Compensation an Element of Strategy Management

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CompensationCompensationan Element of Strategy an Element of Strategy

ManagementManagement

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The Pay ModelThe Pay Model

Pay matters

It matters what you pay for

It matters how you pay

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Economic and social pressures are forcing managers to rethink how people get paid and what difference it makes.

Organizations provide individuals with money and other benefits in return for their availability, capacity and performance.

Traditional approaches to compensation are being questioned.

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For organization, the challenge becomes to:

– Plan

– Direct

– Organize

– Coordinate and control financial resources

– Attract

– Retain and motivate the necessary workforce– Ensure the response that will allow the organization to

meet its objectives.

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Hierachy of NeedsHierachy of Needs

Using Maslow’s terminology (1954), for the individual, the importance of compensation is directly related to his or her needs

• Physiological• Safety• Belonging• Self-esteem• Self-actualization

as well as the relative importance of these needs.

In brief, although compensation is not the only benefit an employee gets from the exchange with the organization, it still remains one of the major one.

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Self-Actualization

Ego

Social

Security

PhysiologicalPhysical survival needs

Water, foodSleep, warmth

ExerciseShelter

Decent compensationWorking in acceptable environmental conditions

Need for a safe environment

Need for safetySense of living in

a fair and just societyBuilt a secure living environment

Taking car of its health

Need for development, creativity and achievement

Living in a non-threatening areaJob stabilityBeing informedBe supported whenever necessary

Need for being loved, belonging, inclusion

Feeling dependantObtain a social status

Be integrated in a groupKnowledge of information

Being able to express ideassharing

Belonging to the communityas a whole, as well as to sub-groupwithin the community

Need for self-esteem, power, recognition, prestige

Develop autonomyBe recognized and appreciated

Earn respect of othersExpress opinions

Be different

Well recognized & appreciated work activitiesExpress specific competenciesVaried and innovated tasksManagerial empowermentBe appreciated and acknowledgedTaking part in objective settings

High level of autonomy & maturityMeditation

Deepen know-how & culturePersonal development

Continuous training & own developmentBeing consulted and listen toGives advices on work directionsAble to manage conflictsDecides as a groupBe autonomous

MASLOW’S HIERARCHY OF NEEDS

PRIVATE LIFE PROFESSIONAL LIFE

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SocietySociety

Most employers believe that how people are paid • affects people’s behaviors at work• which affect an organization’s chances of success.

Compensation systems can help an organization achieve and sustain competitive advantage.

Sometimes differences in compensation among countries are listed as a cause of loss of jobs from more developed, higher-wage economies to less developed ones.

Therefore, understanding productivity differences among international locations is crucial.

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Society Society (cont’d)(cont’d)

Some consumers may view increases in compensation as the cause of price increases. They may not believe that higher labor costs are to their benefit.

Economic realities are relevant to compensation management.

– an organization’s capacity to pay– its industrial sector– as well as geographic location

are all key factors that must be considered.

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An organization’s economic reality is not static

– Today’s decisions about compensation will have an impact on the organization’s financial health for many years and, generally, this impact is difficult to reverse.

Employees have varied needs and view them differently

– The challenge for the organization therefore is to adopt compensation policies and programs that maximize employee motivation.

Compensation is also status, both within the organization and in society.

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Supervisors consider it important to be paid more than their subordinates, and on a different basis.

The same applies to the various perquisites an organization provides to certain employees.

– Often, what counts with such benefits is not their monetary

value but rather the prestige and status they confer.

Organization and individuals pursue different objectives by means of compensation.

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For the organization– the exchange is designed to recruit and retain the

necessary labor, and to elicit employees behavior that will enable it to fulfill its mission.

For individuals– the objective may come down to satisfying needs.

These may differ considerably from one individual to another and may also change with time.

Compensation is a contribution for the organization, a reward for the individual.

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StockholdersStockholders

To stockholders, executive pay is of special interest.

Linking executive pay to company performance is supposed to increase stockholders’ wealth.

Unfortunately, this does not always happen.

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For managers, compensation influences their success in two ways:

1. It is a major expense.

– Competitive pressures, both internationally and domestically, force managers to consider the affordability of their compensation decisions.

– Labor costs can account for more than 50 percent of total costs.

– Unlike other production factors, the organization cannot calculate the cost-effectiveness of this investment with the same degree of accuracy.

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Labor CostsLabor Costs

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For managers, compensation influences their success in two ways:

2. In addition to treating pay as an expense, a manager also uses it to influence employee behaviors and improve organization performance.

The way people are paid affects

– the quality of their work; – their attitude toward customers; – their willingness to be flexible, learn new skills, or

suggest innovations.

People may become interested in unions or legal action against their employer based on how they get paid.

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The Importance of CompensationThe Importance of Compensation

Impacts an employer’s ability to attract and retain employees.

Ensure optimal levels of employee performance in meeting the organization’s strategic objectives.

Compensation’s components• Direct compensation in the form of wages or salary

– Base pay (hourly, weekly, and monthly)– Incentives (sales bonuses and or commissions)

• Indirect compensation in the form of benefits– Legally required benefits (e.g., Social Security)– Optional (e.g., group health benefits)

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The Elements of CompensationThe Elements of Compensation

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Organizations regularly adjust pay. This is done by taking into account many factors, such as :

– changes in the economy

– the amount of the changes made by other organizations in the community or similar labor market

– the organization’s ability to pay

– as well as any increase in an employee’s performance or year of service

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Sometimes a hardship premium is added to the base pay i.e.

– overtime premium– premiums working with hazardous goods– shift premium– premiums working under difficult situation– distance premium– call-back premium– weekend/holiday work premium– standby premium

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Cash Compensation – BaseCash Compensation – Base

Base wage is the cash compensation that an employer pays for the work performed.

Base wage tends to reflect the value of the work or skills and generally ignores differences attributable to individual employees.

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Cash Compensation – Merit Pay/COL adjustmentsCash Compensation – Merit Pay/COL adjustments

Merit pay increases are given as increments to the base pay in recognition of past work behavior.

– Some assessment of past performance is made, with or without a formal performance evaluation program, and the size of the increase is varied with performance.

– Thus, outstanding performers could receive an 8 to 10 percent merit increase 8 months after their last increase,

– whereas an average performer may receive, say, a 3 to 4 percent increase after 12 or 15 months.

In contrast to merit pay, cost-of-living adjustments give the same percent increase across the board to everyone, regardless of performance.

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Cash Compensation – IncentivesCash Compensation – Incentives

Incentives tie pay increases directly to performance

However, incentives differ from merit adjustments.– First, incentives do not increase the base wage, and so must

be re-earned each pay period.– Second, the potential size of the incentive payment will

generally be known beforehand.

Whereas merit pay programs evaluate – past performance of an individual – and then decide on the size of the increase

the performance objective for incentive payments is called out very specifically ahead of time.

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Cash Compensation – IncentivesCash Compensation – Incentives

Incentives can be tied to :

– the performance of an individual employee– a team of employees– a total business unit– or some combination of individual, team, and unit

The performance objective may be :

– expense reduction– volume increases– customer satisfaction– revenue growth– return on investments– or increases in total shareholder value

the possibilities are endless.

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Long-Term IncentivesLong-Term Incentives

Long-term incentives are intended to focus employee efforts on multiyear results.

Typically they are in the form of stock ownership or options to buy stock at specified, advantageous prices.

Stock options straddle the categories of cash compensation and benefits.

– Some argue that they are not compensation at all, that they are more accurately described as an ownership share granted by owners to employees.

The idea behind stock options is that employees with a financial stake in the organization will focus on long-term financial objectives:

– return on investment, market share, return on net assets, and the like.

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Benefits – Income ProtectionBenefits – Income Protection

Benefits, including – income protection– work/life balance services – and allowances

are also part of total compensation

Some income protection programs are legally required. Different countries have different lists of mandatory benefits

– medical insurance– retirement programs– life insurance– and savings plans

are common benefits. They help protect employees fromthe financial risks inherent in daily life.

Because the cost of providing benefits has been rising, they are an increasingly important form of pay.

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Benefits – Work/Life FocusBenefits – Work/Life Focus

Programs that help employees better integrate their work and life responsibilities

– include time away from work (vacations, jury duty)

– access to services to meet specific needs– i.e.drug counseling– financial planning– referrals for child and elder care

– Working hours

– and flexible work arrangements.

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Benefits – Allowances Benefits – Allowances

Allowances often grow out of whatever is in short supply.

– Housing and transportation allowances are frequently part of the pay package.

Companies that resist these allowances must come up with other ways to attract and retain talented employees.

– In many European countries, managers assume that a car will be provided

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PerquisitesPerquisites

There are various forms of perquisites (perks).

They tend to be tax effective even though they are becoming less and less attractive due to some tax harmonization (especially in Europe).

Some organizations provide

– cars for certain employees (very popular in the UK), parking– Meals– tuition fees– financial advice– employee’s assistance programs– tax effective representation allowances.

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Total Earnings OpportunitiesTotal Earnings Opportunities

Compensation decisions have a temporal effect.

– Say you have a job offer of $50,000.

– If you stay with the firm five years and receive an annual increase of 4%, in five years you will be earning $60,833 a year.

– The expected cost commitment of the decision to hire you turns out to be $331,649 in cash.

If you add in an additional 25% for benefits, the decision to hire you implies a commitment of over $400,000 from your employer.

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Total Earnings OpportunitiesTotal Earnings Opportunities

A present-value perspective shifts the comparison of today’s initial offers to consideration of future bonuses, merit increases, and promotions.

Sometimes a company will tell employees that its relatively low starting offers will be overcome by larger future pay increases and bonus payouts.

In effect, the company is selling the present value of the future stream of earnings.

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Non-financial ReturnsNon-financial Returns

There is no doubt that non-financial returns from work have a substantial effect on employees’ behavior

• Relational returns from work as

– recognition and status– employment security– challenging work– and opportunities to learn

are other factors affecting people’s decisions about work.

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Non-financial ReturnsNon-financial Returns

Other relational forms might include

– personal satisfaction from successfully facing new challenges

– teaming with great co-workers– receiving new uniforms, and the like.

Such factors are part of the total return, which is a broader umbrella than total compensation.

Compensation is only one of many.

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Employment RelationshipsEmployment Relationships

Organizations that pay low cash compensation and offer low relational returns are in the “workers as commodity” category.

These organizations view labor as input into the production process. In the United States, employers of migrant workers may offer this type of deal.

Organizations that offer both high compensation and high relational returns may be characterized as cult-like. Microsoft, Medtronic, and Toyota are examples.

The strong commitment to the organization shows in the words and actions of employees: “being at the center of technology”, having an impact on the work, working with smart people, the sheer volume of opportunities, shipping winning products, beating competition.

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Some organizations offer a “family” relationship: high relational and low transactional returns.

Starbucks is an example; one writer calls it the “touchy-feely coffee company”.

Finally, there are the “hired guns”—all-transactional, “show-me-the-cash” relationships.

Brokerage houses, real estate firms, and auto dealerships fit this category.

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Compensation Management ModelCompensation Management Model

Compensation techniques and practices are not developed in the abstract. They are founded on a set of objectives and policies based on

– the nature of the individual, – the organization or the environment in which individual and

organization evolve.

Objectives are what the organization is trying to achieve through various compensation systems

Policies are the foundation for managing such a system

Techniques and practices represent the means available to the HR specialist for achieving the desired results in accordance with developed policy.

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ObjectivesObjectives

Setting compensation objectives is important for two reasons:

1. the objectives are guides for developing necessary policies and practices

– wishing to motivate the workforce to improve productivity should consider using merit increase and various performance bonus systems.

– wishing to emphasize workforce stability, more weight on the fix portion of cash compensation, offering relatively high salaries in comparison to its reference market.

2. objectives are ideal criteria for assessing the effectiveness of practice.

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ObjectivesObjectives

The relative importance assigned to each objective may vary from one employer to the next and from one job category to the next.

• In diversified organizations, objectives may even vary from one unit to the next.

Because of the multiplicity of these objectives, not all can be achieved; compensation management always involve a compromise. These compromises represent strategic choices.

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PoliciesPolicies

Four Policies

Every employer must address the policy decisions :

– (1) internal alignment– (2) external competitiveness– (3) employee contributions, and– (4) management of the pay system.

These policies are the foundation on which pay systems are built. They also serve as guidelines for managing pay in ways that accomplish the system’s objectives.

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Policies - Internal AlignmentPolicies - Internal Alignment

Internal Alignment

Internal alignment refers to comparisonsamong jobs or skill levels inside a single organization

Jobs and people’s skills are compared in terms of

their relative contributions to the organization’s business objectives

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Policies - Policies - External CompetitivenessExternal Competitiveness

External Competitiveness

External competitiveness refers to compensation relationships external to the organization:

– comparison with competitors.

Increasingly, organizations claim their pay systems are market-driven, that is, based almost exclusively on what competitors pay

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Policies - Policies - External CompetitivenessExternal Competitiveness

Employee Contributions

– How much emphasis should there be on paying for performance?

– Should one programmer be paid differently from another if one has better performance and/or greater seniority?

– Or should there be a flat rate for programmers?

– Should the company share any profits with employees?

– With all employees?

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Policies - ManagementPolicies - Management

Management

Ensuring that the right people get the right pay for achieving objectives in the right way. The system will not achieve its objectives unless it is properly managed.

• Are we able to attract skilled workers?

• Can we keep them? Do our employees believe our pay system is fair?

• Do they understand what is expected of them?

• Do they understand how their pay is determined?

• How do the better-performing firms, with better financial returns and a larger share of the market, pay their employees?

• Are the systems used by these firms different from those used by less successful firms?

• How do our labor costs compare to those of our competitors?

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Techniques - Internal ConsistencyTechniques - Internal Consistency

Internal Consistency

An organization trying to ensure internal consistency in compensation must :

• first analyze and describe its jobs, then either :

– evaluate the jobs

– do a competency & skill job assessment

– a maturity curve approach (applicable for certain group of professionals)

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Techniques - CompetitivenessTechniques - Competitiveness

Competitiveness

An organization interested in making its pay competitive must first define its labor market Domestic and international for senior management).

Having selected the market or markets, the next step is to collect information about the various elements of compensation.

– Base salary?– Total Cash?– Working time?– Time off?– Benefits?– Other perks and allowances?

Once the survey or surveys have been done, the organization must determine the level of compensation in relation to the market.

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Techniques - Employee ContributionTechniques - Employee Contribution

Employee Contribution

An organization that wishes to recognize the contribution of its employees may use techniques and practices that vary according to what contribution it wishes to emphasize

– individual performance– group performance– years of services– training

The organization must develop an employee performance appraisal system and determine criteria for measuring individual performance

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Example: The Strategic Compensation Example: The Strategic Compensation Decisions Facing StarbucksDecisions Facing Starbucks

1.1. Objectives:Objectives: How should compensation support business strategy and be adaptive to the cultural and regulatory environment?

Starbucks objectives:Starbucks objectives: • Grow by making employees feel valued.• Recognize that every dollar earned passes through

employees’ hands.• Use pay, benefits, and opportunities for personal

development to help gain employee loyalty and become difficult to imitate.

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Example: The Strategic Compensation Example: The Strategic Compensation Decisions Facing Starbucks Decisions Facing Starbucks (continued)(continued)

2.2. Alignment:Alignment: How differently should the various types and levels of skills be paid within the organization?

Starbucks:Starbucks:• De-emphasize differences.• Use egalitarian pay structures, cross-train

employees to handle many jobs, and call employees partners.

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3.3. Competitiveness:Competitiveness: How should total compensation be positioned against our competitors? What forms of compensation should we use?

Starbucks:Starbucks:• Pay just slightly above other fast-food employers.• Provide health insurance and stock options for all

employees (including part-timers).• Give everyone a free pound of coffee every week.

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4.4. Contributions: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 on each business unit’s performance?

Starbucks:Starbucks:• Emphasize team performance and shareholder

returns.• For new managers in Beijing and Prague, provide

training opportunities in the U.S.

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5.5. Administration:Administration: How open and transparent should pay decisions be to all employees? Who should be involved in designing and managing the system?

Starbucks:Starbucks:• As members of the Starbuck’s “family,” our

employees realize what is best for them.• Partners can and do get involved.

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OutcomeOutcome

Too often, case studies, benchmarking studies of best practices, or consultant surveys are presented as studies that reveal cause and effect

They are not

Just because the best-performing companies are using a practice does not mean the practice is causing the performance.

IBM provides an example of the difficulty of deciding whether a change is a cause or an effect. For a long time IBM pursued a no-layoff policy. Clearly, that policy did not cause the value of IBM stock to increase or improve IBM’s profitability. Arguably, it was IBM’s profitability that enabled its full-employment policy.

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OutcomeOutcome

Compensation research often attempts to answer questions of causality.

• Does the use of performance-based pay lead to greater customer satisfaction, improved quality, and better company performance?

Causality is one of the most difficult questions to answer and continues to be an important and sometimes perplexing problem for researchers.

Compensation techniques and practices sometimes prove to be so fascinating and complex that we lose sight of their objective.

This is one of the greatest risks facing the compensation professional. The technique becomes an end in itself.

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OutcomeOutcome

In contrast to the past

• today’s compensation specialist should not only master the content of various techniques in the field,

– but should also be a management expert

– have an in-depth knowledge of the nature of the organization and the environment in which it operates

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Best Fit vs Best PracticesBest Fit vs Best Practices

A strategic perspective on compensation takes the position that how employees are compensated can be a source of sustainable competitive advantage.

Two alternative approaches are highlighted:• A “best fit” / contingent business strategy /

environmental context approach; and• A “best practices” approach.

The “best fit” approach presumes that one size does not fit all. The art of managing compensation strategically involves fitting the compensation system to the different business and environmental conditions.

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Best Fit vs Best PracticesBest Fit vs Best Practices(continued)(continued)

The best practices approach assumes that there exists a universal, best way.• The focus is not on the question of what the best strategy

is, but how best to implement the system.• Agreement on what are the best practices does not exist.

The four-step process for forming and implementing a compensation strategy includes:• Assessing conditions• Deciding on the best strategic choices following the pay

model• Implementing the strategy through design of the pay

system• Reassessing the fit

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Recent studies have begun to research what aspect of the compensation system really does matter, but the answer is still fuzzy.

An essential point is that the deal (the employment relationship) includes both transactional and relational forms of compensation.

It is the total deal, the relationship with people, that makes an organization successful.

Best Fit vs Best PracticesBest Fit vs Best Practices(continued)(continued)

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Current Compensation TrendsCurrent Compensation Trends

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Profile of the IndividualProfile of the Individual

Cash reward level and perception varies based on the following criteria :

• The age and experience of the incumbent

• The level of education

• The geographical location

• The market sector

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Age and Experience factors

• Starting career with basic education– High supply market– Low bargaining level– Straight salary approach (except sales jobs)– Salary levels usually established by collective

agreements

• Starting career with professional education– Same as above, however with a better bargaining

level– Salary levels are less confined

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• Mid career with basic education– Competitive market– Still low bargaining level unless acquired new specialized

skills– Straight salary approach (except sales jobs)– Salary levels usually established by collective agreements

• Mid career with professional education– High demand for high performers– Top reward environment– Salaries highly negotiable– Cash incentive highly utilized– Deferred incentive considered

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• End career with basic education– Highly competitive market– Little bargaining level unless acquired highly specialized

skills– Some Cash incentive opportunities

• End career with professional education– High demand for top performers– High visibility– Lower bargaining power– Salaries less negotiable– Cash incentive highly utilized– Deferred incentive highly considered

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Geographical LocationGeographical Location

Salary levels and job opportunities for qualified employees

Salaries Opportunities

North America +++++ +++Europe ++++ ++Eastern Europe ++ +++Asia Pacific ++ ++++Latin America ++ +++ME +++ +++Africa + ++

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Market SectorMarket Sector

Salary aggressiveness

Salary levels

Financial/Trading +++++Pharma/Bio medical ++++Oil/Chemicals ++++Fast Consumer Goods ++++High Tech/Telecom +++Industrial Goods ++Services ++

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How to motivate employeesHow to motivate employees

To remunerate managers in a competitive way based on their responsibilities as well as their individual performance

• Establish a coherent salary structure (external equity)

• Create an internal equity within a competitive market environment

• Establish a link between individual performance and the job requirement

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Reward SystemReward System

Reward SystemReward System

Job AnalysisJob Analysis

Jpb EvaluationJpb Evaluation

Managing BasePay

Managing BasePay

Job DescriptionJob Description BenefitsBenefits

Working conditionsWorking

conditions

Variable PayVariable Pay

RecognitionAwards

RecognitionAwards

Long-termIncentivesLong-termIncentives

RecruitmentRecruitment

Training & Dev’mtTraining & Dev’mt

Perf. evaluationPerf. evaluation

HR PlanningHR Planning

Selection & HiringSelection & Hiring

Career planningCareer planning

Documents

Compensation an Element of Strategy Management