McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Milkovich/Newman: Compensation, Ninth EditionMilkovich/Newman: Compensation, Ninth Edition

Chapter 2Chapter 2Strategy: The Strategy: The

Totality of Totality of DecisionsDecisions

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Exhibit 2.1: Three Compensation StrategiesExhibit 2.1: Three Compensation Strategies

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Strategic ChoicesStrategic Choices Strategy Strategy refers to the fundamental directions refers to the fundamental directions

that an organization choosesthat an organization chooses– Corporate level: “What business should we be in?”Corporate level: “What business should we be in?”– Business unit level: “How to gain and sustain Business unit level: “How to gain and sustain

competitive advantage?”competitive advantage?”– Functional level: “How should total compensation Functional level: “How should total compensation

help gain and sustain competitive advantage?”help gain and sustain competitive advantage?” A A strategic perspectivestrategic perspective focuses on those focuses on those

compensation choices that help the organization compensation choices that help the organization gain and sustain competitive advantagegain and sustain competitive advantage

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Support Business StrategySupport Business Strategy Pay systems should align with the organization's Pay systems should align with the organization's

business strategybusiness strategy– Based on contingency notionsBased on contingency notions

Compensation systems can be tailored to:Compensation systems can be tailored to:– Innovator business strategyInnovator business strategy– Cost cutter business strategy Cost cutter business strategy – Customer-focused business strategy Customer-focused business strategy

When business strategies change, pay systems When business strategies change, pay systems should also changeshould also change

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ObjectivesObjectives

Internal AlignmentInternal Alignment

External CompetitivenessExternal Competitiveness

Employee ContributionsEmployee Contributions

ManagementManagement

Five Strategic Guidelines for Compensation Choices

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The Pay Model Guides Strategic Pay The Pay Model Guides Strategic Pay DecisionsDecisions

Decisions based on the five strategic Decisions based on the five strategic compensation choices of the pay model, taken compensation choices of the pay model, taken together, form a pattern that becomes an together, form a pattern that becomes an organization's compensation strategyorganization's compensation strategy– Stated versus Unstated StrategiesStated versus Unstated Strategies

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Exhibit 2.5: Key Steps In Formulating a Total Exhibit 2.5: Key Steps In Formulating a Total Compensation StrategyCompensation Strategy

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Step 1: Assess Total Compensation Step 1: Assess Total Compensation ImplicationsImplications

Competitive Dynamics – Understand the Competitive Dynamics – Understand the BusinessBusiness– Changing customer needsChanging customer needs

– Competitors’ actionsCompetitors’ actions

– Changing labor market conditionsChanging labor market conditions

– Changing LawsChanging Laws

– GlobalizationGlobalization

Competitive dynamics can be assessed globallyCompetitive dynamics can be assessed globally

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Step 1: Assess Total Compensation Step 1: Assess Total Compensation Implications (cont.)Implications (cont.)

Culture/valuesCulture/values– A pay system reflects the values that guide an A pay system reflects the values that guide an

employer's behavior and underlie its treatment of employer's behavior and underlie its treatment of employeesemployees

Social and political contextSocial and political context– Context Context refers to legal and regulatory requirements, refers to legal and regulatory requirements,

cultural differences, changing workforce, cultural differences, changing workforce, demographics, expectations etc.demographics, expectations etc.

– Affects compensation choicesAffects compensation choices– Lobbying is also part of compensation strategiesLobbying is also part of compensation strategies

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Step 1: Assess Total Compensation Step 1: Assess Total Compensation Implications (cont.)Implications (cont.)

Employee preferencesEmployee preferences– How to better satisfy individual needs and How to better satisfy individual needs and

preferencespreferences Choice – Examples: Flexible benefits and choicesChoice – Examples: Flexible benefits and choices Union preferencesUnion preferences

– Pay strategies need to be adapted to the nature of the Pay strategies need to be adapted to the nature of the union-management relationshipunion-management relationship

– Unions' interests can differUnions' interests can differ– Compensation deals with unions can be costly to Compensation deals with unions can be costly to

changechange

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Step 2: Map a Total Compensation Step 2: Map a Total Compensation StrategyStrategy

Mapping is used in marketing to clarify and Mapping is used in marketing to clarify and communicate a product's identitycommunicate a product's identity

Offers picture of a company’s compensation Offers picture of a company’s compensation strategy based on the five choices in the pay strategy based on the five choices in the pay modelmodel

Clarifies the message the company is trying to Clarifies the message the company is trying to establish with its compensation systemestablish with its compensation system

Maps do Maps do notnot tell which strategy is the “best”, tell which strategy is the “best”, providing rather framework and guidanceproviding rather framework and guidance

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Exhibit 2.8: Contrasting Maps Of Exhibit 2.8: Contrasting Maps Of Microsoft And SASMicrosoft And SAS

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Steps 3 and 4: Implement and ReassessSteps 3 and 4: Implement and Reassess Step 3 Step 3

– Involves implementing strategy through the design Involves implementing strategy through the design and execution of compensation systemand execution of compensation system

Step 4Step 4– Reassess and realign, closes the loop and recognizes Reassess and realign, closes the loop and recognizes

that the strategy must be changing to fit changing that the strategy must be changing to fit changing conditionsconditions

– Involves periodic reassessmentInvolves periodic reassessment

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Sources of Competitive Advantage: Sources of Competitive Advantage: Three TestsThree Tests

Three tests determine if a pay strategy is a Three tests determine if a pay strategy is a source of advantagesource of advantage

Is it aligned?Is it aligned? Does it differentiate?Does it differentiate? Does it add value?Does it add value?

– Calculate the return on investment (ROI)Calculate the return on investment (ROI)

Whichhat is unique?