CHAPTER 10 Developing an Approach to Total Compensation
CHAPTER 10
DEVELOPING AN APPROACH TO TOTAL COMPENSATION
Opening Case: Managing Human Resources at Synapse Group, Inc.
Synapse Group, Inc. is a magazine subscriptions marketing company that introduced
innovations such as the multipublisher continuous service subscription system and has
developed a variety of nontraditional marketing channels. Listed as one of the “The
Best Medium Companies to Work for in America”, its unique performance-driven
culture attracts exceptional employees which makes it a fun place to work. Synapse
Group’s philosophy of meritocracy first and democracy second is supported by the
company’s total compensation practices where great performers are given great
rewards.
CHAPTER OUTLINE
I. THE STRATEGIC IMPORTANCE OF TOTAL COMPENSATION
Three important objectives of a total compensation system are to attract and retain
talent, to focus the energies of employees on implementing an organization’s
competitive strategy, and to improve productivity.
A. Attract, Motivate, and Retain Talent
The total compensation system helps to ensure that the rewards offered are
sufficient to attract the right people at the right time for the right jobs.
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1. Low Pay
Employees will be dissatisfied if they perceive the company’s total pay policy
as less generous than that offered by the competition. Employees who are
2. Pay Secrecy
Keeping pay secret is the norm in many U.S. organizations. Managers also
3. Executive Compensation
The pay gap between CEOs and blue collar workers has increased
dramatically over time. This makes many employees feel angry and
B. Implement the Business Strategy
Compensation practices and systems help to motivate employees to engage in
the behaviors needed to implement the business strategy of a firm. Major
C. Improve Productivity
The monetary elements of a total compensation system influence productivity
by focusing employees’ attention on finding new ways to reduce costs or
increase revenues, and motivate them to spend their energy on activities most
important to the firm’s success.
CHAPTER 10 Developing an Approach to Total Compensation
D. Contain Costs
1. Changing the Pay Mix
The way an organization distributes pay among all monetary and
nonmonetary elements of total compensation is referred to as the pay mix.
2. Emphasizing Nonmonetary Compensation
Monetary compensation includes direct payments, such as salary, wages,
II. TOTAL COMPENSATION WITHIN THE INTEGRATED HRM SYSTEM
Total compensation typically includes a mix of both monetary and non-monetary
elements. Exhibit 10.4 provides a summary of the elements of a total compensation
system and how they fit within the total HRM system.
A. Other HRM Practices
An effective total compensation system must be well integrated with other
aspects of the total HRM system.
1. Recruiting and Retaining
2. Training and Developing
Some training and development opportunities expenses may be calculated
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3. Performance Measurement
B. The External Environment
It is most critical that the compensation practices of a firm be responsive to the
external environment in terms of the external labor market, the industry in which
it competes, unions, and laws and regulations.
1. Labor Market
Pay level and pay mix are two important conditions that affect the level of
pay offered. Pay level is how a firm’s pay compares to that of other firms.
2. Unions
One reason that compensation differs across industries is that some
industries are more unionized. Unionized organizations tend to pay more,
C. Laws and Regulations
Legislation often reflects social expectations about work at the time. Even our
concept of the “normal” work week has changed (shortened) drastically since
the nineteenth century.
1. Fair Labor Standards Act
The FSLA set minimum wages (twenty-five cents an hour when the law was
enacted 1n 1938), maximum hours, child labor standards, and overtime pay
CHAPTER 10 Developing an Approach to Total Compensation
Teaching Note: It is often difficult for students to distinguish between exempt
and non-exempt employees. Exempt employees are comparable to
“management” or “salaried” employees, while non-exempt employees are
comparable to “non–management” or wage-earning employees.
2. Equal Pay Act
Passed in 1963, the act amends the Fair Labor Standards Act. It prohibits
sex discrimination in pay for equal jobs requiring equal skill, effort, and
responsibility, performed under similar working conditions. Legally
defensible exceptions:
➢ seniority system.
3. Living Wage Laws
Some jurisdictions require employers to pay minimum wages that are above
federal and state levels and to pay higher minimum wages to workers who
D. The Organizational Environment
The strategy, size and culture of the organization will shape the compensation
policies of the organization.
1. Business Strategy
An organization’s strategic objectives often have important implications for
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2. Company Size
Small companies typically pay less than larger firms, although employees in
3. Company Culture
Companies in the same industry can have very different compensation
III. THE HR TRIAD
A partnership of concerned stakeholders helps ensure a compensation system that
balances the interests of all concerned. See The HR Triad: Roles and
Responsibilities for Total Compensation.
A. HR Professionals
They take primary responsibility for ensuring the legality and fairness of
compensation practices. Their roles and responsibilities are discussed in
greater detail in future chapters.
B. Line Managers
C. Employees
Involving employees in the design of compensation systems goes a long way
toward improved production, better understanding of the pay system, and
employee satisfaction.
IV. ESTABLISHING THE INTERNAL VALUE OF JOBS
A pay structure combines job evaluation information and information about market
pay rates to establish a policy that governs the base pay received by employees.
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A. Objectives of Job Evaluation
Job evaluation involves the systematic, rational assessment of jobs to
determine their relative internal worth. A primary objective of job evaluation is to
establish internal equity in a pay system.
In a job-based pay system, the pay people receive is determined primarily by
B. Job Ranking Method
This is the simplest and least specific method. Jobs are ranked according to
C. Job Classification Method
Similar to ranking, but job classes, usually called pay grades, are established
first, and jobs then put into these broad categories based upon their similar
D. Point Factor Rating Method
As Exhibit 10.9 shows, this is the most widely used method of job evaluation.
The point factor method involves assigning point values to previously
determined compensable factors and then adding them up to arrive at the
overall worth of a job. Subjective judgment may lead to discrimination under this
CHAPTER 10 Developing an Approach to Total Compensation
method. The input of HR professionals, supervisors, incumbents, and job
evaluation experts can help reduce subjectivity. Major steps include:
1. Select Compensable Factors
Compensable factors are the dimensions of work that establish the value of
2. Assign Factor Weights
3. Define Factor Degrees
4. Establish the Degree of Each Factor Present in Each Job
5. Calculate Job Values
E. Competency-Based Method
This helps define career paths according to the development of the individual
rather than his/her ascent up the corporate ladder. It promotes individual
development and growth. Lateral moves are a prominent feature of this
method. The method is so new that many companies are still uncertain about
using it.
1. Domain Competencies
Competency-based job evaluation establishes the value of jobs using
domain competencies instead of job factors. The most commonly used
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2. Broadbanding
Broadbanding results in competency-based pay structures that have very
few (e.g., three to five) pay grades with many jobs that are grouped into the
F. Skill-Based Pay
This approach rewards employees for the range, depth, and types of skills they
V. USING EXTERNAL MARKET RATES TO SET PAY LEVELS
An effective compensation system must take the external labor market into
consideration. The overall objective is to ensure that the compensation is
externally competitive (i.e., it possesses external equity). When external equity
exists, employees feel that they are being paid fairly relative to what people in
similar jobs are paid by other employers. The process of establishing external
equity in a compensation system involves: (1) determining external market rates;
(2) establishing the market pay policy; and (3) setting the organization pay policy.
A. Step 1: Determine Pay Rates in the External Market
Data about market pay rates are generated by a compensation survey
conducted by a consulting firm. The steps include:
1. Relevant Labor Market
One must first establish the geographic location to be considered. This
2. Appropriate Benchmark Jobs
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B. Step 2: Establish the Market Pay Policy
The employer now plots market data against job evaluation scores for
Teaching Note: It is probably best to spend some time on Exhibit 10.13 and
explain how the salary for Job X is calculated.
C. Set the Organization Pay Policy
Now the company has sufficient data to set a policy of matching the market,
exceeding it, or lagging behind it. Each policy has its own advantages and
disadvantages with respect to attracting and retaining employees.
A lead policy involves paying above the market rate. This will help an employer
Teaching Note: Tie this back to Exhibits 10.5 and 10.7. When is a company
likely to lead, lag or pay above market rate?
VI. DESIGNING THE PAY STRUCTURE
A. Job-Based Pay Grades and Ranges
Exhibit 10.15 shows a pay grade structure for a conventional job-based pay
system using the point factor method. In establishing pay ranges, the corporate
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B. Competency-based Pay Structure
Similar to the job-based system, except that the points on the horizontal axis
are based on competencies, not jobs. Jobs that are of lesser value to the
company are on the left side, and those with more value on the right.
C. Skill-Based Pay Structure
With skill-based pay, increases in pay are associated with increases in skills.
The initial assumption is that base pay is equal for everyone covered by the pay
VII. MAKING ADJUSTMENTS
A. Balancing Internal And External Equity
Every organization must find the appropriate balance between internal and
B. Changes Over Time
Most organizations make annual adjustments to their pay structures to address
C. Achieving Individual Pay Equity
Individual pay equity is established when the individual perceives that he or she
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VIII. COMPENSATION IN THE CONTEXT OF GLOBALIZATION
Multinational corporations (MNCs), in designing a global approach to total
compensation, must balance global compensation consistency with sensitivity to
local conditions. Questions that arise are:
IX. CURRENT ISSUES
A. Total Compensation during Difficult Economic Conditions
In economic recessions, companies struggle to cover their expenses because
of decreased income. During these periods, containing labor costs frequently
becomes a primary strategic goal. Although head-count reduction through
layoffs is often used to reduce these costs, it is not always the best way.
1. Wage Freezes
2. Increased Health Care Premiums
3. Reduced Retirement Benefits
This could include shifting more risk to the employee by changing the nature
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4. Wage Cuts
Pay cuts reduce labor costs immediately and are likely to be viewed by
5. Replace Base Pay with Incentives
B. The Government’s Role in Compensation Decisions
In the United States, people disagree about how much the government should
intervene in free labor markets to control total compensation. The requirement
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QUESTIONS FOR REFLECTIVE THINKING AND DISCUSSION
1. Explain how an organization’s approach to total compensation can help it be
effective or prevent it from being effective.
Compensations can help organizations be effective by attracting and retaining
2. How and why do the objectives of total compensation vary across
companies?
Total compensation can act as a strong incentive in the recruitment of high quality
employees as well as acting as a strong means of retaining and motivating valued
3. What are the elements of total compensation? Which ones are most
important to you personally?
4. Describe the purpose of job evaluation. What are the advantages and
disadvantages of using the job ranking method? What are the advantages
and disadvantages of using a customized job evaluation point system?
Job evaluation is used to determine the relative worth of jobs within the
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5. List the possible negative consequences that organizations are likely to
experience if employees do not understand their total compensation.
Lack of employee understanding of a firm’s compensation system can create a
6. What are your views on pay secrecy? How much do you think employees
should be told about how their pay is determined?
7. If you were considering a job offer, which elements of total compensation
would be more important to you: base pay, incentives, or benefits and
services? Why? What are the implications of your answer for employers
seeking to attract people like you to work for them?
8. How involved do ou think the government should be in compensation
decisions? Should there be a minimum wage? A maximum wage?
Opinions will vary. The important thing is not the specific view but rather the
CASE STUDY: THE OVERPAID BANK TELLERS
DISCUSSION QUESTIONS:
Since this case has no questions, you have much flexibility in how it is approached.
However, the first step in any problem solving approach is to determine the problem. It
may seem that the problem is that the bank’s tellers are overpaid. You might ask the
students if perhaps the tellers at the other banks are underpaid and State Bank’s
CHAPTER 10 Developing an Approach to Total Compensation
You might also ask your students whether they agree that the bank should try to keep
the survey of bank employees pay secret? In a relatively small city is it possible to
keep such things secret? If a customer survey suggests that the tellers have little
impact on where they bank, might it be good to let the tellers know the facts so that
they will be grateful for what they have, not expect increases to their income, and
perhaps to endeavor to increase their value so as to retain their level of
compensation?
Since other bank employees might be jealous of the fact that their income is about the
same as that at other local banks while the tellers are above average, would it be best
to show the other employees how they can increase their value to the bank and thus
also increase their pay? Could the problem of jealousy be diminished over time as
tellers quit or retire by implementing a new pay policy in which any new tellers would
start out at a much lower level while “grandfathering” current tellers at their current
rate?
CHAPTER 10 Developing an Approach to Total Compensation
VIDEO CASE STUDY: BRIGHT HORIZONS
Instructors: The following video case can be found on the companion DVD. The video
can be used in class as an introductory activity or a post-lecture activity, as well as an
online assignment for those students using CourseMate.
DISCUSSION QUESTIONS:
1. Based on those who were in the case study, the employees are paid better
than others in the industry but what is the real motivation for many of the
employees?
One of the points that was stressed in the case study was that an important shared
2. One thing that tends to create an upper limit on how much compensation can
be provided to employees is the need to keep costs down so as to offer
customers a competitive price. Although we do not have detailed pricing
information, the firm has clearly been sufficiently competitive to grow into a
large organization. How is it possible for the firm to offer better pay to
employees and yet be competitive?
3. Explain how organizational culture relates to not only compensation but to
overall HR management.
4. If you were a person who liked to work with children, do you think you would
like to work for Bright Horizons? Why or why not?
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Answers will vary. The important thing is not so much the answer but rather the
reasoning that underlies the response.
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