The pay model shown in Exhibit 1.5 serves as both a framework for examining current pay systems and a guide for most of this book. It contains three basic building blocks (1) the compensation objectives, (2) the policies that form the foundation of the compensation system and (3) the techniques that make up the compensation system.
Pay system translate the strategy into practice in order to achieve certain objectives. The basic objectives, shown at the right side of the model, include efficiency, fairness, and compliance with laws and regulations.
Efficiency can be stated more specifically: (1) improving performance, increasing quality, delighting customers and stockholders, and (2) controlling labor costs. Compensation objectives at Medtronic and AES are contrasted in Exhibit 1.6. Medtronic is a medical technology company that pioneered cardiac pacemakers. Its compensation objectives emphasize performance, business success, and salaries that are competitive with other companies whose financial performance matches Medtronic’s.
AES generates and markets electricity around the world. Its goal is to “provide electricity worldwide in a socially responsible way.
” The notion of social responsibility pervades the company. Fairness is a fundamental objective of pay systems. In Medtronic’s objectives, fair-.ness means “ensure fair treatment” and “be open and understandable.”.AES’s mission statement acknowledges, “Defining what is fair is often difficult, but we believe it is helpful to routinely question the relative fairness of alternative courses of action. It does not mean that everyone gets treated equally, but instead treated fairly or with justice given the appropriate situation.”
Thus, the fairness objective calls for Fail treatment for all employees by recognizing both employee contributions (e.
g. higher pay for greater performance, experience, or training) and, employee needs (e.g. a fair wage as Weil as fair procedures). Procedural Fairness refers to the process used to make pay decisions. It suggests that the way a pay decision is made may be as important to employees as the results of the decision. Compliance as a pay objective means conforming to federal and state compensation laws and regulations. If they change, pay systems may need to be adjusted to ensure continued compliance.
There are probably as many statements of pay objectives as there are employers. In fact, highly diversified firms such as general Electric and Eaton, which operate in multiple lines of businesses, may have different pay objectives for different business units. Objectives at Medtronic and AES emphasize the increased complexity of the business and the importance of integrity, competitiveness, ability to attract and retain quality people and having fun.
Objectives serve several purposes. First, they guide the design the pay system. If an objective is to increase customer satisfaction, then incentive programs and merit pay (techniques) might be used to pay for performance (Policy). Another employer’s objective may be to develop new products, to innovate. Job design, training, and team building may be used to reach this objective. The pay system aligned with this employer’s objective may have a- policy of paying salaries that at least equal those of competitors (external competitiveness) and that go up with increased skills or knowledge (internal alignment). This pay system could be very different from our first example, where the focus is on increasing customer satisfaction.
So, objectives guide the design of pay systems. They also serve as the standard for judging the success of the pay system. If the objective is to attract and retain the best and no brightest, yet skilled employees are leaving to take higher -paying. jobs with other employers, the system may not be performing effectively. Although there may be many non-pay reasons for turnover, objectives provide standards for evaluating the effectiveness of a pay system.
Every employer must address the policy decisions shown on the left side of the pay model: (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.
Internal alignment refers to comparisons among 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. How, for example, does the work of the programmer compare with the work of the systems analyst, the software engineer, and the software architect? Does one contribute to providing solutions for customers and satisfying shareholders more than another? Think back to our friend from cats and the variety of work required in a touring company to put on the show. Does one actor’s role require more knowledge or experience than another’s? Internal alignment pertains to the pay rates both for employees doing equal work and for those doing dissimilar work. In fact, determining what is an appropriate difference in pay for people performing different work is one of the key challenges facing managers.
Pay relationship within the organization affect all three compensation objective. They affect employee decisions to stay with the organization, to become more flexible by investing in additional training, or to seek greater responsibility. By motivating employees to choose increased training and greater responsibility in dealing with customers, internal pay relationship indirectly affect the capabilities of the workforce and hence the efficiency of the entire organization. Fairness is affected through employees’ comparisons of their pay to the pay of others in the organization. Compliance is affected by the basis for making internal comparisons. Paying on the basis of race, gender, age, or national origin is forbidden in the United States.
External competitiveness refers to compensation relationships external to the organization: comparison with competitors. How should an employer position its pay relative to what competitors are paying? How much do we wish to pay accountants in comparison to what other employers would pay them? What mix of pay forms base, incentives, stock, benefits will help achieve the compensation objectives? Recall that Medtronic’s policy is to pay competitively in its market on the basis of its financial performance versus the financial performance of its competitors, while AES’s policy is to expect people to be willing to take less to join the company. Increasingly, organizations claim their pay systems are market driven, that is, based almost exclusively on what competitors pay.
However, “market driven” gets translated into practice in different ways. Some employers may set their pay levels higher than their competition, hoping to attract the best applicants. Of course, this assumes that someone is able to identify and hire the “best” from the pool of applicants. What mix of pay forms a company uses is also part of its external competitive policy. Medtronic sets its base pay to match its competitors but ties incentives to performance. Plus it offers stock options to all its employees to promote a culture of ownership. The big assumption is that owners will pay closer attention to the business. Further, Medtronic believes that its benefits, particularly its emphasis on programs that balance work and life, make it a highly attractive place to work. It believes that how its pay is positioned and what forms it uses create an advantage over competitors.
A Medtronic competitor, say, Boston Scientific, may offer lower base pay but greater opportunity to work overtime or fatter bonuses. External competitiveness decisions- both how much and what forms- have a twofold effect on objectives: (1) to ensure that the pay is sufficient to attract and retain employees- it employees do not perceive their pay as competitive in comparison to what other organizations are offering for similar work, they may be more likely to leave- and (2) to control labor costs so that the organization’s prices of products or service can remain competitive. So external competitiveness directly affects both efficiency and fairness. And it must do so in a way that complies with relevant legislation.
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? The emphasis to place on employee contributions is an important policy decision since it directly affects employees’ attitudes and work behaviors. Eaton and Motorola use pay to support other “high-performance” practices in their workplaces. Both use team-based pay and corporate profit-sharing plans. Starbucks emphasizes stock options and sharing the success of corporate performance with the employees. General Electric uses different performance-based pay programs at the individual, division, and companywide level. Performance-based pay also affects fairness in that employees need to understand the basis for judging performance in order to believe that their pay is fair.
Policy regarding management of the system is the last building block in our model. It means ensuring that the right people get the right pay for achieving objectives in the right way. The greatest system design in the world is useless without competent management. While it is possible to design a system that is based on internal alignment, external competitiveness, and employee contributions, the system will not achieve its objectives unless it is properly managed.
Management means understanding and communicating how the pay system works and doing so in ethical and fair ways. Questions to answer include, 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? Answers to these questions are necessary to tune or redesign the system, to adjust to changes, and to highlight potential areas for further investigation. Ethical behavior means the organization cares about how the results are achieved.
The remaining portion of the pay model in Exhibit 1.5 shows the techniques that make up the pay system. The exhibit provides only an overview since techniques are discussed throughout the rest of the book. Techniques tie the four basic policies to the pay objectives. Internal alignment is typically established through a sequence of techniques that starts with analysis of the work done and the people needed to do it. Information about the person and/or the job is collected, organized, and evaluated. Based on these evaluations a structure of the work is designed. This structure depicts relationships among jobs and skills or competencies inside an organization. It is based on the relative importance of the work in achieving the organizations objectives.
The goal is to establish a structure that is aligned with and supports the organizations objectives. In turn, fairness of the pay system affects employee attitudes and behaviors as well as the organizations regulatory compliance. External competitiveness is established by setting the organizations pay level in comparison with how much competitors pay for similar work and what pay forms they use. The sequence of techniques is to define the relevant labor markets in which the employer competes, conduct surveys of other employers’ pay, and use that information in conjunction with the organization’s policy decisions to generate a pay structure. The pay structure influences how efficiently the organization is able to attract and retain a competent workforce and control its labor costs.
The relative emphasis on employee contributions is established through performance and/or seniority-based pay increases, incentive plans, and stock options and other performance – based approaches. Increasingly, organizations in the United State and around the globe are using some form of incentive plan to share their success with employees.33 In addition to managing costs, these practices are all intended to affect employee attitudes and behaviors, in particular the decisions to join the organization, to stay, and to perform effectively. Uncounted variations in pay techniques exist; many are examined in this book. Surveys report differences in compensation policies and techniques among firms. Indeed, most consultant firms have web pages in which they report their survey results. You can obtain updated information on various practices by simply surfing the web.
Setting objectives was our first issue in a strategic approach. Our second, internal alignment, addresses relationships inside the organization. How do the responsibilities and pay of a trimmer versus tyer relate to each other? How do they relate to the responsibilities and pay of the householder’s cook or the steward? Internal alignment addresses the logic underlying these relationships. Exhibit 3.1 shows a structure for the engineering work at a division of Lockheed Martin, the world’s largest defense contractor. Lockheed also builds rockets, shuttles, and rovers for NASA. The six levels in Lockheed’s structure range from entry to consultant. You can see the relationships in the descriptions of each level of work. Decisions on how much to pay the six levels create a pay structure. Pay structure refers to the array of pay rates for different work or skills within a single organization. The number of levels, the differentials in pay between the levels and the criteria used to determine those differences describe the structure.
Fundamentally, organizations exist for a purpose (profits, not-for-profits, government agencies, and so on). The organization’s strategy tells us how it plans to achieve its purpose. Internal structures that are aligned with a strategy help achieve it. Lockheed decided that six levels of engineering work would support the research, design, and development of advanced technology systems to achieve the company’s objectives. The householder’s internal pay structure may have been aligned with his business strategy, but the employee dissatisfaction raises concerns about its fairness to employees.
Work flow refers to the process by which goods and services are delivered to the customer. The pay Structure ought to supports the efficient flow of that work and the design of the organization. For example, drug companies traditionally base the size of their sales forces on the number of, physicians to be called on per day and the number of working days per year. The U.S. drug manufacturer Merck decided to take a nontraditional approach to organizing sales and marketing. Merck created teams of account executives, client representatives, and medical information scientists to serve a broader clientele of health maintenance organizations, insurance companies, and physicians.
A cross-functional team responsible for a distinct, geographic area (rather than a list of physician-clients) provides a relationship- building approach to selling products. Rather than hawking a specific drug and giving out free samples, the Merck-teams are a source of knowledge for the physicians and the health organizations. The teams keep clients apprised of regulations and cover drugs for a wider range of medical conditions. One team even translated brochures that explain a course of treatment into Chinese, Russian, and Spanish for a physician whose patients included non-English-speaking immigrants. Such a response would have been beyond the resources of a single sales representative under Merck’s old approach. (Of course, the brochure recommended treatment with Merck products.)
To support these work teams, Merck designed a new compensation structure. The pay differences between account executives, customer representatives, and medical information scientists who served on the same teams were a major issue-just as they are for Lockheed engineers and just as they likely are for the cast of everwood. Think globally. Ford Motor does. Ford acquired Volvo (Sweden), Jaguar and Land Rover (Britain), and most or Mazda (Japan). To leverage its new engineering and manufacturing knowledge, Ford is creating global teams. This changes the work flow and organization design at Ford. Ford also needs to rethink pay structures to be sure they support the new global teams. Global pay structures create special challenges due to different wages and benefits paid for the same jobs in different parts of the world. Later chapters: will discuss various ways companies manage this challenge.
An internally aligned pay structure is more likely to be judged fair if it is based on the work and the skills required to perform the work and if people have an opportunity to be involved in some way in determining the pay structure. Two sources of fairness arc important: the procedures for determining the pay structure called procedural justice; and the results of those procedures the pay structure itself called distributive justice. Suppose you are given a ticket for speeding. Procedural justice refers to the process by which-a decision is reached: the right to an attorney, the right to an impartial judge, and the right to receive a copy of the arresting officer’s statement. Distributive justice refers to the fairness of the decision: guilty. Researchers report that employees perceptions of procedural fairness significantly influence their acceptance of the results: employees and managers are more willing to accept low pay if they believe that the way this result was obtained was fair.
This research also suggests that pay procedures are More likely to be perceived as fair (1) if they are consistently applied to all employees, (2) if employees participated in the process, (3) if appeals procedures are included, and (4) if the data used are accurate. Nevertheless, a newer study raises a question about the usefulness of employee participation. In a low-wage company, there was no connection between employee participation and pay fairness. It may be that employees were paid so low that no amount of participation could overcome their dissatisfaction. So rather than to sing aside the idea of participation, it may be that in extreme cases (very low wages), a pay raise may trump participation. Applied to internal structures, procedural justice addresses how design and administration decisions are made and whether procedures are applied in a consistent manner. Distributive justice addresses whether the actual internal pay differences among employees are reasonable.
Internal pay structures are part of the network of rewards discussed in Chapter 1: pay increases for promotions, bigger titles, more challenging work. The challenge is to design the structures so that they engage people to help achieve organization objectives. Merck marketing teams work together to share unique knowledge with each other and with their clients. Lockheed engineers do, too. And so do the writers, actors, and crew on Everwood. The structure ought to make clear the relationship between each job and the organization’s objectives .This is an example of “line-of-sight.” The more employees can “see” or understand links between their work, the work of others, and the organization’s objectives, the more likely they will be to achieve those objectives.
An internal pay structure can be defined by (1) number of levels of work, (2) the pay differentials between the levels and (3) the criteria used to determine those levels and differentials.
One feature of any pay structure is its hierarchical nature: the number of levels and reporting relationships. Some are more hierarchical, with multiple levels; others are compressed, with few levels. GE plastics engineers thermoplastic resin “solutions”. (with so many companies offering “solutions,” are we running short of problem?) In comparison to Lockheed’s six levels for engineering alone (Exhibit 3.1), GE plastics uses broad levels, described in exhibit 3.2, to cover engineering as well as all professional executive work. GE plastics would probably fit the Lockheed Martin structure into two or three levels.
The pay differences among levels are referred to as differentials. If we assume that an organization has a compensation budget of a set amount to distribute among its employees, there are a number of ways it can do so. It can divide the budget by the number of employees to give everyone the same amount. The Moosewood Restaurant in Ithaca, New York, adopts this approach. But few organizations in the world are that egalitarian. In most, pay varies among employees. Work that requires more knowledge or skills, performed under unpleasant working conditions, and/or adds more value is usually paid more.
Level Description Executive Provide vision, leadership and innovation to major z business segments or functions of GEP Director Directs a significant functional area or … Leadership Individual contributors leading projects ….. Technical/managerial Individual contributors managing projects or … Professional Supervisors and individual contributors working….
Exhibit 3.3 shows the differentials attached to Lockheed Martin’s engineering Structure. The intention of these differentials is to motivate people to strive for promotion to a higher-paying level.
Content refers to the work performed in a job and how it gets done (tasks, behaviors, required, etc.) Value refers to the worth of the work: its relative contribution to the organization objectives. A structure based on content typically ranks jobs based on skills required, complexity of tasks, and/or responsibility. In contrast, a structure based on the value of the work focuses on the relative contribution of the skills, tasks, and responsibilities of a job to the organization’s goal. While the resulting structures may be the same, there are some important differences. In addition to including relative contribution, value may also include external market pressures (i.e. what competitors pay for level of contribution). Or it may include rates that have been agreed upon through collective bargaining, or even legislated rates (minimum wage). Job values across all organizations in Cuba are set by a government agency.
Following the now discarded approaches of the former Soviet Union and China, Cuba’s government dictates a universal structure: 8 Levels for industrial workers, 16 levels for technical and engineering work, and 26 levels for government employees. Use Value and Exchange Value Use value reflects the value of goods or services in employee produces in a Job. Exchange value is whatever wage the employer and employee agree on for a job. Think about IBM software engineers living in Bangalore, Kiev, and Purchase, New York. Now think about them working together on the same project—same company, same job content, same internal job value, same use value. Yet they are in very different geographies and external markets. Wage rates in Bangalore and Kiev are a lot less than in Purchases.
The exchange value varies. For promotions, IBM treats these jobs as being at the same level in the structure. But the competitive practices and markets in India, the Ukraine, and the United States yield very different pay rates. The difference between exchange value and use value also surfaces when one Firm ac-quires another BM’s acquisition of Price water house coopers; (PWC), where consultants were the lifeblood of the company, is a case in point. Price water house coopers consultants added more knowledge to IBM’s marketing teams. But the use value of their knowledge within IBM differs from that within PWC. So basically similar job content in two different companies may be valued differently based on how it contributes to Organization objectives. Alternatively, the same work content in the same company (IBM software engineers) may have different exchange values based on the different geographic.
A job-based structure relies on the work content—tasks, behaviors, responsibilities; A person-based structure shifts the focus to the employee: the skills, knowledge, or competencies the employee possesses, whether or not they are used in the employee’s particular job. The engineering structure at Lockheed Martin (Exhibit 3.1) uses the work performed as the criterion. GE Plastics (Exhibit 3.2) uses the individual employee’s competencies required at each level of work. In the real world, it is often hard to describe, job without reference to the jobholder’s knowledge and skills. Conversely, it is hard to definc a person’s job-related knowledge or competencies without referring to work content. So rather than it job-or-person-based structure, reality includes both job and person.
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