Managing Compensation

(c) 2007 by Prentice Hall Chapter 10 Overview • Identify the compensation policies and practices that are most appropriate for a particular firm • Weigh the strategic advantages and disadvantages of the different compensation options • Establish a job-based compensation scheme that is internally consistent and linked to the labor market • Understand the difference between a compensation system in which employees are paid for the skills they use and one in which they are paid for the job they hold • Make compensation decisions that comply with the legal framework

(c) 2007 by Prentice Hall What Is Compensation? • Total compensation – The package of quantifiable rewards an employee receives for his or her labors. Includes three components: base compensation, pay incentives, and indirect compensation/benefits

(c) 2007 by Prentice Hall Designing a Compensation System Challenge is to design a compensation system that: • Enables the firm to achieve its strategic objectives • is molded to the firm’s unique characteristics and environment

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) There are nine criteria for developing compensation plans: • Internal vs. external equity: • Internal equity – The perceived fairness of the pay structure within a firm. • External equity – The perceived fairness in pay relative to what other employers are paying for the same type of labor.

(c) 2007 by Prentice Hall Designing a Compensation System Two basic models for determining internal vs. external equity: • The Distributive Justice Model • Labor Market Model How to balance internal and external equity

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) 2. Fixed versus Variable Pay: • Fixed Pay – most common in the USA as it reduces risk to the employee and is easy to administer • Variable Pay – 75% of companies use some type of variable pay, 10% of US workers wages consist of variable pay

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) 3. Performance vs. Membership: • Performance – Substantial part of pay is tied to individual or group contributions and can vary from person to person or group to group • Membership – Same or similar wage to every employee in a given job

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) 4. Job vs. Individual pay • Job based pay – assumes in setting base pay a company should evaluate the value or contributions of each job, not how well an employee performs the job • Individual pay – knowledge based-pay or skill-based pay where employees are paid on the basis of the jobs they can do or talents they have

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) • Job vs. Individual pay Job-based pay is best where: • Technology is stable • Jobs do not change often • Employees do not need to cover for one another frequently • Much training is required to learn a given job • Turnover is relatively low • Employees are expected to move up through the ranks over time • Jobs are fairly standardized within the industry

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) 4. Job vs. Individual Pay (Cont.) Individual-based pay is best where: • The firm has a relatively educated workforce with both the ability and the willingness to learn different jobs • The company’s technology and organizational structure change frequently • Employee participation and teamwork are encouraged throughout the organization • Opportunities for upward mobility are limited • Opportunities to learn new skills are present • The costs of employee turnover and absenteeism in terms of lost production are high

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) 5. Egalitarian vs. Elitist • Egalitarian pay system – A pay plan in which most employees are part of the same compensation systems. • Elitist pay system – A pay plan in which different compensation systems are established for employees or groups at different organizational levels.

(c) 2007 by Prentice Hall Designing a Compensation System (Cont.) • Below-market vs. Above-market compensation 7. Monetary vs. Nonmonetary rewards 8. Open vs. Secret pay 9. Centralization vs. Decentralization of pay decisions

(c) 2007 by Prentice Hall Compensation Tools (Cont.) 1. Job-based compensation plans • Most traditional and widely used • Assumes work gets done by people who are paid to do well-defined jobs • Objective is to allocate pay so that the most important jobs pay the most

(c) 2007 by Prentice Hall Compensation Tools (Cont.) 1. Job-based compensation plans • Achieving Internal Equity: Job Evaluation = process of evaluating the relative value or contribution of different jobs in an organization • The ultimate goal of job evaluation is to provide a rational, orderly & systematic judgment of how important each job is to the firm

(c) 2007 by Prentice Hall Compensation Tools (Cont.) 1. Job-based compensation plans • Achieving Internal Equity – 6 steps : • Step 1: Conduct job analysis – gathering and organizing of information concerning the tasks, duties and responsibilities of specific jobs • Step 2: Write job description • Step 3: Determine job specifications – worker characteristics, that an employee must have to perform a job successfully

Compensation Tools (Cont.) 1. Job-based compensation plans • Achieving Internal Equity – 6 steps (Cont.): • Step 4: Rate worth of all jobs using a predetermined system using a system such as a point factor system: • Uses compensable factors – work related criteria that an organization considers most important in assessing relative value of different jobs • Hay compensable factors – 3 compensable factors (know-how, problem solving, accountability) • Management Association of America (MAA) – 3 units (hourly blue collar, non-exempt clerical technical serviceand professional management)

(c) 2007 by Prentice Hall Compensation Tools (Cont.) 1. Job-based compensation plans • Achieving Internal Equity – 6 steps (Cont.): • Step 5: Create a job hierarchy • Step 6: Classify jobs by grade levels

(c) 2007 by Prentice Hall Compensation Tools (Cont.) • Job-based compensation plans • Achieving External Equity: • Market Surveys – purpose to determine pay ranges for each grade level. Most companies purchase surveys.

Compensation Tools (Cont.) • Job-based compensation plans • Achieving External Equity: • 2 steps: • Step 1: Identify benchmark or key jobs – a job that is similar in content across firms • Step 2: Establish a pay policy – decision whether to pay above, below or at market rate

(c) 2007 by Prentice Hall Compensation Tools • Job-based compensation plans Achieving Individual Equity: Within-Pay-Range Positioning Criteria • Individual equity – The perceived fairness of individual pay decisions.

(c) 2007 by Prentice Hall Compensation Tools • Skill-based compensation plans • Uses skills as the basis for pay • Skills can be depth, horizontal, vertical • Advantages: • Creates flexible workforce • Promotes cross-training • Employee control over pay • Disadvantages: • Small % use it • Higher compensation and training costs • Skills may become rusty • Elaborate and time consuming process

The Legal Environment andPay Systems Governance • The Fair Labor Standards Act (FLSA) • Exempt/Non-exempt employees • Minimum wages – overtime • The Equal Pay Act • Comparable worth • OFCCP • Role of the Office of Federal Contract Compliance • Internal Revenue Code

Managing Compensation