Compensation

Reward Systems
Compensation Theory, Job Evaluation and Pay Administration

Why is compensation important to
organizations?
Need to control costs to remain solvent and
competitive
Need to remain competitive with internal and
external labor markets Need to use pay to motivate employees
The basic problem: a limited pie to divide
among all employees

Page 2 MGMT 412 | Reward Systems Fall 2008
Information from DoL, Bureau of Labor Statistics
Compensation Costs Per Hour

$30 $25 $20 $15 $10 $5 $0
19 93
19 95
19 97
19 99
20 01
20 03
20 05
Wages & Salaries

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Benefits
Fall 2008
MGMT 412 | Reward Systems
20 07
What is a Job Worth?

Market price; willing seller and willing buyer
Issues of justice and equity
Male/female wage differentials U.S. wages vs. wages in less developed countries
Gaps between executive and rank-and-file employee pay

Currently in US around 400x rank-and-file pay (20x for most of 20th century -- comparable to Canada & UK) Especially an issue in the current environment (Fall 2008)
But....does CEO incentive pay lead to performance? Who knows?
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Fall 2008
Womens Pay Equality

100% 80% 60% 40% 20% 0% 1951 1964: 59.1% 2006: 76.9% 1951: 63.9%
1961
1971
1981
1991
2001
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Fall 2008
The Basic Pay Model

Compensation plan efficiency based on:
Internal consistency External competitiveness
Employee contributions to the firm
Compensation:
All forms of financial returns and tangible
services and benefits employees receive as part of an employment relationship

A Basic Question
Can we satisfy everybody?
Perceptions of fairness come from:
Actual pay amounts Relative pay amounts on internal basis Relative pay amounts on external basis Pay administration
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Fall 2008
Job Evaluation
Determining the relative value of jobs within
the organization General basis:

Effort Skill Responsibility Working conditions
Approaches Whole job (ranking, classification) Decomposed (point factor)

Ranking
How to: Order the jobs from highest to lowest
Pro and con Easy to use and to explain to employees Cumbersome for any but the small organization Very difficult to add jobs / re-evaluate jobs Very subjective; it is difficult to say what criteria are being used, so difficult to justify/explain to employees or courts
Classification
How to: Set up grades or categories with descriptions of the necessary responsibility, skill, effort and working conditions (or other factors as desired) Include benchmark or representative jobs to serve as anchors; these should be

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Common and well-known Stable content Truly representative of grade Can be priced on external market
MGMT 412 | Reward Systems Fall 2008
U.S. Government General Schedule

Used since 1923
Includes 18 classes or grades Uses 9 factors to develop grades These factors fit into the four categories
of skill, effort, responsibility and working conditions
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Fall 2008
GS Factors
Knowledge required by the position

Complexity

Nature or kind of knowledge and skills needed How the knowledge and skills are used in doing the work How the work is assigned The employees responsibility for carrying out the work How the work is reviewed The nature of guidelines for performing the work The judgement needed to apply the guidelines or develop new guides
Supervisory controls

The nature of the assignment The difficulty in identifying what needs to be done The difficulty and originality involved in performing the work The purpose of the work The impact of the work product or service
Scope and effort

Guidelines

Personal contacts Purpose of contacts Physical demands Work environment
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Fall 2008
Classification: Pro and Con

Used by U.S. government (not
necessarily a positive factor, but some evidence that it works) Relatively easy to develop and administer Can be difficult to write grades for jobs from multiple job families
Point-Factor Plans
The most commonly used type of job
evaluation method Make the criteria for comparisons explicit, unlike ranking and classification The criteria for classification (the compensable factors) are related to the strategy of the business; they are the factors valued by or of high worth to the firm
Point-Factor: How it Works
Point factor plans all include three elements:

Compensable factors are defined Degrees or level of each factor are given numerical rankings Factors weighted as to their relative value to the organization Job worth is measured by the total number of points
The steps to follow:

Job analysis Determine compensable factors Scale the factors Weight the factors Communications and documentation Apply the plan
Compensable Factors Characteristics in the work that the organization values, that help it pursue its strategy and achieve its objectives
Selecting Compensable Factors
These should be:

Based on the work performed Based on the strategy and values of the organization Acceptable and considered to be fair by all concerned parties
As a result, compensable factors should be developed by each organization, rather than using an off-the-shelf plan Basic group of compensable factors:
Skill Effort Responsibility Working conditions
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Fall 2008
The Hay Plan

A widely used plan developed by a consulting firm, Hay Associates, and aimed toward management jobs It includes:
Know-how Functional expertise Managerial skills Human relations Problem solving Environment Challenge Accountability Freedom to act Impact of end results Magnitude
Other Plans
J.C. Penney looks at:
Decision making impact on the companys objectives Communications Supervision and management
Knowledge requirements
Internal customers External customers
Many firms (i.e., 3M, TRW) add a factor for
International Responsibilities
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Fall 2008
Weighting Compensable Factors
Each factor contributes a different amount towards the total score for the job, depending on the importance of the factor to the organization. These weights can be arrived at in two ways
Committee judgments (compensation committee, which is made up
of management representatives)
Statistical analysis: the weights are chosen so that the factor scores
for a selected group of benchmark jobs will predict market prices or current rates for those jobs
When compensable factors are weighted and the total number of points determined, points assigned to each level of the factors
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Fall 2008
Point-Factor: Pro and Con

Point-factor systems orderly, rational, and
make criteria for evaluating jobs explicit

Time consuming to set up (and they do need
to be periodically updated), but very simple to add new jobs

Job evaluations may still be affected by what
the evaluator already knows or believes the market value of the job to be
Why Conduct Salary Surveys?

To create and adjust pay structure
Adjust actual pay in response to the market
All jobs on scheduled basis (almost a COLA); be careful this
doesnt become an entitlement Jobs for which supply or demand has changed
Monitor other forms of pay, such as shift differentials,
bonuses, incentives, overtime practices Estimate competitors labor costs

However, we cannot market price every job
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Fall 2008
What Is The Market?
Who?

Employers who compete for the same occupations and skills Employers who compete for employees in the same geographic area Employers who compete with the same products
How to determine this?
Who are our competitors?

Where do we recruit? Where are employees going? If labor market is rich in a particular skill, may recruit/price locally If labor market does not include skills, recruiting and pricing are on a wider scale Commuting time within a market may also be a factor
Interaction of skill/place/product

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Fall 2008
Guidelines for Salary Surveys (I)

How many firms to include
Include fewer firms if you are a major employer and make
the market Commercial surveys often include several hundred firms (but they make money by getting participants and selling them surveys)
Price fixing issues

Under the Sherman Act, surveys can be viewed as a
conspiracy in restraint of trade Having a third party conduct the survey protects you, but you lose control
Guidelines for Salary Surveys (II)
Make or buy
For national data, may need to buy from a consultant Some firms may be reluctant to respond to your survey, but will
participate in third-party survey More control with own survey

Purchasing a survey means you get what they want to report Running your own survey takes more time, but may be less
expensive Odd jobs, local jobs may not be available commercially
Free data from Department of Labor...but you get what you pay for (useful in general terms)
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Fall 2008
Guidelines for Salary Surveys (III)

What jobs to survey
Benchmark jobs: Well-known and stable content Stable pricing (stable supply/demand) Represent entire structure Represent majority of covered positions
Market sensitive jobs
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Fall 2008
What Data to Collect

Basic company information, for comparability,
weighting of results How closely surveyed jobs match your jobs Salary range
Actual pay (individuals, range or average); may
include actual pay and tenure/experience Other forms of compensation

Benefits (optional)
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Fall 2008
How to Survey
Mail surveys cheapest, but may not be as
accurate
Interviews are more accurate (allow you to
verify content) but are very time consuming

Compromises may be phone verification or
interviews every second or third year (DoL surveys)
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Fall 2008
Putting it Together: The Pay Regression Line

Job evaluation (internal equity) gives us
relative value of jobs within the organization

Salary surveys (external equity) gives us
dollar value of selected jobs outside the organization

The pay regression line combines the two
sources of information
Basic Information
Job
Receptionist File Clerk Mail Clerk Accounting Clerk Insurance Clerk Customer Service Rep Senior Accounting Clerk Word Processor Telephone Operator Department Secretary HR Assistant Legal Secretary
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Evaluation Points
490 500 510 600 680 825 875 890 1,000 1,150 1,175 1,200
Market Value
$11.45 11.32 12.05 14.39 15.74 14.61 15.28 14.68 15.73 13.68 16.70 19.07
Fall 2008
The Pay Regression Line

$25.00 $20.00 $15.00 $10.00 $5.00 $0.00 0 200 400 600 800 1,000 1,200 1,400
Legal Secty
Dept. Secty
Page 30
Fall 2008
Developing Pay Grades

Pay grades are convenient groupings of a wide
variety of jobs...similar in work difficulty and responsibility requirements but possibly having nothing else in common
Pay grades allow compensation to be administered
for a group of jobs that are worth approximately the same A pay grade can be a single rate or a range of rates
An administrative convenience
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Fall 2008
Basic Characteristics of Pay Grades

Grades normally provide for a range of pay rates, though single rates are possible Pay grades contain a minimum, midpoint and maximum The range from minimum to maximum can be from 20% to 100%, with 30% to 35% being most common The midpoint of pay grades increase in a constant percentage, normally 5% to 15%. However, the percentage increase may be larger at the top of the pay structure There is normally some overlap between pay grades. If there is a 30% range within a pay grade and there is a 10% difference between midpoints, there will be a 67% overlap
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Fall 2008
Developing Pay Grades
How many grades? Differences between grades? Grade width?
The range of jobs included in the structure is an influence. A wider range of jobs requires more grades, possibly wider grades (to cover a wider range of pay) or less overlap between grades Fewer pay grades will normally be wider pay grades, allowing the organization to place more emphasis on recognizing time in job Can be argued that differences between grades should increase as one advances through the pay structure; the value of incumbents in higher level jobs increases more with time and wider variation in performance is possible. In lower level jobs, the learning curve levels off much sooner and there is less scope for harming or contributing to the organization
Small increments between pay grades reduces the effect of an error in assigning a job to a pay grade
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Fall 2008
Other Issues
Single rate pay grade?
Is there a single market rate for the job, or are there a
variety of rates? How do you then reward seniority or performance? Often found in union settings
What is the midpoint?

Midpoint is the market rate for the job However, firm may determine their market rate as being
higher or lower than the survey average
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Fall 2008
Other Pay Plan Issues

Who evaluates jobs?
Moving individuals through pay structures Merit vs. seniority Special situations Pay differentials Compression between employees and supervisors Compression between old and new employees
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Fall 2008
Moving Individuals Through Pay Structures

Merit vs. seniority
Faster progression to the midpoint, then slow
down
Grade maximum; what then?
Special situations Red circled jobs Green circled jobs
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Fall 2008
Pay Compression
Between employees and supervisors

May occur if employees are very senior and supervisors brought in from outside Also possible if employees work significant overtime or have shift pay May also happen with commission sales and sales management Solutions:
Ensure sufficient distance between pay ranges for employees and supervisors (10%) and watch actual pay Pay commissions to sales managers or select sales management staff who are motivated by security rather than money
Compression between current and newly hired employees

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Happens when market rates change faster than employees move through grade
What happens if an employee can quit and be rehired at a higher salary? Solution: Adjust rate of progression through grade
MGMT 412 | Reward Systems Fall 2008

Compensation

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Compensation

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Format Tersedia

Reward Systems

Compensation Theory, Job Evaluation and Pay Administration

external labor markets Need to use pay to motivate employees

The basic problem: a limited pie to divide

among all employees

Information from DoL, Bureau of Labor Statistics

Compensation Costs Per Hour

Wages & Salaries

MGMT 412 | Reward Systems

What is a Job Worth?

Gaps between executive and rank-and-file employee pay

But....does CEO incentive pay lead to performance? Who knows?

MGMT 412 | Reward Systems

Womens Pay Equality

MGMT 412 | Reward Systems

The Basic Pay Model

Employee contributions to the firm

services and benefits employees receive as part of an employment relationship

MGMT 412 | Reward Systems

the organization General basis:

Effort Skill Responsibility Working conditions

Approaches Whole job (ranking, classification) Decomposed (point factor)

U.S. Government General Schedule

of skill, effort, responsibility and working conditions

MGMT 412 | Reward Systems

Knowledge required by the position

Scope and effort

Personal contacts Purpose of contacts Physical demands Work environment

MGMT 412 | Reward Systems

Classification: Pro and Con

Point-Factor: How it Works

Point factor plans all include three elements:

The steps to follow:

Selecting Compensable Factors

These should be:

Skill Effort Responsibility Working conditions

MGMT 412 | Reward Systems

The Hay Plan

Many firms (i.e., 3M, TRW) add a factor for

MGMT 412 | Reward Systems

Weighting Compensable Factors

MGMT 412 | Reward Systems

Point-Factor: Pro and Con

make criteria for evaluating jobs explicit

to be periodically updated), but very simple to add new jobs

Why Conduct Salary Surveys?

Monitor other forms of pay, such as shift differentials,

bonuses, incentives, overtime practices Estimate competitors labor costs

MGMT 412 | Reward Systems

What Is The Market?

How to determine this?

Who are our competitors?

MGMT 412 | Reward Systems

Guidelines for Salary Surveys (I)

Price fixing issues

Guidelines for Salary Surveys (II)

participate in third-party survey More control with own survey

expensive Odd jobs, local jobs may not be available commercially

MGMT 412 | Reward Systems

Guidelines for Salary Surveys (III)

Market sensitive jobs

MGMT 412 | Reward Systems

What Data to Collect