Compensation an Element of Strategy Management

1. Compensationan Element of Strategy Management SESSION 1 - Compensation - An Element of Strategic Management

2. The Pay Model • Pay matters • It matters what you pay for • It matters how you pay SESSION 1 - Compensation - An Element of Strategic Management

3. The Pay Model • 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. SESSION 1 - Compensation - An Element of Strategic Management

4. The Pay Model • 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. SESSION 1 - Compensation - An Element of Strategic Management

5. Hierachy 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. SESSION 1 - Compensation - An Element of Strategic Management

6. MASLOW’S HIERARCHY OF NEEDS Self-Actualization Need for development, creativity and achievement Continuous training & own development High level of autonomy & maturity Being consulted and listen to Meditation Gives advices on work directions Deepen know-how & culture Able to manage conflicts Personal development Decides as a group Be autonomous Ego Need for self-esteem, power, recognition, prestige Well recognized & appreciated work activities Develop autonomy Express specific competencies Be recognized and appreciated Varied and innovated tasks Earn respect of others Managerial empowerment Express opinions Be appreciated and acknowledged Be different Taking part in objective settings Social SESSION 1 - Compensation - An Element of Strategic Management Need for being loved, belonging, inclusion Feeling dependant Belonging to the community Obtain a social status as a whole, as well as to sub-group Be integrated in a group within the community Knowledge of information Being able to express ideas sharing Security Need for a safe environment Living in a non-threatening area Need for safety Job stability Sense of living in Being informed a fair and just society Be supported Built a secure living environment whenever necessary Taking car of its health Physiological Physical survival needs Water, food Decent compensation Sleep, warmth Working in acceptable Exercise environmental conditions Shelter PRIVATE LIFE PROFESSIONAL LIFE

7. Society • 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. SESSION 1 - Compensation - An Element of Strategic Management

8. Society (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. SESSION 1 - Compensation - An Element of Strategic Management

9. Society (cont’d) • 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. SESSION 1 - Compensation - An Element of Strategic Management

10. Society (cont’d) • 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. SESSION 1 - Compensation - An Element of Strategic Management

11. Society (cont’d) • 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. SESSION 1 - Compensation - An Element of Strategic Management

12. Stockholders • 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. SESSION 1 - Compensation - An Element of Strategic Management

13. Management • For managers, compensation influences their success in two ways: • 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. SESSION 1 - Compensation - An Element of Strategic Management

14. Labor Costs SESSION 1 - Compensation - An Element of Strategic Management

15. Management • 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. SESSION 1 - Compensation - An Element of Strategic Management

16. The 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) SESSION 1 - Compensation - An Element of Strategic Management

17. The Elements of Compensation SESSION 1 - Compensation - An Element of Strategic Management

18. The Elements of Compensation • 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 SESSION 1 - Compensation - An Element of Strategic Management

19. The Elements of Compensation • 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 SESSION 1 - Compensation - An Element of Strategic Management

20. Cash 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. SESSION 1 - Compensation - An Element of Strategic Management

21. Cash 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. SESSION 1 - Compensation - An Element of Strategic Management

22. Cash 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. SESSION 1 - Compensation - An Element of Strategic Management

23. Cash 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. SESSION 1 - Compensation - An Element of Strategic Management

24. Long-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. SESSION 1 - Compensation - An Element of Strategic Management

25. Benefits – 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 from the financial risks inherent in daily life. • Because the cost of providing benefits has been rising, they are an increasingly important form of pay. SESSION 1 - Compensation - An Element of Strategic Management

26. Benefits – 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. SESSION 1 - Compensation - An Element of Strategic Management

27. 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 SESSION 1 - Compensation - An Element of Strategic Management

28. Perquisites • 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. SESSION 1 - Compensation - An Element of Strategic Management

29. Total 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. SESSION 1 - Compensation - An Element of Strategic Management

30. Total 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. SESSION 1 - Compensation - An Element of Strategic Management

31. Non-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. SESSION 1 - Compensation - An Element of Strategic Management

32. Non-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. SESSION 1 - Compensation - An Element of Strategic Management

33. Employment 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. SESSION 1 - Compensation - An Element of Strategic Management

34. Employment Relationships • 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. SESSION 1 - Compensation - An Element of Strategic Management

35. Employment Relationships SESSION 1 - Compensation - An Element of Strategic Management

36. Compensation 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. SESSION 1 - Compensation - An Element of Strategic Management

37. Compensation Management Model SESSION 1 - Compensation - An Element of Strategic Management

38. Objectives • Setting compensation objectives is important for two reasons: • 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. SESSION 1 - Compensation - An Element of Strategic Management

39. Objectives • 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. SESSION 1 - Compensation - An Element of Strategic Management

40. Policies 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. SESSION 1 - Compensation - An Element of Strategic Management

41. Policies - Internal Alignment Internal Alignment • 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 SESSION 1 - Compensation - An Element of Strategic Management

42. Policies - External 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 SESSION 1 - Compensation - An Element of Strategic Management

43. Policies - External 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? SESSION 1 - Compensation - An Element of Strategic Management

44. Policies - 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? SESSION 1 - Compensation - An Element of Strategic Management

45. Techniques - 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) SESSION 1 - Compensation - An Element of Strategic Management

46. Techniques - 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. SESSION 1 - Compensation - An Element of Strategic Management

47. Techniques - 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 SESSION 1 - Compensation - An Element of Strategic Management

48. Compensation Management Model SESSION 1 - Compensation - An Element of Strategic Management

49. Example: The Strategic Compensation Decisions Facing Starbucks • Objectives: How should compensation support business strategy and be adaptive to the cultural and regulatory environment? 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. SESSION 1 - Compensation - An Element of Strategic Management

50. Example: The Strategic Compensation Decisions Facing Starbucks (continued) • Alignment: How differently should the various types and levels of skills be paid within the organization? Starbucks: • De-emphasize differences. • Use egalitarian pay structures, cross-train employees to handle many jobs, and call employees partners. SESSION 1 - Compensation - An Element of Strategic Management