MHR 749 notes - final exam
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Chapter 7
External Competitiveness Overview
- Part II focuses on external competitiveness in contrast to internal organizational comparisons.
- Strategic decision: Align pay with competitors or adopt a strategy fitting the organization's goals.
Definition of External Competitiveness
- Refers to pay relationships among organizations.
- Involves the organization's pay relative to competitors and the mix of pay forms aligned with business strategy.
Objectives of Pay Level and Pay Forms
- Focus on controlling costs and increasing revenues.
- Aims to attract and retain employees.
Cost Control and Revenues
- Pay level decisions significantly impact expenses.
- Higher pay levels lead to higher labor costs.
- Relative pay levels influence the costs of providing similar products or services.
- Labour Costs = Pay Level*Number of Employees
Attract and Retain Talent:
- Companies may pay more for higher productivity, better-trained, and innovative employees.
- Higher pay can reduce turnover, saving on recruiting and training costs.
- Other companies may differentiate with non-financial benefits like challenging work, superior training, rapid promotions, or job security.
Variability in Pay Levels:
- Different employers deliberately set pay levels above or below competitors for the same work.
- No single "going rate" in the labor market for specific jobs.
- A single company may have different pay levels for various job families.
Intra-Company Pay Variations:
- Companies set different pay levels for various job families.
- Example: Entry-level engineers, marketing jobs, and marketing managers in a company have different pay levels.
Total Compensation Consideration:
- Pay structures extend beyond base wages to include bonuses, stock options, and benefits.
- Example: Actual company data reveals different pay levels for job families; marketing managers remain above the market.
Pay Form Mix Variability:
- No universal "going mix" of pay forms.
- Exhibit 7.2 example: Two companies offer similar total compensation for marketing managers
but have different allocations for base, bonuses, benefits, and options.
Key Takeaways:
- External competitiveness involves complex decisions on pay levels and forms.
- Companies tailor pay strategies to their unique goals, emphasizing the lack of a standard approach in the labor market.
Key Points from Exhibit 7.1:
- Companies often set different pay level policies for different job families.
- A company's comparison to the market depends on the companies it compares to and the pay forms included.
Factors Affecting Pay Decisions (Exhibit 7.3):
Competition in the labor market for individuals with various skills.
Competition in product and service markets impacting the organization's financial condition.
Unique characteristics of the organization and its employees, including business strategy, technology, and workforce productivity and experience.
Influence on Pay Decisions:
- These factors work together to influence decisions on pay level and pay forms.
Assumptions in Economic Theories of Labour Markets:
Profit Maximization
- Employers always seek to maximize profits.
Homogeneity of Individuals -People are considered homogeneous and interchangeable in the labor market.
Comprehensive Pay Rates
- Pay rates encompass all costs associated with employment, including base wage, bonuses, holidays, benefits, and training.
Competitive Markets
- Labor markets are competitive, offering no advantage for a single employer to pay above or below the market rate.
Framework for Understanding Labour Markets:
- These assumptions, though oversimplified, provide a foundation for comprehending labour markets.
- Organizations often claim to be "market-driven," paying competitively or leading the market.
Demand and Supply Analysis in Labour Markets:
- Understanding labor markets involves analyzing demand and supply.
- Demand side: Actions of employers, including the number of employees sought and the pay offered.
- Supply side: Focuses on potential employees, considering qualifications and acceptable pay.
- Exhibit 7.4 provides an illustration of demand and supply for business school graduates.
Illustration of Demand and Supply (Exhibit 7.4):
- Vertical axis: Pay rates from $25,000 to $100,000 per year.
- Horizontal axis: Number of business school graduates in the market.
- "Demand" line represents employers' hiring preferences at various pay levels.
- "Supply" line indicates the willingness of business graduates to work at different pay rates.
- Market rate is where the lines for labor demand and labor supply intersect.
- Example: $50,000 is determined as the market rate in the illustration.
- All employers and business graduates collectively determine the market rate.
Conclusion on Market Rate:
- Single employers can hire all graduates at the market rate.
- Assumption of equal quality among graduates leads to a standardized market rate, e.g., $50,000 in the illustration.
What factors affect labour demand?
Economic Conditions:
- Economic growth and recession can impact overall labor demand.
- During economic expansion, businesses may increase hiring, while contractions may lead to reduced demand for labor.
Technological Advances:
- Automation and technological innovations can influence labor demand.
- Increased automation may reduce the need for certain types of labor, while new technologies may create demand for specialized skills.
Government Policies:
- Government regulations, tax incentives, and labor laws can impact labor demand.
- Policies affecting business operations, such as changes in minimum wage or labor standards, can influence hiring decisions.
Demographic Changes:
- Population growth, aging, and demographic shifts can influence labor demand.
- For example, an aging population may lead to increased demand in healthcare and related services.
Business Strategies:
- Organizational growth strategies, expansions, mergers, or downsizing can impact labor demand.
- Companies align their workforce with their strategic goals and objectives.
Education and Training:
- The availability of a skilled workforce, influenced by education and training programs, affects labor demand.
- Industries with a shortage of skilled workers may experience higher demand.
What factors affect labour supply?
Demographic Factors:
- Population size, age distribution, and gender composition impact the overall labor supply.
- Changes in birth rates, mortality rates, and migration patterns contribute to demographic shifts.
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Educational Attainment:
- The level of education and skill levels in the population influence labor supply.
- Higher educational attainment often leads to a more skilled workforce.
Training and Skill Development:
- Availability of training programs and skill development opportunities affects the skill set of the labor force.
- Continuous learning and skill enhancement contribute to a more adaptable workforce.
Labor Force Participation Rates:
- The percentage of the population actively participating in the labor market influences labor supply.
- Factors like retirement trends and cultural attitudes toward work affect participation rates.
Government Policies:
- Policies related to employment, retirement, and social welfare programs impact labor supply.
- For instance, policies affecting retirement age or unemployment benefits influence workforce participation.
Economic Incentives:
- Wage levels, benefits, and other economic incentives influence individuals' decisions to join or exit the labor force.
- Economic conditions, such as inflation and cost of living, also impact labor supply.
Marginal Product of Labour:
- Definition: Additional output associated with employing one more person, holding other factors
of production constant.
- Decreases as the number of new hires increases.
- Diminishing marginal productivity observed due to each additional hire having a progressively smaller share of other factors of production.
Example of Consulting Firm:
- Two business graduates form a consulting firm serving ten clients.
- Hiring a third person brings in four more clients, resulting in a marginal product of labour of four clients.
- Adding a fourth business graduate generates only two new clients due to diminishing marginal productivity.
Short-Term Factors:
- In the short term, factors like office space and clerical support are fixed.
- Each additional hire produces less than the previous one until these fixed factors change.
Marginal Revenue of Labour:
- Definition: Money generated by the sale of the marginal product, i.e., additional output from employing one more person.
- For the consulting firm, it is the revenue generated by each additional business graduate.
Revenue Example:
- If each new client generates $25,000, the third employee's four new clients generate $100,000.
- The fourth employee's two new clients generate only $50,000, exactly the wage that must be paid to that employee.
Profit Maximization:
- Businesses seek to maximize profits, a key assumption in labor market theory (profit maximization).
- The consulting firm will continue hiring until the marginal revenue of the last hire equals the costs associated with employing that business graduate.
Break-even and Profit Optimization:
- The consulting firm breaks even on the fourth employee, as the generated revenue equals the wage.
- Beyond the fourth hire, the firm would incur losses.
- The level of demand maximizing profits is when the marginal revenue of the last hire equals the
wage rate for that hire.
Key Principle:
- Employers continue hiring until the marginal revenue of the last hire equals the costs associated
with employing that individual.
Exhibit 7.5 - Labour Market Model and Individual Employer:
- Left Side (Supply and Demand Model):
- Pay level ($50,000) determined by the interaction of all employers' demand for business graduates.
- Right Side (Individual Employer):
- At the market-determined rate ($50,000), an individual employer can hire as many business graduates as desired.
- Supply becomes an unlimited horizontal line.
- Marginal Revenue Product (MRP) Line:
- Downward sloping to the right.
- Intersection with the market rate at 4, indicating that the market-determined wage equals the MRP of the fourth hire.
- The MRP of the fifth graduate is less than $50,000, making it insufficient to cover costs.
- Managerial Actions Using the Model:
- Determine the pay level set by market forces.
- Determine the marginal revenue generated by each new hire.
- This informs the manager about the optimal number of people to hire.
- Model Limitations:
- Oversimplifies the real world.
- Difficult to quantify individual employee contributions due to joint efforts and varied skills in most organizations.
- Challenges in Measuring Marginal Product and Revenue:
- In real-world settings, measuring the goods or services produced by an individual employee is challenging.
- Joint efforts and diverse skills make it almost impossible to separate individual contributions.
- Neither marginal product nor marginal revenue is directly measurable.
- Compensable Factors and Job Evaluation:
- Job evaluation, reflecting a job's contribution to the organization, can be viewed as a proxy for
marginal revenue product.
- Compensable factors are often defined as inputs rather than the value of the output.
- Skills and Competencies:
- Similar logic applies to skills and competencies in terms of their measurement and value determination.
Compensating Differentials Theory:
- Negative characteristics in a job (expensive training, tenuous job security, disagreeable working conditions, low chances of success) require employers to offer higher wages.
- Concept proposed by Adam Smith to compensate for the negative features of certain jobs.
- Examples of Negative Characteristics:
- Expensive Training: Medical school, law school.
- Tenuous Job Security: Stockbrokers, CEOs.
- Disagreeable Working Conditions: Highway construction, garbage collectors.
- Low Chances of Success: Professional sports (NBA, NFL, MLB).
- Rationale for Higher Wages:
- Employers use higher wages as a financial incentive to attract workers to jobs with undesirable features.
- Compensating for the costs, risks, or challenges associated with specific occupations.
- Implications of Compensating Differentials:
- Reflects the economic principle that individuals weigh the overall advantages and disadvantages when making employment decisions.
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- Justifies the variation in wages across different occupations based on the perceived negative aspects associated with those jobs.
Efficiency Wage Theory
- Efficiency Wage Theory: Suggests that high wages can increase efficiency and reduce labor costs by achieving various outcomes.
- Objectives:
Attract higher-quality applicants.
Lower turnover.
Increase worker effort.
Reduce "shirking" (slacking off).
Reduce the need for supervision.
Research Findings:
- High wages attract both more qualified and unqualified applicants.
- Few companies effectively evaluate recruiting programs, making it uncertain if they choose better applicants from a larger pool.
- Above-market wages don't guarantee a more productive workforce.
Impact of Higher Wages:
- Higher wages reduce the likelihood of employees finding comparable-paying jobs elsewhere, lowering overall turnover.
- Motivate current employees to work harder/smarter, assuming pay level influences effort.
Research on Shirking Behavior:
- Some evidence suggests that higher wages are associated with lower shirking behavior, measured by the number of disciplinary layoffs.
- Uncertain if reduced shirking offsets higher wage costs.
Supervision and Wage Levels:
- Higher wages may allow organizations to operate with fewer supervisors.
- Study in hospitals found those paying high wages to staff nurses employed fewer nurse supervisors.
- Relationship between wage attractiveness, nurse quality, and overall nursing costs not specified.
Profitability and Pay Levels:
- An organization's ability to pay is linked to the efficiency wage model.
- More profitable firms tend to have pay levels about 15% greater than less profitable firms.
Mix of Pay Forms:
- The discussion primarily focuses on pay level, neglecting the mix of pay forms.
- Simplifying assumption: Pay level includes the value of different forms.
- Signal theory is considered more useful in understanding the mix of pay forms.
Signalling Theory
- A more useful approach to understanding the mix of pay forms.
- Acknowledges the possibility that individuals may find performance-based bonuses or better health insurance more attractive.
- Notably absent in previous discussions on efficiency wage theory.
- Signalling Theory in Pay Design Definition: Employers deliberately design pay levels and forms as a strategy to signal desired employee behaviors.
- Pay design establishes a "brand" that communicates a message to prospective and current employees, similar to competing products and services.
Types of Pay Policies:
- A policy of paying below the market for base pay but offering generous bonuses or training signals different expectations than matching market wage with no performance-based pay.
- Pay policy, combining lower base with high bonuses, may signal a preference for risk-taking employees.
Exhibit 7.2 Analysis:
- Company A's pay mix emphasizes base (84%), while Company B's mix is closer to the market average.
- Company A communicates a message of potentially earning $112,349 with less apparent link to
performance, while Company B requires performance bonuses and stock options for the same amount.
- The difference in pay mix signals different expectations and risk-reward structures.
University Student Study:
- Pay level and mix of pay forms influence job decisions for university students approaching graduation.
- Preferences include high pay, individual-based pay, fixed pay, job-based pay, and flexible benefits.
- Job seekers' personal dimensions (materialism, confidence, risk aversion) impact pay preferences.
- Materialists prioritize pay level, while those who are risk-averse find pay level less important.
- Applicants select job opportunities based on the perceived match between personal dispositions
and the organization's nature, as signaled by the pay system.
Key Takeaways:
- Both pay level and pay forms send signals affecting who joins and stays with the organization.
- Pay design serves as a crucial aspect of employer branding, influencing employee attraction and retention.
- Individual preferences and organizational fit play a significant role in job decisions, emphasizing the impact of signaling through the pay system.
Summary of Compensating Differentials, Efficiency Wage Theory & Signalling Theory
Reservation Wage Theory:
- Definition: Job seekers have a reservation wage level, below which they will not accept a job offer, regardless of other attractive job attributes.
- Importance: If the pay level falls below their minimum standard, no other job attributes can compensate for this inadequacy.
- Variability: Reservation wages may be above or below the market wage.
- Application: Likely exists for the mix of pay forms; for instance, a parent may prefer a job with benefits.
Human Capital Theory:
- Explanation: Explains pay level differences based on the premise that higher earnings go to those who enhance potential productivity by investing in themselves (additional education, training, experience).
- Assumption: People are paid at the value of their marginal product.
- Factors Influencing Marginal Product:
- Investing in training or physical health increases one's marginal product.
- Value of skills and abilities is determined by time, expense, and resources invested in acquiring them.
- Job Examples:
- Jobs requiring extensive training (engineers, physicians) should have higher pay levels.
- Jobs with less investment (clerical workers, elementary school teachers) have lower pay levels.
- Supply Curve: As pay levels increase, the number of people willing to make investment increases, creating an upward-sloping supply curve.
Additional Factors Affecting Labour Supply:
- Geographic Barriers: Mobility between jobs impacted by geographic constraints.
- Union Requirements: Influence the supply of labor.
- Information Access: Lack of information about job openings can affect labor markets.
- Risk and Unemployment: Degrees of risk and unemployment also play a role.
- Non-Monetary Aspects: Non-monetary aspects of jobs (e.g., flexibility) are crucial aspects of the return on investment.
Overall Implications:
- The reservation wage theory explains job seekers' inflexible minimum wage standards.
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- Human capital theory highlights the relationship between investment in skills and abilities and subsequent pay levels.
- Various factors, including geographical, informational, and non-monetary considerations, contribute to the dynamics of labor markets.
Summary of Labour Supply Theories and Implications
Product Market Forces in Determining Pay Levels
- Constraints on Pay Level: An organization's ability to compete in the product/service market places constraints on its pay level.
Key Product Market Factors:
Product Demand: Influences the organization's ability to adjust product prices and, consequently, affects its capacity to set higher pay levels.
Degree of Competition: Affects the organization's flexibility in changing product prices.
Product Demand:
- Relationship with Pay Levels: While labor market conditions set a floor for pay levels, product market conditions set a ceiling.
- Ceiling Constraint: If an employer pays above the maximum dictated by product market conditions, it must either increase product prices or allocate a larger share of total revenues to cover labor costs.
Degree of Competition:
- Impact on Pricing: Highly competitive markets limit the ability to raise prices without losing revenues.
- Market Examples: - Highly Competitive: Manufacturers of automobiles or generic drugs.
- Less Competitive: Single sellers of unique products like Christian Louboutin shoes or breakthrough cancer treatments.
- Regulatory Considerations: Extremely high prices may attract government regulators' attention,
even for unique products.
Additional Factors Influencing Pay Levels:
- Productivity of Labour: Affects compensation decisions.
- Technology Employed: Plays a role in determining pay levels.
- Production Level Relative to Capacity: Influences compensation decisions.
Variability Across Industries:
- Differences Across Industries: Factors like technology, productivity, and consumer preferences vary more across industries than within them.
- Illustration: Auto manufacturers may have variations in technology and consumer preferences, but these differences are relatively small compared to variations between auto manufacturers and
industries like oil or finance.
Organizational Factors Influencing Pay Decisions
Industry and Technology:
-Influence on Pay Levels: Different industries and technologies impact pay structures.
- Examples: Labor-intensive industries (e.g., education, healthcare) pay less than technology-
intensive ones (e.g., petroleum, pharmaceuticals).
- Impact of Technology: Introduction of new technology within an industry can affect pay levels.
- Example: Automation reducing cashier skills leading to a decline in average pay.
Employer Size:
- Consistent Evidence: Larger organizations tend to pay more than smaller ones.
- Economic Theory Perspective: Larger organizations can afford higher wages due to the broader influence of talented individuals.
- Example: Study shows firms with 100-500 workers paid 6% higher wages than smaller firms,
and those with over 500 workers paid 12% more.
Employees’ Preferences:
- Importance in External Competitiveness: Understanding what pay forms employees value is crucial.
- Challenges in Measurement: Reliable measurement of employee preferences is challenging.
- Observation: People often prioritize pay more than they admit.
Organization Strategy:
- Variety of Strategies: Different pay level and form strategies exist.
- Examples: Low-wage, no-services strategy (e.g., Nike, Reebok outsourcing); low-base, high-
services strategy (e.g., Marriott offering services to low-wage employees).
- Internal Variation: Organizations may employ different strategies within different departments
or job roles.
- Efficiency Wage Perspective: Some firms, due to technology or monitoring complexities, have reasons to offer higher wages.
- Benefits of Higher Wages: Associated with higher pay satisfaction, employee attraction and retention, quality, effort, and performance.
- Return on Higher Wages: Higher wages must contribute to higher productivity, quality, or innovation for the organization's competitiveness and survival.
Conclusion:
- Organizational factors, along with product and labor market conditions, shape external competitiveness policies.
- The interplay of industry, technology, employer size, employee preferences, and organizational strategy determines pay levels and forms.
Competitive Pay Policy Alternatives
- Three conventional pay-level policies:
-To lead
-To meet (match)
-To follow competition (lag)
-Competitiveness of pay may affect the organization’s ability to achieve its compensation objectives, and in turn, affect employees’ performance.
Pay with Competition (Match) Policy
Policy Choices:
- Options: Organizations often choose to match, lead, or lag competitors in setting pay rates.
- Common Policy: The prevalent choice is to match rates paid by competitors.
Justification for Matching:
- Historical Rationale: Managers historically justify matching by citing potential employee dissatisfaction and recruitment challenges if rates differ significantly from competitors.
- Union Avoidance: Non-unionized companies may match or lead to discourage unionization.
Objectives of Match Policy:
- Equal Wage Costs: A match policy aims to keep an organization's wage costs approximately equal to those of its product competitors.
- Attractiveness in Labor Market: It seeks to ensure that the organization can attract applicants at a level comparable to its labor market competitors.
Balancing Pricing and Recruitment:
- Product Pricing: Avoids putting the employer at a disadvantage in product pricing by aligning
wage costs with product competitors.
- Labor Market Attractiveness: May not necessarily provide a competitive advantage in attracting talent in labor markets.
Conclusion:
- The match policy aims to balance wage costs with product competitors and maintain attractiveness in labor markets.
- While preventing disadvantages in product pricing, it might not necessarily confer a recruitment advantage in labor markets.
Lead Policy in Compensation
:
Objective of Lead Policy:
- Maximizing Attraction and Retention: A lead policy aims to maximize the organization's ability to attract and retain high-quality employees.
- Minimizing Dissatisfaction: It seeks to minimize employee dissatisfaction with pay by offering higher-than-average wages.
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- Offsetting Less Attractive Features: Higher pay may offset less attractive aspects of the work, similar to combat pay premiums in the military or higher wages in volatile markets.
Industry and Firm-Specific Considerations:
- Industry Impact: In some industries, high pay rates can be passed on to consumers if pay constitutes a low proportion of total operating expenses or if the industry is highly regulated.
- Firm Advantage: The lead policy must provide a competitive advantage to individual firms within a high-pay industry.
Research Findings on Lead Policy:
- Employee Quality and Retention: Research links high wages to ease of attraction, reduced vacancy rates, shorter training times, and better-quality employees.
- Turnover and Absenteeism: High pay levels are associated with reduced turnover and absenteeism.
- Variable Pay and Financial Performance: The use of variable pay (bonuses and long-term incentives) is connected to improved financial performance, but pay level alone is not.
Potential Negative Effects:
- Internal Alignment Challenges: Implementing a lead policy may require increasing wages for existing employees to maintain internal alignment.
- Masking Negative Attributes: Higher pay might mask negative job attributes contributing to high turnover, such as a lack of challenging assignments or unfavorable workplace culture.
Conclusion:
- Lead policy aims to gain a competitive advantage through attracting and retaining high-
quality employees with above-average wages.
- Positive outcomes include improved employee quality, reduced turnover, and enhanced financial performance, but challenges include internal alignment issues and potential masking of negative job attributes.
Lag Policy in Compensation
:
Objective of Lag Policy:
- Future Returns in Exchange for Lagged Pay: A lag policy involves paying below market rates
with the promise of higher future returns, such as stock ownership in a high-tech start-up firm.
- Enhancing Commitment and Teamwork: The promise of future returns aims to increase employee commitment and foster teamwork, ultimately leading to improved productivity.
Potential Positive Outcomes:
- Employee Commitment: The promise of higher future returns may enhance employee commitment to the organization.
- Teamwork and Productivity: By fostering teamwork, the organization expects to see increased
productivity among its employees.
Consideration for Unmet Expectations:
- Negative Effects of Unmet Expectations: While a lag policy holds the potential for positive outcomes, unmet expectations could result in negative effects. Employees anticipating higher future returns may experience dissatisfaction if these expectations are not fulfilled.
Combining Lag on Pay Level with Leadership in Other Areas:
- Leading in Non-Monetary Returns: It is possible to lag behind competitors on pay level while
leading in other non-monetary returns from work, such as meaningful work, desirable location, outstanding colleagues, access to advanced tools, and achieving work/life balance.
Conclusion:
- Lag policies involve paying below market rates with the promise of higher future returns to enhance employee commitment and teamwork.
- Unmet expectations may lead to negative effects, emphasizing the importance of fulfilling promises.
- Combining lag in pay with leadership in other non-monetary aspects offers a strategic approach to compensation.
Tailored Compensation Policies for Employee Groups
Diversity in Compensation Policies:
- Beyond Single Policy Choices: Employers often move beyond a singular choice among match, lead, or lag policies.
- Consideration for Employee Groups: Tailoring compensation policies to suit the characteristics and needs of specific employee groups is a common practice.
Variation Across Occupational Families:
- Example from Exhibit 7.1: Companies may adopt different policies for various occupational families within the organization.
- Occupational-Specific Considerations: Different job categories or occupational families may have unique requirements, skills, and market competitiveness, justifying distinct compensation approaches.
Differential Policies for Pay Forms:
- Example from Exhibit 7.2: Employers might implement varied policies for different forms of pay, recognizing that employees may prioritize different components of their total compensation.
- Flexibility in Pay Structure: Acknowledging that individuals value diverse elements of their compensation package, organizations tailor policies accordingly.
Adaptation for Business Units:
- Reflecting Competitive Conditions: Companies may adapt policies based on the specific competitive conditions faced by different business units.
- Strategic Alignment: Tailoring compensation to suit the competitive landscape of each business unit ensures alignment with strategic goals.
Conclusion:
- Customized Compensation Strategies: Practical implementations often involve tailoring compensation policies to address the unique characteristics and needs of various employee groups.
- Flexibility Across Occupational Families, Pay Forms, and Business Units: Employers demonstrate flexibility by adapting policies for different job categories, pay structures, and business units.
Employer of Choice and Shared Choice Approach
Employer of Choice Strategy:
- Beyond Monetary Aspects: Some companies, like IBM, differentiate themselves as an "employer of choice" by emphasizing overall workplace reputation.
- Holistic Differentiation: IBM leads in performance emphasis, provides extensive training, challenging assignments, creating an image beyond just pay.
- "Employer of Choice" as a Brand: This approach aligns with projecting the company's brand and image as an employer, extending beyond financial aspects.
Shared Choice Approach:
- Enhancing Traditional Alternatives: Originating from lead, match, or lag, the shared choice approach adds a dimension by allowing employees to customize their pay mix.
- "Employee as Customer" Perspective: Drawing parallels with consumer choices, the approach
treats employees as customers, offering flexibility in pay mix decisions.
- Common in Benefits: Similar to choices in health insurance or retirement plans, this approach
extends to total compensation with evolving software capabilities.
Risks and Considerations:
- Potential Risks: Allowing extensive choices poses risks such as jeopardizing employee well-
being or leading to confusion and dissatisfaction.
- Analogous to Consumer Behavior: Similar to the "24 jars of jam" phenomenon, offering too many choices may overwhelm employees, impacting decision-making and satisfaction.
Conclusion:
- Innovative Strategies: Companies are exploring innovative approaches like "employer of choice" and the shared choice model to attract and retain talent.
- Balancing Choices and Risks: While offering choices can enhance employee satisfaction, there is a need for balance to avoid potential pitfalls such as confusion or suboptimal decisions.
Chapter 8
Competitive Pay Policy & Compensation Survey
- Objective of Compensation Survey:
- Obtain external market data for translating pay policies into practice.
- External Competitive Pay Policy Options:
- (1) Market Leader (Lead):
- Pay rates are set to be above the average market rates.
- (2) Average Pay of Competitors (Match):
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- Pay rates align with the average market rates.
- (3) Below Average Market Rates (Lag):
- Pay rates are set below the average market rates.
- Role of Compensation Surveys:
- Provide data on external pay rates.
- Facilitate the translation of external pay policy into:
- Pay levels.
- Pay mix.
- Pay structures.
- Decision-Making Process:
- The decision on external competitive pay policy precedes the use of compensation surveys.
- Chapter 7 covers the decision-making process for external pay policy.
- Application of External Pay Policy:
- Requires accurate information on pay rates in the external market.
- Compensation surveys serve as a crucial source for this information.
- Overall Function:
- Compensation surveys enable organizations to make informed decisions on pay levels, structures, and mixes based on external market benchmarks.
Purpose of Compensation Surveys
- Conducted by employers for various reasons:
Adjust Internal Pay Level:
- Respond to changes in competitor pay rates.
Set Internal Mix of Pay Forms:
- Determine the distribution of pay forms relative to competitors.
Establish Internal Pay Structure:
- "Price" the internal pay structure.
Analyze Pay-Related Problems:
- Investigate and address issues related to pay.
Estimate Labor Costs of Competitors
:
- Understand competitors' labor costs for product market analysis.
- Adjusting Pay Level:
- Regular adjustments based on:
- Overall upward movement of pay rates in the market.
- Performance, ability to pay, or contract terms.
- Adjusting Pay Mix:
- Less frequent adjustments to different pay forms (base, bonus, incentives, benefits).
- Recognition of the importance of the "pay package."
- Adjusting Pay Structure:
- Market surveys used to validate job evaluation results.
- Discrepancies between internal job evaluation and external market pay structures addressed.
- Some organizations use market surveys to directly establish internal structures.
- Special Situations:
- Specialized surveys focus on specific job groups (e.g., patent attorneys, retail sales managers).
- Addressing unusual turnover through focused market surveys.
- Competitive Intelligence:
- Employers use survey data for competitive intelligence.
- Understand competitors' market share, pricing, and compensation practices.
Select Relevant Labour Market:
- Essential for decisions on pay levels, mix, and structures.
- Includes employers competing in:
The same occupation or skills.
The same geographic area.
The same products and services.
Qualifications and Geography:
- Exhibit 8.2 illustrates how qualifications and geography define market scope.
- Higher qualifications increase geographic limits.
- National competition for managerial and professional skills.
- Local or regional competition for clerical and production skills.
- Generalizations may vary, especially in areas with high concentrations of specific skills.
Industry Considerations:
- Skills tied to a particular industry may define the market on an industry basis.
- Industry relevance depends on the nature of skills (e.g., underwriters in insurance).
- Depending on its location and size, a company may be a relevant comparison even if it is not a
product market competitor.
Cost Control and Ability to Pay:
- Inclusion of competitors in the product/service market is crucial for cost control and ability to pay.
- Competitors' pay rates impact operational costs and financial conditions.
- Depending on its location and size, a company may be a relevant comparison even if it is not a product market competitor.
Advantages & Disadvantage of Various Measures of Compensation
Job Matching
Definition: the degree of match between the organization’s jobs and survey jobs must be carefully assessed on job content rather than on the basis of job title only
Update Pay Survey
- Pay rates change due to decisions from employers, employees, unions, and government agencies.
- Non-Uniform Changes Throughout the Year:
- Companies adjust wages at different times, leading to non-uniform changes in pay rates throughout the year.
- Challenge of Outdated Data:
- Surveys take time to collect and analyze.
- By the time survey data are available, they may be outdated due to ongoing pay adjustments.
- Aging/Trending Survey Data:
- Common practice to age/trend survey data to reflect current or future pay levels when decisions will be implemented.
- Factors in Data Adjustment:
- Adjustment amount is based on various factors:
- Historical trends.
- Market economic forecasts.
- Prospects for the economy where the employer operates.
- Manager's judgment.
Market Pay Line
- Market pay line is an upward-trending line connecting benchmark jobs on the horizontal axis to competitor pay rates on the vertical axis.
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- A market pay line links a company’s benchmark jobs on the horizontal axis with market rates paid by competitors on the vertical axis.
- scatterplots are useful to see what the data look like and construct a market pay line
Develop Pay Grades
- The first step is to group different jobs considered substantially equal for pay purposes into grades. The objective is for all jobs similar for pay purposes to be in one grade.
- Grades enhance an organization's ability to move people among jobs with no change in pay
- All the jobs within a single grade will have the same pay range.
- Number of pay grades varies with organization’s hierarchy.
Pay Ranges
- Pay ranges refer to the vertical dimension of the pay structure – an upper and lower limit on pay for all jobs in a pay grade
- Each range has a midpoint where the pay-policy line crosses the center of the grade, a minimum and a maximum. midpoint represents base pay for a seasoned employee [compa ratio =
1]
- The size of the range is a judgment about how the range supports career paths, promotions, etc.
- Larger ranges in the managerial jobs reflect the greater opportunity for performance variations in the work.
- Some firms use percentiles as maximums and minimums while other establish them separately.
Why Bother With Pay Ranges?
Pay Ranges provides managers with the opportunity to deal with:
Internal pressures
-
Recognize individual performance differences with pay,
-
Meet employees' expectations that their pay will increase over time, even in the same job, and
-
Encourage employees to remain with the organization.
External pressures
-
Differences in quality among individuals applying for work,
-
Differences in the productivity or value of these quality variations, and
-
Differences in the mix of pay forms competitors use.
Red & Green Circles
Red circle
-
employee pay goes above the pay grade – (long-term employees who pass up promotions or do not get promotions are potential red circles)
-
To avoid red circles, promote that person only if there is a legitimate vacancy. if that person is competent and performs well and if that person is willing to take the promotion
-
What if the person says no – merit increases become a merit bonus, a lump sum payment, rather than an increase to your salary; therefore, the person is still being recognized and paid, but their salary is not affected; thus, they do not become a red circle.
Green Circle
-
you have an employee getting paid below the minimum of the grade pay range (if someone is moving between positions, or training someone for the next position, or new grads)
-
Is the employee doing the job if not make a performance improvement plan (PIP) to ensure the person receives s raise and fall under the minimum requirement
Potential question for final:
What are green and red circles? What does management do to rectify these situations?
Range Overlap
- Overlap Between Pay Grades:
- Size of pay ranges affects the degree of overlap between adjacent pay grades.
- Exhibit 8.13 Overview:
- Illustrates extremes in the degree of overlap between adjacent grades.
- Figure A - High Degree of Overlap:
- Indicates small differences in the value of jobs in adjoining grades.
- Promotions may involve title changes but minimal pay changes.
- Figure B - Less Overlap:
- Smaller ranges create less overlap.
- Allows managers to reinforce promotions with larger pay increases.
- Potential downside: Fewer opportunities for promotion.
- Overlap ought to be large enough to induce employees to seek promotions.
- Not all employers use grades and ranges.
- Skill-based plans establish a single flat rate for each skill level, regardless of performance or seniority.
- Many collective bargaining contracts establish flat rates per job.
- Increasingly, broad bands are being adopted for greater flexibility
Broad banding
- Broad banding Definition: Technique that consolidates multiple traditional salary grades into a few broad bands.
- Advantages of Broad banding:
- Flexibility in Job Responsibilities:
- Broadbands allow for a broader definition of job responsibilities.
- Support for Redesigned Organizations:
- Ideal for organizations eliminating layers of managerial jobs.
- Supports downsized or boundary-less structures.
- Cross-Functional Growth and Development:
- Facilitates lateral movement across functions within a band.
- Employees gain depth of experience through cross-functional exposure.
- Managing Flattened Organization Structures:
- Emphasis on lateral movement without pay adjustments.
- Manages the reality of fewer promotion opportunities in flattened structures.
Difference between Ranges and Bands
Job Structure and Pay Structure:
- Job structure: Orders jobs based on internal organizational factors (job evaluation or skill/competency certification).
- Pay structure: Anchored by the organization's external competitive position, reflected in pay policy lines.
- Reconciling Differences Between Job and Pay Structures:
- Differences between market structures/rates and job evaluation rankings warrant a review.
- Review involves job analysis, job description, job evaluation, or market data re-evaluation.
- May entail a review of: job analysis, job evaluation and market data
- Differences may arise due to shortage of a particular skill, driving up market rate.
- Decisions made for expediency may undermine the integrity of pay decisions.
- Short-term solutions may have long-term consequences.
- Market Pricing in Pay Strategies:
- Some organizations emphasize external competitiveness over internal alignment.
- A "core change" is noted, reflecting diminished concern for internal salary relationships.
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Market Pricing
- Market Pricing Definition: Sets pay structures primarily based on rates paid by external competitors.
- Known as market pricing.
- Implementation:
- Market prices match a large percentage of jobs with external market data.
- Competitive rates for benchmark positions are calculated first.
- Example - Pfizer:
- Begins with job analysis and descriptions, followed by market analysis and pricing.
- Remaining non-benchmark jobs blended into the pay hierarchy based on external rates.
- Internal job relationships reviewed for alignment with organization workflow.
- Extremes of Market Pricing:
- Objective:
- Base most, if not all, of the internal pay structure on external rates.
- Detailed Matching:
- Some companies match all forms of pay for each job to competitors, including base pay, bonus, stock options, and benefits.
- Competitive Advantage:
- Raises questions about whether competitors' pay decisions should be the sole determinant of a company's pay structure.
- If so, uniqueness and competitive advantage are diminished.
- Fairness and Employee Behavior:
- Presumption that fairness is reflected by market rates.
- Employee behavior presumed to be reinforced by totally market-priced structures, similar to competitors.
- Balancing Internal and External Pressures:
- Judgment Required:
- Balancing internal and external pressures is a matter of judgment aligned with strategic perspectives and pay system objectives.
- Potential Consequences:
- De-emphasizing internal pay alignment may lead to unfair treatment and inconsistency with organizational strategy.
- Neglecting external competitive pay practices impacts recruitment, hiring, retention, labor costs, and competitiveness in the market.
Conclusion
- Most organizations survey other employers’ pay practices to determine the competitors’ rates
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- Aging of survey data will ensure information is up-to-date when the pay decisions are made.
- A market pay line links a company’s benchmark jobs on the horizontal axis (job evaluation points) with market rates paid by competitors (market survey) on the vertical axis. A pay policy line represents external competitive position in the market (i.e., lead, match, lag).
- Pay grades are created by grouping jobs that are worth similar number of job evaluation points. Pay ranges provide an upper and lower limit for pay for all jobs in a pay grade. - Broadbanding is the practice of establishing large bands of jobs containing several pay grades.
Chapter 9
Employee Benefits
-
that part of the total compensation package, other than pay for time worked, provided to employees in whole or in part by employer payments.
Why the growth in employee benefits?
Government:
- Key role in employee benefits growth.
- Mandated benefits include Workers’ Compensation, Employment Insurance, and Canada/Quebec Pension Plan.
- Laws like the Employment Standards Act, Income Tax Act, and human rights acts influence other benefits.
- Human rights laws mandate equal family and survivor benefits for unmarried partners.
- Mandatory retirement at age 65 abolished in all provinces and territories.
- Protect minimum income upon unemployment or retirement
Unions:
- Fought for and contributed to the introduction and improvement of benefits.
- Auto and steelworkers unions played a significant role.
- Initial impetus for pension plans, supplementary unemployment benefits, and retiree benefits.
- Better total compensation package for their membership
Employer Impetus:
- Many existing benefits originated from employer initiatives.
- Driven by concerns about employee satisfaction and productivity.
- Benefits like rest breaks aimed at reducing fatigue-related accidents.
- Savings and profit-sharing plans implemented for improved performance and worker retirement security.
- Employer-initiated benefits designed to convey genuine concern for employee welfare.
- Attract new talent (ex: free childcare, talent: single moms or moms in general), retain employees (longer you work there, the more benefits you receive, ex: vacation)
Cost-Effectiveness of Employee Benefits:
- Non-taxable nature of most benefits provides a cost advantage.
- Provision of benefits avoids personal income tax payment.
- Group-based benefits obtained at lower rates than individual plans.
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- Group insurance has easy qualification standards, offering security to a broader set of employees.
- Benefit premiums and pension contributions are tax-deductible within specified limits in the Income Tax Act.
Key Issues In Benefits Planning, Design and Administration
- Decide the role of benefits and integrate them into the overall compensation package.
- Benefit plan design must ensure that benefits are adequate.
- Evaluation involves considering financial liability with and without specific benefits.
- No universal formula for defining benefits adequacy
- Include strategies for:
- ensuring external competitiveness: Know what your competitors offer
- adequacy of benefits: there is no magic formula for defining adequacy.
- The answer may be a relationship between benefit adequacy and cost effectiveness.
- Are employee benefits cost justified?
- Benefits administration: Who should be covered? How much choice for employees? How should benefits be financed?
- who should be covered? the employees (yes), spouses and partners (yes), dependents (up to the age of 25 and enrolled in full-time school) (yes) part-time employees (yes, but offer prorated benefit plans- many companies do not offer benefits for part-time workers)
- Why offer spouses and children benefits? Because the employee is responsible for the well-being of their spouse and children, If the employee’s spouse or child is sick, they have to take sick days to take care of their spouse/kids.
- Retirees benefit plan: the company will organize a benefit plan with a cost advantage but will not pay for it
Major Administration Issues in Benefits Package Setup:
Coverage and Protection:
- Determining who should be covered or benefited.
- Consideration of different employment statuses and equal treatment concerns.
- Questions regarding eligibility, probationary periods, coverage during layoffs, leaves, etc.
Choice and Flexibility:
- Addressing the level of choice (flexibility) in plan coverage.
- Traditional vs. flexible benefit plans.
- Flexibility seen as a response to diverse workforce and cost pressures.
Financing Benefits Plans:
- Alternatives include non-contributory, contributory, and employee-financed plans.
- Organizations prefer contributory plans to emphasize the value of benefits.
- Increasing efforts to cut costs due to rising benefit expenses.
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Legislative Compliance:
- Ensuring benefits plans comply with legislation and regulations.
- Legal considerations regarding retirees, dependents, survivors, disabilities, and more.
Coverage Considerations:
- Probationary periods and immediate coverage decisions.
- Determining coverage for dependents, retirees, survivors, and employees with disabilities.
- Questions about coverage during layoffs, leaves, and strikes.
Choice and Flexibility:
- Traditional vs. flexible benefit plans.
- Flexible plans provide employees with greater choice.
- Even non-flexible plans are offering increased flexibility, such as optional levels of insurance.
Financing Options:
- Non-contributory (employer pays total costs).
- Contributory (costs shared between employer and employee).
- Employee-financed (employee pays total costs for some benefits).
- Preference for contributory plans to emphasize value and control costs.
Legislative Compliance:
- Ongoing need to ensure benefits plans align with legal requirements.
- Considerations for compliance with legislation and regulations in different operating locations.
Employee Benefits: Legal & Employee Sponsored
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Workers’ Compensation (Provincial)
-
a mandatory, government-sponsored, employer-paid no-fault insurance plan that provides compensation for injuries and diseases that arise out of, and while in the course of, employment
-
regulated by provinces/territories and provides benefits for
- Lost earnings due to temporary/permanent disability
- Health care expenses - Survivor benefits after fatalities
-
compensation varies from 75 to 90 percent of net earnings (two jurisdictions provide 75 percent of gross earnings)
cost control is an ongoing concern
-
Compensation is received if you injure yourself (an accident occurs) in the workplace
-
Workplace accident – no-fault insurance plan -
The higher the number of workplace accidents – the higher the premium the employer
has to pay
-
Covers mental health issues as well
Canada/Quebec Pension Plan (Federal)
-
a mandatory, government-sponsored pension plan for all employed Canadians
-
funded equally by employers and employees [contribution rate increase by 1% by 2023]
-
provides benefits upon -
retirement
-
disability
-
death
Employment Insurance (Federal)
-
a mandatory government-sponsored plan for all employed Canadians that provides workers with temporary income replacement as a result of employment interruptions due to circumstances beyond their control
-
funded by employer and employee contributions
-
basic benefit is 55 percent of average insurable earnings
Government-Sponsored Medical Plans (Provinicial)
-
all provinces/territories provide basic medical and hospital services
-
no direct fee to patients; funding through tax revenues, premiums, or payroll tax
-
do not cover prescription drugs, dental care, eyeglasses, private duty nursing, cosmetic surgery, semi-private or private hospital accommodation Vacations, Holidays, Paid Breaks & Leaves (Provincial)
Vacation
-
minimum amount of paid vacation must be provided to employees
Holidays
-
varies by jurisdiction
Paid breaks
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-
uninterrupted break within a work day
-
e.g. 30 minute break on a shift over 5 hours
Leaves
-
pregnancy, parental, personal emergency leave, family caregiver leave, family medical leave, etc.
Pay on Termination of Employment (Provincial)
-
does not apply to those on short-term contract or fired for just cause
-
amount of payment varies according to jurisdiction and circumstances:
-
pay in lieu of reasonable notice
-
severance pay
-
pay for mass layoffs
Potential final exam question
-
List and briefly explain four mandated benefits by the government
-
Who pays
-
What it is
-
Federal or provincial
Employer-Sponsored Pension Plans
- Defined contribution plans (
DCB
): specify the contributions by employer and employee, but the pension benefits depend on the total accumulated on an employee’s behalf with no guarantees
of specific amounts.
- Defined Contribution Plan Overview:
- Requires specific contributions by the employer.
- Employee contributions may be required or optional.
- All contributions deposited in a pension fund for investment until retirement.
- Accumulation and Retirement Benefit:
- Contributions, along with investment earnings, accumulate in the pension fund.
- At retirement, the accumulated amount is utilized to provide a retirement income benefit.
- Final benefit amount is unknown and depends on the success of investments.
- Defined Benefit Plan (DBP) Overview:
- Employer commits to providing a specific retirement income level.
- Retirement income may vary with years of seniority.
- Defined benefit plans: pay the plan member a specific level of retirement income based on a formula that takes into account the average of the employees best three to five years of earning prior to retirement. Example: FAE x multiple x years of service
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Pension Calculation Exercise
Ian Brown has been working in sales for 20 years. He is turning 60 at the end of this year and
is seriously considering retirement at the end of the year. Can he afford to retire?
His date of birth: 31 December 1963
He started to work at TDS in 31 December 2003
His base pay for the last three years is as follows:
January to December 2023
$72,000 January to December 2022
$70,000
January to December 2021
$68,000
TDS has a defined benefit pension plan that uses the following formula to determine payout:
FAE (last 3 years) x 1.45% x years of service
Notes:
1. The normal retirement age based on the company’s pension plan is 65 but employees can opt for early retirement as early as at age 60.
2. To qualify for early retirement with an unreduced pension before the normal retirement age of 65, the employee must satisfy the rule of 85, i.e. age + service should be at least 85.
3. There is a 25% reduction in his monthly pension benefits if the rule of 85 is not met.
FAE= Final Average Earning
If you don’t satisfy the rule of 85, there is a 25% reduction on the monthly benefit
This will be on the final exam – calculating pension
Ian Brown gets $15 225.00
70 000*0.0145*20*0.75 (75% because of the 25% reduction)
Life Insurance
- Frequently offered by organizations.
- Typically, a group insurance policy with a face value of 1-2 times the employee's annual salary.
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- Coverage and Premiums:
- Group insurance coverage is common.
- Premiums often fully paid by the employer.
- Additional Options:
- Optional employee-paid life insurance may be offered.
- Some employers provide retirees with life insurance at minimal or no cost.
- Other Forms of Life Insurance:
- Dependent Life Insurance:
- Benefits provided in case of the death of the spouse or child of an employee.
- Accidental Death and Dismemberment Insurance: - Pays double the regular life insurance benefit if the employee dies in an accident.
- Provides a percentage of the death benefit for accidental paralysis or loss of limbs, eyesight, speech, or hearing.
Employer-Sponsored Medical Plans
- Employer-Sponsored Medical Insurance:
- Covers expenses not covered by provincial/territorial plans.
- Importance of Drug Plans:
- Canadian employees highly value drug plans as a significant employee benefit.
- Challenges in Healthcare Costs:
- Dramatic increases in healthcare costs, primarily driven by prescription drugs.
- Prescription drugs account for 75% of employer medical benefit costs in Canada.
- Key Issues for Benefits Managers:
- Rising healthcare costs, especially in prescription drugs, pose a significant challenge.
- Factors contributing to cost increases include the use of expensive new biologic drugs, increased drug utilization by an aging population, and reductions in coverage under provincial/territorial healthcare plans.
- Concerns about Retiree Healthcare Benefits:
- Many Canadian employers providing healthcare benefits to retirees are considering eliminating these benefits due to the escalating costs.
Cost Containment
What can be done to save money on benefit package
- group plan (economies of scale)
- benefit cap (maximum amount that employees can use before they run out of benefits)
- deductible (amount employee has to pay before insurance pays the rest of the amount)
- co-insurance (employee pays for some/employer pays for some)
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- flexible benefits (employers give employees a set amount of money to choose which benefits they want a part of their benefit package)
- subsidies to gyms – exercising to limit the needs for medical plan Income Security Benefits
- Sick Leave Plans:
- Grant full pay for a specified number of sick days per month or year.
- Typically require a medical certificate.
- Some employees misuse sick leave for extra vacation days.
- Serious illness or injury may result in no pay after exhausting sick days until short-term or long-term disability benefits begin.
- Short-Term Disability Plans:
- Provide continuation of all or part of an employee's earnings during a prolonged absence (up to 26 weeks).
- Cease when the employee returns to work or qualifies for long-term disability.
- Often integrated with Employment Insurance (EI) disability benefits.
- Long-Term Disability Plans:
- Offer income protection for non-work-related long-term illness or injury.
- Payments start after 26 weeks of short-term disability, lasting to age 65 or for life.
- Benefits range from 50% to 75% of the employee's base pay.
- Not taxable if the employee covers the full cost; employer contributions result in taxable benefits for the disabled employee.
- If employee is at risk of long-term disability
- offer reduced and modified hours worked
- offer reduced and modified work duties
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Pay for Time Not Worked
- Paid vacations beyond legal requirements, paid holidays (statutory and others), and miscellaneous allowances (jury duty, bereavement pay, paid personal leave, paid time for community volunteer work).
- Employee Preferences and Union Contracts:
- Pay for time not worked remains a high-demand benefit.
- Historically, time off was typically granted for vacations, holidays, and sick leave.
- Current trends involve extending paid time off to cover civic responsibilities and obligations.
- Civic Duties Compensation:
- Outside pay for civic duties is usually nominal.
- Many organizations supplement this pay, often providing up to 100% of wages lost for civic responsibilities and obligations (jury duty).
Miscellaneous Benefits
-
educational assistance / tuition refund
-
child-care services
-
eldercare services
-
employee and family assistance plans (EFAPs)
-
provide confidential counselling and/or treatment programs for personal problems including addiction, stress, and mental health issues
-
wellness programs
-
employee discounts
-
prayer rooms / napping rooms
-
food and concierge services
-
employers will offer food as a benefit because it forces employees to stay within the building. Therefore, employees can work while eating, and less time is spent on commuting to go grab food and eat it. So, it increases productivity.
Administering the Benefit Program
-
communicating the benefits program
-
revolves around four issues: what is communicated, to whom, how it is communicated, and how frequently
-
Effective communication involves repetition and consistency
-
claims processing: a claims processor determines eligible benefits and ensures coordination of benefits
-
cost containment
Provide total compensation statement to allow employees to know how much they pay for each benefit, how much the employer would pay, and how much is left. Potential Exam Question – similar
Your CEO just read the Globe and Mail that employee benefit cost, on average, 38% of payroll.
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To save money, he suggests that the company fire its two benefits administrators, do away with all benefits, and give employees a 38% pay rise.
What argument could you provide to persuade the CEO that it is not a good idea?
Answer:
- not all employees will buy benefits using the 38% increase
-higher pay is not all. People are looking for lucrative benefits, so to attract and retain talent, a lucrative benefits package is needed.
- government-mandated benefits – not in compliance with the government standards, legal issues
- tax liability due to the progressive tax system; therefore, you pay higher taxes for higher wages
- 38% of base salary differs between employees; not all employees will have access to suitable insurance that covers all their needs
Chapter 10
What Behaviors Do Employers Care About?
-
Employers want employees to perform in ways that lead to better organizational performance
-
Behaviors that compensation needs to reinforce:
-
compensation is sufficiently attractive to make recruiting and hiring good potential employees possible (attraction)
-
Make sure the good employees stay with the company (retention)
-
Build further knowledge and skills (development)
-
Find ways to motivate employees to perform well on their jobs (motivation)
Employee performance
Employee performance = f (A, M, E), where
-
A = Ability
-
M = Motivation to perform
-
E = Supportive environment
Motivation Theories
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Do People Join Because of Pay?
- Influence of Pay on Job Candidate Decisions:
- Pay level and system characteristics significantly impact a job candidate's decision to join a firm.
- Pay is a prominent and visible aspect in the recruitment process, clearly outlined in job offers, including discussions about bonuses and profit sharing.
- Fit with Reward Systems:
- Research suggests job candidates seek organizations with reward systems that align with their personalities.
- Materialistic – concerned about pay level.
- Low self-esteem – want little pay for performance.
- Risk takers – want pay based on performance.
- Risk-averse – want less performance-based pay.
- Individualist – want pay based on individual performance
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-
Reward systems should be designed to attract people with desired personalities and values.
Do People Stay in a Firm (Or Leave) Because of Pay?
- **Impact of Pay on Employee Turnover:**
- Employee decisions to leave are influenced by their performance and the extent to which pay is performance-based.
- **Equity Theory and Turnover:**
- Equity theory research from the 1970s reveals that perceived unfair treatment in pay leads employees to leave for better opportunities.
- **Performance-Based Pay and Turnover Outcomes:**
- Poor performers under individual performance-based pay conditions exhibit higher turnover—
a positive outcome.
- Group incentive plans may result in higher turnover among better performers, which is undesirable.
- **Example of AT&T Shift:**
- Shift from individual to team-based incentives at AT&T led to reduced output or quitting by star performers.
- Dissatisfaction arose as incentives for higher individual performance were spread across all group members.
- **Dissatisfaction and Turnover:**
- Dissatisfaction with pay is a key factor in turnover.
- Inadequate pay leads to feelings of unfair treatment, while reasonable pay can help reduce turnover.
- **Impact of Pay Systems on Turnover:**
- Some employees are uncomfortable with pay systems that risk substantial future earnings or link less to personal effort and more to group effort.
- **Using Compensation for Retention:**
- Efforts to retain workers, especially scarce talent like information technology employees, involve developing variable pay components tied to individual factors such as length of stay on a
project, peer ratings, and project results.
- **Informative Study on Pay System Change:**
- A study on a glass installation company showed a 44% overall increase in plant productivity after switching from a salary-only to an individual incentive plan.
- Half of the productivity gain came from individual employees becoming more productive, while the other half was attributed to less productive workers leaving and being replaced by more productive workers.
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Do Employees More Readily Agree to Develop Job Skills Because of Pay?
- **Skill-Based Pay and Employee Learning:**
- Skill-based pay is designed to compensate employees for learning new skills, potentially improving current job performance and adaptability to future job demands.
- **Uncertain Impact on Promise:**
- The actual fulfillment of the promise that skill-based pay improves performance and adaptability is unclear.
- **Cost Implications and Training Requests:**
- Skill-based pay plans can have significant cost implications as more employees seek training in anticipation of pay raises tied to skill acquisition.
- Poorly administered plans, such as allowing more certifications than necessary or not maximizing the benefits of a multi-skilled workforce, lead to cost inefficiencies.
- **Focus on Quality:**
- Emerging evidence suggests that pay for skill may not necessarily increase productivity.
- However, it does focus employees on recognizing the importance of quality and producing products of significantly higher quality.
Do Employees Perform Better on Their Jobs Because of Pay?
- **Link Between Pay and Employee Behaviors:**
- Well-designed pay plans linked to employee behaviors result in improved individual and organizational performance.
- **High-Performance Work Practices and Sales:**
- A study of over 3,000 companies found those with high-performance work practices, including formal appraisals tied to pay increases and promotions based on performance, had annual sales averaging $27,000 more per employee.
- **Use of Individual Performance in Determining Pay:**
- A survey of 1,001 organizations revealed that 92% used individual performance to determine salary increases, and 84% utilized variable pay tied to performance.
- **Merit Pay Studies and Performance:**
- Review of 42 studies on merit pay shows higher performance when pay is linked to performance.
- **Motivation and Performance:**
- Strong evidence indicates that linking pay to performance increases worker motivation and leads to improved performance.
- **Individual Incentives and Productivity:**
- Studies analyzing the introduction of individual incentives into work settings show an average
productivity increase of 30%.
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- **Higher Rewards for Higher Performers:**
- Higher performers receive significantly higher merit increases (4.5% vs. 2.6%) and more substantial bonuses (140% of target vs. 99% of target) compared to average performers.
- **Group Incentive Plans and Performance:**
- Gain-sharing and profit-sharing plans in union and non-union companies increase individual and team performance by 18% to 20%.
- **Performance-Based Pay Impact on Return on Assets:**
- Across 200 companies, a 10 percentage point increase in the size of a bonus (as a percentage of base salary) led to an 8% to 20% increase in the return on assets.
- **Management and Worker Beliefs:**
- Management and workers both believe that pay should be tied to performance, with job performance rated as the most important factor for determining salary increases.
- **Challenges and Failures of Variable-Pay Plans:**
- Variable-pay plans may fail due to employees focusing solely on rewarded behaviors to the exclusion of other desired behaviors.
- Problems can also arise from challenges in defining and measuring performance, contributing to plan failures.
The Role of Performance Appraisal
- **Objective Measurement in Pay-for-Performance Plans:**
- Objective and accurate measurement of performance is crucial for appropriate rewards in pay-
for-performance plans.
- Performance appraisal processes are key elements in these plans.
- **Challenges in Objective Performance Standards:**
- Sometimes objective performance standards may not be feasible, especially when job output is
not easily quantifiable or when quantifiable components do not reflect important job dimensions.
- Quantifiability does not guarantee objectivity; even measurable elements may involve subjective decision-making.
- **Subjectivity in Financial Measures:**
- Financial measures, often considered objective, involve some subjective decision-making, as seen in accounting practices.
- **Concerns About Objectivity in Data:**
- Experts caution that so-called objective data may be deficient and may not provide a complete
picture.
- **Impact of Dissatisfaction on Employees:**
- Dissatisfaction with the appraisal process leads to lower satisfaction with the firm, pay, decreased commitment, and increased likelihood of turnover.
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- **Strategies for Understanding and Measuring Job Performance:**
- The chapter discusses strategies for better understanding and measuring job performance to address these challenges and improve the effectiveness of performance appraisal processes.
Strategy 1: Improve Appraisal Formats
Two categories of evaluation formats are:
Ranking
-
The rater compare employees against each other
-
Methods include straight ranking, Alternation ranking, and paired-comparison ranking
Rating -
Requires evaluating employees on some absolute standard rather than relative to other
employees
-
Each performance standard is measured on a scale whereby appraisers can check the point that best represents the employee’s performance. -
Examples: standard rating scale; Behaviorally anchored rating scales (BARS); management by objectives (MBO)
Strategy 2: Select the Right Raters
-
Focus on who might conduct the ratings and which of these sources is more likely to be accurate
-
360-degree feedback
-
Assesses employee performance from five points
of view: supervisor, peer, self, customer, subordinate -
Improves employee understanding and self-awareness
-
Promotes communication between supervisors and staff
-
Promotes better performance and results
Strategy 3: Understand How Raters Process Information
-
The rater
-
Observes the behavior of a ratee
-
Encodes ratee behavior
-
Stores information in memory
-
When evaluating a ratee:
-
Reviews performance dimensions
-
Retrieves stored observations to determine relevance to performance dimensions
-
Information is reconsidered and integrated with other available information as rater decides on final ratings
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Factors Leading to Inaccurate Appraisals
-
Guilt
-
Embarrassment about giving praise
-
Taking things for granted
-
Not noticing good or poor performance
-
The halo effect -
Dislike of confrontation
-
Spending too little time on preparation of the appraisal
Strategy 4: Training Raters to Rate More Accurately
-
Rater-error training
Goal is to reduce psychometric errors (leniency, severity, central tendency, halo), by familiarizing raters with their existence.
-
Performance-dimension training
Exposes supervisors to the performance dimensions to be used in rating (e.g., quality of work, job knowledge), thus clarifying dimensions.
-
Performance-standard training
Provides raters with a standard of comparison or frame of reference for making appraisals (what constitutes good, average, and bad).
The Performance Appraisal Process
- **Key Elements for a Good Appraisal Outcome:**
- Relevance of performance dimensions to company culture and strategy.
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- Updated job descriptions and clear expectations communicated to employees.
- Focus on behavior, not the person, during performance evaluation and feedback.
- Informal discussions with employees about progress and barriers.
- **Involvement of Employees:**
- Involvement of employees in developing performance dimensions and measurement scales.
- Positive employee reactions to assessment results when they are involved.
- Increased satisfaction with system fairness and assessment accuracy.
- **Training and Understanding:**
- Raters need training in using the appraisal system.
- All employees should understand how the system operates and its purpose.
- **Motivation for Accuracy:**
- Create a culture where employees value constructive performance feedback.
- Motivate raters to provide accurate assessments.
- **Documentation and Performance Diary:**
- Raters should maintain a diary of employee performance for documentation and memory.
- **Performance Diagnosis:**
- Raters should attempt a performance diagnosis to identify motivation, skill deficiency, or external constraints.
- **Timely Feedback:**
- Feedback to employees should be timely, aligning with the preference for frequent feedback, especially among millennials.
- Some companies, like Facebook, encourage regular feedback after meetings, presentations, or project completions.
- **Appraisal Process Goals:**
- Clear direction, employee participation in goal setting, and prompt, honest, and meaningful feedback.
- Immediate and sincere reinforcement, coaching for improvement, fair and respectful treatment.
- Opportunity for employees to understand and influence decisions.
- **Transition to Pay-for-Performance:**
- Only when the performance evaluation system is working satisfactorily should attention be focused on designing a pay-for-performance plan.
Designing a Pay-for-Performance Plan
Effectiveness depends on three things:
-
Efficiency
-
Fairness
-
Compliance
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Efficiency:
- **Evaluation of Pay-for-Performance Plan:**
- Assess if the plan aligns with corporate objectives and is cost-effective.
- Ensure the plan supports HR strategy and objectives, avoiding rewards for maintaining
the status quo.
- **Determining Meaningful Pay Increases:**
- Question the effectiveness of small pay increases (e.g., 2.5%) in motivating higher performance.
- Evidence suggests that an increase of at least 6-7% is seen as meaningful, and employees notice incentives starting at 10%, with 15-20% being more effective.
- **Flexibility in Pay-for-Performance Plans:**
- Consider whether the organizational structure allows for decentralized and flexible variations of pay-for-performance plans.
- Different operating units may require different approaches based on competencies and competitive advantages.
- **Designing Performance Standards:**
- Set specific yet flexible performance standards in the pay-for-performance plan.
- Address the "line of sight" issue, ensuring employees understand how their behavior influences company objectives.
- Clarify the measures used for assessments (individual appraisals, peer reviews, financial measures, etc.).
- Define the extent of eligibility for the plan within the organization.
- **Inclusion of Employees and Funding:**
- Decide whether all employees or only top management should be included in the pay-for-performance plan.
- Consider how program funding will work, especially in challenging economic conditions or poor management decisions that may affect bonuses.
- Some companies, like PepsiCo and Starbucks, advocate for the inclusion of all employees in the plan.
On Fairness & Compliance
-
There are two types of equity, or fairness:
-
Distributive justice – fairness in the amount that is distributed to employees.
-
Procedural justice – fairness of the procedures used to determine the amount of rewards.
-
A key element in fairness is communications.
-
A pay-for-performance system should comply with existing laws.
-
Firms want a reward system that maintains and enhances their reputation.
Linking Pay to Subjectively Appraised Performance
-
Equal increases to all employees regardless of performance provides low motivational
potential
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-
Across-the-board increase
-
Cost-of-living adjustments
-
Increases based on seniority
-
To be effective, organizations need to define desired performance
-
Behaviors
-
Competencies
-
Traits
-
Requires three things:
-
A definition of performance.
-
A continuum showing levels from low to high.
-
Awarded merit increase at each level
Promotional Increases as a Pay-for-Performance Tool
-
One of the most effective methods of rewarding good performance is a promotion accompanied by a salary increase -
Characteristics of promotional pay increases
-
Size of increment is approximately double a normal merit increase
-
Represent a reward to employees for commitment and exemplary performance
What would you do
When Mary was hired, she was told verbally that she would receive a raise when she finished her
college degree and yet another raise when she was given additional responsibility. She accepted the job offer based on this understanding. However, during the next 2 years, the firm experienced
slow sales and had to ask all factory employees to accept a 12% pay cut. But Mary, who does not
work in the factory, has finished college and has accepted more responsibility. Should she receive a raise?
Answer:
Yes, because…
- she delivered on her promise and got her degree
-she is doing more work, so she should be compensated for it
No, because…
As a manager, what would you say…
- pay in installments - communicate and let her know that she is a good employee and all her efforts and work has been acknowledged, however the company is experiencing financial hardship and can not give you the raise we promised at the start. Can we revisit this topic once we our finances improve.
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