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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