Tenth Edition: Building Pay Structures That Recognize Employee Contributions

Strategic Compensation: A Human Resource
Management Approach
Tenth Edition
Chapter 8
Building Pay Structures
That Recognize Employee
Contributions
Copyright © 2020, 2017, 2015 Pearson Education, Inc. All Rights Reserved
Learning Objectives
8.1 Explain the concept of pay structures and the five steps
necessary to construct pay structures.
8.2 Discuss the components of merit pay systems.
8.3 Summarize the features of sales compensation plan
design.
8.4 Describe the essentials of person-focused pay program
design.
8.5 Summarize pay structure variations.
Learning Objective 8.1
• Explain the concept of pay structures and the five steps
necessary to construct pay structures.
Pay Structure
• Pay structures represent
– Pay rate differences for jobs of unequal worth
– The framework for recognizing differences in employee
contributions
• Companies recognize these differences by paying
individuals according to their:
– Credentials
– Knowledge
– Job performance
Constructing a Pay Structure
• Five steps:
1. Decide how many pay structures to construct.
2. Determine a market pay line.
3. Define pay grades.
4. Calculate pay ranges.
5. Evaluate results.
Step 1: Decide on the Number of Pay
Structures
• Exempt and nonexempt: companies establish these pay
structures for administrative ease
• Based on job families: executive, managerial, professional,
technical, clerical, and craft represent distinct job families
• Based on geography: companies with multiple, geographically
dispersed locations such as sales offices, manufacturing plants,
service centers, and corporate offices
Exempt and Nonexempt Pay Structures
• Exempt
– Not subject to overtime provisions
– Salaried supervisors, managers, professionals, and
executives
• Nonexempt
– Subject to overtime provisions
– Hourly, nonsupervisory
Step 2: Determine a Market Pay Line
• Market pay rates relative to company’s job structure
• Pay levels corresponding with pay line are market
competitive
• Rates promote internal consistency
Determine a Market Pay Line
Step 3: Define Pay Grades
• Based on compensable factors, values, management
philosophy
• Widths
– Narrow or wide
– Affects hierarchy and social distance
– Absolute or percentage-based job evaluation points
Pay Grade Illustrations
Step 4: Calculate Pay Ranges
• Build upon pay grades
• Pay grades represent horizontal dimension
• Pay ranges represent vertical dimension
Pay Grades and Ranges
Calculating Pay Ranges and Spreads
Table 8-1 The Impact of Alternative Range Spreads on Pay Range
Minimum and Maximum Values, with Midpoint of $25,000
Blank Range Range Range Range

Spread ($) Spread ($) Spread ($) Spread ($)
20% 50% 80% 120%
start fraction midpoint over 100 start expression $22,727 $20,000 $17,857 $15,625
midpoint
Minimum:
start fraction range spread over 2 end fraction
end expression100+(range
end fractionspread/2)
.
Maximum: $27,272 $30,000 $32,143 $34,375
minimum + (range spread × minimum)
Difference between maximum $4,545 $10,000 $14,286 $18,750
and minimum values
Pay Range Overlap
• Overlapping ranges: adjacent pay ranges overlap where
the highest rate paid in one range is above the minimum
pay rate, but less than the maximum rate, in the successive
pay grade
• Non overlapping pay ranges: adjacent pay ranges do not
overlap where highest rate in one range is equal to or
greater than the minimum pay rate in the successive pay
grade
Pay Compression
• When the pay spread between newly hired or less
qualified individuals, and more qualified job incumbents is
small
• Threatens competitive advantage
• Caused by:
– Failure to raise pay range minimum and maximum
rates
– Scarcity of qualified applicants
Green Circle Rates
• Paying below minimum pay rates
• Result from
– Paying employees who do not meet the minimum
requirements less than the minimum rate
– Failure to raise pay range minimum and maximum rates
Red Circle Rates
• Paying above maximum pay rates
• Results from
– Failure to raise pay range maximums
– Attempt to retain exemplary employees not ready for
promotion to jobs in successive pay grade
– Demotion of employee from a higher pay grade to a
lower pay grade
Step 5: Evaluate the Results
• The use of compa-ratios evaluates pay structures.
• Compa-ratios index competitiveness of internal pay rates
based on midpoints.
• Divide pay rates by midpoint
• Compa-ratio meanings
1 = market match rate
< 1 = market lag rate
> 1 = market lead rate
• Discuss the components of merit pay systems.
Merit Pay Systems
• Pay for Performance
• Considerations
– Communicate link between pay and performance
– Use effective appraisal methods
– Establish increase amounts and types
– Settle on base pay level
Merit Increase Amounts
• Reflects prior job performance levels
• Needs to motivate
• Needs to be meaningful
• Influenced by the cost of living
• Indexed as a percentage of budget
Timing
• Companies typically take one of two approaches in timing
of pay raises:
– Common review date or common review period
– Employee’s anniversary date
• Nonrecurring merit increases
Present Level of Base Pay
• Needs to be within limits of pay grade
• Consistent with new employees at similar jobs
• Needs to abide by mandates of:
– Title VII, 1964 Civil Rights Act
– Equal Pay Act of 1963
The Merit Pay Grid
• Amounts are determined by two factors jointly
– Performance ratings
– Position of employees’ present base pay rates within
pay ranges
Merit Pay Grid (1 of 2)
Table 8-2 Merit Pay Increase Grid
Performance Performance Performance Performance

Rating Rating Rating Rating Performance
Excellent Above Average Below Rating
Blank Blank (%) Average (%) (%) Average (%) Poor (%)
to
Q4 Goes $70,000 Blank Blank Blank Blank Blank
Q4 Goes to $65,000 5 3 1 0 0
Q4 Goes to $60,000 Blank Blank Blank Blank Blank
Q3 Goes to
 $55,000 Blank Blank Blank Blank Blank
Q3 Goes to $50,000 7 5 3 0 0
Merit Pay Grid (2 of 2)
Table 8-2 [continued]
Performance Performance Performance Performance

Rating Rating Rating Rating Performance
Excellent Above Average Below Rating
Blank Blank (%) Average (%) (%) Average (%) Poor (%)
to
Q2 Goes $40,000 Blank Blank Blank Blank Blank
Q2 Goes to $35,000 9 7 6 2 0

Q1 Goes to $20,000 12 10 8 4 0
Increases within Budget
• Determine performance categories and percentage of
employees in each
• Place percent in quartiles
• Put percent and quartiles into cells
• Estimate performance distribution
• Distribute increase to each cell
• Ensure total is within budget
Learning Objectives 8.3
• Summarize the features of sales compensation plan
design.
Sales Objectives
• Pay-for-Performance incentives
• Objectives:
– Improve sales productivity
– Improve sales coverage of current customers
– Grow sales overall
Sales Compensation Plans
• Salary only
• Salary plus bonus
• Salary plus commission
• Commission plus draw
• Commission only
Salary-Only Plans
• Fixed base compensation
• From the employees’ perspective → risk-free
• From a company’s perspective → burdensome
Salary-Plus-Bonus Plans
• Set salary coupled with a bonus
• Bonuses usually are single payment
Salary-Plus-Commission Plans
• Commissions based on percentage of price
• Spreads risks
• Designed to attract quality sellers
• Allows employees to do other tasks
Commission-Plus Draw Plans
• Draw
– Advance pay for living expenses
– Charged against future commissions
– Recoverable or non recoverable
• Provides strong incentive to excel
Commission Only (1 of 2)
• Straight
– Based on fixed percentage of sales price
– Ex: 10% commission, service sold $100 → $10
• Graduated
– Increased percentage rates for higher sales volume
– Ex: 5% commission, per unit for 100 units → 8%
commission per unit from 101 to 500, 12% commission
per unit in excess of 500
Commission Only (2 of 2)
• Multi-tiered
– Increased percentage rates for meeting and exceeding
sales goal
– Ex: 8% if total sales volume < 1,000 units, 12% if total
sales volume > 1000 units.
Fixed Pay and Compensation Mix
• Three main factors
– Salesperson’s influence on the buying decision
– Competitive pay standards within industry
– Amount of nonsales duties
• Describe the essentials of person-focused pay program
design.
Person-Focused Pay Programs
• Reward employees based on learning new skills and
knowledge
• Compensates on potential – the promise of future
performance
Skill and Knowledge Blocks
• Develop job descriptions (blueprint)
– Skills and knowledge needed
– Training required
– Accurate evaluation process
• Organize jobs into family/group
– List similar skills and tasks per job
• Group skills and knowledge into blocks
Sample Knowledge Block: Building Market
Competitive Compensation System
I. Strategic analyses
A. External market environment
B. Internal capabilities
II. Compensation surveys
A. Using published compensation survey data
B. Compensation surveys: Strategic considerations
C. Compensation survey data: Summary, analysis,
and interpretation
Transition Matters
• From job-based pay to person-focused pay:
– Assessment of skills and knowledge
▪ Who assesses
▪ On what
▪ How often
– Align pay with skills and knowledge structure
– Access to training
▪ Equal access to all
In-House vs Outsourced Training
er us
• Expertise
– Needed and available
• Timeliness
– How soon and how often
• Number of trainees
• Proprietary nature of topic
– Too sensitive to share
• Summarize pay structure variations.
Pay Structure Variations
• Broadbanding
• Two-tier wage structures
Broadbanding
• Consolidates pay grades and ranges
• Flattens corporate hierarchies
• Emphasizes teamwork
• Broadens job duties and responsibilities
• Promotes quicker decision making
• More latitude in pay rate decisions
Broadbands and Pay Grades
Two-Tiered Pay Structures (1 of 3)
• New employees paid less
• Temporary or permanent rewards
• Mainly in unionized companies
• May hinder recruiting
• Can lower employees’ morale
Table 8-4 Two-Tier Wage Structures
Typical Base Rate
Blank Assembler ($) Tool & Die ($)

Base Rate—Contract End 26.86 31.52
COLA Fold-In 1.19 1.19
New Agreement Base 28.05 32.71
Beginning COLA Float 1.06 1.06
Base Rate Plus COLA 29.11 33.77
Table 8-4 [continued]
Lump Sum Examples
Blank Assembler ($) Tool & Die ($)

October 2014 Settlement Bonus 3,000 3,000
September 2015 Performance Bonus (3%) 2,171 2,534
Note: Based on a standard 2,080-year, plus 10 percent overtime, with projected C OLA adjustments
based on inflation averaging 2.44 percent.
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Strategic Compensation: A Human Resource

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