BUS 681 Week 3 Assignment

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7 Building Market-Competitive Compensation Systems

Learning Objectives

When you �inish studying this chapter, you should be able to:

7-1. Explain the concept of market-competitive compensation systems and summarize the four activities compensation professionals engage in to create these systems.

7-2. Discuss compensation survey practices.

7-3. Describe how compensation professionals integrate internal job structures with external market pay rates. 7-4. Explain the basic concepts of compensation policies and strategic mandates: pay mix and pay level.

CHAPTER WARM-UP!

If your professor has assigned this, go to the Assignments section of mymanagementlab.com (http://mymanagementlab.com) to complete the Chapter Warm-Up! and see what you already know. After reading the chapter, you’ll have a chance to take the Chapter Quiz! and see what you’ve learned.

Compensation surveys function as a cornerstone in the development of market-competitive compensation systems. Well-designed and executed surveys provide compensation professionals with suf�icient data about other companies’ pay rates and practices to begin establishing competitive pay policies that are focused on pay level and pay mix. With sound data in hand, compensation professionals will be well positioned to establish pay structures (Chapter 8 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch08#ch08) ) that ful�ill strategic mandates and to effectively attract and retain talented employees.

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7.1 MARKET-COMPETITIVE PAY SYSTEMS: THE BASIC BUILDING BLOCKS

7-1. Explain the concept of market-competitive compensation systems and summarize the four activities compensation professionals engage in to create these systems.

Market-competitive pay systems (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss266) represent companies’ compensation policies that �it the imperatives of competitive advantage. Market-competitive pay systems play a signi�icant role in attracting and retaining the most quali�ied employees. Well-designed pay systems should promote companies’ attainment of competitive strategies. Paying more than necessary can undermine lowest-cost strategies: Excessive pay levels represent an undue burden. In addition, excessive pay restricts companies’ abilities to invest in other important strategic activities (e.g., research and development, training) because money is a limited resource. Companies that pursue differentiation strategies must strike a balance between offering suf�iciently high salaries to attract and retain talented candidates and providing suf�icient resources to enable them to be productively creative.

Compensation professionals create market-competitive pay systems based on four activities:

Conducting strategic analyses

Assessing competitors’ pay practices with compensation surveys

Integrating the internal job structure with external market pay rates

Determining compensation policies

First, a strategic analysis (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss430) entails an examination of a company’s external market context and internal factors. Examples of external market factors include industry pro�ile, information about competitors, and long-term growth prospects. Internal factors encompass �inancial condition and functional capabilities (e.g., marketing and human resources). If your instructor assigned this, you will have the opportunity to develop a strategic analysis plan in the Building Strategic Compensations Systems case, which is available in MyManagementLab.

Second, compensation surveys (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss67) involve the collection and subsequent analysis of competitors’ compensation data. Compensation surveys traditionally focused on competitors’ wage and salary practices. Employee bene�its have more recently become a target of surveys because bene�its are a key element of market-competitive pay systems. Compensation surveys are important because they enable compensation professionals to obtain realistic views of competitors’ pay practices. In the absence of compensation survey data, compensation professionals would have to use guesswork to try to build market- competitive compensation systems, and making too many wrong guesses could lead to noncompetitive compensation systems that undermine competitive advantage.

Third, compensation professionals integrate the internal job structure (Chapter 6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch06#ch06) ) with the external market pay rates identi�ied through compensation surveys. This integration results in pay rates that re�lect both the company’s and the external market’s valuations of jobs. Most often, compensation professionals rely on regression analysis, a statistical method, to achieve this integration.

Finally, compensation professionals recommend pay policies that �it with their companies’ standing and competitive strategies. As we discuss later in this chapter, compensation professionals must strike a balance

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between managing costs and attracting and retaining the best-quali�ied employees. Top management ultimately makes compensation policy decisions after careful consideration of compensation professionals’ interpretation of the data.

Ideally, companies engage in these steps annually to ensure that their systems remain competitive as market pay rates generally rise over time. Recent survey data indicates that most companies update their pay structures on an annual basis followed by companies that update their structures as needed based on market conditions.1

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end1) Compensation plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss65) represent the selection and implementation of pay level and pay mix policies over a speci�ied time period, usually one year.

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7.2 COMPENSATION SURVEYS

7-2. Discuss compensation survey practices.

Compensation surveys contain data about competing companies’ compensation practices.

Preliminary Considerations

There are two important preliminary considerations compensation professionals take under advisement before investing time and money into compensation surveys:

What companies hope to gain from compensation surveys

Custom development versus use of an existing compensation survey

WHAT COMPANIES HOPE TO GAIN FROM COMPENSATION SURVEYS

Clarifying what companies hope to gain from compensation surveys is critical to developing effective compensation systems. Compensation professionals usually want to learn about competitors’ compensation practices and something about employees’ preferences for alternative forms of compensation due to economic changes. Staying abreast of new developments in market surveys will enable compensation professionals to get the most out of surveys. Oftentimes, compensation professionals think about surveys as a translator.2

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end2) Information to be learned about competitors’ compensation offerings includes base pay levels and mix of total monetary compensation. We will discuss pay level policies and pay mix policies in more detail later in this chapter. For example, a company may choose to set base pay levels that exceed the average market pay rate by 5 percent. Pay mix can be described as the percentage of employer compensation costs applied to core compensation and bene�its. For example, 60 percent of an employee’s core compensation may consist of core compensation, and 40 percent of employee bene�its. Said another way, for every dollar that an employer spends on total compensation, $0.60 funds core compensation and $0.40 funds employee bene�its.

Compensation professionals wish to make sound decisions about pay levels based on what the competition pays its employees. Sound pay decisions promote companies’ efforts to sustain competitive advantage, and poor pay decisions compromise those efforts. Compensation surveys enable compensation professionals to make sound judgments about how much to pay employees. Offering too little will limit a company’s ability to recruit and retain high-quality employees. Paying well above the competition represents opportunity costs. Financial resources are limited. Companies therefore cannot afford to spend money on everything they wish. Excessive pay represents an opportunity cost because it is money companies could have spent on other important matters.

CUSTOM DEVELOPMENT VERSUS USE OF AN EXISTING COMPENSATION SURVEY

Managers must decide whether to develop their own survey instruments and administer them or rely on the results of surveys conducted by others. In theory, customized surveys are preferable because the survey taker can tailor the questions the survey asks and select respondent companies to provide the most useful and informative data. Custom survey development should enable employers to monitor the quality of the survey developers’ methodologies.

In practice, companies choose not to develop and implement their own surveys for three reasons. First, most companies lack employees quali�ied to undertake this task. Developing and implementing valid surveys require specialized knowledge and expertise in sound questionnaire design, sampling methods, and statistical methods.

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Second, rival companies are understandably reluctant to surrender information about their compensation packages to competitors because compensation systems are instrumental to competitive advantage issues. If companies are willing to cooperate, the information may be incomplete or inaccurate. For example, rival companies may choose to report the salaries for their lowest-paid accountants instead of the typical salary levels. Such information may lead the surveying company to set accountants’ salaries much lower than if they had accurate, complete information about typical salary levels. Setting accountants’ salaries too low may hinder recruitment efforts. Thus, custom development is potentially risky.

Third, custom survey development can be costly. Although cost �igures are not readily available, it is reasonable to conclude that most companies use published survey data to minimize such costs as staff salaries and bene�its (i.e., for those involved in developing a compensation survey as well as analyzing and interpreting the data), distribution costs, and statistical packages for data analyses.

Using Published Compensation Survey Data

Companies usually rely on existing compensation surveys rather than creating their own. Using published compensation survey data starts with two important considerations:

Survey focus: core compensation or employee bene�its

Sources of published compensation surveys

SURVEY FOCUS: CORE COMPENSATION OR EMPLOYEE BENEFITS

Human resource professionals should decide whether to obtain survey information about base pay, employee bene�its, or both. Companies historically competed for employees mainly on the basis of base pay. Many companies offered similar, substantial bene�its packages to employees without regard to the costs. Companies typically did not use bene�its offerings to compete for the best employees.

Times have changed. Bene�its costs are now extremely high, which has led to greater variability in bene�its offerings among companies. As of December 2014, companies spent an average approaching $15,000 per employee annually to provide discretionary bene�its.3

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end3) In 2014, discretionary bene�its accounted for as much as 23.6 percent of employers’ total payroll costs. When we factor in legally required bene�it costs as well, total employee bene�its account for 31.3 percent of total compensation costs. That is a huge cost to employers, one that has been rising rapidly over time,4

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end4) but one that cannot be avoided; bene�its have become a basis for attracting and retaining the best employees, particularly as noted earlier in this chapter. As a result, employers are likely to use compensation surveys to obtain information about competitors’ base pay and bene�its practices so they can compete effectively for the best candidates.

SOURCES OF PUBLISHED COMPENSATION SURVEYS

Companies can obtain published survey data from various sources such as professional associations, industry associations, consulting �irms, and the federal government. Oftentimes, it makes sense to obtain multiple surveys because differences in survey methodology can lead to differences in results. Using multiple surveys should give compensation professionals a more accurate picture of market practices.5

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end5) For example, as we discussed in Chapter 2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch02#ch02) , interindustry wage differentials explain some of the variation we observe in average pay rates for similar or identical jobs. In that chapter, we explained that capital intensive businesses tend to pay more highly than do service industry businesses. In this case, a survey of exclusively capital intensive companies will show higher average pay rates than a survey of exclusively service industry companies.

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Professional and industry associations survey members’ salaries, compile the information in summary form, and disseminate the results to members. The survey data tend to be accurate because participants—as well as association members—bene�it from the survey results. In addition, membership fees often entitle members to survey information at no additional cost.

For example, the Society for Industrial and Organizational Psychology’s (SIOP) primary membership includes college and university faculty members and practitioners who specialize in such HR management-related �ields as selection, training, performance appraisal, and career development. SIOP periodically provides members’ salary information based on gender, age, employment status (i.e., part time versus full time), years since earning degree, and geographic region according to metropolitan area (e.g., Boston, San Francisco/San Jose, and Washington, DC). Employers use the survey results to judge whether they are paying employees too much or too little relative to the market and to determine how much to pay new hires. Employees use the survey results to judge the adequacy of job offers and to ask their deans for pay raises when their salaries fall below the market rates.

Professional associations that specialize in the �ield of compensation often conduct surveys that focus on broader types of employees and employers. WorldatWork collects comprehensive data on an annual basis.

Consulting �irms are another source of compensation survey information. Some �irms specialize in particular occupations (e.g., engineers) or industries (e.g., �inancial services); other �irms do not. Examples of consulting �irms that provide compensation services include:

Aon (www.aon.com/human-capital-consulting/ (http://www.aon.com/human-capital-consulting/) )

Frederic W. Cook & Company (www.fwcook.com (http://www.fwcook.com) )

Hay Group (www.haygroup.com (http://www.haygroup.com) )

Pearl Meyer & Partners (www.pearlmeyer.com (http://www.pearlmeyer.com) )

Towers Watson (www.towerswatson.com (http://www.towerswatson.com) )

William M. Mercer (www.mercer.com (http://www.mercer.com) )

Xerox-Buck Consultants (www.services.xerox.com (http://www.services.xerox.com) )

You will �ind useful updates about compensation and bene�its on these �irms’ Web sites. Clients may have two choices. First, consulting �irms may provide survey data from recently completed surveys. Second, these �irms may literally conduct surveys from scratch exclusively for a client’s use. In most cases, the �irst option is less expensive to companies than the second option; however, the quality of the second option may be superior because the survey was custom-designed to answer a client’s speci�ic compensation questions.

The federal government is an invaluable source of compensation survey information. The U.S. Bureau of Labor Statistics (BLS) provides free salary survey results to the public. Highly quali�ied survey takers and statisticians are responsible for producing these surveys. Many factors contributed to the implementation of BLS pay and bene�its surveys. The government began collecting compensation data in the 1890s to assess the effects of tariff legislation on wages and prices. The government’s survey programs have been rooted in competitive concerns ever since.

The BLS publishes a large amount of information on the wages, earnings, and bene�its of workers. Generally, this information is grouped in one or more of the following eight categories:

Employment cost trends

National compensation data

Wages by area and occupation

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Earnings by demographics

Earnings by industry

County wages

Employee bene�its

Compensation costs in other countries

The following summary of these programs was excerpted from the public domain U.S. Bureau of Labor Statistics Web site (www.bls.gov (http://www.bls.gov) ).

EMPLOYMENT COST TRENDS

This program publishes quarterly statistics that measure change in labor costs (also called employment costs or compensation costs) over time; quarterly data measuring the level of costs per hour worked are also published. Indexes are available for total labor costs, and separately for wages and salaries and for bene�it costs. Some information is available by region, major industry group, major occupational group, and bargaining status.

NATIONAL COMPENSATION DATA

The National Compensation Survey (NCS) provides comprehensive measures of occupational earnings; compensation cost trends, bene�it incidence, and detailed plan provisions. Detailed occupational earnings are available for metropolitan and non-metropolitan areas, broad geographic regions, and on a national basis. The index component of the NCS – Employer Cost Index (ECI) – measures changes in labor costs. Average hourly employer cost for employee compensation is presented in the Employer Costs for Employee Compensation (ECEC) feature.

WAGES BY AREA AND OCCUPATION

Wage data are available by occupation for the nation, regions, states, and many metropolitan areas. Wage data by area and occupation are derived from the National Compensation Survey, Occupational Employment Statistics Survey, or the Current Population Survey.

EARNINGS BY DEMOGRAPHICS

Data are available by demographic characteristics such as age, sex, race, and Hispanic or Latino ethnicity.

EARNINGS BY INDUSTRY

The Current Employment Statistics survey is a monthly survey of the payroll records of business establishments that provides national estimates of average weekly hours and average hourly earnings for the private sector for all employees and for production and nonsupervisory employees. Average weekly overtime hours in manufacturing are also available. State and area estimates of hours and earnings from this survey are available for all employees as well as for production workers (in the goods-producing industries) and nonsupervisory workers (in the private service-providing industries).

COUNTY WAGES (QUARTERLY CENSUS OF EMPLOYMENT AND WAGES)

Annual and quarterly wage data are available by detailed industry for the Nation, states, and many metropolitan areas and counties.

EMPLOYEE BENEFITS NATIONAL COMPENSATION SURVEY

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This survey provides information on the share of workers who participate in speci�ied bene�its, such as health care, retirement plans, and paid vacations. These data also show the details of those bene�its, such as deductible amounts, retirement ages, and amounts of paid leave.

COMPENSATION COSTS IN OTHER COUNTRIES

Comparative hourly compensation costs in national currencies and U.S. dollars for production workers and all employees in manufacturing are available on the International Labor Comparisons Hourly Compensation Costs tables. (The Bureau of Labor Statistics discontinued the International Labor Comparisons program; the most recent data are for 2012.) Since then, the Conference Board (http://www.conference-board.org (http://www.conference-board.org) ) has incorporated surveys of international labor costs into its portfolio of survey research. (The Conference Board is a global, international business and membership research association.)

Compensation Surveys: Strategic Considerations

Two essential strategic considerations are:

De�ining the relevant labor market

Choosing benchmark jobs

DEFINING THE RELEVANT LABOR MARKET

Relevant labor markets (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss374) represent the �ields of potentially quali�ied candidates for particular jobs. Companies collect compensation survey data from the appropriate relevant labor markets. Relevant labor markets are de�ined on the basis of occupational classi�ication, geography, and product or service market competitors.

As we discussed in Chapter 6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch06#ch06) , an occupation is a group of jobs found at more than one establishment, in which a common set of tasks are performed or are related in terms of similar objectives, methodologies, materials, products, worker actions, or worker characteristics. The U.S. Bureau of Labor Statistics’ Standard Occupational Classi�ication System (SOC) helps business professionals and government economists make proper occupational matches for collecting compensation data. As we noted in Chapter 6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch06#ch06) , the SOC links to the O*NET, a Web site containing detailed job description information to facilitate compensation professionals making precise comparisons for pay-setting purposes.

Companies that plan to hire accountants and auditors should consider data about accountants and auditors only, rather than individuals from such other job families as engineers. After all, the worker characteristics and work tasks are clearly different: Accountants and auditors prepare, analyze, and verify �inancial reports and taxes, as well as monitor information systems that furnish this information to managers in business, industrial, and government organizations. Engineers apply the theories and principles of science and mathematics to the economical solution of practical technical problems. For example, civil engineers design, plan, and supervise the construction of buildings, highways, and rapid transit systems.

Companies search over a wider geographical area for candidates for jobs that require specialized skills or skills that are low in supply relative to the demand. For instance, hospitals are likely to search nationwide for neurosurgeons because their specialized skills are scarce. Companies are likely to limit searches for clerical employees to more con�ined local areas because clerical employees’ skills are relatively common, and their supply tends to be higher relative to companies’ demand for them. For example, an insurance company based in Hartford, Connecticut, most likely restricts its search for clerical employees to the Hartford area.

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Companies use product or service market competitors to de�ine the relevant labor market when industry-speci�ic knowledge is a key worker quali�ication and competition for market share is keen. For example, beverage companies probably prefer to lure marketing managers away from industry competitors rather than from such unrelated industries as software or medical and surgical supplies. Knowledge about the features of software has little to do with customers’ preferences for soft drinks.

Occupational classi�ication, geographic scope, and product or service market competitors are not necessarily independent dimensions. For example, a company uses product or service market competitors as the basis for de�ining the relevant labor market for product managers; however, this dimension overlaps with geographic scope because competitor companies are located throughout the country (e.g., Boston, San Francisco, Dallas, and Miami).

With many professional, technical, and management positions, all three factors (i.e., job family, geographic scope, and companies that compete on the basis of product or service) can be applicable. For more information about relevant labor markets for various occupations, employers can consult professional and industrial associations and consulting �irms.

CHOOSING BENCHMARK JOBS

As we discussed in Chapter 6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch06#ch06) , benchmark jobs are key to conducting effective job evaluations. They also play an important role in compensation surveys. Human resource professionals determine the pay levels for jobs based on typical market pay rates for similar jobs. In other words, HR professionals rely on benchmark jobs as reference points for setting pay levels. Benchmark jobs have four characteristics:6

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end6)

The contents are well known, relatively stable over time, and agreed upon by the employees involved.

The jobs are common across a number of different employers.

The jobs represent the entire range of jobs that are being evaluated within a company.

The jobs are generally accepted in the labor market for the purposes of setting pay levels.

Why are benchmark jobs necessary? Human resource professionals ideally would match each job within their companies to jobs contained in compensation surveys; however, in reality, one-to-one matches are not feasible for two reasons. First, large companies may have hundreds of unique jobs, making one-to-one matches tedious, time- consuming, and expensive because of the salary and bene�its paid to staff members responsible for making these matches. Second, it is highly unlikely that HR professionals will �ind perfect or close matches between each of a company’s jobs and jobs contained in the compensation surveys: Companies adapt job duties and scope to �it their particular situations. In other words, jobs with identical titles may differ somewhat in the degrees of compensable factors. Perfect matches are the exception rather than the rule. For example, Company A’s Secretary I job may require only a high school education or GED equivalent. Company B’s Secretary I job may require an associate’s degree in of�ice administration.

The following Watch It! video describes talent management at the Weather Channel. The company’s executive vice president of human resources discusses the importance of job analysis and job descriptions in this practice. Compensation professionals contribute to talent management in a variety of ways. Related to this chapter’s material, they determine the extent to which benchmark job duties and responsibilities match the company’s job description so that they may accurately assess market pay rates. Failure to do so may result in setting pay rates too low, which would undermine efforts to recruit and retain talent.

WATCH IT!

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If your professor has assigned this, go to the Assignments section of mymanagementlab.com (http://mymanagementlab.com) to complete the video exercise titled Weather Channel: Talent Management.

Companies can make corrections for differences between their jobs and external benchmark jobs. These corrections are based on subjective judgment rather than on objective criteria. This process is referred to as job leveling (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss237) . There are a variety of job leveling approaches. Compensation professionals can adopt a point rating approach referred to as point factor leveling (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss340) 7

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end7) to achieve the job leveling objective. Table 7-1 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab01) illustrates a physical environment factor. Participants will rate a job based on a standard set of compensable factors that have point values associated with each level of the factor, much like we accomplished with the point rating job evaluation approach (Chapter 6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch06#ch06) ). Table 7-2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab02) illustrates a rating sheet that shows the relevant compensable factors, point totals, and point ranges. Both job incumbents and supervisors should complete a rating form separately to achieve job leveling based on all of the relevant factors. Independent ratings should help to minimize rater biases. Differences in ratings generally can be reconciled through discussion.

Compensation Survey Data

TABLE 7-1 Sample Compensable Factor and Point-Level De�initions: Physical Environment

Factor 4. Physical Environment

• Nonstrenuous with Low Risk (See de�initions below.) 10 Points

• Moderately Strenuous with Low Risk or • Nonstrenuous with Moderate Risk (See de�initions below.)

25 Points

• Strenuous with Low Risk or • Moderately Strenuous with Moderate Risk (See de�initions below.)

40 Points

• Moderately Strenuous with High Risk or • Strenuous with Moderate Risk (See de�initions below.)

70 Points

• Strenuous with High Risk (See de�initions below.) 100 Points

De�inition

Nonstrenuous—Primarily sedentary with some walking, standing, and carrying of light objects.

Moderately strenuous—Often lifts 30 to 50 pounds, walks over uneven surfaces, and/or stands for long periods.

Strenuous—Often lifts more than 50 pounds, climbs high, runs, or defends against physical attack.

Low risk—Adequately lighted, ventilated, and heated area where normal precautions must be observed.

Moderate risk—Requires special mitigating precautions and/or protective gear or clothing due to potential risk from such sources as moving machinery, chemicals, animals, or diseases.

High risk—Extreme temperatures, likelihood of physical attack, or potential exposure to smoke and �ire.

Source: U.S. Bureau of Labor Statistics (2013) National Compensation Survey: Guide for Evaluating Your Firm’s Jobs and Pay (revised, May). Available: http://www.bls.gov (http://www.bls.gov) , accessed March 3, 2015.

Compensation professionals should be aware of three compensation survey data characteristics. First, compensation surveys contain immense amounts of information. A perusal of every datum point would be mind- boggling even to the most mathematically inclined individuals. In addition, there is bound to be wide variation in

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pay rates across companies, making it dif�icult to build market-competitive pay systems. Thus, compensation professionals should use statistics to describe large sets of data ef�iciently. Second, compensation survey data are outdated because there is a lag between when the data were collected and when employers implement the compensation plan based on the survey data. Third, compensation professionals must use statistical analyses to integrate their internal job structures (based on job evaluation points; see Chapter 6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch06#ch06) ) with the external market based on the survey data. We will discuss this matter in detail later in this chapter.

TABLE 7-2 Leveling Instructions and Points

After recording the level for each factor for a job, determine points associated with that level from the chart below. Sum the points to determine overall work level. Points associated with each factor

Factor Factor number

Knowledge 50 200 350 550 750 950 1250 1550 1850

Job controls and complexity 100 300 475 625 850 1175 1450 1950 X

Contacts 30 75 110 130 280 X X X X

Physical environment 10 25 40 70 100 X X X X

Points range by work level

Level Minimum points Maximum points

1 190 254

2 255 454

3 455 654

4 655 854

5 855 1104

6 1105 1354

7 1355 1604

8 1605 1854

9 1855 2104

10 2105 2354

11 2355 2754

12 2755 3154

13 3155 3604

14 3605 4054

15 4055 and up

Source: U.S. Bureau of Labor Statistics (2013) National Compensation Survey: Guide for Evaluating Your Firm’s Jobs and Pay (revised, May). Available: http://www.bls.gov (http://www.bls.gov) , accessed March 3, 2015.

Table 7-3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab03) contains sample salary information collected from a salary survey of 35 accounting jobs according to seniority. Accountant I

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incumbents possess less than 2 years of accounting work experience. Accountant II incumbents have 2 to less than 4 years of accounting work experience. Accountant III incumbents possess 4 to 6 years of work experience as accountants. Seven companies (A–G) from Atlanta participated in the survey, and most have more than one incumbent at each level. Company B has three accountant I incumbents, three accountant II incumbents, and two accountant III incumbents.

As a starting point, let’s begin with basic tabulation of the survey data. Basic tabulation helps organize data, promotes decision makers’ familiarization with the data, and reveals possible extreme observations (i.e., outliers). Table 7-4 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab04) displays a frequency table, and Figure 7-1 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07�ig01) displays a histogram. Both indicate the number of job incumbents whose salaries fall within the speci�ied intervals. For example, 11 accountants’ annual salaries range between $30,000 and $35,000. Only one job incumbent falls in the $45,001 and above interval, which suggests the possibility of an outlier. We’ll discuss the importance of recognizing outliers shortly.

TABLE 7-3 Raw Compensation Survey Data for Accountants in Atlanta, Georgia

Company Job Title 2015 Annual Salary ($)

A Accountant I 33,000

A Accountant I 34,500

A Accountant II 36,000

A Accountant III 43,500

B Accountant I 33,000

B Accountant I 33,000

B Accountant I 36,000

B Accountant II 37,500

B Accountant II 36,000

B Accountant II 37,500

B Accountant III 45,000

B Accountant III 43,500

C Accountant I 34,500

C Accountant II 37,500

C Accountant III 43,500

D Accountant I 36,000

D Accountant I 36,000

D Accountant III 55,000

E Accountant I 33,000

E Accountant I 33,000

E Accountant I 34,500

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Company Job Title 2015 Annual Salary ($)

E Accountant II 36,000

E Accountant II 36,000

E Accountant II 37,500

E Accountant III 45,000

F Accountant I 34,500

F Accountant II 37,500

F Accountant III 45,000

F Accountant III 45,000

F Accountant III 43,500

G Accountant I 34,500

G Accountant I 33,000

G Accountant II 37,500

G Accountant II 37,500

G Accountant III 43,500

TABLE 7-4 Frequency Table for Accountants

Salary Interval ($) Number of Salaries from Survey

30,000–35,000 11

35,001–40,000 14

40,000–45,000 9

45,000+ 1

USING THE APPROPRIATE STATISTICS TO SUMMARIZE SURVEY DATA

Two properties describe numerical data sets:

Central tendency

Variation

Central tendency (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss41) represents the fact that a set of data clusters or centers around a central point. Central tendency is a number that represents the typical numerical value in the data set. What is the typical annual salary for accountants in our data set? Two types of central tendency measures are pertinent to compensation—arithmetic mean (often called mean or average) and median.

We calculate the mean (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss272) annual salary for accountants by adding all the annual salaries in our data set and then dividing the total by the number of annual salaries in the data set. The sum of the salaries in our example is $1,337,500 based on 35 salaries. Thus, the mean equals $38,214.29 (i.e., $1,337,500 divided by 35). In this example, the mean informs

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compensation professionals about the “typical” salary or going market rate for the group of accountants I, II, and III. Compensation professionals often use the mean as a reference point to judge whether employees’ compensation is below or above the market.

We use every data point to calculate the mean. As a result, one or more outliers can lead to a distorted representation of the typical value. The mean understates the “true” typical value when there is one or more extremely small value, and it overstates the “true” typical value when there is one or more extremely large value. The mean’s shortcoming has implications for compensation professionals.

FIGURE 7-1 Histogram of Survey Data for Accountants

Understated mean salaries may cause employers to set starting salaries too low to attract the best-quali�ied job candidates. Overstated mean salaries probably promote recruitment efforts because employers may set starting salaries higher than necessary, a condition that creates a cost burden to companies.

The median (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss273) is the middle value in an ordered sequence of numerical data. If there is an odd number of data points, the median literally is the middle observation. Our data set contains an odd number of observations. The median is $36,000. Table 7-5 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab05) illustrates the calculation of the median.

TABLE 7-5 Calculation of the Median for Accountant Survey Data

The salary data are arranged in ascending order. The median is (n + 1)/2, where n equals the number of salaries. The median is item 18 ([35 + 1]/2). Thus, the median value is $36,000.

1. $33,000

2. $33,000

3. $33,000

4. $33,000

5. $33,000

6. $33,000

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7. $34,500

8. $34,500

9. $34,500

10. $34,500

11. $34,500

12. $36,000

13. $36,000

14. $36,000

15. $36,000

16. $36,000

17. $36,000

18. $36,000 ← Median

19. $37,500

20. $37,500

21. $37,500

22. $37,500

23. $37,500

24. $37,500

25. $37,500

26. $43,500

27. $43,500

28. $43,500

29. $43,500

30. $43,500

31. $45,000

32. $45,000

33. $45,000

34. $45,000

35. $55,000

If there is an even number of data points, the median is the mean of the values corresponding to the two middle numbers. Let’s assume that we have four salaries, ordered from the smallest value to the highest value: $25,000, $28,000, $29,500, and $33,000. The median is $28,750. The median does not create distorted representations like the mean because its calculation is independent of the magnitude of each value.

Variation is the second property used to describe data sets. Variation (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss463) represents the amount of spread or dispersion in a set of data. Compensation professionals �ind three measures of dispersion to be useful (i.e., standard deviation, quartile, and percentile).

Standard deviation (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss425) refers to the mean distance of each salary �igure from the mean (i.e., how larger observations �luctuate above the

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mean and how smaller observations �luctuate below the mean). Table 7-6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab06) demonstrates the calculation of the standard deviation for our data set.

The standard deviation equals $5,074.86. Compensation professionals �ind standard deviation to be useful for two reasons. First, as we noted previously, compensation professionals often use the mean as a reference point to judge whether employees’ compensations are below or above the market. The standard deviation indicates whether an individual salary’s departure below or above the mean is “typical” for the market. For example, Irwin Katz’s annual salary is $27,500. His salary falls substantially below the typical average salary: The difference between the mean salary and Katz’s salary is $10,714.29 ($38,214.29 - $27,500). This difference is much greater than the typical departure from the mean because the standard deviation is just $5,074.86.

Second, the standard deviation indicates the range for the majority of salaries. The majority of salaries fall between $33,139.43 ($38,214.29 - $5,074.86) and $43,289.15 ($38,214.29 + $5,074.86). Remember, $38,214.29 is the mean, and $5,074.86 is the standard deviation. Compensation professionals can use this range to judge whether their company’s salary ranges are similar to the market’s salary ranges. A company’s salary ranges are not typical of the market if most fall below or above the market range. A company will probably �ind it dif�icult to retain good employees when most salaries fall below the typical market range.

TABLE 7-6 Calculation of the Standard Deviation (S.D.) for Accountant Survey Data

Both quartiles and percentiles describe dispersion by indicating the percentage of �igures that fall below certain points. Table 7-7 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab07) illustrates the use of quartiles and percentiles for our survey data. Quartiles (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss364) allow compensation professionals to describe the distribution of data—in this case, annual base pay amount—based on four groupings. The 1st quartile is $34,500. In other words, 25 percent of the salary �igures are less than or equal to $34,500. The 2nd quartile is $36,000. Fifty percent of the salary �igures are less than or equal to $36,000. The 3rd quartile is $43,500. Seventy-�ive percent of the salary �igures are less than or equal to $43,500. The 4th quartile is $55,000. One hundred percent of the salary �igures are less than or equal to $55,000. There are one hundred percentiles (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss330) ranging from the �irst percentile to the 100th percentile. For our data, the 10th percentile equals $33,000, and the 90th percentile equals $45,000.

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TABLE 7-7 Percentile and Quartile Ranks for Accountant Survey Data

$55,000 ← 4th quartile

$45,000

$45,000 ← 90th percentile

$45,000

$45,000

$43,500

$43,500

$43,500 ← 3rd quartile

$43,500

$43,500

$37,500

$37,500

$37,500

$37,500

$37,500

$37,500

$37,500

$36,000

$36,000

$36,000

$36,000

$36,000

$36,000

$36,000 ← 2nd quartile (also, the 50th percentile)

$34,500

$34,500

$34,500 ← 1st quartile

$34,500

$34,500

$33,000

$33,000

$33,000 ← 10th percentile

$33,000

$33,000

$33,000

Quartiles and percentiles complement standard deviations by indicating the percentage of observations that fall below particular �igures. Compensation professionals’ reviews of percentiles and quartiles can enhance their

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insights into the dispersion of salary data. For example, compensation professionals want to know the percentage of accountants earning a particular salary level or less. If $33,000 represents the 10th percentile for accountants’ annual salaries, then only 10 percent earn $33,000 or less. Compensation professionals are less likely to recommend similar pay for new accountant hires. Although paying at this level represents a cost savings, companies are likely to experience retention problems because 90 percent of accountants earn more than $33,000.

It is important to keep in mind that statistics of a given type (e.g., central tendency) provide consistent information for a given set of data. As we discussed, the mean and median are measures of central tendency. The mean and median are often different for a given set of data points. When the distribution of data is skewed to the left (i.e., there is a higher frequency of larger values than smaller values), the mean will be less than the median. On the other hand, when the distribution of data is skewed to the right (i.e., there is a lower frequency of larger values than smaller values), the mean will be greater than the median.

Let’s look at an example. The mean hourly wage rate for production workers in Company A is $8.72. The union in Company A is demanding that management grant pay raises to production workers because the mean hourly pay rate for production workers in Company B is higher—$9.02. The mean value for Company B is based on the following survey of its production workers:

Hourly Wage Rates of Production Workers

$8.15 $8.39 $8.51 $8.55 $8.60 $10.25 $10.72

Company A’s management is unwilling to raise production workers’ pay: Company A’s production workers earn a higher mean hourly wage ($8.72) than the median hourly wage rate of Company B’s production workers ($8.55).

Updating the Survey Data

Compensation professionals must rely on historical salary data to build market-competitive pay systems. Obviously, it is impossible to obtain future salary data for an upcoming compensation plan. Changes in the cost of living tend to make survey data obsolete fairly quickly. Over time, the average cost of goods and services usually increases. Failure to adjust pay rates could lead to a situation where real compensation falls below nominal compensation. Real compensation (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss367) measures the purchasing power of a dollar while nominal compensation (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss291) is the face value of a dollar. Increases in the costs of goods and services cause nominal pay to be less than real pay. For example, let’s assume that an employee accepted a job at $10 per hour. This �igure—$10 per hour—represents nominal pay. At the same time, $10 also represents real pay. However, over 1 year, let’s assume that the price of goods and services increased, on average, 5 percent. At the end of the year, nominal pay remains at $10. Real pay, on the other hand, declined by 5 percent, or $0.50. In other words, $10 purchases only $9.50 worth of goods and services. In this example, $9.50 represents real pay.

To remain competitive, companies therefore update salary survey data with the consumer price index (CPI) (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss76) , the most commonly used method for tracking cost changes, or consumer in�lation, throughout the United States. CPI data are available on the U.S. BLS Web site (www.bls.gov (http://www.bls.gov) ). Table 7-8 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab08) provides descriptive information about the CPI as well as how to calculate cost changes between two periods. The Crunch the Numbers! feature illustrates how to update salary survey data. It is important to note that the CPI does not permit for comparison between locations (e.g., cost of living differences between Chicago and Seattle); rather, it only allows for a comparison of cost of living differences over time within a single location.

Several additional factors play an important role in updating. The most in�luential could be the supply relative to demand for labor as we discussed in Chapter 2

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(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch02#ch02) . We noted that there tend to be pressures to raise starting pay when the demand for quali�ied workers in particular jobs is greater than supply. These market dynamics require that companies compete for limited quali�ied workers. This appears to be the case for information security analysts. According to the Occupational Outlook Handbook,8

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec9#ch07end8) demand for information security analysts is expected to be very high because cyberattacks have grown in frequency and sophistication.

TABLE 7-8 The Consumer Price Index: Basic Facts and Interpretation Issues

Basic Facts

The CPI indexes monthly price changes of goods and services that people buy for day-to-day living. The index is based on a representative sample of goods and services. The BLS gathers price information from thousands of retail and service establishments. Thousands of landlords provide information about rental costs, and thousands of home owners give cost information pertaining to home ownership. The CPI represents the average of the price changes for the representative sample of goods and services within each of the following areas:

Urban United States

4 regions

4 class sizes based on the number of residents

27 local metropolitan statistical areas

The BLS publishes CPI for two population groups: a CPI for All Urban Consumers (CPI-U) and the CPI for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-U represents the spending habits of 80 percent of the population of the United States. The CPI-U covers wage earners; clerical, professional, managerial, and technical workers; short-term and self-employed workers; unemployed persons; retirees; and others not in the labor force. The CPI-W represents the spending habits of 32 percent of the population, and it applies to consumers who earn more than one-half of their income from clerical or wage occupations. The distinction between the CPI-U and CPI- W is important because the CPI-U is most representative of all consumers, whereas unions and management use the CPI-W during negotiations to establish effective cost-of-living adjustments; most unionized jobs are clerical or wage jobs rather than salaried professional, managerial, or executive jobs. CPI data are both available as not seasonally adjusted and seasonally adjusted. Seasonal adjustment removes the effects of recurring seasonal in�luences from many economic series, including consumer prices. For example, changing climatic conditions, production cycles, model changeovers, and holidays can cause seasonal variation in prices. Automobile makers often discount car prices for current model year vehicles in preparation for incoming new model year vehicles.

The BLS also computes a chained CPI-U (C CPI-U). It is based on the idea that when prices go up for some goods, consumers will substitute the higher priced goods with lower priced goods. For example, increases in the price of beef may lead many consumers to choose a less expensive alternative such as chicken. Compared to the CPI-U, the C CPI-U shows a slower cost increase rate than the CPI-U because of the substitution effect. Interpreting the CPI: Percentage Changes versus Point Changes The span from 1982 to 1984 is the base period for the CPI-U and CPI-W, which is 100. For example, how much did consumer prices increase in Atlanta between the base period and December 2014?

The CPI database indicates that the 2014 CPI-U for Atlanta was 218.05. We know that the base period CPI is 100. Consumer prices in Atlanta increased 118.05 percent between December 2014 and the base period. We determine price change with the formula:

Source: Based on U.S. Bureau of Labor Statistics. Consumer Price Index. Available: http://www.bls.gov (http://www.bls.gov) , accessed March 1, 2015.

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Basic Facts

For this example:

Compensation professionals are most concerned with annual CPI changes because they are updating recently collected survey data. The same formula yields price changes between periods other than the base period. How much did prices increase in Atlanta between December 2013 and December 2014? The CPI database indicates that the December 2013 CPI-U for Atlanta was 216.01, and we know that the December 2014 average is 218.05

Consumer prices in Atlanta increased approximately 0.94 percent between December 2013 and December 2014. Source: Based on U.S. Bureau of Labor Statistics. Consumer Price Index. Available: http://www.bls.gov (http://www.bls.gov) , accessed March 1, 2015.

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7.3 INTEGRATING INTERNAL JOB STRUCTURES WITH EXTERNAL MARKET PAY RATES

7-3. Describe how compensation professionals integrate internal job structures with external market pay rates.

In Chapter 6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch06#ch06) , we discussed that compensation professionals use job evaluation methods to establish internally consistent job structures. In other words, companies value jobs that possess higher degrees of compensable factors (e.g., 10 years of relevant work experience) than jobs with fewer degrees of compensable factors (e.g., 1 year of relevant work experience). These valuation differences ultimately should correspond to pay differences based on compensation survey data.

Earlier, we indicated that paying well below or well above the typical market rate for jobs can create a competitive disadvantage for companies. Thus, it is important that companies set pay rates by using market pay rates as reference points. To this end, we use regression analysis (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss372) , which is a statistical analysis technique. Regression analyses enable compensation professionals to establish pay rates for a set of jobs that are consistent with typical pay rates for jobs in the external market.

We’ll apply regression analysis to determine pay rates for the accountant I, accountant II, and accountant III jobs listed in Table 7-3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab03) . Before presenting the regression analysis technique, we need two sets of information: the job evaluation point totals for each accountant job based on job evaluation and the updated salary survey data. In this sample, the accountant jobs have the following job evaluation points: accountant I (100 points), accountant II (500 points), and accountant III (1,000) points.

Regression analysis enables decision makers to predict the values of one variable from another. A compensation professional’s goal is to predict salary levels for each job based on job evaluation points. Why not simply “eyeball” the list of salaries in the survey to identify the market rates? There are two reasons. First, companies pay different rates to employees who are performing the same (or very similar) jobs. Our salary survey indicates that accountant III pay rates vary between $43,500 and $55,000. “Eyeballing” the typical rate from the raw data is dif�icult when surveys contain large numbers of salaries.

Second, we wish to determine pay rates for a set of jobs in a particular company (i.e., accountant I, accountant II, and accountant III) based on their relative worth to typical market pay rates for the corresponding jobs contained in the salary survey. Our focus is on pricing a job structure in the market pay context, not pricing one job in isolation.

How does regression analysis work? Regression analysis �inds the best-�itting line between two variables. Compensation professionals use job evaluation points assigned to benchmark jobs (based on the matching process discussed earlier) and the salary survey data for the benchmark jobs. They refer to the best-�itting line as the market pay line (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss270) . The market pay line is representative of typical market pay rates, expressed as a mean or median, relative to a company’s job structure. Pay levels that correspond with the market pay line are market-competitive pay rates. Figure 7-2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#ch07�ig02) displays the regression results.

The following equation models the prediction.

Ŷ = a + bX Ŷ = predicted salary

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X = job evaluation points a = the Y intercept (This is the Y value at which X = 0.) b = the slope

FIGURE 7-2 Regression Analysis Results for the Accountant Survey Data

The slope represents the change in Y for every one unit change in job evaluation points. In other words, the slope represents the dollar value of each job evaluation point. For example, let’s assume that the slope is 26. A job consisting of 301 job evaluation points is worth $26 more than a job consisting of 300 job evaluation points.

For our data, the equation is:

Ŷ = $32,315.66 + $12.21X

Thus, this market policy line indicates the following market pay rates:

Accountant I: $33,536.66

Ŷ = $32,315.66 + ($12.21 × 100 job evaluation points)

Accountant II: $38,420.66

Ŷ = $32,315.66 + ($12.21 × 500 job evaluation points)

Accountant III: $44,525.66

Ŷ = $32,315.66 + ($12.21 × 1,000 job evaluation points)

The regression analysis provides an additional important statistic known as R2. This statistic tells us how well the variation in the company’s valuation of jobs based on job evaluation points explains the variation in market pay rates from the compensation survey. The R2 statistic can range in numerical value between 0 and 1. When R2 equals 0, none (0 percent, i.e., 0.0 × 100 percent) of the variation in market pay rates can be explained by the company’s job structure. When R2 equals one, this means that all (100 percent) of the variation in market pay

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rates can be explained by the company’s job structure. Just one more example—when R2 equals 0.52, 52 percent (i.e., 0.52 × 100 percent) of the variation in market pay rates can be explained by the company’s job structure. As you can see, we interpret R2 in this context as the percentage variation in y values (market pay rates) that can be explained by x values (job evaluation points).

By now, you may be asking how to describe the difference between an R2 equal to 1.0 and, for example, an R2 equal to 0.71 in this situation. The difference (0.29) refers to the percentage of variation in market pay rates that cannot be explained by the company’s job structure. In this illustration, 29 percent of the variation is unexplained. Discrepancies often exist between the job duties of the jobs speci�ied in the compensation survey (i.e., the benchmark jobs) and the company’s job de�initions.

Your HR colleagues are likely to ask you to interpret your conclusion even further because they will want to know whether the obtained R2 value represents a small, medium, or large amount. As a rule of thumb, R2 values between 0.0 and 0.30 represent a small amount; between 0.31 and 0.70 represent a medium amount; and between 0.71 and 1.0 represent a large amount.

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7.4 COMPENSATION POLICIES AND STRATEGIC MANDATES

7-4. Explain the basic concepts of compensation policies and strategic mandates: pay mix and pay level.

Compensation policies refer to choices that compensation professionals make to promote competitive advantage. Broadly, choices are made about pay level policies and pay mix policies.

Pay Level Policies

Companies can choose from three pay level policies:

Market lead

Market lag

Market match

The market lead policy (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss268) distinguishes a company from the competition by compensating employees more highly than most competitors. Leading the market denotes pay levels that place in the area above the market pay line (Figure 7-2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#ch07�ig02) ). The market lag policy (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss267) also distinguishes a company from the competition, but by compensating employees less than most competitors. Lagging the market indicates that pay levels fall below the market pay line (Figure 7-2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#ch07�ig02) ). The market match policy (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss269) most closely follows the typical market pay rates because companies pay according to the market pay line. Thus, pay rates fall along the market pay line (Figure 7-2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#ch07�ig02) ). Most often, market lead policies are set to the 3rd quartile (also, 75th percentile) ranking in the salary survey. Similarly, market match policies are set to the 2nd quartile (also, 50th percentile or median) ranking, and market lag policies are set to the 1st quartile (also, 25th percentile) ranking.

The market lead policy is clearly most appropriate for companies that pursue differentiation strategies. A company may choose a market lead pay policy for its accountants because the company needs the very best accountants to promote its competitive strategy of being the top manufacturer of lightest-weight surgical instruments at the lowest possible cost by 2018.

The market lag policy appears to �it well with lowest-cost strategies because companies realize cost savings by paying lower than the market pay line. Paying well below the market will yield short-term cost savings; however, these short-term savings will probably be offset by long-term costs. Companies that use the market lag policy may experience dif�iculties in recruiting and retaining highly quali�ied employees. Too much turnover will undercut a company’s ability to operate ef�iciently and to market goods and services on a timely basis. Thus, companies that adopt market lag policies need to balance cost savings with productivity and quality concerns.

The market match policy represents a safe approach for companies because they generally are spending no more or less on compensation (per employee) than competitors. This pay policy does not �it with the lowest-cost strategy for obvious reasons. It does �it better with differentiation strategies. This statement appears to contradict previous ones about differentiation strategies (i.e., pay “high” salaries to attract and retain the best talent). Some

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companies that pursue differentiation strategies follow a market match policy to fund expensive operating or capital needs that support differentiation (e.g., research equipment and research laboratories).

Pay Mix Policies

Pay mix policies refer to the combination of core compensation and employee bene�its components that make up an employee’s total compensation package. In Chapter 1 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch01#ch01) , we identi�ied and brie�ly described the various elements of core compensation and employee bene�its; then we discussed core compensation elements fully in Chapters 3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch03#ch03) , 4 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04#ch04) , and 5 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch05#ch05) . We will review the main elements of employee bene�its in Chapters 9 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch09#ch09) and 10 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch10#ch10) .

Pay policy mix may be expressed in dollars (or other currency as relevant) or as a percentage of total dollars allocated for an employee’s total compensation. The following is an example of a pay policy mix:

This example indicates that base pay accounts for 57 percent of the money allocated to an employee’s total compensation. Let’s assume that the company spends $200,000 annually to fund a particular employee’s total compensation package. Of the total, an employee receives base pay in the amount of $114,000 (that is, $200,000 × 57 percent).

What is an appropriate pay mix? For policy purposes, it makes sense to consider guidelines for jobs within a particular structure (for example, managerial, administrative, or sales) because of the common job content and worker requirements of jobs within a particular structure. For example, in a technology company, a greater portion of bonus compensation might be allocated to engineers than to administrative staff. Engineers possess crucial skills relating to the company’s ability to �ind innovative applications of technology, and bonus incentives throughout the year may promote innovation initiatives. On the other hand, the administrative staff, though important to the company, may not play as important a role in determining the company’s pro�itability or objectives. Therefore, less of their total compensation would likely be devoted to bonus funds. Also, with some job structures, such as sales, employees may receive the majority of their compensation in the form of bonuses. In order to motivate a sales force to continually exceed quarterly targets, quarterly bonuses equal to or exceeding their annual base salaries might be used.

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COMPENSATION IN ACTION

What employees are paid internally can have a signi�icant impact on what happens externally. As with any business function, an overemphasis on the activities within the �irm can blind decision makers to the activities outside the �irm, which could undermine competitive advantage. Paying too little for top talent will ensure that those highly sought-after individuals go elsewhere for employment; paying too much could come at the cost of investing additional capital into resources that are critical to the execution and delivery of company strategy. By measuring the right variables and seeking data that will lead to informed and up-to-date decisions, you as line managers, HR professionals, and compensation specialists will work together in providing a system that is in line with the needs of the organization and the objectives of the individual.

Action checklist for line managers and HR—staying current and attracting the right employees

HR takes the lead

Work with compensation specialists to access compensation and bene�its data from other �irms to �ind out what they are offering employees; the means by which this data will be collected— customized survey, professional organization, or compensation consultant—will depend on budget, relationships with competitors, and expertise of staff.

Together with line managers, compare internal roles with external roles to create job matches that, although subjective, will allow a side-by-side comparison to see how compensation matches up.

Compensation specialists analyze data using appropriate statistics to identify consistencies with competitors and areas of high discrepancy.

Line managers take the lead

Identify the types of resources necessary to carry out company strategy; if talent is the top priority, HR will seek to establish a compensation system that will lead competitors; if other resources are deemed a higher priority (e.g., infrastructure and research), the sought-after compensation system will be lower than the industry standard (this will be the context within which the data are assessed).

Lead the identi�ication of the internal employee market (e.g., marketing professionals, accountants, and �inance managers in China) that needs to be assessed.

Partnering with HR, recommendations are made to members of senior management based on the data that are revealed and the assessment of these data in relation to the strategy of the �irm.

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In summary, a “one size �its all” approach to pay policy selection is inappropriate. Most companies use more than one pay policy simultaneously. For example, companies generally use market match or market lead policies for professional and managerial talent because these employees contribute most directly to a company’s competitive advantages. Companies typically apply market match or market lag policies to clerical, administrative, and unskilled employees (e.g., janitorial). Companies’ demands for these employees relative to supply in the relevant labor markets are low, and these employees’ contributions to attainment of competitive advantage are less direct. Companies are likely to apply different pay policy mixes to jobs in different structures given differences in the level of strategic importance placed on jobs as well as to promote desired behaviors as previously discussed.

END OF CHAPTER REVIEW

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Summary

Learning Objective 1: Market-competitive pay systems represent companies’ compensation policies that �it the imperatives of competitive advantage. Compensation professionals create market-competitive pay systems based on four activities: Conducting strategic analyses, conducting compensation surveys, integrating the internal job structure with external market pay rates, and determining compensation policies.

Learning Objective 2: Compensation surveys involve the collection and subsequent analysis of competitors’ compensation data.

Learning Objective 3: Integrating internal job structures with external market pay rates is based on statistical analysis, most often, regression analysis. Regression analyses enable compensation professionals to establish pay rates for a set of jobs that are consistent with typical pay rates for jobs in the external market.

Learning Objective 4: Compensation professionals develop two types of compensation policies. The �irst, pay- level, is the relationship between the company’s pay rates and the market pay rates for corresponding jobs. A company can choose to match, lead, or lag the market. The second, pay mix, refers to the combination of core compensation and employee bene�its components that make up an employee’s total compensation package.

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Key Terms market-competitive pay systems 146 (ch07.xhtml#page_146) strategic analysis 147 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec1#page_147) compensation surveys 147

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec1#page_147) compensation plans 147

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec1#page_147) relevant labor markets 151

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_151) job leveling 153 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_153) point factor leveling 153

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_153) central tendency 156 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_156) mean 156 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_156) median 157 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_157) variation 158 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_158) standard deviation 158

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_158) quartiles 158 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_158) percentiles 159 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_159) real compensation 160

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_160) nominal compensation 160

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_160) consumer price index (CPI) 160

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#page_160) regression analysis 162

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#page_162) market pay line 162 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#page_162) market lead policy 164

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#page_164) market lag policy 164 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#page_164) market match policy 164

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec3#page_164)

MyManagementLab CHAPTER QUIZ! If your professor has assigned this, go to the Assignments section of mymanagementlab.com (http://mymanagementlab.com) to complete the Chapter Quiz! and see what you’ve learned.

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Discussion Questions 7-1. You are a compensation analyst for a pharmaceuticals company, which is located in Los Angeles,

California. De�ine the scope of the relevant labor markets for chemists and for data entry clerks. Describe the rationale for your de�initions.

7-2. Can companies easily develop compensation that is both internally consistent and market competitive? What are some of the challenges to this goal?

7-3. Which do you believe is most important for a company’s competitive advantage: internal consistency or market competitiveness? Explain your answer.

7-4. Refer to the regression equation presented earlier in this chapter. When b = 0, the market pay line is parallel to the x-axis (i.e., job evaluation point scale). Provide your interpretation.

7-5. Refer to Table 7-3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07lev1sec2#ch07tab03) . Cross out salaries for Company F and Company G. Calculate the mean and median for the set of Companies A through E.

CASE Nutriment’s New Hires

An additional Supplemental Case can be found on MyManagementLab.

With the demand for more nutritional food options growing, Nutriment Biotech is positioned to become a leader in agricultural biotechnology. Nutriment is a start-up biotech company that is working to develop genetically engineered food crops that offer enhanced nutrition along with easier production for farmers. Emily Hart and Harold James established Nutriment as a research organization through national grant funding 5 years ago. Nutriment is one of only a few agricultural biotechnology companies focused on enhancing nutrition in food crops. The company currently has an edge over competitors as its research has led to some scienti�ic discoveries that now position them to grow their company signi�icantly. As a result, Nutriment is ready to start hiring staff to get operations started.

Emily and Harold have hired Jack Stewart, an HR management consultant, to help them determine how to hire the most talented staff to grow their business. Jack works mostly with start-up technology-based companies and plans to help Nutriment implement a recruiting and hiring plan and establish its preliminary HR management practices such as its pay structure.

Nutriment has secured additional funding to allow it to ramp up full operations quickly. An analysis of its projected workload suggests it will need to hire approximately 15 new employees to get started. It will need to hire not only 10 new scientists but also administrative staff members including a receptionist, an of�ice manager, a lab manager, a marketing professional, and an accountant.

As an experienced recruiter, Jack is con�ident that he will be able to quickly identify strong candidates for the administrative staff positions. The current labor market works in Nutriment’s favor, and, therefore, Jack will be able to easily generate a pool of quali�ied applicants. The scientists, on the other hand, will be challenging to �ind as they need speci�ic expertise related to agricultural biotechnology and genetic engineering. The number of scientists with this combination of skills is limited, and the scientists are in demand by competitors. However, Nutriment is located

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in a geographic area rich with research universities and other biotech �irms, so Jack is con�ident that it can attract a good pool of talent if it is able to offer an opportunity that is attractive to the scientists.

To start the recruiting process, Jack must �irst establish a pay structure. Before he starts researching market rates, Jack plans to meet with Emily and Harold to establish pay level policies and discuss other strategic aspects of determining the compensation structure for the new employees. Nutriment must offer a pay package that will allow it to attract and retain both the administrative staff members and the scientists. Establishing the right pay practices will help ensure that the recruitment process allows it to put talent in place to position Nutriment for success.

Questions:

7-6. What are some strategic considerations in establishing a pay structure at Nutriment?

7-7. Should Jack suggest a pay policy to lead, lag, or match the market? Explain your recommendation.

Crunch the Numbers! Updating Salary Survey Data

An additional Crunch the Numbers! exercise can be found on mymanagementlab.com (http://mymanagementlab.com) .

As a newly hired compensation analyst, you’ve been asked by the Director of Compensation to assist with the preparation of next year’s compensation plan. The period for the compensation plan is January 1 – December 31, 2015. Your assignment is to update salary survey data using the CPI-U to estimate new salary information. Also, assume that it is July 1, 2014, and you have been asked to submit your analysis within the next two days. The salary survey data were current through the end of 2013, and the initial average salary reported for accountant jobs in the survey was $50,000. The salary data will be 12 and 24 months old at the pay plan’s implementation (on January 1, 2015) and end (December 31, 2015), respectively. You have been provided with national CPI-U data, which were obtained from the BLS website.

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2009 211.933 212.705 212.495 212.709 213.022 214.790 214.726 215.445 215.861 216.509 217.234 217.347

2010 217.488 217.281 217.353 217.403 217.290 217.199 217.605 217.923 218.275 219.035 219.590 220.472

2011 221.148 221.904 223.044 224.060 224.869 224.841 225.419 226.082 226.676 226.811 227.157 227.145

2012 227.759 228.285 228.866 229.172 228.785 228.626 228.584 229.911 231.104 231.741 231.202 231.165

2013 231.444 232.803 232.245 231.672 231.990 232.583 232.980 233.413 233.773 233.903 234.038 234.697

2014 235.128 235.356 235.790 236.240 236.950 237.348

Questions:

7-8. By what percent did the cost of goods and services change between December 2013 and June 2014?

7-9. (A) By what percent might you expect the average cost of goods and services to change over the second 6-month period of 2014? Hint: First, calculate the percentage cost change for the period July through December for each of the previous years: 2009 through 2013. Second, take the average of these �ive �igures. This calculation gives us the average percent cost change. We often rely on multiple years for estimations to give us a more stable picture of percent cost changes. (B) What is the estimated average salary for December 31, 2014? Hint: [(initial average salary × average percent cost change) + initial average salary] × 100%.

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7-10. (A) By what percent might you expect the average cost of goods and services to change between January 1, 2015 and December 31, 2015? Hint: First, calculate the percent cost change for the period January through December for each of the previous years: 2009 through 2013. Second, take the average of these �ive �igures to calculate the average percent cost change. (B) What is the estimated average salary for December 31, 2015? Hint: [(December 2014 average salary × average percentage cost change) + December 2014 average salary] × 100%.

MyManagementLab Go to mymanagementlab.com (http://mymanagementlab.com) for Auto-graded writing questions as well as the following Assisted-graded writing questions:

7-11. Is it appropriate to utilize the same pay mix arrangement for clerical employees and sales professionals? Explain your answer and how the pay mix arrangements might differ.

7-12. Explain what the market pay line is. How is it used in the context of pay level policies such as market lead, market lag, and market match?

7-13. MyManagementLab Only – comprehensive writing assignment for this chapter.

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Endnotes 1. WorldatWork (2015). Compensation Programs and Practices (January). Scottsdale, AZ: WorldatWork. 2. Greene, R. J. (2014). Compensation surveys: The Rosetta Stones of market pricing. WorldatWork Journal, First Quarter: pp. 23–31.

3. U.S. Bureau of Labor Statistics (2014). Employer Costs for Employee Compensation—September 2014. Available: www.bls.gov (http://www.bls.gov) , accessed March 6, 2015.

4. U.S. Bureau of Labor Statistics (2014). Employer Costs for Employee Compensation Historical Listing—March 2004 – September 2014. Available: www.bls.gov (http://www.bls.gov) , accessed March 6, 2015.

5. Weinberger, T. E. (2013). Incremental market intelligence: Does it make sense to purchase that additional salary survey? WorldatWork Journal (First Quarter): pp. 6–18.

6. Milkovich, G. T., & Newman, J. M. (1996). Compensation (5th ed.). Homewood, IL: Irwin. 7. U.S. Bureau of Labor Statistics (2013) National Compensation Survey: Guide for Evaluating Your Firm’s Jobs and Pay (revised, May). Available: www.bls.gov (http://www.bls.gov) , accessed March 3, 2015.

8. U.S. Bureau of Labor Statistics. Information Security Analysts. Occupational Outlook Handbook, 2014–15 Edition. Available: http://www.bls.gov/ooh/computer-and-information-technology/information-security- analysts.htm (http://www.bls.gov/ooh/computer-and-information-technology/information-security-analysts.htm) , accessed February 17, 2015.