Designing Pay Structures, Pay for Performance, External Competitiveness

Labor Costs =

(pay level) x (# of employees) *higher the pay level, greater the labor costs

Characteristics of jobs that are thought to increase susceptibility to offshoring:

-Easily *routinized* -*Inputs/outputs easily transmitted electronically* -*Little need for interaction* with other workers -*Little need for local knowledge* such as unique social and cultural factors

What size should the range be?

-Size of the range is based on judgment about how the ranges support career paths, promotions, and other organization systems e.g., larger ranges reflect the greater opportunity for individual discretion and performance variations in the work Maximums and minimums - some compensation managers use the actual survey rates, particularly the 75th and 25th percentiles

Pay level & mix decisions focus on (2) objectives

1) Control costs and increase revenues 2) Attract and retain employees

Cable & Judge (1994) (college students seeking jobs)

171 college students who were seeking jobs (represented six majors, three degree types, and two degree levels) Two analyses - one policy-capturing, the other examining actual companies pursued (ex: actual company pay characteristics) Individuals were significantly more attracted to positions with: Higher pay level, individual-based pay (vs. group), fixed pay (vs. contingent), flexible benefits (vs. rigid), and job-based pay (vs. skilled based, although only true in the policy-capturing analysis)

Pay policy line as a % of market line

Another way to translate pay-level policy into practice is to simply specify a percent above or below the regression line (market line) that an employer intends to match and then draw a new line at this higher (or lower) level -Adjust the line based on a lead or lag strategy e.g., *pay-policy line could define a policy of, "we lead the market by 10 percent"* -Can also lead for some job families and lag for others

Three factors often used to determine the relevant labor markets are:

COG *Occupation* (skill/knowledge required) *Geography* (willingness to relocate, commute, or work as virtual employee) *Competitors* (other employers in the same product/service markets)

Salary survey

Collecting and making judgments about the compensation paid by others Provides the data for translating policy into pay levels, pay mix, and structures

Sears example

Contingent pay rewarded on basis of parts and services to customers who brought cars in for repair Unnecessary repairs, overcharged customers, billed for work never done

Efficiency-wage theory

High wages may increase efficiency and actually lower labor costs if they: 1) attract higher-quality applicants 2) lower turnover 3) increase worker effort 4) reduce "shirking" 5) reduce the need to supervise employees *efficiency increases by hiring better employees or motivating present employees to work smarter or harder*

Green Giant example

Implemented bonus plan that rewarded employees for removing insects from vegetables ...Employees started planting insects in the vegetables

Fairness

Satisfaction with pay is directly related to pay level Sense of fairness is related to how others are paid

Defining the relevant market

Though people speak of "the market"...organizations often operate in many labor markets, each with unique demand and supply Managers must define the markets that are relevant for pay purposes and establish the appropriate competitive positions in these markets

Select Relevant Market Competitors

To make decisions about pay level, mix, and structures, a relevant labor market must be defined: (COG) -The same occupations or skills -Employees within the same geographic area -The same products and services

Koys, Keaveny, and Allen (1989)

Unionized workers prefer seniority

Employers are __________, and potential employees are ____________

buyers, sellers

Modifications to the Demand Side:

compensating differentials, efficiency-wage theory

Hybrid policies

different policies regarding occupational groups, forms of pay, or business units

Risk sharing plans

differs from success sharing in that employee not only shares in the successes, but also is penalized during poor performance years. Penalty is in form of lower total compensation in years where the company is doing poorly

Industry & technology

e.g., labor-intensive industries (education) tend to pay lower than technology-intensive industries (petroleum or pharmaceuticals), whereas professional services (consulting firms) pay high The introduction of new technology within an industry can also influence pay levels (e.g., pay for grocery checkers has declined over time after the introduction of scanners, etc.)

Consequences of Pay-Level and Mix

efficiency, fairness, compliance

Gerhart & Milkovich (1990)

examined 200 companies Found a 1.5% increase in return on assets for every 10% increase in the size of a bonus Variable portion of pay had stronger impact on org. performance than level of base pay

Base pay

guaranteed portion of a wage package, amount that you can count on as long as employment relationship continues

Labor Demand

how many new hires a company seeks and what they are willing and able to pay new employees

Globalization and relevant markets

offshoring & outsourcing

Labor supply

potential employees' qualifications and the pay they are willing to accept in exchange for their services

Product market factors

product demand, degree of competition

Modifications to the Supply Side:

sorting & signaling, reservation wage, human capital, additional factors

Pay Level

the average of the array of rates paid by a company

Sorting

the effect that pay strategy has on the composition of the workforce (i.e., who is attracted and who is retained)

Pay Mix

the various types of payments that make up total compensation

Market line using regression analysis

y= a + bx Pay for job A = a + (b x job evaluation points for job A) Pay for job B = a + (b x job evaluation points for job B)

Market pricing

* emphasize external competitiveness and deemphasize internal alignment sets pay structures almost exclusively on external market rates -Match a large percentage of their jobs with market data (collect as much market data as possible) *competitive rates for jobs for which external market data are available are calculated; then the remaining (non-benchmark) jobs are blended into the pay hierarchy created by the external rates*

Product demand

*Labor market* conditions (and legal requirements) put a *floor* on the pay level required to attract sufficient employees, the *product market puts a ceiling on the maximum* pay level

Interpret survey results

*Verify data* - if a company job is similar but not identical, some companies use the benchmark conversion/survey leveling approach i.e., multiply the survey data by some factor that the analyst judges to be the difference between the company job and the survey job *Statistical analysis* Frequency distributions - gives a sense of the "shape" of the salary distribution Measures of central tendency (mean, median, mode) and variability (standard deviation) Percentiles and quartiles - often used to set pay ranges *Look for anomalies* Does one company dominate the sample? Are there outliers?

Examples of compensation influencing retention

-AT&T shifted from individual to team based incentive system, many star performers quit or slacked off -Applebees (high turnover industry) allow managers to earn up to 30k above base salary for hitting specific performance targets. To reduce turnover, extra pay differed for 2 years

Pay range has 3 salient features:

-Midpoint—point where the pay-policy line crosses the center of the grade -Minimum and maximum

An employee pay rate may fall above the pay-range maximum for several reasons:

-The employee is demoted, but keeps the current compensation -The employee is deemed a "high performer" -There is a reorganization or an acquisition Potential actions: -Freeze the employee's pay -Give less-frequent salary increases -Reduce the employee's base pay and make up the difference using lump-sum payments -Reduce salary (this is a rare circumstance) -Promote the employee to a higher-level job he or she can perform -Give lump-sum increases in the future -Look to career-development opportunities

Dyer, Schwab, and Theriault (1976)

180 managers, 72 companies Rated the importance of 9 factors in determining the size of salary increases The most important factor was *performance*

Organization strategy

A variety of pay-level and mix strategies, between and within organizations -Some employers adopt a low-wage, no-service strategy; compete by producing goods/services with lowest total compensation possible (e.g., Nike and Reebok) -Others select a low-wage, high-services strategy (e.g., Marriot - room cleaners) -Others use a high-wage, high-services approach (e.g., Google)

Compensating differentials

Adam Smith - argued that individuals consider the "whole of the advantages and disadvantages of different employments" and make decisions based on the alternative with the greatest "net advantage" -If a job has negative characteristics, then employers must offer higher wages to compensate for these negative features -Explains the presence of various pay rates in the market

Broad banding

Collapsing salary grades into a few "broad bands," each with a sizable range Two basic steps: 1) Set the number of bands -Usually bands are established at the major "breaks," or differences, in work or skill/competency requirements -Titles used to label each band reflect these major breaks, such as "associate" (entry-level individual contributor), "professional" (experienced, knowledgeable team member), "leader" (project or group supervisor), "director," etc. 2) Price the bands Reference market rates - each band includes multiple job families Advantage - provide even greater flexibility

Fossum and Fitch (1985)

College students and managers ranked job performance as most important factor in allocating pay raises

Pay range

Exists whenever two or more rates are paid to employees in the same job Provide managers the opportunity to: -recognize individual performance differences with pay -meet employees' expectations that their pay will increase over time, even in the same job -encourage employees to remain with the organization From an internal alignment perspective, the range reflects the differences in performance or experience that an employer wishes to recognize with pay From an external competitiveness perspective, a range maximum sets the lid on what the employer is willing to pay for that work; the range minimum sets the floor

Higher the pay level relative to what competitors pay:

Greater the relative costs to provide similar products or services

Human capital

Higher earnings go to those who improve their potential productivity by investing in themselves (through additional education, training, and experience) In general, the value of an individual's skills and abilities is a function of the time, expense, and effort to acquire them

People's preferences

Increasingly important in determining external competitiveness e.g., preferences for base pay, health insurance, eye care, bonuses, etc. Some challenges in measuring preferences (e.g., social desirability - people sometimes care more about pay than they're willing to admit)

Reservation wage

Job seekers have a "reservation wage level," below which they will not accept a job offer, no matter how attractive the other job attributes i.e., may be above or below the market wage Seeks to explain differences in workers' responses to offers

Lead Pay-Level Policy

Maximizes the ability to attract and retain quality employees Minimizes employee dissatisfaction with pay May offset less attractive features of work

Lag Pay-Level Policy

May hinder a firm's ability to attract potential employees IF coupled with the promise of higher future returns (e.g., start-up firm): -May increase employee commitment -Foster teamwork -May possibly increase productivity

Salmon & Hom, 2005

Superior performing employees less likely to leave if they received bonuses (but no effect for base pay increase)

Profit sharing

add-on linked to group performance, all about exceeding some financial goal

Lump sum bonuses

granted for performance, one time increase

Additional factors

i.e., geographic barriers to mobility among jobs, union requirements, lack of information about job openings, degree of risk involved, degree of unemployment

Employer's demand for labor coincides with:

marginal *product* of labor & marginal *revenue* of labor

Competitive pay policy alternatives

match, lag, lead, hybrid

Marginal product of labor

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

Marginal revenue of labor

the additional revenue generated when the firm employs one additional person, with other production factors held constant

External Competitiveness

the organization's pay relative to its competitors

Across the board

wage increase granted to all employees (cost of living expenses), typically an add-on to base pay in subsequent years

Match Pay-Level Policy

*Wage costs* Approximately equal to those of its product competitors *Ability to attract potential employees* Approximately equal to its labor market competitors Avoids placing an employer at a disadvantage in pricing products

Update the survey data

*Wages paid by competitors are constantly changing* "Aging" or "Trending" - pay data are usually updated to forecast the competitive rates for the future date when the pay decisions will be implemented Amount to update is based on several factors e.g., historical trends in the labor market, prospects for the economy in which the employer operates, and the manager's judgment, etc.

Design the survey

*Who should be involved?* Compensation manager, managers, and employees Outside consulting firms *How many employers?* No firm rules Publicly available data - Bureau of Labor Statistics Online salary information (e.g., salary.com) *Which jobs to include?* Benchmark-job approach Low-high approach Wages of lowest- and highest-paid benchmark jobs used as anchors

Market pay line

*links a company's benchmark jobs with market rates paid by competitors* *Internally aligned structure on the horizontal (x) axis* Salaries paid by relevant competitors for the benchmark jobs, as measured by the survey—the *external competitive data—are shown on the vertical (y) axis* May be drawn freehand by connecting the data points or using statistical techniques such as regression analysis

Purpose of a salary survey:

-Adjust pay level—how much to pay? Based on overall movement of pay rates caused by competition in the market -Adjust pay mix—what forms? Base, bonus, stock, and benefits -Adjust pay structure? Validate job evaluation results and establish internal structures -Estimate competitors' labor costs Competitive intelligence

Factors to consider w/ offshoring & outsourcing (4)

-Countries w/ *lower average labor costs also tend to have lower average productivity* i.e., a company must determine if labor costs savings will not be neutralized by lower productivity -Companies *must devote resources to systems that monitor worker effort or output* - this can be more difficult and more costly when geographic or cultural distance is great -*Customers' reactions* -*How long will the labor cost advantage hold and will sufficiently qualified employees continue to be available as other companies also tap into this pool of labor*

Cerasoli, Nicklin, and Ford (2014)

-Meta-analysis: broader approach (surveyed lit in psychological, educational, medical, and business) focusing on research that specifically operationalized intrinsic motivation -When extrinsic incentives were not offered, the relationship between intrinsic motivation and performance was positive, modest, and significant (p=.27) -When intrinsic incentives were offered, the relationship between intrinsic motivation and performance was stronger (p=.45) when extrinsic incentives were indirectly salient and (p= .30) when extrinsic incentives were directly salient -Can work simultaneously!

Cameron & Pierce (1994)

-Meta-analysis: first of extrinsic reward literature -Popular theory at the time suggested that extrinsic rewards were not motivating -Found extrinsic rewards were effective and did not diminish intrinsic motivation -Shortcoming: studies did not include investigation involving actual financial incentives -These results were counter to the prevailing thought that they did this study twice

Jenkins, Mitra, Gupta & Shaw (1998)

-Meta-analysis: only studies with financial incentives -Financial incentives- moderately strong positive relationship with individual performance quantity (p= 0.34) -Relationship was stronger in field settings (p=.48) compared to the lab -Task type did not moderate the incentives-performance relationship (magnitude of the positive association was the same in mundane and pleasing task situations) -Financial incentives were not significantly related to performance quality, but only 6 studies

Garbers & Konradt (2014)

-Meta-analysis: only studies with financial incentives -Overall finding (p=.32) for individual performance of all types was nearly identical to Jenkins et. al. -Effect size for financial incentives and performance quality was actually larger (p=.39) than the estimate for performance quality (p=.28)

Byron & Khazanchi (2012)

-Meta-analysis: rewards and creative performance -Results suggested that creativity-contingent rewards tend to increase creative performance (p=.62) -More positively related when given positive, contingent, and task-focused performance feedback and are provided more choice -Performance -contingent or completion-contingent rewards tend to have a slight negative effect on creative performance (not making the reward contingent on the actual creativity- misaligned)

Cable & Judge (1994) Sorting/Fit effects

-More materialistic job seekers placed greater emphasis on pay levels -Individualists attracted to individual-based pay plans -High self-efficacy more likely to pursue an organization with individual-based pay than those with low self-efficacy, also more attracted to organizations with skill-based pay systems than were those with lower self-efficacy (duh) -More risk-averse more attracted to organizations with fixed (non-contingent) pay systems than were risk takers, not as concerned with pay level as a criterion in their job pursuit process

To attract & retain the right employees...

-One company may pay more because it believes its higher-paid employees are *more productive* than those at other companies -Another company may pay less because it is *differentiating itself on non-financial returns*

Reason why contingent pay plans FAIL:

-Poor PM systems in place (biased, measurement of unrelated performance dimensions,etc.) May lead employees to challenge contingent pay plan legally -Rewarding behaviors/ results that are not job related are likely to cause good performers to leave the organization -Folly of rewarding A, while hoping for B -Rewards are not considered significant - pay increases are so small they don't differentiate between outstanding and poor performers -Managers are not accountable (if managers aren't accountable, they may inflate ratings, or employees may set easily attainable goals, rewards become the driver for the performance eval instead of vice versa) -Extrinsic motivation at the expense of intrinsic motivation- sole emphasis on financial rewards

An employee pay rate may fall below the pay-range minimum for several reasons:

-The employee recently received a promotion to a new grade, and then the grade subsequently moves -The employee is a new hire, and then the grade subsequently moves -The job is re-evaluated -There is a reorganization or an acquisition Potential actions: -Raise the pay to a new minimum when the range moves -Raise all pay levels to a minimum, and set an organizational policy which doesn't allow for green-circle rates -Establish an "adjustment to minimum" pay policy, separate from the merit budget -Evaluate the position to ensure it is properly graded

TED Talk- Daniel Pink (the puzzle of motivation)

-Went to law school, did poorly -Case for rethinking how businesses are run -"The candle problem" - Carl Duncker -The benefits of autonomy in motivation -"FedEx days" "Google 20% time" -Breaking down the idea of "either or" in terms of pay for performance/pay for intrinsic motivation

Combs, Liu, Hall, & Ketchen (2006) meta-analysis of HPWP

Compensation 2nd most important factor second to HR planning in HPWP-- but just one aspect of many factors that impact behavior/performance

Degree of competition

Employers in highly competitive markets (e.g., manufacturers of automobiles or generic drugs) are less able to raise prices without loss of revenues

Compliance

Employers must pay at or above the legal minimum wage Prevailing wage laws and equal rights legislation must be met Pay forms are regulated (e.g., pensions and health care)

What shapes external competitiveness? (3)

L-P-O 1) *Labor market factors* (nature of demand, nature of supply) 2) *Product market factors* (degree of competition, level of product demand) 3) *Organization factors* (industry, size, strategy, individual manager)

Employer size

Large organizations tend to pay more than small ones Consistent with economic theory - talented individuals have a higher marginal value in a larger organization because they can influence more people and decisions, thereby leading to more profits

Efficiency

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

Pay grades & ranges

Offer flexibility to deal with pressures from external markets and differences among organizations

Huselid (1995)

Surveyed HR practices over 3,000 companies Did the company have a formal appraisal process? Was the appraisal tied to the size of pay increases? Did performance influence who would be promoted? Companies significantly above average on these and other high performance work practices had annual sales $27,000 more per employee

Individual incentive

form of variable pay, contingent upon performance, often objective indicators of performance (sales volume, widgets produced, etc.)

Game sharing

goal to exceed is not financial performance of organization but some cost index labor cost is most common, might also include scrap costs, utility costs

Success sharing

group based incentive system- meant to incentivize and entire team, unit, or organization as a whole to perform well, rewarded if entire group does well, not added to base pay, get something if a "success" but not penalized if a failure

Pay grades

group different jobs that are considered substantially equal for pay purposes -Requires the analyst to reconsider the original job evaluation results -Each grade will have its own pay range, and all the jobs within a single grade will have the same pay range *Grades group job evaluation data on the horizontal axis; ranges group salary data on the vertical axis*

Turnover is higher for poor performers when pay is based on ______________

individual performance (this is a good thing)

Organization factors

industry & technology, employer size, people's preferences, organization strategy

Merit pay

pay tied to performance 1) permanent increase to base pay & 2) determined by subjective evaluations of performance (performance ratings, forced ranking system)

Signaling

process that underlies the sorting effect: -Employers deliberately design pay levels and mix as part of a strategy that signals to both prospective and current employees the kinds of behaviors that are sought e.g., An employer that combines lower base pay with high bonuses may be signaling that it wants employees who are risk takers