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CHAPTER TWO
STRATEGY: THE TOTALITY OF DECISIONS
Overview
This chapter examines the key aspects of decisions taken during the creation of compensation
strategy. The key premise is that the way employees are compensated can be a source of
sustainable competitive advantage. The three tests to identify if a pay strategy provides
competitive advantage are discussed. The steps involved in developing a total compensation
Learning Objectives
• Identify and describe similarities and differences in strategies within the same industry
and within the same company.
Chapter Two: Strategy: The Totality of Decisions 2 – 2
Lecture Outline: Overview of Major Topics
I. Similarities and Differences in Strategies
A. Different Strategies within the Same Industry
B. Different Strategies within the Same Company
II. Strategic Choices
III. Support Business Strategy
IV. Support HR Strategy
V. The Pay Model Guides Strategic Pay Decisions
A. Stated versus Unstated Strategies
VI. Developing a Total Compensation Strategy: Four Steps
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Lecture Outline: Summary of Key Chapter Points
I. Similarities and Differences in Strategies
• Compensation strategies of three companies (Google, Nucor, and Merrill Lynch) are
compared and contrasted.
o All three are innovators in their industry.
o All three formulate their pay strategy to support their business strategy.
▪ All three emphasize outstanding employee performance and commitment.
o However, there are major differences (See Exhibit 2.1).
• While Google is one of the largest companies in the world, it positions itself as still
being, at heart, the feisty start-up populated by nerds and math whizzes.
• Nucor Steel is a pioneer in recycling steel scrap and other metals into steel products.
The emphasis is on high productivity, high quality, and low cost products.
o Nucor provides an opportunity for those who are willing to work hard to make a
lot of money by helping the company be productive and profitable.
o In a good year, an hourly worker can make $75,000 or more in wages and
bonuses combined.
• Merrill Lynch, now part of Bank of America, relies heavily on the human capital of
its employees to compete.
o Pay objectives are straightforward: to attract, motivate, and retain the best talent.
▪ Brokers are paid bonuses on a sliding scale for up to 50% of the broker’s
annual commissions (called production).
Chapter Two: Strategy: The Totality of Decisions 2 – 4
• These three companies operate in very different industries and face different
condition, serve different customers, and employ different talent.
A. Different Strategies within the Same Industry
• Google, Microsoft, and SAS all compete for software engineers and marketing
skills but they focus on different components of an employees’ compensation.
• In its earlier years, Microsoft adopted a very similar strategy to Google’s, except
its employees accepted less base pay to join a company whose stock value was
increasing exceptionally.
o But, when its stock quit performing so spectacularly, Microsoft shifted its
strategy to increase base and bonus to the 65th percentile from the 45th
• SAS Institute, the world’s largest privately owned software company, takes a
different approach.
o It emphasizes work/life programs over cash compensation and provides
B. Different Strategies within the Same Company
• Sometimes different business units within the same corporation face very
different competitive conditions, adopt different business strategies, and thus fit
different compensation strategies.
o For example, the Korean company SK Holdings has much variety in its
business units.
• A simple “let the market decide our compensation” strategy does not work
internationally.
o In many nations, markets do not operate as in the United States or may not
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even exist.
II. Strategic Choices
• Strategy refers to the fundamental directions that an organization chooses.
o An organization defines its strategy through the tradeoffs it makes in choosing
what (and what not) to do.
• Exhibit 2.2 ties the strategic choices to the quest for competitive advantage.
o At the corporate level, the fundamental strategic choice is: What business should
we be in?
Definition: A strategic perspective focuses on those compensation choices that help
the organization gain and sustain competitive advantage.
III. Support Business Strategy
• A currently popular theory proposes that pay systems align with an organization’s
business strategy. The rationale is based on contingency notions.
• Exhibit 2.3 gives an example of how compensation systems might be tailored to the
three general business strategies.
Chapter Two: Strategy: The Totality of Decisions 2 – 6
▪ It encourages productivity increases, and specifying in greater detail exactly
how jobs should be performed.
o The customer focused strategy stresses delighting customers and bases employee
pay on how well they do this.
• Compensation strategies can also be based on generic strategy frameworks:
o Michael Porter’s business strategy framework would label firms that cut costs to
• Conventional wisdom would be that competing on cost requires lower compensation,
whereas competing through innovation is likely to be more successful with high-
powered incentives/pay for performance.
• Most firms, however, do not have generic strategies. Instead, they tend to have
aspects of cost and innovation.
• Likewise, compensation strategies do not necessarily line up neatly with generic
business strategies.
o For example, Nucor and Southwest Airlines rely heavily on cost leadership in
• To do better than competitors, a firm must consider how to fashion its own unique
way of adding value through matching its business strategy and pay strategy.
o Looking at Exhibit 2.3, Google might fit as an innovator, Merrill Lynch as
• If an organization changes its business strategy, the pay systems should change.
o A classic example is IBM’s strategic and cultural transformation is discussed in
the text.
o A redesigned IBM focuses on the high-growth, high-value segments of the IT
industry. A new business strategy meant a new compensation strategy.
▪ They cut layers of management to streamline the organization.
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Education.
▪ They increased incentive pay to more strongly differentiate on performance.
▪ They kept a constant eye on costs.
• Exhibit 2.4 depicts IBM’s “New Blue” approach to executing its strategy.
o It is unclear if the strategy is working, IBM’s stock price is down 19% over the
last five years, in contrast to an increase of 66% in the Dow Jones Index over the
same period.
IV. Support HR Strategy
• A compensation strategy that supports the business strategy implies alignment
between compensation and overall HR strategies.
o In the literature on high-performance work systems (HPWS) and HR strategy,
researchers Boxall and Purcell have found a commonly used performance theory.
o Compensation is the key to attracting, retaining, and motivating employees with
the abilities necessary to execute the business strategy and handle greater
decision-making responsibilities.
o Compensation is also the key to motivating them to fully utilize those abilities.
o Higher pay levels and pay for performance are often part of such a HPWS.
• Compensation strategy and HR strategy are central to successful business strategy
execution.
V. The Pay Model Guides Strategic Pay Decisions
• Using the pay model, the five strategic compensation choices facing Whole Foods
managers will be:
o Objectives: How should compensation support the business strategy and be
adaptive to the cultural and regulatory pressures in a global environment?
▪ Whole Foods objectives:
• Increase shareholder value through profits and growth.
o Internal Alignment: How differently should the different types and levels of skills
and work be paid within the organization?
▪ Whole Foods:
Chapter Two: Strategy: The Totality of Decisions 2 – 8
• Store operations are organized around self-managed teams.
o External Competitiveness: How should total compensation be positioned against
competitors? What forms of compensation should be used?
▪ Whole Foods:
o Employee Contributions: Should pay increases be based on individual and/or team
performance, on experience and/or continuous learning, on improved skills, on
changes in cost of living, on personal needs, and/or on each business unit’s
performance?
▪ Whole Foods:
• Uses a shared fate technique where monthly team performance, in terms of
revenue per hour worked, directly affects what the team is paid.
o Management: How open and transparent should the pay decisions be to all
employees? Who should be involved in designing and managing the system?
▪ Whole Foods:
• These decisions, taken together, form a pattern that becomes an organization’s
compensation strategy.
A. Stated versus Unstated Strategies
• All organizations that pay people have a compensation strategy. Some have a
written compensation strategy shared with all employees.
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VI. Developing a Total Compensation Strategy: Four Steps
• Exhibit 2.6 shows the four simple steps involved in developing a compensation
strategy.
o While the steps are simple, executing them is complex.
A. Step 1: Assess Total Compensation Implications
Business Strategy and Competitive Dynamics—Understand the Business
o This first step includes an understanding of the specific industry in which the
organization operates and how the organization plans to compete in that
industry.
o Learn to gauge the underlying dynamics in the business (or build relationships
with those who can).
o Competitive dynamics can be assessed globally.
▪ However, comparing pay among countries is complex.
HR Strategy: Pay as a Supporting Player or Catalyst for Change?
o Whatever the overall HR strategy, a decision about the prominence of pay in
that HR strategy is required.
Culture/Values
o A pay system reflects the values that guide an employer’s behaviors and
Social and Political Context
o Context refers to a wide range of factors—legal and regulatory requirements,
cultural differences, changing workforce demographics, and employee
expectations.
Chapter Two: Strategy: The Totality of Decisions 2 – 10
▪ These also affect compensation choices.
o Because governments are major stakeholders in determining compensation,
Employee Preferences
o Employees have different needs and wants which are easily overlooked when
formulating a compensation strategy.
Choice is Good. Yes, No, Maybe?
o Contemporary pay systems in the United States do offer some choices
including flexible benefits and choices among health care plans.
o Some studies have found that people do not always choose well.
Union Preferences
o Pay strategies need to be adapted to the nature of the union-management
relationship.
B. Step 2: Map a Total Compensation Strategy
• A compensation strategy is formulated based on the five elements of the pay
model: objectives, and the four policy choices of alignment, competitiveness,
contributions, and management.
• Mapping is often used in marketing to clarify and communicate a product’s
identity.
• Exhibit 2.8 maps the compensation strategies of Microsoft and SAS.
o Each company’s profile on the strategy map reflects its main message or “pay
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brand.”
▪ Microsoft: Total compensation is prominent, with a strong emphasis on
• Strategic maps provide a visual reference.
o They are useful in analyzing a compensation strategy that can be more clearly
• It is important to realize that the decisions in the pay model work in concert. It is
the totality of the decisions that forms the compensation strategy.
C. Steps 3 and 4: Implement and Reassess
• Step 3 in Exhibit 2.6 is to implement the strategy through the design and
execution of the compensation system.
• Step 4, reassess and realign, closes the loop.
o This step recognizes that the compensation strategy must change to fit
VII. Source of Competitive Advantage: Three Tests
• Three tests determine whether a pay strategy is a source of competitive advantage.
1. Is it aligned?
2. Does it differentiate?
3. Does it add value?
A. Align
• Alignment of the pay strategy includes three aspects:
1. Align with the business strategy,
• Alignment is probably the easiest test to pass.
Chapter Two: Strategy: The Totality of Decisions 2 – 12
B. Differentiate
• Some believe that the only thing that really matters about a strategy is how it is
different from everyone else’s.
o If the pay system is relatively simple for any competitor to copy, then how can
it possibly be a source of competitive advantage?
• The answer according to the advocates of the strategic approach, is in how the pay
system is managed.
o The map profiles in Exhibit 2.8 show how Microsoft and SAS differ in their
• It is difficult for a company to imitate the compensation strategy of another
company since each strategy is woven into the fabric of a company’s overall HR
strategy.
o Copying one or another dimension of a strategy means ripping apart the
C. Add Value
• Compensation is often a company’s largest controllable expense
• Since consultants and a few researchers treat different forms of pay as
investments, the task is to come up with ways to calculate the return on those
investments (ROI).
• Trying to measure an ROI for any compensation strategy implies that people are
“human capital,” a view that some people find dehumanizing.
• Of the three tests of strategy—align, differentiate, add value—the last is the most
difficult to “pass.”
• Are there advantages to an innovative compensation strategy?
o In products and services, first movers (innovators) have well-recognized
VIII. “Best Practices” versus “Best Fit”?