Strategic approach to

Compensation

Lecture Slides for Chapter 13

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 Objectives
• Objectives of this chapter are to
understand why traditional compensation
policies are inadequate to link well with the
achievement of strategic goals of an
organization and what compensation
policies are likely to bring about an
improvement in relations between the two.

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 Objectives of compensation
policies
• Equity need:
– Meets the expectations of an employee for his/her
work in the company;
• Personal Needs:
– Meets the needs of the employee for income;
• Ownership needs:
– Profit share creates feeling of oneness;
• Strategic needs:
– Direct employee energy and efforts towards areas
that are of strategic value to the company.

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 Generic compensation policies
• Traditional compensation policy;
• Performance based compensation;
• Team Performance based compensation;
• Skill based compensation;
• Variable compensation.
• Seniority based compensation;
• Deferred compensation;
• Paying by way of benefits.

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 Traditional Compensation
• Job Analysis
– Identify compensable factors:
– Education, Training, work experience.
– Find Relative value of each job based on
degree of compensable factors
– Find the market wage for key jobs
– Use market wage of key jobs to value other
jobs in company internal market.

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 Strategic Inadequacies of
Traditional Compensation
• Payment based on compensable factors creates
problem of skill development.
– Employee is paid for a specified job. If new job appears, existing
employees cannot be used without renegotiating and
reevaluating the job value using industrial engineering method;
Example: A secretarial who was hired to take boss’s dictation
may refuse to draft letter because this was not his/her job
description.
– This method is not useful for managerial jobs that are
unstructured and hard to define;
– Limited flexibility to use workers intelligence and skill.

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 Broad Banding
• Broad Banding of Job:
– It reduces the number of salary bands. The salary levels
within each band cover a wide range of compensation
• Advantages:
– Employee salary can be raised without changing the level;
– With broad banding an employee being paid according to
market value can earn more by acquiring more skills;
• Broad Banding of Skill:
– It abandons job evaluation and moves to individual based
compensation based on a broad definition of skills.

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 Broad banding

• Job evaluation Broad banding

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 Performance based
compensation
• Employees are placed on a position after his/her
evaluation during selection. But because such
evaluations are not adequate, subsequent
evaluations are used to reset his/her annual
compensation.
• Advantage: May create a performance oriented
culture
• Disadvantage: Inter-employee competition may
make them to take short-run approach.

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Team Performance Based Pay
• Project Performance Based compensation
• Advantage:
– Facilitate cooperation;
– Bonus to teams can be given immediately at the completion of
job;
– Team reward can be linked to develop skill.
• Disadvantages: Could be more costly both financially as
well as managerially than individual performance based
pay. May affect individual motivation to excel. Past
practices could work as a barrier against implementation.

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 Team based pay: Process
issues
• Entire compensation should not be tied to team
performance;
• Decentralized decision making must be in place
for team based pay to be successful; Team
should have adequate autonomy on operational
matters.
• Inter-team competition must be under close
supervision;
• Certain organizational culture may not be
suitable for team based compensation.

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 Skill based compensation
• In this scheme employees are paid more
when they acquire new skill and show
mastery of acquired expertise.
• Advantage: It encourages employees to
take initiative to acquire new expertise.
• Disadvantage: Company wage bill could
be higher than the competitors.

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 Variable Bonus and
Compensation
• Compensation policy:
• It tries to link a portion of employee compensation to various
performance measures. A typical arrangement is to keep a portion of
compensation “at risk”.
• Form
– “Add on”: Yearly increment to base pay is linked to company
performance
– “At Risk” : Reduce employee base pay by certain percentage and
allowing him to collect a variable amount of that percentage
depending on company performance.
– “Potential Base Pay at Risk”: Making a part of the annual
increment contingent on achieving certain performance target.
Variable bonus Policy
 Under this policy the employee bonus varies according to the
performance of the company or division.

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 Strategic Compensation
• HR strategy driven;
• Business strategy driven.

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 HR Strategy Driven
Compensation
• Elements of HR strategy
– Using HR system for competitive advantage;
– Strategy to attract talent from market;
– Strategy to stem employee exodus;
– Strategy to control wage bill

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 HR system driven
compensation

Structure Compensation Placement

Selection

Business HR
Acquisition T&D Performance Incentive
strategy Planning
evaluation
Promotion

T&D
Union

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 HR system based strategy
• Link compensation with Selection,
development, performance evaluation,
structure, task structure.

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Strategy of attracting best talent
• Pay at least 20% to 30% more than what
others in the same industry and same
level are paying.
• Problem: Salary leadership strategy may
not be sustainable unless you have
business in other countries.

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 Strategy to stem employee
exodus
• Factors affecting employee desire to stay
Facility for
Compensation
family

Supervisory Employee Nature of

behavior job

Opportunity
To grow

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 Strategy to stem employee
exodus
• Invest on employee career development,
provide opportunity for personal growth.
• Use long term oriented payment e.g.
employee stock options;
• Invest in employee family organization.

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 Strategy to control wage bill
• Develop internal labor market for
employee career.
• Job analysis based regular compensation
plus company performance based bonus.

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 Business strategy driven
compensation
• Cost leadership;
• Differentiation;
• Focus.

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 Cost leadership strategy
• Large scale production ensures lots of
employees doing same type of jobs;
• Use internal labor market based regular
compensation plus company performance based
bonus;
• Lot of employees in similar positions keep the
compensation administration cost low. Economy
of scale in managing the administration.

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 Strategy of differentiation
• Strategy requires unique skill and risk taking to
launch new untested products and services;
• This could be encouraged through regular
position specific compensation plus new product
performance based compensation;
• There could be some difference between
employees working in standardized functions
and innovation function.

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 Strategy of focus
• Employees need to go into new market
with limited knowledge and infrastructure.
• In order to encourage taking such risk,
they could be paid their regular position
specific compensation and market
penetration based bonus.

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 Key Learning
• Job based, team based, skill based and company,
divisional or individual performance based variable
compensation are some of the common methods
used for paying manager.
• HR strategy based compensation could be used to
create HR system based competitive advantage, to
attract talent from market, to reduce high turnover
rates or to keep control on wage bill.
• Business strategy of cost leadership, differentiation
and focus uses a mixture of position based pay and
additional compensation based on company, product
or market penetration respectively.

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