978-0134320540 Chapter 8 Lecture Notes

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CHAPTER 8

Building Pay Structures That Recognize Employee Contributions

Learning Objectives

8-1. Explain the concept of pay structures and the five steps necessary to construct

pay structures.

8-2. Discuss the components of merit pay systems.

8-3. Summarize the features of sales compensation plan design.

8-4. Describe the essentials of person-focused pay program design.

8-5. Summarize pay structure variations.

Outline

I. Constructing a Pay Structure

II. Designing Merit Pay Systems

III. Designing Sales Incentive Compensation Plans

IV. Designing Person-focused Programs

V. Pay Structure Variations

VI. Key Terms

VII. Discussion Questions and Suggested Answers

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

IX. Crunch the Numbers! Questions and Suggested Student Responses

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

and Suggested Student Responses

Lecture Outline

I. Constructing a Pay Structure

A. Overview

1. Based on five steps

a. Deciding on how many pay structures to construct

b. Determining a market pay line

c. Defining pay grades

d. Calculating pay ranges for each pay grade

e. Evaluating the results

B. Step 1: Deciding on the Number of Pay Structures

1. Usually more than one depending on market rates and company’s job structure

2. Exempt and nonexempt pay structures

a. Categories reflect a distinction in the Fair Labor Standards Act (FLSA)

b. Exempt jobs are not subject to overtime provisions of the act and are

expressed as an annual salary.

c. Nonexempt jobs are subject to overtime provisions and compensation is

expressed as an hourly pay rate

3. Pay structures based on job family

a. Pay structures are defined on the basis of job family which show a distinct

pattern in the market

b. Distinct job families include:

i. Executive

ii. Managerial

iii. Professional

iv Technical

v. Clerical

vi. Craft

4. Pay structures based on geography

a. The pay for similar positions that are within the same company, but are

located in different parts of the country, can be paid differently

b. Local influences, like cost-of-living, influence pay structures

C. Step 2: Determining a Market Pay Line

1. Market pay line is representative of typical market pay rates relative to a

company’s job structure

2. Pay levels that correspond with the market pay line are market-competitive pay

rates

D. Step 3: Defining Pay Grades

1. Pay grades group jobs for pay policy application based on similar compensable

factors and value

2. Job groupings are influenced by other factors such as management philosophy

4. Wider pay grades minimize hierarchy and social distance between employees

5. Narrower pay grades tend to promote hierarchy and social distance

6. Companies may choose to vary the “absolute” point spread by increasing the

point spread as they move of up the pay structure, in recognition of the broader

range of skills that higher pay grades represent

E. Step 4: Calculating Pay Ranges for Each Pay Grade

1. Pay ranges build upon pay grades

a. Pay ranges represent the vertical dimension (pay rates) and are designated

with the following pay rates

i. Minimum – the lower bound of pay within a pay grade

ii. Midpoint – generally represents the competitive market average or median

iii. Maximum – the upper bound of pay with a pay grade

2. Setting pay range midpoints

a. According to competitive pay policy

b. If the company adopts a market lead policy, that company’s midpoint will be

higher than the market average

c. If the company adopts a market match policy, that company’s midpoint will be

similar to the market average

e. If the company adopts a market lag policy, that company’s midpoint will be

lower than the market average

3. Setting pay range minimums and maximums

a. According to the market averages

b. By developing a range spread

i. The difference between the minimum and maximum pay rates of a given

pay grade

ii. Progressively higher range spreads for pay grades that contain more

valuable jobs in terms of a company’s criteria

iii. Smaller range spreads characterize pay grades that contain narrowly

defined jobs that require simple skills with relatively low responsibility

c. Higher-level jobs afford employees greater promotion opportunities than entry

level jobs

d. Adjacent pay ranges usually overlap with other pay ranges so that the highest

rate paid to one is greater than the lowest rate of the successive pay grade

4. Pay compression

a. Occurs whenever a company’s pay spread between new hires or less qualified

employees and more qualified job incumbents is small

b. Occurs when

i. Companies fail to raise pay range minimums and maximums

ii. Scarcity of qualified candidates for particular jobs

c. Can threaten a companies’ competitive advantage when it results in

dysfunctional turnover (high performing employees voluntarily terminate their

employment)

5. Green circle pay rates

a. Are below-minimum pay range rates

b. Are usually offered because applicants do not meet every minimum

requirement in the job description

6. Red circle pay rates

a. Are above maximum pay range rates

b. For exemplary performers, may offer lump sum bonus not added to regular

pay

F. Step 5: Evaluate the Results

1. To determine if there was any significant difference between the company’s

internal values for jobs and the market’s value for the same jobs

a. If the company’s valuation exceeds the market’s valuation, the company must

decide whether its higher-than-market pay rates will undermine its attainment

of competitive advantage

b. If the company undervalues a position, it must determine if the discrepancy is

limiting its ability to recruit quality employees

2. Compa-ratios

a. Index the relative competitiveness of internal pay rates, based on pay range

midpoints

b. Are calculated by dividing the employee’s pay rate by the pay range midpoint

c. A ratio of one means that the employee’s pay rate equals the pay range

midpoint

d. A ratio of less than one means the employee’s pay rate falls below the

competitive pay rate for the job

II. Designing Merit Pay Systems

A. An effective merit pay program that recognizes employee contributions requires

avoiding such pitfalls as ineffective performance appraisal methods and poor

communication regarding the link between pay and performance

B. Merit Increase Amounts

1. Should reflect prior job performance levels and motivate employees to perform

their best

2. Considerations in setting amount:

a. There are diminishing marginal returns on each additional dollar allocated to

merit increases

b. Employees’ perceptions of just-meaningful differences in merit increases

depend on their cost of living, their attitudes toward the job, and their

expectations of rewards from the job

c. Equity theory suggests that an employee must regard his or her own ratio of

merit increase pay to performance as similar to the ratio for other comparably

performing people

g. Compensation budgets are blueprints that describe the allocation of monetary

resources to fund pay structures

C. Timing

1. Most increases given on an annual basis

2. Two main approaches

a. Common review date/period which is best suited for smaller companies

b. Employee’s anniversary which can be burdensome as reviews must be

conducted regularly throughout the year

D. Recurring versus Nonrecurring Merit Pay Increases

1. Recurring increases are permanently added to base pay

2. Nonrecurring increases contain costs and are given as one-time lump sum bonuses

E. Present Level of Base Pay

1. Pay structures specify acceptable pay ranges for jobs within each pay grade

2. Should be within federal guidelines of several equal employment opportunity

laws

F. Rewarding Performance: The Merit Pay Grid

1. Amounts are determined by two main factors

a. Performance ratings

b. The position of employees’ present base pay rates within pay ranges

2. Employee performance ratings

a. Overall performance ratings guide the pay raise decision

b. Based on the principle of recognizing higher performance with greater

rewards

3. Employees’ position within the pay range

a. Salaries and hourly wages are indexed by quartile ranking

b. Holding performance ratings constant, merit pay increase percentages are

reduced as quartile ranks increase, to control employees’ progression through

the pay ranges

G. Merit Pay Increase Budgets

1. Budgets limit the merit pay increase percentages in each cell

2. Expressed as a percentage of the sum of employees’ current base pay

3. Varies according to performance level and position in the pay range

4. Steps to ensuring that merit pay increases do not exceed the limit

a. Supervisors and managers determine how many employees fall within each

performance category

b. Determine the percentage of employees whose pay falls into each quartile

c. Combine both sets of information to determine the percentage of employees

who fall into each cell

d. Calculate the expected number of employees in each cell to provide an

estimate of the employees’ performance distribution

e. Use this formula: (Expected number of each cell) X (Desired pay increase for

cell %) X (Current median pay level for quartile)

f. Ensure the total amount is within budget

III. Designing Sales Incentive Compensation Plans

A. Purposes of Sales Incentive Compensation Plans

1. Help businesses meet their objectives by aligning the financial self-interest of

sales professionals with the company’s marketing objectives

2. Particular sales objectives include:

a. Improve sales productivity

b. Improve sales coverage of current customers

c. Grow sales overall

B. Alternative Sales Compensation Plans

1. Choosing the appropriate plan depends on the company’s competitive strategy

2. Five main alternatives

a. Salary-only

b. Salary-plus-bonus

c. Salary-plus-commission

d. Commission-plus-draw

e. Commission-only

3. Salary-Only Plans

a. Sales professionals receive fixed base compensation which does not vary with

level of units sold, increase in market share, or any other indicator of sales

performance

b. Relatively risk-free compensation for employees

c. Burdensome to employers because they must compensate regardless of their

achievement levels

d. Appropriate where

i. Sales are of high-priced products and services, or technical products with

long lead times for sales

ii. Sales professionals are primarily responsible for generating demand

whereas other employees actually close the sales

iii. It is impossible to follow sales results for each sales professional since

sales are accomplished through team efforts

iv. Sales professionals are involved in training or other activities when they

are not directly involved in making sales

4. Salary-plus-bonus plans

a. Offer set base pay with an incentive bonus

b. Give one-time bonuses, usually tied to meeting specific, exceptional goals

5. Salary-plus-commission plans

a. A commission is a form of incentive compensation based upon a percentage of

the selling price of the product or service

b. These plans spread the risk of selling between the company and the sales

professional

6. Commission-plus-draw plans

a. Award sales professionals with subsistence pay (draw) to cover basic living

expenses and also incentives to excel

b. The draws are just advances on the commissions the sales professional will

earn in the future

c. Two types of draws

i. Recoverable draws act as company loans to employees that are carried

forward indefinitely until the employee sells enough to repay

ii. Non-recoverable draws act as salary because employees are not obligated

to repay the loans if they do not sell enough

7. Commission-only plans

a. Sales professionals derive their entire income through commissions and

therefore shoulder all the risk

b. Straight commissions award sales professionals with a fixed percentage of the

sales revenue

d. Graduated commissions award sales professionals with an increased

percentage of the sales price as the volume increases

e. Multiple-tiered commissions

i. Award sales professionals with higher percentages of the sales made in a

given period

ii. Earned if the sales level exceeds a predetermined level

f. Commission plans not always best tactic

i. Can cause competitive behaviors between employees

iii. Can undermine employees’ intrinsic motivation to sell

May lose their genuine interest for the challenge and enjoyment that

selling brings

May “go through the motions” of selling and disregard quality and

customer satisfaction

C. Sales Compensation Plans and Competitive Strategy

1. Sales plans with salary components are most appropriate for differentiation

strategies because sales professionals can turn attention to addressing client needs

2. Commission-oriented sales compensation plans are best suited for lowest cost

strategies because compensation expenditures vary with sales revenue

D. Determining Fixed Pay and the Compensation Mix

1. Depends mainly on three factors:

a. Influence of the sales professional on the buying decision

b. Competitive pay standards within the industry

c. Amount of non-sales activities required

2. Influence of the sales professional on the buying decision

a. The more influence sales professionals have on the “buying decisions”, the

more the compensation mix will feature incentive pay

b. In some industries, it is the sales professional’s technical expertise, more than

sales skills that influences the “buying decision”

3. Competitive pay standards within the industry

a. The compensation mix must be competitive with market standards to attract

and retain quality sales professionals

4. Amount of non-sales activities required

a. The more non-sales duties sales professionals are required to perform the

more their compensation packages should include a fixed pay component

IV. Designing Person-focused Programs

A. Overview

1. Person-focused programs refer to both knowledge and skills

2. Reward employees for acquisition of job-related knowledge and/or skills

3. A fundamental issue is whether investments in training provide measurable

pay-offs to companies

B. Establishing Skill Blocks

1. Skill or knowledge “blocks” are sets of skills necessary to perform a specific job,

or group of jobs

2. The number of blocks varies according to the variety of jobs within a company

generally from two to several

4. Development should be based on three considerations:

a. Job descriptions should be developed

b. Individual jobs should be organized into job families or groups

c. Skills should be grouped into blocks

C. Transition Matters

1. Concerns moving from job-based pay exclusively to including person-focused

knowledge plans

2. Skills assessment

a. Centers on who should assess:

i. Whether employees possess skills at levels that justify a pay raise

ii. On what basis assessments should be made

iii. When assessments should be conducted

b. Input should come from peers, self-assessment, and experts (e.g. supervisors)

c. Must identify performance measures

d. Performance should be assessed frequently to during transition phases

4. Aligning pay with the knowledge structure

a. One of most difficult tasks in moving toward a person-focused system

b. If an employee’s actual earnings is more than the person-focused system

indicates as being appropriate, managers must develop a reasonable course of

action for that employee to acquire the skills or knowledge

c. If employees are underpaid (over qualified), the company must provide pay

adjustments quickly

5. Access to training

a. Person-focused systems make training necessary rather than optional for

employees motivated towards self-improvement

b. Employees must have equal access to training

i. To meet the intended aim of person-focused programs

ii. To reward employees for enhancing their skills

iii. To address legal imperatives

c. Restricting access to training can lead to violation of

i. Title VII, Civil Rights Act of 1964

ii. Age Discrimination in Employment Act of 1967

d. Employees must be formally informed of the options and rewards

D. Training and Certification

1. Successful person-focused programs depend on a company’s ability to develop

and implement systematic training programs

2. Companies typically increase the amount of classroom and on-the-job training

3. Should be based on accurate job descriptions

E. In-house or Outsourcing Training

1. Training can be in-house or outsourced depending on:

a. Expertise: The availability of in-house expertise

b. Timeliness: Training will be outsourced if there is not enough time to develop

and deliver it in-house

c. Size of the employee population to be trained: Large numbers make in-house

more cost effective

d. Sensitivity or proprietary nature of the subject matter: The more sensitive the

subject matter, the more likely the training will be in-house

2. Certification and recertification

a. Certification ensures that employees possess minimal levels of skills

proficiency

b. Recertification involves retraining or retesting employees to ensure employees

have retained minimal skills proficiency

V. Pay Structure Variations

A. Broadbanding

1. The broadbanding concept and its’s advantages

i. Consolidates existing pay grades and ranges into fewer, wider pay grades and

broader pay ranges

ii. Represents the organizational trend toward flatter, less hierarchical corporate

structures that emphasize teamwork over individual contributions alone

iii. Can reduce management layers and promote quicker decision-making cycles

iv. Shifts responsibility to supervisors and managers for administering each

employee’s compensation within the confines of the broadbands

2. Limitations of broadbanding

a. Changes how compensation dollars are allocated, but not how much

b. Broadbanding can increase compensation expenses, because managers have

greater latitude in assigning pay to their employees

c. Necessitates a trade-off between the flexibility to reward employees for their

unique contributions and a perception among employees that fewer

promotional opportunities are available

d. Makes employees and employers rethink the idea of promotions as a positive

step through the job hierarchy

B. Two-Tiered Pay Structures

1. The two-tier pay system concept and its advantages

a. Reward newly hired employees less than established employees

b. On temporary basis, employees have opportunity to progress from lower

entry-level pay rates to higher rates enjoyed by more senior employees

b. Permanent two-tier systems reinforce the pay-rate distinction by retaining

separate pay scales

c. Lower-paying scales apply to newly hired employees, whereas current

employees enjoy higher-paying scales

d. Maximum rates to which newly hired employees can progress are always

lower than more senior employees’ pay scales

e. Most prevalent in unionized companies

2. Limitations of two-tier pay structures

a. The lower pay scale for new hires may restrict a company’s ability to recruit

and retain quality employees

b. Lower tier employees may resent pay differential and not extend themselves

beyond their job descriptions

c. Can cause lower employee morale

d. Can lead to excessive turnover

End of Chapter

VI. Key Terms

Pay structures: Assign different pay rates for jobs of unequal worth and provide the framework

for recognizing differences in individual employee contribution

Pay grades: Group jobs for pay policy application

Pay ranges: Represent the vertical dimension (pay rates) and includes midpoint, minimum, and

maximum pay rates

Midpoint pay value: The halfway mark between the range minimum and maximum rates

Range spread: The difference between the maximum and minimum pay rates of a given pay

grade

Pay compression: Occurs whenever a company’s pay spread between newly hired or less

qualified employees, and more qualified job incumbents is small

Green circle rates: Below-minimum pay range rates

Red circle rates: When companies pay certain employees greater than maximum rates for their

pay ranges

Compa-ratios: Index the relative competitiveness of internal pay rates based on pay range

midpoints

Equity theory: Suggests that an employee must regard his or her own ratio of merit increase

pay to performance as similar to the ratio for other comparably performing people in the

company

Compensation budgets: Blueprints that describe the allocation of monetary resources to fund

pay structures

Common review date: All employees’ performances are evaluated on the same date Common

review period: All employees’ performances are evaluated on the same date or during the same

period

Employee’s anniversary date: The day on which the employee began to work for the company

Nonrecurring merit increases: Lump sum bonuses

Merit pay increase budget: Is expressed as a percentage of the sum of employees’ current base

pay

Salary-only plans: Sales professionals receive fixed base compensation, which does not vary

with the level of units sold, increase in market share, or any other indicator of sales performance

Salary-plus-bonus plans: Offer a set salary coupled with a bonus

Commission: A form of incentive compensation based on a percentage of the selling price of a

product or service

Salary-plus-commission plans: Spread the risk of selling between the company and the sales

professional

Commission-plus-draw plans: Award sales professionals with subsistence pay or draws

Draw: Subsistence pay component awarded as an advance, which is charged against

commissions that sales professionals are expected to earn

Recoverable draws: Act as company loans to employees that are carried forward indefinitely

until employees sell enough to repay their draws

Nonrecoverable draws: Act as salary because employees are not obligated to repay the loans if

they do not sell enough

Commission-only plans: Salespeople derive their entire income from commissions

Straight commission: Is based on a fixed percentage of the sales price of the product or service

Graduated commissions: Increase percentage pay rates for progressively higher sales volume

Multiple-tiered commissions: Similar to graduated commissions except employees earn a

higher rate of commission for all sales made in a given period if the sales level exceeds a

predetermined level

Skill (knowledge) blocks: Sets of skills (knowledge) necessary to perform a specific job or

group of similar jobs

Certification: Ensures that employees possess at least a minimally acceptable level of skill

proficiency upon completion of a training unit

Recertification: Employees periodically must demonstrate mastery of all the jobs they have

learned or risk losing their pay rates

Broadbanding: Consolidates existing pay grades and ranges into fewer, wider pay grades and

broader pay ranges

Two-tier pay structures: Reward newly hired employees less than established employees.