The Pay Model

THE PAY MODEL

POLICIES TECHNIQUES OBJECTIVES

EFFICIENCY
Work Descriptions Evaluation/ INTERNAL
Internal ALIGNMENT
analysis certification STRUCTURE • Performance
• Quality
• Customers
External Market Surveys Policy PAY • Stockholders
COMPETITIVENESS definitions lines STRUCTURE
• Costs
FAIRNESS
Seniority Performance Merit INCENTIVE
CONTRIBUTIONS based based based

COMPLIANCE

MANAGEMENT Costs Communication Change EVALUATION

Pay Objectives at Medtronic and
Whole Foods
 Four Policy Choices
• Internal alignment
–Focus - Comparisons among jobs or skill levels inside
a single organization
–Pay relationships within an organization affect
employee decisions to:
• Stay with the organization
• Become more flexible by investing in additional training
• Seek greater responsibility
• External competitiveness
–Focus - Compensation relationships external to the
organization: comparison with competitors
–Pay is ‘market driven’
 Four Policy Choices (cont.)
• External competitiveness (cont.)
– Effects of decisions regarding how much and what forms:
• To ensure that pay is sufficient to attract and retain employees
• To control labor costs to ensure competitive pricing of products/
services
• Employee contributions
– Focus - Relative emphasis placed on employee
performance
• Performance based pay affects fairness
• Management
– Focus - Policies ensuring the right people get the right pay
for achieving the right objectives in the right way
 Listening to HR’s Critics
• Quantify people-management results into dollars
– Productivity of workforce
– Cost of vacant position
– Cost of keeping bad manager
– Dollar impact of hiring and keeping top performers vs. average
ones in mission-critical jobs
• Adopt “fact-based” decision-making
– Not “I think” or “I believe” but “I know” re: cause and effect
• Causes of turnover
• What motivates workers to produce more
• Which HR actions can turn business unit around
 Evidence-based HR Decision-making
• Assumption that correlation implies causation pervades decision making in
human resources and pay plan design.
– Inferential issue: "The CEO drank Wild Turkey; the company performed well;
ergo, all CEOs should drink more Wild Turkey. The company uses individual
incentives; the company performs well; ergo all companies should use more
incentives.“
• "The first step is to know what the evidence says. Know the research
literature that pertains to your business. Diffusion and persistence do not
prove effectiveness.“
• “The goal is to transform human resources into the R&D department for the
human system, which is the most important system in almost all
organizations.”
– "In R&D, you go into the laboratory, you experiment and you keep up with the
research that others do. Can you imagine walking into the R&D lab at a
pharmaceutical company, asking the chief chemist about an important new study
and having him respond that they don't keep up with the literature in
chemistry?“
 Strategic Perspective Towards
Compensation
• Different strategies within the same industry
• Different strategies within the same company
• “Let the market decide our compensation”
philosophy is untenable in the real world,
especially in global environments
Three Compensation Strategies
 Strategic Choices
• Strategy refers to the fundamental directions
that an organization chooses
– Corporate level: “What business should we be
in?”
– Business unit level: “How to gain and sustain
competitive advantage?”
– Functional level: “How should total compensation
help gain and sustain competitive advantage?”
• A strategic perspective focuses on those
compensation choices that help the
organization gain and sustain competitive
advantage
Strategic Choices
 Support Business Strategy
• Pay systems should align with the
organization's business strategy
– Based on contingency notions
• Compensation systems can be tailored to:
– Innovator business strategy
– Cost cutter business strategy
– Customer-focused business strategy
• When business strategies change, pay systems
should also change
Tailor the Compensation System to the
Strategy
Key Steps In Formulating a Total Compensation
Strategy
 Developing A Total Compensation
Strategy: Four Steps

• Step 1: Assess total compensation

implications
• Step 2: Map a total compensation strategy
• Steps 3: Implement strategy
• Step 4: Reassess
 Step 1: Assess Total Compensation
Implications
• Competitive Dynamics – Understand the
Business
– Changing customer needs
– Competitors’ actions
– Changing labor market conditions
– Changing Laws
– Globalization
• Competitive dynamics can be assessed globally
 Step 1: Assess Total Compensation
Implications (cont.)
• Culture/values
– A pay system reflects the values that guide an
employer's behavior and underlie its
treatment of employees
• Social and political context
– Context refers to legal and regulatory
requirements, cultural differences, changing
workforce, demographics, expectations etc.
– Affects compensation choices
– Lobbying is also part of compensation
strategies
Medtronic Values
 Step 1: Assess Total Compensation
Implications (cont.)
• Employee preferences
– How to better satisfy individual needs and
preferences
• Choice – Examples: Flexible benefits and choices
• Union preferences
– Pay strategies need to be adapted to the nature of
the union-management relationship
– Unions' interests can differ
– Compensation deals with unions can be costly to
change
 Step 1: Assess Total Compensation
Implications (cont.)
• Prominence of pay in overall HR strategy:
Pay strategy is influenced by how it fits with
other HR systems
– High-performance systems
• High skill/knowledge requirements
• Work designed so that employee teams enjoy discretion
in making decisions and continue to learn
• Pay systems based on performance
– Pay can be a supporting player or a catalyst for
change
 Step 2: Map a Total Compensation
Strategy
• Mapping is used in marketing to clarify and
communicate a product's identity
• Offers picture of a company’s compensation
strategy based on the five choices in the pay
model
• Clarifies the message the company is trying to
establish with its compensation system
• Maps do not tell which strategy is the “best”,
providing rather framework and guidance
Steps 3 and 4: Implement and Reassess
• Step 3
– Involves implementing strategy through the
design and execution of compensation system
• Step 4
– Reassess and realign, closes the loop and
recognizes that the strategy must be changing to
fit changing conditions
– Involves periodic reassessment
 Sources of Competitive Advantage:
Three Tests
• Three tests determine if a pay strategy is a
source of advantage
Which
 Is it aligned? hat is
uniqu
 Does it differentiate? e?

 Does it add value?

– Calculate the return on investment (ROI)
 Best Practices” Versus “Best Fit”?
Best Practices
• Assumptions
– A set of best-pay practices
exists
– Practices can be applied
universally across all
situations
– Results in better
performance with almost
any business strategy
Best Fit
• If design of pay system
– Reflects company’s
strategy and values
– Is responsive to
employees’ and unions’
needs
– Is globally competitive
• Company is more likely
to achieve competitive
advantage
 Guidance from the Evidence
• Consistent research evidence that the
following practices do matter to the
organization's objectives
– Internal alignment
• Pay differences among internal jobs can affect results
– External competitiveness
• Paying higher than average paid by competitors can
affect results
– Employee contributions
• Performance-based pay can affect results
Guidance from the Evidence (cont.)
– Managing compensation
• Need to consider all dimensions of pay strategy
– Compensation strategy
• Embedding compensation strategy within the broader
HR strategy affects results
• “What practices pay off best under what
conditions” is an important question to be
answered
 Virtuous and Vicious Circles
• One study concluded that how you pay also
matters as much as how much you pay
• Studies conclude that performance-based pay
that shares success with employees improves
employee attitudes, behaviors, performance –
especially when combined with high-
performance practices
• Performance-based pay can be the best
practice under right circumstances
Virtuous and Vicious Circles (cont.)
 Summary
Strategy: The Totality of Decisions”

Managing total compensation strategically

means fitting the compensation system to the
business and environmental conditions.

We believe the best way to proceed is to

start with the pay model: The objectives and the
four policy; Internal alignment, external
competitiveness, employee contributions,
management.