Organisationspsychologie PhilippsUniversitt Marburg Dr' Bernad Batinic WS 0304

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MOS 342B Section 002 Winter 2007 Compensation
and Benefits Management Components of
Compensation Strategy
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MOS 342B Strategic Components

• Overview
• Compensation Mix Components
• Base pay
• Performance pay
• Indirect pay
• Methods for Establishing Base Pay
• Individual Performance Pay
• Group Performance Pay
• Organization Performance Pay Plans

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MOS 342B Strategic Components

• Base Pay
• The portion of an individuals compensation that
  is based on a unit of time worked
• Wages Pay based on an hourly time period
• Salary Pay based on a weekly, monthly, or annual
  time period
• Most common and largest pay component
• 98 of Canadian firms use it
• Makes up ca. 80 of total compensation volume
• Why is base pay so popular?

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MOS 342B Strategic Components

• Base Pay
• Reasons for using base pay
• Employees (and employers) prefer certainty
• Output-related pay may be impractical or have
  undesirable consequences
• Simplicity
• Flexibility (e.g., adaptable to managerial
  strategy)
• Signals relative importance of jobs
• Signals employers commitment to employees

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MOS 342B Strategic Components

• Base Pay
• Disadvantages of base pay
• Fixed costs
• Little extrinsic motivation for task-related
  behaviour
• No link to organizational success, and thus
  little motivation for off-task behaviours
• Does not signal unsatisfactory performance (not
  self-correcting)

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MOS 342B Strategic Components

• Performance Pay
• Any type of financial reward provided only when
  certain specified performance results occur
• These results may be based on the performance of
  individual employees, a group or team, or an
  entire organization
• Steady rise in popularity until 2000, but recent
  decline
• Depending on type of performance pay, between 16
  and 41 of Canadian firms use it
• Makes up 6.5 of total compensation volume

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MOS 342B Strategic Components

• Performance Pay
• Advantages of performance pay
• Signal key behaviours and motivate employees
• Make pay more variable
• Substitute for more invasive control mechanisms
• Set performance standards and provide feedback
• Support specific managerial strategies

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MOS 342B Strategic Components

• Performance Pay
• Disadvantages of performance pay
• Uncertainty of rewards
• May require higher overall compensation
• Narrows focus on rewarded behaviours, with
  unanticipated side effects
• Higher complexity and overhead costs than base
  pay

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MOS 342B Strategic Components

• Indirect Pay
• Any type of employer-provided reward (or
  benefit) that serves an employee need but is
  not part of base or performance pay (non cash)
• Second largest pay component, proportion recently
  rising again
• 95 of Canadian firms use it
• Makes up 14.5 of total compensation volume

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MOS 342B Strategic Components

• Indirect Pay
• Major categories of indirect pay
• Mandatory benefits (e.g., Canada Pension Plan,
  Employment Insurance)
• Discretionary retirement and pension plans
• Health benefits
• Paid holidays and leaves
• Employee services (food, counselling, recreation,
  etc.)
• Purchase discounts, company cars, and other
  miscellaneous benefits

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MOS 342B Strategic Components

• Indirect Pay
• Reasons for using indirect pay
• Competitive pressure
• Satisfy the security needs
• More favourable income tax benefit
• Group plans purchased cheaper
• Sense of responsibility
• Reinforce a managerial strategy
• Promote consequences beneficial to organization
  (e.g., employee health)

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MOS 342B Strategic Components

• Indirect Pay
• Disadvantages of indirect pay
• Long-term commitment of fixed costs
• Difficult to develop and administer
• Little motivation for specific behaviours
• Fosters mainly continuance commitment
• May encourage absenteeism
• Does not fit with classical managerial strategy,
  ambivalent for HI strategy

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MOS 342B Strategic Components

• Methods for Establishing Base Pay
• Market Pricing Establishing base pay by
  determining the amount of pay necessary to
  attract qualified individuals from the labour
  market
• Job Evaluation Establishing base pay by ranking
  or rating all jobs in the firm according to their
  relative values
• Pay-for-Knowledge System (PKS) Establishes base
  pay on the capabilities of individuals rather
  than on the characteristics of jobs, often called
  person-based pay

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MOS 342B Strategic Components

• Methods for Establishing Base Pay
• Market pricing advantages
• Simplicity
• Keeps all jobs in the organization aligned with
  market conditions
• Market pricing disadvantages
• Wage surveys may not apply to individual
  situation
• Market wages vary dramatically
• Internal equity not addressed
• Lack of control over own compensation
• May be illegal due to payment equity violation

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MOS 342B Strategic Components

• Methods for Establishing Base Pay
• Job evaluation advantages
• Signals relative importance of jobs
• Systematic way to promote equitable pay
• Can be used to calibrate market wages
• Can be used for new jobs, standardized procedures
• Job evaluation disadvantages
• Costly to develop (job descriptions) and maintain
  (changing jobs)
• Can inhibit flexibility (-gt broad banding)
• May create tendency to inflate values

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MOS 342B Strategic Components

• Methods for Establishing Base Pay
• PKS advantages
• Incentive for skill development
• Promotes flexibility
• Promotes broader understanding of the job and
  intrinsic motivation
• PKS disadvantages
• Topping out problem
• High costs for training and certification
• Difficult to understand and sell to some
  employees

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MOS 342B Strategic Components

• Exercise How do methods for establishing base
  pay fit to managerial strategies?

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MOS 342B Strategic Components

• Individual Performance Pay
• The menu of individual performance pay
• Piece rates Individuals receive a fixed sum for
  each unit of output they produce
• Sales commissions Pay geared to the number of
  units sold or the dollar value of the sales
• Merit raises Permanent increase to employees
  base pay in recognition of good job performance
• Merit bonus Temporary bonus provided to
  recognize good employee performance that does not
  increase base pay
• Targeted incentive Incentive designed to
  motivate a specific type of employee behaviour

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MOS 342B Strategic Components

• Individual PfP Piece Rates
• Advantages
• Direct link between pay and task behaviour
• Partly self-funding, self-controlling
• Communicates expected level of performance
• Disadvantages
• Limited applicability
• Unfair differences between jobs likely
• Causes conflicts, low commitment, quality
  problems, variable income
• Restrictive social norms may apply

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MOS 342B Strategic Components

• Individual PfP Sales Commissions
• Advantages
• Similar to piece rates
• Easier set than piece rates, and even more
  directly self-funding
• Disadvantages
• Similar to piece rates
• Encourages aggressive sales, discourages
  behaviour related to customer service, advising
  new salespeople, etc.
• Better suited to new market selling (new products
  and customers) than maintenance selling (old
  products, customers)

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MOS 342B Strategic Components

• Individual PfP Merit Pay
• Advantages
• Focus on overall performance, widely applicable
• Matches accepted values in Western world
• Merit raise Retain outstanding employees
• Merit bonus Avoids many cost problems of
  permanent raises
• Disadvantages
• Problems associated with performance appraisal
  (cf. chapter 9)
• Merit raise Becomes increasingly expensive
• Merit bonus Higher amount needed to make
  noticeable difference to base pay

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MOS 342B Strategic Components

• Group Performance Pay
• In contrast to individual PfP, group systems can
  be used with interdependent work
• The menu of group performance pay
• Gain-sharing Shares cost savings or productivity
  gains generated by a work group or team with all
  members of that group
• Goal-sharing Work group or team receives a bonus
  when pre-specified performance goals are met
• Other types competitive bonus plan, pooled
  performance pay, group commissions and piece
  rates, team-based merit pay

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MOS 342B Strategic Components

• Group PfP Gain-Sharing
• Advantages
• Self-funding
• Creates norms favourable of productivity, etc.
• Can be tailored to different goals (productivity,
  quality, cost savings)
• Less supervision required
• Disadvantages
• Substantial kick-off costs
• Difficult and less effective in unstable
  environments
• No direct link to individual effort (social
  loafing)
• Requires trustful and participative culture

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MOS 342B Strategic Components

• Group PfP Goal-Sharing
• Advantages
• Similar to gain-sharing
• Goals can be more difficult to attain, may
  prevent social loafing
• Disadvantages
• Similar to gain-sharing
• Difficulty in establishing realistic and fair,
  but challenging goals
• Frustrating if goals are not met

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MOS 342B Strategic Components

• Organization Performance Pay
• In contrast to other PfP plans, organization PfP
  can be used in any organization
• The menu of organization performance pay
• Profit-sharing bonus payments to employees based
  on the profitability of the firm (cash or shares,
  paid or deferred)
• Stock plans Any type of plan through which
  employees acquire shares in the firm that employs
  them (stocks, options, bonus or purchase)
• Other types Long-term incentives

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MOS 342B Strategic Components

• Organization PfP Profit-Sharing
• Advantages
• Fosters sense of shared goals between management
  and workforce
• Fosters organizational commitment
• May improve company image
• Relatively easy to set up
• Similar to other PfP plans (but weaker)
• Disadvantages
• Weak link between individual behaviour and bonus
• Reduces profit margin of owner / stockholders
• Similar to group PfP (e.g., social loafing)

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MOS 342B Strategic Components

• Organization PfP Stock Plans
• Advantages
• Similar to profit-sharing
• Funded by tax credits, save cash
• Reduces turnover,
• can fund retirement plans
• Disadvantages
• Similar to profit-sharing
• More costly to establish, maintain, explain
• If stocks are purchased, individual employees
  risk management becomes an issue

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MOS 342B Strategic Components

• Organization PfP Empirical Findings
• High-involvement firms most likely to adopt
  organization PfP plans
• Profit-sharing associated with productivity
  increases, higher 5-year survival, but decreasing
  stock prices
• Stock plans also associated with higher
  productivity, especially in conjunction with
  employee participation

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MOS 342B Strategic Components

• Case Study Fit Stop Ltd.
• Determine whether base pay should be an important
  component of compensation for sales staff. If so,
  identify the most appropriate method for
  determining base pay for their sales staff. What
  factors did you consider in your decisions?
• Do you think that Fit Stop would be a suitable
  organization in which to implement on
  organization PfP? Explain why or why not. If the
  Fit Stop is suitable,what type of organization
  PfP would be most appropriate? Describe the key
  elements of this plan, as applied to Fit Stop.