978-0134320540 Chapter 7 Lecture Notes

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CHAPTER 7

Building Market-Competitive Compensation Systems

Learning Objectives

7-1. Explain the concept of market-competitive compensation systems and summarize the

four activities compensation professionals engage in to create these systems.

7-2. Discuss compensation survey practices.

7-3. Describe how compensation professionals integrate internal job structures with external

market pay rates.

7-4. Explain the basic concepts of compensation policies and strategic mandates: pay mix and

pay level.

Outline

I. Market-Competitive Pay Systems: The Basic Building Blocks

II. Compensation Surveys

III. Integrating Internal Job Structures with External Market Pay Rates

IV. Compensation Policies and Strategic Mandates

V. Key Terms

VI. Discussion Questions and Suggested Answers

VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

VIII. Crunch the Numbers! Questions and Suggested Student Responses

IX. Assisted-graded Questions

X. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions

and Suggested Student Responses

Lecture Outline

I. Market-Competitive Pay Systems: The Basic Building Blocks

A. Definition

1. Market-competitive pay systems represent companies’ compensation policies that

fit the imperatives of their competitive advantage

2. These systems play a significant role in attracting and retaining the most qualified

employees

3. Based on four activities

a. Conducting strategic analyses which entails an examination of a company’s

external market factors

b. Assessments of competitors’ pay practices with compensation surveys

c. Integrating the internal job structure with external market pay rates

d. Determining compensation policies

II. Compensation Surveys

A. Preliminary Considerations

1. Main considerations

a. What companies hope to gain from compensation surveys

b. Which type of survey to use

2. What companies hope to gain from compensation surveys

a. Competitors’ compensation practices

b. Employee’s preferences for alternative forms of compensation due to

economic changes

3. Custom development versus use of an existing compensation survey

a. Custom surveys preferable because the questions can be tailored specifically

for each company

b. Most companies choose not to develop own survey for three reasons:

i. Not always practical because of the specialized knowledge and skills

needed to develop effective ones

ii. Not always effective because businesses are reluctant to give information

directly to competitors

iii. The staffing and design costs can be prohibitive

B. Using Published Compensation Survey Data

1. Two important considerations

a. Survey focus: core or fringe compensation

b. Sources of published survey data

2. Survey focus: Core Compensation or Employee Benefits

a. Must decide on obtaining information about base pay, employee benefits, or

both

3. Sources of published surveys

a. Professional associations that survey members

b. Industry associations

c. Consulting firms who provide data from recently completed surveys or create

surveys from scratch for clients

d. Federal government through the Bureau of Labor Statistics

i. Employment cost trends: Program publishes quarterly statistics that

measure change in labor costs

ii. National compensation data: National Compensations Survey (NCS)

provides comprehensive measures of occupational earnings; compensation

cost trends, benefit incidence, and detailed plan provisions

iii. Wages by area and occupation: Available for the nation, regions, states,

and many metropolitan areas

iv. Earnings by demographics: Available for characteristics such as age, sex,

race, and Hispanic or Latino ethnicity

v. Earnings by industry: Current Employment Statistics survey is monthly

and provides estimates of average weekly hours and average hourly

earnings for the private sector for all employees and for production and

nonsupervisory employees

vi. County wages (quarterly census of employment and wages: Annual and

quarterly wage data are available

vii. Employee benefits national compensation survey: Provides information

on the share of workers who participate in specified benefits

viii.Compensation costs in other countries: International Labor Comparisons

Hourly Compensation Costs tables provide comparative hourly

compensation costs in national currencies and U.S. dollars for production

workers and all employees in manufacturing

C. Compensation Surveys: Strategic Considerations

1. Two essential strategic considerations

a. Defining the relevant labor market

b. Choosing benchmark jobs

2. Defining the relevant labor market

a. Relevant labor markets represent the fields of potentially qualified candidates

for particular jobs

b. Defined on the basis of occupational classification, geography, and product or

service market competitors

c. Occupational classification refers to a group of two or more jobs that are

based on similar work characteristics and responsibilities

d. Companies search a wider geographic area for candidates for jobs that require

specialized skills or skills that are low in supply

e. Companies use product or service market competitors to define the relevant

labor market when industry specific knowledge is key and competition for

market share is keen

3. Choosing benchmark jobs

a. Used as reference points for setting pay levels

b. Four characteristics

i. The contents are well-known, relatively stable over time, and agreed upon

by the employees involved

ii. The jobs are common across a number of different employers

iii. The jobs represent the entire range of jobs that are being evaluated within

a company

iv. The jobs are generally accepted in the labor market for the purposes of

setting pay levels

c. Necessary because matches between a company’s position to a position in a

survey is not always possible since:

i. Large companies may have hundreds of unique jobs

ii. Companies adapt job duties and scope to fit their specific needs

d. Companies use job leveling to make corrections for differences between their

jobs and external benchmark jobs

i. Point factor leveling is a job leveling approach where participants rate a

job based on a standard set of compensable factors that have point

values associated with each level of the factor

D. Compensation Survey Data

1. Three compensation survey data characteristics

a. Contains immense amounts of information

i. May be a wide variety of pay rates across companies, making it hard to

build market-competitive pay systems

ii. Statistics needed to describe large sets of data

b. The data is generally outdated because of the lag time between data collection

and use

c. Statistical analysis should be used to integrate internal job structures (based on

job evaluation points) with the external market (based on the survey data)

2. Data analysis

1. Begins with basic tabulation of survey data which helps organize data,

promotes decision makers’ familiarization with the data and reveals outliers

3. Using the appropriate statistics to summarize survey data

a. Central tendency represents the fact that a set of data cluster (or center)

around a central point

c. Two central tendency measures

i. Arithmetic mean which is calculated by adding all the salaries together

and dividing by the sum of number of salaries added

ii. Median is the meddle value in an ordered sequence of numerical data

4. Variation

a. Represents the amount of spread or dispersion in a set of data

b. Standard deviation refers to the mean distance of each salary from the mean

i. Used as a reference point to judge whether employees’ compensation is

below or above the market

ii. Indicates the range for the majority of salaries, so it can be used to judge

how a company’s salary range compares to the market

c. Quartile

i. Describe dispersion by indicating the percentage of figures that fall below

certain points

ii. Allows compensation professionals to describe the distribution of data

based on four points

Quartile 1 at 25%

Quartile 2 at 50%

Quartile 3 at 75%

Quartile 4 at 100%

d. Percentiles

ii. Describe dispersion by indicating the percentage of figures that fall below

certain points

ii. Based on 100 points

5. Updating the survey data

a. Necessary because of the lag-time between data collection and data use

b. Failure to adjust could lead to real compensation (purchasing power of dollar)

falls below nominal compensation (face value of dollar)

c. Consumer Price Index (CPI) which is the most commonly used method to

track cost changes can be used to update salary survey data

III. Integrating Internal Job Structures with External Market Pay Rates

A. Overview

1. Differences in the internal value of jobs should correspond to pay differences

based on compensation survey data

2. Regression analysis

a. Uses market pay rates as reference points for determining internal pay

structures

b. Enables decision makers to predict the values of one variable from another

c. Finds the best fitting line (market pay line) between two variables

i. Job evaluation points of benchmark jobs

ii. Salary survey data for the benchmark jobs

d. Equation

i. Y = a + bX

ii. Y = predicted salary

iii. X = job evaluation points

iv. a = the Y intercept: the Y value at which X = 0

v. b = the slope

Represents the change in Y for every change in the job evaluation

points

Represents the dollar value of each job evaluation point

e. R2

i. Tells how well the variation of jobs based on job evaluation points

explains the variation in market pay rates from the survey

ii. Ranges from 0 to 1

iii. Represents the percentage variation in Y values that can be explained by

the X values

Y = market pay rates

X = job evaluation points

iv. Values

R2 = 0 means that none of the variation in market pay rates can be

explained by the company’s job structure

R2 –= 1 means that all the variation in market pay rates can be

explained by the company’s job structure

R2 between 0 and .30 represents a small amount of variation

R2 between .31 and .70 represents a medium amount of variation

R2 above .71 represents a large amount of variation

IV. Compensation Policies and Strategic Mandates

A. Pay level policies

1. Companies can choose from three pay level policies

a. Market lead

b. Market lag

c. Market match

2. Market lead policy distinguishes companies from the competition by

compensating employees more highly than most competitors

3. Market lag policy distinguishes from competition by compensating less than most

competitors

4. Market match policy most closely follows the typical market pay rates because

companies pay according to the market pay line

B. Pay mix policies

1. Pay mix policies refer to the combination of core compensation and employee

benefits components that make up an employee’s total compensation package

2. Pay mix may policies may be expressed in dollars (or other currency as relevant)

or as a percentage of total dollars allocated for an employee’s total compensation

3. What is an appropriate pay mix?

a. For policy purposes, it makes sense to consider guidelines for jobs within a

particular structure (for example, managerial, administrative, or sales) because

of the common job content and worker requirements of jobs within a

particular structure

End of Chapter

V. Key Terms

Market-competitive pay systems: Represent companies’ compensation policies that fit the

imperatives of competitive advantage

Strategic analysis: Entails an examination of a company’s external market context and internal

factors

Compensation surveys: Involve the collection and subsequent analysis of competitors’

compensation data

Compensation plans: Represent the selection and implementation of pay level and pay mix

policies over a specified time period, usually on year

Relevant labor markets: Represent the fields of potentially qualified candidates for particular

jobs

Job leveling: Process of making corrections for differences between their jobs and external

benchmark jobs

Point factor leveling: Job leveling approach where participants rate a job based on a standard

set of compensable factors that have point values associated with each level of the factor

Central tendency: Represents the fact that a set of data clusters or centers around a central

point

Mean: Average of salaries used as a reference point to judge whether employees’ compensation

is below or above the market

Median: Is the middle value in an ordered sequence of numerical data. If there is an odd

number of data points

Variation: Represents the amount of spread or dispersion in a set of data

Standard deviation: Refers to the mean distance of each salary figure from the mean

Quartiles: Allow compensation professionals to describe the distribution of data based on four

groupings

Percentiles: There are one hundred percentiles ranging from the first percentile to the 100th

percentile

Real compensation: Measures the purchasing power of a dollar

Nominal compensation: Is the face value of a dollar

Consumer Price Index (CPI): The most commonly used method for tracking cost changes, or

consumer inflation, throughout the United States

Regression analysis: A statistical analysis technique that enables compensation professionals to

establish pay rates for a set of jobs that are consistent with typical pay rates for jobs in the

external market

Market pay line: Representative of typical market pay rates, expressed as a mean or median,

relative to a company’s job structure

Market lead policy: Distinguishes a company from the competition by compensating

employees more highly than most competitors

Market lag policy: Appears to fit well with lowest-cost strategies because companies realize

cost savings by paying lower than the market pay line

Market match policy: Represents a safe approach for companies because they generally are

spending no more or less on compensation (per employee) than competitors