Strategic Uses of

Compensation
Practices

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 Key Issues and Questions
 What events in recent years have influenced the
way organizations compensate their employees?
 What is organizational strategy and why is it
important to align compensation with it?
 How have downsizing and reorganization affected
compensation practice
 How might compensation be used as a device for
implementing business strategy
 How might pay be used as a lag system? As a lead
system
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 Introduction : The Strategic
Imperative
Three events have contributed to business
environment changes:
– Increased domestic and international
competition
– A shift from manufacturing to a service
economy
– Response to these changes by many firms that
includes downsizing and restructuring
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 Competition
Increased competition has forced organizations
to look more carefully at three dimensions :
1. Efficiency in producing goods and services
2. Product and service quality
3. Customer service
The only way to meet this new competition is
to develop and implement business plans that
will improve productivity, quality and customer
service.

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 The Shift to Services
 A dramatic shift from manufacturing based
economy to a service economy. E.g.“Mc Donalds has more
employees than Krakatau Steel.

 The difference between selling services and

selling manufactured products.
 When companies sell a service, in contrast, they
are selling an intangible.
 The major thing a service provider sells is the
performance of the person delivering the service.
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 The Shift to Services
Traditional Economy Service Economy
Tangible Products Intangiables Services
Selling stand-alone products Selling individual performance
Focus on product characteristic Focus on customer needs
Service is a cost and chore Service is a startegy

Margin of
discretionary
performance
(percents)

Peak

Acceptable
Manufacturing Service

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Compensation :
An Implementation Strategy
Strategic Challenges :
1. The need to compete with discretionary effort in
service performance
2. The need to relate labor costs to revenues –
productivity
3. The need to stop treating compensation as sunk
costs
4. The need to treat compensation dollars as
investments for leveraging results related to
strategic plans
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 Element of Compensation
Element Employee Organization
Interest Interest
Base Pay Provide standard of Manage external and
living internal equity –
attract and retain
employees
Employee Benefits Protect standard of Attract and retain
living employees
Short-term incentives Prospect of more Motivate effort and
income for more direct behavior
effort
Long-term incentives Capital accumulation/ Encourage long-term
estate building view/
commitment/retentio
n of valued 8
Pay as lead System has four
potential advantages
1. Pay can be used to communicate business plans
2. Pay can be used to articulate unit, group, and
individual performance objectives in terms of
business plans
3. Pay establishes incentives for employees and
groups to change current practices and adopt
new ones
4. Pay communicates management’s intentions

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Pay as lag System has four
potential advantages
1. Pay reinforces individual and group
performance required by business plans.
2. Pay rewards discretionary effort
3. Pay shares returns from productivity
improvements and long-run goal
achievement.

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Alternative Compensation
Strategies
1. Performance-based pay
2. Merit awards or incentives not tied to base pay
3. Lump-sum bonuses
4. Gain sharing plans
5. Skill/Competency based pay
6. Profit-sharing plans
7. Cafeteria plans

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 Performance-based pay
Adjustments to pay are based on indivi-
dual or group performance and are not
granted simply because of organizational
membership or time with the employer.

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Merit awards or incentives not
tied to base pay
Adjustments to pay must be earned through
performance and are not rolled into base
pay. Thus, they must be re-earned each
year and do not constitute a payment into
the future.

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 Gain sharing Plans
Any gain in actual dollars or hours within
the standard goal that has been set is
shared with workers in the form of gain
sharing cash bonuses.

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 Lump-sum bonuses

Merit or incentive awards are granted on a one-

time “lump sum” basis are not distributed in the
form of weekly or monthly pay checks.

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 Skill/Competency based pay

Pay-for-knowledge plans create incentives for

workers
To learn more than one task or position in a plant.
Skill based pay systems set higher level rates of each
new task or position that is mastered. The highest rate
is achieved once all positions are learned.

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 Profit-sharing plans
These plans establish profit goals for the
organization and set aside share of all
profits exceeding the goal into a pool that
is distributed back in the from of bonuses
to employees.

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 Cafeteria plans
These are compensation plans that allow
employees individual flexibility in their
choices among benefit plan elements.
Some cafeteria plans are total
compensation plans, in that the employee
can pool dollars going into both direct pay
and benefits.

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 Corporate Strategy and
Compensation Fit
Business plans often contain elements :
 Financial objectives
 Market share objectives
 Growth objectives
 An organization design specifying units,
each with performance objectives derived
from the business plan.
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Corporate Strategy and
Compensation Fit
Business Compensation
Strategy Fit Design

Performance
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 Four question
1. To what extent are organizations using
alternative compensation design?
2. Are there any risks associated with such
designs?
3. Is there any evidence that companies currently
adapt compensation designs to their strategies?
4. Is there any evidence that companies that do so
perform better than those that do not?

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Risks and Benefits of alternative
Compensation Designs
Low Incentive Pay High

high

At risk

Base Pay

Entitlement

Low

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Matching Compensation Design
with Business Strategy
 Definitions of Compensation Practices
 Strategic Business Units Types
 Compensation Design
– Pay/Strategy Fit:Compensation Design
– Pay/Strategy Fit:Compensation
Administration
 Emerging Compensation Issues

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Definitions of Compensation Practices
Compensation
Characteristic
Design Elements
1. External/Internal
Equity Emphasis
2. Individual pay participation
(Individual equity)
3. Pay adjsutment policy
Administrative Elements
4. Participation in Design
5. Participation in
Administration
6. Centralization/
decentralization
7. Communication
8. Formalization/standardization
Issue
Relative importance placed on-external
market compettiton versus internal job
value relationships
Relative emphasis placed on entitlement
based on membership versus merit
based on performance in setting
Individual pay rates
Relative empahsis on ability to pay
(productivity) versus broader business
plan performance
Degree to which employees are involved
in the design of pay system
Degree to which employees are involved
in administering pay practices
Degree to which pay design and
adminsitration are allowed to vary
across organizational units
Degree of openness and disclosure about
pay plan design and admnistration
Degree to which pay practices are
constrained by explicit rules and
guide lines.
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Strategic Business Unit Types
Defender Prospector Analyzer

Product market Narrow, stable Changing product Characterized by

Definition market; market emphasis; mixed strategy
market concerned search for new
with protecting market; focus on
market share innovation

Technology Single core Multiple Prototype Single core

technology; tehnologies; invest technology;
investment in more in people than and investment in
improvements in machines people

Management Dominated by Tends to change Dominated by

production, often; dominated marketing &
finance types by marketing & research relatively
R&D types stable

Design/ Functional Product centered Divisionalized or

Administration Dividion of labor; division of labor matrix structure
highly formal. few formal rules combined of
market relatively structured and
open. centralized formal
work

Performance Criteria Promotion based Performance Performance

on past performance measured against measured on
cost and budget market outcomes combination
viz competitors of cost market
outcomes.

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 Compensation Design

Pay/Strategy Fit : Compensation Design

Issue Defender Prospector

Market versus internal equity Internal External
Award Basis Entitlement Performance
At-risk earnings Productivity Business Plan
performance

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 Compensation Design

Pay/Strategy Fit : Compensation Administration

Issue Defender Prospector

Communication Low High
Participation/Involvement Low High
Standardization-pay adjsutments Low High
Standardization-administration High Low
Centralization High Low

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Emerging Compensation Issues

Emerging Pay Strategy

Pay Issue From to

Base pay Large % Small %
Incentive/Trigger Budgets Business Plan performance
Incentive/earnings Small % Large %
Pay determination Emphasis on the job Emphasis on the individual

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Emerging Compensation Issues

Emerging Pay Methods Issues

Issue From to
Communication Secret Open
Design Top Down Broad involvement
Design Traditional Strategy Driven
Pay mix Standard Choice

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