COMPENSATION

from their leaders. Thus, leadership behaviors must be consistent with the
values and philosophy of the compensation system. If behaviors that support
the desired and required norms and values of the new culture are rewarded,
then people will get the message that compensation is tied to cultural leader-
ship. If the compensation system continues to reward old ways of doing busi-
ness, then cultural proclamations and business imperatives will ring empty
and employees will become increasingly cynical. In order to create an envi-
ronment in which people feel great about their jobs, the compensation
system must be aligned with stated values and operating principles. Leaders
must be clear about performance expectations and how associates will be
rewarded.
At the foundation level, rewards need to be in line with the market and sup-
port the business strategy. Organizations need to make a policy decision to
pay at the 50th percentile, the 75th percentile, or whatever is appropriate.
If a company pays less than the 50th percentile, there will need to be multi-
ple factors in the culture to “compensate” for a lack of compensation or it
will be impossible to attract great talent or star performers. On the other
hand, the strategy may not be to hire stars. The compensation strategy may
be to attract solid performers by paying fair wages in exchange for security
and growth opportunities. In essence, the compensation strategy should
reflect the needs of the business strategy in attracting the most appropriate
15
talent.
Once a company decides the strategy and the corresponding pay percentile,
benchmarking analyses are required to determine the comparability of each job
in relation to market rates. In order to execute business strategy, it is usually nec-
essary to compete for appropriate talent. Business strategy drives decisions
related to compensation because it specifies requirements for critical talent that
can only be acquired and retained through competitive compensation programs.
The corporate culture also influences compensation decisions because it either
consists of a number of compelling reasons for joining or staying with a com-
pany (for example, a winning company, great branding, quality of life, career
development, or any of the Great Job/Great Company indicators listed in the
Introduction) . . . or it doesn’t. If there are few compelling reasons for joining
or staying with a company other than compensation, then the compensation
package will need to be very rich. A good compensation system does not keep
people focused on their compensation, it keeps them focused on other com-
pelling aspects of the organization because pay is not a distraction. Again, the
operative word is fairness. Employees will always ask, “Am I being paid fairly
and rewarded appropriately for my contributions to what the company says is
important?”
 HR OPTIMIZATION

Decisions surrounding compensation present a terrific opportunity for HR busi-

ness partners to take a leadership role with their clients. Since compensation
usually tops the list of what’s most important to corporate clients, business
partners can add real value to their clients through their consultation on
compensation issues. In any company, the way compensation issues are handled
is critical to the perceived effectiveness of HR.
It is also important to minimize inequities within departments. Over a period of
time, because market rates vary according to supply and demand curves, there
may be several people in a department doing very similar jobs but who are paid
at significantly different rates. For example, one person may have been hired as
a computer programmer in 1997 when the market value for such jobs was
$50,000. Another programmer could have been hired in 2000 when the market
rate for the same job was $75,000. Thus, while appropriate market measures
were used to determine salary, the changing rates create inequity issues within
the department. These issues are compounded when gender and race come into
play. Salary offers, merit increases, and other compensation decisions must take
into account both comparability and equity considerations. These issues typically
consume a large share of compensation specialists’ time.
While it seems to be common sense to tie rewards to individual performance,
16 this practice is far too uncommon. We have worked in multiple corporations in
which the compensation team and performance management team did not talk
to each other. Unfortunately, very few organizations are satisfied with their per-
formance management system and even fewer believe that performance is linked
fairly and accurately to compensation. In too many cases, employees perceive
that rewards are tied more to who you know than to what you deliver. This per-
ception violates one of the primary characteristics of a “great job”: I am fairly
compensated. While performance management will be discussed in more detail
in Chapter 12, it is important to make the connection here. The other common
factor that causes employees to rate a job as “depressing” is to have an opinion-
ated boss who uses only one source of input to make compensation decisions—
his or her own perception. Not only are managers often not in the best position
to evaluate performance, they may also suffer from biases that could taint their
evaluations. In the worst of cases, the manager may be a golfing buddy of an
employee who is of the same age, race, sex, background, and sexual orientation.
This employee may benefit from a “halo effect,” while another employee from
a different set of circumstances may be unjustly compensated. These situations
feed the negative perception among employees that compensation decisions are
based more on “how you dance vs. what you do.” In single-rater situations,
quiet contributors are also often ignored unless the manager is finely attuned to
each employee’s various levels of contribution. When compensation is linked
 COMPENSATION

closely to performance and employees feel that evaluation decisions are done
fairly and accurately, employees are much more likely to proclaim, “I’ve got a
great job!”
Assuming that a company has addressed internal equity and market comparabil-
ity issues and that compensation is linked intimately to performance, the next
level of achievement is to tie compensation to organizational performance. This
linkage is typically accomplished through incentive programs. When bonuses are
given every year independent of the financial performance of the firm, then
employees begin to see this form of compensation as an entitlement. If bonuses
are tied to company performance, employees are more likely to think interde-
pendently and the company has a greater chance of survival in tough economic
times. If employees know that they will be compensated based on how well the
company achieves its revenue and profitability goals, then everyone will actively
seek ways to help each other succeed. A one-team mentality starts to take form
in which all members of the community work collaboratively for the greater
good. This phenomenon is what makes people experience their everyday work
experience as a great job. Feeling part of a community in which all members are
focused on common goals leads to greater satisfaction than simply working inde-
pendently to collect a pay check each week. It is important to point out, however,
that variable compensation can only be leveraged so far. Base salary needs to be
fair enough for employees to “hang in” during tough times. The perception of 17
fairness is based on both structural fairness and reward fairness. Structural fair-
ness relates to how the job fits into the career path framework; reward fairness
relates to the amount and timing of incremental increases.
At level 5 on our compensation scale, reward systems are tied to desired behav-
iors and values. Stock option grants are the most common way of making a
statement that particular behaviors are valued and that the organization wants
the person to remain in the community. When stock option grants are awarded
to people who achieve financial goals at the expense of all other stated values
in the culture, employees rightly conclude that they are simply a member of a
mercenary community with one value—money—not a growth community in
which several values are rewarded and recognized. Linking rewards to desired
behaviors and values requires three key elements: (1) a clear articulation of what
the desired behaviors and values are; (2) a commitment to tie compensation to
those behaviors; and (3) a reward system that takes into account the contribu-
tion that individuals make to the desired culture. Articulating the desired values
is not an event that the executive committee performs; it is a process in which
employees at all levels of the organization participate. If employees are involved
in the process of stating desired behaviors and values, they will be much more
likely to own them. When values are clear, they can become a vital part of the
 HR OPTIMIZATION

performance management system, so employees get regular feedback on how

well they are contributing to the values or detracting from them. That feedback
should influence compensation adjustments.

Your Critical Success Factors

The Reality
While the theoretical constructs of compensation appear logical, the reality
often presents many challenges. Here are some examples from our experience.
Tenured vs. new employees. With changing economic conditions, it is not
unusual for people to be recruited into the organization in boom times with
inflated salaries. When this happens, loyal employees who have served many
years may find themselves with far smaller salaries than new employees with less
experience. These situations, which are difficult to avoid, are even more difficult
18 to resolve when the economy slows and profit margins come under pressure. Do
you always pay market value for new jobs? Do you always limit pay raises for
existing employees to a certain amount? What happens when you refuse to pay
inflated market values or if you start making exceptions for certain employees?
If rigid adherence to a philosophy of limiting pay raises to a certain percentage
results in a situation in which employees have to quit and return to get signifi-
cant bumps in compensation, how do you deal with those employees and the
ones who stayed with you and came up short?
Legacy products vs. new technologies. Supply and demand curves sometimes
create bidding wars for people who have skills in hot products. For example,
when SAP first emerged, consulting companies were paying “hot skills” bonuses
to attract people who had SAP implementation skills. The problem occurs when
the supply and demand curve shifts and the hot skills cool off. What happens if
the bonuses for these skills are baked into base salary? Do you take away the
bonus? Should you use variable compensation to deal with “hot skill” pressures
on compensation?
Transfers between organizations. In many organizations, some departments
follow the compensation rules, while other departments don’t. When an individ-
ual transfers from a department that doesn’t follow the rules into a department
that does, what do you do if the person’s compensation is far above his or her
 COMPENSATION

colleagues in the new organization because he or she benefited from exceptions?

For example, a Web designer in marketing with essentially the same job as a
Web designer in IT makes much more money because the marketing department
tended to pay higher wages and regularly made exceptions to the rules. In
addition, the person in marketing has an incentive plan and the person in IT
does not. What do you do when the marketing person gets transferred to IT?
What do you do when exceptions become the rule?

Your Reality

Top Ten Lessons Learned

1. It is important to start with a guiding philosophy and stick to it.
19
2. HR business partners can have a tremendous impact on the business by
optimizing the compensation value proposition.
3. Effective compensation policy requires a balanced approach with thought-
ful consideration for how compensation is configured among base, variable,
and stock incentives.
4. As the business climate changes and business strategy changes, compen-
sation must adjust policies to be aligned with the changes.
5. The leadership team must own and believe in the compensation strategy.
6. It is critical to be able to accommodate exemplars and star performers
without destroying internal equity.
7. Compensation is as much art as science.
8. Compensation decisions need to take into account performance, equity,
and market conditions.
9. Structured flexibility is the best policy. There is always a need for discretion.
10. Compensation must be interdependent with other initiatives such as
performance management, career development, etc.