Compensation

Chap 7

Defining Competitiveness MGMT 474

CSULA – SPRING 2014

Learning Objectives

 Compensation Strategy: External Competitiveness

 What shapes external competitiveness

 Labor market factors

 Modifications to the demand side

 Modifications to the supply side

 Product market factors and ability to pay

Learning Objectives

 Organization factors

 Relevant markets

 Competitive pay policy alternatives

 Consequences of pay-level and mix

 Decisions: Guidance from the research

Compensation Strategy: External

Competitiveness

 External Competitiveness

 Expressed by:

 Setting a pay level that is above, below or equal to that of competitors

Determining the mix of pay forms relative to those of competitors

 Refers to:

 Pay relationship among organizations

Organization’s pay relative to its competitors

Compensation Strategy: External

Competitiveness

 Pay level

 The average of the array of rates paid by an employer

 Pay forms

 Various types of payments, or pay mix, that make up total

compensation

 Objectives

 Control costs and increase revenues

 Attract and retain employees

Control Costs and Increase Revenues

 Labor costs = Pay level X (times) number of employees

 Higher the pay level, greater the labor costs

 Higher the pay level relative to what competitors pay, the greater

the relative costs to provide similar products or services

Attract and Retain the Right Employees

 Pay rates for similar jobs vary among employers

 Companies set different pay-level policies for different job families

 Comparisons regarding pay are based on:

 Companies setting different pay-level policies for different job

families

 What competitors the company compares to and what pay

forms are included

Exhibit 7.5 – What shapes External

Competitiveness

Labor Market Factors

 Types of Markets

 Quoted price

 Example: Stores that label each item’s price

 Bourse

 Example: eBay allows haggling over the terms and conditions

 In BOTH markets

 Employers are the buyers and potential employees are the sellers

How Labor Markets Work

 Assumptions

 Employers always seek to maximize profits

 People are homogenous (same; similar) and therefore

interchangeable

 Pay rates reflect all costs associated with employment

 Markets faced by employers are competitive

Exhibit 7.6 – Supply and Demand for

Business School Graduates in the Short Run

Labor Demand

 Analysis of labor demand:

 Indicates how many employees will be hired by an employer

 Marginal product of labor

 Additional output associated with the employment of one additional

person, with other production factors held constant

 Diminishing marginal productivity

 Each additional employee has a progressively smaller share of factors

of production

Labor Demand

 Marginal revenue of labor

 Additional revenue generated when the firm employs one

additional person while other production factors are constant

 A manager using the marginal revenue product model must determine:

 Pay level set by market forces

Marginal revenue generated by each new hire

Exhibit 7.7 – Supply and Demand at the

Market and Individual Employer Level

Labor Supply

 This model assumes:

 Many people are seeking jobs

 People possess accurate information about all job openings

 No barriers to mobility exist

Modifications to the Demand Side

 Economic theories must frequently be revised to account for reality

 Issue for economists:

 Why would an employer pay more than the market-determined

rate?

Labor and Demand Theories and

Implications

Theory Prediction So What?

Compensating Differentials Work with negative

characteristics requires

higher pay to attract

/retain workers

Job evaluation and

compensable factors must

capture these negative

characteristics

Efficiency Wage Above market wage/ pay

level will improve

efficiency by attracting

higher ability workers and

by discouraging shrinking

because of losing high

wage job . A high wage

policy may substitute

intense monitoring

The pay off to a higher

wage depends on

employee selection

systems ability to validly

identify best workers. An

efficiency wage policy

may require the use of few

supervisors

Labor Demand Theories and

Implications

Theory Prediction So What?

Sorting and Signaling Pay policies signal to

applicants the attributes

that fit the organizations.

Applicants may signal their

attributes by investments

they have made in

themselves

How much, but also how

pay mix and performance

will influence attraction-

selection-attrition and

resulting work force

composition

Job Competition Job requirements may be

fixed. Workers compete for

jobs based on

qualifications and not how

low wages they are willing

to accept. Thus wages are

sticky downward

As hiring difficulties

increase, employers should

expect to spend more to

a) train new hires, b) to

increase compensation, c)

search/recruit more

Compensating Differentials

 Explain the presence of various pay rates in the market

 Hard to document due to:

 Difficulties in measuring and controlling various pay rates

Efficiency Wage

 High wages may increase efficiency and lower labor costs if they:

 Attract higher-quality applicants

 Lower turnover

 Increase worker effort

 Reduce shirking

 Reduce the need to supervise employees

Efficiency Wage

 Greater profits than competitors allows share success with

employees by:

 Leading competitors’ pay levels

 Bonuses that vary with profitability

 Rent sharing-return received from activities that are:

 In excess of the minimum needed to attract people to those

activities

Sorting and Signaling

 Designing pay levels and mix as part of a strategy that:

 Signals employees kinds of behaviors sought

 Employer signals

 Organization decisions about:

 Pay level (lead, match, lag)

 Pay mix (higher bonuses, benefit choices)

 Employee signals

 Applicant characteristics (degree, grades, experience, etc.)

Exhibit 7.9 – Labor Supply Theories and

Implications

Product Market Factors and Ability to

Pay

 Product demand

 Limits maximum pay level an employer can set

 Degree of competition

 Highly competitive markets

 Lesser ability to raise prices without loss of revenues

 Single sellers are able to set whatever price they choose

Segmented Supplies of Labor and

(Different) Going Rates

 People flow to the work

 A segmented labor supply involves:

Multiple sources of employees

 For multiple locations

With multiple employment relationships

 Level and mix of cash and benefits paid depends on the source

Segmented Supplies of Labor and

(Different) Going Rates

 Work flows to the people – on site, off-site, offshore

 Determining pay levels and mix requires

 Understanding market conditions in different locations

 Managers need to know:

 Jobs required to do the work

 Tasks to be performed

 Knowledge and behaviors required to perform them.

Organization Factors

 Industry and technology

 Labor-intensive industries tend to pay lower than technology-

intensive industries

 New technology within an industry influences pay levels

 Employer size

 Large organizations tend to pay more than small ones

Organization Factors

 People’s preferences

 Determine external competitiveness

 Markets involve employers’ and employees’ choices

 Organization strategy

 Low-wage, no-service strategy

 Low-wage, high-service strategy

 High-wage, high-service strategy

Relevant Markets

 Determined on the basis of:

 Occupation

 Geography

 Competitors

 Chosen on the basis of:

 Competitors: Products, location and size

 Jobs: Required skills and knowledge

Relevant Markets

 Data from product market competitors receives greater weight

when:

 Employee skills are specific to the product market

 Labor costs are a large share of total costs

 Product demand is responsive to price changes

 Supply of labor is not responsive to changes in pay

Globalization of Relevant Labor

Markets: Offshoring and Outsourcing

 Factors to consider while deciding where to locate jobs

 Labor costs and productivity

Countries with lower average labor costs tend to have lower average productivity

 Agency Theory

Devote resources to systems that monitor worker effort or output

 Customer reaction

 How long the labor cost advantage will last

Competitive Pay Policy Alternatives

 Conventional pay-level policies

 To lead, to meet, to follow competition

 Newer policies

 Emphasize flexibility among:

 Policies for different employee groups

 Pay forms for individual employees

 Elements of the employee relationship that company wishes to emphasize

Exhibit 7.11 – Probable Relationships

Between External Pay Policies & Objectives

Pay with Compensation (Match)

 Wage costs

 Approximately equal to those of its product competitors

 Ability to attract potential employees

 Approximately equal to its labor market competitors

 Avoids placing an employer at a disadvantage in pricing products

Lead Pay-Level Policy

 Maximizes the ability to attract and retain quality employee

 Minimizes employee dissatisfaction with pay

 May offset less attractive features of work

 May lead to dissatisfaction

 If used only to hire new employees

 May mask certain negative attributes

Lag Pay-Level Policy

 May hinder a firm’s ability to attract potential employees

 Coupled with the promise of higher future returns:

 May increase employee commitment

 Foster teamwork

 May possibly increase productivity

Different Policies for Different

Employee Groups

 Employers may vary the policy for:

 Different occupational families

 Different forms of pay

 Different business units

 Pay-mix strategies may be:

 Performance driven

 Market match

 Work/life balance

 Security

Exhibit 7.15: Pay-mix

Policy Alternatives

Employer of Choice/Shared Choice

 Employer of choice

 Corresponds to the brand the company projects as an employer

 Shared choice

 Begins with traditional options of lead, match or lag

 Offers employees choices in the pay mix

 Risks

 EE’s will make “wrong” choices

Offering too many choices may lead to confusion, mistakes and dissatisfaction

Exhibit 7.16 – Volatility of Stock Value

Changes Total Pay Mix

Exhibit 7.17 – Dashboard: Total Pay Mix

Breakdown vs Competitors’

Exhibit 7.19 – Some consequences of

Pay Levels

Consequences of Pay-Level and Mix

Decisions: Guidance from the Research

 Efficiency

 No research suggests:

 Under what circumstances managers should choose which

pay-mix alternative

 Pay level may not gain any competitive advantage

Wrong pay-level may be a serious disadvantage

Consequences of Pay-Level and Mix

Decisions: Guidance from Research

 Fairness

 Satisfaction with pay is directly related to pay level

 Sense of fairness is related to how others are paid

Consequences of Pay-Level and Mix

Decisions: Guidance from Research

 Compliance

 Employers must pay at or above the legal minimum wage

 Prevailing wage laws and equal rights legislation must be met

 Pay forms are regulated

 Caution must be exercised when sharing salary information