Compensation and Rewards

1. Compensation and Rewards Business 158 Spring Semester 2007 Tim Brown

2. Agenda This week in compensation To this point in the course Strategic perspectives Break Internal alignment

3. Strategic considerations Philosophies Entitlement orientation Performance orientation Design options Culture Market Decisions Person-based or Team-based Short-term or Long-term Product-based or Service-based Incentive mix

4. Types of Employment Relationships

5. ATTRACT RETAIN MOTIVATE Key Objectives in Reward Systems EFFICIENT FAIR COMPLIANT

6. Explain the idea of strategic perspective to compensation Identify five dimensions of a compensation strategy and how compensation strategy supports organization strategy Discuss four steps in developing a total comp strategy Describe three tests to determine if a pay strategy can be a source of competitive advantage Present key arguments related to two approaches: best-fit and best-practice Learning Objectives (Chapter 2)

7. What is the strategic perspective?

8. Strategic Brain Teasers Do you even need a strategy? Why bother? It worked fine for them What works �here� may not work �there� Is �no strategy� a strategy? Example: chess game So what will this do for us? Be able to defend your position

9. 5 Dimensions of Strategy Objectives Internal alignment External alignment/competitiveness Employee contributions Management

10. Strategic Perspectives Toward Total Compensation

11. Strategic Perspectives Toward Total Compensation

12. Les Wiletzky Strategic Alignment

13. Exhibit 2.2: Strategic Choices

14. Innovator Cost Cutter Customer Focused Generic Business-level Strategies

15. Tailor the Compensation System to the Strategy

16. 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.

17. Example: The Strategic Compensation Decisions Facing Starbucks (cont.) Alignment: How differently should the various types and levels of skills be paid within the organization? Starbucks� Approach De-emphasize differences. Use egalitarian pay structures, cross-train employees to handle many jobs, and call employees partners.

18. Competitiveness: How should total compensation be positioned against our competitors? What forms of compensation should we use? Starbucks� Approach Pay just slightly above other fast-food employers. Provide health insurance and stock options for all employees (including part-timers). Give everyone a free pound of coffee every week. Example: The Strategic Compensation Decisions Facing Starbucks (cont.)

19. Example: The Strategic Compensation Decisions Facing Starbucks (cont.) 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? Starbucks� Approach Emphasize team performance and shareholder returns. For new managers in Beijing and Prague, provide training opportunities in the U.S.

20. Management: How open and transparent should pay decisions be to all employees? Who should be involved in designing and managing the system? Starbucks� Approach As members of the Starbuck�s �family,� our employees realize what is best for them. Partners can and do get involved. Example: The Strategic Compensation Decisions Facing Starbucks (cont.)

21. 4 Steps in Strategy Development Assess Strategic map Implement Reassess Discover Develop Deploy Debrief

23. Step 1: Assess Implications Before any new compensation program is designed, there must be a clear understanding of the implications: Competitive dynamics Culture/values Social and political context Employee needs Customization and flexibility

24. Competitive dynamics Customer needs Competitors� actions Labor market conditions Regulations Global environment Culture/values A pay system reflects values guiding an employer�s behaviors and treatment of employees Step 1: Assess Total Compensation Implications (cont.)

25. Social and political context Legal and regulatory requirements Cultural differences Changing work force demographics Employee values and expectations Step 1: Assess Total Compensation Implications (cont.)

26. Employee needs Contemporary pay systems Flexible compensation systems Nature of employee-mgmt relationship Informal opinion leaders Union representations Step 1: Assess Total Compensation Implications (cont.)

27. Role of pay in overall HR strategy Supporting player Agent of change Step 1: Assess Total Compensation Implications (cont.)

28. 3 Tests for Strategic Advantage Is it aligned? Does it differentiate? Does it add value?

29. 2 Approaches Contrasted Best fit Do what works in a specific situation Best practice Do what works best in other places

30. Best Fit vs. Best Practices Best Fit Reflects company�s strategy and values Responsive to employees� needs Globally competitive Provides company some competitive advantage Best Practices Assumes a set of best-pay practices exists Practices can be applied universally across all situations

31. Best-Practices Options The New Pay External market-sensitive-based pay, not internal alignment Variable performance-based pay, not annual increases Risk-sharing partnership, not entitlement Flexible opportunities to contribute, not jobs Lateral promotions, not career path Employability, not job security Teams, not individual contributors

32. Best-Practices Options High Commitment High wages: get what you pay for Employment security Apply incentives; share gains, not risks Employee ownership Participation/Empowerment Stress team over individual Reduce pay differences Promote from within Selective recruiting Enterprise-wide info sharing Training, cross-training, and skill development Egalitarianism adds value Stress Long-term perspective Emphasize measurement

33. So What Matters More -Best Practices or Best Fit? Some research supports the �best practices� approach Some research supports the �best fit� approach

34. BREAK 15 minute break

36. Explain why internal alignment is an important policy issue and how to evaluate internal alignment Discuss three key factors that define internal pay structures Describe how external and organization factors shape the design of pay structures Discuss the pros and cons of egalitarian and hierarchical structures and how they relate to an organization�s strategy Describe the key effects associated with an internally aligned pay structure Learning Objectives (Chapter 3)

37. Topics Internal Alignment How Structures Vary Among Organizations Internal Structures and Work Environment Strategic Choices in Designing Internal Structures Contributions from Structures

38. Key Issues Two basic questions lie at the core of compensation management . . . How is pay determined for the wide variety of work performed in organizations? Does how much an organization pay for different work make a difference?

39. What Is Internal Alignment?

40. Internal Alignment Matters: The relationships formed in a pay structure should support the organization strategy, support the workflow, be fair to employees, and motivate behavior toward organization objectives.

41. What Is Pay Structure?

42. Internal Alignment Fairness Issues Procedural justice Process by which a decision is reached Distributive justice Results/outcomes of the process Pay procedures more likely to be viewed as fair if . . . They are consistently applied to all employees Employee participation/representation is allowed An appeals procedure is available Data used are accurate Supports Work Flow. Work flow refers to the process by which goods and services are delivered to the customer. The challenge is to design a pay structure that supports the efficient flow of that work. (Text page 53) Supports Fairness. An internally consistent 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 are important: the procedures for determining the pay structure, called procedural justice; and the actual results of those procedures, which is the pay structure itself, called distributive justice. (Text page 55) Directs Behavior Toward Organization Objectives. Internal pay structures influence employees� behavior. The challenge is to design the structures so they direct people�s efforts toward organization objectives. The criteria or rationale on which the structure is based 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 and the organization�s objectives, the more likely the structure will direct their behavior toward those objectives. Internal consistency in pay structures help create that line-of-sight. (Text page 55)Supports Work Flow. Work flow refers to the process by which goods and services are delivered to the customer. The challenge is to design a pay structure that supports the efficient flow of that work. (Text page 53) Supports Fairness. An internally consistent 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 are important: the procedures for determining the pay structure, called procedural justice; and the actual results of those procedures, which is the pay structure itself, called distributive justice. (Text page 55) Directs Behavior Toward Organization Objectives. Internal pay structures influence employees� behavior. The challenge is to design the structures so they direct people�s efforts toward organization objectives. The criteria or rationale on which the structure is based 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 and the organization�s objectives, the more likely the structure will direct their behavior toward those objectives. Internal consistency in pay structures help create that line-of-sight. (Text page 55)

43. Structures Vary An internal pay structure is defined by Number of levels of work Pay differentials between levels Criteria used to determine levels and differentials Content - Work performed in a job and how it gets done Value - Worth of the work: its relative contribution to objectives Job- and person-based structures

44. Structures Vary: Examples Number of levels of work Exhibit 3.1: Engineering Structure at Lockheed Exhibit 3.2: Managerial/Professional Levels at General Electric Plastics (GEP) Pay differentials between levels Exhibit 3.3: Engineering Pay Structure at Lockheed Martin Criteria Job-based - Exhibit 3.1 Person-based - Exhibit 3.2 Text page 62Text page 62

45. Exhibit 3.2: Managerial/Professional Levels at General Electric Plastics

46. Exhibit 3.3: Engineering Pay Structureat Lockheed Martin

47. Exhibit 3.4: What Shapes Internal Structures?

48. Exhibit 3.5: Illustration of anInternal Labor Market See Exhibit 3.3, text page 68See Exhibit 3.3, text page 68

49. Strategic Choices in DesigningInternal Structures See text page 64 The basic premise underlying the strategic approach is that fit matters. So the belief is that pay structures tailored to be consistent with the organization, to support the way the work gets done, and to fit the organization�s business strategy will be more likely to lead to success. Misaligned structures become obstacles. They may motivate employee behavior that is inconsistent with the organization�s strategy. Two strategic choices are involved: (1) how tailored to organization design and work flow to make the structure; and (2) how to distribute pay throughout the levels in the structure. Tailored versus Loosely Coupled. A low-cost, customer-focused business strategy such as followed by McDonald�s or Wal-Mart may be supported by a closely tailored structure. Jobs are well defined with detailed tasks or steps to follow. You can go into a McDonald�s in Cleveland, Prague, or Shanghai and find they are all very similar. Their pay structures are too. In contrast to McDonald�s, Microsoft�s business strategy requires constant product innovation and short product design-to-market cycle times. Companies like Microsoft need to be very agile, constantly innovating and adapting. Hence, their pay structures need to be more loosely coupled to the organization in order to facilitate constant change. Egalitarian versus Hierarchical. Pay structures can range from egalitarian at one extreme to hierarchical at the other. Egalitarian structures have fewer levels and smaller differentials between adjacent levels and between the highest and lowest paid workers.See text page 64 The basic premise underlying the strategic approach is that fit matters. So the belief is that pay structures tailored to be consistent with the organization, to support the way the work gets done, and to fit the organization�s business strategy will be more likely to lead to success. Misaligned structures become obstacles. They may motivate employee behavior that is inconsistent with the organization�s strategy. Two strategic choices are involved: (1) how tailored to organization design and work flow to make the structure; and (2) how to distribute pay throughout the levels in the structure. Tailored versus Loosely Coupled. A low-cost, customer-focused business strategy such as followed by McDonald�s or Wal-Mart may be supported by a closely tailored structure. Jobs are well defined with detailed tasks or steps to follow. You can go into a McDonald�s in Cleveland, Prague, or Shanghai and find they are all very similar. Their pay structures are too. In contrast to McDonald�s, Microsoft�s business strategy requires constant product innovation and short product design-to-market cycle times. Companies like Microsoft need to be very agile, constantly innovating and adapting. Hence, their pay structures need to be more loosely coupled to the organization in order to facilitate constant change. Egalitarian versus Hierarchical. Pay structures can range from egalitarian at one extreme to hierarchical at the other. Egalitarian structures have fewer levels and smaller differentials between adjacent levels and between the highest and lowest paid workers.

50. Exhibit 3.6: Strategic Choice:Hierarchical versus Egalitarian This slide clarifies the differences between egalitarian and hierarchical structures. The choice, however, is not either / or. Rather, the differences are a matter of degree. So levels can range from many to few, differentials can be large or small, and the criteria can be based on the job, the person, or some combination of the two. (text page 66)This slide clarifies the differences between egalitarian and hierarchical structures. The choice, however, is not either / or. Rather, the differences are a matter of degree. So levels can range from many to few, differentials can be large or small, and the criteria can be based on the job, the person, or some combination of the two. (text page 66)

51. Structure A Layered Chief Engineer Engineering Manager Consulting Engineer Senior Lead Engineer Lead Engineer Senior Engineer Engineer Engineer Trainee Structure B De-layered Chief Engineer Consulting Engineer Associate Engineer Exhibit 3.7: Structural Impact on Performance and Fairness

52. Perceived Equity of a Pay Structure See Exhibit 3.11 in the text on page 71. The equity theory model shown suggests that employees judge equity on the basis of comparisons between the work, qualifications, and pay for the jobs held by others against their own.See Exhibit 3.11 in the text on page 71. The equity theory model shown suggests that employees judge equity on the basis of comparisons between the work, qualifications, and pay for the jobs held by others against their own.

53. Exhibit 3.8: Some Consequences of anInternally Aligned Structure

54. More hierarchical structures are related to greater performance when the work flow depends more on individual contributors More egalitarian structures are related to greater performance when collaboration and sharing of knowledge are required Structures not aligned with the work flow appear to be related to greater turnover Which Structure Fits Best?

55. Consequences of Structures