets to permit
organisations to attract and keep
competent employees.
External Competitiveness:
Determining the Pay Level
 Worries!!!
Your organization is experiencing higher than
normal turnover & you want to know why.
You want to attract the top middle managers
in your industry & you need to know how they
are compensated in order to compete.
You want to know if your salespeople are
motivated by their current compensation plan.
Defining External Competitiveness
…refers to the pay relationships among
organisations-the organisation’s pay relative
to competitors.
…comparisons with other employers that hire
people with the same skills.
 …is expressed in practice by (i) setting a pay
level that above, below, or equal to that of
competitors; & (ii) determining the mix of pay
forms relative to those of competitors.
 Compensation Terminologies
Pay Level: Refers to the average of the array of rates paid
by an employer:
(Base+bonuses+benefits+value of stocks)
Number of employees
Pay Mix: Relative emphasis among compensation
components such as base pay, merit, incentives, & benefits.
Pay Forms: Are the various types of payments, or pay mix,
that make up total compensation.
Pay Structures: The array of pay rates for different jobs
within a single organisation; they focus attention on
differential compensation paid for work of unequal worth.
External Competitiveness: Pay Level & Pay Mix
Two objectives
1. Control cost:
Pay level decisions have a significant impact on
expenses.
Other things being equal, the higher the pay level,
the higher the labour costs:
Labour Costs= (Pay level) times (Number of employees)
The higher the pay level relative to what competitors
pay, the greater the relative costs to provide similar
products & services.
 External Competitiveness: Pay Level & Pay Mix
Two objectives…
2. Attract & Retain Employees
 Believes… higher-paid employees are more productive…
 Pay less because… it is differentiating itself on nonfinancial
returns…
 Deliberately choose to pay above or below what others are
paying for the same work…
 There is no single ‘going rate’ in the labour market for a
specific job…
 A single company may set a different pay level for different job
families…
 How a company compares to the market depends on what
competitors it compares to & what pay forms are included…
What Shapes External Competitiveness?

Labour Market Factors

Nature of Demand
Nature of Supply

Product Market Factors

Degree of Competition
External
Level of Product Demand Competitiveness

Organisation Factors
Industry, Strategy, Size
Individual Manager
 1. Labour Market Factors
Theories of labour markets…four basic assumptions…
I.Employers always seek to maximise profits.
II.People are homogenous & therefore interchangeable;
a business school graduate is a business school graduate
is a business school graduate.
III.The pay rates reflect all costs associated with
employment (base wage, bonuses, holidays, benefits,
even training).
IV. The markets faced by employers are competitive, so
there is no advantage for single employer to pay above
or below the market rate.
Oversimplify reality…just a framework for understanding
 1. Labour Market Factors…
Nature of Demand
The marginal product of labour is the
additional output associated with
employment of one additional person, with
other production factors held constant.
The marginal revenue of labour is the
additional revenue generated when the firm
employs one additional person, with other
production factors held constant.
 1. Labour Market Factors…

Nature of Supply
As the assumptions change, so does the
supply.
Lowering the job requirements & hiring
less-skilled workers a better choice than
raising wages.
 Labour demand theories & implications
Theory Prediction So what?
Compensating Work with negative Job evaluation &
differentials characteristics compensable factors must
requires higher pay to capture these negative
attract workers. characteristics.
Efficiency wage Above-market wages Staffing programs must have
will improve efficiency the capability of selecting
by attracting workers the best employees; work
who will perform must be structured to take
better & be less willing advantage of employees'
to leave. greater efforts.

Signaling Pay polices signal the Pay practices must recognize

kinds of behaviour the desired behaviours with
employer seeks. more pay, larger bonuses, &
other forms of
compensation.
 2. Product Market Factors
 Pay level is constrained by its ability to compete in the
product/service market.
 Product market conditions to a large extent determine
what the organisation can afford to pay.

1. Degree of Competition:
 Employers in highly competitive markets, such as
manufacturers of automobiles or generic drugs, are less
able to raise prices without loss of revenues.
 Single sellers of a Lamborghini or breakthrough Cancer
treatment are able to set whatever price they choose.
 Too high a price often invites the eye of government
regulators.
 2. Product Market Factors…
2. Level of Product Demand:
The product market puts a lid on the
maximum pay level that an employer can
set.
If the employer pays above the
maximum, it must either pass on to
consumers the higher pay level through
price increases or hold prices fixed &
allocate a greater share of total revenues
3. Organisation Factors
Industry & technology
Employer size
People’s preferences
Organization strategy
Industry, Strategy, Size
Individual Manager
Consequences of Pay-level & Mix Decisions: Guidelines from Research

Contain operating
expenses (labour costs)

Increase pool of
qualifies applicants

Competitiveness of Increase quality &

total compensation experience

Reduce voluntary
turnover

Increase probability of
union-free status

Reduce pay-related
work stoppages
Designing Pay Levels, Mix,
and Pay Structure
Determining Externally Competitive
Pay Levels and Structures
 Set Competitive Pay Policy

Lead the market with respect to pay

Match average pay of competitors

Lag behind average market pay rates

 Major decisions in setting externally competitive
pay & designing the corresponding pay structures

Some major decisions in pay-level determination

1. Specify pay-level policy
2. Define purpose of survey
3. Specify relevant market
4. Design & conduct survey
5. Interpret & apply result
6. Design grades & ranges or bands
Some major decisions in pay-level determination

1. Specify competitive pay-level policy

Requires information on the external market.
Matching the competition.
Adapting a lead policy.
Following a lag approach.
Surveys provide the data for translating the policy
into pay levels, pay mix, & structure.
Some major decisions in pay-level determination
2. Define purpose of a survey
A survey is the systematic process of
collecting & making judgments about the
compensation paid by other employers.
Aimed at determining prevailing wage rates.
A good salary survey provides specific wage
rates for specific jobs.
Goal of wage surveys is to find data from
employers with whom the organization
competes for employees.
Some major decisions in pay-level determination
2. Define purpose of survey… (Cont.)
Survey data analysis involves comparing going
market rate & approximating this rate within
organization's own pay structure.
Hiring & retaining competent employees.
Promoting worker productivity.
Developing an adequate & acceptable
pay structure.
Recognizing pay trends in the marketplace.
Defending pay practices in a court of law.
Some major decisions in pay-level determination
3. Select relevant market competitors
Specify relevant markets…to make decisions
about pay level, mix, & structures,… a relevant
market must be defined that includes
employers who complete in one or more of the
following areas…
 The same occupations or skills
 Employees within the same geographical area
 The same products & services
Some major decisions in pay-level determination
4. Design the survey
 Who should be involved?
 How many employers?
Publicly available data
 Word of mouse
 Where are the standards?
 Which jobs to include?
 Benchmark-job approach
 Low-high approach
 Benchmark conversation approach
 What information to collect?
 Organisation data
 Total compensation data
 Base pay
 Total cash (base+bonus)
 Total compensation
 Advantages and Disadvantages of
Measures of Compensation
Base Pay Tells how competitors are Fails to include performance incentives
valuing the work in and other forms, so will not give true
similar jobs picture if competitors offer low base
but high incentives
Total Cash Tells how competitors are All employees may not receive
(base + bonus) valuing work; also tells incentives, so it may overstate the
the cash pay for competitors’ pay; plus, it does not
performance opportunity include long-term incentives.
in the job.
Total Tells the total value All employees may not receive all the
Compensation competitors place on this forms. Be careful; don’t set base equal
(base + bonus + work to competitors’ total compensation.
stock options + Risks high fixed costs.
benefits)
 Some major decisions in pay-level determination
5. Interpret survey results & construct a market line
Verify data
Accuracy of match
Anomalies
Statistical analysis
Frequency distribution
Central tendency
Variation
Update the survey data
Construct a market pay line
 A market pay line links a company’s
benchmark jobs on the horizontal axis
(internal structure) with market rates
paid by competitors (market survey) on
the vertical axis. It summarises the
distribution of going rates paid by
competitors in the market.
 Combine Job Evaluation
and Market Survey Data
 Each benchmark job has:
Job evaluation points
An average wage paid by survey companies.
 Scatterplots are useful to see what the data
look like.
 Summarize the data further by fitting a line
through the points  the MARKET PAY LINE
 Can “eyeball” data or use regression
techniques
 Scatterplot
7

SURVEY 6
monthly 5
salary
($000) 4
PAY 3

80 120 160 200 240 280 320 360

OUR Job Evaluation Points

© 2010 McGraw Hill Ryerson

 Scatterplot With
7
Regression Line
6
SURVEY
monthly 5
salary 4
($000)
PAY 3

2 Market Pay Line

1

80 120 160 200 240 280 320 360

OUR Job Evaluation Points

© 2010 McGraw Hill Ryerson

 Adjust Market Data to Reflect Organization’s Pay Policy

Lead the Market:

• pay level above market for the year and equal at year end
• update factor will be equal to the projected market
increase.
Match the Market:
• pay level above market for first half of year and below for
second half.
• update factor will be half of the projected market increase.
Lag the Market:
• pay level below the market for the entire year.
• no adjustment will be made to account for the projected
market increase.
 Developing a Pay Policy Line
lead
match
7
lag
6
OUR
monthly 5
salary
4
($000)
3 Pay Policy Line :
PAY using market-survey data
2 (updated and aged to reflect
Market pay line pay policy)
1 (beginning of year)

80 120 160 200 240 280 320 360

OUR Job Evaluation Points

© 2010 McGraw Hill Ryerson

Some major decisions in pay-level determination
6. Design grades and ranges or bands
 From Policy to Practice: Designing Grades & Ranges
 Why bother with grades & ranges
o Differences in quality (skills, abilities, experience) among
individuals applying for work (e.g., Microsoft may have stricter hiring
requirements for engineers than does HP, even though job descriptions
appear identical)
o Differences in the productivity or value of these variations
o Differences in the mix of pay forms competitors use (Oracle uses
more stock options & lower base compared to IBM)
 Develop grades
 Establish range midpoints, minimums, & maximums
 What size should be the range be?
 Overlap
 Promotion increases matter
Combine Internal Structure and External Market Rates

Two parts of the total pay model have

merged
Internally aligned structure - Horizontal axis
External competitive data - Vertical axis
Two aspects of pay structure
Pay-policy line
Pay ranges
 Pay Structure

 Two components:
 Pay policy line: represents an
adjustment to the market pay line to
reflect the organization’s external
competitive position in the market.
 Pay ranges: upper and lower limits
on pay.
Develop Pay Grades
 From Policy to Practice: Grades and Ranges (cont.)

 Typical range spread

 Top-level management positions – 30 to 60%
above & below midpoint.
 Midlevel professional & managerial positions –
15 to 30% above & below midpoint.
 Office & production positions – 5 to 15% above
& below midpoint.
6. Design grades and ranges or bands…
From Policy to Practice: Broad banding
Broad banding of salary means…
Reducing the many narrow pay grades into
few wide levels.
Which allows employees greater flexibility to
workout the pay range they wish to move
into.
In broad banding employees will have
significant scope for salary increase based on
performance.
From Grades to Bands
 Contrasts Between Ranges and Bands
Ranges Support:
 some flexibility within controls
 relative stable organization
design
 recognition via titles or career
progression
 midpoint controls,
comparatives
 controls designed into system
 give managers “freedom with
guidelines”
 Up to 150 percent range
spread
Bands Support:
 emphasis on flexibility within
guidelines
 global organizations
 cross-functional experience
and lateral progression
 reference market rates,
shadow ranges
 controls in budget, few in
system
 give managers “freedom to
manage” pay
 100 – 400 percent spreads
 Market Pricing
Issues
Validity of market data.
Use of competitors’ pay decisions as
primary determinant of pay structure.
Lack of value added via internal alignment.
Difficult-to-imitate aspects of pay structure
are deemphasized.
Fairness.
 Market Pricing (cont.)
Market pricing: pay strategies that emphasize
external competitiveness and deemphasize
internal alignment.
Sets pay structures almost exclusively on external
market rates.
Objective
Is to base most of the internal pay structure on
external rates, breaking down the boundaries
between the internal organization and the
external market forces.
 Methods of Salary Surveys
Generally three methods are employed for
salary surveys:
Personal Interviews
Mailed Questionnaires
Telephone Inquiries

Formal written questionnaire surveys are the most

comprehensive, but telephone surveys and
newspaper ads are also sources of information.
 Sources for Salary Surveys
Consulting firms
Its difficult to set pay rates if you don’t
know what others are paying, so salary
surveys, surveys of what others are
paying, play a big role in pricing jobs.
Virtually every employer conducts an
informal telephone, newspaper or
internet salary surveys.
 Sources for Salary Surveys…

Professional associations
o Many employers use surveys published by
consulting firms, professional associations, or
government agencies.
o For example the U.S department of Labor's
Bureau of Labor Static's conducts three
annual surveys: (1)area wage surveys; (2)
industry surveys and;(3) professional,
administrative, technical, and clerical surveys.
 Sources for Salary Surveys…

Area wage surveys

o The 200 or so Area wage survey provide salary
data for clerical and manual occupations
ranging from secretary to manager. Area wage
survey also provide data on weekly work
schedules, paid holidays and vacations
practices, health insurance and pension plans.
 Sources for Salary Surveys…

Industry wage surveys

o Industry wage surveys provide similar data,
but by industry.
o They also provide national pay data for
workers in selected jobs for industries like
building, tea plantation, & printing.
 Sources for Salary Surveys…
Internet
o A rapidly expanding array of internet-based
options makes it easy for anyone to access
published compensation survey
information.
oSalary.com
oWageweb.com
oCnnmoney.com
 Critical pay survey problems
1.Obtaining a proper job match.
2.Collecting useful pay data.
3.Ensuring an acceptable sample of organizations & jobs.
4.Relating data to organizational pay policies.
5.Integrating market pay data with internally generated job-
worth data & pay structure design data.
6.Recognizing the goals of pay survey data designers &
implementers.
7.Analyzing & making inferences from collected pay data
8.Recognizing pay as but one component of the total
compensation or even total reward system of the organization.
9.Using third-party data versus performing a survey.
Theories of Wage Determination
 Theories of Wage Determination
There are two key theories to determine wages
1. The traditional theory of wage determination; and
2. The theory of negotiated wages;
1. Traditional theory of wage determination
 This theory assumes that market forces, that is, demand and
supply determine wages.
 Computer programmers are in short supply, so they are able to
command higher salaries. In our country, many organisations pay
very high salaries to entry level.
 IT professionals, who sometimes get more than senior
managerial employees in other sectors. This is because of
demand and supply gap.
 Theories of Wage Determination…

2. Theory of negotiated wages

Union employees can negotiate salaries. This
is done through collective bargaining.
Normally, in any unionized organisations
unions periodically submit their memorandum
to the management, asking for wage raises to
keep pace with market standards and
organisational profitability.
Principles of Compensation Determination
 Principles of Compensation Determination
Subsistence theory (David Ricardo 1772-1832)
Also called as “Iron Law of Wages”
Assumptions
1. Law of diminishing returns apply to the
industry.
2. Population increases or decreases on the
basis of subsistence wages paid to the
workers.
3. Labour demand constant
4. No wage differentials.
 Principles of Compensation Determination
Wages fund theory (Adams Smith 1723-1790)
Wages are paid out of a predetermined fund
of wealth, the surplus savings of the wealthy.
This fund could be utilized for employing
labourers for work.
If the fund was large, wages would be high; if
it was small, wages would be reduced to
subsistence level.
The demand for labour and the level of wages
were determined by the size of the fund.
 Principles of Compensation Determination

Surplus value theory (Karl Marx 1818-1883)

Labour was an article of commerce, which
could be purchased on payment of the
‘subsistence price’.
The price of any product was determined by
labour & time needed for producing it. The
labour was not paid in proportion to the time
spent on work, but was paid much less, & the
surplus was utilized for paying other expenses.
 Principles of Compensation Determination

Residual claimant theory (Francis Walker 1840-1897)

There are four factors of production/business
activity: land, labour, capital &
entrepreneurship.
Wages represent the amount of value created
in the production, which remains after
payment has been made for all these factors
of production. In other words, labour is the
residual claimant.