Chapter 7

Defining Competitiveness

McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

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Chapter Topics

Compensation Strategy: External CompetitivenessWhat Shapes External Competitiveness?Labor Market FactorsModifications to the Demand SideModifications to the Supply SideProduct Market Factors and Ability to Pay

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Chapter Topics (cont.)

Organization FactorsRelevant MarketsCompetitive Pay Policy AlternativesConsequences of Pay-Level and Mix Decisions: Guidance from the Research

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Compensation Strategy: External Competitiveness

External competitiveness is expressed by:Setting a pay level that is above, below, or equal to that of competitorsDetermining the mix of pay forms relative to those of competitorsExternal competitiveness refers to the pay relationships among organizationsthe organizations pay relative to its competitors

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Compensation Strategy: External Competitiveness (cont.)

Pay level refers to the average of the array of rates paid by an employer:

(base + bonuses + benefits + value of stock holdings) / number of employees

Pay forms are the various types of payments, or pay mix, that make up total compensation

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Compensation Strategy: External Competitiveness (cont.)

Objectives: Control costs and increase revenues Attract and retain employees

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Control Costs and Increase Revenues

Labor costs = (pay level) times (number of employees)Higher the pay level, the higher the labor costsHigher the pay level relative to what competitors pay, the greater the relative costs to provide similar products or services

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Labor Market Factors

Two basic types of markets: Quoted price Example: Stores that label each items price Bourse Example: eBay allows haggling over the terms and conditions

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Labor Market Factors (cont.)

In both markets, employers are the buyers and potential employees are the sellersIf inducements offered by the employer and skills offered by the employee are mutually acceptable, a deal is struck

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How Labor Markets Work (cont.)

The market rate is where the lines for labor demand and labor supply cross

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Labor Demand

Analysis of labor demand indicates how many employees will be hired by an employerIn the short run, an employer cannot change any factor of production except human resources

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Labor Demand (cont.)

An employers level of production can change only if it changes the level of human resourcesAn employers demand labor coincides with the marginal product of labor

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Marginal Product

Marginal product of labor is the additional output associated with employment of one additional person, with other production factors held constant Diminishing marginal productivity Each additional employee has a progressively smaller share of the other factors of production with which to work

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Marginal Revenue

Marginal revenue of labor is the additional revenue generated when the firm employs one additional person, with other production factors held constantA manager using the marginal revenue product model must:Determine pay level set by market forcesDetermine marginal revenue generated by each new hire

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Labor Supply

This model assumes: Many people are seeking jobs They possess accurate information about all job openingsNo barriers to mobility existThese assumptions greatly simplify the real world

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Modifications to the Demand Side

Economic theories must frequently be revised to account for realityWhen focus changes from all the employers in an economy to a particular employer Issue for economists:Why would an employer pay more than what theory states is the market-determined rate?

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Compensating Differentials

According to Adam Smith, If a job has negative characteristics then employers must offer higher wages to compensate for these negative features For instance, if: Necessary training is very expensive Job security is tenuous Working conditions are disagreeable Chances of success are low

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Efficiency Wage

According to efficiency-wage theory, high wages may increase efficiency and actually lower labor costs if they: Attract higher-quality applicants Lower turnover Increase worker effort Reduce shirking Reduce the need to supervise employees

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Efficiency Wage (cont.)

Firms with greater profits than competitors are able to share success with employees via: Leading competitors pay levels Bonuses that vary with profitability

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Signaling

Employers deliberately design pay levels and mix as part of a strategy that signals to both prospective and current employees kinds of behaviors soughtOn the supply side of the model:Suppliers of labor signal to potential employersCharacteristics of applicants and organization decisions about pay level and mix act as signals

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Product Market Factors and Ability to Pay

Product Demand Puts a lid on maximum pay level an employer can set Degree of competition In highly competitive markets, employers are less able to raise prices without loss of revenuesSingle sellers are able to set whatever price they choose

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Segmented Supplies of Labor and (Different) Going Rates

People flow to the work A segmented labor supply involves: Multiple sources of employees From multiple locations With multiple employment relationshipsLevel and mix of cash and benefits paid depends on the sourceWork flows to the peopleon site, off-site, offshore

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Segmented Supplies of Labor and (Different) Going Rates (cont.)

Reality is complex; theories abstractsSegmented sources of labor means that determining pay levels and mix requires understanding market conditions in different locationsManagers need to know:Jobs required to do the workTasks to be performedKnowledge and behaviors required to perform them

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Organization Factors

Industry and technologyLabor-intensive industries tend to pay lower than technology-intensive industries; New technology within an industry influences pay levels Employer sizeLarge organizations tend to pay more than small ones

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Relevant Markets

Three factors determine relevant labor markets: Occupation Geography Competitors

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Relevant Markets (cont.)

Employers choose their relevant markets based on:Competitors Products, location, and size Jobs Skills and knowledge required and their importance to organizational success

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Globalization of Relevant Labor Markets:
Offshoring and Outsourcing

Factors to consider in deciding where jobs will be:Countries with lower average labor costs tend to have lower average productivityCompanies must devote resources to systems that monitor worker effort or output (Agency theory)

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Globalization of Relevant Labor Markets:
Offshoring and Outsourcing (cont.)

Customers reactions must be consideredHow long the labor cost advantage will lastWhether qualified employees will continue to be available as other companies tap into this labor pool

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Pay with Competition (Match) (cont.)

Attempts to ensure that an organizations:Wage costs are approximately equal to those of its product competitorsAbility to attract potential employees will be approximately equal to its labor market competitors

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Lead Pay-Level Policy

Maximizes the ability to attract and retain quality employees and minimizes employee dissatisfaction with payMay also offset less attractive features of workIf used only to hire new employees, may lead to dissatisfaction of current employeesMay mask negative job attributes that contribute to high turnover later on

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Lag Pay-Level Policy

Paying below-market rates may hinder a firms ability to attract potential employeesLag pay-level policy coupled with the promise of higher future returns: May increase employee commitment Foster teamwork May possibly increase productivity

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Exhibit 7.16: Some Consequences of Pay Levels

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Consequences of Pay-Level and Mix
Decisions: Guidance from the Research (cont.)

FairnessSatisfaction with pay is directly related to pay levelSense of fairness is related to how others are paid ComplianceEmployers must pay at or above the legal minimum wagePrevailing wage laws and equal rights legislation must be met

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Consequences of Pay-Level and Mix
Decisions: Guidance from the Research (cont.)

Pay forms are also regulatedCaution must be exercised when sharing salary information to avoid antitrust violations