Strategic Compensation: A Human

Resource Management Approach

Chapter 1
Strategic
Compensation: A
Component of
Human Resource
Systems
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Learning Objectives (1 of 2)
1.1 Define strategic compensation.
1.2 Summarize the role of compensation as a strategic
business partner.
1.3 Explain strategic compensation decisions.
1.4 Identify and discuss the building blocks and
structural elements of strategic compensation
systems.

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Learning Objectives (2 of 2)
1.5 Describe the fit of the compensation function in
organizations.
1.6 Identify the stakeholders of the compensation
function and summarize their stakes in the work
compensation professionals perform.

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Learning Objective 1.1
• Define strategic compensation.

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What Is Compensation?
• Compensation represents the rewards employees receive
for performing their jobs. These rewards are either:
– Intrinsic: intrinsic compensation represents
employees’ critical psychological states that result from
performing their jobs
– Extrinsic: extrinsic compensation includes both
monetary and nonmonetary rewards

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What Is Strategic Compensation?
• Strategic Compensation refers to the design and
implementation of compensation systems to reinforce the
objectives of both HR strategies and competitive business
strategies.

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Competitive Business Strategy
• The planned use of company resources
– Financial capital
– Equipment capital
– Human capital
• Multiple years of time span
• Competitive strategy choices
– Lowest cost strategy
– Differentiation strategy

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Human Resource Strategies
• The use of multiple HR practices to reinforce competitive
business strategy, for example:
• We (Eli Lilly) are a global healthcare leader
headquartered in Indianapolis, IN. Our 39,000
employees around the world work to discover and
bring life-changing medicines to those who need
them, and improve the understanding and
management of disease.

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Relationship Between Strategic
Decisions and Compensation Practices

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Learning Objective 1.2
• Summarize the role of compensation as a strategic
business partner.

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Compensation as a Strategic
Business Partner (1 of 3)
• HR and compensation professionals need to think like the
chief executive officer (CEO)
• These individuals can give the CEO and chief financial
officer (CFO) an understanding of how employees
combine with business processes to expand or shrink
shareholder value

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Compensation as a Strategic
Business Partner (2 of 3)
• Think about the role of capital for value creation
• Capital refers to the factors that enable companies to
generate income, higher stock prices, economic value, and
reputation
• Human capital refers to sets of collective skills,
knowledge, and abilities that employees can apply to
create value for their employers

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Compensation as a Strategic
Business Partner (3 of 3)
• Compensation professions can leverage the value of
human capital in a variety of ways:
– Well-designed merit pay and incentive programs, which
reinforce excellent job performance
– Incentive programs which reduce employee entitlement
– Person-focused pay which is based on extensive
employer-sponsored training that enables employees
to work in changing environments

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Learning Objective 1.3
• Explain strategic compensation decisions.

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Strategic Compensation Decisions (1 of 2)
• Compensation professionals provide a strategic
contribution when they can answer yes to 3 questions:
– What are the competitive business strategy options
and does compensation strategy fit well with the
objectives of company competitive business and HR
strategies?
– Does the choice and design of compensation practices
fit well to support compensation strategy?

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Strategic Compensation Decisions (2 of 2)
• Does the implementation of compensation practices
effectively direct employee behavior to enhance job
performance that supports the choice of compensation
practices?

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Competitive Business Strategy
Choices
• Lowest cost strategy: focus on being lowest cost
producer/seller of goods or services
• Differentiation strategy: focus on offering unique goods
or services to the public

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Lowest Cost Strategy
• Effective when jobs:
– Include predictable behaviors
– Have a short-term focus
– Require autonomous activity
– Focus on quantity of output
• Ex: Ryanair (reduced operations costs).

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Differentiation Strategy
• Effective when jobs:
– Require highly creative behaviors
– Have a long-term focus
– Demand cooperation and independence
– Involve risk-taking
• Ex: Apple Computer relies on this strategy to build market
demand and loyalty and strives to establish leading-edge
electronic devices.

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Learning Objective 1.4
• Identify and discuss the building blocks and structural
elements of strategic compensation systems.

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Building Blocks and Structures of
Strategic Compensation Systems (1 of 2)
• The main building blocks are extrinsic compensation and
intrinsic compensation
• Our focus is on extrinsic compensation:
– Core compensation
– Adjustments to core compensation
– Legally required employee benefits
– Discretionary employee benefits

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Building Blocks and Structures of
Strategic Compensation Systems (2 of 2)

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Base Pay
• Base Pay
– Hourly wage
– Annual salary
• Compensable factors
– An employee’s skill level
– An employee’s effort
– An employee’s level of responsibility
– The severity of the working conditions

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Elements of Core Compensation
• Base Pay
– Hourly pay
– Annual salary
• How Base Pay Is Adjusted over Time
– Cost-of-living adjustments
– Seniority pay
– Merit pay
– Incentive pay
– Person-focused pay or competency-based pay: pay-
for-knowledge, skill-based pay

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Base Pay Adjustments (1 of 2)
• COLAs: COLAs represent periodic base pay increases
that are founded on changes in prices as indexed by the
consumer price index (CPI)
• Seniority pay: seniority pay systems reward employees
with periodic additions to base pay according to
employees’ length of service in performing their jobs
• Merit pay: merit pay programs assume that employees’
compensation over time should be determined, at least in
part, by differences in job performance

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Base Pay Adjustments (2 of 2)
• Incentive pay: incentive pay (or variable pay) rewards
employees for partially or completely attaining a
predetermined work objective
• Pay-for-knowledge plans: pay-for-knowledge plans
reward managerial, service, or professional workers, for
successfully learning specific curricula
• Skill-based pay: skill-based pay is used mostly for
employees who perform physical work and increases
these workers‘pay as they master new skills

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Employee Benefits
• Discretionary benefits
• Legally required benefits

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Discretionary Benefits
• Three broad categories
– Protection programs: provide family benefits,
promote health, and guard against income loss caused
by such catastrophic factors as unemployment,
disability, or serious illness
– Paid time-off: provides employees with pay for time
when they are not working
– Services: provides such enhancements as tuition
reimbursement and day care assistance to employees
and their families

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Legally Required Benefits
• Federal legislation designed to:
– Promote worker safety and health
– Maintain family income
– Assist families in crisis
– Provide assistance in case of
 Disability
 Unemployment

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Employer Costs for Compensation (1 of 2)
Table 1.2 Employer Costs per Hours Worked for Employee Compensation, Civilian Workers
Total Retirement
Compen Wages and Legally
sation and All Paid Supplemental Insurance Savings Required
Cost per Salaries Benefits Cost Leave Cost Pay Cost per Cost per Benefits Cost
hour Cost per per hour per hour Cost per hour hour hour per hour
blank worked hour worked worked worked worked worked worked

Cost Per Hour

Civilian
32.20 22.13 10.07 2.25 0.79 2.89 1.67 2.47
Workers

Occupational
Blank Blank Blank Blank Blank Blank Blank Blank
Group

Management,
professional, 53.38 36.74 16.65 4.32 1.26 4.36 3.28 3.44
and related

Sales and
24.02 16.83 7.19 1.54 0.53 2.39 0.87 1.87
office

Natural
resources,
construction, 34.03 22.54 11.49 1.91 0.97 3.19 2.17 3.25
and
maintenance

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 Employer Costs for Compensation (2 of 2)
[Table 1.2 continued]
Wages Paid Retirement Legally
and All Leave Insurance and Required
Total Salaries Benefits Cost per Supplemental Cost per Savings Benefits
Compensation Cost per Cost per hour Pay hour Cost per Cost per
Cost per hour hour hour worked Cost per hour worked hour hour
worked (in worked (in worked (in (in worked (in (in worked (in worked (in
blank dollars) dollars) dollars) dollars) dollars) dollars) dollars) dollars)

Production,
transportation,
26.75 17.54 9.21 1.64 0.95 2.99 1.10 2.53
and material
moving

Industry
Blank Blank Blank Blank Blank Blank Blank Blank
Group

Goods-
36.37 24.04 12.32 2.38 1.41 3.46 1.95 3.12
producing

Service 31.46 21.79 9.67 2.23 0.68 2.79 1.62 2.36

a
Includes workers in the private nonfarm economy excluding households and the public sector excluding the federal
government. Source: U.S. Department of Labor (December 10, 2014). Employer costs for employee compensation,
September 2014 (USDL: 14-2208). Available: www.bls.gov, accessed February 1, 2015.

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Fundamental Compensation System
Design Elements
• Compensation professionals promote effective
compensation systems by meeting three important goals:
– Internal consistency
– Market competitiveness
– Recognition of employee contributions

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Internal Consistency
• Achieved when the value of each job is clearly defined
• Represents
– Job structure
– Hierarchy
• Achieved using
– Job analysis
– Job evaluation

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Market Competitiveness
• Compensation policies that fit with business objectives
• Vital in attracting and retaining employees
• Based on:
– Strategic analyses
– Compensation surveys

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Individual Contributions
• Pay structures: determined by employees’
credentials, job knowledge, and job performance
• Pay grades: based on compensable factors
• Pay ranges: built on grades, uses midpoint,
minimum, and maximum pay rates

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Pay Grades and Ranges

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Alternative Pay Structure
Configurations
• Alternative pay structure configurations to be explored in
this book:
– Merit plans
– Sales compensation plans
– Broadband structures
– Two-tier wage structures
– Executive compensation
– Contingent worker compensation
– Expatriate compensation
– Compensation structures in countries other than the
United States
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Learning Objective 1.5
• Describe the fit of the compensation function in
organizations.

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Fitting the Compensation Function in an
Organization’s Structure (1 of 3)
• How HR professionals fit into the corporate hierarchy
– Line employees: directly involved in producing
companies’ goods or delivering their services such as
manufacturing leaders
– Staff employees: support the line functions, human
resource professionals and accountants are examples
of staff employees

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HR’s Role
• Jay Hannah of BancFirst Corporation:
– “The HR department is the source and keeper of
critical information, which is key in today’s workplace.
With the information they provide, we in turn can build
and design strategies to hire and retain the best
workforce possible. And this may sound cliché, but it’s
very true—the real competitive advantage is our
company’s human resources.”

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Fitting the Compensation Function in an
Organization’s Structure (2 of 3)
• Compensation profession roles:
– Executives: report directly to the corporation’s CEO or
head of a major division, perhaps responsible for the
entire compensation program
– Generalists: perform tasks in a variety of HR-related
areas such as involvement in most or all of the
compensation functions such as building job structures,
market competitive pay systems, and merit pay
structures

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Fitting the Compensation Function in an
Organization’s Structure (3 of 3)
• Compensation profession roles:
– Specialists: work within only one of the areas of
compensation practice such as compensation
survey development

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HR Practices
• HR professionals design and implement practices:
– Recruitment
– Selection
– Performance appraisal
– Training
– Career development
– Labor-management relations
– Employment termination
– Managing HR within the context of legislation

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Learning Objective 1.6
• Identify the stakeholders of the compensation function and
summarize their stakes in the work compensation
professionals perform.

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Stakeholders (1 of 6)
• Individuals or entities directly affected by compensation
practices:
– Employees
– Line managers
– Executives
– Unions
– U.S. Government

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Stakeholders (2 of 6)
• Employees rely on compensation professionals to:
– Develop and implement systematic training programs
– Inform them of training and pay links
– Offer discretionary benefits that provide:
 Income protection
 Paid time off
 Services

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Stakeholders (3 of 6)
• Line managers rely on compensation professionals to:
– Ensure knowledge of relevant laws to help them
make sound compensation judgments
– Advise for establishing pay differentials
– Train them how to properly evaluate jobs

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Stakeholders (4 of 6)
• Executives rely on compensation professionals to:
– Develop and manage sound compensation systems
– Insure the company’s practices are:
 Legally consistent
 Sufficiently attractive to recruit and retain
 Cost effective

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Stakeholders (5 of 6)
• Unions rely on compensation professionals to:
– Abide by their collective bargaining agreements
– Ensure they get their COLA adjustments and
seniority pay

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Stakeholders (6 of 6)
• The U.S. government requires compensation
professionals to:
– Keep updated and comply with all employment
legislation
– Demonstrate that alleged discriminatory pay
practices are not in fact discriminatory; or, are a
business necessity

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Copyright

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