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 Stockholders
Views Views

Employees Managers
Views Views
 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

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

Hourly compensation costs include (1) hourly direct pay and (2)
employer social insurance expenditures and other labor 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)
Compensation: Definition (cont.)
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%
Labor Costs as a Percentage of
Revenues, Airline Industry
 What Is Compensation?
Compensation refers to all forms of financial
returns and tangible services and benefits
employees receive as part of an employment
relationship
Exhibit 1.4: Total Returns for Work
 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
 Forms Of Pay (cont.)
Cash Compensation/ transactional (cont.)
Incentives/ Variable pay tie pay increases
directly to performance
Does not increase base wage; must be re-earned
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)
 Exhibit 1.5: THE PAY MODEL
POLICIES TECHNIQUES OBJECTIVES

ALIGNMENT Work Descriptions Evaluation/ INTERNAL EFFICIENCY

analysis certification STRUCTURE
Performance
Quality
Market
COMPETITIVENESS lines
Surveys Policy PAY definitions Customers
STRUCTURE
Stockholders
Costs
Seniority Performance Merit INCENTIVE
CONTRIBUTORS based based guidelines PROGRAMS FAIRNESS

MANAGEMENT Costs Communication Change EVALUATION COMPLIANCE

 Exhibit 1.5: THE PAY MODEL
POLICIES TECHNIQUES OBJECTIVES

ALIGNMENT Work Descriptions Evaluation/ INTERNAL

analysis certification STRUCTURE

COMPETITIVE Market Surveys Policy PAY definitions

NESS lines STRUCTURE

EFFICIENCY
Performance
Quality
Customers
Stockholders
Costs
 Exhibit 1.5: THE PAY MODEL
POLICIES TECHNIQUES OBJECTIVES

Seniority Performance Merit INCENTIVE

CONTRIBUTORS based based guidelines PROGRAMS

FAIRNESS

MANAGEMENT Costs Communication Change EVALUATION

COMPLIANCE
Exhibit 1.6: Pay Objectives at
Medtronic and Whole Foods
 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
 Four Policy Choices
External competitiveness
Focus - Compensation relationships
external to the organization: comparison
with competitors
Pay is market driven
 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
 Four Policy Choices (cont.)
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
 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
 Listening to HRs Critics
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
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.
Evidence-based HR Decision-making
"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.
Evidence-based HR Decision-making
"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
 END
OF
THE
CHAPTER