Strategic Uses of

Compensation
Practices

Key Issues and Questions

What events in recent years have influenced the way
organizations compensate their employees?
What is organizational strategy and why is it
important to align compensation with it?
How have downsizing and reorganization affected
compensation practice
How might compensation be used as a device for
implementing business strategy
How might pay be used as a lag system? As a lead
system
2

Introduction : The Strategic

Imperative
Three events have contributed to business
environment changes:
Increased domestic and international

competition
A shift from manufacturing to a service
economy
Response to these changes by many firms that
includes downsizing and restructuring
3

Competition
Increased competition has forced organizations
to look more carefully at three dimensions :
1.
2.
3.

Efficiency in producing goods and services

Product and service quality
Customer service

The only way to meet this new competition is

to develop and implement business plans that
will improve productivity, quality and customer
service.
4

The Shift to Services

A dramatic shift from manufacturing based
economy to a service economy. E.g.Mc Donalds has more
employees than Krakatau Steel.

The difference between selling services and

selling manufactured products.
When companies sell a service, in contrast, they
are selling an intangible.
The major thing a service provider sells is the
performance of the person delivering the service.
5

The Shift to Services

Traditional Economy

Service Economy

Tangible Products
Selling stand-alone products
Focus on product characteristic
Service is a cost and chore

Intangiables Services
Selling individual performance
Focus on customer needs
Service is a startegy

Margin of
discretionary
performance
(percents)

Peak

Acceptable
Manufacturing

Service

Compensation :
An Implementation Strategy
Strategic Challenges :
1.
2.
3.
4.

The need to compete with discretionary effort in

service performance
The need to relate labor costs to revenues
productivity
The need to stop treating compensation as sunk costs
The need to treat compensation dollars as
investments for leveraging results related to strategic
plans

Element of Compensation
Element

Employee
Interest

Organization
Interest

Base Pay

Provide standard of
living

Manage external and

internal equity
attract and retain
employees

Employee Benefits

Protect standard of
living

Attract and retain

employees

Short-term incentives Prospect of more

income for more
effort
Long-term incentives

Motivate effort and

direct behavior

Capital accumulation/ Encourage long-term

estate building
view/
commitment/retention
of valued employees.

Pay as lead System has four

potential advantages
1. Pay can be used to communicate business plans
2. Pay can be used to articulate unit, group, and
individual performance objectives in terms of
business plans
3. Pay establishes incentives for employees and
groups to change current practices and adopt
new ones
4. Pay communicates managements intentions
9

Pay as lag System has four

potential advantages
1. Pay reinforces individual and group
performance required by business plans.
2. Pay rewards discretionary effort
3. Pay shares returns from productivity
improvements and long-run goal
achievement.

10

Alternative Compensation
Strategies
1.
2.
3.
4.
5.
6.
7.

Performance-based pay
Merit awards or incentives not tied to base pay
Lump-sum bonuses
Gain sharing plans
Skill/Competency based pay
Profit-sharing plans
Cafeteria plans
11

Performance-based pay
Adjustments to pay are based on individual or group performance and are not
granted simply because of organizational
membership or time with the employer.

12

Merit awards or incentives not

tied to base pay
Adjustments to pay must be earned through
performance and are not rolled into base
pay. Thus, they must be re-earned each
year and do not constitute a payment into
the future.

13

Gain sharing Plans

Any gain in actual dollars or hours within
the standard goal that has been set is
shared with workers in the form of gain
sharing cash bonuses.

14

Lump-sum bonuses
Merit or incentive awards are granted on a onetime lump sum basis are not distributed in the
form of weekly or monthly pay checks.

15

Skill/Competency based pay

Pay-for-knowledge plans create incentives for
workers
To learn more than one task or position in a plant.
Skill based pay systems set higher level rates of each
new task or position that is mastered. The highest rate
is achieved once all positions are learned.

16

Profit-sharing plans
These plans establish profit goals for the
organization and set aside share of all
profits exceeding the goal into a pool that
is distributed back in the from of bonuses
to employees.

17

Cafeteria plans
These are compensation plans that allow
employees individual flexibility in their
choices among benefit plan elements.
Some cafeteria plans are total
compensation plans, in that the employee
can pool dollars going into both direct pay
and benefits.
18

Corporate Strategy and

Compensation Fit
Business plans often contain elements :
Financial objectives
Market share objectives
Growth objectives
An organization design specifying units,
each with performance objectives derived
from the business plan.
19

Corporate Strategy and

Compensation Fit
Business
Strategy

Fit

Compensation
Design

Performance
20

Four question
1. To what extent are organizations using
alternative compensation design?
2. Are there any risks associated with such
designs?
3. Is there any evidence that companies currently
adapt compensation designs to their strategies?
4. Is there any evidence that companies that do so
perform better than those that do not?
21

Risks and Benefits of alternative

Compensation Designs
Incentive Pay

Low

High

high

At risk
Base Pay

Entitlement
Low

22

Matching Compensation Design

with Business Strategy
Definitions of Compensation Practices
Strategic Business Units Types
Compensation Design
Pay/Strategy Fit:Compensation Design
Pay/Strategy Fit:Compensation Administration

Emerging Compensation Issues

23

Definitions of Compensation Practices

Compensation
Characteristic
Design Elements
1. External/Internal
Equity Emphasis
2. Individual pay participation
(Individual equity)

3. Pay adjsutment policy

Administrative Elements
4. Participation in Design
5. Participation in
Administration
6. Centralization/
decentralization
7. Communication
8. Formalization/standardization

Issue

Relative importance placed on-external

market compettiton versus internal job
value relationships
Relative emphasis placed on entitlement
based on membership versus merit
based on performance in setting
Individual pay rates
Relative empahsis on ability to pay
(productivity) versus broader business
plan performance
Degree to which employees are involved
in the design of pay system
Degree to which employees are involved
in administering pay practices
Degree to which pay design and
adminsitration are allowed to vary
across organizational units
Degree of openness and disclosure about
pay plan design and admnistration
Degree to which pay practices are
constrained by explicit rules and
guide lines.

24

Strategic Business Unit Types

Defender

Prospector

Analyzer

Product market
Definition

Narrow, stable
market;
market concerned
with protecting
market share

Changing product
market emphasis;
search for new
market; focus on
innovation

Characterized by
mixed strategy

Technology

Single core
technology;
investment in
improvements

Multiple Prototype
tehnologies; invest
more in people than
in machines

Single core
technology;
and investment in
people

Management

Dominated by
production,
finance types

Tends to change
often; dominated
by marketing &
R&D types

Dominated by
marketing &
research relatively
stable

Design/
Administration

Functional
Dividion of labor;
highly formal.

Product centered
division of labor
few formal rules
market relatively
open.

Divisionalized or
matrix structure
combined of
structured and
centralized formal
work

Performance Criteria

Promotion based
on past performance
cost and budget

Performance
measured against
market outcomes
viz competitors

Performance
measured on
combination
of cost market
outcomes.

25

Compensation Design
Pay/Strategy Fit : Compensation Design
Issue
Market versus internal equity
Award Basis
At-risk earnings

Defender

Prospector

Internal
External
Entitlement Performance
Productivity Business Plan
performance

26

Compensation Design
Pay/Strategy Fit : Compensation Administration
Issue
Communication
Participation/Involvement
Standardization-pay adjsutments
Standardization-administration
Centralization

Defender

Prospector

Low
Low
Low
High
High

High
High
High
Low
Low

27

Emerging Compensation Issues

Emerging Pay Strategy
Pay Issue

From

to

Base pay
Incentive/Trigger
Incentive/earnings
Pay determination

Large %
Budgets
Small %
Emphasis on the job

Small %
Business Plan performance
Large %
Emphasis on the individual

28

Emerging Compensation Issues

Emerging Pay Methods Issues
Issue
Communication
Design
Design
Pay mix

From

to

Secret
Top Down
Traditional
Standard

Open
Broad involvement
Strategy Driven
Choice

29