4-1

Module

4 Determining
External
Competitiveness
and Benefits
Management

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-2

Learning Objectives
After discussing Chapter 4, students should be able to:
1. Identify the major decisions in establishing externally
competitive pay.
2. Describe the purpose(s) of a salary survey.
3. Discuss the importance of defining the relevant
market in a pay survey.
4. Explain the steps involved in designing a pay survey.
5. Describe the key issues involved in interpreting the
results of a pay survey.
6. Explain how the market pay line combines the
internal structure with external market rates.
7. Discuss the use of pay grades and pay ranges and
their relationship to internal alignment and external
competitiveness.
8. Discuss the pros and cons of the market pricing
approach to establishing a pay structure.
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-3

Exhibit 4.1: Determining Externally

Competitive Pay Levels and Structures

External
Merge Competitive
competitiveness: Draw policy
Select Design internal & pay levels,
Pay relationships Set Policy lines
market survey external mix, and
among
pressures structures
organizations

Some Major Decisions in Pay Level Determination

 Determine pay-level policy.

 Define purpose of survey.

 Specify relevant labor market.

 Design and conduct survey.

 Interpret and apply results.

 Design grades and ranges or bands.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-4

Specify Competitive Pay Policy

Pay with
Competition
(Match) Lead Policy

Lag Policy

Flexible Policies

Employer of
Shared Choice Choice

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-5

What Is the Purpose of a Salary

Survey?
Systematic process of collecting and
making judgments about compensation
paid by other employers

Provides data for

 Setting the pay policy relative to competition

 Translating that policy into pay levels and

structures

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-6

Why Conduct a Salary Survey?

Adjust pay level – How much to pay?

Adjust pay mix – What forms?

Adjust pay structure?

Analyze special situations

Estimate competitors’ labor costs

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-7

Select Relevant Market Competitors

Relevant labor market includes
employers who compete
 For same occupations or skills
 For employees in same geographic area
 With same products or services
Examples

 Exhibit 4.2: Relevant Labor Markets by

Geographic and Employee Groups
 Exhibit 4.3: Pay Differences by Location
Fuzzy markets
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-8

Exhibit 4.2: Relevant Labor Markets by

Geographic and Employee Groups
Geographic Production Office and Technicians Scientists & Managerial Executive
Scope Clerical Engineers Professional

Local: Within Most likely Most likely Most likely

relatively small
areas such as
cities or MSAs
Regional: Only if in Only if in Most likely Likely Most likely
Within a short short
particular area supply or supply or
of the state or critical critical
several states
National: Most likely Most likely Most likely
Across the
country
International: Only for Only for Sometimes
Across several critical skills critical skills
countries or those in or those in
very short very short
supply supply

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-9

Exhibit 4.3: Pay Differences by Location

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-10

Design the Survey

Who should be involved?
How many employers?
 Publicly available data
 “Word-of-mouse”

Exhibit 4.4: Salary Data on the Web

 Where are the standards?
Which jobs to include?
What information to collect?
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-11

Exhibit 4.4: Salary Data on the Web

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-12

Which Jobs to Include?

Benchmark-job
approach

Low-high
approach
(skill-based)

Benchmark
conversion
approach
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-13

What Information to Collect?

Nature of organization

Total compensation
system

Specific pay data on

incumbents in jobs
under study
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-14

Exhibit 4.6: Possible Survey Data

Elements and Rationale
Nature of organization Incumbent and job
 Financial  Date
performance  Job
 Size  Individual
 Structure  Pay
Nature of total HR outcomes
compensation system  Productivity
 Cash forms used  Total labor costs
 Non-cash forms used  Attraction & retention
 Employee views

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-15

Exhibit 4.7: Advantages and Disadvantages

of Measures of Compensation
Base Pay Tells how competitors are Fails to include performance incentives
valuing the work in similar jobs and other forms, so will not give true picture if
competitors offer low base but high incentives

Total Cash Tells how competitors are All employees may not receive incentives, so it
(base + bonus) valuing work; also tells the may overstate the competitors’ pay; plus, it
cash pay for performance does not include long-term incentives.
opportunity in the job.

Total Tells the total value All employees may not receive all the forms.
Compensation competitors place on this work Be careful; don’t set base equal to competitors’
(base + bonus + total compensation. Risks high fixed costs.
stock options +
benefits)

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-16

Interpret Survey Results (1 of 2)

No single best approach
Verify data
 Check accuracy of job matches
Survey leveling
 Check for anomalies
Does any one company dominate?
Do all employers show similar patterns?
Outliers?

Example

 Exhibit 4.9: Survey Data

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-17

Interpret Survey Results (2 of 2)

 Statistical analysis
 Frequency distribution
 Exhibit 4.10: Frequency Distributions
 Measures of central tendency
 Mode
 Mean

 Median

 Weighted mean

 Measures of variation
 Standard deviation
 Quartiles and percentiles

 Exhibit 4.11: Statistical Measures for Analyzing Survey

Data
 Update survey data
 Exhibit 4.12: Choices for Updating Salary Data Reflect Pay
Policy
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-18

Construct a Market Pay Line

Exhibit 4.4: Salary Graphs Using
Different Measures of Compensation
Definition of market pay line
 Links a company’s benchmark jobs on
horizontal axis (internal structure) with
market rates paid by competitors (market
survey) on vertical axis
 Approaches to constructing a market pay line
Freehand approach - Exhibit 4.4
Regression analysis - Exhibit 4.13 and Exhibit
4.14
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-19

Exhibit 4.13: From Regression

Results to a Market Line

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-20

Exhibit 4.14: Understanding Regression

16
14
Survey: Salary ($000)

12
10
4
6
4
2

0
20 40 60 40 100 120 140 160 140
Job Evaluation Points
Tech A Sr Tech Eng 1 Eng 3 Eng 5 Mgr 1 Mgr 3

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-21

Combine Internal Structure

and External Market Rates
Two parts of the total pay model have
merged
 Exhibit 4.15
 Internally aligned structure - Horizontal axis
 External competitive data - Vertical axis
Two aspects of pay structure
 Pay-policy line
 Pay ranges
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-22

Exhibit 4.15: Develop Pay Grades

55,000
Salaries paid by competitors
External Competitiveness:

50,000

45,000

40,000

35,000

Pay Policy Line

30,000

AB CDEF GHIJK LMN OP

Internal Structure: JE Points
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-23

From Policy to Practice:

Pay Policy Line
Approaches to translate external
competitive policy into practice
 Choice of measure
50th percentile for base pay
75th percentile for total compensation

 Updating
Policy line as percent of market line
 Specifya percent above or below market line
an employer intends to match
 Other options
Pay among the leaders
Lead for some job families and lag for others

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-24

From Policy to Practice:

Grades and Ranges
Why bother with grades and ranges?
 Offer flexibility to deal with pressures from
external markets and differences among firms

Develop grades
Establish range midpoints, minimums,
and maximums
Overlap

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-25

Why Bother with Grades and Ranges?

External pressures
 Differences in quality (KSAs) among individuals
in external market
 Differences in productivity or value of quality
variations
 Differences in mix of pay forms of competitors
Internal pressures
 Recognize individual performance differences
with pay
 Meet employees’ expectations that their pay will
increase over time
 Encourage employees to remain with
organization
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-26

Develop Grades
Grades group job evaluation data on
horizontal axis
 Alljobs considered substantially equal for pay
purposes placed in same grade
 Each pay grade has its own pay range and all
jobs in a single grade have same pay range
 Enhances ability to move people among jobs
within a grade with no change in pay
How many pay grades?
 Number of jobs
 Organization hierarchy
 Reporting relationships
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-27

Establish Range Midpoints,

Minimums, and Maximums (1 of 3)
Ranges group salary data on vertical
axis
 Establish upper and lower pay limits for all
jobs in each grade
 Exhibit 4.16
Midpoints correspond to competitive pay
policy
 Point where pay-policy line crosses center of
each grade
 Often represents base pay for a seasoned
employee
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-28

Exhibit 4.16: Range Midpoint,

Minimum, and Maximum

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-29

Establish Range Midpoints,

Minimums, and Maximums (1 of 3)
Size of range based on judgment about how
ranges support
 Career paths
 Promotions
 Other organization systems
Typical range spread
 Top-level management positions – 30 to 60% above
and below midpoint
 Entry to midlevel professional and managerial
positions – 15 to 30% above and below midpoint
 Office and production positions – 5 to 15% above and
below midpoint

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-30

Overlap
Importance of overlap
 Exhibit 4.17: Range Overlap

High degree of overlap and low midpoint

differentials
 Exhibit 4.17(a)

Small ranges with less overlap

 Exhibit 4.17(b)

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-31

Exhibit 4.17: Range Overlap

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-32

From Policy to Practice:

Broad Banding
Alternative to traditional salary structures
Involves collapsing salary grades into a few
broad bands, each with a sizable range
 One minimum and one maximum
 Range midpoint often not used
Purposes

 Provide flexibility to define job responsibilities more

broadly
 Foster cross-functional growth and development
 Ease mergers and acquisitions
Example

 Exhibit 4.14
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-33

Exhibit 4.14: From Grades to Bands

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.


Exhibit 4.19: Contrasts Between
Ranges and Bands
Ranges support . . .
 Some flexibility within
controls
 Relatively stable
organization design
 Recognition via titles or
career progression
 Midpoint controls,
comparatives
 Controls designed into
system
 Give managers “freedom
with guidelines”
 Up to 150 percent range-
spread
McGraw-Hill/Irwin
4-34
Bands support . . .
 Emphasis on flexibility
within guidelines
 Global organizations
 Cross-functional
experience and lateral
progression
 Reference market rates,
shadow ranges
 Controls in budget, few
in system
 Give managers “freedom
to manage” pay
 100 – 400 % spreads
© 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-35

Steps Involved in Broad Banding

1. Set number of bands
 Determine number of distinct levels of
employee contributions within organization
that actually add value
 Challenge - How much to actually pay
people in same band who are performing
different functions and work

2. Price bands: Reference market rates

 Exhibit 4.20: Reference Rates Within Bands

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-36

Exhibit 4.20: Reference Rates Within

Bands

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-37

Balancing Internal and External Pressures:

Adjusting the Pay Structure

Internal Pressures External Pressures

Job Structure Pay Structure

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-38

Market Pricing
Approach
 Sets pay structures almost exclusively by relying
on external market rates
 Emphasizes external competitiveness (market-
based factors) and de-emphasizes internal
alignment
Issues
 Validity of market data
 Use of competitors’ pay decisions as primary
determinant of pay structure
 Lack of value added via internal alignment
 Difficult-to-imitate aspects of pay structure are
deemphasized
 Fairness
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-39

Benefits

The Benefits Determination

Process

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-40

What Are 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, e.g. life insurance,
pension, workers’ compensation,
vacation

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-41

Exhibit 12.1: Changes in Benefit Costs

Over Time

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-42

Why the Growth in Employee

Benefits?

Wage and Employer

Price Controls Impetus

Cost Effectiveness
of Benefits

Unions Government
Impetus

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-43

Value of Employee Benefits

 Employees:

 Expect benefits as part of their total compensation

 Do not understand true value of benefits
 Often undervalue their benefits
 Often take benefits for granted
 Often cannot list all benefits received
 Have preferences regarding types of benefits they
want

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-44

Exhibit 12.2: Ranking of Employee

Benefits

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-45

Key Issues in Benefit Planning, Design,

and Administration
Benefits Planning and Design Issues
 How to attract good employees
 How to deal with undesirable turnover
 Integrating benefits with other compensation
components
 Strategies for ensuring external
competitiveness
 Ensuring that benefits are adequate
 Whether employee benefits are cost justified

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-46

Benefit Administration Issues

Who should be protected or benefited?
 Series of questions need to be addressed
How much choice should employees have
among an array of benefits?
 Concerns choice (flexibility) in plan coverage
 Standard benefit package
 Cafeteria-style,” or flexible, benefit plans

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-47

Benefit Administration Issues (cont.)

How issues associated with flexibility
should benefits be financed?
 Noncontributory
 Contributory
 Employee financed
 Are your benefits legally defensible?

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 Exhibit 12.3: Contingent Worker 4-48

Benefits Compared to Full-Time

Workers

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-49

Exhibit 12.4: Possible Options in a

Flexible Benefit Package

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-50

Exhibit 12.5: Advantages of Flexible

Benefits
Employees choose packages that best satisfy
their unique needs.
Flexible benefits help firms meet the
changing needs of a changing workforce.
Increased involvement of employees and
families improves understanding of benefits.
Flexible plans make introduction of new
benefits less costly.
Cost containment: Organization sets dollar
maximum; employee chooses within the
constraint.
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-51

Exhibit 12.5: Disadvantages of

Flexible Benefits
Employees make bad choices and find
themselves not covered for predictable
emergencies.
Administrative burdens and expenses
increase.
Adverse selection: Employees pick only
benefits they will use; the subsequent high
benefit utilization increases its cost.
Subject to non-discrimination requirements
in Section 125 of the Internal Revenue Code.
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-52

Financing Benefits Plans: Alternatives

Non-contributory

 Employer pays total costs

Contributory

 Costs shared between employer and employee

Employee financed
 Employee pays total costs for some benefits
 By law the organization must bear the cost for some
benefits

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-53

Exhibit 12.6: Factors Influencing Choice of

Benefit Package

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-54

Exhibit 12.7: Impact of Legislation

on Selected Benefits

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-55

Approaches to Assess Employee

Preferences
Demographic differences
 Age
 Sex
 Marital status
 Number of dependents
 Blue collar vs. white collar
Employee survey via questionnaire
Flexible benefit plan

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-56

Exhibit 12.8: Questionnaire Format for Benefit

Surveys

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-57

Administering the Benefits Program

Three Administrative Issues

Communicating about the benefits

1 program

2 Claims processing

3 Cost containment

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-58

Communicating the Benefits Program

 Three elements of effective communications
 Company must spell out its benefit objectives
and ensure communications achieve the
objectives
 Match the message with the appropriate
medium
Use of intranet – an internal organizational
online Web through which all forms of
communication within the organization can
be streamlined
Streamlined call center operation

 Content of communications package must be

complete, clear, and free of complex jargon
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.
 4-59

Communicating Employee Benefits

Methods of communication
 Employee handbook
 Personalized benefit statementsCompany
 Meetings with employees Benefits

 Multi-media presentations
 Intranet
 Streamlined call center operation

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-60

Claims Processing
Claims processor must:
 Determine whether the act has, in fact,
occurred
 Determine if the employee is eligible for the
benefit
 Calculate the payment level

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-61

Cost Containment

Prevalent Practices

1 Probationary periods

2 Benefits limitations

3 Co-pay

4 Administrative cost containment

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-62

Exhibit 12.12: Basic Primer of Cost

Containment Terminology

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

 4-63

Trends Related to Cost Containment

Probationary periods

Benefit limitations

Copay

Administrative cost containment

Retaining strategic function internally

Significant movement to outsourcing

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All rights reserved.