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Business Research Report

Evaluation and Comparison of an

Appropriate Compensation Strategy
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Table of Contents
EXECUTIVE SUMMARY......................................................................................................................................... 3

INTRODUCTION...................................................................................................................................................... 4

RESEARCH FINDINGS........................................................................................................................................... 5

MERIT-BASED PAY................................................................................................................................................................. 5

GAIN-SHARING........................................................................................................................................................................ 6

PAY FOR SKILLS, KNOWLEDGE OR COMPETENCIES (SKC).............................................................................................. 8

RECOMMENDATIONS........................................................................................................................................ 11

CONCLUSION......................................................................................................................................................... 12

REFERENCES......................................................................................................................................................................... 13
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Executive Summary
While there are many aspects of a company that help recruiting and retention of
employees, few aspects have the impact like an attractive compensation strategy. Management
has determined that our existing compensation strategy of base pay plus annual cost of living
increase is antiquated and needs to be compared and reviewed with emerging strategies to
determine if there would be a more appropriate strategy that we should adopt. Additionally, our
industry and labor market are becoming increasingly competitive and we need to safeguard our
existing employees from being pouched by other companies. We feel that our employees are our
most valuable assets and as such, we need to do all that is within our power to keep their
expertise and valuable hard work within our company and to reward them for their performance.
Finally, our existing compensation strategy does not adequately align with our corporate
strategy of having a close-knit, highly skilled and highly diverse workforce. We believe in being
the best and feel that the competitive advantage that we currently enjoy will quickly slip out of
our fingers if we do not do more to reward our employees for their continued top performance
and innovation. As a result of these reasons, I have been tasked with researching and comparing
available compensation strategies. In my research, three different strategies stuck out to me for
different reasons. These strategies are merit-based pay, gain sharing and pay for skills,
knowledge or competencies (SKC).
Merit-based pay seems very practical for the company because it is so similar to our
existing compensation strategy. Just like how we currently operate, pay increases will be given
annually, however instead of the increases being based on cost of living increase and provided as
a blanket to all employees, the merit-based system provides increases based upon the level of
performance for each employee for the previous year. If someone performs well, his or her
annual increase will be substantially higher than someone who performs poorly.
The gain sharing strategy stood out because it provides a means to focus the attention of
our employees on different aspects of performance specifically and not on productivity levels
generally. Aspects such as cost savings, quality, safety, and customer service can be the focus of
a gain sharing strategy and employees share the benefits of the cost savings or increased profit
with the company. While the initial start-up would require a great deal of compensation and
communication, the benefits could be substantial to both company and employee.
Finally, the pay for SKC strategy is a viable option because it would take all of the best
skills and competencies within the company and help to develop a better understanding of
strategic competencies. We could look at what has worked for our best performers in the past
and make skills for which we will reward our employees as they develop the same skills.
Additionally, we can look towards the future with strategic competencies and that would help us
to not get caught with our pants down as our industry and competitors adapt and change.
I ultimately felt that the gain sharing strategy would be the most affective for our
company at the present time because the return on investment is high, it allows us to quickly
obtain and retain a competitive advantage and we can specifically focus on key aspects of our
productivity that will benefit the company. Employees will also reap the rewards quickly and by
a substantial amount, potentially.
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Introduction
As you are aware, our company strategy has a focus on providing the best products and
services to our customers. Since the beginning of this young company, we have used highly
skilled and trained employees as our means of achieving that strategy. We feel, and have always
felt, that our greatest asset is our employees; their hard work, skills and values. Due, in part, to
our strategy and the hard work of our employees, we have now expanded to 120 employees and
foresee continuous expansion as budget and resources become available. We wish to not only
focus on what has previously made us strong, but also look towards the future, to increase our
versatility, flexibility and innovation. Additionally, it is the opinion of management that we need
to take care of our employees and show our appreciation for their efforts in making us so
successful.
As a result of this desire, management has tasked me with the responsibility of evaluating
a number of different compensation strategies and then presenting a recommended strategy that
would be most appropriate and effective for our company. This compensation strategy must be
able to support our corporate strategy, help us to attract and retain top-notch employees at every
level of the company and show appreciation to our employees for their great performance.
According to Kleiman, “the compensation program of the organization must support totally the
strategic plans and actions of the organization” (n.d., Employee Compensation, para. 2) and as
such management has felt the importance of aligning our compensation strategy to our corporate
strategy.
An appropriate compensation strategy is one of the most important and influential aspects
of business. “Pay and benefits are extremely important to both new applicants and existing
employees” (Kleiman, n.d., Employee Compensation, para. 6). Fogleman, McCorkle and
Schwart put it this way, “compensation can be linked…to employee recruitment, retention,
motivation, performance, feedback and satisfaction” and “for employees, compensation signifies
not so much how they are paid, but how they are valued” (1999, para. 1).
As explained by Berger and Berger, there are several questions one must ask to determine
the most appropriate compensation strategy:
1. Who are the direct and labor market competitors for employee resources?
2. What characteristics are similar and/or different from other companies?
3. In respect to market pay practice, where does the company wish to positions itself?
4. Where is the company located and how does that affect our ability to attract the people
we are seeking? (2000, Chapter 9, para. 2)
In answer to these questions and other questions, I recognized that I should consider a
number of challenges that the company will face with our continuous growth, the location of our
company, the competition that we face for highly skilled workers, the emerging trend for
workers to change jobs often and balancing labor costs with our competitive advantage. As
Kleiman states, “labor costs greatly affect competitive advantage because they represent a large
portion of a company’s operating budget” (n.d., Employee Compensation, para. 2).
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Since we are located in a mid-sized city that works diligently to attract new businesses,
competition for highly skilled workers is fierce. This issue is compounded by the fact that we
have a number of existing and upcoming competitors that have the potential to lure away our
employees. Additionally, as Berger and Berger have stated, “with so many opportunities for
change, people are becoming more independent and less committed to one organization, acting
as contractors in a short-handed market” (2000, Chapter 9, para. 1). Because of these factors, the
company has always chosen to be in the high side of the market pay practices, as a way to
encourage retention and recruitment.
Additionally, while we are a manufacturing company, our practices and procedures
require employees to develop and use new skills and knowledge. We encourage our workers to
cross-train with other staff, attend classroom training, and get a good education so that their
value to the company will increase, but more importantly, their knowledge, self worth and self-
esteem will improve.
We also must consider how pay affects attitude, behavior and productivity and what kind
of behavior and motivation we want to see in our employees. Pay can serve to satisfy one’s ego
and self-esteem, it can motivate and encourage workers to work harder and faster, and new
strategies have been developed that have proven to increase innovation. Pay can serve as a
positive reinforcement of previous actions and to encourage development of new skills and
proper forward thinking to develop the most cutting edge techniques. The company has always
maintained the desire to develop, grow and to include employees in that process.

Research Findings
As stated above, the company has always stayed on the high side of market pay practices
when compensating employees. We have strived to express appreciation and to use wages as a
means to encourage hard work and development. The base pay that we offer our employees is
higher than both our direct competitors, as well as competitors in the surrounding labor market.
We are one of the highest paying employers in the area, respectively. However, the concern is
that base pay has very limited competitive advantage, other than to pay a higher amount. Our
pay structure has the potential to be modified in such a way has to instill an even stronger
competitive advantage, and focus the attention of our employees towards specific aspects of the
business’s practices.
After reviewing a variety of relevant and credible resources, and weighing the company’s
unique and specific situation and challenges, there are three strategies that should be considered
for implementation at our company. These strategies are: Merit-based pay, Gain-sharing, and
Pay for skills, knowledge & competencies or SKC for short.

Merit-Based Pay
Merit-based pay, sometimes referred to as variable pay, is an extremely common and
popular compensation strategy and is most similar to our current compensation strategy. As
such, this strategy would be the easiest and least time consuming strategy to implement. Merit-
based pay is a performance-driven pay system where employees receive annual pay increases
based upon their previous annual performance.
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Our current approach for annual pay increases is a cost of living increase. Everyone,
across the board, gets the same percentage increase added to their base pay each year, which
offsets inflation and the increase in cost of living expenses. Our current approach ‘rewards’
good performers and bad performers alike, and provides no distinction or real incentive for
strong performers.
As stated by Mazurek, in the merit-based pay system “compensation is usually provided
as base pay and/or variable pay. Base pay is based on the role in the organization and the market
for the expertise required to conduct that role. Variable pay is based on the performance of the
person in that role, for example, for how well that person achieved his or her goals for the year”
(n.d., Employee Compensation (in the U.S.A.), para. 3).
Merit-based pay is closely linked to annual employee performance reviews. When
employees are reviewed, their ratings are used as a way to distribute pay increases based upon
their performance. If the employee performed exemplary, they will receive a higher pay increase
than an employee that only completed the most minimum of productivity. This system allows
the company to differentiation between individual and company performance, and reward the
employee accordingly.
There are some downsides to merit-based pay, however. According to Obringer, “the
downside of this [system] is that employees may begin to see it as a given that they will get a
salary increase after each evaluation, and it ceases to be a motivation to perform better in their
jobs” (2003, Setting Up Your Compensation Structure, para. 2).
Additionally, since this approach relies upon the annual performance review of
employees, the system can be tainted with an evaluator’s subjective view of the employee that is
being reviewed, which would affect the annual pay increase. There are ways to make the review
process more foolproof and limit this subjectivity, but that is a subject of another discussion.
Analysis: Regardless of the disadvantages, the merit-based pay system is a much more
justified pay system that what we are currently using, as it would show to our employees that the
company truly values hard work and performance. We would be providing positive
reinforcement to those that work hard and negative reinforcement to those who do not. While
some employees might view our current system as more ‘fair’ because everyone is getting an
annual pay increase, the merit-based system would provide at least a marginal level of
competitive advantage and would encourage more employees to increase their level of
productivity.
Since the merit-based pay system is so similar to our current approach, it would take the
least amount of resources and communication to implement. It would, however, also provide the
lowest amount of return on investment for the company, as employees would soon begin to
expect the increase each year, as they have received with our current system.

Gain-Sharing
While the gain-sharing compensation strategy is not new, it is an emerging method of
compensating employees. According to Risher, “as recently as the early 1990s, the only people
who could expect to participate in incentive plans or to be eligible for stock ownership
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opportunities were senior executives” (1999, Chapter 1, para. 4). This plan allows for not just
executives, but everyone to enjoy an incentive plan. This compensation strategy encourages
higher levels of employee performance through the involvement and participation of the
employees themselves. When performance improves, employees share financially in the gain.
The gain-sharing strategy works by measuring some criteria of performance (quality,
customer satisfaction, cost savings, safety, etc.) and through pre-set formulas share surplus
money generated from the savings or profit increase with the employees involved in the
operations (the entire work force, an individual or work teams). The savings are split between
the company and the employees, usually with the split being fifty-fifty. For the most part, gain-
sharing plans are self-funded, since they are either saving the company money, which then pays
for the strategy, or generating new revenue by adding value to the company’s products and
services. These types of pay for performance plans “rewards high performance and does not
reward mediocre or low performance” (“Employee Compensation”, n.d.)
One of the key advantages to this strategy is that it creates employees that are highly
motivated to align with the organizational goals. Risher states, “evidence shows that people will
commit to the achievement of organizational goals when they feel their efforts and their
contributions are appropriately recognized and rewarded” (1999, Chapter 1, para. 8).
Since the distribution of pay lies almost entirely on the workforce, gain sharing fosters an
environment of continuous improvement, instills a feeling of ownership amongst the employees
and increases the level of teamwork and cooperation, all of which are positive and admirable
qualities that we strive for within our company.
Gain sharing opportunities can be abundant and overlapping. Generally, all employees
would continue to receive a base pay, albeit a little lower than we have typically provided. The
employees will then have several opportunities to increase their compensation by achieving gain
sharing goals individually, within their teams and across the entire company. This method of
compensation has the potential to increase employee compensation significantly, while only
marginally increasing payroll costs to the company.
This system does not come without its disadvantages, however. Unlike with our current
system and with merit-based pay, there would be no guaranteed annual pay increases for any
worker. If no one in the company reaches the pre-set goals, there will be no gain-sharing payout.
Additionally, the payout may only be nominal at times. If the gain is only several hundred
dollars, the split amongst the employees could equal out to be merely pennies.
While the gain sharing strategy would incur any significant costs, if any at all, to
implement, there would be significant amount of communication involved. Employees would
need to know initially what is involved in the system, how their base pay would be affected,
what opportunities they will have individually and collectively to increase their pay, and of the
potential for their pay to drop if their effort to work hard is low. As stated by Newman,
“incentives and bonus plans need to have clear guidelines to minimize any confusion. They
shouldn’t be seen as guaranteed payment, but instead should be measured by performance of the
individual, team or company” (2007, para. 1)
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Throughout the process, management would need to be very participative in the

continuous communication process. Management would need to be open in sharing performance
measures to employees and they would need to be aware and expectant of some pushback if they
ask employees to do something that doesn’t directly related to the current gain sharing strategies,
as the increased pay will be a highly motivating factor.
Analysis: There are some significant advantages to implementing this strategy. We
could potentially see increased teamwork, even more motivated employees, decrease in costs,
increased employee safety and improved quality throughout the entire production process. This
all could come at a no or very minimal cost to implement. Although there would be a significant
portion of time spent communicating the changes, defining pre-set levels, and evaluating the
effectiveness of the goals, other companies have recognized significant payoff for this strategy of
compensation.
However, the advantages and disadvantages of this program would need to be seriously
reviewed before this strategy could be implemented at the company. Additionally, it would be
important and would help the transition process, if employees at every level within the company
were involved in the design, implementation and communication of this strategy, if it were to be
implemented at the company. It seems the success of this plan falls squarely on a thoroughly
reviewed design and effective implementation through intensive communication to employees.

Pay for Skills, Knowledge or Competencies (SKC)

Historically, compensation strategies have provided wages to employees based upon the
position they maintained, with a measure of initial fluctuation based upon the previous
knowledge and experience that the worker brought with them. Employees were paid based upon
what job they were filling at that given time, not based upon what they had the potential to do.
Pay was rewarded for the job, not for the individual. However, it is the reverse, paying people
for their potential, the skills, knowledge and/or competencies (SKC) that this next strategy is
based.
The pay for SKC compensation strategy pays employees based upon how much manual
labor skills, managerial or professional knowledge, and/or understanding of the strategic
competencies of the company that they have and can demonstrate. This strategy rewards the
employee not for the job that they are simply filling, but for the job that they have the potential to
perform and for their collection of capabilities.
While this system is drastically different than our current approach, it comes with some
great benefits to the company. Since jobs are constantly changing and becoming more complex,
our employees will have to acquire the appropriate skills and knowledge required to keep up
with that change. These changes require additional training and cooperation on the part of the
employee to learn and perform new tasks. The pay for SKC strategy rewards employees for their
effort to learn and develop this new knowledge and these skills. The pay for SKC strategy links
the acquisition of job knowledge and job skills with pay that rewards employees for that effort.
This strategy is designed to stimulate the growth and development of our employees. It provides
an additional motivation for our employees to become better, contribute more and become a
more valuable asset to the company.
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Depending on the focus, either skills, knowledge or competencies, this strategy is

implemented by first performing extensive analysis and evaluation of the necessary skills,
desirable knowledge or required understanding of strategic competencies that the company seeks
in their workers. For skills, the evaluation determines all of the required skills to perform all
work at the organization. Related to knowledge, performers judged superior on specific
performance criteria are studied to determine the differences between workers. Those
differences are then packaged into competencies that are then tied to the compensation system.
(Heneman, 2000, Varieties of Plans to Pay for Skills, Knowledge, and Competencies, para. 3 &
10). Skills and knowledge are closely tied to previous performance – what skills and knowledge
have been successful and valuable in the past.
However, when it comes to employees having a focus on strategic competencies of the
company, the emphasis is on looking forward to new and innovative ways to improve. As
Heneman states, “one of the most positive aspects of the focus on strategic competencies is that
it encourages forward thinking” (2000, Varieties of Plans to Pay for Skills, Knowledge, and
Competencies, para. 17). This is important, because our industry is changing so rapidly and to
reward someone for old successful habits might only perpetuate that past experience, without
encouraging an employee to look forward to new techniques and opportunities.
There are disadvantages for implementing this strategy. First and foremost would be the
considerable time and money involved in the initial start-up. As I have stated, there is a
significant amount of analyzing, interviewing and evaluating necessary to establish valuable
skills, knowledge packages and strategic competencies. This evaluation could be done in house
but is often tackled by outside Human Resource professionals and consultants. These people
would have to be paid for this evaluation. Once the evaluation is completed, the necessary
communication to introduce and roll out this strategy would be on par with the gain sharing
approach. We would need to ensure that our employees are comfortable with the change and
understand the opportunities that they will have before them to increase their wages.
Additionally, in order for a system such as this to function properly, it must be closely
aligned with a stellar training system. If this strategy is to work, the company would need to
ensure that the training staff is prepared to teach and provide the necessary hands-on training
required for each specific skill, knowledge and competency. This would involve a tremendous
effort to control staffing and scheduling tasks, as employees will be jockeying for time and
opportunities to attend in-class and cross training. The company would have to ensure that
production would not suffer as employees focus their attention on attaining skills and knowledge
that will then make them more valuable to the company.
Analysis: With this strategy, we could both solidify our company today, by focusing on
skills and knowledge, and encourage more employees to look towards the future by provoking
employees to learn strategic competencies. We would be rewarding employees for earnestly
seeking the best skills and knowledge that would benefit the company. It would be a win-win
situation for everyone as employee compensation will increase and we will have more skilled
workers that should produce quality products faster and safer. Our base payroll budget would
decrease, as we would start all employees at a lower base pay, but then the payroll budget could
potentially exceed the existing budget as more and more employees attend training and seek out
the valuable skills, which would be a significant disadvantage if there were not a plan in place.
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Armstrong puts it this way, “skill-based pay systems are expensive to introduce and
maintain. They require a considerable investment in skill analysis, training and testing. Although
in theory a skill-based scheme will pay only for necessary skills, in practice individuals will not
be using them all at the same time and some may be used infrequently, if at all. Inevitably,
therefore, payroll costs will rise” (2010, Skill-Based Pay, para. 5). Add to this the cost of
training and certifying employees skills and this strategy might prove to be more money than it is
worth.
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Recommendations
It is after much consideration and a significant amount of research and review that I
present these three recommendations that fulfill the request by management, and would allow
opportunities for the company to be more innovative, more adequately reward our employees
and more closely align the compensation strategy with our adopted corporate strategy.
My recommendations are listed below.

 Recommendation One: retire our current base pay plus annual cost of living
compensation strategy in favor of a new compensation strategy as recommended below
 Recommendation Two: first lowering the corporate base pay to the lower end of the
market pay practice in preparation for a new compensation strategy and then
 Recommendation Three: adopt the gain sharing compensation strategy by creating a
company-wide committee to define pre-set levels, evaluate effectiveness of goals and
establish communication techniques to present the changes to all employees
By adopting the gain sharing compensation strategy, the company will be able to focus
the attention of our workers towards important corporate goals, and provide them incentives to
perform to specified levels. Our potential gains would be increased safety, quality, efficiency,
cost savings, customer service or any other aspect which we choose to focus our attention.
Employees will gain a portion of the cost savings or increased income that comes as a result of
these focal points.
As I stated before, the most important items to consider and address when implementing
this strategy are a thoroughly reviewed design and effective implementation through intensive
communication to employees. We must focus on a measure of cooperation and communication,
in order to create and present a strong and thorough strategy. As I recommended above,
considerations can be addressed by creating a company-wide committee to create a fair and
workable strategy for both management and manufacturing employees. This company has
always maintained a strong cooperative atmosphere and communication from top to bottom has
recently improved significantly. With this consideration, I do not foresee any specific
roadblocks to implementation.
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Conclusion
While all three compensation strategies that I have reviewed in this business report would
be an improvement over our current system of annual cost of living increase, I strongly
recommend the company implement the gain sharing compensation strategy. This strategy will
allow the company to focus attention on specific aspects of production and service. Employees
will benefit by receiving a share of the proceeds and the company will increase our existing
competitive advantage. Additionally, the employees will have a greater vested interest in the
company and can see how their hard work directly impacts the results of the company.
During my research it became apparent that the pay for skills, knowledge and
competency pay strategy could be implemented as a companion to the gain sharing strategy and
work to both share incentives and provoke employee improvement. In the future, this strategy
could be considered. Additionally, to perform a more in-depth review of our total compensation
system, we should review other compensation aspects, such as employee bonuses, flexible work
schedules, health care, wellness services, convenience services, and other benefits. Often times,
employees consider these aspects to be almost as important as salary.
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