Expert Opinion

Compensation Philosophy

Organisations frequently need to evaluate new compensation programmes and to reassess the design of those already in existence. Christopher Kelley, managing partner at HR Analytic Services, and David Gustat consultant, write [1] that when considering an organisation's compensation philosophy the following questions should be asked:

• Should salaries be related to competitive rates, or to internal worth?

• How should the organisation be positioned relative to the market?

• Should pay be differentiated, and if so on what basis e.g. performance, knowledge, or seniority?

• Should salaries be 100-percent fixed or should there be a mix of base wages and variable compensation?

In formulating a sound compensation philosophy it is important to link employee incentives to the overall strategy and mission of the organisation.  [1]

One of the most important roles of management is the motivation of staff. In regard to this Adrian Furnham, Professor of Psychology at University College, London, states [2] that the concept that better paid people are more productive and happy does not tie in with the evidence found in the workplace. Professor Furnham provides the following four key reasons that money is much more likely to be a cause of dissatisfaction rather than of satisfaction:

1. Money as a de-motivator; there is no simple correlation between pay and performance. Perceived low pay often leads lead to considerable dissatisfaction and de-motivation, but not vice versa. The effects of any pay increases will very soon wear off, and any improvements are likely to be temporary.
2. Absolute salary vs. comparative salary; if pay increases significantly but in concert with the rest of the work group there is likely to be little change in behaviour. This crucial factor relates to an essential problem associated with performance related pay. If employees believe, with or without evidence, that they are not equitably and fairly paid, they will become de-motivated.
3. Money is not everything; Employees are often happier with more time off, or greater job security, and are prepared to trade these for money. Essentially once employees have enough they grow weary of the game.
4. Taxation; when taxes eat heavily into pay increases then motivation benefits are diluted.

Efficiency improvements need to be measured, processes understood, goals/targets set and achievements rewarded. If there is no clear relationship between the effort extended, and rewards received, either by individuals or by teams, then there is little point in implementing incentives encouraging employees to be more productive. [2]

Talented people want to work for organisations that recognise their value and which provide opportunities to move ahead. Consultant Howard Risher, Ph.D., writes [3] that there is a global trend to adopt pay-for-performance policies. Many of the compensation and reward systems that are in use today are based on assumptions that have not been tested for many years. There are other alternatives that focus less on individual wage increases and introduce group incentives, such as incentives related to a common goal. Group incentives have proved to be effective in practice and employees generally like them. Pay for performance systems need to be closely overseen and owned by the organisation's managers i.e. not by its HR department. It is also wise to involve employees in the planning and design process of compensation schemes because this best develops in them a sense of ownership. Employees who are to be covered under proposed pay-for-performance systems can be used in focus groups or task forces to fine tune proposals. These employees will then tend to serve as valuable communication channels among their co-workers. They will be able to explain the reasons for decisions and be trusted by their colleagues. Pay for performance is most effective at obtaining the desired behaviours when it is related to  a management process and when it truly matches the goals of the organisation [3]

Goal Setting and Business Strategy 

It is prudent for organisations to focus upon setting those goals which are critical to achieving its success; and as part of this process ensuring that its employees understand how success will be measured, and how personally they can influence the outcomes that lead to success. Goal setting and measurement are central elements of incentive plans, and in particular for the design of executive compensation plans. Blair Jones and Seymour Burchman, both of whom held senior positions at Sibson Consulting, state [4] that the primary objective of goal setting and measurement is the selection of instruments which align with business strategy. The most common goal-setting approaches involve linking incentive goals to annual budgets, or to longer term business plans. In connection with this process three steps are suggested below:

1.    Firstly "top-down" goals should be set considering important benchmarks/targets i.e.

• Historical performance,

• Future expectations and

• Continuous year-over-year performance improvement

2.     Next a "bottom-up" perspective should be developed concerning what the organisation believes it can deliver. This may be divided up into the following areas:

• Understanding the financial and non-financial drivers of the value of the company's stock;

• Identifying the drivers that need additional focus in order to improve company results;

• Determining and summarising opportunities for improving performance associated with these key drivers.

3. Finally, reconcile the actions that need to be taken to achieve the desired goals, and then appropriately link pay with performance. This involves the evaluation of both the intended and unintended consequences of potential measures. For example, if performance increases in one area ensure that it will not have an adverse impact on another area. Participants should understand the measures used, and how these affect their efforts. Payouts should also reflect the toughness of the goals that have been set, and the potential volatility of the likely results.  [4]

Debi O'Donovan, employee benefits editor of the UK Director magazine, writes [5] that clever employers usually link their benefits to specific  goals. For example,  those aiming at a loyal workforce offer pension schemes, those wanting to project a caring, family image, offer healthcare benefits, or days off to work for charity, and for those having employee performance as a key business aim, share options, and bonuses are likely to be attractive. Regarding staff turnover, organisations in the technology sector, which tend to depend upon small numbers of key people, need to work harder at retaining their staff. O'Donovan cites the Small Business Service report, "Closing the Gap", written by the Centre for Business Performance at Cranfield University, which reported that small businesses performing in the upper quartile recruit 10 percent of their staff each year; while those in the lower quartile recruit 30 percent annually. It was reported that most businesses use benefits as a tool for staff retention. [5]

 Pay for Performance Sstems

Many pay for performance systems are compensation systems in which an employee's pay opportunities are indexed to the performance of the company in addition to the individual's performance. William B. Abernathy Ph.D. performance systems design and reengineering practitioner wrote [6] that the primary objectives for pay for performance systems are:

• To increase the profitability of the organisation,
• To fairly share the profits with owners, customers, and employees, and
• To create a highly responsive open system that operates on a principle of positive reinforcement.

To achieve these objectives requires the identification of key employee behaviours that drive organisational profitability and the implementation of a performance feedback/performance pay system to provide the impetus to reach the desired objectives. The design of such a system requires the removal of all performance constraints, and the creation of an open behaviour system involving:

1. A high proportion of performance pay  relative to base pay; Employees who have only a modest performance pay opportunity along with market-competitive base pay, are not true stakeholders in the organisation. They have no significant risk component in their pay, and there is no strong motivation for behavioural change.
2. An increase in the proportion of workers to managers; Higher numbers of managers relative to productive staff can create "silos" and less responsive behaviours. In comparison self managed personnel tend to be more productive.
3. An enterprise-wide job enlargement and enrichment program; Enabling individuals to earn more pay through their own efforts can provide satisfaction without the need to move through the ranks.[6]

 Sales Compensation Plans

1. Review sales and profit potential by aligning sales compensation with the profitability/growth potential of revenue streams.
2. Break down compensation costs by segmenting these under sales strategies, products, customer segments, geography, and job type.
3. Evaluate sales job content to ensure that compensation reflects the complexity and responsibilities required.
4. Re-evaluate goal-setting accuracy to ensure that a reasonable percentage of sales people will achieve quotas
5. Audit upside earnings, or the amount of variable compensation, that top earners can achieve. In this regard it is wise to consider the levels of competition for sales talent, the degree of influence that the seller has over purchasing decisions, and the need to strike a balance between lower base salaries and higher total cash compensation potential.
6. Rigorously assess eligibility by measuring if employees have a high degree of influence over customers' purchasing decisions, have direct customer contact, and spend most of their time on sales activities.

Deriving the highest possible return from sales compensation plans requires that managers strike the right balance between economics and the organisation's strategic priorities. [7]

Gainsharing 

Gainsharing plans are pay-for-performance programmes that motivate employees to use their skills and efforts to boost company performance. Under Gainsharing a proportion of any savings made are awarded to the employees as a bonus, and the remainder is retained by the company. Pay-outs are made periodically in accordance with overall company performance improvements. Woodruff Imberman, PhD, writing for Foundry Management & Technology journal [8] states that American producers need to boost productivity to remain competitive with overseas manufacturers. Citing the U.S. Bureau of Labour Statistics the main contributor to higher productivity is collaboration i.e. joint employer/employee efforts to improve productivity. Imberman believes that such collaboration may be achieved with no extra cost by implementing proper incentive programs for reaching higher goals, and that Gainsharing is both a popular and effective group-incentive program. Due to better performance, employees typically earn bonuses of 6-9% of their monthly pay. No improvement means no gain, and no gain means no bonus, and this simple fact can strongly drive employee behaviour. Bonuses under Gainsharing programmes are essentially self-funded by the incremental productivity and quality improvements that Gainsharing generates. [8]

Long Term Incentives

Long term incentives are used to encourage executives in particular to focus on business activities which can lead to improved organisational performance. Long term incentives can also be used to minimise fixed costs to an organisation.  Robin Ferracone [9] a senior consultant and thought leader at Mercer Human Resource Consulting provides the following examples of long term incentive schemes:

1. Stock Option Plans; which give employees the right to buy stock at a designated point in the future at the issue date's price. If the stock price increases the employees can benefit by exercising this option. Alternatively should the stock price fall below the issue price, and the option expires, then the employees will receive nothing.
2. Service-Based Restricted Stock Plans; which can be used as an alternative to stock options, or instead of complex incentive schemes. For service-based restricted stock, the employee receives the value of the stock at the time of investing as long as the agreed service requirement has been met.
3. Performance Share Plans; which reward executives for having a positive impact on performance including company financial performance/stock price performance. Using performance share plans, executives are offered the ability to earn shares based on pre defined performance measures. [9] 

Total Rewards 

When designing an effective compensation plan organisations need to take into account the overall packages offered to employees. "Total Rewards" is a generic term used to describe such compensation and incentive packages. The Canadian HR Reporter [10] describes total rewards packages as including:

• Pay, bonuses, incentives;
• Core benefits such as health, dental and vision, and motor vehicle for private use;
• Recognition;
• Pensions;
• Voluntary benefits i.e. discounted rates for car and home insurance;
• Training and development and;
• Workplace culture and the work environment [10]

To maximise the value of flexible benefit packages for both employees and the employer it is worthwhile to survey employees regarding the type of benefits that they favour and value most. Jean Richards of Helios Associates Ltd writing for the Chartered Institute of Personnel and Development (CIPD) in London provided [11] the following core benefits forming typical schemes in use in the UK.

• Holidays
• Life assurance
• Private medical insurance
• Critical illness insurance / long-term disability insurance
• Personal accident insurance
  

• Bicycles
• Cars (for eligible staff) or employee vehicle schemes
• Childcare vouchers
• Dental insurance
• Discounted services
• Financial planning
• Give-As-You-Earn charitable contributions
• Health screening
• Home phone package
• Legal expenses insurance
• Life assurance
• Pension
• Personal computers
• Pet insurance
• Retail vouchers
• Season ticket for travel
• Travel insurance
• Concierge benefits (e.g. laundry service)
  

Smaller firms in particular may need to improve their benefits packages or risk losing their best performers. Louisa Roberts of Facilities Management World [12] cites Catherine Redmond, head of employee benefits at Barclay's Bank who said that investing money in benefits programmes typically helped organisations to attract and retain key talent. Individual benefits were also believed to add significant value to those organisations e.g. benefits such as share purchase schemes were able to focus employees' attention on the organisation's share price and business performance.

Comprehensive benefits packages can be of significant value to employees because organisations are usually better placed to secure much better deals than those available to individuals. Employees at the top end of the banking, financial services and IT industries in particular are able to command generous reward packages. Louisa Roberts cites Steve Carter, UK and Ireland managing director of financial recruitment company Robert Hall International, as saying that job seeking candidates are now expecting more from potential employers, and especially at times of high demand they may ask the interviewers "If you want me, what else do I get?"

Carter's viewpoint was that innovative companies need to recognise that the way forward was to offer compensation packages which allowed people to choose from a list of benefits that included a pension, more holidays or healthcare-related offerings. To a 40-year-old person the offer of a great pension could be very attractive however a 21-year-old high performing graduate might rather have cash. Such options did not present a large administrative burden and in addition they enabled employers to keep better in touch with the workplace. [12]

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