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Library of Congress Cataloging-in-Publication Data
Martocchio, Joseph J.
Strategic compensation: a human resource management approach / Joseph J. Martocchio. pages cm
Earlier edition: 2015.
ISBN 978-0-13-432054-0
1. Compensation management. I. Title. HF5549.5.C67M284 2017 658.3'22—dc23
2015030687
ISBN 10: 0-13-432054-9
ISBN 13: 978-0-13-432054-0
Brief Table of Contents
Part I Setting the Stage for Strategic Compensation 1
Chapter 1 Strategic Compensation: A Component of Human Resource Systems 2
Chapter 2 Contextual Influences on Compensation Practice 25
Part II Bases For Pay 51
Chapter 3 Traditional Bases for Pay: Seniority and Merit 52
Chapter 4 Incentive Pay 77
Chapter 5 Person-Focused Pay 100
Part III Designing Compensation Systems 119
Chapter 6 Building Internally Consistent Compensation Systems 120
Chapter 7 Building Market-Competitive Compensation Systems 146
Chapter 8 Building Pay Structures that Recognize Employee Contributions 171
Part IV Employee Benefits 201
Chapter 9 Discretionary Benefits 202
Chapter 10 Legally Required Benefits 227
Part V Contemporary Strategic Compensation Challenges 251
Chapter 11 Compensating Executives 252
Chapter 12 Compensating the Flexible Workforce: Contingent Employees and Flexible Work Schedules 280
Part VI Compensation Issues Around the World 305
Chapter 13 Compensating Expatriates 306
Chapter 14 Pay and Benefits Outside the United States 325
Epilogue 343
Chapter 15 Challenges Facing Compensation Professionals 344
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Preface xvi
Part I Setting the Stage for Strategic Compensation 1
Chapter 1
Strategic Compensation: A Component of Human Resource Systems 2
Defining Strategic Compensation 3
What is Compensation? 3
What is Strategic Compensation? 3
Compensation as a Strategic Business Partner 5
Strategic Compensation Decisions 6
Competitive Business Strategy Choices 7
Compensation Decisions that Support the Firm’s Strategy 8
Employee Roles Associated with Competitive Strategies 8
Building Blocks and Structure of Strategic Compensation Systems 8
Building Blocks: Core Compensation and Employee Benefits 9
Fundamental Compensation System Design Elements 11
Alternative Pay Structure Configurations 13
Fitting the Compensation Function in an Organization’s Structure 14
How HR Professionals Fit into the Corporate Hierarchy 14
The Compensation Profession 14
How the Compensation Function Fits into HR Departments 15
Stakeholders of the Compensation System 18 Employees 18
Line Managers 18
Executives 19 Unions 19
U.S. Government 19
◼ COmPenSatiOn in aCtiOn 19
Summary 20 • Key Terms 21 • Discussion Questions 21
◼ CaSe: Competitive Strategy at Sportsman Shoes 21
◼ CRUnCH tHe nUmBeRS! CalCUlating tHe COStS OF inCReaSing tHe tOtal COmPenSatiOn BUDget at BUtCHeR enteRPRiSeS 22
• Endnotes 23
Chapter 2 Contextual Influences on Compensation Practice 25
interindustry Wage Differentials 26
Pay Differentials Based on Occupational Characteristics 27
geographic Pay Differentials 29 labor Unions 30
employment laws Pertinent to Compensation Practice 32
Income Continuity, Safety, and Work Hours 34
Pay Discrimination 38
Civil Rights Act of 1964 40
Accommodating Disabilities and Family Needs 43
Prevailing Wage Laws 44
◼ COmPenSatiOn in aCtiOn 45
Summary 45 • Key Terms 46 • Discussion Questions 46
◼ CaSe: exempt or nonexempt? 47
◼ CRUnCH tHe nUmBeRS! WHetHeR tO WORk OveRtime OR HiRe aDDitiOnal emPlOyeeS 47
• Endnotes 48
Part II Bases for Pay 51
Chapter 3 Traditional Bases for Pay: Seniority and Merit 52
Seniority and longevity Pay 52
Historical Overview 53
Who Participates? 53
Effectiveness of Seniority Pay Systems 54
Design of Seniority Pay and Longevity Pay Plans 54
Advantages of Seniority Pay 56
Fitting Seniority Pay with Competitive Strategies 56 merit Pay 57
Who Participates? 57
Exploring the Elements of Merit Pay 57
Performance appraisal 59
Types of Performance Appraisal Plans 60
Exploring the Performance Appraisal Process 65
Strengthening the Pay-for-Performance link 67 Link Performance Appraisals to Business Goals 68
Analyze Jobs 68
Communicate 68
Establish Effective Appraisals 68 Empower Employees 68
Differentiate among Performers 68
Possible limitations of merit Pay Programs 69
Failure to Differentiate among Performers 69 Poor Performance Measures 70
Supervisors’ Biased Ratings of Employee Job Performance 70
Lack of Open Communication between Management and Employees 70
Undesirable Social Structures 70
Mounting Costs 71
Factors Other than Merit 71
Undesirable Competition 71
Little Motivational Value 71
◼ COmPenSatiOn in aCtiOn 71
Summary 72 • Key Terms 72 • Discussion Questions 73
◼ CaSe: appraising Performance at Precision 73
◼ CRUnCH tHe nUmBeRS! COStS OF lOngevity anD meRit Pay 74
• Endnotes 75
Chapter 4 Incentive Pay 77
exploring incentive Pay 77
Contrasting incentive Pay with traditional Pay 78 individual incentives 79
Defining Individual Incentives 80
Types of Individual Incentive Plans 81
Advantages of Individual Incentive Pay Programs 83
Disadvantages of Individual Incentive Pay Programs 83 group incentives 84
Defining Group Incentives 85
Types of Group Incentive Plans 85
Advantages of Group Incentives 89
Disadvantages of Group Incentives 90
Company-wide incentives 91
Defining Company-wide Incentives 91
Types of Company-wide Incentive Plans 91
Designing incentive Pay Programs 93
Group versus Individual Incentives 93
Level of Risk 94
Complementing or Replacing Base Pay 94
Performance Criteria 94
Time Horizon: Short Term versus Long Term 95
◼ COmPenSatiOn in aCtiOn 95
Summary 96 • Key Terms 96 • Discussion Questions 96
◼ CaSe: individual or team Reward? 97
◼ CRUnCH tHe nUmBeRS! CalCUlating PieCeWORk Pay aWaRDS 97
• Endnotes 98
Chapter 5 Person-Focused Pay 100
Defining Person-Focused Pay: Competency-Based, Pay-for-knowledge, and Skill-Based Pay 100
Usage of Person-Focused Pay Programs 103
Reasons to adopt Person-Focused Pay Programs 104
Technological Innovation 104
Increased Global Competition 105
varieties of Person-Focused Pay Programs 106
Contrasting Person-Focused Pay with Job-Based Pay 110 advantages and Disadvantages of Person-Focused Pay Programs 111
Advantages 111
Disadvantages 113
◼ COmPenSatiOn in aCtiOn 114
Summary 114 • Key Terms 115 • Discussion Questions 115
◼ CaSe: Person-Focused Pay at mitron Computers 115
◼ CRUnCH tHe nUmBeRS! tRaining BUDget COStS 116
• Endnotes 117
Part III Designing Compensation Systems 119
Chapter 6
Building Internally Consistent Compensation Systems 120
internal Consistency 120
Job analysis 122
Steps in the Job Analysis Process 122
Legal Considerations for Job Analysis 127
Job Analysis Techniques 128
U.S. Department of Labor’s Occupational Information Network (O*NET) 128
Job evaluation 132
Compensable Factors 133
The Job Evaluation Process 134
Job evaluation techniques 135
The Point Method 136
Alternative Job-Content Evaluation Approaches 139
Alternatives to Job Evaluation 140
internally Consistent Compensation Systems and Competitive Strategy 141
◼ COmPenSatiOn in aCtiOn 141
Summary 142 • Key Terms 142 • Discussion Questions 143
◼ CaSe: internal Consistency at Customers First 143
◼ CRUnCH tHe nUmBeRS! mODiFying a JOB evalUatiOn WORkSHeet 144
• Endnotes 145
Chapter 7 Building Market-Competitive Compensation Systems 146
market-Competitive Pay Systems: the Basic Building Blocks 146
Compensation Surveys 147
Preliminary Considerations 147
Using Published Compensation Survey Data 148
Compensation Surveys: Strategic Considerations 151
Compensation Survey Data 153
Updating the Survey Data 160
integrating internal Job Structures with external market Pay Rates 162
Compensation Policies and Strategic mandates 164
Pay Level Policies 164
Pay Mix Policies 165
◼ COmPenSatiOn in aCtiOn 166
Summary 167 • Key Terms 167 • Discussion Questions 168
◼ CaSe: nutriment’s new Hires 168
◼ CRUnCH tHe nUmBeRS! UPDating SalaRy SURvey Data 169
• Endnotes 170
Chapter 8 Building Pay Structures that Recognize Employee Contributions 171
Constructing a Pay Structure 171
Step 1: Deciding on the Number of Pay Structures 172
Step 2: Determining a Market Pay Line 172
Step 3: Defining Pay Grades 174
Step 4: Calculating Pay Ranges for Each Pay Grade 175
Step 5: Evaluating the Results 178
Designing merit Pay Systems 179
Merit Increase Amounts 179
Timing 180
Recurring versus Nonrecurring Merit Pay Increases 181
Present Level of Base Pay 181
Rewarding Performance: The Merit Pay Grid 181
Merit Pay Increase Budgets 183
Designing Sales incentive Compensation Plans 185
Alternative Sales Compensation Plans 186
Sales Compensation Plans and Competitive Strategy 187
Determining Fixed Pay and the Compensation Mix 188
Designing Person-Focused Programs 189
Establishing Skill Blocks 189
Transition Matters 190
Training and Certification 191
In-House or Outsourcing Training 191
Pay Structure variations 192
Broadbanding 192
Two-Tier Pay Structures 194
◼ COmPenSatiOn in aCtiOn 195
Summary 196 • Key Terms 196 • Discussion Questions 197
◼ CaSe: a new Sales Representative 197
◼ CRUnCH tHe nUmBeRS! CalCUlating Pay Range minimUmS, maximUmS, anD Pay Range OveRlaP 198
• Endnotes 198
Part IV Employee Benefits 201
Chapter 9
Discretionary Benefits 202
Origins of Discretionary Benefits 202
Categories of Discretionary Benefits 204
Protection Programs 204
Paid Time Off 209
Services 211
legislation Pertinent to Discretionary Benefits 214
Internal Revenue Code 214
Employee Retirement Income Security Act of 1974 (ERISA) 215
Pension Protection Act of 2006 216
Designing and Planning the Benefits Program 216
Determining Who Receives Coverage 217
Financing 217
Employee Choice 217
Cost Containment 218
Communication 218 the Benefits and Costs of Discretionary Benefits 220
◼ COmPenSatiOn in aCtiOn 221
Summary 222 • Key Terms 222 • Discussion Questions 223
◼ CaSe: time Off at Superior Software Services 223
◼ CRUnCH tHe nUmBeRS! 401(k) Plan COntRiBUtiOnS: allOWaBle amOUntS anD emPlOyeR matCH 224
• Endnotes 225
Chapter 10
Legally Required Benefits 227
Origins of legally Required Benefits 227
Categories of legally Required Benefits 228
Social Security Programs 228
Workers’ Compensation 233
Family and Medical Leave 234
Health Insurance 236
Health insurance Program Design alternatives 237
Fee-For-Service Plans 237
Managed Care Approach 239
Specialized Insurance Benefits 240
Consumer-Driven Health Care 241
additional Health Care legislation 243
Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) 243
Health Insurance Portability and Accountability Act of 1996 (HIPAA) 243 the Benefits and Costs of legally Required Benefits 244
◼ COmPenSatiOn in aCtiOn 245
Summary 246 • Key Terms 246 • Discussion Questions 247
◼ CaSe: a Health Savings account at Frontline PR 247
◼ CRUnCH tHe nUmBeRS! CalCUlating taxeS UnDeR tHe Patient PROteCtiOn anD aFFORDaBle CaRe aCt 248
• Endnotes 248
Part V Contemporary Strategic Compensation Challenges 251
Chapter 11
Compensating Executives 252
Contrasting executive Pay with Pay for nonexecutive employees 252
Defining executive Status 253
Who Are Executives? 253
Key Employees 253
Highly Compensated Employees 255
executive Compensation Packages 255
Components of Current Core Compensation 255
Components of Deferred Core Compensation 257
Equity Agreements 257
Separation Agreements 259
Clawback Provisions 260
Employee Benefits: Enhanced Protection Program Benefits and Perquisites 260 Principles and Processes for Setting executive Compensation 262
The Key Players in Setting Executive Compensation 262
Theoretical Explanations for Setting Executive Compensation 264
executive Compensation Disclosure Rules 266 Securities and Exchange Act of 1934 266
Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) 269
executive Compensation: are U.S. executives Paid too much? 270
Comparison between Executive Compensation and Compensation for Other Worker Groups 270
Strategic Questions: Is Pay for Performance? 271
Ethical Considerations: Is Executive Compensation Fair? 272
International Competitiveness 273
◼ COmPenSatiOn in aCtiOn 274
Summary 275 • Key Terms 275 • Discussion Questions 276
◼ CaSe: CeO Pay in the news 276
◼ CRUnCH tHe nUmBeRS! COmPaRiSOn OF Pay WitHin anD aCROSS inDUStRieS 277
• Endnotes 277
Chapter 12 Compensating the Flexible Workforce: Contingent Employees and Flexible Work Schedules 280 the Contingent Workforce 280
Groups of Contingent Workers 281
Reasons for U.S. Employers’ Increased Reliance on Contingent Workers 286
Pay and employee Benefits for Contingent Workers 287
Part-Time Employees 288
Temporary Employees 289
Leased Workers 290
Independent Contractors, Freelancers, and Consultants 291
Flexible Work Schedules: Flextime, Compressed Workweeks, and telecommuting 293
Flextime Schedules 294
Compressed Workweek Schedules 294
Telecommuting 295
Flexible Work Schedules: Balancing the Demands of Work Life and Home Life 295
Pay and employee Benefits for Flexible employees 296 Pay 296
Employee Benefits 296
Unions’ Reactions to Contingent Workers and Flexible Work Schedules 297
Strategic issues and Choices in Using Contingent and Flexible Workers 298
◼ COmPenSatiOn in aCtiOn 299
Summary 300 • Key Terms 301 • Discussion Questions 301
◼ CaSe: telecommuting at medex 301
◼ CRUnCH tHe nUmBeRS! CalCUlating tHe COStS OF FUll-time anD PaRt-time emPlOyment 302
• Endnotes 303
Part VI Compensation Issues Around the World 305
Chapter 13 Compensating Expatriates 306
Competitive advantage and How international activities Fit in 307
Lowest-Cost Producers’ Relocations to Cheaper Production Areas 307
Differentiation and the Search for New Global Markets 307 How Globalization is Affecting HR Departments 307
Complexity of International Compensation Programs 308
Preliminary Considerations 308
Host Country Nationals, Third Country Nationals, and Expatriates: Definitions and Relevance for Compensation Issues 309
Term of International Assignment 309
Staff Mobility 309
Equity: Pay Referent Groups 310
Components of international Compensation Programs 310
Setting Base Pay for U.S. expatriates 310
Methods for Setting Base Pay 311 Purchasing Power 311
incentive Compensation for U.S. expatriates 313
Foreign Service Premiums 313
Hardship Allowances 313 Mobility Premiums 314
establishing employee Benefits for U.S. expatriates 314
Standard Benefits for U.S. Expatriates 315
Enhanced Benefits for U.S. Expatriates 316
Balance Sheet approach for U.S. expatriates’ Compensation Packages 317
Housing and Utilities 318
Goods and Services 319
Discretionary Income 319
Tax Considerations 319
Repatriation Pay issues 320
◼ COmPenSatiOn in aCtiOn 320
Summary 321 • Key Terms 322 • Discussion Questions 322
◼ CaSe: Jenkins goes abroad 323
◼ CRUnCH tHe nUmBeRS! CalCUlating an exPatRiate’S BaSe Pay anD inCentiveS 323
• Endnotes 324
Chapter 14 Pay and Benefits Outside the United States 325
Pertinent Concepts for Quantifying elements in the Discussion of Pay and Benefits Outside the United States 326
north america 327
Canada 327
Mexico 329
South america 330
Brazil 330
europe 331
Germany 331
asia 333
India 333
People’s Republic of China 334
◼ COmPenSatiOn in aCtiOn 336
Summary 337 • Key Terms 337 • Discussion Questions 338
◼ CaSe: north american expansion for threads apparel 338
◼ CRUnCH tHe nUmBeRS! COmPaRing tHe RateS OF CHange in gDP PeR CaPita FOR SeleCt COUntRieS 339
• Endnotes 340
Epilogue
343
Chapter 15 Challenges Facing Compensation Professionals 344
Possible increase to the Federal minimum Wage Rate and Strengthening Overtime Pay Protections 345
Raising the Minimum Wage 345
Strengthening Overtime Pay Protections 346
Rising Wages in China 347
Underemployment and the Compensation–Productivity gap 348
Underemployment 348
The Compensation-Productivity Gap 351
Workforce Demographic Shifts 352
Labor Force Diversity 352
Relevance for Employee Benefits 353
Summary 353 • Key Terms 354 • Discussion Questions 354
◼ CaSe: Benefits for Part-time Workers 354
◼ CRUnCH tHe nUmBeRS! CalCUlating RegiOnal anD inDUStRy Pay DiFFeRenCeS in CHina 355
• Endnotes 356
Glossary 357
Author Index 376
Subject Index 378
Preface
The measure of a company’s success is as much a function of the way it manages its employees as it is a function of its structures and financial resources. Compensating employees represents a critical human resource management practice: Without strategic compensation systems, companies cannot attract and retain the best-qualified employees. Spending more than is necessary to attract and retain top talent adds costs unnecessarily to companies in search of competitive advantage.
The purpose of this book is to provide knowledge of the art and science of compensation practice and its role in promoting companies’ competitive advantage. Students will be best prepared to assume the roles of competent compensation professionals if they possess a grounded understanding of compensation practices and the environments in which business professionals plan, implement, and evaluate compensation systems. Thus, we examine the context of compensation practice, the criteria used to compensate employees, compensation system design issues, employee benefits, challenges of compensating key strategic employee groups, pay and benefits around the world, and challenges facing compensation professionals.
New to the Ninth Edition
1. Crunch the Numbers! are data driven exercises written to provide students with an opportunity to analyze data about one or more compensation issue contained within the respective chapters. One of the key skills a successful compensation professional should have is quantitative analysis for making informed compensation decisions. There are two exercises per chapter, which are assignable. The first exercise is contained at the end of each chapter and in MyManagementLab. An additional exercise appears in MyManagementLab only. Answers are found in the Instructors Manual and in the instructor’s section of MyManagementLab.
2. Dozens of new company examples, including Apple Computer, Boeing, Uber, and Wyeth Pharmaceuticals, appear throughout the book, bringing discussions of compensation practices to life.
3. The ninth edition includes 39 additional concepts and practices to maintain the book’s position on leading edge knowledge and practice. Some of these concepts and practices include definitive proxy statements, point factor leveling, and the newly approved CEO pay-ratio rule. More than 150 new endnotes document the substantially updated material. For example, Chapter 15 includes a discussion of a possible increase to the federal minimum wage rate and its potential impact on a company’s practice.
4. Each chapter contains a feature titled Watch It which highlights a short video of a company’s experience with particular elements of compensation or HR-related issues, and it is integrated within the chapter material. The video and accompanying questions are available in MyManagementLab.
5. The ninth edition has 15 chapters, which is one fewer than in the eighth edition. Specifically, Chapter 10 in the eighth edition on retirement plans and health care plans has been revised and streamlined, and the material redistributed to Chapter 9 (Discretionary Benefits) and Chapter 10 (Legally Required Benefits). In the ninth edition, employer-sponsored retirement plans appear in Chapter 9 and employer-sponsored health care appears in Chapter 10, to properly represent this practice as a legally required benefit under the Patient Protection and Affordable Care Act of 2010.
6. An expanded chapter summary is organized by learning objectives.
MyManagementLab Suggested Activities
For the ninth edition, the author is excited that Pearson’s MyManagementLab has been integrated fully into the text. These new features are outlined below. Making assessment activities available online for students to complete before coming to class will allow you the professor more discussion time during the class to review areas that students are having difficulty in comprehending.
Chapter Warm-Up
Students can be assigned the Chapter Warm-Up before coming to class. Assigning these questions ahead of time will ensure that students are coming to class prepared.
Watch It
This feature recommends a video clip that can be assigned to students for outside classroom viewing or that can be watched in the classroom. The video corresponds to the chapter material and is accompanied by multiple choice questions that re-enforce student’s comprehension of the chapter content.
Crunch The Numbers
There are two data-driven exercises per chapter, one in the book and both in MyManagementLab. Answers are found in the Instructors Manual and in MyManagementLab.
Assisted-Graded Writing Questions
These are short essay questions that the students can complete as an assignment and submit to you, the professor, for grading.
About This Book
This book contains 15 chapters, lending itself well to courses offered as 8-week modules, 10-week quarters or, 15-week semesters. The chapters are organized in six parts and an epilogue (contained in Chapter 15):
• Part I: Setting the Stage for Strategic Compensation
• Part II: Bases for Pay
• Part III: Designing Compensation Systems
• Part IV: Employee Benefits
• Part V: Contemporary Strategic Compensation Challenges
• Part VI: Compensation Issues Around the World
• Epilogue: Challenges Facing Compensation Professionals
Course instructors on an 8-week module schedule or a 10-week schedule might consider spending about two weeks on each part. Instructors on a 15-week schedule might consider spending about one week on each chapter.
A practical approach to teaching compensation will focus on the considerations and practices common in the field of compensation. This textbook is well suited to a variety of students, including undergraduate and master’s degree students. In addition, this text was prepared for use by all business students, regardless of their majors. Both human resource management majors and other majors (e.g., accounting, finance, general management, international management, marketing, and organizational behavior) will benefit equally well from Strategic Compensation After all, virtually every manager, regardless of functional area, will be involved in making compensation decisions. Both practitioners beginning work in compensation and current professionals will find Strategic Compensation a useful reference. Among the features, Compensation in Action will clarify the connections between compensation and other functions.
Available Teaching and Learning Aids
The teaching and learning accessories are designed to promote a positive experience for both instructors and students.
A feature titled Compensation in Action appears at the end of every chapter in the text. This feature provides clear operational points to illustrate how line managers, employees, and compensation professionals interact to put compensation concepts into practice. The feature was prepared by Mr. Gentz Franz, Director of Development at the University of Illinois.
Short end-of-chapter cases have been included in the text. These cases were written by Professor Lori Long of Baldwin-Wallace College about real-world compensation issues, with questions to facilitate class discussion or to be used as homework assignments. The new Crunch the Numbers! feature, as described previously, appears in each chapter following the case as well as in MyManagementLab as assignable exercises. This feature provides students with an opportunity to provide a quantitative analysis of data pertinent to compensation practice.
Building Strategic Compensation Systems Project
This accompanying experiental case available online in MyManagementLab will allow students to work in small compensation consulting teams charged with the responsibility for developing a compensation plan for a company named e-sonic. The project is divided into four sections. The first section, Strategic Analysis, is described fully in the casebook for faculty and students who choose to complete this optional analysis of the business environment prior to the remaining three sections that directly address compensation system design, and it relates to Chapter 1 of the textbook.
Section 1: Chapter 6
Section 2: Chapter 7
Section 3: Chapters 2 through 5, 8 through 9
The development of a strategic analysis provides context for all decisions made regarding students’ compensation systems throughout the project. The strategic analysis reveals firm-specific challenges, objectives, and initiatives that allow students to align the goals of a compensation system effectively with that of their company strategy.
Section 1 introduces students to the specification of internally consistent job structures. Through writing job descriptions, the development of job structures, and both the development and implementation of a point job evaluation method to quantify job differences objectively, students build the framework for internal equity.
Section 2 shifts students’ focus outside of their firm to understand its relationship with the external marketplace. Students will use market survey data to compare pay rates of positions inside the firm with those in the marketplace to establish the foundations of market-competitive pay. The analysis of market data also leads students to the determination of appropriate pay-policy mixes for each of their job structures. In this section, students are asked to use CompAnalysis software developed by Howard Weiss at Temple University, which is also available on MyManagementLab. The software is enabled to work in Apple and PC products.
Finally, in Section 3, students will recognize the contributions of employees through the creation of a merit-pay system and put their plan into action by paying employees within their firm. Hypothetical pay discrepancies are introduced to each student group for resolution within the parameters of their designed compensation system. They are tasked with many of the difficult decisions that compensation professionals face on a daily basis.
The Strategic Analysis section and Sections 1 through 3 may each be completed in two to three weeks, which fits well with semester-long courses. Instructors whose courses include a variety of additional activities or span only 7 to 10 weeks may have students complete only three of the four sections in either configuration (Strategic Analysis and Sections 1 and 2 or Sections 1 through 3). The instructor may have student groups prepare written reports or oral presentations to the class. Report outlines are included in the casebook.
Instructor Resources
At the Instructor Resource Center, www.pearsonhighered.com/irc, instructors can easily register to gain access to a variety of instructor resources available with this text in downloadable format. If assistance is needed, our dedicated technical support team is ready to help with the media supplements that accompany this text. Visit http://247.pearsoned.com for answers to frequently asked questions and toll-free user support phone numbers. The following supplements are available with this text:
• Instructor’s Resource Manual
• Test Bank
• TestGen® Computerized Test Bank
• PowerPoint Presentation
Acknowledgments
From Pearson Education, I would like to thank Senior Acquisitions Editor Kris Ellis-Levy, Program Manager Sarah Holle, and Project Manager Meghan DeMaio for their guidance and expertise, as well as for the many other professionals who worked behind the scenes in the design, marketing, and production of this edition. I thank each and every one of those individuals for their contributions.
Joseph J. Martocchio
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Strategic compensation a component of Human resource Systems 1
Learning objectives
When you finish studying this chapter, you should be able to:
1-1. Define strategic compensation.
1-2. Summarize the role of compensation as a strategic business partner.
1-3. Explain strategic compensation decisions.
1-4. Identify and discuss the building blocks and structural elements of strategic compensation systems.
1-5. Describe the fit of the compensation function in organizations.
1-6. Identify the stakeholders of the compensation function and summarize their stakes in the work compensation professionals perform.
chapter Warm-Up!
If your professor has assigned this, go to the Assignments section of mymanagementlab.com to complete the Chapter Warm-Up! and see what you already know. After reading the chapter, you’ll have a chance to take the Chapter Quiz! and see what you’ve learned.
Through the early twentieth century, manpower planning was the predecessor to contemporary human resource (HR) management. Manpower planning focused on the effective deployment of employees in factories to achieve the highest manufacturing output per employee per unit of time. That is, management sought to increase productivity (such as the number of handmade garments per hour) while also maintaining or lowering employee compensation costs. All else equal, higher employee productivity while maintaining or lowering employee compensation costs contributed to higher profitability for the firm.
Through the decades, mounting government regulation involving payroll taxes and laws centered on ensuring a minimum wage, prevailing wage, equal pay for equal work, and equal employment opportunity later gave rise to the personnel management function, of which compensation was a component. Legal compliance necessitated that personnel management take on the role of an administrative, support function to maintain compliance with the myriad details of employment laws (e.g., determining prevailing wages in localities). Personnel management departments also engaged in transactions (e.g., payroll administration) with an eye toward administrative efficiency. Administrative efficiency is essential because it can indirectly contribute to company success through cost control.
Since the early 1980s, there has been growing widespread recognition that managing employees or human resources can contribute more directly to competitive advantage. Competitive
advantage describes a company’s success when the company acquires or develops capabilities that facilitate outperforming the competition. For example, Walmart is a successful retailer, in part, because its sheer size enables it to negotiate lower prices with suppliers (e.g., of clothing) than smaller retailers. In turn, Walmart is able to sell products at a price advantage relative to most competitors. Other resources may include the employment of highly skilled employees who can operate and troubleshoot problems with sophisticated robotic equipment, which can increase the pace of production while also maintaining quality.
Designing HR practices with competitive advantage in mind casts HR as a strategic function rather than as one that focuses exclusively on conducting transactions. In a strategic role, HR professionals proactively put forth forward-looking principles and ideas, and they play an important role in contributing to successful business outcomes by attracting, motivating, and retaining highly qualified employees.
Defining Strategic compenSation
“What is strategic compensation? Answering this question requires that we first answer the question, “What is compensation?”
What is compensation?
Compensation represents both the intrinsic and extrinsic rewards employees receive for performing their jobs and for their membership as employees. Together, both intrinsic and extrinsic compensation describe a company’s total compensation system, which we will look at more closely in this chapter, and, in even greater detail throughout the remainder of this textbook. Intrinsic compensation reflects employees’ psychological mind-sets that result from performing their jobs, for example, experiencing a great feeling from the belief that one’s work matters in the lives of others. Perhaps it is easy to imagine that many health care providers feel this way. Extrinsic compensation includes both monetary and nonmonetary rewards. Organizational development professionals promote intrinsic compensation through effective job design. Compensation professionals are responsible for extrinsic compensation, which is the focus of this textbook.
Compensation professionals establish monetary compensation programs to reward employees according to their job seniority, performance levels, or for learning job-related knowledge or skills. Some describe this exchange as a pay-effort bargain. As we will discuss shortly, monetary compensation represents core compensation. Nonmonetary rewards include protection programs (e.g., medical insurance), paid time off (e.g., vacations), and services (e.g., day care assistance). Most compensation professionals refer to nonmonetary rewards as employee benefits. Employees receive some or all of these offerings as part of an employment arrangement. Rarely do employers base employee benefits on job performance. Employee benefits are becoming an increasingly important element of compensation packages. Since the so-called Great Recession (2007–2009) ended, fewer companies have offered pay increases and, those that do, are offering lower amounts (from roughly an average 3.8 percent increase to less than 2 percent).1
Both monetary and nonmonetary compensation represents costs to companies. In the case of core compensation, employers pay an hourly wage or salary. In the case of employee benefits, employers pay some or all of the cost for employees to have health insurance coverage rather than providing dedicated monetary payments, apart from wage or salary, to pay for health care.
What is Strategic compensation?
Defining strategic compensation requires that we place the relevance and importance of compensation practices in a broader context where compensation practices are linked to competitive business strategy, as shown in Figure 1-1. Competitive business strategy refers to the
1-1 Define strategic compensation.
figUre 1-1 Relationship between Strategic Decisions and Compensation Practices
planned use of company resources—financial capital, equipment capital, and human capital— to promote and sustain competitive advantage. The time horizon for strategic decisions may span multiple years. For example, Exxon Mobil Corporation, a company in the oil and gas exploration industry, strives to be the world’s premier petroleum and petrochemical company by achieving superior financial and operating results while simultaneously adhering to high ethical standards.2 Eli Lilly and Company, a manufacturer of pharmaceutical products, pursues a competitive strategy, which focuses on creating innovative medicines that improve patient health outcomes.3
Human resource executives collaborate with company executives to develop human resource strategies. Human resource strategies specify the use of multiple HR practices to reinforce competitive business strategy. These statements are consistent with a company’s competitive strategy. For example, Eli Lilly is well known for the innovative environment that it creates for employees to make discoveries for pharmaceutical products that will enhance the life of people throughout the world.4
Within the context of competitive business strategy and human resource strategy, compensation professionals practice strategic compensation. Strategic compensation refers to the design and implementation of compensation systems to reinforce the objectives of both HR strategies and competitive business strategies. Compensation and benefits executives work with the lead HR executive and the company’s chief financial officer (CFO) to prepare total compensation strategies. At Lilly, it is evident that the use of compensation and benefits practices supports both human resource strategies and competitive strategies. Eli Lilly is well known for offering a balanced compensation and benefits program which recognizes employee contributions and embraces employees through recognition of their needs outside the workplace.5
compenSation aS a Strategic BUSineSS partner
As noted earlier, personnel administration was transformed from a purely administrative function, engaged in transactions such as payroll processing, to a competitive resource in many companies emerging during the 1980s. Technological advances (e.g., the use of robotics in manufacturing) and global competition (e.g., increased imports of Japanese automobiles) contributed greatly to the need for a strategic approach. As a strategic business partner, HR and compensation professionals today need to think like the chief executive officer (CEO) to become a strategic partner in achieving organizational plans and results. 6 Essentially, they must know more than just HR work. 7 For example, GE’s Human Resources Leadership Program (HRLP) 8 is an exemplar of these ideas. The HRLP provides participants with opportunities to learn HR competencies, global leadership skills, and business acumen through formal training and rotational assignments in areas such as compensation, staffing, and employment relations. Participants also receive exposure to GE executives and HR leaders to put their work in the context of strategic issues facing the company. In doing so, they understand the production and service sides of the business and help to determine the strategic capabilities of the company’s workforce, both today and in the future. For example, increasing sales and building brand loyalty are important goals of soft drink companies such as Coca Cola and PepsiCo. Increasing sales requires hiring highly dedicated and motivated sales employees whose success is rewarded through innovative sales incentive arrangements.
Compensation professionals can give the CEO and CFO a powerful understanding of the role that employees play in the organization and the way it combines with business processes to expand or shrink shareholder value. Compensation professionals are integrating the goals of compensation with the goals of the organization and focusing on expanding its strategic and high-level corporate participation with an emphasis on adding value.
Perhaps a useful way to better understand how HR functions serve as a strategic business partner is to think about the role of capital for value creation. Capital refers to the factors that enable companies to generate income, higher company stock prices, economic value, strong positive brand identity, and reputation. There is a variety of capital that companies use to create value, including financial capital (cash) and capital equipment (state-of-the-art robotics used in manufacturing). Employees represent a specific type of capital called human capital. Human capital, as defined by economists, refers to sets of collective skills, knowledge, and abilities that employees can apply to create value for their employers. Companies purchase the use of human capital by paying employees an hourly wage or salary and providing benefits such as paid vacation and health insurance.
Compensation professionals can help leverage the value of human capital in a variety of ways. For example, well-designed merit pay programs reinforce excellent performance by awarding pay raises commensurate with performance attainments. The use of incentive pay practices is instrumental in changing the prevalent entitlement mentality U.S. workers have toward pay and in containing compensation costs by awarding one-time increases to base pay once work objectives have been attained. Pay-for-knowledge and skill-based pay programs are key to giving employees the necessary knowledge and skills to use new workplace technology effectively. Management can use discretionary benefit offerings to promote particular employee behaviors that have strategic value. For example, employees who take advantage of tuition reimbursement programs gain knowledge and skills that directly add value to the work they do. In line with these ideas, Bosch offers a unique program to individuals who are pursuing PhD degrees at well-respected universities.9 The company hires doctoral candidates on a limited-term basis while these students undertake dissertation work under the auspices of Bosch scientists who are working on pressing company matters of scientific importance. This
1-2 Summarize the role of compensation as a strategic business partner.
