Chap 002

McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Milkovich/Newman: Compensation, Ninth EditionMilkovich/Newman: Compensation, Ninth Edition

Chapter 2Chapter 2Strategy: The Strategy: The

Totality of Totality of DecisionsDecisions

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Chapter TopicsChapter Topics

Similarities and Differences in Strategies Strategic Choices

Support Business Strategy

The Pay Model Guides Strategic Pay Decisions Developing a Total Compensation Strategy:

Four Steps

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Chapter Topics (cont.)Chapter Topics (cont.) Source of Competitive Advantage: Three Tests

“Best Practices” versus “Best Fit”

Guidance from the Evidence

Virtuous and Vicious Circles

Your Turn: Mapping Compensation Strategies Still Your Turn: Pay Matters (Productivity

Does, Too)

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Exhibit 2.1: Three Compensation StrategiesExhibit 2.1: Three Compensation Strategies

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Similarities and DifferencesSimilarities and Differencesin Strategiesin Strategies

Different strategies within the same industryDifferent strategies within the same industry Different strategies within the same companyDifferent strategies within the same company ““Let the market decide our compensation” Let the market decide our compensation”

philosophy is untenable in the real world, philosophy is untenable in the real world, especially in global environmentsespecially in global environments

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Strategic ChoicesStrategic Choices Strategy Strategy refers to the fundamental directions refers to the fundamental directions

that an organization choosesthat an organization chooses– Corporate level: “What business should we be in?”Corporate level: “What business should we be in?”– Business unit level: “How to gain and sustain Business unit level: “How to gain and sustain

competitive advantage?”competitive advantage?”– Functional level: “How should total compensation Functional level: “How should total compensation

help gain and sustain competitive advantage?”help gain and sustain competitive advantage?” A A strategic perspectivestrategic perspective focuses on those focuses on those

compensation choices that help the organization compensation choices that help the organization gain and sustain competitive advantagegain and sustain competitive advantage

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Exhibit 2.2: Strategic ChoicesExhibit 2.2: Strategic Choices

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Support Business StrategySupport Business Strategy Pay systems should align with the organization's Pay systems should align with the organization's

business strategybusiness strategy– Based on contingency notionsBased on contingency notions

Compensation systems can be tailored to:Compensation systems can be tailored to:– Innovator business strategyInnovator business strategy– Cost cutter business strategy Cost cutter business strategy – Customer-focused business strategy Customer-focused business strategy

When business strategies change, pay systems When business strategies change, pay systems should also changeshould also change

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Exhibit 2.3: Tailor the Compensation System to the Strategy

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Exhibit 2.4: IBM’s StrategicExhibit 2.4: IBM’s StrategicPrinciples and PrioritiesPrinciples and Priorities

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ObjectivesObjectives

Internal AlignmentInternal Alignment

External CompetitivenessExternal Competitiveness

Employee ContributionsEmployee Contributions

ManagementManagement

Five Strategic Guidelines for Compensation Choices

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The Pay Model Guides Strategic Pay The Pay Model Guides Strategic Pay DecisionsDecisions

Decisions based on the five strategic Decisions based on the five strategic compensation choices of the pay model, taken compensation choices of the pay model, taken together, form a pattern that becomes an together, form a pattern that becomes an organization's compensation strategyorganization's compensation strategy– Stated versus Unstated StrategiesStated versus Unstated Strategies

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Example: The Strategic Compensation Example: The Strategic Compensation Decisions Facing Whole FoodsDecisions Facing Whole Foods

ObjectivesObjectives: How should compensation support : How should compensation support business strategy and be adaptive to the cultural business strategy and be adaptive to the cultural and regulatory global environment?and regulatory global environment?

Whole Foods’ ObjectivesWhole Foods’ Objectives

– Increase shareholder value through profits and Increase shareholder value through profits and growthgrowth

– Go to extraordinary lengths to satisfy and delight Go to extraordinary lengths to satisfy and delight customerscustomers

– Seek and engage employees who are going to help Seek and engage employees who are going to help the company make moneythe company make money

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Example: The Strategic Compensation Example: The Strategic Compensation Decisions Facing Whole Foods (cont.)Decisions Facing Whole Foods (cont.)

Internal Alignment: How differently should the Internal Alignment: How differently should the various types and levels of skills and work be various types and levels of skills and work be paid within the organization?paid within the organization?

Whole Foods’ ApproachWhole Foods’ Approach– Store operations are organized around eight to ten Store operations are organized around eight to ten

self-managed teamsself-managed teams– Egalitarian, shared-fate philosophy – executive Egalitarian, shared-fate philosophy – executive

salaries do not exceed 14 times the average pay of salaries do not exceed 14 times the average pay of full-time employeesfull-time employees

– All full-time employees qualify for stock options, All full-time employees qualify for stock options, and 94 percent of the company's options go to non-and 94 percent of the company's options go to non-executive employeesexecutive employees

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External competitivenessExternal competitiveness: How should total : How should total compensation be positioned against our compensation be positioned against our competitors? What forms of compensation competitors? What forms of compensation should we use?should we use?

Whole Foods’ ApproachWhole Foods’ Approach

– Offer a unique deal compared to competitorsOffer a unique deal compared to competitors

– Provide health insurance for all full-time employees Provide health insurance for all full-time employees

– 20 hours of paid time a year to do volunteer work20 hours of paid time a year to do volunteer work


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Employee contributionsEmployee contributions: Should pay increases : Should pay increases be based on individual and/or team be based on individual and/or team performance, on experience and/or continuous performance, on experience and/or continuous learning, on improved skills, on changes in cost learning, on improved skills, on changes in cost of living, on personal needs, and/or on each of living, on personal needs, and/or on each business unit’s performance?business unit’s performance?

Whole Foods’ ApproachWhole Foods’ Approach

– A shared fate – every four weeks, assess the A shared fate – every four weeks, assess the performance of each teamperformance of each team

– Top teams get an extra $1.50 to $2.00 an hour in the Top teams get an extra $1.50 to $2.00 an hour in the next pay periodnext pay period

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ManagementManagement: How open and transparent should : How open and transparent should pay decisions be to all employees? Who should pay decisions be to all employees? Who should be involved in designing and managing the be involved in designing and managing the system?system?

Whole Foods’ ApproachWhole Foods’ Approach– ““No-secrets” management; every store has a book No-secrets” management; every store has a book

listing the previous year's pay for every employee listing the previous year's pay for every employee including executivesincluding executives

– “ “You Decide” – employees recently voted to pick You Decide” – employees recently voted to pick their health insurance rather than having one their health insurance rather than having one imposed by leadershipimposed by leadership


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Exhibit 2.5: Key Steps In Formulating a Total Exhibit 2.5: Key Steps In Formulating a Total Compensation StrategyCompensation Strategy

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Developing A Total Compensation Developing A Total Compensation Strategy: Four StepsStrategy: Four Steps

Step 1: Assess total compensation implications Step 2: Map a total compensation strategyStep 2: Map a total compensation strategy Steps 3: Implement strategy Steps 3: Implement strategy Step 4: ReassessStep 4: Reassess

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Step 1: Assess Total Compensation Step 1: Assess Total Compensation ImplicationsImplications

Competitive Dynamics – Understand the Competitive Dynamics – Understand the BusinessBusiness– Changing customer needsChanging customer needs

– Competitors’ actionsCompetitors’ actions

– Changing labor market conditionsChanging labor market conditions

– Changing LawsChanging Laws

– GlobalizationGlobalization

Competitive dynamics can be assessed globallyCompetitive dynamics can be assessed globally

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Exhibit 2.6: Toshiba’s Managerial Exhibit 2.6: Toshiba’s Managerial Compensation Plan, Annual Amount (in Yen)Compensation Plan, Annual Amount (in Yen)

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Step 1: Assess Total Compensation Step 1: Assess Total Compensation Implications (cont.)Implications (cont.)

Culture/valuesCulture/values– A pay system reflects the values that guide an A pay system reflects the values that guide an

employer's behavior and underlie its treatment of employer's behavior and underlie its treatment of employeesemployees

Social and political contextSocial and political context– Context Context refers to legal and regulatory requirements, refers to legal and regulatory requirements,

cultural differences, changing workforce, cultural differences, changing workforce, demographics, expectations etc.demographics, expectations etc.

– Affects compensation choicesAffects compensation choices– Lobbying is also part of compensation strategiesLobbying is also part of compensation strategies

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Exhibit 2.7: Medtronic ValuesExhibit 2.7: Medtronic Values

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Employee preferencesEmployee preferences– How to better satisfy individual needs and How to better satisfy individual needs and

preferencespreferences Choice – Examples: Flexible benefits and choicesChoice – Examples: Flexible benefits and choices Union preferencesUnion preferences

– Pay strategies need to be adapted to the nature of the Pay strategies need to be adapted to the nature of the union-management relationshipunion-management relationship

– Unions' interests can differUnions' interests can differ– Compensation deals with unions can be costly to Compensation deals with unions can be costly to

changechange

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Prominence of pay in overall HR strategy: Supporting Prominence of pay in overall HR strategy: Supporting player or catalyst for changeplayer or catalyst for change– Pay strategy is influenced by how it fits with other Pay strategy is influenced by how it fits with other

HR systemsHR systems– High-performance systemsHigh-performance systems

High skill/knowledge requirementsHigh skill/knowledge requirements Work designed so that employee teams enjoy discretion in Work designed so that employee teams enjoy discretion in

making decisions and continue to learnmaking decisions and continue to learn Pay systems based on performancePay systems based on performance

– Pay can be a supporting player or a catalyst for Pay can be a supporting player or a catalyst for changechange

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Step 2: Map a Total Compensation Step 2: Map a Total Compensation StrategyStrategy

Mapping is used in marketing to clarify and Mapping is used in marketing to clarify and communicate a product's identitycommunicate a product's identity

Offers picture of a company’s compensation Offers picture of a company’s compensation strategy based on the five choices in the pay strategy based on the five choices in the pay modelmodel

Clarifies the message the company is trying to Clarifies the message the company is trying to establish with its compensation systemestablish with its compensation system

Maps do Maps do notnot tell which strategy is the “best”, tell which strategy is the “best”, providing rather framework and guidanceproviding rather framework and guidance

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Exhibit 2.8: Contrasting Maps Of Exhibit 2.8: Contrasting Maps Of Microsoft And SASMicrosoft And SAS

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Steps 3 and 4: Implement and ReassessSteps 3 and 4: Implement and Reassess Step 3 Step 3

– Involves implementing strategy through the design Involves implementing strategy through the design and execution of compensation systemand execution of compensation system

Step 4Step 4– Reassess and realign, closes the loop and recognizes Reassess and realign, closes the loop and recognizes

that the strategy must be changing to fit changing that the strategy must be changing to fit changing conditionsconditions

– Involves periodic reassessmentInvolves periodic reassessment

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Sources of Competitive Advantage: Sources of Competitive Advantage: Three TestsThree Tests

Three tests determine if a pay strategy is a Three tests determine if a pay strategy is a source of advantagesource of advantage

Is it aligned?Is it aligned? Does it differentiate?Does it differentiate? Does it add value?Does it add value?

– Calculate the return on investment (ROI)Calculate the return on investment (ROI)

Whichhat is unique?

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Best Practices” Versus “Best Fit”?Best Practices” Versus “Best Fit”?Best FitBest Fit

If design of pay systemIf design of pay system

– Reflects company’s Reflects company’s strategy and valuesstrategy and values

– Is responsive to Is responsive to employees’ and unions’ employees’ and unions’ needs needs

– Is globally competitiveIs globally competitive

Company is more likely Company is more likely to achieve competitive to achieve competitive advantageadvantage

Best PracticesBest Practices

AssumptionsAssumptions

– A set of best-pay practices A set of best-pay practices existsexists

– Practices can be applied Practices can be applied universally across all universally across all situationssituations

– Results in better Results in better performance with almost performance with almost any business strategyany business strategy

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Guidance from the EvidenceGuidance from the Evidence Consistent research evidence that the following

practices do matter to the organization's objectives– Internal alignmentInternal alignment

Pay differences among internal jobs can affect resultsPay differences among internal jobs can affect results

– External competitivenessExternal competitiveness Paying higher than average paid by competitors can affect Paying higher than average paid by competitors can affect

resultsresults

– Employee contributionsEmployee contributions Performance-based pay can affect resultsPerformance-based pay can affect results

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Guidance from the Evidence (cont.)Guidance from the Evidence (cont.)– Managing compensationManaging compensation

Need to consider all dimensions of pay strategyNeed to consider all dimensions of pay strategy

– Compensation strategyCompensation strategy Embedding compensation strategy within the broader HR Embedding compensation strategy within the broader HR

strategy affects resultsstrategy affects results

““What practices pay off best under what What practices pay off best under what conditions” is an important question to be conditions” is an important question to be answeredanswered

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Virtuous and Vicious CirclesVirtuous and Vicious Circles One study concluded that One study concluded that howhow you pay also you pay also

matters as much as matters as much as how muchhow much you pay you pay Studies conclude that performance-based pay Studies conclude that performance-based pay

that shares success with employees improves that shares success with employees improves employee attitudes, behaviors, performance – employee attitudes, behaviors, performance – especially when combined with high-especially when combined with high-performance practicesperformance practices

Performance-based pay can be the best practice Performance-based pay can be the best practice under right circumstancesunder right circumstances

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Exhibit 2.9: Virtuous and Vicious Exhibit 2.9: Virtuous and Vicious Circles (cont.)Circles (cont.)

Chap 002

Documents

sustain competitive

total compensation

competitive

business strategy

pay strategy

compensation

vicious circles

supporting