Lesson 7 Person-Based Structures partly (often largely) depends on people - their standards of literacy and education, work attitudes,
y) depends on people - their standards of literacy and education, work attitudes, value
PERSON-BASED STRUCTURES
Skill based pay sometimes referred to as ‘person based pay’ is a system that places a monetary value on
skills rather than the job. Business owners must always be thinking about what’s next and continuously
strive to improve in a rapid changing marketplace with increasing customer demands and both global and
domestic competitors. Growing in popularity is a move from traditional seniority and merit based pay to
skill based pay systems which communicate to employees that financial rewards are directly related to
the knowledge and skill they can bring to the workplace.
Skill-based pay refers to a pay system in which pay increases are linked to the number or depth of skills an
employee acquires and applies and it is a means of developing broader and deeper skills among the
workforce. Such increases are in addition to, and not in lieu of, general pay increases employees may
receive. The pay increases are usually tied to three types of skills:
• horizontal skills, which involve a broadening of skills in terms of the range of tasks
• vertical skills, which involve acquiring skills of a higher level
• depth skills, which involve a high level of skills in specialized areas relating to the same job.
Skill-based pay differs in the following respects from traditional pay systems which reflect skills
differences in a structure consisting of rates of pay for unskilled, semi-skilled and skilled workers:
• Skill-based pay is a person-based and not a job-based, system. It rewards a person for what
he/she, rather than the job, is worth. Job worth is reflected in a basic rate of pay for minimum skills, but
pay progression is directly linked to skills acquisition (rather than to general pay increases applicable to
all).
• It rewards (and therefore emphasizes) a broad range of skills which makes the employee multi-
skilled and therefore flexible.
• It positively encourages skills development.
• A skill-based pay system may not necessarily reflect how well the skill is used, as this falls within
the performance component of pay. But there is nothing to prevent injecting performance criteria into
the system. In such cases the system will be more performance oriented than a structure which merely
recognizes different rates of pay for skills.
• The system needs to be underpinned by opportunities for training which is critical to the
success of the system. The traditional structure is not dependent on such opportunities.
Reasons for Skill-Based Pay
More than ever before in industrial relations history a commonality of interests in the skills of employees
has developed between employers and employees. Skills provide employees with a measure of
protection against unemployment, as well as opportunities for higher earnings. At the same time, skills
provide employers with an important means of achieving competitiveness.
Many countries today are seeking to advance to more technology and skill-based industries, while others
have become (or are becoming) 'postindustrial’ societies, in which the application of knowledge
determines productivity, performance and competitiveness. Comparative advantage based on for
instance, cheap labor or raw materials, has declined in importance relative to competitive advantage
based on the ability to add value to a particular resource or advantage. Such comparative advantage
systems, skills and motivation. Critical today is the ability to innovate and develop clusters of competitive
enterprises in particular industries.
For the more industrialized countries this means 'capturing' some of the key industries of the next
century - microelectronics, biotechnology, new materials science industries, telecommunications, civil
aviation, computers and software, robotics and machine tools and entertainment. An employee with skills
is most flexible and productive when he develops a broad range of skills, is able to learn the next higher
skill, develop analytical skills and is also able to work in a team. Important aspects of today's skills package
include multi-skills, cognitive skills, interpersonal and communication skills, positive work attitudes and
quality consciousness. Training is no longer only for current competence, but is also to prepare for the
next stage of skills. Thus pay systems which promote current and future skills needs are increasing in
importance among employers.
The impact of rapid technological change, the increasing globalization of product markets, greater
customer choice and the emphasis on quality necessitate a frequent updating of skills, and flexibility to
respond to rapid changes in the requirements of markets. A flexible workforce, which is one that is multi-
skilled, ensures that production is not interrupted due to the narrow skills of workers, and that workers
are themselves responsible for the quality of products.
Advantages of Skill-Based Pay
Among the advantages of skill-based pay are the following:
• It contributes to job enlargement and enrichment by breaking down narrow job classifications.
• Flexibility is increased by encouraging the performance of multiple tasks. It enables job
rotation, and filling of temporary vacancies due, for instance, to absenteeism. It therefore contributes to
a leaner workforce.
• It enhances productivity and quality through better use of human resources.
• It facilitates technological change, which may meet with resistance in a purely job-based
system.
• The higher pay levels, continuous training, and job enlargement through the broadening of
skills, tend to reduce staff turnover.
• Elimination of unnecessary jobs can result from a workplace having broad, rather than narrow,
skills. It also reduces the need for supervision.
• Job satisfaction is engendered through employees having greater control over the planning and
implementation of their work.
• Broadening of skills leads employees to develop a better perspective of operations as a whole.
• It is an incentive for self-development.
• It provides employment security through skills enhancement.
• It reduces the need to look to promotion to higher levels (which are always limited) as the only
way to enhance earnings, and it facilitates the planning of an employee's career development path.
• Since the reward flows from the application of a skill and it does not reduce opportunities for
others to similarly increase their skills and earnings, there is likely to be less competition among
individuals.
• Since the pay increases on account of skills are linked to a measurable standard, the criticism of
subjectivity often associated with performance appraisals and individual-based performance-related pay,
is avoided
Six Steps to Prepare for a Skill-Based Compensation Program
Before moving to a skill-based compensation model, a few steps need to be observed.
1. Identify the skill profiles you have in your company.
We differentiate between three different skill profiles as outlined below:
• Breadth: Being able to perform in different work settings and environments and have
transferable skills that can be used in an agile work environment. In the past, this was oftentimes
associated with a unionized environment where skills to work across different machinery were rewarded.
In today’s digital world, this may be comparable to a full stack developer — someone with broad
technical skills that can work across multiple platforms. This could also be a software architect who
understands how different aspects of an application interconnect.
• Depth: Becoming a deep expert in a subject matter. An example today would be a software
engineer who develops deep understanding of one programming language but also is able to write a code
that is non-repetitive, efficient, maintainable and dependable.
• Self-management and management of others: Optimizing self-management or management of
others; for example, software development teams that organize themselves effectively and efficiently. In
an agile software development environment, the developers’ teams not only ensure information flow
between themselves but also to the outside world (e.g., the client or the business sponsor). This can also
mean the team is able to absorb new business requirements that may impact various aspects of the
development process.
2. Identify the specific skills your company needs.
As a first step, the business needs to assess their skill requirements and measure their current skill base
against their internal benchmark. This can be done internally or with outside help. Figure 1 shows the
skills that our technology survey clients identify as hard to attract and retain by career level. Not
surprisingly, it’s the “specialist” career level where most of these skills are in highest demand.
These hot skills require a substantial amount of training in many cases. However, it’s not realistic to
expect many employees to embark on a multi-year rigorous training schedule for skills that are outside of
their core job duties. Therefore, employees with adjacent skills that complement desired new skills will
have an easier time acquiring new knowledge. For example, it may be possible to train a statistician in the
concepts of machine learning algorithms and programming languages as the statistician was surely
exposed to some of the programming languages in their university training. A certification program can
build on these skills.
3. Assess your current workforce.
Once you take time to evaluate the current skills among your workforce, you’ll be able to identify and
map out skills gaps. When considering a skill-based compensation model, it may make sense to look
outside your organization to determine how readily available talent with the skills you need are and what
it will cost to bring them into the organization vs. upskilling and retraining your current workforce. If
there’s a need for hiring new talent, there a few things to be considered:
• How much will the talent cost to the company?
• Will there be compression issues to hire new talent with the skills you need?
• What is the risk of losing new talent in the next two years?
• How much will it cost the company to train employees with adjacent skills to get up to speed
instead of hiring new talent?
4. Establish a skill-based bonus system with internal and external certification.
Training and certifying employees are key to a skill-based compensation model. This can be done through
your own training departments or with the help of external online certification centers or universities.
Traditional manufacturing companies that used skill-based compensation models had an easier time
identifying the training employees needed as they were often geared around a process and machinery. In
the digital world, determining the necessary training requires an in depth understanding of your business
goals in the future and what skills are needed to meet these demands.
5. Determine which path of skill-based compensation to follow.
When moving to a skill-based compensation program, a company can choose between a more traditional
path or a progressive one. The traditional approach, as illustrated in Figure 2, combines your pay band
methodology with skill-based compensation by allowing employees a better positioning within the pay
band. However, in a traditional pay band, there are usually two pay bands that overlap. This means that
salary points in the upper quartile of the lower pay band overlap with the lower quartile with the higher
pay band.
The basic pay approach as shown in Figure 3, is a more progressive version of the traditional approach.
Everyone gets the same basic pay and any movement on the pay band is due to someone’s skill level and
the deployment of these skills. Someone with many valuable skills and the deployment of these skills can
reach the basic pay level of someone on a pay band several grades above. In a changing work
environment with more highly skilled specialist and fewer managers, this approach can make sense with
specialists able to advance themselves financially by acquiring and deploying critical skills. This will
prevent employees from seeing promotion as the only way of significantly improving their earning
potential.

6. Establish a monitoring system.
Establishing a monitoring system for a skill-based compensation program is essential to ensuring that
digital skills move along with the development of the technology. This means that re-certification does
not simply ensure there is a skill upkeep but that skills move along with the technology. In some
instances, technology may become obsolete and the skill may not be worth anything to the company.
This also means that the company should stop paying a bonus to employees with this skill. Alternatives
can be offered that may require a different certification.
Skill-based compensation is designed to drive digital skills into an organization, strengthen the individual
contributor role and allow companies to adapt to technology changes. It also takes pressure off
employees that feel the only way for them to advance in the organization is to seek higher management
roles, thus allowing some specialists to focus on developing technology, products and services that their
customers want.
However, companies shouldn’t implement a skill-based compensation program without being prepared
to invest time and resources into training managers and HR leaders properly and communicating the
program to employees. Without laying the proper foundation, the new compensation model won’t be
effective or receive buy-in from employees and managers.
In the era of rapidly evolving technology, companies can benefit from adopting a skill-based
compensation program as way to ensure they are maintaining current and cutting-edge skills in their
organization and up skilling current employees instead of constantly replacing the workforce in a
competitive hiring environment. However, adopting a skill-based compensation program requires
constant upkeep. Given the prediction that in 15 years 40% of jobs may be replaced by artificial
intelligence, new compensation models that are linked to innovation may lead the way.
Lesson 8: External Competitiveness
EXTERNAL COMPETITIVENESS
In external competitiveness, (the second pay policy) comparisons are made outside the
organization- comparisons with other employers that hire the same kinds of employees.
External competitiveness is expressed in practice by
(1) setting a pay level that is above, below, or equal to that of competitors, and
(2) determining the mix of pay forms relative to those of competitors.
External competitiveness refers to the pay relationships among organizations – the organization’s
pay relative to its competitors.
Pay level refers to the average of the array of rates paid by an employer:
(base + bonuses + benefits + options) number of employees
Pay forms are the various types of payments, or pay mix, that make up total compensation.
Both pay level and pay mix focus on two objectives: (1) control costs, and (2) attract and retain
employees.
1. Control Costs
The higher the pay level, the higher the labor costs:
Labor costs = pay level x number of employees
The higher the pay level relative to what competitors pay, the greater the relative costs to provide similar
products or services. So you might think that all organizations would pay the same job the same rate.
However, they do not.
2. Attract and Retain Employees
Different employers set different pay levels. They deliberately choose to pay above or below what others
are paying for the same work. Not only do the rates paid for similar jobs vary among employers, but a
single company may set a different pay level for different job families. However, when total
compensation (bonuses, stock options, and benefits) is looked at, the pay rate for the position might be
further below or actually above the market rate. For example, an engineer is 2% below the market rate
when only his base wage is observed. But when total compensation is taken into consideration, he might
be 30% below the market rate.
This makes two points. First, companies often set different pay-level policies for different job families.
Second, how a company looks in comparison to the market depends on the companies it is compared to
and the pay forms included in the comparison. Even though people love to talk about “market rates,”
there is no single “going rate” in the marketplace.
There is no single “going mix” of pay forms, either. This compares the mix of pay forms for the same job.
Both companies offer about the same total compensation. Yet the percentages allocated to base,
bonuses, benefits, and options are very different.
What Shapes External Competitiveness?
Factors that affect a company’s decision on pay level and mix:
(1) (LABOR MARKET FACTORS) competition in the labor market for people with various skills;
(2) (PRODUCT MARKET FACTORS) competition in the product and service markets, which affects the
financial condition of the organization; and
(3) (ORGANIZATION FACTORS) characteristics unique to each organization and its employees, such as its
business strategy, technology, and the productivity and experience of its work force.
These factors act in concert to influence pay-level and pay-mix decisions.
LABOR MARKET FACTORS
Economists describe two basic types of markets: the quoted price and the bourse. Stores that label each
item’s price or ads that list a job opening’s starting wage are examples of quoted-price markets (Amazon).
Bourse markets allow for haggling to occur over the terms and conditions until an agreement is reached
(e-Bay). In both the bourse and the quoted market, employers are the buyers and the potential
employees are the sellers. People and jobs match up at specified pay rates.
How Labor Markets Work
Theories of labor markets usually begin with four basic assumptions: Employers always seek to
maximize profits. People are homogeneous and therefore interchangeable; a business school graduate is
a business school graduate is a business school graduate.
The pay rates reflect all costs associated with employment (e.g., base wage, bonuses, holidays, benefits,
even training). The markets faced by employers are competitive, so there is no advantage for a single
employer to pay above or below the market rate.
Understanding how markets work requires analysis of the demand and supply of labor. The demand side
focuses on the actions of the employers: how many employees they seek and what they are able and
willing to pay those employees. The supply side looks at potential employees: their qualifications and the
pay they are willing to accept in exchange for their services.
PRODUCT MARKET FACTORS (AND ABILITY TO PAY)
Any organization must, over time, generate enough revenue to cover expenses, including compensation.
It follows that an employer’s pay level is constrained by its ability to compete in the product/service
market. So product market conditions to a large extent determine what the organization can afford the
pay. Product demand and the degree of competition are the two key product market factors.
Product Demand – the product market puts a lid on the maximum pay level that an employer can set. If
the employer pays above the maximum, it must either pass on to consumers the higher pay level through
price increases or hold prices fixed and allocate a greater share of total revenues to cover labor costs.
Degree of Competition – Employers in highly competitive markets are less able to raise prices without
loss of revenues. At the other extreme, single sellers are able to set whatever price they choose.
However, too high a price often invites the eye of political candidates and government regulators.
A Dose of Reality: What Managers Say
Managers pay depending on whatever the C.F.O. says they can afford. Managers feel it is
shortsighted to pay less, even if market conditions would permit the lower pay. In direct
contradiction to efficiency-wage theory, managers believed that problems attracting and keeping
people were the result of poor management rather than inadequate compensation
. More Reality: Splintering Supply of Labor
St. Luke’s faces a splintered labor supply. This means it uses multiple sources of nurses, from
multiple locations, with multiple employment relationships. The level and mix of cash and benefits
paid each nurse depends on the source. The splintered supply results in nurses working the same
jobs side by side on the same shift but earning significantly different pay.
Work Flow to the People – On Site, Off-site, Offshore
Which source is included in a bid depends on many factors:
• Customer preferences
• Time schedules
• The nature of the project.
Work flowing to lower-wage locations, presuming similar levels of output and quality, I not
new. Work flows across national borders were first low-skill; low wage jobs (T-shirts and sneakers)
to China and Central America. , then higher paid blue collar (electronics, appliances, cars), now its
service and professional (accounting, engineering). Vastly improved communications and software
connectivity has accelerated these dynamics.
Three Points to take from this discussion:
1. Reality is complex; theory abstract. It is not that our theories are useless. They simply abstract away the
detail. Theories of market dynamics, the interaction of supply and demand, form a useful foundation.
2. The splintering of labor supplies means that determining pay levels and mix increasingly requires
understanding market conditions in different locations, even worldwide locations.
3. Managers also need to know:
• The jobs required to the work
• The tasks to be performed, and
• The knowledge and behaviors required to perform them
So that they can bundle the various tasks to send to different locations.
ORGANIZATION FACTORS
Although product and labor market conditions create a range of possibilities within which
managers create a policy on external competitiveness, organization factors influence pay level and mix
decisions, too.
Industry Managers look at both competitors – their products, location, and size –and the jobs --- the skills and
The industry in which an organization competes influences the technologies used. Labor intensive knowledge required and their importance to the organizations success. So depending on its location and
industries such as education and health care tend to pay lower than technology intensive industries. The size, a company may be deemed a relevant comparison even if it’s not a product market competitor.
introduction of new technology within an industry influences pay levels.
The data from product market competitors (as opposed to labor market competitors are likely to
Qualifications and experience tailored to particular technologies is important in the analysis of labor receive grater weight when:
markets.
1. Employee’s skills are specific to the product market.
Employer Size
2. labor costs are a large share of total costs
There is consistent evidence that large organizations tend to pay more than small ones. This relationship
between organization size, ability to pay, and pay level is consistent with economic theory. It says that 3. product demand is responsive to price changes
talented individuals have a higher marginal value in a larger organization because they can influence 4. the supply of labor is not responsive to changes in pay
more people and decisions, thereby leading to more profits. However theories are less useful in
explaining why practically everyone at bigger companies is paid more. 5. Relevant markets are shaped by pressures from the labor and product market and the
organization.
People’s Preferences

Better understanding of employee preferences is increasingly important in determining external COMPETITIVE PAY POLICY ALTERNATIVES
competitiveness. Markets involve both employers’ and employees’ choices. However, there are Pay level is the average of the array of rates inside an organization. There are three conventional pay-
substantial difficulties in reliably measuring preferences. level policies:
Organization Strategy 1. to lead
A variety of pay-level and mix strategies exist. Some employers adopt a low-wage, no-services strategy; 2. to meet, or
they compete by producing goods and services with the lowest total compensation possible. i.e. Nike and
Reebok. 3. To follow competition.

Low wage, high-service = Marriott 6. Newer policies emphasize flexibility, among policies for different employee groups, among pay
forms for individual employees and among elements of the employee relationship that the
High-wage, high-service = Medtronic company wishes to emphasize in the external competitiveness policy.
Relevant Markets
What Differences Does the Pay Level Policy make?
The market determines wages. Defining the relevant markets is a big part of figuring out how much to The basic premise is that the competitiveness of pay will affect the organization’s
pay and what mix of pay forms to offer. ability to achieve its compensation objectives and this in turn will affect the
organizations performance.
What is the right pay to get the right people to do the right things?
Base pay represents only a portion of compensation.
Managers must define the markets that are relevant for pay purposes and establish the appropriate Many managers believe they get more bang for the buck by allocation dollars away
competitive positions in these markets. from base pay and into variable forms that more effectively shape employee
behavior.

The three factors usually used to determine the relevant labor markets are:
Pay with competition (Match)
1. The occupation (skill/knowledge required),
Given the choice to match, lead, or lag, the most common policy is to match rates paid by
2. Geography (willingness to relocate, commute or become virtual employees), and competitors. A pay-with-competition policy tries to ensure that an organizations wage costs are
approximately equal to those of its competition and that its ability to attract applicants will be
3. Competitors (other employers in the same product/service and labor markets).
approximately equal. Classical economic models predict that employers meet competitive wages.
Defining the Relevant Market

If the markets are incorrectly defined, the estimates of competitors pay rates will be incorrect and the
pay level and mix inappropriately established.
Lead Policy 1. Select the jobs to be surveyed

A lead policy maximizes the ability to attract and retain employees and minimizes employee 2. Define the relevant markets
dissatisfaction with pay. Several studies found that variable pay (bonuses and long-term incentives) is
related to an organizations improved financial performance but that pay level is not. 3. Select the firms to be surveyed

A lead policy can also have negative effects. It may force the employer to increase wages of current 4. Determine the information to ask
employees to avoid internal misalignment. A lead policy may mask negative job attributes that may lead 5. Determine the data collection technique
to high turnover.
6. Administer the survey
Lag Policy
2. Specify Competitive Pay Policy
A policy of paying below market rates may hinder a firm’s ability to attract potential employees. It
is possible to lag competition on pay level but lead on other returns from work (e.g. hot assignments, • An external pay policy requires information on the external market
desirable location, outstanding colleagues, cool tools, work/life balance).
• Surveys provide the data for translating that policy into pay levels, pay mix & pay
Flexible Policies
Structures
In practice many employers go beyond a single choice month the three policy options. They may
vary the policy for different occupational families, different business units etc. 3. The Purpose of a Survey

Limited attention has been devoted to pay-mix policies. Some obvious alternatives include: A. Conducting a salary survey is necessary to obtain data to set an organization’s pay policy
relative to its competitors.

• Performance driven
B. An employer conducts/participates in a survey for the following reasons
• Market driven

• Work/life balance • It is an opportunity to collect information to make judgment regarding compensation

• To adjust pay to changing external pay rates and recognize pay trends in marketplace
Lesson 9: Designing Pay Levels, Mix, and Pay
• To establish/develop or price an adequate pay structure
DESIGNING PAY LEVELS, MIX AND PAY STRUCTURES
• To analyze personnel problems that may be pay related
1. Major Decisions
• Defending pay practices in a court of law
There are seven major decisions involved in setting externally competitive pay and designing the
corresponding pay structures. • To attempt to estimate the labor costs of product market competitors
1. Specifying employer's external/competitive pay policy • Hiring and retaining competent employees
2. Define the purpose of the survey • Promoting worker productivity
3. Select the relevant market competitors C. Adjust Pay Level – How Much to Pay?
4. Designing and conducting surveys Market surveys provide information so that an employer will be able to adjust the firm's pay levels
5. Interpreting survey results and constructing the market line relative to competitors (ex. AACSB salary survey).

6 Constructing a pay policy line that reflects the external pay policy 1. Most organizations make adjustments to employees’ pay on a regular basis

7. Balancing competitiveness with internal alignment through the use of ranges, flat rates, and/or bands. 2. These adjustments can be based on one, or more, of the following issues:

A survey is the systematic process of collecting and making judgments about the compensation paid by a. overall upward movement of pay rates caused by competition for people in
other employers. the market.

Steps in conducting wage and salary surveys: b. performance.

 c. ability to pay. D. The generalizations do not always hold true.

d. terms specified in a contract. Examples include:

D. Adjust Pay Mix – What Forms? 1. In areas with high concentrations of scientists, engineers, and managers, the primary market
comparison may be regional, with national data used only secondarily
1. The mix of forms and their relative importance makes up the “pay package”
2. Some larger firms ignore local market conditions
2. Adjustments to the different forms that competitors use (base, bonus, benefits, etc)
& the relative importance they place on each form occur less frequently than E. Research suggests that if skills are tied to a particular industry, as underwriters, actuaries, and claims
adjustments to overall pay level representatives are to insurance, the market should be defined on an industry basis

3. It is unclear why changes to the pay mix occur less frequently than changes in the 1. If certain skills, i.e. accounting, sales, clerical, are not limited to one particular
pay level industry, then industry considerations are less important.

4. Since some pay forms may affect employee behavior more than others, collecting 2. From the perspective of cost control and ability to pay, competitors in the
information on total compensation, the mix of pay competitors us, and costs of product/service market should be included since the pay rates of these competitors
various forms is increasingly important will affect both an employer’s costs of operations and its financial condition.

E. Adjust Pay Structure F. While the quantity of data available for international comparisons is improving, using the data
to adjust pay requires a lot of judgment.
Survey information used for directly valuing jobs in some cases in other instances, used to validate job
evaluation results (see if market rates vary greatly from those obtained in the firm’s job evaluation) G. Fuzzy Markets

F. Study Special Situations 1. New organizations and jobs fuse together diverse knowledge and experience, so “relevant” markets
appear more like “fuzzy” markets
1. Information used to review competitor pay scales in case of high turnover or to justify
differentials between certain genders dominated jobs in legal situations b. Organizations with unique jobs and structures face the double bind of finding it hard
to get comparable market data at the same time they are placing more emphasis on
2. Many special studies appraise the starting salary offers or current pay practices for targeted external market data
groups, such as patent attorneys, sales managers, or software engineers.
Design the Survey
G. Estimate Competitors' Labor Costs
A. Consulting firms offer a wide variety of surveys covering almost every job family and
1. Surveys allow for organizations to compare labor costs industry group imaginable.
especially in a highly competitive industry, as input for
decisions making, etc. B. Survey design involves considering the following issues:

2. They may use salary survey data to benchmark against 1. Who should be involved in the survey design?
competitors’ product pricing and manufacturing practices
2. How many employers should be included?
4. Select Relevant Market Competitors
3. Which jobs should be included?
A. To make decisions about pay level, mix, and structures, a relevant labor market must be
defined that includes employers who compete in one or more of the following areas Relevant 4. What information should be collected?
markets are expressed as: C. Whom to Involve?
• Employers who compete for the same occupations and skills required • Compensation specialist or HRM manager
• The geographic distance employees are willing to commute/relocate • Operating managers
• Employers who compete with the same products/services • Employees (task managers)
B. As the importance and complexity of qualifications increase, the geographic limits also increase • Outside consultants (avoid wage fixing allegations)
C. Competition tends to be national or international for managerial and professional skills and D. How Many Employers?
local or regional for clerical and production skills
 • Depends on circumstances, no set/magic numbers (problematic for global • Slot the remaining wage rates into the structure
companies)
3. Benchmark Conversion Approach
• In small markets with few employers: 2 or 3 firms
• Traditional approach
• In larger local markets with 200-300 positions: 12-24 firms
• Perform job evaluation on all jobs and use benchmarks on survey
• In national labor market and some regional survey: 100+ firms
• Transfer salary info from benchmark jobs & convert internal structure
• Salary surveys reflect industry, geographical area
F. What Information to Collect?
Publicly Available Data
Collect information about:
a. The Bureau of Labor Statistics is the major source of publicly available compensation data and
publishes extensive information on various occupations in different geographic areas • The nature of the organization (size, structure, financial)

b. While some private sector firms may track the rate of change in BLS data as a cross-check on
other surveys, the data are not specific enough to be used alone “Word-of-Mouse”
a. A click of the mouse makes a wealth of data available to everyone and means that managers
must be able to explain the salaries paid to employees compared to those a mouse-click away.
b. The quality of salary data on the Web is highly suspect.
Where Are the Standards?
• Information about the total compensation system (bonus, benefit)
• Actual rates paid to each incumbent for jobs included in survey
No survey includes all the data included in the discussion; the data collected depend on the purpose of
the survey.
Organization Data – data includes company identification, financial information, size of company, and the
structure of the organization..

A. Opinions about the value of consultant surveys are Rampant Total Compensation Data

B. Many firms select one survey as their primary source and use others to cross-check of validate • All the basic types of pay forms are required to assess the total pay package and
the results competitors’ practices

C. Some firms routinely combine the results of several surveys and weight each survey in a • Data collected includes:
composite based on a judgment of the quality of the data reported (1) Base pay – amount of cash competitors decided each job and incumbent is worth.
D. For staffing decisions, employment test designers report the test’s performance against a set of (2) Total cash – includes base plus bonus; indicates competitors’ use of performance-based cash
standards (reliability, validity, etc.) For market surveys and analysis, similar indices and payments.
standards do not exist
(3) Total compensation – includes total cash plus stock options and benefits
E. Which Jobs to Include?
7. From Policy To Practice: The Pay Policy Line
Keep the survey simple and include only enough jobs necessary to accomplish the purpose of the survey
and to encourage participation A. The pay policy line reflects external competitive position in the
market
1. Benchmark Jobs Approach
B. There are several ways to translate external competitive policy
• include only benchmark (stable in content) jobs in the surveys into practice
• ensure that benchmark jobs represent all function/levels in the firm 1. Choice of measure – based on Colgate’s stated policy, Colgate would use the 50th percentile for
• slotting of remaining jobs base pay and the 75th percentile for total compensation as compensation measures in its
regression
2. Low-High Approach
2. Updating – the approach used by an organization to update salary survey data reflects its pay
• Useful for skills based structure that has no match with competitors policy.

• Identify highest and lowest paid benchmark jobs for the relevant C. Policy Line as Percent of Market Line

• Skills and use these as anchors for skills based structures

 1. Another way to translate pay-level policy into practice is to simple specify a percent above or However, according to Chris Fusco, the Senior Vice President of Compensation at Salary.com, the external
below the regression line (market line) that an employer intends to match and then draw a new market is progressing in pay faster than merit pay increases alone can match. This makes top performers
line at this higher (or lower) level in your organization a flight risk, because they could potentially walk out the door just to take a job that
offers more competitive pay.
2. here are alternatives among competitive pay policies, and there are alternative ways to
translate policy into practice Addressing Market Movement with Pay-for-Performance Programs

3. if the practice does not match the policy, then employees receive the wrong message
Lesson 10: Employee Contributions Pay-for-Performance
EMPLOYEE CONTRIBUTIONS-PAY-FOR-PERFORMANCE
The term “pay-for-performance compensation” refers to performance-based pay programs where an
employee is incentivized and rewarded for achieving goals or objectives. Pay-for-performance plans are
extremely popular – according to salary.com’s recent Pay Practices and Compensation Strategy survey,
75% of organizations currently leverage pay-for-performance compensation as part of their overall
compensation plan.
In this competitive environment, many organizations are turning to variable pay programs to keep top
recruits’ and top performers’ pay competitive with the market. Whereas salary increase budgets have
remained flat at 3% for the last several years, data from Salary.com’s Pay Practices and Compensation
Strategy Survey shows that many firms are adding budget to their variable pay programs. According to
our survey, the percentage of organizations committing at least 10% of their payroll budget towards non-
discretionary bonuses and discretionary bonuses has more than doubled since 2017, while the
percentage of organizations committing less than 3% of their total payroll budget to such programs has
diminished over time.

Pay-for-performance compensation can come in many varieties depending on your organization’s budget,
compensation philosophy, and organizational goals. When designing a pay-for-performance plan, you’ll
want to consider the outcomes your organization is looking to achieve, the frequency with which you will
reward employees, and the total increase you will be budgeting to fund these programs.

It is important to review the organization’s strategic plan at least annually, and to discuss basic strategic
pay decisions with senior management to ensure the success of the pay-for-performance compensation
strategy and prevent serious consequences, such as employee turnover and lawsuits.

Goals for the Pay-for-Performance System

A compensation system should influence employees to make
personal decisions that are congruent with the organization’s
needs. Generally, this goal can be broken down into three parts:
• Motivate people to join the organization.
• Motivate employees to perform at the top of their skill
set.
• Motivate employees to stay.
How Does Pay-for-Performance Compensation Work?
There are two general categories of pay-for-performance compensation: merit pay increases and variable
pay programs. As you look to implement a pay-for-performance program in your organization, you can
use either of these two types of pay-for-performance plans – or both – to incentivize employee
performance and drive your desired outcomes.
1. Merit Pay Increases
A merit pay increase refers to an increase to an employee’s base pay due to high performance. These
raises are typically delivered an annual basis, and are budgeted for as part of the annual salary increase
budgeting process. Merit pay increases are the most commonly used pay-for-performance model for
recognition of employee performance, as they deferentially reward top performers for their contributions
with a bump to their base salary for the following year.
Proportion of Payroll Budget Allocated to Variable Pay
Clearly, the organizations that offer variable pay programs have seen performance boosts because of
these incentives, and are now beginning to allocate a larger proportion of their budget to them each year.
Variable Pay Programs
Variable pay programs encompass a variety of discretionary and non-discretionary bonuses that can vary
according to the payout period, the employees who are eligible, and the metrics that employees are
measured against. Unlike merit pay increases, variable pay programs are increasingly administered not
just annually but multiple times a year (e.g., once a quarter) and a mix of different variable pay programs
are often used in combination to achieve the desired results.
Discretionary bonuses are awarded on an ad-hoc basis to employees who demonstrate exceptional
performance, often without consideration of pre-defined goals and objectives. Some common
discretionary bonus types are:
• Spot bonuses – Reward employees “on the spot” for achievements that deserve special
recognition.
• Project bonuses – Reward employees for completion or superior completion of a specific
project.
 • Retention bonuses – Typically awarded to long-tenured employees, or employees in hot
jobs, to decrease their flight risk.
Nondiscretionary bonuses are awarded when employees, teams, or the entire organization meets
specific, pre-defined goals and objectives. Based on the duration of the assessment period (the amount of
time over which performance is measured), they are considered either short-term incentives (STI) or
long-term incentives (LTI). Some common nondiscretionary bonus types include:
• Company-wide bonuses – these focus around specific improvement goals for the
organization, and reward employees based on how much improvement is made on these
goals within a certain period of time.
• Team-incentive bonuses – these focus around specific improvement goals for one team
(e.g., marketing or sales) and are rewarded based on performance for that team.
• Individual incentive bonuses – these plans are often based on predetermined, measurable
business objectives (MBOs) that are evaluated periodically (e.g., each quarter) based on
one person’s performance.
Of all the variable performance bonus types, individual incentive pay plans were the most popular, used
by 53% of participants in our survey. An organization’s pay-for-performance compensation strategy will
likely include a combination of merit increases and short-term incentive plans.
Hiring bonuses and referral bonuses, while not tied pay for performance, were the most widely used form
of bonus compensation in according to the survey. These bonuses are designed to attract and hire strong
candidates, and are especially popular in today’s tight recruiting market.
Bonuses in Use
A Proven Recipe to Boost Employee Engagement – Compensation and Performance
The research also shows that organizations with a formal pay-for-performance philosophy are more
than twice as likely to have above average or excellent employee engagement. That means that tying
compensation to performance can be a strategic human resource management strategy.
Pay-for-performance compensation models improve employee engagement and retention by clearly
tying employee or company achievement of performance goals to tangible financial rewards. These
programs also enable employees to see a clear connection between the work they do every day and the
success of the company as a whole.
Since they are frequently awarded, they can also facilitate more regular conversations about individual
and company performance, allowing managers to provide critical feedback outside the annual review
process.
Pay-for-performance compensation plans are not just necessary to keep up with today’s talent market.
Pay-for-performance plans can help employees grow professionally due to their desire to be rewarded.
Frequent rewards can also lead to increased employee retention, as the money motivation helps keep
staff at your business long-term. And of course, increased retention will lead to greater productivity and
lower turnover costs.
What are some constraints?
It is too easy for an employer to take a shortcut and not acknowledge that all organizations have to work
within some important constraints when managing their pay-for-performance system. There are five
major constraints: the organization’s ability to pay; legal constraints; union and non-union issues; the
internal labor market and the external labor market.
1. Ability to pay. Fancy compensation programs are impressive, but the bottom line is that an
organization must be able to afford its pay system. This is true in good and in bad financial times. It is
critical that design decisions align with the organization’s financial ability to pay. By partnering with an
organization’s chief financial offer, it will be easier to develop a plan that makes sense financially.
2. Legal constraints. In general, base pay plans are regulated by the Fair Labor Standards Act (FLSA), which
regulates wages, hours and recordkeeping.
3. Union/non-union issues. For unionized organizations, pay issues are a mandatory bargaining issue that
must be negotiated. Organizations must obtain buy in from union leadership early in the negotiation
process to be successful in changing the way they pay their employees.
4. Internal labor market. This is where internal equity comes into play. Pay plans must motivate
employees to want to stay with the organization and, hopefully, take on management roles or higher-
level technical roles in the future. To illustrate, an organization can structure a pay plan that will motivate
high-level technical employees to move out of overtime-eligible positions into first-line management
positions that do not pay overtime.
5. External labor market. In today’s global market, organizations cannot operate their pay plan in a
vacuum. Basic economics of supply and demand affect employee compensation. To illustrate, the amount
of education required to become a pharmacist recently changed. To compound the problem, Medicare
added a pharmacy plan for senior citizens. This resulted in a shortage in pharmacists and an increase in
pay levels for the job.
Collecting information regarding the above compensation questions and issues will give HR professionals
a good start in developing a compensation philosophy that can then be shared internally with their
employees and externally with the general public, customers and potential applicant pool.
HR professionals should enlist senior management to help champion the compensation philosophy as a
working document that can set the stage for the design of a new compensation system.
Lesson 11: Pay for Performance Plans
PAY FOR PERFORMANCE PLANS
Pay-for-performance compensation can come in many different forms depending on an organization’s
budget, compensation philosophy, and organizational goals. However, despite their usefulness in building
a competitive compensation plan, very few organizations have feasible and effective pay-for-
performance models in place.
The Pros and Cons of a Pay-for-Performance Model
Despite embracing its concept, many employers claim that their pay-for-performance programs
are failing in driving and rewarding individual or group performance.
In a Talent Management and Rewards Pulse Survey conducted by Willis Tower Watson, a surprisingly
large number of North American employers claimed their programs were not accomplishing what they
had promised they would do. Specific findings included:
• Only 20% North American companies find pay-for-performance effective in driving higher levels
of individual performance at their organization.
• Only 32% claimed that their performance-based pay program is effective in differentiating pay
based on individual performance.
• 53% agreed that annual incentives are ineffective in differentiating pay based on how well
employees perform.
The survey also pointed out the discrepancies in employee’s understandings of how merit is specifically
measured, with their understandings of the merit-influencing values not aligning with their employers.
For example, two-thirds (64%) of employees claim the managers at their organization consider the
demonstration of knowledge and skills in an employee’s current role when making pay-increase
decisions. However, less than half (46%) claim their programs are designed to take these performance
indicators into consideration.
Pay-for-performance models can be great tools in driving performance and recognizing and reward top-
performing employees, but only when they are designed and implemented correctly. Traditional thinking
on merit-based pay is no longer applicable – companies instead need to define what performance means
specifically for their organization, and what managers can do to ensure they are driving the right
performance.
Re-evaluation the objectives of rewards programs can help to realign pay-for-performance models with
their benefits, rather than misaligning them and causing detriments.
Implementing an Effective Pay-for-Performance Model
While the concept of constructing and implementing a merit-based compensation model may seem
daunting to many organizations, there are several tricks you can use to do it effectively and ensure it is
sustainable in the ever-changing job market.
Most employee performance can be classified into one of the two categories:
1. Qualitative Performance – activities related directly to customer experience and outcomes, such as
sales, customer satisfaction, employee engagement, employee productivity, etc.
2. Quantitative Performance – activities related to the operations side of the organizations, such as
programming, accounting, administration, etc.
Once an employee’s performance is quantified, it becomes much easier to link their performance to
rewards, guiding you towards a fair and flexible pay-for-performance model suitable to your
organization.
Best Practices in Linking Performance to Rewards
1. Identify the triggers for top performers.
Not every employee will view higher base pay or bonuses as the ultimate form of reward. Management
should recognize what specifically drives engagement and productivity in their top performers, allocating
the annual budget to flow into these triggers specifically.
2. Identify clear-cut objectives for employees.
Pay-for-performance heavily relies on both the employee’s and the employer’s understanding of what
good performance actually looks like. When the ‘what’ of performance is clearly articulated, employees
will have a better understanding of what they’re working towards, making the measurement of
performance against your model much more cohesive.
3. The Benefit of Linking Pay to Performance
The objective of any pay-for-performance model should be maintaining a structure that rewards the
employees who best contribute to organizational and departmental goals. Establishing fair and consistent
practices in how you reward and compensate performance is critical.
5 Components of an Effective Pay-for-Performance Program
There are 5 major components of an effective pay-for-performance program:
1. Evaluation forms.
These can be differentiated by employee groups if necessary. The evaluation form should clearly show
the rating options for each category or goal and overall ratings. The form should clearly define what
constitutes each performance or rating level. (For example, what would constitute "outstanding"
performance for one of the specific goals? What does the employee need to do to be rated as
"outstanding" overall? This should be clearly spelled out.)
2. Administrative manual or handbook for managers
It should be something managers can reference to ensure they're conducting the evaluations correctly.
The guidebook should provide the rules for ongoing administration and effectiveness.
3. Initial and on-going training
Effective pay-for-performance programs require consistent and ongoing training from HR at key points:
when the plan is first introduced, when the plan is changed, and when employees are promoted into
managerial positions. HR must also monitor how well managers are using the program and may need to
hold refresher training sessions to remind managers of the process.
4. Effective communication channels
Communication needs to occur both from top management to managers and from managers to staff.
Communications should be both written and verbal. HR has a very important role in the process, acting as
liaison, interpreter, and problem-solver.
5. On-going coaching and feedback
Pay-for-performance programs can't be based solely on annual performance evaluations. Continual
conversations are needed to support the program and to support employee development throughout the
year. Effectiveness of the program is also based on ongoing coaching and feedback.
workers rely on commissions and/or bonuses for their income. While this can result in less of a sense of
financial security for the employee, there are several advantages for both the employee and employer.
1. Unlimited Compensation
A pay-per-performance plan can sometimes result in situations where the employee may be able to earn
a substantial income. A talented salesperson who works strictly on commission may be able to earn more
money than a salaried salesperson since he is paid based on the volume of sales. Depending on the
compensation structure and the amount of effort put forth, the result could be a six-figure income.

On-going coaching and feedback between the manager and the employee throughout the performance 2. Increased Motivation
period ensures that the employee is on track. These sessions also ensure that the manager reinforces the
right behaviors by providing positive feedback, and that the manager provides coaching to correct areas The opportunity to earn a substantial income can lead to increased motivation. Since employees are
that may need improvement. Ultimately, the goal is to enhance performance throughout the year in compensated based on performance, they may be more likely to work harder and longer in order to
order to avoid surprises at the review meeting. reach income goals.

Challenges of Pay for Performance 3. Flexibility

Despite the obvious benefits of pay for performance plans, they are not always easy to implement
correctly and successfully. Here are a couple of reasons why:
1. Wrong Tools: Not all companies are equipped with the appropriate tools to assess the
performance of every employee.
2. Poor Tracking: In many organizations, goals are set, and then forgotten. There is no
accountability between the goal setter (manager) and goal achiever (employee). This drastically
reduces the effectiveness of pay for performance plans.
Employees who are paid based on their performance are typically judged by results rather than more
subjective methods, resulting in increased flexibility. For example, life insurance salespeople often make
their own appointments and set their own schedules. They will be evaluated not by how much time they
spent working or the sales methods used, but by their sales volume.
4. Increased Productivity
From the employer's standpoint, productivity may increase due to the employee's desire to earn a high
income. The result can be greater productivity from fewer workers, reducing the employer's labor cost
and transferring the financial risk from the employer to the employee.

5. Better Retention
Having the wrong tools and wrong approach to pay for performance not only wastes precious hours and
resources of the people, but also creates the illusion among employees that pay for performance plans High-achieving performers who are happy with their income and work environment may be more likely to
are ineffective. stay instead of exploring other opportunities. They can also attain a certain level of prestige and respect
in the company due to their achievements.
The Guide to Successful Pay for Performance Plans

A successful pay for performance plan requires consistent engagement with the employees to let them
know that their performance has a direct impact on the compensation they will be receiving. In other
words, the communication and education to them needs to be clear and effective. Besides these, here
are some more elements to that constitute a successful pay for performance plan:

• Easy to use

• Automated workflow

• Real time visibility to improve decision-making

• Clear communication of goals and objectives

• Integration with other databases and software suites

The Advantages of Pay for Performance Plans

Pay-for-performance plans are a method of compensation where workers are paid based on productivity,
as opposed to hours spent on the job or at a set salary. They are often used in fields such as sales, where