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Strategic Compensation: A Human Resource Management Approach

Ninth Edition

Chapter 7

Building Market-Competitive Compensation Systems

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Market-Competitive Pay Systems

Market-competitive pay systems refer to:

A company’s compensation policy

The imperatives of competitive advantage

The key role in promoting recruitment and retention of talented employees

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

Conduct strategic analyses

Assess competitors’ practices with compensation surveys

Integrate internal job structures with external market pay rates

Determine compensation policies

Four Activities of Market Competitive Pay Systems

First, Strategic analysis entails an examination of a company’s external market context and internal factors

External market context: industry profile, information on competition, long-term prospects

Internal factors: financial condition, functional capabilities

Second, Compensation surveys involve the collection and subsequent analysis of competitors’ compensation data. Compensation surveys are important because they enable compensation professionals to obtain realistic views of competitors' pay practices.

Four Activities of Market Competitive Pay Systems

Third, Compensation professionals integrate the internal job structure with the external market pay rates identified through compensation surveys. This integration results in pay rates that reflect both the company’s and the external market’s valuations of jobs.

Fourth, Compensation professionals recommend pay policies that fit with their companies’ standing and competitive strategies. Compensation professionals must strike a balance between managing costs and attracting and retaining the best qualified employees.

Compensation Surveys

Compensation surveys contain data about competing companies’ compensation practices.

Preliminary Considerations

There are two preliminary considerations 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?

Compensation professionals usually want to learn about competitors’ compensation practices and something about employees’ preferences for alternative forms of compensation due to economic change.

Information to be learned about competitors’ compensation offering includes base pay levels, incentive awards structures, and both the mix and level of discretionary benefits.

Compensation professionals wish to make sound decisions about pay levels based on what the competition pay its employees.

Sound pay decisions promote companies’ effort to sustain competitive advantage.

Competitors’ Pay Practices

Base pay

Incentive awards structure

Mix and level of discretionary benefits

Custom Developed Surveys

Can be custom tailored

Quality can be monitored by employer

Usually not done in-house

External data not readily accessible

Can be expensive

Using Published Survey Sources (1 of 4)

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 or employee benefits.

Sources of published compensation surveys.

Survey focus: core or employee benefits (2 of 4)

Human resource professional should decide whether to obtain survey information about base pay, employee benefits, or both.

Employers are likely to use compensation surveys to obtain information about competitors’ base pay and benefits practices so they can compete effectively for the best candidates.

Using Published Survey Sources (3 of 4)

Sources of published compensation surveys:

Professional associations

Industry associations

Consulting firms

Federal government (U.S. Bureau of Labor Statistics)

Compensation Surveys

Two essential strategic considerations are:

Defining the relevant labor market

Choosing benchmark jobs

Defining Relevant Labor Market

Relevant labor markets represent the fields of potentially qualified candidates for particular jobs

Companies collect compensation survey data from the appropriate relevant labor markets.

Relevant labor markets are defined on the basis of :

Occupational classification

Geography

Market competitors

Defining Relevant Labor Market

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 confined local areas because clerical employees’ skills are relatively common, and their supply tends to be higher relative to companies’ demand for them.

Choosing a Benchmark Jobs

Benchmarks jobs are used for:

Job evaluations

Compensation surveys

Benchmark jobs have 4 characteristics:

The contents are established, well-known, stable

The jobs are common across employers

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

The jobs are accepted in the labor market for the purpose of setting pay rates

Why are benchmark jobs necessary?

Human resource professionals ideally would match each job within their companies to job 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 time consuming, and expensive because of the salary and benefits paid to staff members responsible for making these matches.

Second, it is highly unlikely that HR professionals will find perfect or close matches between each of a company’s jobs and jobs contained in the compensation surveys: jobs with identical titles may differ in the degree of compensable factors.

Companies can make corrections for differences between their jobs and external benchmark jobs. These corrections are based on subjective judgment.

Compensation Policies and Strategic Mandates

Pay-level policies

Pay mix policies

Pay-Level Policies

Market lead (75th percentile)

Levels above market pay lines

Best for differentiation strategies. Distinguishes a company from the competition by compensating employees more highly than most competitors.

The market lead policy is clearly most appropriate for companies that pursue differentiation strategies.

Pay-Level Policies

Market lag (25th percentile)

Levels below market pay lines

Best for lowest-cost strategies

Distinguishes a company from the competition, but by compensating employees less than most competitors.

Lagging from the market indicates that pay level fall below the market pay line.

Market lag (25th percentile)

The market lag policy appears to fit well with lowest cost strategies because companies realize cost saving by paying lower than the market pay line.

Paying well below the market will yield short term cost savings; however, these short-term saving will probably be offset by long term costs.

Companies that use the market lag policy may experience difficulties in recruiting and retaining highly qualified employees.

Too much turnover will undercut a company’s ability to operate efficiently and to market goods and services on a timely basis.

Pay-Level Policies

Market match (50th percentile)

Pay according to market pay line

Represents a safe approach for companies because they generally are spending no more or less on compensation (per employee) than competitors.

They use the money somewhere else. In fact this pay policy does fit with differentiation strategies. ( some companies that purse differentiation strategies follow a market match policy to fund expensive operating or capital needs that support differentiation)

This pay policy does not fit with the lowest cost strategy

Pay Mix Policies

Pay mix policies refer to the combination of core compensation and employee benefits components that make up an employee’s total compensation package

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

Pay Mix Policy Example