Compensation Strategy: Internal Alignment 1. Supports Organization Strategy 2. Supports Workflow 3 Motivates Behavior -

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Shonda Gilbert
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1 Chapter 3: Defining Internal Alignment Compensation Strategy: Internal Alignment Internal alignment (internal equity)- the pay relationships between the jobs/skills/competencies within a single organization Pay structure- the array of pay rates for different work or skills within a single organization; the number of levels, differentials in pay between the levels, and the criteria used to determine these differences create the structure -relationships among different jobs inside an organization form a job structure that should: 1. Supports Organization Strategy -organization s strategy indicates how it plans to achieve its purpose -internal job structures that are aligned help to achieve it 2. Supports Workflow Workflow- process by which goods and services are delivered to the customer -structure should support the efficient flow of that work and the design of the organization 3 Motivates Behavior -internal pay structure influence employees behavior by providing pay increases for promotions, more challenging work, and greater responsibility as employees move up in the structure Line-of-sight-link between an individual employee s work and the achievement of organizational objectives -employees should be able to see or understand the links between their work, the work of others, and the organization s objective -internal alignment helps create that line-of-sight Structures Vary Between Organizations -managers may vary to design a structure that supports workflow and directs employee behaviors toward objectives -internal pay structure is defined by: 1. Levels of work -pay structures usually reflect flow of work in the organization, some more hierarchal with multiple levels, others compressed with few levels 2. Pay Differentials Between Levels Differentials-pay difference between job levels -if organization has compensation budget of set amount to distribute among its employees, there are a number of ways to do so: -divide the budget by the number of employees, giving everyone the same amount -pay different employees different amounts based on work that requires more human capital (knowledge, skills, abilities, work performed under less than desirable work conditions, and/or whose results are more valued) 3. Criteria (Content and Value) used to determine those levels and differentials -work content and work value are most common bases for determining internal structures -content refers to the work performed in a job and how it gets done (tasks, behaviors, knowledge required, and so on) -value refers to the worth of the work; its relative contribution to the organization objectives

2 -structure based on content typically ranks jobs based on skills required, complexity of tasks, and/or responsibility -structure based on value of work focuses on relative contribution of the skills, tasks, and responsibilities of a job to the organizations goals Use value reflects value of goods of services an employee (labour) produces in a job Exchange value- is whatever wage the employer and employee agree on for a job -new technologies associated with Industrial Revolution increased use value of labour without corresponding increase in exchange value Job- and Person-Based Structures -job-based structure looks at work content (tasks, behaviors, responsibilities) -person-based structure shifts the focus to the employee: the skills, knowledge or competencies the employee possesses, whether or not they are used on the particular job the employee is doing -in real world it is hard to describe a job without reference to the job holders knowledge and skills -hard to define person s job-related knowledge or competencies without referring to work content What Factors Shape Internal Structures? -external factors: economic pressures, government policies/laws/regulations, stakeholders cultures and customs -organization factors: strategy, technology, human capital, HR policy, employee acceptance, cost implications -internal structure: levels, differentials, criteria Economic Pressures Marginal productivity theory- unless an employee can produce something of value from his/her job equal to the value received in wages, it will not be worthwhile for an employer to hire that employee -employers pay use value -pay differences among job levels reflect differences in relative productivity of the job and/or differences in how much a consumer values the output -differences in productivity provide a rationale for the internal pay structure -supply and demand for labour/products/services affects internal pay structure Government Policies, Laws and Regulations -in Canada, human rights legislation forbids pay systems that discriminate o basis of race, religion, sexual orientation, national origin, etc. -pay equity acts require equal pay for equal value based on skill, effort, responsibility, and working conditions -internal pay structure may have any number of levels, differentials of any size, as long as the criteria for setting them doesn t infringe on any rights -a lot of pay-related legislation attempts to regulate economic forces to achieve social welfare objectives (maximums and minimum pay) External Stakeholders -unions, stockholders, and even political groups have a stake in establishing internal pay structures -most unions seek smaller pay differences among jobs as well as seniority-based promotions in order to promote solidarity among members

3 Cultures and Customs -culture is the mental programming for processing information that people share in common -shared mindsets in society may for judgment about what size of pay differential is fair Organization Strategy -different business strategies may require different pay structures to support them -pay structures that aren t aligned with organization strategy may become obstacles to organizations success Organization s Human Capital Human capital- the education, experience, knowledge, abilities and skills that people possess -stronger the link between skills and experience and an organizations objective, the more pay these will command Technology and Work Design -technology used in producing goods/services influences organizational design, the work to be performed and the skill/knowledge required to perform the work and therefore technology is another factor influencing design of pay structure Overall HR Policies -organizations other HR policies also influence pay structure -most organizations tie pay to promotions to influence employees to apply higher-level positions -if organization has more levels it can offer more promotions, but there may be smaller pay differential between levels Internal Labour Markets: Combining External and Organizational Factors Internal labour markets- rules and procedures that determine the pay for different jobs within a single organization and that allocate employees to those different jobs -combine external and organizational factors -because employer competes in external market for people to fill entry level jobs, their pay is linked to external market -must be high enough to attract qualified pool of applicants -non-entry level jobs is buffered from external forces and more heavily influenced by internal factors (technology, human capital required, organizations strategy) -external factors are dominant influences on pay for entry jobs but the differences for non-entry jobs tend to reflect organizations internal factors Employee Acceptance: A Key Factor -employees judge fairness of their pay compared to others for related work (to jobs in same internal job structure and in external market at competing employers) -important factor influencing internal pay structure is acceptability to the employees involved Distributive justice- fairness of a decision outcome (results of procedures, pay structure itself -addresses whether the actual pay differences among employees are acceptable Procedural justice- fairness of process by which a decision is reached (procedures for determining pay) -employees are more willing to accept lower pay if they believe the way the decision was made was fair -research also suggests that pay procedures are more likely to be perceived as fair it: 1) they consistently applied to all employees, 2) employees participate in the process (exception when wages are very low), 3) appeals procedures are included, 4) the data used are accurate

4 -addresses how design and administration decisions are made and whether procedures are applied in consistent manner Pay Structures Change -pay structures change in response to changing external pressures (skill shortages) -over time distorted pay differences become accepted as equitable and customary (may take another economic jolt to overcome cultural resistance and new mores are formed around new structure) Strategic Choices in Designing Internal Structures -internally aligned pay structures support way work gets done, fit the organizations business strategy, and are fair to employees -greater internal alignment (fit) is more likely to lead to success -misaligned structures become obstacles and motivate employee behavior that s inconsistent with organizations strategy Tailored versus Loosely Coupled Tailored structure- pay structure for well-defined jobs with relatively small differences in pay -low cost customer-focused business strategy -example: McDonalds everything is well defined, detailed, low pay difference between jobs Loosely coupled structure- pay structure for jobs that are flexible, adaptable, and changing -need more flexible structure to facilitate constant change -example:3m where there s constant innovation and short product design-to-market cycle times Egalitarian versus Hierarchical -egalitarian pay structures have fewer levels (then hierarchical) and smaller differentials between adjacent levels and between highest-paid and lowest-paid workers -can be classified as de-layered or compressed (several layers of responsibility and supervision are removed so all employees at all levels become responsible for broader range of tasks and have greater freedom to determine how best to accomplish what s expected of them) -implies belief that more equal treatment will improve employee satisfaction, support cooperation, and therefore improve workers performance -equal treatment can result in more knowledgeable employees with more responsible jobs going unrecognized and unrewarded which may cause them to leave organization (physically get new job or slack off/tune out) which will lower performance -hierarchical pay structures are consistent with a belief in the motivational effects of frequent promotion -value differences in individual employee skills, responsibilities and contrition to organization -choice is not either or but matter of degree Guidance from the Evidence -before managers choose pay structure they should look at factors in their organization (workflow, what is fair, and how to motivate employee behavior) as well as look to theory and research for guidance Equity Theory: Fairness -employees judge fairness or equity of pay by comparing it to that of other jobs at their own employer (internal equity) and to that of jobs at other companies (external equity)

5 -equity theory could support egalitarian or hierarchical structures, depending on comparisons and accuracy of information about them Tournament Theory: Motivation and Performance -according to tournament theory, all players play better in tournaments where prize differentials are sizable (hierarchical structure) -greater the differential between an employees present salary and their bosses, the harder employee will work (applies when individual performance matters) -teams with egalitarian structures (more flexible, supportive organizational culture) did better than hierarchical Institutional Theory: Copy Others -institutional theory predicts that very few firms are first movers and instead they copy innovative practices after innovators have learned how to make the practices work (copiers have little concern for alignment and even less for innovative pay practices) Guidelines from the Evidence -more hierarchical structures are related to greater performance when the workflow depends more on individual contributors (ie. Consulting and law practices, surgical units, stockbrokers, even university researchers) -high performers quit less under more hierarchical systems when pay is based on performance rather than seniority and when people have knowledge of the structure -more egalitarian structures are related to greater performance when close collaboration and sharing of knowledge is required (ie. Firefighting, hotel service staff, global software design teams) competition fostered in winner-take-all tournament hierarchies appears to have negative effects on performance when the workflow and organization design require teamwork -impact of any internal structure on organization performance is affected by the other dimension of the pay model: pay levels (competitiveness), employee performance (contributions), and employee knowledge of the pay structure (management) -hardly no research on optimal size of promotional increase or its effect on behaviors, satisfaction, or performance OR about smaller, more frequent promotions are better than fewer, larger, less frequent promotions

6 Pay Structure Undertake training Increase Experiance Reduce Turnover Facilitate Career Progression Facilitate Performance Reduce Pay- Related Grievances Reduce Pay- Related Work Stoppages Consequences of Structures Efficiency -aligned pay structures can lead to better organization performance -if structure doesn t motivate employees to help achieve organizations objectives then it is candidate for redesign -internal pay structures imply future returns -size of pay differential between entry level and highest level in structure may induce employees to remain with organization, increase experience and training, cooperate with coworkers, and seek greater responsibility -number of levels and titles in career path may be rewarding beyond the pay attached to titles (motivated by frequent steps in career ladder) Fairness -departures from acceptable wage structure will result in higher turnover, grievances and diminished motivation -some argue that if fair (ie. Sizable) differentials between jobs are not paid, individuals may harbor ill will toward employer, resist change, change employment if possible, become depressed or lack the zest and enthusiasm which makes for high efficiency and personal satisfaction in work -some argue (includes labour union) for small differentials, in the belief that more egalitarian structures support team cooperation, high commitment to organization and improved performance Legal Compliance -with any pay decision, design and management of internal pay must comply with regulations of countries in which organization operates

Chapter 3. Defining Internal Alignment

Chapter 3. Defining Internal Alignment Chapter 3 Defining Internal Alignment Learning Objectives Compensation strategy - Internal alignment Structures vary among organizations What shapes internal structures? Strategic choices in designing