Ch 2 Compensation

1. Because learning changes everything.®
Chapter 2
Strategy: The Totality of
Decisions
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

2. © McGraw-Hill Education
Similarities and Differences in Strategies
Google, Nucor, and Merrill Lynch are all innovators in their industry.
• All three formulate their pay strategy to support their business strategy.
• All emphasize outstanding employee performance and commitment.
However, there are major differences.
• Google positions itself as a start-up but offers generous stock options
and benefits that go beyond the norm.
• Nucor Steel emphasizes high productivity, quality and low cost with
bonuses that raise wages above average, and no layoffs.
• Merrill Lynch relies heavily on human capital and pays to attract,
motivate, and retain the best talent.
2

3. © McGraw-Hill Education
Different Strategies within the Same Industry
Google, Microsoft, and SAS all compete for software engineers and
marketing skills but they focus on different components of compensation.
• Google believes strongly in pay for performance as a small percentage
of employees create a large percentage of value.
• Microsoft scaled back its stock awards, replacing that with cash – in
order to retain top talent.
• SAS Institute emphasizes work/life programs over cash compensation
and provides limited bonuses and no stock awards.
3

4. © McGraw-Hill Education
Different Strategies within the Same Company
Sometimes different business units face different competitive conditions,
adopt different business strategies, and fit different pay strategies.
• The Korean company SK Holdings has much variety in its business
units.
• SK has different compensation strategies aligned to each of its very
different businesses.
A simple “let the market decide our compensation” strategy does not work
internationally.
• In many nations, markets do not operate as in the U.S. or may not
even exist.
• Some emerging labor markets and highly regulated labor markets
means less movement of people among companies.
4

5. © McGraw-Hill Education
Different Strategies within the Same Company (between
business units/market)
When business strategies change, pay systems should also change.
For years, IBM placed strong emphasis on internal alignment.
• Then IBM shifted its focus away from personal computers to “high-
growth, high value segments of the IT industry.”
• The new business strategy meant a new compensation strategy.
• They cut layers, redesigned jobs, increased incentive pay, all with an
eye to keeping costs low.
• So far, the strategy has not worked.
Microsoft made more gradual changes in its business strategy and how it
changed its compensation strategy to support those changes.
• Its stock price performance far exceeded the broader market.
5

6. © McGraw-Hill Education
Strategic Choices
Strategy refers to
the fundamental
directions that an
organization
chooses.
Access text alternative for this image.
6

7. © McGraw-Hill Education
Support Business Strategy
A current popular theory leads managers to align pay systems with the
organization’s business strategy.
• Compensation that supports an innovator strategy places less
emphasis on evaluating skills/jobs and emphasizes incentives.
• The cost cutter focuses on efficiency and increased productivity, so
their system details steps in a job and uses variable pay.
• The customer focused strategy stresses delighting customers and
bases employee pay on how well they do this.
Most firms have aspects of cost and innovation.
• Compensation strategies may not line up neatly with generic strategies.
To do better than competitors, a firm must consider its own unique way of
adding value through matching its business strategy and pay strategy.
7

8. © McGraw-Hill Education
Support HR Strategy
A compensation strategy that supports the business strategy implies
alignment between compensation and overall HR strategies.
• The AMO theory states that performance (P) is a function (f) of three
factors: ability (A), motivation (M), and opportunity (O).
P = f (A, M, O).
Compensation strategy and HR strategy are central to successful
business strategy execution.
Horizontal Fit: fit of compensation strategy with overall HR strategy.
Vertical Fit: fit of compensation strategy and HR strategy with business strategy.
Access text alternative for this image.
8

9. © McGraw-Hill Education
The Pay Model Guides Strategic Pay Decisions
Using the pay model, these are the five strategic compensation choices
managers face.
• Objectives: How should compensation support business strategy and
adapt to the cultural and regulatory pressures in a global market?
• 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 stack up
against competitors? What forms of compensation should be used?
• 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 on each business unit’s performance?
• Management: How open and transparent should pay decisions be?
Who should be involved in designing and managing the system?
9

10. © McGraw-Hill Education
Stated versus Unstated Strategies
All organizations that pay people have a compensation strategy.
• Some have a written strategy shared with all employees.
The compensation strategy of other organizations emerges from the pay
decisions they make.
• Some comprise a strategy in a rational, deliberate way.
• While others do it more chaotically.
10

11. © McGraw-Hill Education
Developing a Total Compensation Strategy: Four Steps
Access text alternative for this image.
11

12. © McGraw-Hill Education
Step 1: Assess Total Compensation Implications
Think about any organization’s past, present, and future.
• What factors in its business environment have contributed to the
company’s success?
• Which of these factors are likely to become more (or less) important as
the company looks ahead?
This first step includes an understanding of the specific industry in which
the organization operates and how the organization plans to compete.
• Learn to gauge the underlying dynamics in the business (or build
relationships with those who can).
• Different compensation strategies must align with different business
strategies.
• Competitive dynamics can be assessed globally but managers must
be knowledgeable about all competitive conditions, even locally.
12

13. © McGraw-Hill Education
Step 1: Assess Total Compensation Implications HR Strategy
Pay can be a supporting player, as in the high-performance approach, or
it can take the lead and be a catalyst for change.
• A pay system reflects the values that guide an employer’s behaviors
and underlie its treatment of its employees.
• Context refers to a wide range of factors and remember that
governments are major stakeholders.
• A major challenge is how to better satisfy individual needs—offering
more choice is one approach, but may just cause confusion.
• Pay strategies need to be adapted to the nature of the union-
management relationship.
13

14. © McGraw-Hill Education
Step 2: Map a Total Compensation Strategy
A compensation strategy is formulated
based on the five elements of the pay
model.
• Mapping is often used in marketing
to clarify and communicate a
product’s identity.
• Each company’s profile on the
strategy map reflects its main
message or “pay brand.”
• Strategic maps provide a visual
reference.
• It is the totality of the decisions that
forms the compensation strategy.
Access text alternative for this image.
14

15. © McGraw-Hill Education
Steps 3 and 4: Implement and Reassess
Step 3 is to implement the strategy through the design and execution of
the compensation system.
• The compensation system translates strategy into practice.
Step 4, reassess and realign, closes the loop.
• This step recognizes that the compensation strategy must change to fit
changing conditions.
• Thus, periodic reassessment is needed to continuously learn, adapt,
and improve – assess against the objectives to be achieved.
15

16. © McGraw-Hill Education
Source of Competitive Advantage: Three Tests Align
Alignment of the pay strategy includes three aspects.
• Align with the business strategy.
• Align externally with the economic and sociopolitical conditions.
• Align internally with the overall HR system.
16

17. © McGraw-Hill Education
Source of Competitive Advantage: Three Tests Differentiate
Some believe that the only thing that really matters about a strategy is
how it is different from everyone else’s.
• If the pay system is relatively simple for any competitor to copy, then
how can it possibly be a source of competitive advantage?
• The answer according to the advocates of the strategic approach, is in
how the pay system is managed.
It is difficult to imitate the compensation strategy of another since each
strategy is woven into the fabric of a company’s overall HR strategy.
• As the strategic perspective implies, it is the way programs fit together
and fit the overall organization that is difficult to copy.
17

18. © McGraw-Hill Education
Source of Competitive Advantage: Three Tests Add Value
Compensation is often a company’s largest controllable expense.
• The task is to come up with ways to calculate the return on those
investments (ROI).
• Trying to measure an ROI for any compensation strategy implies that
people are “human capital.”
Are there advantages to an innovative compensation strategy?
• In products and services, first movers (innovators) have well-
recognized advantages that can offset the risks involved.
• But, it is not yet proved whether such advantages accrue to innovators
in total compensation.
18

19. © McGraw-Hill Education
“Best Practices” versus “Best Fit”
The premise of any strategic perspective is the following.
• If managers align pay decisions with the organization’s strategy and
values,
• Are responsive to employees and union relations,
• And are globally competitive,
• Then the organization is more likely to achieve competitive advantage.
In contrast to the notion of strategic fit, some believe a set of best-pay
practices exists.
• And these practices can be applied universally across situations.
• They say that best practices result in better performance with almost
any business strategy.
19

20. © McGraw-Hill Education
Guidance from the Evidence
Internal alignment.
• Smaller internal pay differences and larger internal pay differences can both be
a “best” practice.
External competitiveness.
• Is higher competitive pay a “best” practice? Depends on content.
Employee contributions.
• Evidence is strong that pay-for-performance of some form is likely to be more
effective than when pay is independent of performance.
Managing compensation.
• All dimensions need to be considered together.
Compensation strategy.
• Compensation does not operate alone; it is part of the overall HR perspective.
20

21. © McGraw-Hill Education
Virtuous and Vicious Circles
One study says it is not only how much you pay but also how you pay.
• Think of pay as part of a circle.
• Other studies support improved performance and the virtuous circle.
• This leads to how circles can also gain downward momentum to
become a vicious circle.
Access text alternative for this image.
21

22. Because learning changes everything.®
www.mheducation.com
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.