ARTICLES - Remuneration

MAKING PAY COMPETITIVE

Vinayak Kamath & Ganesh Shermon

Over the years, organizations have, either explicitly or implicitly, sometimes by default, recognized the fact that the key to achievement of the organizational purpose is the human resource. If this resource is treated as an input resource in the overall organizational processes, there is a resource cost attached to it. The economics of demand and supply and the theories of price elasticity would definitely apply to the human resource. What complicates the management of the human resource is that to this economic theory, one has to superimpose the complex theories of managing human behavior. Designing and managing a compensation system is therefore a management exercise that involves economic, financial expertise and mastery of knowledge of human behavior. Organizations must reward employees because they are in turn looking for certain kinds of behavior: they need competent individuals who agree to work with a high level of performance, loyalty, ground level commitment. Individual employees, in exchange for their commitment, expect certain extrinsic rewards in the form of performance pay promotions, salary, fringe benefits, perquisites, bonuses, or stock options. Individuals also seek the intrinsic rewards such as feelings of competence, achievement, responsibility, significance, influence, personal growth and meaningful contribution. In todays world compensation systems cope with paying for risk of continuing to be employable. A compensation program is therefore the fine art of balancing the extrinsic reward element in the overall reward management exercise of all human resource systems. To gain an insight, into the scheme of rewards and influencing human motivation towards desired behavior and ultimately satisfaction, it would be worthwhile studying Ed Lawlers Expectancy Theory Model, which states that human behavior is a function of effort to performance expectancies; performance to reward expectancies; perceived attractiveness of rewards (Figure 1) To this we must add the implementation dimension: Peer equity and parity across boardPeer equity and parity across board, in several situations, peer definitions cut across organizations and move into the realm of classmates, equivalent talent sources, market comparisons not industry relevant, etc. Organizational ability and willingness to pay and benchmarkOrganizational ability and willingness to pay and benchmark. Basic definitions of the compensation survey group influences the performance to reward expectancies. Corporate philosophy and cultureCorporate philosophy and culture, both inherited and desired, become relevant for the compensation plan. Cultures oscillate between take home compensation, to perks, benefits, facilities, retirement advantages, severance pay, variable pay, ownership options, risk sharing , rewards etc. Several aspects of the culture become significant and dynamic in the compensation plan. Team working, emphasis on sales versus production, supply chain considerations, conflict management issues, tolerance for ambiguity etc. Hiring and attrition in industryHiring and attrition in industry. This is a critical strategy in the compensation planning. Where do we hire out talent from and where do we lose our talent to. What

is our target market for hiring talent and leaders for the company. Where do we receive the right resources. Corporate strategy and short, medium, long term business plans perhaps are the single most important influencer of the compensation philosophy. Business plans determine the ability and the willingness. In our opinion, intodays context many organizations simply do not have a choice. Talent does not come cheap, provided they are available to the organization looking for them. Organizations look at talent management in more than a todays perspective. Institutions like Hindustan Levers and Citibank have clearly articulated goals in compensation planning of their desire to nurture and retain talent with a tight fit compensation program apart from their several culturally proactive policies which attract and retain talent. and short, medium, long term business plans perhaps are the single most important influencer of the compensation philosophy. Business plans determine the ability and the willingness. In our opinion, intodays context many organizations simply do not have a choice. Talent does not come cheap, provided they are available to the organization looking for them. Organizations look at talent management in more than a todays perspective. Institutions like Hindustan Levers and Citibank have clearly articulated goals in compensation planning of their desire to nurture and retain talent with a tight fit compensation program apart from their several culturally proactive policies which attract and retain talent.

Compensation models philosophy Having understood the position of a compensation system in the organizational reward systems, let us now examine the philosophy behind designing a robust compensation system. To do that, we must articulate generic organizational objectives in contemporary organizations especially in the human resource areas.

Leanness and effectiveness small numbers, best talent, high performing Character, commitment and loyalty- perceived equity in reward systems, early growth needs, punitive differentiation on performance basis High growth orientation- merit, meritocracy, risk orientation, peak performance Continuous learning and development- individual and organizational learning Perpetuity- sustaining partnerships in relationships, managing youth, short span of careers, mindset for fast track growth.

To fulfill these organizational objectives and their implications on the human resource, the compensation system must in turn have the following characteristics: Must be attractive enough for hiring, retaining and motivating the best available talent to continuously perform on a sustained basis. The system must be equitable and must be seen to be equitable. A lot of compensation systems which have been designed with the fairest of intent, when administered, leave perceptions that do no fulfill this criterion. While being equitable, individual and team performance has to be triggered for continuous

improvement and therefore, performance has to be rewarded. To ensure the objective of organizational learning, individual learning that would translate itself into organizational learning has to be incentivized. To focus on short and long term earnings To help build net-worth and demystify psychological compulsions of burnout, stress, plateau, and doped. To address individual needs yet suitably moderate to create a corporate compensation philosophy or policy. Manage with resilience peaks and troughs in business cycle and performance. Make compensation budget and disbursement in the same currency and exchange rate as is applicable in the business plan and budget. This is to offer the fairness that if your sales and profit budgets are in US$ denominated targets, then the compensation plan/budget as well as its disbursement should be in the same currency. Finally, to ensure the organizations objective of perpetuity, the compensation system must facilitate lifestyles of employees. Having said all this, we must reinforce the fact that generic organization objectives have been used in adopting the philosophies of compensation that have been stated above. It is important to understand that like all organization systems and processes, the compensation system must reflect the organizations culture, engender the values and adopt the practices that the organization cherishes. Designing compensation systems Base Pay and Position Evaluation Base Pay and Position Evaluation : The first aspect that the compensation system has to address is the economic theory of reward for a particular job or role value. Conventionally base pay reflects the job value for the position, level, skill and parity. Within the organization structure, there are many positions, each of which are expected to deliver a certain set of results. Each of these positions calls for a set of skills, knowledge, and experience base. The exercise of determining the pay for the position calls for an extensive study of the market forces, which determines what the industry is paying for a particular job. The terminology used here is "position evaluation, which simply stated implies what to pay for a job that gives a particular result or a set of outcomes and demands a particular knowledge level, a skill set, competencies and an experience profile. However, the base pay does not ensure the outcome that is desired from the job incumbent. That is, the presence of a base pay does not ensure the organizational objectives of effectiveness, growth, or value addition. By itself, the base pay ensures the objective of attracting talent and arriving at peer equivalence. In contemporary compensation systems, the rate of growth of the base pay has been diminishing according to many surveys. This statement should be read in the context of the developed world where a large number of tax effective allowances/reimbursements are not credited. Base pay largely reflects compensation for the job/skill performed with remaining components being benefits, perks,

bonuses and stocks. Some proactive Indian/MNCs have commenced this practice. Role AwardRole Award: In the present environment that is constantly changing, organizations have to resort to several adapting strategies to cope with accelerated rates of learning that is demanded. This means hiring specialist talent that brings in a new dimension of organizational competencies, or doubling up of employees to manage new venture areas. During the process of dynamic consolidation, these actions are short-term while adding significant value to the organization in the short run. "the rate of growth of the base pay has been diminishingBase pay largely reflects compensation for the job/skill performed with remaining components being benefits, perks, bonuses and stocks" In reality , when the organization needs specialist talent to cope with a new competence area, or an existing employee is called to double up, there is a dilemma. The potential employee perceives the new venture area as a risk because the organization has no performance history in that area and the organization itself cannot venture into the new area without the best available skill-set. The conventional job value related base pay approach would not serve the purpose in such a case. An approach to counter this dilemma is the concept of Role Award , which is a short -term, high value pay for the added competency that the employee brings in. After the implementation of the new venture area is consolidated, the other reward systems would take over. The Role Award also serves to reward the employee within the organization who has doubled up to manage an additional role. In effect, Role Award is an element of compensation for the specialist roles of higher risk in the organizations and one which serves to bring out the employees from their comfort zones to drive into new areas of performance. Incentivizing performanceIncentivizing performance: Merit increase and performance awards: To make this human talent perform, and on a sustained basis, there has to be a mechanism that rewards performance. The next aspect therefore, that the system addresses, is that of meritocracydistinguishing and rewarding performance. As Charles Handy wrote, the new organization equation for success is that profit and productivity are best created by half the workforce, paid twice as well and producing three times as much. Translated into practice, this means that a mechanism for differentiating and rewarding performance through compensation has to be built in. This gives rise to merit increments and performance linked awards. Merit and meritocracy has another element built in. What is the organizational model that determines merit and what is this meritorious behavior. If, for example, team performance, is what will determine organizational success and individual performance is rewarded, then the organizational objective would be defeated ab initio. Therefore the schemes of rewarding merit must be designed based on the definition of merit in the organizations objectives. For example, one luxury car dealer in Texas has created a team based reward program in which pay is largely determined by customer satisfaction. Creating lifestyles: One of the trends of current work-life is the amount of time and effort that the employees have to invest on the workplace. Long work hours are therefor a reality in todays times. In doing so, the employee diverts a lot of time and effort from the pursuits of creating lifestyles. The organization has to recognize and aid the effort of creating a lifestyle for the employee. Translated into compensation practice, this means, evolving benefit schemes such as asset building schemes and the non tradables A large number of young professionals including business school graduates have shown greater preference for compensation that includes some amount of lifestyle benefits.: One of the trends of current work-life is the amount of time and effort that the employees have to

invest on the workplace. Long work hours are therefor a reality in todays times. In doing so, the employee diverts a lot of time and effort from the pursuits of creating lifestyles. The organization has to recognize and aid the effort of creating a lifestyle for the employee. Translated into compensation practice, this means, evolving benefit schemes such as asset building schemes and the non tradables A large number of young professionals including business school graduates have shown greater preference for compensation that includes some amount of lifestyle benefits. Some of the contemporary practices in the creation of lifestyles include: Asset building through soft-loan options Club memberships Asset lease options, home furnishings Property owning options. Company paid holidays at international locations, e.g. holiday cruise on QE2 Premium schooling for employees children Housing at elite locations. Farm houses, beach resorts, holiday homes Entertainment vacations, e.g. visit to Disneyland Timeshare holidays (including RCI membership) Usage of the corporate jet Home office Holiday caravans Active participation in cultural and arts societies, and many more.

Perquisites, benefits and fringes : On the need hierarchy of every employee is the esteem and the social need of the facilities that come with ones advancement in career and in life. To fulfill this need, the compensation program has to create perquisites and benefits. : On the need hierarchy of every employee is the esteem and the social need of the facilities that come with ones advancement in career and in life. To fulfill this need, the compensation program has to create perquisites and benefits. An observable trend of these benefits is that visible nature of benefits increases with career advancement and gives the employee something to strive for. Some of the benefits and perquisites include: Provision of a company car, family car

Reimbursement of a chauffeurs wages Reimbursement of entertainment bills Leave travel reimbursement Reimbursement on attire provided the culture necessitates uniform executive attire. Scholarships for employees children

Incentivizing learningIncentivizing learning: With the increasing importance of augmenting intellectual capital within the organization, individual learning has to be encouraged and incentivised. A good compensation plan fulfills this objective in ways ranging from reimbursement of books, subscription to educational periodicals, CD ROMs, internet connections on the one hand to sponsoring employees for short terms and long term education in prestigious universities on the other. Employees are also encouraged to take training programs within the organization as well as guest lectures at universities. This fact is reflected and rewarded through the performance appraisal system, which incentivizes sharing of learning. Employee partnerships- stock options, phantom stock options: Organizations increasingly need to have employees with an entrepreneurial spirit. From the organizations point of view, the entrepreneurial spirit would ensure greater contribution from the employee through diverse ideas, complete ownership for the role and the organization, higher element of calculated risk taking and higher commitment.- stock options, phantom stock options: Organizations increasingly need to have employees with an entrepreneurial spirit. From the organizations point of view, the entrepreneurial spirit would ensure greater contribution from the employee through diverse ideas, complete ownership for the role and the organization, higher element of calculated risk taking and higher commitment. From the behavioral perspective, entrepreneurship has several intrinsic rewards like fulfilling of esteem needs and moving towards self-actualization. From the economic perspective, the extrinsic reward for entrepreneurship has been profit. An organization that expects entrepreneurship from the employee has to create this extrinsic reward system of sharing returns with select, committed employees. The mechanism of stock options fulfills this need. Select employees in the organization are rewarded through company shares. The benefit to the employee is that an asset is created whose asset-value at any point in time, is the market capitalization; in time, is the market capitalization; plus the ongoing revenue reward of dividends. To the organization, this is a mechanism of creating a new stakeholder whose interest in organizational success is enhanced by virtue of such status, thereby inventivizing employees to perform an ensuring entrepreneurship and commitment. Extended versions of this concept could include partnerships in a backward integrated unit, a suppliers company etc. Facilitating life planningFacilitating life planning: A good human resource philosophy intends that the employee during his/her worklife contributes with the security of a sound future and without the worries of being left high and dry at the end of the career. Beyond the age of retirement, the only element of the human resource strategy that would impact the individual, is the kind of retiral benefits that the compensation plan provides. While statures around the world provide for some pension, social security benefits and retirement

schemes, good organizations have come to terms with the fact that only the bare minimum of retirement benefits would not serve their utility with good talent. Some organizations have designed superannuation schemes that are well above the minimum statutory norms. These schemes complemented with the asset building programs ensure life planning for the employee. For example, a pension plan, which offers a superannuated employee, last drawn salary as a pension for the next 25 years. Evolving futuristic compensation plans The workforce in organizations is shrinking with each employee expected to add a distinct value to the business. Added to that is the increased emphasis in technology, quality and service, which results in the business world changing from a mechanized workforce to the knowledge workforce. The knowledge workforce is expected to take decisions, respond instantaneously and take risks. This behavior has to be rewarded differently. Performance is no longer a lifelong contract of commitment, but one that has to be continually reinforced. Changing organization structures also necessitate changing compensation practices. Some of the implications of the futuristic structure on compensation are as follows: Networks of competencies: For a network or a team based structure to succeed, it would demand sharing of rewards and therefore the creation of team-based reward programs Lean organizations and strategic outsourcing: Based on a pure economic evaluation, an organization has to prioritize the building of owned human assets and skill sets and the leveraging of competencies available with specialist individuals or consulting firms. In the contemporary cost environment, the organizational priorities would be for owning customer focussed and service skills and hiring most of the value-adding specialist skills.

One of the objectives of association with these specialists and consulting firms would be rapid absorption of a higher knowledge technology. In such a scenario, the compensation system would have to address the absorption of specialist skills and the delivery of customer value by the employees. This learning has therefore to be incentivized. Virtual organizations: In high technology areas like software development and I.T., where specialist skills are leveraged without the physical need for people coming together at an office the creation of a home office is facilitated. This provides integrated rewards of flex-hours combined with the facilities like home computer, fax, telephone, modem, and internet connection. Compensation zones and tailored compensation: Like the business organization where the need of the hour is flexibility and mass customization, to cater to the top class skilled human resources, the compensation plan of the future will have to be customized to individual needs. This plan would work as follows. There would be zones or bands of compensation, reflecting total cost to company for different competencies. The employee would choose from a laundry list of options like base pay, retirement benefits, asset options, benefits, perquisites and lifestyle options. The compensation manager would act as a consultant in aiding the employee choose from amongst the various options available, and thereafter delivering the plan in a tax effective manner to the employee. This, perhaps, is themost effective system for compensation management going forward. With the emphasis on increasing resource productivity that will continue into the organizations of tomorrow, the compensation plan will continue to come up for debate for increasing cost effectiveness. The only constant in the organizations of tomorrow will be the continued struggle for a cost versus benefit in compensation programs.