chap 2 compensation newman

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

Milkovich/Newman: Compensation, Ninth Edition

Chapter 2Strategy: The

Totality ofDecisions


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Chapter Topics

Similarities and Differences in Strategies

Strategic Choices

Support Business Strategy

The Pay Model Guides Strategic Pay Decisions

Developing a Total Compensation Strategy:Four Steps


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Chapter Topics (cont.)

Source of Competitive Advantage: Three Tests

Best Practices versus Best Fit

Guidance from the Evidence

Virtuous and Vicious Circles

Your Turn: Mapping Compensation Strategies Still Your Turn: Pay Matters (Productivity

Does, Too)


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Exhibit 2.1: Three Compensation Strategies


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Similarities and Differencesin Strategies

Different strategies within the same industry

Different strategies within the same company

Let the market decide our compensationphilosophy is untenable in the real world,especially in global environments


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Strategic Choices

Strategy refers to the fundamental directions thatan organization chooses

Corporate level: What business should we be in?

Business unit level: How to gain and sustaincompetitive advantage?

Functional level: How should total compensationhelp gain and sustain competitive advantage?

Astrategic perspectivefocuses on thosecompensation choices that help the organizationgain and sustain competitive advantage


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Exhibit 2.2: Strategic Choices


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Support Business Strategy

Pay systems should align with the organization'sbusiness strategy

Based on contingency notions

Compensation systems can be tailored to:Innovator business strategy

Cost cutter business strategy

Customer-focused business strategy When business strategies change, pay systems

should also change


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Exhibit 2.3: Tailor the CompensationSystem to the Strategy


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Exhibit 2.4: IBMs StrategicPrinciples and Priorities


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The Pay Model Guides Strategic PayDecisions

Decisions based on the five strategiccompensation choices of the pay model, takentogether, form a pattern that becomes anorganization's compensation strategy

Stated versus Unstated Strategies


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Example: The Strategic CompensationDecisions Facing Whole Foods

Objectives: How should compensation supportbusiness strategy and be adaptive to the culturaland regulatory global environment?

Whole Foods ObjectivesIncrease shareholder value through profits and

growth

Go to extraordinary lengths to satisfy and delightcustomers

Seek and engage employees who are going to helpthe company make money


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Example: The Strategic CompensationDecisions Facing Whole Foods (cont.)

Internal Alignment: How differently should thevarious types and levels of skills and work bepaid within the organization?

Whole Foods ApproachStore operations are organized around eight to ten

self-managed teams

Egalitarian, shared-fate philosophyexecutive

salaries do not exceed 14 times the average pay offull-time employees

All full-time employees qualify for stock options,and 94 percent of the company's options go to non-executive employees


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External competitiveness: How should totalcompensation be positioned against ourcompetitors? What forms of compensationshould we use?

Whole Foods ApproachOffer a unique deal compared to competitors

Provide health insurance for all full-time employees20 hours of paid time a year to do volunteer work



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Employee contributions: Should pay increasesbe based on individual and/or teamperformance, on experience and/or continuouslearning, on improved skills, on changes in cost

of living, on personal needs, and/or on eachbusiness units performance?

Whole Foods ApproachA shared fate every four weeks, assess the

performance of each teamTop teams get an extra $1.50 to $2.00 an hour in the

next pay period


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Management: How open and transparent shouldpay decisions be to all employees? Who shouldbe involved in designing and managing thesystem?

Whole Foods Approach No-secrets management; every store has a book

listing the previous year's pay for every employee

including executivesYou Decide employees recently voted to pick

their health insurance rather than having oneimposed by leadership



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Exhibit 2.5: Key Steps In Formulating a TotalCompensation Strategy


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Developing A Total CompensationStrategy: Four Steps

Step 1: Assess total compensation implications

Step 2: Map a total compensation strategy

Steps 3: Implement strategy Step 4: Reassess


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Step 1: Assess Total CompensationImplications

Competitive Dynamics Understand theBusiness

Changing customer needs

Competitors actions

Changing labor market conditions

Changing Laws

Globalization

Competitive dynamics can be assessed globally


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Exhibit 2.6: Toshibas ManagerialCompensation Plan, Annual Amount (in Yen)


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Step 1: Assess Total CompensationImplications (cont.)

Culture/values

A pay system reflects the values that guide anemployer's behavior and underlie its treatment ofemployees

Social and political context

Context refers to legal and regulatory requirements,cultural differences, changing workforce,demographics, expectations etc.

Affects compensation choices

Lobbying is also part of compensation strategies


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Exhibit 2.7: Medtronic Values


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Step 1: Assess Total CompensationImplications (cont.)

Employee preferences

How to better satisfy individual needs andpreferences

ChoiceExamples: Flexible benefits and choices Union preferences

Pay strategies need to be adapted to the nature of theunion-management relationship

Unions' interests can differ

Compensation deals with unions can be costly tochange


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Step 2: Map a Total CompensationStrategy

Mapping is used in marketing to clarify andcommunicate a product's identity

Offers picture of a companys compensation

strategy based on the five choices in the paymodel

Clarifies the message the company is trying toestablish with its compensation system

Maps do nottell which strategy is the best,providing rather framework and guidance


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Exhibit 2.8: Contrasting Maps OfMicrosoft And SAS


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Steps 3 and 4: Implement and Reassess

Step 3

Involves implementing strategy through the designand execution of compensation system

Step 4

Reassess and realign, closes the loop and recognizesthat the strategy must be changing to fit changingconditions

Involves periodic reassessment


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Sources of Competitive Advantage:Three Tests

Three tests determine if a pay strategy is asource of advantage

Is it aligned? Does it differentiate?

Does it add value?

Calculate the return on investment (ROI)

Which

hat is

unique?


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Guidance from the Evidence

Consistent research evidence that the followingpractices do matter to the organization'sobjectives

Internal alignment

Pay differences among internal jobs can affect results

External competitiveness

Paying higher than average paid by competitors can affectresults

Employee contributions

Performance-based pay can affect results


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Virtuous and Vicious Circles

One study concluded that howyou pay alsomatters as much as how muchyou pay

Studies conclude that performance-based pay

that shares success with employees improvesemployee attitudes, behaviors, performanceespecially when combined with high-performance practices

Performance-based pay can be the best practiceunder right circumstances


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Exhibit 2.9: Virtuous and ViciousCircles (cont.)

chap 2 compensation newman

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