Milkovich/Newman: Compensation, Ninth Edition

Chapter 1

The Pay Model

McGraw-Hill/Irwin

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Contrasting Perspectives of Compensation

Societys Views Stockholders Views

Employees Views

Managers Views
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Compensation: Definition

Employees
Major source of financial security Return in an exchange between employer and themselves Entitlement for being an employee of the company Reward for a job well done

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Compensation: Definition (cont.)

Society
Pay as a measure of justice
Gender pay gap in U.S., after adjusting for differences in education, experience, occupation, has narrowed from 36 percent in 1980 to 13 percent in 2006

Benefits as a reflection of justice in society

~46m Americans do not have health insurance (16% of population) Proportion of Americans w/ private insurance 67.5% in 2007

Job losses (or gains) attributed to differences in compensation (see Ex. 1.1) Belief that pay increases lead to price increases

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Exhibit 1.1 update: Hourly Compensation Costs for Production Workers (2007 data)
United States Brazil Canada Mexico Australia Hong Kong Japan South Korea Singapore Sri Lanka Taiwan $24.59 5.96 28.91 2.92 30.17 5.78 19.75 16.02 ($8.23 in 2000) 8.35 0.61* (comparable to China?) 6.58 Ireland Italy Netherlands Norway Poland Portugal Spain Sweden Switzerland United Kingdom Source: U.S. Department of Labor, Bureau of Labor Statistics, January 2009. Denmark Finland France Germany Hungary Austria Belgium Czech Republic 35.33 35.45 8.20 ($2.83 in 2000) 42.29 34.18 28.57 37.66 7.91 ($2.79 in 2000) 29.04 28.23 34.07 48.56 6.17 8.27 20.98 36.03 32.88 29.73

Hourly compensation costs include (1) hourly direct pay and (2) employer social insurance expenditures and other labor 1-5 taxes.

Compensation: Definition (cont.)

Stockholders
Linking executive pay to company performance theoretically increases stockholders' returns (see Ex. 1.2)

Managers
A major expense (labor expense can account for 50+% of total costs) Used to influence employee behaviors and to improve the organization's performance (see Ex. 1.3)
Grocery store clerk pay (2005):
Industry average: $12.28/hr Costco: $16 Whole Foods $12.50 Sams Club $12 Wal-Mart $9.68 Labor costs as % of total costs for grocery stores historically 15-18%; today norm is 9-12%; warehouse stores 4-6%; Whole Foods 25%
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Labor Costs as a Percentage of Revenues, Airline Industry

(8e)

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What Is Compensation?

Compensation refers to all forms of financial returns and tangible services and benefits employees receive as part of an employment relationship
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Exhibit 1.4: Total Returns for Work

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Forms Of Pay

Relational returns
Psychological in nature

Total compensation
Cash Compensation/ transactional
Base wages
Difference between wage and salary

Merit pay/cost-of-living adjustments

Merit increases given in recognition of past work behavior adjustments to base Cost-of-living adjustments same increases to everyone, regardless of performance
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Forms Of Pay (cont.)

Cash Compensation/ transactional (cont.)
Incentives/ Variable pay tie pay increases directly to performance
Does not increase base wage; must be reearned each pay period Potential size generally known beforehand

Long-term (stock options), and short-term

Benefits
Income protection (some are legally required)

Work/life balance (includes pay for time not worked)

Allowances (e.g., expatriates)
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Exhibit 1.5: THE PAY MODEL

POLICIES TECHNIQUES OBJECTIVES

ALIGNMENT

Work Descriptions Evaluation/ INTERNAL analysis certification STRUCTURE

COMPETITIVENESS

Market Surveys definitions

Policy lines

PAY STRUCTURE

EFFICIENCY Performance Quality Customers Stockholders Costs FAIRNESS

CONTRIBUTORS

Seniority based

Performance based

Merit guidelines

INCENTIVE PROGRAMS

COMPLIANCE
MANAGEMENT
Costs Communication Change EVALUATION

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Exhibit 1.6: Pay Objectives at Medtronic and Whole Foods

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Four Policy Choices

Internal alignment

Focus - Comparisons among jobs or skill levels inside a single organization Pay relationships within an organization affect employee decisions to:
Stay with the organization Become more flexible by investing in additional training Seek greater responsibility

External

Focus - Compensation relationships external to the organization: comparison with competitors Pay is market driven
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competitiveness

Four Policy Choices (cont.)

External competitiveness (cont.)

Effects of decisions regarding how much and what forms:
To ensure that pay is sufficient to attract and retain employees To control labor costs to ensure competitive pricing of products/ services

Employee contributions
Focus - Relative emphasis placed on employee performance
Performance based pay affects fairness

Management
Focus - Policies ensuring the right people get the right pay for achieving the right objectives in the right way

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Listening to HRs Critics

Quantify people-management results into dollars

Productivity of workforce
Cost of vacant position Cost of keeping bad manager

Dollar impact of hiring and keeping top performers vs. average ones in mission-critical jobs

Adopt fact-based decision-making

Not I think or I believe but I know re: cause and effect
Causes of turnover What motivates workers to produce more Which HR actions can turn business unit around
Source: Workforce Management, 7/31/06
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Evidence-based HR Decision-making

Assumption that correlation implies causation pervades decision making in human resources and pay plan design.
Inferential issue: "The CEO drank Wild Turkey; the company performed well; ergo, all CEOs should drink more Wild Turkey. The company uses individual incentives; the company performs well; ergo all companies should use more incentives.

"The first step is to know what the evidence says. Know the research literature that pertains to your business. Diffusion and persistence do not prove effectiveness. The goal is to transform human resources into the R&D department for the human system, which is the most important system in almost all organizations.
"In R&D, you go into the laboratory, you experiment and you keep up with the research that others do. Can you imagine walking into the R&D lab at a pharmaceutical company, asking the chief chemist about an important new study and having him respond that they don't keep up with the literature in chemistry?
Jeffrey Pfeffer, Stanford University, in Workforce Management, 11/3/08
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