=c:

.. ;ca·en:

=.=:CI.,

e:c'CJ:

INTEGRATING COMPENSATION STRATEGIES:

A Holistic Approach to

Compensation Design

e live in an innovative compen­sation environment in which ithas become commonplace forcompanies to develop ever­new approaches to age-oldcompensation questions. Theresult, of course, is a myriad ofnew compensation designs­from cash incentives to broad­banding to competency-basedpay to team incentives, and thelist goes on.

lt is enough to make com­pensation professionals looklongingly at the "good old days"

when it was enough to document jobs, evaluatethem and place them in a pay structure that wascompetitive with the organization's labor marketfor talent. In today's environment, compensationprofessionals must choose from a laundry list ofcompensation possibilities to find the approachthat makes the most sense from all perspectives.

This is where the challenge becomes mostdaunting. Although there has been much writtenabout new compensation innovations as individ­ual programs, there is less frequent discussion ofthe impact these programs can have when imple-

Thomas J. HackettPartner

D.G. McDermott Associates, LLC

Donald G. McDermottPartner

D.G. McDermott Associates, LLC

In this case study? a

company in a high-grDlvthindustry successftLliy useda new ;ntoarn+od 17/!'nirQ-f-':-n.D

, . #1 .••••.. 0 ...."ilt:!,.v-" ;;;..'il~L~/iJ.;~jn'./v

compensation progrcun to• I' •

satlSJY strategrc con{;zrns

ddi-Pr., . i-' [{'.an .... ljJ erentluiB ltse if z-n

the n'larketplace.

mented in a piecemeal fashion or even in tandemas part of a strategic compensation design. As aresult, compensation professionals often lackexperience and insight when making someimportant choices about when and how to designand implement these types of programs.

Some key questions go unanswered: Which ofthese compensation approaches or what combi­nation of approaches will satisfy senior manage­ment's need for effective and cost-effective com­pensation programs, while also silencingemployee cries for equitable and significantapproaches that reward employees for perfor­mance? Should these programs exist separately?Can these programs actually work against eachother? This article provides some answers tothese questions, using a case study to illustratehow one company developed an integrated com­pensation solution to a potentially cripplinghuman resources problem.

Holistic vs. PiecemealCompanies must heed some basic but importantcaveats when developing innovative compensa­tion approaches. First, it is strategically impor­tant that companies don't become enamoredwith the latest and most popular approach to

COMPENSATION & BENHITS REVIEW

~.~N ..P..~.~.~.9.W:C":

:=:=...

..............................................•......•.......•........•...................................

...........................•...............•.........•....................................................

Issue

Business Strategy

Corporate Culture

EXHIBIT 1

Compensation Considerations

Things to Consider

Is the compensation approach in sync with the company's five-year

strategic plan?

If the company is expecting to pay for performance, do managers and

employees have the willingness and ability to share the information

necessary to improve their performance?

.....:rr.:A::.....:c......

...........................•....•..•........•....••.•••...•............•.........••..••....•..............

Pay Philosophy Does the company pay below, at or above market?........•..••.•....•.•••...•..•...................••..•..............•.......•..••...••...................

Pay for Performance Is management willing to provide above-market pay for superior

performance?..................................•••..........•••••.••..•••..•...•••••...•...........•...................

Base Pay Does the company prefer to pay at market or use a merit approach?................•.........•.....•••..•••...••.•...••••••..•.....•.•••...•.••.••...•••••........••.........

Pay Structure How will the company structure its pay program-no ranges, traditional

ranges or broadbanding? ,•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• c •••••••••••••••••••• •

Variable Pay Which is most appropriate for the company, individual, group, team or

corporate-wide incentives?...........•...•...••....••....•...•..•••.•..••••••••••..•••.••.•••••.•••.•.•••......•.......•••••...•...•

Performance Management Is the company able to develop good job, team, or group performance

measures to support any new compensation approach?•••••••••••••••••••••••••••••••••••••••••••••••••••••• 4 ••••••••••••••••••••••••••••••• ••••••••••••••••••••

Upward mObility/turnover Is the organization willing to pay a premium to retain ,highly skilled human

capital? ,,- .,••.........•....•••.•.•..•....•••..•••••.•••....•.•...••...•.........••.•.•...•••••••.....................

Individual pay programs .,. ~.~ Does the nature of the work lend itself to skill- or competency-based pay

,-::? programs?.'1' ••••• "':, .• j' __ .••

.................•.•......•.•.•••••••••....•..•..•••.•.•.•...•••..•.•••••••.....•.••...•.•................

Incentive pay delivery ':~i~ Can the company afford cash inc6ntive programs?. - .'

....•..•...••••..•••.•.••.•••••..••••.••.•••••••••••...•.•••....•..•............•.•••.•••.................

Use of stock .'->.15, the company willing to provide equity-based incentives at lower levels. of

·,,~~.organization? ' ~ - >':/ .;.~'-~\~

compensation as the answer to their problems.Instead, companies must conduct a thoughtfulanalysis of their situation and goals and developthe compensation approach that is best suited tohelp meet those goals. Exhibit 1 lists some keyconsiderations for companies that are develop­ing new compensation programs.

Second, it is also important for organizationsto avoid implementing several compensationapproaches piecemeal. Without a holistic andstrategic approach to compensation design,companies may find that they have developedand implemented compensation programs thatmotivate behavior that is actually contrary totheir ultimate objective of maximizing organiza­tional efficiency and making the most of itshuman capital. In the end, this approach canleave a company no better or even worse offthan it was when it launched the program.

Here are some common examples of this phe­nomenon:

Teams vs. individuals. It is troubling to thinkabout the number of companies that have adopt­ed a team approach to organizing work, only toundermine those teams with the wrong compen­sation approach. By implementing individualincentive programs in a team environment, thesecompanies often inhibit the willingness of indi­viduals to cooperate with each other. Even poorlyconceived and designed team-based incentivescan inhibit teams from sharing information withone another if they feel they are competing forincentive dollars. What these companies fail tograsp is that effective group incentives should betied to overall unit measures that everyonebelieves they can influence.

Supporting programs. Base pay programs,such as broadbanding, should be implemented

SfPHMBfR/OCTOB£R 1999 37

~.~~..p..~~.~.~.~=:=:.- .

with an overall corporate human resources strat­egy in mind. Broadbanding as a stand-alone sys­tem usually doesn't work unless it is actually anoverlay to skill- or competency-based pay pro­grams that encourage continuous learning.Companies that implement broadbanding forreasons other than as a means of supportingsome other objective, like competency-basedpay, often find themselves suffering from salarycreep. Here's why. Broadbanding allows a pro­gression within a job family by removing the oldbarriers to pay increases, such as specific jobgrade midpoints set at market and a maximumpay rate for a job in a specific grade with a tradi­tional pay grade minimum.

Under a traditional system, job incumbents atmaximum could only increase salary by beingpromoted to the next higher grade range. In abroadbanding approach, those limitations areusually removed. Therefore, if broadbanding isimplemented without being supported by a skill­or competency-based pay program to controlsalary movement on the basis of the incumbentdemonstrating increased skills and competenciesthat justify a higher pay rate, salaries couldincrease as a matter of course through the annu­al merit review. Companies may then find thattheir cost of labor has increased without anincrease in human capital contribution.

Even implementing broadbanding and skill­or competency-based pay in tandem may not beenough. Other human resources programs oftenhave to change to support the overall goals ofbroadbanding and skill- or competency-basedpay. For example, for continuous learning tooccur, skill- and competency-based pay pro­grams must be supported by adequate trainingand development budgets.

Sending consistent messages. Annual meritbudgets within an organization that heavilyemphasizes incentives can send employees con­flicting messages by reinforcing an entitlementmentality of expecting an annual salary adjust­ment. That mentality can take the focus offrewardsfor performance improvements through incentivepay. Ifan organization wishes to move to a variablepay compensation system that truly rewards forannual performance, then salary adjustmentsshould only be based on either market movementor promotions to a higher job category.

An Integrated ApproachIf these are the don'ts involved in developing anappropriate compensation approach, what arethe dos that will help compensation profession-

COMP£NSATION & B£NHlTS R£VI£W

als develop a program that will meet companyand management goals and ensure that the com­pany is paying for performance? That was thechallenge facing HomeBuilder, Inc. (a pseudo­nym), a publicly traded national company thatdevelops residential properties, including singleand multiple family homes, condominiums andwhole communities.

The company developed an integrated com­pensation approach using several innovative pro­grams to create an overall compensation designthat not only pays for performance, but also sup­ports the company's business strategy. In this sit­uation' the key to success was the company'sability to step back and decide how to use payprograms to support business strategy. Then, thecompany built an integrated compensation pro­gram that drives organizational success. In theprocess, the company realized two importantthings: (1) No one program would address all itsneeds and (2) it was critical that the companydevelop multiple programs in tandem to makesure they complemented each other and sup­ported the company's ultimate goal.

But it had not always been that way. In thepast, HomeBuilder's compensation approachhad been built around an annual incentive for­mula based on overall corporate profitability. Thecompany fed its talent pool by recruiting new col­lege graduates into its associates program anddeveloping them to become builders. The associ­ates started out as technicians and were sup­posed to progress to superintendents, adminis­trators and eventually to builders. The highestposition in the home-building hierarchy is theRegional Vice President who manages multiplecommunities.

Unfortunately, a few years ago, that approachbegan to show signs of strain. The company wasfacing increasing pressure from competitors whowere raiding the company of its future talent.Entry-level associates were being recruited awayjust as they were maturing and ready to assumegreater levels of responsibility. Base pay was notthe only attraction that lured the best talent awayfrom the company. Competitors offered poten­tially faster promotions and greater incentiveopportunities than those available atHomeBuilder, Inc. Exit interviews revealed thatthe associates were frustrated with the promo­tional process. It seemed to take too long andthere was a lack of consistency in determiningwhat qualifications were necessary to be promot­ed to the next level. Finally, annual incentiveawards at the associate level were not only based

P._~N._~.~.~.~.~.~:n:CI

:!:"CI

:m:=:111

:=

on a superintendent's discretion but also seemedto be arbitrary to the associates.

The net result of all this was that HomeBuilder,Inc., in effect, had become the training center forthe industry. Growing defections among the asso­ciate ranks were sabotaging the company's longerterm strategy to build human capital superior toits competitors. The company's goal was to have areputation for building quality residences, ontime and well within budgets. If it was successfulin that goal, both its reputation in the market­place, and the potential for its stock to appreciatein value would be assured. With that in mind, thecompany began looking for ways to reverse thetide of associate defections.

Finding The SolutionRecognizing the importance of finding a solutionto this problem, HomeBuilder's senior manage­ment appointed a task force to address these prob­lems. The task force consisted of first-line con­struction management personnel (vice presidentsand builders) and Human Resources manage­ment, including representatives from training anddevelopment and compensation.

A competency-based approach. The task force'sfirst step was to identify the skills and competen­cy requirements for each position in the homebuilding hierarchy. The ultimate goal of this exer­cise was to identify career progression opportu­nities that associates could understand. Therationale was that ifthe company could develop asystem that provided associates with more directcontrol over their own upward mobility, the com­pany could solve its turnover problem.

Even though identifying, defining and decidinghow to measure competencies was tedious andtime consuming, the outcome was a clearlydefined set of competencies for each job category,as well as formal and informal ways to measurethe demonstration of those competencies. Thosecompetencies that associates could developthrough training and testing were integrated intoformal training programs. Skillsthat could only bemeasured through on-the-job performance wereintegrated into the annual performance reviewsfor each job category with corresponding qualify­ing standards of performance for the specific skill.

Next, the task force divided each job categoryinto three levels: low (I),intermediate (II)and high(III).This way, each job category, such as superin­tendent, has three levels, each with its own set ofdiscrete competencies. An associate knew exactlywhich competencies had to be mastered to be

able to move from one level to the next. They alsoknew exactly what would be required to be pro­moted from one category to another.

Support for training. But having these distinctcompetencies would be of little use unless associ­ates had access to the training resources neces­sary to move from one level to the next. Therefore,the task force's representatives from the Trainingand Development department came up with twotraining options for associates. Associates could(1) attend and pass identified formal in-housetraining courses, (2) find ways to demonstrateskills developed through on-the-job training, or(3) some combination of the two. Whateverapproach they took, associates had to find a wayto qualify for each level within each job categoryin order to move up in the career progression.

It is important to note that HomeBuilderbacked up this competency-based approach topay and career development by increasing itstraining budget to accommodate additional

Thecompany backed upthe pay program withadditional training.training courses. It also modified its educationalreimbursement policy to include skills develop­ment seminars in addition to college-level cours­es.Without this willingness to invest in training, itis doubtful that the competency-based approachwould have made much of an impact on associ­ate development, satisfaction or retention.

Changing the compensation structure. Once thecompetency-based approach to career progres­sion was in place, the HomeBuilder task forceturned its attention to developing a supportingpay structure. The first step was to conduct amarket study of the subject positions and deter­mine "going rates" for each job category in thehierarchy.

Next, to maximize flexibility, the task forceused these going rates to develop salary bands.This broadbanding structure allowed for mobili­ty within each job category, as well as substantialsalary increases when an associate qualified tobe promoted from one band (category) to thenext higher one. The bands were developed toprovide for ever increasing minimum-to-maxi­mum band range spreads going up the hierarchyof jobs categories.

S[PHMB[R/OCTOBH 1999

:-.-:CI

:=

P..~N..~.~§.~.~~=:= :.- .

For example, the band for the technician cate­gory had a range spread of 50%,while the builderband had a range spread of 100%.The wide rangespreads were necessary to accommodate move­ment within each job category. Since the inter­mediate level (II) for each category was set atmarket, incumbents at the Level I were paid abase salary below market. Incumbents at Level IIIwere paid above market for mastering all thecompetencies required of the job category.

Allowing for adjustments. The bands alsoallowed for all incumbents within each categoryto be eligible for annual merit reviews based onthe performance of the level of the job categorythey were in. This approach was intended to easeassociates' passage through each job category.The task force estimated that it would take anaverage of 18months for associates to master theskills and competency requirements for move­ment to the next level in a job category. Thanks tothis approach, associates would be less likely tofeel that their salaries had stagnated while theywere learning the skills necessary for intra-cate­gory movement.

As they mastered the competencies necessaryto move to the next level within the job category,associates were also eligible for an additionaladjustment to bring their salaries to the "mini­mum" of the next level, if necessary. For example,a technician Level II who mastered all the com­petencies required to be moved to Level III waseligible to receive a salary adjustment to the min­imum of Level III if his or her current salary wasbelow that minimum. The compensation designprovided for additional incentive to master thecompetencies required to be moved to the nexthighest level.

Overall, this structure had immediate tangiblebenefits for everyone in the company. For theirpart, managers and supervisors had a definitiveset of guidelines for appraising individual perfor­mance each year. And for associates, the newprogram provided clear communication and sig­nals about what they had to do to get to the nextlevel and what they had to do to be promoted tothe next highest job category. The structure alsodid not impose artificial limits. For example,there were no limits placed on the number of staffwho could be in each category below the VicePresident level.

The incentive component. With a career progres­sion and base pay structure in place, the taskforce was able to turn its attention to a pay-for-

performance component of the overall compen­sation package. To do this, the task force decidedto make all associates eligible for incentive pay.However, to distinguish the new incentive fromthe previous incentive program, the companyrevised the incentive formula to provide an annu­al incentive pool based on overall company prof­itability. Because everyone in the home-buildingcareer path influenced product costs, schedules,and customer service, it made sense to includeeveryone in the annual incentive program. Targetincentive amounts were developed for each level

The new structure

has tangible benefitsfor everyone.

within each job category. Thus, incumbents atthe intermediate level (II) within each categorywho performed well could receive total cashcompensation (base salary plus bonus) greaterthan the market rate, assuming the companyachieved its annual profittargets.

ResultsAlthough it took HomeBuilder almost a year todevelop this new approach to compensation andcareer development, the company felt the pro­gram's effects much sooner. (See Exhibit 2 for abefore-and-after comparison of HomeBuilder'scompensation approach. Exhibit 3 illustrates thelayers involved in HomeBuilder's approach tointegrated compensation.) In fact, turnoverdiminished while the company was working onthe new compensation and career developmentprogram because associates felt that the compa­ny was finally addressing their concerns.

When the program was rolled out, associateswere enthusiastic about the possibilities it pre­sented, not only in the potential for additionalcompensation but for the potential for takingcontrol of their own career development.Through their own efforts, associates could affectthe level of their annual merit increase, annualincentive, progress through the job categoryband and, eventually, how fast they would be pro­moted. By taking responsibility for developingthe required skills and competencies, associatescould influence their career growth within thecompany. The ball was firmly in the associates'court and the associates were eager to play.

continued on page 42

40 COMP[NSATION & B[N[tlTS R[VI[W

P.~N..~.~.~~.~.N:~:CI

:-5:"1:1

:11:=:111

:111

:-.-:CI

:=

EXHIBIT 2Out with the Old and In with the NewHomeBuilder: Before and AfterThe Old Approach

The New Approach

Career

Associates frustrated with a promotionalNew competency-based structure provides

progression

process that took too long and lackedclearly defined set of competencies for each job

consistency in determining necessary

category, and formal and informal ways to

qualifications for promotions.

measure the demonstration of those

competencies. Each job category has threelevels, each with its own set of discretecompetencies. Associates now know exactlywhich competencies to master in order to moveto the next level or to be promoted to the nextjob category.

Supporting

Training not tied to skills and abilities needed toTwo training options provide formal in-house

programs

get promoted. training courses and on-the-job training. The

training bUdget increased to accommodateadditional training courses. Educationalreimbursement policy was also modified toinclude skills development seminars andcollege-level courses.

Base pay

The annual merit increase was based onA broadbanding structure provided substantialstructure

arbitrary performance standards. salary increases for promotions from one band

(category) to the next. There are ever increasingminimum-to-maximum band range spreadsthroughout the hierarchy of job categories toaccommodate movement within each jobcategory . .Adjustments

Job progression and promotions wereAssociates eligible for annual merit reviews to

haphazard and pay inequities occurred.

keep pay competitive as associates worked

through each job category. Associates alsoeligible for an additional adjustment to bring theirsalaries to the minimum of the next job level, ifnecessary.

Incentives

Awards were not as rich as competitors, wereAll associates eligible for incentive with a

based on supervisors' discretion and seemed

formula based on overall company profitability.

arbitrary.

Each level within each job category has its own

target incentive amounts.

Results

Associates found compensation and careerAssociates were excited about the program,

progreSSion decisions arbitrary and out of their

the company's willingness to address their

control. The result was high turnover among

concerns and their ability to impact their own

associates, who left to join competitors.

compensation and career progression. Turnover

dropped even before the program was rolled outand dropped further once the program was inplace.

mHMBfR/OCTOBfR 1999 ~ 1

~.~N ..~.~~_~_G..~=:

- = :.-

EXHIBIT 3Using An Integrated Approach to Effect Change

-:ca:en:

=:G):=-:E:=:C,):

continued from page 40

Learnin!( fromHomeBUilder's ExperienceAlthough each company's situation is different,there are some important lessons to learn fromHomeBuilder's experience. By integrating meritpay, competency-based pay, broadbanding,career paths and an annual incentive eligibility,HomeBuilder developed a compensation pro­gram that satisfied several strategic concernssimultaneously. It not only empowered employ­ees, it gave the company a system for ensuringthat its human capital was constantly beingdeveloped.

This, in turn, provided HomeBuilder with theedge it desired to differentiate itself in the market­place. The most obvious and immediate improve­ment was the cost savings realized throughreduced turnover. Then, as the company was ableto retain enough qualified staff, it could more eas­ilycomplete jobs on time and within budget. Witha more stable and productive work force, thecompany could commit to bringing more build­ing projects into the pipeline without worryingabout its ability to deliver those projects on time

and within cost budgets.This increased project

efficiency had an importantimpact on the company'sbottom line because thefaster a project was com­pleted, the faster the hous­ing units could be sold.This, in addition to bettercost containment, helpedHomeBuilder realize itsprojected profit margins.The overall result was toincrease the company's rep­utation in the marketplaceand assure investors thatthe company would contin­ue to grow.

It is important to remem­ber, however, that whatworked for HomeBuilder isnot likely to work for everycompany. Therefore, com­pensation professionalsmust not yield to the pres­sure to implement the latestpopular pay program.Instead, they need to pickand choose those that make

the most sense for the company's long-termstrategic goals. Even in today's tight labor marketswhere there is ever-increasing pressure to pro­vide the most popular pay programs, like annualincentives, competency-based pay, and' broad­bands, to attract the best talent, such programsshould be part of an overall human resourcesstrategy.

Moreover, the myriad of design options givecompensation professionals an opportunity tointegrate several pay techniques in ways thatwill best support the overall business strategy ofthe organization while at the same time ensur­ing that employees are being paid for measur­able performance. Compensation professionalsmust first encourage management to communi­cate specifically what the five-year businessplan is and then step back and think throughhow the compensation plan can be designed tosupport the achievement of the plan, not towork against it.

And finally, it is critical for companies to iden­tify the pro blems they need to address, the goalsthey want to pursue and the needs of their workforces before developing any compensationapproach. Only then can a company expect to

COMptNSATION & BfNHIT5 RfVlfW