Chapter-11 Establishing Strategic Pay Plans

The main purpose of this chapter is to show you how to establish a pay plan. We explain job evaluation–techniques for finding the relative worth of a job–and how to conduct online and offline salary surveys. We also explain how to price the jobs in your firm by developing pay grades and an overall pay plan.

BASIC FACTORS IN DETERMINING PAY RATES

Employee compensation refers to all forms of pay going to employees and arising from their employment. It has two main components, direct financial payments (wages, salaries, incentives, commissions, and bonueses) and indirect financial payments (financial benefits like employer-paid insurance and vacations).

In turn, there are two basic ways to make direct financial payments to employees: base them on increments of time or on performance.

Several factors determine the design of any pay plan: legal, union, company strategy and policy, and equity.

Legal Considerations in Compensation

Various laws specify things like minimum wages, overtime rates, and benefits. For example, Davis-Bacon Act in 1931, Walsh-Healey Public Contract Act in 1936, Title VII of the 1964 Civil Rights Act.

The 1938 Fair Labor Standards Act (FLSA) contains minimum wage, maximum hours, overtime pay, equal pay, record-keeping, and child labor provisions.

One familiar provision governs overtime pay. It says employers must pay overtime at a rate of at least one-and-a-half times normal pay for any hours worked over 40 in a workweek.

The FLSA also sets a minimum wage, which sets a floor for employees covered by the act (and usually bumps up wages for practically all workers when Congress raises the minimum).

Exempt/Nonexempt Specific categories of employees are exempt from the FLSA or certain provisions of the act, and particularly from the at’s overtime provisions–they are “exempt employees”.

1963 Equal Pay Act an amendment to the FLSA, states that employees of one sex may not be paid wages at a rate lower than that paid to employees of the opposite sex for doing roughly equivalent work.

1974 Employee Retirement Incomes Security Act provided fro the creation of government-run, employer-financed corporations to protect employees against the failure of their employer’s pension plans.

Other Legislation Affecting Compensation For example, Age Discrimination in Employment Act, Americans with Disabilities, Family and Medical Leave Act.

Union Influences on Compensation Decisions

Unions and labor relations laws also influence pay plan design. The National Labor Relations Act of 1935 (Wagner Act) gave unions legal protection, and granted employees the right to unionize, to bargain collectively, and to engage in concerted activities for the purpose of collective bargaining or other mutual aid or protection.

Competitive Strategy, Corporate Policies, and Compensation

The compensation plan should advance the firm’s strategic aims–management should produce an aligned reward strategy.

Developing an Aligned Reward Strategy Questions to ask:

1. What must our company do (for instance interms of improving customer service), to be successful in fulfilling its mission or achieving its desired competitive position?
2. What are the employee behaviors or actions necessary to successfuly implement this competitive strategy?
3. What compensation programs should we use to reinforce those behaviors? What should be the purpose of each program in reinforcing each desired behavior?
4. What measurable requirements should each compensation program meet to be deemed successful in fulfilling it’s purpose?
5. How well do our current compensation programs match these requirements?

The employer’s compensation strategy will manifest itself in pay policies.

IBM Example IBM provides a classic example of how managers use compensation policy to support their strategic aims. CEO–Louis Gerstner instituted four new incentive and other pay policies:

1. Pay to market.
2. Fewer, “broadband” jobs. 24 narrow wage grades –> 10 grades based on three factors (skills, leadership requirements, and scope/impact)
3. Let managers manage.
4. Incentivize employees.

Types of Pay Policies emphasize seniority or performance.

Other pay policies usually cover how to award salary increases and promotions, overtime pay, probationary pay, leaves for military service, jury duty, and holidays.

Salary and Incentive in Tough Times Not surprisingly, one way that employers deal with economically challenging times is by cutting back on salary increases and merit pay.

Interestingly though, the challenging times were also prompting employers to pay closer attentiaon to their highest performing employees.

Pay Raises Employers compute pay raises in one of two ways. merit pay(绩效工资) policies, award raises across-the-board.

Salary Compression means longer-term employees’ salaries are lower than those of workers entering the firm today, and is a creature of inflation.

Geography How to account for geographic differences in cost of living is another big pay policy issue. Overseas, most multinational enterprises set expatriates’ salaries according to their home-country base pay. In addition, the person typically gets allowances including cost-of-living, relocation, housing, education, and hardship allowances.

Equity and Its Impact on Pay Rates

Equity Theory of Motivation postulates that people are strongly motivated to maintain a balance between what they perceive as their inputs or contributions, and their rewards.

With respect to compensation, managers should address four forms of equity: external, internal, individual, and procedural.

• External equity refers to how a job’s pay rate in one company compares to other job’s pay in other companies.
• Internal equity refers to how fair the job’s pay rate is when compared to other jobs within the same company.
• Individual equity refers to the fairness of an individual’s pay as compared with what his or her coworkers are earning for the same or very similar jobs within the company, based on each individual’s performance.
• Procedural equity refers to the “perceived fairness of the processes and procedures used to make decisions regarding the allocation of pay.

Addressing Equity Issues Managers use salary surveys to monitor and maintain external equity. They use job analysis and job evaluation comparisons of each job to maintain internal equity. They use performance appraisal and incentive pay to maintain internal equity. And they use communications, grievance mechanisms, and employee’s participation in developing the company’s pay plan to help ensure that employees view the pay process as transparent and procedurally fair.

ESTABLISHING PAY RATES

The process of establishing pay rates while ensuring external, internal, and procedural equity consists of five steps:

1. Conduct a salary survey of what other employers are paying for comparable jobs.
2. Determine the worth of each job in your organization through job evaluation.
3. Group similar jobs into pay grades.
4. Fine-tune pay rates.

Step 1. The Salary Survey

It’s difficult to set pay rates if you don’t know what others are paying, so salary surveys–surveys of what others are paying–play a big role in pricing jobs. Salary surveys can be formal or informal. Informal phone or Internet surveys are good for checking specific issues. Some large employers can afford to send out their own formal surveys to collect compensation information from other employers.

Commercial, Professional, and Government Salary Surveys For example, the U.S. Department of Labor’s Bureau of Labor Statistics’ (BLS) National Compensation Survey (NCS) (read more: http://www.bls.gov/bls/wages.htm).

Using the Internet to Do Compensation Surveys Some Pay Data Web Sites:

• Salary.com
• www.wageweb.com
• www.opm.gov/oca/09Tables/index.asp
• http://jobstar.org/tools/salary/sal-prof.php
• cnnmoney.com

Step 2. Job Evaluation

Job evaluation aims to determin a job’s relative worth. The basic principle of job evaluation is this: Jobs that require greater qualifications, more responsibilities, and more complex job duties should receive more pay than jobs with lesser requirements.

Compensable Factors A fundamental, compensable element of a job, such as skills, effort, responsibility, and working conditions. For example, Hay consulting firm emphasizes three factors: know-how, problem solving, and accountability. Walmart bases its wage structure on knowledge, problem-sovling skills, and accountability requirements.

Preparing for the Job Evaluation The main steps include identifying the need for the program, getting cooperation, and then choosing an evaluation committee.

Job Evaluation Methods: Ranking There are several steps in the job ranking method.

1. Obtain job information.
2. Select and group jobs.
3. Select compensable factors.
4. Rank jobs.
5. Combine ratings.

Job Evaluation Methods: Job Classification Job classification (or job grading) is a simple, widely used method in which raters categorize jobs into groups; all the jobs in each group are of roughly the same value for pay purposes.

The most popular procedure is to choose compensable factors and then develop class or grade descriptions for each class or grade in terms of the amount or level of the compensable factor(s) in those jobs.

Job Evaluation Methods: Point Method The point method is a quantitative technique. It involves identifying (1) several compensable factors, each having several degrees, as well as (2) the degree to which each of these factors is present in the job.

Job Evaluation Methods: Factor Comparison is a refinement of the ranking method.

Computerized Job Evaluations have two main componets: a structured questionnaire, and use statistical models.

Step 3. Group Similar Jobs into Pay Grades

A pay grade is comprised of jobs of approximately equal difficulty or importance as established by job evaluation.

Step 4. Price Each Pay Grade–Wage Curves

The wage curve shows the pay rates currently paid for jobs in each pay grade, relative to the points or rankings assigned to each job or grade by the job evaluation.

Here is how to price jobs with a wage curve. First, find the average pay for each pay grade, since each of the pay grades consists of several jobs. Next, plot the average pay rates for each pay grade. Then fit a line, called a wage curve, through the points just plotted. Finally, price the jobs.

Step 5. Fine-Tune Pay Rates

Fine-tuning involves (1) developing pay ranges and (2) correcting out-of-line rates.

Developing Pay Ranges Pay ranges often appear as vertical boxes within each grade, showing minimum, maximum, and midpoint pay rates for that grade.

Correcting Out-of-Line Rates

HR in Practice: Developing a Workable Pay Plan

Developing a pay plan is as important in a small firm as a large one.

Wage Surveys Four sources can be especially useful. Internet and Web sites, classified newspaper ads, Local Job Service offices, and local employment agencies.

Job Evaluation split employees into three clusters–managerial/professional, office/clerical, and plant personnel.

Pay Policies The better is to have a policy of once-a-year raises following a standard 1-week appraisal period, preferably about 4 weeks before you produce the budget for next year.

Other required compensation policies include amount of holiday and vacation pay, overtime pay policy, method of pay, garnishments, and time card or sign-in sheet procedures.

PRICING MANAGERIAL AND PROFESSIONAL JOBS

The basic aim is the same: to attract and keep good employees. Managerial jobs tend to stress harder-to-quantify factors like judgment and problem solving more than do production and clerical jobs. There is also more emphasis on paying managers and professionals based on results–based on their performance or on what they can do–rahter than on the basis of static job demands like working conditions.

Compensating Executives and Managers

Compensation for a company’s top executives usually consists of four main elements: base pay, short-term incentives, long-term incentives, and executive benefits/perquisites or “perks.”

What Determines Executive Pay?

three main factors: job complexity (span of control, the number of functional divisions over which the executive has direct responsibility and management level), the employer’s ability to pay (total profit and rate of return), and the executive’s human capital (educational level, field of study, work experience) accounted for about two-thirds of executive compensation variance.

Elements of Executive Pay Salary is traditionally the cornerstone of executive compensation. On it, employers layer benefits, incentives, and perquisites. Boards are boosting the emphasis on performance-based pay.

Managerial Job Evaluation The basic approach is to classify all executive and management positions into a series of grades, each with a salary range.

Compensating Professional Employees

Compensable factors focus on problem solving, creativity, job scope, and technical knowledge and expertise. Most employers use a market-pricing approach.

COMPETENCY-BASED PAY

Introduction

An increasing number of compensation experts and employers are moving away from assigning pay rates to jobs based on the jobs’ numerically rated, intrinsic duties.

What is Competency-Based Pay?

In brief, competency-based pay means the company pays for the employee’s range, depth, and types of skills and knowledge, rather than for the job title he or she holds. Two basic types of pay programs: pay for knowledge or skilled pay.

In sum, probaly the biggest difference between traditional and competency-based pay is this:

• Traditional job evaluation-based pay plans tie the worker’s pay to the worth of the job based on the job description–pay here is more job oriented.
• Competence-based pay ties the worker’s pay to his or her competencies–pay is more person oriented.Employees here are paid based on what they know or can do–even if, at the moment, they don’t have to do it.

Why Use Competency-Based Pay?

The main reason is that traditional pay plans may actually backfire if a high-performance work system is your goal. The whole thrust of these systems is to encourage employees to work in a self-motivated way.

Competency-Based Pay in Practice

In practice, any skill/competency/knowledge-based pay program generally contains five main elements, which are listed as follows:

1. A system for defining specific required skills.
2. A process for tying the person’s pay to his or her skill level.
3. A training system that lets employees acquire the skills.
4. A formal skills competency testing system.
5. A work design that lets employees move among jobs to permit work assignment flexibility.

General Mills Example four clusters of jobs: mixing, filling, packaging, and materials.

The Bottom Line on Competency-Based Pay

Competency-based pay has detractors. Some note that competency-based pay “ignores the cost implications of paying [employees] for knowledge, skills and behaviors even if they are not used.”

SPECIAL TOPICS IN COMPENSATION

How employers pay employees has been evolving. We can sum up the main changes as follows:

• We’ve seen that there is somewhat less emphasis on the job’s duties, and more on the person’s skills and competencies and how these fit with the firm’s strategic needs.
• We’ve seen that there is less emphasis on seniority, and more on the employee’s performance.
• There is less emphasis on narrowly defined pay ranges and jobs, and more on broader jobs and pay ranges.
• There is increased interest in ensuring that men and women are paid comparably for essentially the same work.
• There is more emphasis on board oversight and regulation of executive pay.

Broadbanding

Broadbanding means collapsing salary grades into just a few wide levels or bands, each of which contains a relatively wide range of jobs and pay levels. Broadbanding breeds flexibility.

Use A survey of 783 employers found that about 15% were using broadbanding. Note that even with competence/skill-based pay and broadbanding, 60% to 70% of U.S. firms use quantitative point and factor comparison plans to create pay structures.

Comparable Worth

Comparable worth* refers to the requirement to pay men and women equal wages for jobs that are of comparable value to the employer.

The Pay Gap Women in the United States earn only about 77% as much as men.

Board Oversight of Executive Pay

There are various reasons why boards are clamping down on executive pay.

Tomorrow’s Pay Programs

Companies around the world will continue to face severe economic and competitive challenges. consultants McKinsey & Co. calls a “war for talent”. Younger “Generation Y” applicants will enter the workforce with greater expectations for recognition and feedback than di their predecessors.

Improving Productivity Through HRIS: Automating Compensation Administration

Usually, the employer identifies set times during the year when all the firm’s managers review employees’ performance and match these with budgetary constraints and formulate pay raise recommendations for the coming year.

CHAPTER SECTION SUMMARIES

1. In establishing strategic pay plans, managers first need to understand some basic factors in determining pay rates. Employee compensation includes both direct financial payments and indirect financial statements. The factors determining the design of any pay plan include legal, union, company strategy/policy, and equity. Legal considerations include, most importantly, the Fair Labor Standards Act, which governs matters such as minimum wages and overtime pay. Specific categories of employees are exempt from the act or certain provisions of the act, particularly its overtime provisions. The Equal Pay Act of 1963 and the Employee Retirement Income Security Act are other important laws.

2. The process of establishing pay rates while ensuring external, internal, and procedural equity consists of five steps: conducting a salary survey, determining the worth of each job, doing a job evaluation, grouping jobs comprised of approximately equal difficulty and pricing each pay grade with wage curves, and fine-tuning pay rates.

   • Salary surveys may be informal phone or Internet surveys, or formal surveys conducted by the employer or utilizing commercial, professional, and/or government salary surveys.
   • Job evaluation is a systematic comparison done in order to determine the worth of one job relative to another based on compensable factors.
   • Compensable factors refer to compensable elements of a job such as skills and efforts.
   • Popular job evaluation methods include ranking, job classification, the point method, and factor comparison. With ranking, for instance, you conduct a job analysis, group jobs by department, and have raters rank jobs.
   • Once the commitee uses job evaluation to determine the relative worth of each job, it can turn to the task of assigning pay rates to each job; it would usually first want to group jobs into pay grades to streamline the process.
   • The team can then use wage curves to price each grade and then fine-tune pay rates.

3. Pricing managerial and professional jobs involves some special issues. Managerial pay typically consists of base pay, short-term incentives, long-term incentives, and executive benefits and, particularly at the top levels, doesn’t lend itself to job evaluation but rather to understanding the job’s complexity, the employer’s ability to pay, and the need to be competitive in attracting top talent.

4. More employers are moving from paying jobs based on their intrinsic duties toward paying jobs based on the competencies the job requires. The main reason for doing so is to encourage employees to develop the competencies they need to move seamlessly from job to job. At General Mills, for instance, certain plant personnel are paid based on the skill levels they attain.

5. We addressed several important special topics in compensation. Broadbanding means consolidating several rates and ranges into a few wide levels or “bands,” each of which contains a relatively wide range of jobs in salary levels. Braodbanding encourages employees to move freely from job to job and facilitates implementing team-based high-performance management systems. Comparable worth refers to the requirement to pay men and women equal pay for jobs that are of comparable rather than strictly equal value to the employee. With manay stockholders concerned with executive remuneration, board oversight of executive pay has become an important issue, and boards of directors need to make sure they use qualified advisers and exercise diligence and independence in formulating executive pay plants.