HR 202 Chapter 02

1. Compensation
Chapter 02
Strategy: The Totality of Decisions
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Similarities and Differences in Strategies
Google, Nucor, and Merrill Lynch are all industry innovators.
• All three have pay strategies that support their business strategies.
Google positions itself as a feisty startup.
Nucor emphasizes high productivity, high quality, and low cost.
Merrill Lynch pay objectives are to attract, motivate, and retain
the best talent.

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Different Strategies within the Same Industry
Google, Microsoft, and SAS focus on different components of
employees’ compensation.
Like Google, Microsoft offered generous stock options, except
employees accepted less base pay.
• More recently, Microsoft scaled back its stock awards, replacing that
with cash but its benefits continue to lead the market.
SAS Institute emphasizes work/life programs over cash
compensation, provides limited bonuses and no stock options.

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Different Strategies within the Same Company
Sometimes units within the same corporation face different
competitive conditions, adopt different strategies, and fit
different compensation strategies.
• SK Holdings have business units as diverse as a gasoline retailer, a cell
phone manufacturer, and SK Construction.
• Different compensation strategies align to each different unit.
A “let the market decide” strategy does not work internationally.
• In many nations, markets do not operate as in the U.S. or may not
even exist.
Strategic perspective on compensation is more complex than it
first appears.

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Strategic Choices
Strategy – the fundamental directions an organization chooses.
At the corporate level, the fundamental strategic choice is:
• What business should we be in?
At the business unit level, the choice shifts to:
• How do we gain and sustain competitive advantage in this business?
At the functional level the strategic choice is:
• How should total compensation help this business gain and sustain
competitive advantage?
A strategic perspective focuses on compensation choices that
help the organization gain and sustain competitive advantage.

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Exhibit 2.2
Strategic Choices

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Support Business Strategy
The greater the alignment between a business strategy and the
compensation system, the more effective the organization.
• A supporting compensation strategy for an innovator, places more
emphasis on incentives encouraging innovations.
• Compensation in a cost cutter strategy encourages productivity
increases.
• The customer focused strategy uses customer satisfaction incentives
in the compensation strategy.
Compensation strategies can be based on generic strategy
frameworks, such as Michael Porter’s strategy framework, or
Miles and Snow’s framework.

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Matching Business Strategy and Pay Strategy
A firm must fashion its own unique way of adding value by
matching its business strategy and pay strategy.
• Companies may have a blend of strategies – innovator, customer
focus, and cost cutter.
If an organization changes it business strategy, the pay systems
should change.
• A redesigned IBM focuses on high-growth, high-value segments of IT.
• To support the new business strategy, the compensation strategy:
• Cut layers of management.
• Redesigned jobs to build in flexibility.
• Increased incentive pay to differentiate on performance.
• Kept a constant eye on costs.

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Support HR Strategy
Researchers Boxall and Purcell found a commonly used
performance theory they refer to as “AMO theory.”
Performance (P) is a function (f) of three factors: ability (A),
motivation (M), and opportunity (O).
Compensation is key to attracting, retaining, and motivating
employees with the abilities necessary to execute the business
strategy.
Compensation strategy and HR strategy are central to successful
business strategy execution.
O)M,(A,fP 

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Exhibit 2.5: Fit between HR Strategy and
Compensation Strategy and Effectiveness

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The Pay Model Guides Strategic Pay Decisions
The five strategic compensation choices facing Whole Foods.
• Objectives – increase shareholder value, satisfy and delight customers,
and seek employees who will help the company make money.
• Internal alignment – store is organized into self-managed teams,
executive salaries capped at 19X average full-time employee pay, and
all full-time employees qualify for stock options.
• External competitiveness – offers a unique total compensation
package compared to competitors.
• Employee contributions – uses a shared fate technique and monthly
performance affects team pay.
• Management – uses a “no-secrets” management technique making
salaries known to all and a “you decide” technique allowing
employees to chose their health insurance.

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Stated versus Unstated Strategies
All organizations have a compensation strategy – some are
shared with all employees.
Some compensation strategies emerge from pay decisions.
Managers in all organizations make the five strategic decisions –
objectives, internal alignment, external competitiveness,
employee contribution, and management.
Some do so in a rational, deliberate way, while others do it more
chaotically.

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Exhibit 2.6:
Key Steps in
Formulating a
Total
Compensation
Strategy

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Total Compensation Strategy: Step One
Step one is to assess total compensation implications.
• Business strategy and competitive dynamics – understand the business.
• HR strategy – pay as a supporting player or a catalyst for change?
• Culture / Values – pay systems mirror image and reputation.
• Social and political context affects compensation choices.
• Employee preferences are easily overlooked.
• Choice is good, up to a point.
• Employees do not always choose well.
• Unlimited choice is near impossible to design or manage and may conflict
with IRS regulations.
• Union preferences – adapt pay strategies to the union-management
relationship.

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Total Compensation Strategy: Step Two
Step two is to map a total compensation strategy using the five
elements of the pay model.
• Assign descriptors to each element and rate from high to low the level
of importance of each descriptor.
The profile on the strategy map reflects a company’s “pay brand.”
• At Microsoft, total compensation is prominent.
• At SAS, total compensation supports a work / life balance.
Strategic maps are a visual reference but do not tell which
strategy is “best.”
Decisions in the pay model work in concert and the totality of
decisions form the compensation strategy.

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Steps 3 and 4: Implement and Reassess
Step three is to implement the strategy through the design and
execution of the compensation system.
• The compensation system translates strategy into practice.
Step four, reassess and realign, closes the loop.
• This step recognizes that compensation strategy must change to fit
changing conditions.
• Periodic reassessment is needed to continuously learn, adapt, and
improve.

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Source of Competitive Advantage: Three Tests
1. Is it aligned?
• Is it aligned with the business strategy? With external conditions?
Internally with the overall HR system?
2. Does it differentiate?
• How is the pay system managed?
• Each strategy is woven into the company’s overall HR strategy.
3. Does it add value?
• Calculate the return on (pay) investments (ROI).

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“Best Practices” versus “Best Fit”
In contrast to the notion of strategic fit, some believe that:
• A set of best-pay practices exists and these practices can be universally
applied across situations.
Guidance from the evidence.
• Both smaller and larger internal pay differences can be a “best practice.”
• Paying higher than competitor’s average can affect results.
• Performance-based pay can affect results.
• Consider all dimensions of the pay strategy together.
• Embedding compensation strategy into HR strategy affects results.
A more useful question is: “What practices pay off best under
what conditions?”

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Virtuous and Vicious Circles
One study reported that while pay levels differed among
companies, they were not related to financial performance.
• Conclusion: it is not only how much you pay but how you pay.
Performance-based pay works best when there is shared success.
• Shared success improves employee attitudes, behaviors, and
performance when coupled with other “high performance” practices.
• When organizational performance declines, performance-based pay
plans do not pay off – with potentially negative effects.
• Unless increased risks are offset by larger returns, the risk-return
imbalance will reinforce declining employee attitudes and speed the
downward spiral.

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Exhibit 2.9: Virtuous and Vicious Circles

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End of Chapter 02.