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