CMS 2 Assignment 6: Attracting and Retaining Talent

Both pay level and pay mix decisions focus on two objectives:

(1) control costs and increase revenues (2) attract and retain employees

Pay form

are the various types of payments, or pay mix, that make up total compensation

A manager using the marginal revenue product model must do only two things:

(1) Determine the pay level set by market forces, and (2) determine the marginal revenue generated by each new hire. -This will tell the manager how many people to hire.

What influences external competitiveness?

External competitiveness is influenced by the following three factors: (1) Competition in the labor market for people with various skills (2) Competition in the product and service markets, which affects the financial condition of the organization (3) Characteristics unique to each organization and its employees, such as its business strategy, technology, and the productivity and experience of its workforce.

Pay level

refers to the average of the array of rates paid by an employer (base + bonuses + benefits + value of stock holdings) / number of employees

Explain compensating differentials as a modification to the demand side.

More than 200 years ago, 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." This advantage can be found in factors such as greater job security or better working conditions. Work with negative characteristics requires higher pay to attract workers. Such compensating differentials explain the presence of various pay rates in the market.

Describe how pay level and mix focus on the ability to control costs.

Pay-level decisions have a significant impact on expenses. Other things being equal, the higher the pay level, the higher the labor cost. Labor costs are equal to pay level times the number of employees. Furthermore, the higher the pay level relative to what competitors pay, the greater the relative costs to provide similar products or services. So one might think that all organizations would pay the same job the same rate. However, they do not. The same work is paid differently.

Define product demand and degree of competition.

Product demand is a product market that sets the upper limit within which an employer's pay level is set. The degree of competition comes into play when employers in a highly competitive market will be less able to raise prices without loss of revenues.

Which pay policy achieves competitive advantage?

Research on the effect of pay-level policies is difficult because companies' stated policies often do not correspond to reality. Beyond opinions, there is little evidence of the consequences of different policy alternatives. It is known that pay level affects costs. It is not known whether any effects it might have on productivity or attracting and retaining employees are sufficient to offset costs. Where does this leave the manager? In the absence of convincing evidence, the least-risk approach may be to set both pay level and pay mix to match the competition. A manager may adopt a lead policy for skills that are critical to the organization's success, a match policy for less critical skills and a lag policy for jobs that are easily filled in the local labor market.

How does human capital modify the supply side?

The theory of human capital is based on the premise that higher wages flow to those who improve their potential productivity by investing in themselves through additional education, training and experience. The theory assumes that people are in fact paid at the value of their marginal product. The value of an individual's skills and abilities is a function of the time, expense and resources expended to acquire them. Higher pay is required to induce people to train for more difficult jobs. Consequently, jobs that require long and expensive training receive higher pay levels than jobs that require less investment.

Identify two factors on which external competitiveness is expressed

Two factors upon which external competitiveness is expressed in practice are: (1) setting a pay level that is above, below or equal to the competitors and (2) determining the mix of pay forms relative to those of competitors.

In _______________________, our second pay policy, we look at comparisons outside the organization - comparisons with other employers that hire people with the same skills. A major strategic decision is whether to mirror what competitors are paying or to design a pay package that may differ from competitors but better fits the business strategy.

external competitiveness

A _____________ maximizes the ability to attract and retain quality employees and minimizes employee dissatisfaction with pay. It may also offset less attractive features of the work.

lead pay-level policy

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

marginal product of labor

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

marginal revenue of labor

External competitiveness

refers to the pay relationships among organizations - the organization's pay relative to its competitors.

Economists describe two basic types of markets:

the quoted price and the bourse. -Stores that label each item's price or ads that list a job opening's starting wage are examples of quoted-price markets - eBay allows haggling over the terms and conditions until an agreement is reached; eBay is a bourse

The marginal revenue of labor is...

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

Economists describe two basic types of markets. These two basic types of markets are...

... the quoted price and the bourse (the negotiating over the terms and conditions until an agreement is reached)

How does a reservation wage act as a modification to the supply side?

It is recognized that job seekers will not accept jobs whose pay is below a certain wage, no matter how attractive other aspects of the job may be. What this means is that job seekers have a reservation wage level below which they will not accept a job offer. The pay level will affect one's ability to recruit. If pay level does not meet the minimum standard of job seekers, no other job attributes can compensate for this flaw.

Factors that affect decisions on pay level and mix:

(1) competition in the labor market for people with various skills (2) competition in the product and service markets, which affects the financial condition of the organization (3) characteristics unique to each organization and its employees, such as its business strategy, technology, and the productivity and experience of its workforce.

External competitiveness is expressed in practice by:

(1) setting a pay level that is above, below, or equal to that of competitors (2) determining the mix of pay forms relative to those of competitors

Labor costs =

(pay level) times (number of employees) Other things being equal, the higher the pay level, the higher the labor costs

The marginal product of labor is...

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

How do managers choose a competitive pay policy?

The basic premise is that the competitiveness of pay will affect the organization's ability to achieve its compensation objectives, which in turn will affect the organization's performance. The problem with much pay-level research is that it focuses on base pay and ignores bonuses, incentives, options, employment security, benefits or other forms of pay. Many managers seem to believe they get more bang for the buck by allocating dollars away from base pay and into variable forms that more effectively shape employee behavior.

Compensation professionals create market-competitive pay systems based on four activities:

(1) conducting strategic analysis (2) assessing competitors' pay practices through compensation surveys (3) integrating the internal job structure with external market pay rates (4) determining compensation policies

What (a) must a manager do when he or she uses the marginal revenue product model to determine how many people to hire, and (b) are the disadvantages inherent in this model?

(a) A manager using the marginal revenue product model must do only two things. These two things are: (1) determine the pay level set by market forces and (2) determine the marginal revenue generated by each new hire. (b) The model provides a valuable analytical framework, but it oversimplifies the real world. In most organizations, it is almost impossible to quantify the goods or services produced by its individual employees since most production is through joint efforts of employees with a variety of skills. Neither the marginal product nor the marginal revenue is directly measurable.

Organizations often claim to be market driven. They pay competitively with the market or even are the market leaders. Understanding how markets work requires...

... analysis of the demand and supply of labor. The demand side of the market focuses on the actions of the employer. The supply side looks at potential employees.

The supply and demand for labor are...

... major determinants of an employer's pay level. However, any organization must, over time, generate enough revenue to cover expenses, including compensation. It follows that an employer's pay level is constrained by its ability to compete in the product/service market. So product market conditions to a large extent determine what the organization can afford to pay.

External competitiveness refers to...

... the pay relationships among organizations or the organization's pay relative to its competitors. Pay level refers to the average of the array of rates paid by an employer. Pay forms refer to the mix of the various types of payments that make up total compensation.

The data from product market competitors (as opposed to labor market competitors) are likely to receive greater weight when:

1. Employee skills are specific to the product market 2. Labor costs are a large share of total costs 3. Product demand is responsive to price changes 4. The supply of labor is not responsive to changes in pay

How do efficient wages act as a modification to the demand side?

The efficiency wage theory says that sometimes high wages may increase efficiency and actually lower labor costs if they: (a) Attract higher quality applicants (b) Lower turnover (c) Increase worker effort (d) Reduce "shirking" (e) Reduce the need to supervise employees. Basically, efficiency increases through hiring better employees or motivating present employees to work smarter or harder. The underlying assumption is that pay level determines effort.

What are the four basic assumptions that theories of labor markets usually begin with?

Theories of labor markets usually begin with the following four basic assumptions: (1) Employers always seek to maximize profits. (2) People are homogeneous and therefore interchangeable. (3) The pay rates reflect all costs associated with employment. (4) The markets faced by employers are competitive, so there is no advantage for a single employer to pay above or below the market rate.

Briefly explain other forms of competitive pay policies than the three traditional ones.

In practice, many employers go beyond a single choice among the three policy options. They may vary the policy for different occupational families or they may vary the policy for different forms of pay. An employer-of-choice policy goes beyond pay level and forms to focus on all returns from employment including a firm's overall reputation as a place to work. Some characteristics of an "employer of choice" may include a strong emphasis on performance, extensive training opportunities, challenging work assignments and the like. Just as companies compete for customers by offering a choice of product features, quality and services at the right price, some employers also compete for employees by offering an appealing work environment. Another form of pay policy is the shared choice approach. It begins with the traditional alternatives of lead, meet or lag. But it then adds a second part, which is to offer employees choices in the pay mix. With shared choice, employees have more say in the forms of pay they receive. This employees-as-customer perspective is not all that revolutionary, at least in the United States. Many employers offer choices on health insurance, retirement investments and so on.

Explain how companies set their pay levels to attract and retain employees.

Different employers set different pay levels. That is, they deliberately choose a pay level above or below what others are paying for the same work. That is why there is no single going rate in the labor market for a specific job. Not only do the rates paid for similar jobs vary among employers, a single company may set a different pay level for different job families. Many companies use very different pay levels for different job families. First, companies often set different pay-level policies for different job families. Second, how a company looks in comparison to the market depends on the companies it compares to and the pay forms included in the comparison. There is no single "going rate" in the marketplace. Nor is there a single "going mix" of pay forms.

What organizational factors influence pay level and mix decisions?

First, the industry in which an organization competes influences the technologies used. Labor-intensive industries such as education and health care tend to pay lower than technology-intensive industries such as petroleum or pharmaceuticals. In addition to differences in technology across industries affecting compensation, the introduction of new technology within an industry influences pay levels. Another organizational factor exerting influence is employer size. There is consistent evidence that large organizations tend to pay more than small ones. This relationship between organization size, ability to pay and pay level is consistent with economic theory. It says that the talented individuals have a higher marginal value in a larger firm because they can influence more people and decisions, which leads to more profits. A third factor influencing compensation decisions is what organizations believe are employees' preferences. What pay forms do employees really value? What forms should be changed to improve their value to employees? Better understanding of employee preferences is increasingly important in determining external competitiveness. Markets involve both employees' and employers' choices. However, there are substantial difficulties in reliably measuring preferences. And it is important to keep in mind that people place more importance on pay than they are willing to admit. A variety of pay level and mix decision also exist because of employers adopting different total compensation strategies. Some employers adopt a low-wage/no-services strategy. They compete by producing goods and services with as low total compensation as possible. Others use a high-base, high-services approach. These are extremes on a continuum of possibilities.

Briefly discuss three different competitive pay policies.

Given the choice to match, lead or lag, the most common pay policy is to match rates paid by competitors. Managers historically justify this policy by saying that failure to match competitors' rates would cause dissatisfaction among present employees and limit the organization's ability to recruit. Many non-unionized companies tend to match or even lead competition to discourage unions. A pay-with-competition policy tries to ensure that an organization's wage costs are approximately equal to those of its product competitors and that its ability to attract applicants will be approximately equal to its labor market competitors. While this policy avoids placing an employer at a disadvantage in pricing products, it may not provide an employer with a competitive advantage in its labor market. A lead pay policy maximizes the ability to attract and retain quality employees and minimizes employee dissatisfaction with pay. It may also offset less attractive features of work. Sometimes an entire industry can pass high pay rates onto customers if pay is a relatively low proportion of total operating expense, or if the industry is highly regulated. A lead policy can have negative effects, too. It may force the employer to increase wages of current employees, too, to avoid internal misalignment and murmuring against the employer. Additionally, a lead policy may mask negative job attributes that contribute to high turnover later on. A lag policy is one that pays below market rates and may hinder a firm's ability to attract potential employees. However, if pay level is lagged in return for the promise of higher future returns, such a promise may increase employee commitment and foster teamwork, which may increase productivity.

Sorting is the effect that pay strategy has over the composition of the workforce—who is attracted and who is retained. Signaling is a closely related process that underlies the sorting effect. How does signaling act as a modification to the demand side?

Signaling theory says that employers deliberately design pay levels and mix as part of a strategy that signals to both prospective and current employees what kinds of behaviors are sought. A policy of paying below the market for base pay yet offering generous bonuses or training opportunities sends a different signal, and presumably attracts different people, than a policy of matching market wage with no performance-based pay. An employer who combines lower base pay with high bonuses may be signaling that it wants employees who are risk takers. Signaling works on the supply side of the model too, as suppliers of labor signal to potential employers. People who are better trained, have higher grades in relevant courses and/or have related work experience signal to prospective employers that they are likely to be better performers. So both characteristics of the applicants and organization decisions about the pay level and mix act as signals that help communicate.

What factors should be considered in defining relevant markets?

Since one homogeneous labor market does not exist in practice, organizations must define the markets relevant to them. Factors to be considered in defining relevant markets include occupations, the geographic location of the organization and its competitors in the same product/service market. The skills, knowledge and qualifications required in an occupation are important because they tend to limit mobility among other occupations. Qualifications include not only training and education, but also licensing and certification requirements. (Qualifications interact with geography to further define the scope of the relevant labor markets. Top management is recruited globally. Typically, most degreed professionals are recruited nationally or regionally. Technicians, craftspeople and operatives are usually recruited regionally. Office workers are recruited locally. However, the geographic scope of a market is not fixed. It changes in response to workers' willingness to relocate or commute certain distances. This propensity to be mobile in turn may be affected by personal and economic circumstances as well as the employers' pay level. In addition to the occupation and geography, the industry in which the employer competes also affects the relevant labor markets by relating the qualifications required to particular technologies. Product market comparisons also focus on comparative labor costs.) Little research has been done on how employers choose their relevant markets. But if the markets are incorrectly defined, the estimates of competitors' pay rates will be incorrect and the pay level and mix inappropriately established. Research has shown that competitors look at both their competitors (their products, location and size) and the jobs (the skills and knowledge required, and their importance to the organization's success). Labor market comparisons gain importance if the organization is having difficulty attracting and retaining employees.