Compensation: Chapter 7- Defining Competitiveness

Looking for top talent = competitive advantage Different employers set different pay levels and different pay mixes No single "going rate" or "going mix" in labor market

How do you attract and retain the right employees?

Labor Costs: (pay level) x (number of employees) Roughly 60%-70% of company's expenses Pay level decisions have a significant impact on expenses Not all organizations pay the same rate Pay strategy should translate into revenues exceeding the cost of the strategy

How do you control costs and increase revenues?

Hard to define - usually trade-off between competitors (products, location, size) and jobs (skills, knowledge). Defining relevant labor markets, organizations that would hire the same type of people

How do you define relevant markets?

Have to figure out two pieces of information: Determine the pay level set by market forces Determine the marginal revenue generated by each new hire Be careful of this oversimplified framework.

How do you figure out two pieces of information for marginal revenue?

Labor market theories all begin with four basic assumptions: 1. Employers always seek to maximize profits 2. People are homogeneous and therefore interchangeable 3. Pay rates reflect all costs associated with employment 4. Markets are competitive, no advantage for paying above or below market rate

How does the labor market work?

Employers may vary policy for: -different occupational families -different forms of pay -different business units

How might employers vary policies?

Employers must pay at or above the legal minimum wage. Prevailing wage laws and equal rights legislation must be met. Pay forms are regulated. Caution must be exercised when sharing salary information.

What are Consequences of Pay-Level and Pay-Mix Decisions: Compliance?

No research suggests under what circumstances managers should choose which pay-mix. Pay level may not gain any competitive advantage. Wrong pay level may be a serious disadvantage.

What are Consequences of Pay-Level and Pay-Mix Decisions: Efficiency?

Satisfaction with pay is directly related to pay level: more is better. A sense of fairness is also related to how others are paid. Recall: Equity Theory

What are Consequences of Pay-Level and Pay-Mix Decisions: Fairness?

Geographic barriers Union requirements Lack of information about job openings The degree of risk involved The degree of unemployment Nonmonetary aspects of the job

What are additional factors affecting labor supply?

Conventional pay-level policies are to lead, meet, or follow competition. Newer policies emphasize flexibility. What difference does the pay-level policy make? The basic premise is it affects performance.

What are competitive pay policy alternatives?

1. Training very expensive/time consuming (Medical school, law school) 2. Poor working conditions (Highway construction, stigmatized jobs) 3. Low job security (Stockbrokers) 4. Low chance of success (Professional sports)

What are examples of negatives characteristics of compensating differentials?

Product Demand - puts a lid on the maximum pay level Degree of Competition - highly competitive markets are less able to raise prices

What are key market factors?

Industry and Technology: Customer preferences, time schedules, nature of the work New technology influences pay levels Employer Size: Larger firms pay more than smaller firms 100 to 500 worker firms pay 6 % more than smaller firms 500 + worker firms pay 12% more People's Preferences: should tailor but difficult to measure

What are organizational factors?

Other factors: productivity of labor, the technology employed, and the level of production relative to capacity.

What are other factors of product market factors?

Part 2 about Internal alignment outcome = job or person structure Based on internal factors Part 3 about external competitiveness outcome = pay structure Based on external (market) factors

What are part 2 and 3 about?

Organizations operate in many labor markets, each with unique supply and demand. Must define relevant markets for pay purposes and establish appropriate competitive positions within these markets.

What are relevant markets?

Risks include employees making the "wrong" choices and offering too many choices causes confusion, mistakes, and dissatisfaction

What are risks of employer of choice/shared choice?

Two market types: 1. Quoted price markets e.g., stores that label each item's price or ads that list job opening's starting wage 2. Bourse markets e.g., stores that allow haggling until an agreement is reached (ebay) In both markets: employers are buyers and potential employees are sellers.

What are the two market types?

1. Control costs and increase revenues 2. Attract and retain employees Have to strike a balance

What are the two objectives of external competitiveness?

1. How much to pay relative to competitors "How much?" SIZE OF THE PIE 2. What mix of base, bonus, stock options, and benefits relative to pay mix of competitors "What forms?" PIECES OF THE PIE

What are the two questions of external competitiveness?

The combination may: 1. increase employee commitment 2. foster teamwork 3. which may increase productivity

What does a lag pay level combination do?

Who your competitors are What forms of pay are included

What does competitive advantage depend on?

Work with negative characteristics requires higher pay to attract/retain workers. People look for "net advantage" Job evaluation and compensable factors must capture negative characteristics

What is compensating differentials?

Containing operating expenses (labor costs) Increase pool of qualified applicants Increase quality and experience Reduce voluntary turnover Increase proability of union-free status Reduce pay-related work stoppages

What is competitiveness of total compensation?

Diminishing marginal productivity: each additional employee has a progressively smaller share of production factors to work with, thus produce less. e.g., office space, number of computers, telephone lines, etc.

What is diminishing marginal productivity?

Above market pay can improve efficiency by attracting top talent (sorting effect) and discouraging shirking (incentive effect). Can also substitute need for intense monitoring. But, need: Valid selection systems that identify best workers Utility analysis

What is efficiency wage?

Corresponds to the brand the company projects as an employer

What is employer of choice?

The pay relationships among organizations - the organization's pay relative to its competitors. Made up of: Pay level: the average of the array of rates paid by an employer (base + bonuses + benefits + value of stock holdings) / number of employees Pay mix: the various types of payments, or pay forms that make up the total compensation

What is external competitiveness and what is it made up of?

Prediction: General and specific skills require an investment in human capital. Firms will invest in firm-specific skills, but not general skills. Workers must pay for investment in general skills So what?: Skill/ability requires investment by workers and firms. There must be a sufficient return (ex pay level) on investment for the investment to take place. Workers, for example, must see a payoff to training

What is human capital?

Demand: sum of all employers' hiring preferences for a particular skill set at various pay levels Q: If $40K is the market rate for business graduates, how many will a specific employer hire? A: requires analysis of labor demand: Marginal product of labor Marginal revenue of labor

What is labor demand?

Paying below market rates may not attract employees unless coupled with higher future returns.

What is lag pay level policy?

Maximizes the ability to attract and retain top talent minimize dissatisfaction with pay offset less attractive job features Linked to: Ease of attraction, reduced turnover, reduced absenteeism, low vacancy rates, lower training time, better quality employees Negative effects include the need to increase current employees wages and it may mask negative job attributes (e.g., reasons for turnover).

What is lead pay level policy?

The additional output associated with the employment of one additional person, with other production factors constant.

What is marginal product?

The additional revenue generated when the firm employers one additional person, with other production factors constant. Recall, employers seek to maximize profits. Employers will hire until the marginal revenue equals the costs associated with the most recent hire (e.g., total compensation)

What is marginal revenue?

The most common policy is to match rates paid by competitors. A pay-with-competition policy tries to: match wage costs to product competitors attract applicants equal to the labor market competitors

What is pay with competition (match)?

Employer's pay level is constrained by its ability to compete in the product/service market.

What is product market factors?

Prediction: Job seekers wont accept jobs if pay is below a certain wage, no matter how attractive other job aspects. So what?: Pay level will affect ability to recruit. Pay must meet some minimum level.

What is reservation wage?

Begins with traditional options of lead, meet, or lag Offers employees choices in the pay mix

What is shared choice?

Pay policies signal to applicants the attributes that form the organization. Applicants signal their attributes to the organization through the investments they have made in themselves. Pay rate and pay mix will influence the Attraction-Selection-Attrition process

What is sorting and signaling?

Array of different pay rates for different jobs within an organization Defined by pay ranges or pay grades May have single pay structure or different structures for different job functions/families

What is the goal of pay structure?

Supply: total number of individuals with a particular skill set Assumptions: Many people seeking jobs They posses accurate information about all job openings There are no barriers to mobility e.g., discrimination, licensing provisions, etc.

What is the labor supply and assumptions?

Major strategic decision: Mirror what competitors are paying or Design a pay package that may differ from competitors but better fits the business strategy

What is the major strategic decision of external competitiveness?

The market rate is where the lines for labor demand and labor supply cross.

What is the market rate?

Part 3 about external competitiveness: the pay relationships among competing organizations by answering two questions: 1. How much to pay relative to competitors 2. What mix of base, bonus, stock options, and benefits relative to pay mix of competitors

What is this chapter about?

Pay-mix strategies may be: -performance driven -market match -work/life balance -security

What might pay mix strategies be?

In reality, must consider: 1. Those actually qualified for jobs Labor force: Requisite KSAs and/or working/actively seeking work Participation rate: number of people in the labor force/total number of people of working age 2. Unemployment rates - if low, supply is low unemployment rate: number of unemployed people/ number of people in the labor force 3. Homogeneity of recruiting populations Discrimination that occurs

What must you consider for the labor supply?

Occupation - skill/knowledge required Geography - willingness to relocate, commute, virtual Competitors - same product/service market and labor market

What must you consider in relevant markets?

1. Competition in the labor market for people with various skills 2. Competition in the product and service markets Affects financial condition of institution 3. Characteristics unique to the organization and its employees e.g., business strategy, technology, productive/experience of employees

What shapes external competitiveness?

Product market more important when: 1. Employees skills are specific to product market 2. Labor costs are a large share of total costs 3. Product demand is responsive to price change 4. Labor supply is unresponsive to pay changes

When is the product market important?