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D. Construct a Market Pay Line
Market pay line involves making decisions about which salary survey jobs
to include that are judged to closely match internal benchmark jobs, which
companies to include, and which measures of pay to use.
Definition: A market line links a company’s benchmark jobs on the horizontal
axis (internal structure) with market rates paid by competitors (market survey)
on the vertical axis. It summarizes the distribution of going rates paid by
competitors in the market.
A market line may be drawn freehand by connecting the data points or
statistical techniques such as regression analysis may be used.
Regression generates a straight line that best fits the data by minimizing
the variance around the line.
E. Setting Pay for Non-Benchmark Jobs
Setting pay for benchmark jobs is straightforward to the degree that good
matches with survey jobs are found. Once it is known what other organizations
pay for each job, a pay level can be chosen that is a function of what other
organizations pay and what role the job plays in executing the strategy of one’s
own organization.
For nonbenchmark jobs (i.e., those jobs for which there is no good match
among jobs included in the pay survey), the market pay lines in Exhibit 8.16 are
especially useful.
Not all survey results look like the example given in the text and not all
companies use the statistical and analytical techniques given in the text. There is
no “right way” to analyze survey data.
F. Combine Internal Structure and External Market Rates
At this point, two parts of the total pay model have merged. Their
relationship to each other can be seen in Exhibit 8.18.
oThe internally aligned structure is shown on the horizontal (x) axis.
oThe salaries paid by relevant competitors for the benchmark jobs, as
measured by the survey—the external competitive data—are shown on the
vertical (y) axis.
These two components—internal alignment and external competitiveness
—come together in the pay structure. The pay structure has two aspects:
oPay-policy line
oPay ranges
VII. From Policy to Practice: The Pay-Policy Line
There are several ways to translate external competitive policy into practice.
A. Choice of Measure
For example, a company can use a specific percentile for base pay and
another percentile for total compensation as compensation measures in its
regression.
B. Updating
If a company chooses a “match” policy but then updates survey data to the
end of the current year/start of the plan year and keeps this rate in effect
throughout the plan year, the company will actually be lagging the market. It
will match its desired market pay level only at the beginning of the plan year.
The market rates continue to rise throughout the year; the company’s rates do
not.
Aging the market data to a point halfway through the plan year is called
lead/lag. The original survey rates are updated to the end of the current year plus
half the projected amount for the plan year.
An employer who wants to lead the market may age data to the end of the
plan year and pay at this rate throughout the plan year.
C. Policy Line as Percent of Market Line
Another way to translate pay-level policy into practice is to simply specify
a percent above or below the regression line (market line) that an employer
intends to match and then draw a new line at this higher (or lower) level. This
pay-policy line would carry out a policy statement of, “We lead the market by
10 percent,” for example.
If the practice does not match the policy, then employees receive the
wrong message.
VIII. From Policy to Practice: Grades and Ranges
The next step is to design pay grades and pay ranges. These analyses are usually
done with base pay data, since base pay reflects the basic value of the work rather
than performance levels of employees.
A. Why Bother with Grades and Ranges?
Grades and ranges offer flexibility to deal with pressures from external
markets and differences among organizations. These include:
odifferences in quality (skills, abilities, experience) among individuals
applying for work.
odifferences in the productivity or value of these quality variations.
odifferences in the mix of pay forms competitors use.
A pay range exists whenever two or more rates are paid to employees in the
same job. Hence, ranges provide managers the opportunity to:
orecognize individual performance differences with pay.
omeet employees’ expectations that their pay will increase over time, even
in the same job.
oencourage employees to remain with the organization.
From an internal alignment perspective, the range reflects the differences in
performance or experience that an employer wishes to recognize with pay.
From an external competitiveness perspective, the range is a control device. A
range maximum sets the lid on what the employer is willing to pay for that
work; the range minimum sets the floor.
B. Develop Grades
The first step in building flexibility into the pay structure is to group different
jobs that are considered substantially equal for pay purposes into a grade.
oThe question of which jobs are substantially equal and therefore slotted
into one grade requires the analyst to reconsider the original job evaluation
results. Each grade will have its own pay range, and all the jobs within a
single grade will have the same pay range.
oJobs in different grades should be dissimilar from those in other grades
and will have a different pay range.
Although grades permit flexibility, they are challenging to design. If jobs with
relatively close job evaluation point totals fall on either side of grade
boundaries, the magnitude of difference in the salary treatment may be out of
proportion to the magnitude of difference in the value of the job content.
C. Establish Range Midpoints, Minimums, and Maximums
Grades group job evaluation data on the horizontal axis; ranges group
salary data on the vertical axis.
A range has three salient features:
oMidpoint—point where the pay-policy line crosses the center of the grade.
oMinimum
oMaximum
What Size Should the Range Be?
oThe size of the range is based on judgment about how the ranges support
career paths, promotions, and other organization systems.
oTop-level management positions commonly have ranges of 30 to 60 percent
above and below the midpoint; entry to midlevel professional and
managerial positions, between 15 and 30 percent; office and production
work, 5 to 15 percent.
oLarger ranges in the managerial jobs reflect the greater opportunity for
individual discretion and performance variations in the work.
oSome compensation managers use the actual survey rates, particularly the
75th and 25th percentiles, as maximums and minimums.
oOthers establish the minimum and maximum separately, with the amount
between the minimum and the midpoint a function of how long it takes a
new employee to become fully competent. Short training time may translate
to minimums much closer to the midpoints. The maximum becomes the
amount above the midpoint that the company is willing to pay for sustained
performance on the job.
D. Overlap
Exhibit 8.20 shows two extremes in overlap between adjacent grades.
The high degree of overlap and low midpoint differentials in Exhibit
8.20(a) indicate small differences in the value of jobs in adjoining grades. Being
promoted from one grade to another may include a title change but not much
change in pay.
The smaller ranges in Exhibit 8.20(b) create less overlap, which permits
the manager to reinforce a promotion into a new grade with a larger pay
increase.
Promotion Increases Matter
oThe size of differentials between grades should support career movement
through the structure.
A managerial job would typically be at least one grade higher than
the jobs it supervises.
Although a 15% differential between manager and employee has
been offered as a rule of thumb, large overlap and possible overtime in
some jobs but not in managerial jobs can make it difficult to maintain
manager–employee pay differentials.
oOptimal overlap between grades ought to be large enough to induce
employees to seek promotion into a higher grade.
oNot all employers use grades and ranges.
Skill-based plans establish single flat rates for each skill level
regardless of performance or seniority. And many collective bargaining
contracts establish single flat rates for each job.
This flat rate often corresponds to some midpoint on a survey of
that job.
And increasingly, broad bands (“really fat ranges”) are being
adopted for even greater flexibility.
IX. From Policy to Practice: Broad Banding
Exhibit 8.21 collapses salary grades into only a few broad bands, each with a
sizable range. This technique, known as broad banding, consolidates as many as four
or five traditional grades into a single band with one minimum and one maximum.
Because the band encompasses many jobs of differing values, a range midpoint is
usually not used.
Contrasts between ranges and broad bands are highlighted in Exhibit 8.22.
Supporters of broad bands list several advantages over traditional approaches:
oBroad bands provide flexibility to define job responsibilities more broadly.
oThey support redesigned, downsized, or boundaryless organizations that have
eliminated layers of managerial jobs.
oThey foster cross-functional growth and development in these new organizations.
Employees can move laterally across functions within a band in order to gain depth
of experience.
oThe emphasis on lateral movement with no pay adjustments helps manage the
reality of fewer promotion opportunities in flattened organization structures.
oThe flexibility of banding eases mergers and acquisitions since there are not a lot of
levels to argue over.
Broad bands are often combined with more traditional salary administration
practices by using midpoints, “zones,” or other control points within bands.
Perhaps the most important difference between the grades-and-ranges and
broad-banding approaches is the location of the controls.
oThe grade-and-range approach has guidelines and controls designed into the pay
system. Range minimums, maximums, and midpoints ensure consistency across
managers.
oManagers using bands have only a total salary budget limiting them. But as
experience with bands has advanced, guidelines and structure are increasingly
designed into them.
Bands may add flexibility—less time will be spent judging fine distinctions
among jobs. But perhaps the time avoided judging jobs will now be spent judging
individuals, a prospect managers already try to avoid.
Banding takes two steps.
oSet the number of bands: Usually bands are established at the major “breaks,” or
differences, in work or skill/competency requirements. Titles used to label each
band reflect these major breaks, such as “associate” (entry-level individual
contributor), “professional” (experienced, knowledgeable team member), “leader”
(project or group supervisor), “director,” “coach,” or even “visionary.” The
challenge is how much to pay employees who are in the same band but different
functions performing different work.
oPrice the bands: reference market rates: Each band includes multiple job families.
Usually external market differences exist, so the different functions or groups
within brands are priced differently. As the pop-out in Exhibit 8.23 depicts, the
three job families (purchasing, finance, and engineering) in the professional band
have different reference rates, drawn from survey data.
A. Flexibility-Control
Broad banding encourages employees to seek growth and development by
moving cross-functionally. The assumption is that this cross-fertilization of
ideas will benefit the organization.
oHence, career moves within bands are more common than between bands.
oAccording to supporters, the principal payoff of broad banding is this
flexibility. But flexibility is one side of the coin; chaos and favoritism is the
other.
Banding presumes that managers will manage employee pay to
accomplish the organization’s objectives (and not their own) and treat
employees fairly.
The challenge today is to take advantage of flexibility without increasing
labor costs or leaving the organization vulnerable to charges of inconsistent or
illegal practices.
X. Balancing Internal and External Pressures: Adjusting the Pay Structure
Up until now, the text made a distinction between the job structure and the pay
structure.
oA job structure orders jobs on the basis of internal factors (reflected in job
evaluation or skill certification).
oThe pay structure, on the other hand, is anchored by the organization’s external
competitive position and reflected in its pay-policy line.
A. Reconciling Differences
The problem with using two standards (internal and external) to create a
structure is that they are likely to result in two different structures.
The order in which jobs are ranked on internal versus external factors may
not agree.
Differences between market structures and rates and job evaluation
rankings warrant a review of the basic decisions in evaluating and pricing a
particular job.
oThis may entail a review of the job analysis, the evaluation of the job, or the
market data for the job in question.
oOften this reanalysis solves the problem. Sometimes, however,
discrepancies persist.
One study of how differences are actually reconciled found that
managers weigh external market data more heavily than internal job
evaluation data.
In light of all the judgments that go into internal evaluation, market
data are often considered to be more objective.
Yet research show that market data are also based on judgment.
Sometimes, differences arise because a shortage of a particular skill has
driven up the market rate.
oBut reclassifying such a job into a higher salary grade, where it will remain
long after the supply/demand imbalance has been corrected, creates
additional problems.
oCreating a special range that is clearly designated as market responsive may
be a better approach.
XI. Market Pricing
Some organizations adopt pay strategies that emphasize external competitiveness
and deemphasize internal alignment.
Called market pricing, this approach sets pay structures almost exclusively on
external market rates.
oMarket pricers match a large percentage of their jobs with market data and collect
as much market data as possible.
oThe competitive rates for jobs for which external market data are available are
calculated; then the remaining (nonbenchmark) jobs are blended into the pay
hierarchy created by the external rates (“rank to market”).
The objective of market pricing is to base most, if not all, of the internal pay
structure on external rates, breaking down the boundaries between the internal
organization and the external market forces.
Some companies even match all forms of pay for each job to its competitors in the
market.
A. Business Strategy (More Than “Follow the Leader”)
Pure market pricing carried to this extreme ignores internal alignment
completely. Gone is any attempt to align internal pay structures with the
business strategy and the work performed.
oRather, the internal pay structure is aligned with competitors’ decisions as
reflected in the market. In a very real sense, the decisions of its competitors
determine an organization’s pay.
oIf a competitor’s pay decisions is the sole or even primary determinant of
another company’s pay structure, then how much or what mix of forms a
company pays is no longer a potential source of competitive advantage. It is
not unique, nor is it difficult to imitate.
oFairness is presumed to be reflected by market rates; employee behavior is
presumed to be reinforced by totally market-priced structures, which are the
very same as those of competitors.
In contrast, an organization may choose to differentiate its pay strategy
from that of its competitors to better execute its own strategy.
oOrganizations may choose different overall pay levels, depending on their
business strategy.
oOrganizations may choose to pay some of its jobs above market, but other
jobs at or below market.
In sum, the process of balancing internal and external pressures is a matter
of judgment, made with an eye on the pay system.
oDe-emphasizing internal alignment may lead to unfair treatment among
employees and inconsistency with the strategy and fundamental culture of
an organization.
oNeglecting external competitive pay practices, however, will affect both the
ability to attract applicants and the ability to retain valued employees.
oExternal pay relationships also directly impact labor costs and hence the
ability to compete in the product/service market.
XII. Review
The end of Part Two of the textbook is a logical spot for a midterm exam. Exhibit
8.24 has been designed to help you review.
XIII.Your Turn: Google’s Evolving Pay Strategy
Summary of Case
Students are provided with an example of the pay strategy applied by
Google. When Google went public in 1994, its stock price was around
$100/share and then rose rapidly, peaking at $747 in November 2007. As a
result, Google is now subjected to comments such as “Google isn’t the hot
place to work” and has “become the safe place to work,” (per Robert Greene,
who recruits engineers for start-ups such as Facebook). This was because
Google announced that it was giving a 10% across the board increase in
salary.
“Analysts say Google is facing what all Silicon Valley companies struggle with
when they graduate from startup status and into the realm of Big Tech.”
Also, Google engaged itself in repricing their stock options. A majority of
employees took advantage of the opportunity to replace their existing
options with new options.
Learning Objective
Understand how start-ups struggle when they graduate from startup status
into a higher status. Discover solutions to overcome the issues.
Teaching Guidelines
Use this case to help students analyze the struggles faced by start-ups and
suggest ways to overcome these problems.
Discussion of Case Questions
1. What is Google’s pay level? How do you define and measure its pay level? How well is
it captured by salary alone?
Google’s pay level currently ranges from $90,000 to $105,000. Google could have defined
and measured its pay level only after:
specifying its competitive pay policy;
defining the purpose of the survey;
selecting relevant market competitors;
designing the survey;
interpreting survey results and constructing the market line;
constructing a pay policy line that reflects external pay policy; and
balancing competitiveness with internal alignment through the use of ranges, flat rates,
and/or bands.
Google offers many benefits besides just salary
2. Does your answer to the above question depend on what point in time it is answered?
For example, what was Google’s pay level the day before it repriced employee stock
options? What was Google’s pay level the day after it repriced employee stock options?
And now?
Yes, the answer to the above question depends on what point in time it is answered. Most
organizations make adjustments to employees’ pay on a regular basis. Such adjustments can
be based on the overall movement of pay rates caused by the competition for people in the
market. Adjustments may also be based on performance, ability to pay, or terms specified in a
contract.
Google’s pay level varied from $90,000 to $105,000 after it repriced employee stock options.
Google’s pay level was as much as $20,000 lesser before it repriced employee stock options.
3. Why did Google reprice its stock options and also give a 10 percent salary increase (in
an era when 2 to 3 percent annual salary increase budgets are the norm)? Is it because
its business strategy and/or product life cycle changed? Is it because it was concerned
that employees’ perceived value of compensation did not match what Google was
spending?
Student answers will vary.
Microsoft had changed its pay strategy to rely less on stock options, more on stock grants,
and then to rely less on stock grants and more on cash as its product cycle phase changed
from growth to maintenance and its stock price growth slowed, Perhaps following in the
footsteps of Microsoft, Google announced recently that it was giving a 10% across the board
increase in salary. “Analysts say Google is facing what all Silicon Valley companies struggle
with when they graduate from startup status and into the realm of Big Tech.”
4. Do you think Google has made the right choices in changing its compensation strategy?
How much do these changes cost? How do these costs compare to Google’s total costs
and operating income? Are these increased compensation costs likely to be a good
investment? In other words, will they pay for themselves (and more)? Explain.
Student answers will vary.
Google changed its pay strategy differently by increasing its salary and not stock grants and
stock options. It increased the salaries in order to retain its top talent and to avoid them from
going to other companies like Facebook. The cost of the salary increase was estimated by
Barclay’s to be $400 million. This strategy forces the company to give an increase to
employees who are not doing that well as well as people who should not be there in the
company. Hence, one cannot completely agree that an increase in compensation costs is a
good investment.
5. Will Google’s pay strategy work “forever”? Consider the evolution of Microsoft’s pay
strategy as its growth slackened. Should Google prepare for a similar future? If so,
when and what sort of actions should they take to prepare?
Google’s pay strategy will not work forever. At some point, when Google reaches maturity,
their growth will slow. At this point, they may consider restructuring their objectives and
their pay system.
Source:
http://www.tlnt.com/2010/11/23/googles-compensation-strategy-hints-of-desperation/
