The Compensation Handbook PDF

 THE COMPENSATION HANDBOOK FIFTH EDITION A S TATE - OF - THE -A RT G UIDE TO C OMPENSATION S TRATEGY AND D ESIGN LANCE A. BERGER and DOROTHY R. BERGER New Yor...

 THE COMPENSATION HANDBOOK FIFTH EDITION A S TATE - OF - THE -A RT G UIDE TO C OMPENSATION S TRATEGY AND D ESIGN LANCE A. BERGER and DOROTHY R. BERGER New York San Francisco Washington, D.C. Auckland Bogotá Caracas Lisbon London Madrid Mexico City Milan Montreal New Delhi San Juan Singapore Sydney Tokyo Toronto Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Manufactured in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher. 0-07-164287-0 The material in this eBook also appears in the print version of this title: 0-07-149675-0. All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after every occurrence of a trade- marked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringe- ment of the trademark. Where such designations appear in this book, they have been printed with initial caps. McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs. For more information, please contact George Hoare, Special Sales, at [email protected] or (212) 904-4069. TERMS OF USE This is a copyrighted work and The McGraw-Hill Companies, Inc. (“McGraw-Hill”) and its licensors reserve all rights in and to the work. Use of this work is subject to these terms. Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior con- sent. You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited. Your right to use the work may be terminated if you fail to comply with these terms. THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTH- ERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. McGraw-Hill and its licensors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free. Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom. McGraw-Hill has no responsibility for the con- tent of any information accessed through the work. Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages. This limitation of liability shall apply to any claim or cause what- soever whether such claim or cause arises in contract, tort or otherwise. DOI: 10.1036/0071496750  Professional Want to learn more? We hope you enjoy this McGraw-Hill eBook! If you’d like more information about this book, its author, or related books and websites, please click here.  For more information about this title, click here Contents Preface vii About the Editors ix Contributors xi Part 1 Introduction 1 Employee Pay: A Riddle Wrapped in a Mystery Inside an Enigma 3 Lance A. Berger 2 Total Rewards and the Future Workforce 11 Steven E. Gross and Shelley Peterson 3 Total Rewards Strategy 21 Thomas B. Wilson 4 Three Trends Shaping the Future of Compensation and Human Resources 31 Allan Schweyer 5 Demographics: The Tempest Driving Compensation 49 Dorothy R. Berger Part 2 Base Salary 6 Salary Administration 63 Andrew S. Rosen 7 Merit Pay 85 Myrna Hellerman and James Kochanski 8 Job Analysis, Documentation, and Job Evaluation 95 Bernard Ingster, Ph.D. 9 Salary Surveys 111 Don York and Tim Brown iii iv CONTENTS 10 Benchmarking 125 Iain Fitzpatrick and Thomas D. McMullen 11 Skills, Knowledge, and Competency-Based Pay 143 Gerald E. Ledford, Jr, Ph.D., Robert L. Heneman, Ph.D. and Aino Salimäki 12 Broadbanding 159 Kenan S. Abosch 13 Nonmonetary Awards 167 Rodger D. Stotz and Melissa Van Dyke 14 Salary Administration at a Prestigious Cultural Institution: Pennsylvania Academy of the Fine Arts 187 Leslie Moody 15 Compensation Practices in a Middle Market Company 191 David E. Griffith 16 A Vision for Information Technology in Compensation 197 Steven T. McGuire Part 3 Variable Compensation 17 Incentive Compensation Program Design 205 Linda E. Amuso and David Knopping 18 Using Variable Pay Programs to Support Organization Goals 215 Erin C. Packwood 19 Rationalizing Variable Pay Plans 227 Kenan S. Abosch 20 Sales Compensation 239 Jerome A. Colletti and Mary S. Fiss 21 Team-Based Incentives 259 Theresa M. Welbourne, Ph.D. and Luis R. Gomez-Mejia, Ph.D. 22 Gainsharing or Profit Sharing 277 Robert L. Masternak 23 Scanlon Gainsharing 295 Paul Davis and Dow Scott, Ph.D. Part 4 Executive Compensation 24 Executive Compensation Strategy 311 Ted Buyniski and Marvin A. Mazer 25 Long-Term Incentives 323 Jeffrey S. Hyman, Esq. CONTENTS v 26 Executive Compensation: A Recruiter’s Recommendations 339 Randy Jayne 27 Executive Compensation: An Academic’s Perspective 349 Johannes M. Pennings, Ph.D. 28 Regulation of Executive Compensation 365 Frank P. VanderPloeg, Esq. 29 Executive Employment Agreements 385 Richard L. Alpern Part 5 Compensation and the Board 30 The Compensation Committee and Executive Pay 397 Seymour Burchman and Blair Jones 31 New Dynamics of CEO Pay 415 David N. Swinford 32 Board Compensation 423 Pearl Meyer and Nora McCord 33 Board Critical Issues in Executive Pay 433 Bruce R. Ellig Part 6 Performance and Compensation 34 Performance Management Best Practices 447 Thomas B. Wilson and Susan Malanowski 35 Guidelines for Effective Executive Performance Appraisals 459 James F. Reda 36 Forced Ranking 479 Dick Grote 37 The Balanced Scorecard and Compensation 493 Paul R. Niven 38 Performance Metrics and Compensation 511 Mark Graham Brown 39 Using Compensation to Drive Workforce Productivity 521 Christian M. Ellis and Summer F. Barnes 40 Return on Investment of Compensation Expenditures 531 Fred Whittlesey 41 Pay-for-Performance: New Developments and Issues 543 Mark D. Cannon, Ph.D. vi CONTENTS Part 7 Talent Management and Compensation 42 Using Compensation to Win the Talent Wars 559 Deborah Rees 43 Talent Management, Organization Transformation, and Compensation 571 Lance A. Berger 44 Work–Life Effectiveness and Total Rewards Strategy 585 Kathleen M. Lingle 45 Compensating and Motivating a Diverse Workforce 597 Martin G. Wolf, Ph.D. 46 Communicating Compensation Programs 607 John A. Rubino 47 Talent Management and Compensation in the Fast Food Industry 617 Jerry M. Newman Part 8 Global Compensation 48 Expatriate Compensation Practices 627 Geoffrey W. Latta 49 Global Local National Compensation Practices 641 Paul Coleman 50 Global Compensation Processes 653 Robert Mattson and David Turetsky Index 665  Preface HE COMPENSATION HANDBOOK HAS BEEN recognized as T the most authoritative reference book in the compensation field for over 35 years. The book’s success has resulted from: Identifying the most significant issues impacting compensation and human resources practitioners Providing the best straightforward, comprehensive, and understandable solutions to deal with issues Presenting the thoughts and research of respected and prestigious compensa- tion leaders Offering unique and innovative approaches not found elsewhere Building on the strong foundation of past editions Imparting the best historical and current compensation tools, methods, and diagnostics for compensation and human resources professionals to align their programs with key issues Each edition of the book has its own novel foundation. The first three editions focused on the evolution of new compensation techniques and methodologies as they applied to the business and social environment of their eras. The fourth edition is based on a framework of compensation diagnostics. It structures prior and cur- rent approaches into a cohesive set of guiding principles that helps practitioners to select the most appropriate compensation methodology. vii Copyright © 2008 by The McGraw-Hill Companies, Inc. Click here for terms of use. viii PREFACE The fifth edition’s objective is to demonstrate to human resources and com- pensation professionals how they can address a dramatically changing set of human capital issues. These include: New strategies for winning the talent wars Addressing the retirement of the baby boomers, the greatest talent manage- ment issue of the twenty-first century Responding to a multicultural, multigenerational workforce The globalization of human capital Thanks to the contributions of 64 compensation specialists, 45 of whom are new authors to The Compensation Handbook, this edition contains new, updated, or revised chapters. This “linkage” to talent management issues provides com- mon threads and a roadmap for developing a comprehensive approach to com- pensation program design and implementation. The fourth edition’s structural integrity is maintained because our readers have expressed their appreciation of consistency when seeking updated information and solutions to compensation issues. We again, as we did for the fourth edition, dedicate this book with apprecia- tion and affection to Milton L. Rock, consummate compensation and business guru, whose vision spearheaded the first through third editions of The Compensation Handbook. Dorothy R. Berger Lance A. Berger  About the Editors Lance A. Berger is CEO of Lance A. Berger & Associates, Ltd., a Bryn Mawr, Pennsylvania management consultant firm specializing in compensation, talent management, and change management. A former general partner for the largest compensation practice worldwide at The Hay Group, he cowrote Management Wisdom from the New York Yankees’ Dynasty and Deengineering The Corporation, and cowrote and coedited the third and fourth editions of The Compensation Handbook, The Talent Management Handbook, and The Change Management Handbook. Dorothy R. Berger is Managing Director of Lance A. Berger & Associates, Ltd. She coordinates all organizational activities for the firm and is also a talent man- agement consultant. She cowrote Management Wisdom from the New York Yankees’ Dynasty, and cowrote and coedited The Compensation Handbook, fourth edition, The Talent Management Handbook, The Change Management Handbook, and Deengineering The Corporation. Dorothy has over 20 years’ experience in the field of education. ix Copyright © 2008 by The McGraw-Hill Companies, Inc. Click here for terms of use. This page intentionally left blank  Contributors Kenan S. Abosch Broad-Based Compensation Practice Segment Leader, Hewitt Associates, LLC, Lincolnshire, Illinois (Chapters 12 and 19) Richard L. Alpern Principal, Frederic W. Cook & Company, Inc., New York, New York (Chapter 29) Linda E. Amuso Senior Vice President, Radford Surveys & Consulting, An Aon Business, San Francisco, California (Chapter 17) Summer F. Barnes Senior Consultant, Sibson Consulting, Los Angeles, California (Chapter 39) Dorothy R. Berger Managing Director, Lance A. Berger & Associates, Ltd, Bryn Mawr, Pennsylvania (Chapter 5) Lance A. Berger Chief Executive Officer, Lance A. Berger & Associates, Ltd, Bryn Mawr, Pennsylvania (Chapters 1 and 43) Mark Graham Brown President, Mark Graham Brown & Associates, Manhattan Beach, California (Chapter 38) Tim Brown Vice President, Radford Surveys & Consulting, An Aon Business, San Jose, California (Chapter 9) Seymour Burchman Managing Principal, Semler Brossy Consulting Group, LLC, Los Angeles, California (Chapter 30) Ted Buyniski Senior Vice President, Radford Surveys & Consulting, An Aon Business, Southborough, Massachusetts (Chapter 24) Mark D. Cannon, Ph.D. Associate Professor of Leadership and Organizational Studies, Peabody College, Vanderbilt University, Nashville, Tennessee (Chapter 41) Paul Coleman Senior Consultant, ORC Worldwide, London, UK (Chapter 49) Jerome A. Colletti Colletti–Fiss, LLC, Scottsdale, Arizona (Chapter 20) Paul Davis President, Scanlon Leadership Network, East Lansing, Michigan (Chapter 23) Bruce R. Ellig Author and retired Corporate Vice President, HR, Pfizer Inc., New York, New York (Chapter 33) Christian M. Ellis Senior Vice President, Sibson Consulting, Los Angeles, California (Chapter 39) xi Copyright © 2008 by The McGraw-Hill Companies, Inc. Click here for terms of use. xii CONTRIBUTORS Mary S. Fiss Colletti–Fiss, LLC, Scottsdale, Arizona (Chapter 20) Iain Fitzpatrick Reward Information Services General Manager, Hay Group, Philadelphia, Pennsylvania (Chapter 10) Luis R. Gomez-Mejia, Ph.D. Professor of Management, W.P. Carey School of Business, Arizona State University, Tempe, Arizona (Chapter 21) David E. Griffith President and CEO, Modern Group Ltd, Bristol, Pennsylvania (Chapter 15) Steven E. Gross Worldwide Partner and Segment Leader, Broad-based Performance and Rewards Segment Leader, Mercer Human Resources Consulting, Philadelphia, Pennsylvania (Chapter 2) Dick Grote President, Grote Consulting Corporation, Dallas, Texas (Chapter 36) Myrna Hellerman Senior Vice President, Sibson Consulting, Chicago, Illinois (Chapter 7) Robert L. Heneman, Ph.D. Professor of Management and Human Resources, Max M. Fisher College of Business, Ohio State University, Columbus, Ohio (Chapter 11) Jeffrey S. Hyman, Esq. Exequity LLP, Wilton, Connecticut (Chapter 25) Bernard Ingster, Ph.D. Consultant, Human Resources Management, Philadelphia, Pennsylvania (Chapter 8) Randy Jayne Managing Partner Global Aerospace, Defense, and Aviation Practice, Heidrick & Struggles, McLean, Virginia (Chapter 26) Blair Jones Managing Principal, Semler Brossy Consulting Group, LLC, Los Angeles, California (Chapter 30) David Knopping Vice President, Radford Surveys & Consulting, An Aon Business, San Francisco, California (Chapter 17) James Kochanski Senior Vice President, Sibson Consulting, Raleigh, North Carolina (Chapter 7) Geoffrey W. Latta Executive Vice President, ORC Worldwide, New York, New York (Chapter 48) Gerald E. Ledford, Jr., Ph.D. President, Ledford Consulting Network, LLC, Redondo Beach, California (Chapter 11) Kathleen M. Lingle Director, Alliance for Work–Life Progress, WorldatWork, Scottsdale, Arizona (Chapter 44) Susan Malanowski Principal, Wilson Group, Inc., Concord, Massachusetts (Chapter 34) Robert L. Masternak President, Masternak & Associates, Medina, Ohio (Chapter 22) CONTRIBUTORS xiii Robert Mattson Product Marketing, Workscape, Marlborough, Massachusetts (Chapter 50) Marvin A. Mazer Senior Vice President, Radford Surveys & Consulting, An Aon Business, Atlanta, Georgia (Chapter 24) Nora McCord Consultant, Steven Hall & Partners, New York, New York (Chapter 32) Steven T. McGuire Manager, Human Resources, GlaxoSmithKline, Philadelphia, Pennsylvania (Chapter 16) Thomas D. McMullen Vice President and Reward Practice Leader, Hay Group, Chicago, Illinois (Chapter 10) Pearl Meyer Senior Managing Director, Steven Hall & Partners, New York, New York (Chapter 32) Leslie Moody Senior Vice President of Human Resources and Administration, Pennsylvania Academy of the Fine Arts, Philadelphia, Pennsylvania (Chapter 14) Jerry M. Newman Distinguished Teaching Professor and Chair Department of Organization and Human Resources, State University of New York at Buffalo, Buffalo, New York (Chapter 47) Paul R. Niven President, The Senalosa Group, Inc., Ramona, California (Chapter 37) Erin C. Packwood Principal, Mercer Human Capital Consulting Group, Houston, Texas (Chapter 18) Johannes M. Pennings, Ph.D. Department of Management, The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania (Chapter 27) Shelley Peterson Senior Associate Broad-based Performance and Rewards, Mercer Human Resources Consulting, Philadelphia, Pennsylvania (Chapter 2) James F. Reda Managing Director, James F. Reda & Associates, LLC, New York, New York (Chapter 35) Deborah Rees Director, Innecto Reward Consulting, Woodborough, UK (Chapter 42) Andrew S. Rosen Vice President, ORC Worldwide, New York, New York (Chapter 6) John A. Rubino President, Rubino Consulting Services, Pound Ridge, New York (Chapter 46) Aino Salimäki Researcher, Helsinki University of Technology, Helsinki, Finland (Chapter 11) Dow Scott, Ph.D. Professor of Human Resources, Loyola University Chicago, Chicago, Illinois (Chapter 23) xiv CONTRIBUTORS Allan Schweyer President and Executive Director, The Human Capital Institute, Quebec, Canada (Chapter 4) Rodger D. Stotz Vice President and Managing Consultant, Maritz, Inc., Fenton, Missouri (Chapter 13) David N. Swinford President, Pearl Meyer & Partners, New York, New York (Chapter 31) David Turetsky Director of Product Management, Workscape, Marlborough, Massachusetts (Chapter 50) Frank P. VanderPloeg, Esq. Partner, Employee Benefits and Executive Compensation, Sonnenschein Nath & Rosenthal, Chicago, Illinois (Chapter 28) Melissa Van Dyke Consultant, Maritz, Inc., Fenton, Missouri (Chapter 13) Theresa M. Welbourne, Ph.D. Adjunct Professor of Executive Education, Ross School of Business, University of Michigan, Ann Arbor, Michigan; President and CEO, eePulse, Inc., Ann Arbor, Michigan (Chapter 21) Fred Whittlesey Principal Consultant, Compensation Venture Group, Inc., Bainbridge Island, Washington (Chapter 40) Thomas B. Wilson President, Wilson Group, Inc., Concord, Massachusetts (Chapters 3 and 34) Martin G. Wolf, Ph.D. President, Management Advisory Services, Inc., Jalisco, Mexico (Chapter 45) Don York Senior Vice President, Radford Consulting & Surveys, An Aon Business, San Jose, California (Chapter 9)  P 1 A R T Introduction Copyright © 2008 by The McGraw-Hill Companies, Inc. Click here for terms of use. This page intentionally left blank  C H 1A P T E R EMPLOYEE PAY: A RIDDLE WRAPPED IN A MYSTERY INSIDE AN ENIGMA Lance A. Berger, Chief Executive Officer Lance A. Berger & Associates, Ltd T O MOST EMPLOYEES WINSTON CHURCHILL could have been describing their pay package instead of Russia when he said that “it was a riddle wrapped in a mystery inside an enigma.” The purpose of this chapter is to solve the riddle by unwrapping the mystery and explaining the enigma. To employees the most recognizable deliverable in a compensation program is their own pay package. It is essential to the organization that this deliverable be transparent. To the practitioner the challenge is to ensure transparency by ratio- nalizing the employee’s pay package as the end result of an unambiguous, disci- plined, and explainable thought process based on a coherent business and human resources strategy. We will explain the enigma (how the pay components are derived) by unwrapping three layers of mystery. 3 Copyright © 2008 by The McGraw-Hill Companies, Inc. Click here for terms of use. 4 THE COMPENSATION HANDBOOK LAYER 1: A WINNING BUSINESS STRATEGY BEGINS WITH A DEFINITION OF STRATEGY A strategy is a risk management program for allocating major resources today where the identified competitive opportunities and returns are in the future. Lance A. Berger & Associates research indicates that a winning business strategy is based on allocating major resources to accomplish the three goals outlined in Figure 1.1. Successful organizations seek to answer the following three questions when they develop action plans to address the three goals. 1. Continuous stakeholder satisfaction: Are the customers, employees, share- holders, suppliers, and vendors satisfied that their own goals have been and will continue to be met? 2. Perpetual competitive advantage: Did the organization stay in the top three of its competitive comparison group over time? 3. Sustained “employer of choice”: Do employees and candidates prefer the organization to others as a place to work? Are turnover rates relatively low? Does the organization have a performance-driven culture? To help an organization answer these questions and achieve these goals, we need to engage in strategic thinking from a human resources perspective. What is strate- gic thinking? Strategic thinking is the application of intuition, creativity, synthesis, FIGURE 1.1 A winning business strategy Continuous stakeholder satisfaction Organizational success Sustained Perpetual “employer of competitive choice” advantage Copyright Lance A. Berger & Associates, Ltd. EMPLOYEE PAY: A RIDDLE WRAPPED IN A MYSTERY INSIDE AN ENIGMA 5 and judgment to design a strategy. In this case we are applying strategic thinking to create a human resources environment that supports the three objectives of a winning business strategy. LAYER 2: THE HR STRATEGY THAT SUPPORTS THE WINNING BUSINESS STRATEGY IS BASED ON THE CREATION OF A WINNING CULTURE Before exploring the elements of a winning culture we must first define the mean- ing of culture. We define culture as the shared knowledge, experience, emotions, beliefs, values, attitudes, meanings, and concepts developed, acquired, and trans- mitted by the people in an organization. Culture determines whether business strategies can and/or will be supported at an employee’s personal risk level and what reward systems will actually work in the culture. In our highly competitive world the only acceptable culture is one that drives business excellence defined by strategic goals. A culture of excellence is one in which people have shared knowl- edge, experience, emotions, beliefs, values, attitudes, meanings, and concepts that contribute to business, group, and personal success now and in the future. Cultural excellence enables an organization to be an “employer of choice,” perpetually achieve competitive advantage, and continuously generate stakeholder satisfac- tion. There are three dimensions and several components of cultural excellence. The three dimensions, expressed as competency clusters, are shown in Figure 1.2. FIGURE 1.2 The three dimensions of cultural excellence Business/ Professional Cultural Excellence Personal Social Copyright Lance A. Berger & Associates, Ltd. 6 THE COMPENSATION HANDBOOK The competencies (organizational and personal success factors) that comprise these clusters are: Business/professional—knowledge-based competencies needed to produce a product or service (technical, functional), customer orientation, and results orientation Social—leadership, interpersonal skills, teamwork, citizenship (ethics and morality) Personal—creativity, communications, and risk tolerance In many organizations culture evolves in a happenstance way largely through a mosaic of unconnected and nonstrategic processes that affect how people are hired, promoted, developed, and terminated. Culture is transmitted through bureaucratic and perfunctory policies, processes, and employee manuals designed to mechanically regulate daily work and employee behaviors. In a highly compet- itive world, however, organizations cannot let culture evolve in a haphazard way. Companies must manage the creation, development, and sustenance of a culture of excellence based on the behaviors associated with competency clusters such as those cited above. It is only when employee behavior is connected to organiza- tional success that its talent pool spawns a culture of excellence. All human resources and compensation strategies must be transparently focused on driving behaviors associated with a culture of organizational excellence. Three talent management strategies drive the culture of excellence. These strategies are shown in Figure 1.3. FIGURE 1.3 Three talent management strategies Superkeepers Strategy Resource Key position allocation back-ups Copyright Lance A. Berger & Associates, Ltd. EMPLOYEE PAY: A RIDDLE WRAPPED IN A MYSTERY INSIDE AN ENIGMA 7 The three talent management strategies are defined as follows: Cultivate a Superkeeper™ pool—the keepers of the flame for the culture of excellence (2–3 percent of the workforce) Enhance incumbents and handcuff strong backups in key/mission critical positions (8–12 percent of positions are critical) Allocate TREADs (training, rewards, education, and development) based on current and future employee contribution (actual and potential achievement) In order to allocate resources in accordance with a talent management strategy such as that outlined above, an organization must be able to classify every member of its workforce based on her actual and potential contribution to success. Our research generated the following employee classifications. 1. Superkeeper™—demonstrates superior accomplishments; inspires others to superior accomplishment; serves as the embodiment of organizational competencies (about 2–3 percent of the workforce) 2. Keeper—exceeds expectations for performance; can lead others; exceeds expectations on organizational competencies (about 20 percent of the workforce) 3. Solid citizen—meets expectations for performance; can work with others; meets expectations on organizational competencies (about 70 percent of the workforce) 4. Misfit—does not meet expectations for performance; does not work well with others; does not reflect institutional competencies (about 7 percent of the workforce) Most successful organizations generate their employees’ classifications based on some combination of three types of assessment. These are: performance, com- petencies (current and future), and potential. Performance. This is a measurement of actual results achieved within those areas for which the employee is held accountable. All individual and group performance measures must be woven into the fabric of organizational success measures in order to connect the employee to institutional achievement. Core/Institutional Competencies. These are behavioral/skill expectations that are crucial to the success of each employee and to the success of the entire orga- nization. Our research has determined that most organizations use between seven and eleven institutional competencies in their assessment process. Typical core competencies can be communications, innovation, critical judgment, customer orientation, interpersonal skills, leadership, teamwork, and technical/functional expertise. 8 THE COMPENSATION HANDBOOK An example of an organization’s competency definition may be: Communication: communicates well both verbally and in writing. Effectively conveys ideas and shares information with others. Listens carefully and understands different points of view. Presents ideas clearly and concisely and understands relevant detail in presented information. Competency definitions can further be differentiated into glossaries of behaviors associated with each level of the organization. This provides amplification, clarity, and greater specificity to the definition. As an example, when considering communications all employees are required to clearly and appropriately express their desires and needs, whereas in addition supervisors are expected to adapt communications to audience requirements to optimize understanding, managers are required to actively present information and ideas to all appropriate levels and lead others to do the same, and individuals in top management are required to promote open expression of ideas and encourage communication without retribu- tion, assuming that they have mastered the behaviors outlined for lower-level employees. Potential. This is a prediction of how many levels (organization or job) an employee can progress through based on their past/current/projected performance appraisals, training and development needs, career preferences, and actual and projected competency levels. Underlying the assessment of potential is the employee’s desire to improve, need to achieve tangible results, probable accep- tance by higher peer levels, self-confidence, and emotional stability. LAYER 3: THE ORGANIZATION’S PAY STRATEGY IS DEVELOPED AND IMPLEMENTED TO SUPPORT ITS TALENT MANAGEMENT STRATEGY BUILT UPON ITS EMPLOYEE CLASSIFICATION SYSTEM In order to transparently deliver pay to each employee, in accordance with the human resources strategy defined above it must first be filtered through a set of principles known as a pay strategy. The five elements that compose a pay strategy are: philosophy, pay/talent market, competitive level, mix, and contribution. The definitions of rules for a pay strategy are discussed below. Compensation Philosophy. Organizations customize their compensation philosophy based on their particular business and human resources requirements. Most commonly, these philosophies focus on delivering pay, based on institutional affordability, in a way that enables them to attract, retain, and reward employee performance in an equitable, competitive, and legal way. To complete the state- ment of philosophy, organizations are now adding the goal of “allocating pay based on business and human resources strategies” such as those described above. EMPLOYEE PAY: A RIDDLE WRAPPED IN A MYSTERY INSIDE AN ENIGMA 9 Pay/Talent Markets. In order to determine the competitiveness of pay associated with a given position, an organization must survey its pay, or talent, market. A pay/talent market consists of incumbents in institutions that have or will provide a source of talent for, or would pirate talent from, an organization. The surveyed compensation for people in benchmark (commonly found) jobs in a chosen talent market should be the basis for establishing pay in an organization. The best surveys are those that accurately measure a pay market derived from sources of recruitment and exit interviews. Positions within a talent market that have no survey counterpart can derive their value from a comparison of relative organiza- tional worth with those jobs that can be surveyed. Note that pay/talent market competitors may not necessarily be in the same business. Competitive Level. Within each pay/talent market and within the organization as a whole, management must determine the competitive level of total human resources costs it can afford to pay to attract, retain, and reward its employees. Competitive level is generally expressed as a percentile in surveys associated with a given pay/talent market (25th, 50th, 75th). The total affordable pot of money is the basis of allocation of pay. It is possible that the characteristics of different pay/talent markets (supply and demand) will necessitate different pay structures and competitive levels. Regardless, individual employees should be paid at com- petitive levels that reflect their own current and projected contribution (value) to the organization. Mix. The percentage of total pay targeted for each pay component (base salary, annual incentives, and long-term incentives) defines its mix. Furthermore, within a total pay package, there may be different competitive levels targeted for base, annual incentives, long-term incentives, and total compensation. The greater the amount of variable or non-base pay, the more leverage (upside opportunity) or risk (non-guaranteed pay) becomes a factor in an employee’s compensation package. In general, the level of risk or leverage decreases in employee pay packages as organizational financial strength evolves from that of a perilous start-up to that of a secure established organization. Within an organization the amount of leverage in a pay package also reflects the risk and accountability associated with a given position. Senior management and line positions typically have more variable pay than staff positions. Figure 1.4 illustrates the typical mix of pay in organizations at different stages of growth. Contribution. This refers to the employee’s classification, based on her assessed current and future organizational value, derived from factors such as those previously defined (performance, competencies, and potential). The final pay package architecture for a single employee is now in place. The employee’s mix and competitive level of pay based on the characteristics of her own talent market and consideration for her personal contribution can now be expressed in 10 THE COMPENSATION HANDBOOK FIGURE 1.4 Pay mix and stage of business growth 80 70 60 50 Base 40 Short Term Incentives 30 Long Term Incentives 20 10 0 Fast Grow Grow No Grow Copyright Lance A. Berger & Associates, Ltd. TABLE 1.1 Application of Employee Classification and Compensation Strategy Employee Pay/Talent Compensation Compensation Classification Market Position Competitive Level Mix SuperkeeperTM Top 3% Accelerate much Strong use of than pay markets long-term incentive devices Keeper Top 20% Accelerate faster than Use of long-term pay markets incentive devices Solid citizen Middle 70% Accelerate at pace Consistent with of pay market pay/talent market categories such as those defined below. In every case there may be an additional pay premium for each employee whose pay category is projected to increase to or remain at a higher contribution level over time. Like the batting averages of baseball players, an employee’s classification must be re-earned each year. Table 1.1 illustrates the application of an individual employee’s contribution level (classification) to an organization’s pay strategy (philosophy, pay/talent market, competitive level, and mix). We now have the answer to the “riddle wrapped in a mystery inside an enigma.”  C H 2A P T E R TOTAL REWARDS AND THE FUTURE WORKFORCE Steven E. Gross, Worldwide Partner and Segment Leader, and Shelley Peterson, Senior Associate Broad-based Performance and Rewards Mercer Human Resources Consulting A LTHOUGH THE CONCEPT OF COMPENSATION has changed a great deal in recent decades—moving from a traditional base pay and bonus structure to a broader “Total Rewards” approach—its evolution is hardly complete. The years to come will see continued change in market and workforce dynamics. A new employment model is evolv- ing, as organizations face pressure to perform domestically and globally in a tight- ening labor market while balancing cultural and generational differences in employee wants and needs along with long-term sustainability of employment costs. Adapting to a new model requires the creation of alternative employment arrangements that recognize the role of flexible work plans, contingent staff, and nonlinear careers. Optimizing the new model requires Total Rewards strategies to be changed, or finite resources to be strategically allocated across unique work- force segments with holistic yet customized approaches. 11 Copyright © 2008 by The McGraw-Hill Companies, Inc. Click here for terms of use. 12 THE COMPENSATION HANDBOOK THE NEW EMPLOYMENT MODEL The evolving employment model is driven not by one dominant perspective, as in the past—a perspective typically founded on the employer’s capacity to draw from a deep labor pool and rely on long-tenured workers happy to have jobs—but by multiple perspectives. Now, the employer perspective recognizes an emerging shortage of labor skills, knowledge, and experience (in part driven by the aging of the baby boomer population in mature economies) in a less company-loyal, more geographically mobile workforce. The employee perspective is marked by changing cultural and generational attitudes, needs, and wants when it comes to work. The cost perspective is that of increasing employment costs and their sustainability—driven largely by the ever-inflating cost of health care (primarily) and other benefits, along with the competitive cost of paying for skilled talent in a tightening global job market. Though operating in an increasingly global marketplace, employers are often recruiting from a smaller qualified workforce, as statistics show that the level and quantity of technical education is not keeping pace with demand. At the same time, the loss of experienced workers to retirement—a phenomenon that will only accelerate as the baby boom generation moves out of the workforce en masse in the coming years—results in a loss of institutional knowledge that cannot easily be replaced simply by adding new hires. Not only do less-experienced workers need more on-the-job training, forcing organizations to invest more energy and resources, but today’s and tomorrow’s employees question a one-company career. In the United States, for example, median years of tenure with current employer is 1.7 years less across age groups in 2006 versus 1996 (U.S. Bureau of Labor Statistics), reflecting the general decline of historical lifetime-employment and job-security covenants. Human resource professionals around the world consis- tently and repeatedly cite attracting and retaining talent as the number one rewards challenge (Mercer’s 2006 global snapshot survey, Measuring the Return on Total Rewards). Labor dynamics suggest that employers will continue to face the daunt- ing task of engaging a diverse new workforce so that it joins, grows its own insti- tutional knowledge, and stays with the organization. Myriad employee perspectives of this diverse workforce are illustrated in Mercer’s 2006 What’s Working global employee survey of workers’ perceptions and attitudes toward their organizations. When asked to rank the factors that influ- ence their commitment and motivation at work, survey participants in North America, Asia, and Western Europe put “Being treated with respect,” “The type of work that you do,” and “work/life balance” among the top three (only Asian participants cited “base pay” as the primary factor). But the cultural context of employee perspectives often varies. “Being treated with respect” may mean promotion and rewards based on performance in one country or seniority in another. Different generations also have different priorities. The traditionalist, 60- plus generation values security and company loyalty, and wants its expertise and TOTAL REWARDS AND THE FUTURE WORKFORCE 13 experience to be recognized; hard-working baby boomers (ages 43–60) want their hard work to be valued; Generation X (ages 30–42) seeks work/life balance and wants the company to value its contributions; while the so-called millennials (ages 18–29), a technology-savvy generation that values work/life balance and changes jobs most frequently, want to value their own contributions, living and working with a strong sense of purpose outside a specific company’s value system. Balancing the attitudes, wants, and needs of a diverse employee population adds complexity and cost to workforce management. In fact, assessing the sustainability of current costs for employers points disturbingly to the escalating price of providing Total Rewards. Suppose an orga- nization’s total cost of pay and benefits equaled 60 percent of revenue in 2007, with a projected annual 2 percent growth in employee headcount and 5 percent growth in revenue. At the same, the annual cost of pay and benefits is increasing at 3.5 and 12 percent, respectively. In 2012, five years later, the total cost of pay and benefits would equal 67 percent of revenue. This realistic estimate points to the very real risk that employment costs pose to an organization’s sustained finan- cial success. Adding to the cost dilemma is the fact that for most businesses— especially those operating in a global context—workforce requirements vary over time and location. For example, the traditional model of permanent, full-time employees is not flexible or cost-efficient in addressing periods of under-capacity or over-capacity of staff. Cost and flexibility pressures, changing employee demands, and the chal- lenges employers face in attracting, engaging, and motivating talent are the realities of the new employment model that promote the growth of alternative employment arrangements. ALTERNATIVE EMPLOYMENT ARRANGEMENTS The workforce of the future demands a suite of employment arrangements that meet employer, employee, and cost concerns. Traditional, long-term, permanent, full-time positions will always have a role in delivering organizational success. But employers and employees will see an expanded range of work arrangements, from long-term to contingent. Long-term employment is typically traditional permanent full-time or part-time work. The visible shift in long-term arrangements is the increasing demand for flexible work plans. Contingent employment is a more varied mix of nonlinear, multicompany work experiences, including short-term employment that may be structured as temporary/full-time or part-time; temporary-to-hire; specific project employment structured as temporary/full-time or part-time; and contractor arrangements, including consultants and the self- employed. Including contingent workers in an organization’s staffing model allows it to optimize the number and cost of permanent headcount while adding resources as required to meet fluctuating capacity demands (see Figure 2.1). 14 THE COMPENSATION HANDBOOK FIGURE 2.1 Fluctuating capacity requirements Under Under Capacity Capability Traditional Staffing Model Over Capacity Alternative Staffing Model Long-term employment with flexible work options can include flexitime, telecommuting, job sharing, compressed work weeks, sabbaticals, and generally a greater level of employee autonomy in scheduling and delivering work. Growth of flexible work plans speaks to what employees want and need and how employers are rising to the challenge. Surveys on workplace policies and practices con- ducted by Mercer over the years reveal some material changes—for example, only about 30 percent of surveyed companies had telecommuting arrangements in 1999, but by the 2006 survey, more than 65 percent had telecommuting arrange- ments for professional staff. The prevalence of flexitime arrangements grew from less than 60 percent in 1990 to more than 90 percent of survey respondents in 2006. A 2005 National Study of Employers conducted by the Families and Work Institute showed that more than 20 percent of workplaces had employees who moved from full-time to part-time status and back to full-time, along with rising numbers of phased-retirement and temporary workers. Taking “flexible” one step further, the growth of temporary/contingent labor is expected to outpace total employment growth over the next decade, according to the most recent Temporary Jobs Guidebook: Niche Market Opportunities for Staffing Firms (2007, Staffing Industry Analysts Inc.). While total employment is expected to grow by 1.2 percent, the contingent workforce is expected to triple that, at 3.8 percent. Shifting employment patterns are further underscored by the growth of one-person businesses, which increased by more than one million in the U.S. between 2002 and 2003. As a result, the contingent-workforce phenomenon will modify such tradi- tional patterns as those seen in Figure 2.2 in career paths, where long-term career growth is predicated on a typically linear progression from job A to jobs B, C, and ultimately D. Contingent-workforce careers tend to move nonlinearly from job A to modified work arrangements (lateral jobs B1, and then B2, for example) before acceding to next-level jobs C or D. Ultimately, organizations will have to recognize and respond to different views of career paths—that of permanent, TOTAL REWARDS AND THE FUTURE WORKFORCE 15 FIGURE 2.2 Linear and nonlinear career paths Long Term Careers Contingent Careers D D C C B2 B1 B A A long-term workers who see a career path within the firm and contingent workers who see a career path moving from firm-to-firm. Increasing demands for alternative employment arrangements such as flexible work plans and contingent staff along with the changing view of “career path” require organizations to re-think workforce management for the future. WORKFORCE SEGMENTATION Clearly, in this one-size-doesn’t-fit-all employment universe, businesses require a strategic solution to managing the workforce, one that encompasses the realities of generations and geographies, emerging nontraditional staffing models and pres- sure to produce return on human capital investments. That strategy begins with the identification of unique workforce segments. There are four important aspects of segmentation to consider: Business life cycle—a company’s position on the business life cycle curve; whether it is experiencing rapid, moderate or declining growth. A young start-up will have different characteristics than a mature firm in a flat market. Business design—a company’s business model; how the entity is organized and types of competencies required to create value. There may be one overall design or different emphases for units or divisions within the company. Geography—a company’s geographic breadth and complexity as well as its need for cross-border interconnectedness and mobility. Brand reputation—the extent to which a company’s brand is an asset or liability in attracting and retaining both customers and employees. 16 THE COMPENSATION HANDBOOK Once the portfolio of workforce segments is identified, it is important to assess the contribution each segment makes to organization success. Segments may include: Performance drivers—segments that create value for the organization, such as marketing in consumer products companies, research scientists in pharmaceutical organizations, or China operations in a globally expanding manufacturing firm Performance enablers—segments that support value creation, such as staff (HR, IT, accounting, etc.), and workers who play an important role in facili- tating the efficiency of performance drivers Legacy drivers—segments (skill sets) that historically created value for the organization but no longer drive competitive advantage, e.g., production and circulation functions in a media organization may become legacy drivers as content is increasingly delivered online. It is critical to emphasize that different job families, geographies, and skills sets are not universally categorized as performance drivers, performance enablers, or legacy drivers, since their role in value creation depends on organization and even business-unit profit models. A good example would be a single group of information technology (IT) professionals that might play a different role in value creation for different organizations. How? To a buyer of IT outsourcing services that relies on IT to support its operations, those IT professionals function as performance enablers, but to the IT outsourcing vendor that sells their services, they are performance drivers. In other words, workforce segmentation requires an organization-specific view of value creation. The rewards challenge for each workforce segment is often different. For per- formance drivers, the value proposition must succeed in attracting, engaging, and retaining these value-creators through an optimal mix of base pay, incentive com- pensation, benefits, and career-development offerings. For performance enablers, the rewards mix must ensure that these workers continue to effectively support the business. And for legacy drivers, appropriate rewards depend on the value of retaining their institutional knowledge. Complex organizations are complex compilations of workforce segments. If an organization does not rigorously identify and qualify its workforce populations, it cannot act on differences in relative value-contribution or design programs that reflect varying workforce needs and performance goals. Workforce segmentation is required to ensure Total Rewards resources can be strategically, intentionally allocated across the organization to promote the greatest opportunity for success. TOTAL REWARDS STRATEGY Strategic allocation of Total Rewards means taking both a holistic (recognizing all the tools in a rewards toolkit) and customized (using the right tool for the right job) approach. TOTAL REWARDS AND THE FUTURE WORKFORCE 17 Considerable strides have been made in shifting both employee and employer focus from disparate pay components to a holistic Total Rewards approach that encompasses: Compensation, which includes base pay, short-term and long-term incentives, and recognition awards Benefits, comprising health and other group benefits, retirement plans, work/life programs, and perquisites and Careers, including training and development, stretch assignments, and other career opportunities, and formal career and succession planning According to Mercer’s 2006 global snapshot survey, Measuring the Return on Total Rewards, this paradigm shift has occurred globally, with approximately two- thirds of companies in Asia, Europe, and North America now taking a compre- hensive view of rewards as a blend of compensation, benefits, careers, and other intrinsic factors (such as working conditions). In a competitive and cost-conscious environment, employers know they must utilize and communicate the value of the full rewards package provided. But a universal holistic approach can (see Figure 2.3) lead to over-rewarding or under-rewarding specific workforce segments—or, worse, inappropriately rewarding all segments. Strategic Total Rewards means THAT organizations must make tactical decisions in customizing programs for unique workforce segments. A good example is the case of the global energy company which identified multiple business models: in one, profit is generated through a premium, long-term position in global exploration; and in another, profit is generated through low-margin, intensely competitive, local retail market share transactions. This organization needed to distinguish two workforce segments and build tailored Total Rewards approaches. One design, relating to the firm’s global FIGURE 2.3 Regional, total rewards data Pay, benefits, careers, 40% 43% More than 2/3 of intrinsic factors 55% organizations adopt a holistic approach to defining rewards Pay, 26% 22% benefits, 12% careers Pay, 24% 30% 29% benefits Pay only 9% 5% 5% US & Canada Europe APAC Source: Mercer’s 2006 Snapshot Surveys “Measuring the Return on Total Rewards” (APAC, Europe, US & Canada) 18 THE COMPENSATION HANDBOOK organization, involved paying above-market salaries for “hot” skills; building talent from within the organization through a Total Rewards program that emphasized career-based rewards, nondifferentiated, corporate performance awards, and a focus on learning and development; and centralized decision making. The other approach, keyed to the local, retail end of the business, involved paying market price for talent (and “buying” it on the open market rather than “building” it from within the orga- nization); spot rewards and differentiated performance awards; less emphasis on learning and development; and entrepreneurial decision making. While this may seem like a mix-and-match, one-from-column-A, two-from-column-C approach to Total Rewards, it reflects the need for a holistic yet customized Total Rewards strat- egy that aligns with different business models. Segmentation helps organizations understand where customization of Total Rewards will drive business performance, but organizations cannot forget that in the new employment reality there are likely to be multiple work arrangements across or even within workforce segments. This dimension further refines how and where a company should target its rewards spending to attract, engage, and retain diverse employee populations. All the elements of Total Rewards play a role. The question is where to place the greatest emphasis. Long-term, permanent perfor- mance drivers, for example, should be engaged by career opportunity, offered through access to quality training and development, leading edge projects, inter- national assignments, etc. Contrast that with long-term, permanent legacy drivers. Unfortunately, these employees operate in an area of business that is no longer a growth engine or source of competitive advantage. The organization should not invest in career opportunity or promote career opportunity as a means of motivat- ing or retaining these employees. Emphasis on short-term incentives which reap the remaining benefits of legacy market share or transferred institutional knowl- edge is a better and more realistic allocation of funds. For contingent workers, current cash is often the driving factor. This is particularly true for traditionalist or baby boomer employees that may consider cash the primary reason to remain in the workforce as they may be unable to retire in the lifestyle they desire. Contingent Generation X and millennials may be more forward-looking. For per- formance drivers in this group, the opportunity for potential full-time employment holds significant appeal (see Figure 2.4). Addressing alternative employment arrangements and unique workforce segments requires significantly more sophisticated Total Rewards strategies than those of the past. However, effectively defining strategy is not the only hurdle. Initial and ongoing execution presents challenges as well. CHALLENGES OF STRATEGIC TOTAL REWARDS Executing strategic, customized Total Rewards means coming to grips with insti- tutional attitudes and operations that need to change—and change again. One of TOTAL REWARDS AND THE FUTURE WORKFORCE 19 FIGURE 2.4 Rewards offers by work arrangement and workforce segment Performance Performance Legacy drivers enablers drivers Employment Arrangement Permanent Contingent Permanent Short-term Career Base pay incentives Long-term Alternative work Benefits Alternative work arrangements arrangements Traditionalists Cash Cash Cash Baby boomers Benefits Benefits Contingent Cash Generation X Potential Short-term Millennials full-time incentives employment the most widespread struggles is addressing organizational views of equity and fairness. By definition, segmented, differentiated Total Rewards programs treat people differently—some perhaps better than others. And though organizations often vary rewards in response to market pressures, skill shortages, and so on, a strategy of explicit differentiation-based employment arrangement and/or value creation is a difficult approach for organizations to adopt and communicate. When an organization seeks change, it may be a difficult undertaking. Systems, processes, and people must adapt; compensation management systems may need to accommodate multiple base pay and incentive programs, compensation, training and development, recruiting may need to make trade-offs across historically silo budgets, and managers will need to handle more challenging conversations about an individual’s compensation, benefits, and career. Once an organization has changed, it must be prepared to change again. Business strategies continuously evolve. If Total Rewards strategy does not keep pace, costly misalignments can occur, hindering business progress and diminishing return on investment. Overcoming these challenges requires leadership support, pragmatic segmentation (recognizing meaningful differences in workforce segments), and comprehensive implementation and communication change management with an eye on both today’s and tomorrow’s change. SUMMARY The workforce of the future is taking shape now, as the new employment model continues to evolve to address changing employer, employee, and cost dynamics. 20 THE COMPENSATION HANDBOOK More and more, today’s and tomorrow’s employees will be re-thinking traditional employment arrangements and taking a nonlinear, multicompany, individually driven attitude towards career success. Organizations need to take steps to better understand their workforce—the cultural and generational differences of the people they employ, the emerging alternative work arrangements they demand, and the relative value creation of unique workforce segments in the business models they advance—and strategically design and invest in holistic and customized Total Rewards programs for that workforce. These differentiated strategies recognize the role of each Total Rewards component but emphasize the element that best meets employer and employee needs for various combinations of employment arrangements and workforce seg- ments. It is a challenging task that requires organizations to think differently about the definition of fairness and strategic Total Rewards in order to create sustainable employment costs while driving performance now and engaging the workforce of the future.  C H 3A P T E R TOTAL REWARDS STRATEGY Thomas B. Wilson, President Wilson Group, Inc. E VERY ORGANIZATION WANTS TO ATTRACT, retain, and moti- vate employees. Many think that this is the primary purpose of the total compensation and reward programs. These companies then define their compensation strategy as being at “X” percentile in their industry, with the belief that this will enable them to attract and retain desired talent; motivation is achieved by the belief that their “pay-for-performance” program works. It would be interesting to determine if other systems within the organiza- tion are viewed in such a simple manner. Recent changes in the regulations for disclosure of executive compensation require public companies to describe their compensation philosophy in detail. In the past, boards of directors (and executives as well) would use boilerplate state- ments to describe their programs in general, vague terms that provided little insight for the reader. This change in regulation has many compensation commit- tees, boards, executive managers and human resource directors looking for verbiage that does not require them to invest too much effort or divulge too much information. Some companies are using this situation to examine their fundamen- tal philosophy and requirements, while others are missing a critical opportunity. While one can appreciate the need to keep specific compensation information confidential, the inability to define the firm’s basic philosophy in meaningful and 21 Copyright © 2008 by The McGraw-Hill Companies, Inc. Click here for terms of use. 22 THE COMPENSATION HANDBOOK substantial ways often leads to haphazard decisions and undermines the confi- dence of shareholders and employees alike. Consider. What would happen if your marketing department presented to exec- utive management a strategy that positioned a new key product to be the same as your competitors—in the price, features, and value proposition? How would your executives respond? Then, why does a company seek to make their compensation and reward programs “the same” as other firms in the market? Is it better for your compensation programs to conform to the market or be distinctive? Why should someone come to work for your company, remain with your company, or buy your company’s products, services or stock? What is different about your organization that would compel one to work for your company? Furthermore, how much money does your organization spend on compensation? What is compensation as a percentage of revenues or operating income? Does the company apply the same level of strategic and operational thought to expenditures for compensation as it does to other major expenditures or investments? When an organization spends (or invests) its dollars, it should know what it is paying for and seek to maximize the “value” from these expenditures. Addressing these issues is the value a reward strategy provides to an organization. PURPOSE OF A TOTAL REWARD STRATEGY To understand what a Total Reward strategy is, let us start with a definition. “Total Rewards” are those policies, programs, and practices that provide employees of a company (or organization) with something of value in return for their contribu- tions to the mission and goals of the organization. These can include salary and variable cash compensation programs, employee benefits and services, stock options and other equity awards, and special recognition, promotions, etc. Therefore, the purpose of a Total Rewards strategy is to provide the objectives, guidelines, and principles necessary to design and operate the company’s reward programs consistent with its core requirements. Fundamentally, this means that the reward strategy should: Reinforce the core mission, values, and critical success factors of the company in terms that reflect the role of reward programs and practices Define what are (or will be) the key elements that will create a strong competitive advantage for the company in the marketplace for talent Provide sufficient clarity and guidance to key decision makers so they can assess the effectiveness of current programs and practices, and determine what actions are needed to improve their effectiveness Answer “why” a particular program is designed or functions in a particular manner TOTAL REWARDS STRATEGY 23 We have found that, while the words may appear similar from one organiza- tion to another, the real value is the meaning the reward strategy has to the members of the organization. The words become reality when they are effectively translated into action through policies, programs (or systems) and practices. The result is simple—an effective framework to allocate resources and create strong capabilities to influence desired behaviors (i.e., performance) of people. KEY ELEMENTS OF THE TOTAL REWARD STRATEGY Developing a reward strategy that meets these requirements is a real challenge for many organizations. An increasing number of companies realize that their performance is truly based on the talents and actions of their people, and that these programs in fact exert significant influence on behaviors by the messages they send, the opportunities they provide, and the needs they meet for the workforce. An organization’s culture is not shaped by its stated values and communication, but by what and how actions are encouraged, rewarded, and punished. A reward strategy translates a company’s strategy and core values into policies, programs, and practices that directly influence the performance of people. The reward strategy statement needs to include these elements: 1. Establish the context for the total reward philosophy, especially if the organization is facing particular challenges or has implemented a fundamental change in the way programs have been managed in the past 2. Provide a unifying statement of philosophy (or principles) that connects reward programs to the core mission, strategy, and values of the organization 3. Express the importance of these programs to the company’s ability to attract and retain people, as well as develop talent and reward desired performance 4. Define the primary programs and their basic purpose or focus, including base salaries, variable cash compensation and equity participation, employee benefits and services, and workplace opportunities for development, careers and recognition, etc. 5. Identify the primary drivers of these programs—the competition for talent, corporate/unit/individual performance, the infrastructure to make sound decisions, desired types of behaviors and support for strategic change A Total Reward strategy is therefore a statement that sets the stage for specific policies and programs, and defines the requirements and impact desired from them. Here is an example: IBM has significantly reoriented its reward strategy, focusing more of its com- pensation investment on programs that recognize results than on those that reflect only tenure. Today, IBM’s overall compensation strategy is designed to deliver market-based, performance driven pay in all segments of our business portfolio, and to reward appropriately our highest contributors. We do this through a 24 THE COMPENSATION HANDBOOK combination of base salaries and variable performance-driven bonuses. Our goal is nothing less than to sustain and renew the highest performing, most cost effective culture in business. To do that, we seek to hire, measure and reward the individuals who create that culture every day.1 DETERMINE THE RIGHT REWARD STRATEGY Carl Sagan once said that, in order to make an apple pie, we must first create the universe. Without going into this level of design, the reward strategy is fundamen- tally based on the strategic and organizational requirements the organization has for its people. This process involves addressing four primary areas. As these are under- stood, the task of developing a reward strategy that makes sense and is effective for the organization becomes significantly easier. These areas are shown in Figure 3.1. Define the Organization’s Philosophy To develop the total rewards strategy, the first stage is to understand the organiza- tion’s business model, vision, and strategy as well as its critical success factors. One needs to know the leadership philosophy, values, and desired culture, whether or not it is written into a formal document. The following questions may be helpful in defining this philosophy: Is the organization focused on broad markets or specific niches or market segments? Is the core competence of the company stronger in creating innovative solutions to meet customer’s needs or in providing low-cost, efficient services to customers? Is growth achieved through organic, market expansion or through acquisitions, joint ventures, and business networks? FIGURE 3.1 Defining the Total Reward strategy Organizational Strategy, Value & Leadership Philosophy Purpose and Organization Design Specifications for Principles and Reward Programs Structure Key Employee Groups and Their Requirements TOTAL REWARDS STRATEGY 25 Do the firm’s leaders have a particular philosophy, values, and operating principles by which they lead the organization, and seek to create its position in the marketplace? Is the organization facing pressures to adapt to changing market conditions or transform itself into a different business model or marketing strategy? Examine the Organizational Structure plus its Guiding Principles The response to these questions provides the context and frames the challenges facing the organization from both a talent management and performance perspec- tive. This information should provide insights on why the organization is struc- tured and operates as it does, as well as the types of rewards that will be most effective in supporting the long-term strategy of the organization. The next stage is to articulate how the firm is organized to implement the strat- egy and operate within the constructs of the firm’s values and leadership philosophy. This goes beyond examining the structure of the organization (i.e., who reports to whom), and identifies the guiding principles by which the organization functions. Questions that may be important to understand this stage are: Is the company organized around markets (i.e., geographic, industry, or customers), functions (i.e., sales, operations, engineering, etc.) or independent business units? Why? Does the culture of the organization emphasize collaboration and teamwork or individual initiative and accountability? Does it emphasize short-term, concrete results or long-term development? Does it foster transactions or long-term relationships? How and why? Are decisions made in a highly centralized, well-controlled manner, in a highly decentralized, entrepreneurial manner, or in a cross-functional, collab- orative manner? Are there differences in how specific types of decisions are made (e.g., financial, operational, customer, capital investment, etc.)? Why? This information is important to forming a reward strategy because it defines how much flexibility various reward programs will foster as well as the process for making decisions related to goal setting, performance assessments, staffing levels, and hiring agreements. Determine Employee Groups with Unique Reward Requirements The third stage is then to define the groups of employees where reward policies or programs should be distinct or specifically tailored to unique requirements. These groups may be by business unit, function (e.g., sales, engineering, manufacturing, corporate services), level (e.g., executives, senior management, managers and supervisors, professional and technical contributors, administrative and operational 26 THE COMPENSATION HANDBOOK employees), or where “special attention” is needed (e.g., high potentials, key contributors, technical/product specialists, diversity groups, recent acquisition). By identifying specific groups of employees and understanding what they may want or need as well as what the organization needs from them, the reward strategy becomes more pragmatic and grounded in the realities of the organization. Create Specific Reward Policies The next stage is to identify the specific reward policies, programs (or systems) and practices the organization will employ to achieve short- and long-term require- ments. While this can be defined for specific groups (based on the previous stage), it can also be framed for the entire organization. We have found that it is useful to categorize reward programs according to dimensions that reflect their inherent function and impact. To be more specific, there are reward programs that are: Available to virtually everyone because they are employed by the organiza- tion (or for a specific level or group within the organization). These programs provide a foundation for the employment relationship. Based on performance or meeting other requirements of individuals or groups to which they belong. In these types of programs not everyone receives these rewards, and the amount depends on many factors related to the design of the specifications of the particular policy or program. Furthermore, there are programs that are: clearly compensation based (e.g., salaries, variable cash compensation, equity based plans, etc.), and meet the personal needs of individuals (e.g., employee benefits, services, recognition award programs, promotions, career opportunities, training and development, etc.). These two sets of dimensions provide a simple framework for understanding and organizing reward programs according to their primary function or inherent purpose. Figure 3.2 shows this framework and illustrates the types of reward programs that correspond to these dimensions.2 As the organization conducts its own “inventory” of reward programs using this framework, it creates a portfolio of rewards that can be analyzed and refined to specific employee groups. People within an organization often have different needs and values; this “portfolio approach” enables the organization to target specific programs to address the unique needs and expectations of population segments within their organization, similar to how a company targets products and services to specific market segments. Using this framework, the organization can develop a strategy that is consistent with its strategic objectives and the requirements it has for key groups within the organization. TOTAL REWARDS STRATEGY 27 FIGURE 3.2 Compensation strategy and performance reward programs Foundation Programs: Performance Rewards: SALARY & CASH & EQUITY BASED WAGES VARIABLE PAY Job or market based pay Individual variable pay Total Compensation Competency based pay Team/unit variable pay Salary ranges/Broad bands Company profit sharing Career path based pay Stock options/restricted Geographic differentials Long-term cash or Merit/Market increases phantom share plans EMPLOYEE BENEFITS DEVELOPMENT & & SERVICES RECOGNITION Health and life insurance Public/private recognition Workplace Retirement and investment Verbal/informal recognition Opportunities Disability and long-term care Personal item rewards Training and education Special award bonuses ($) Company events/parties Promotions Employee discounts/services Professional development Develop the Reward Strategy Once the organization has identified its formal and primary informal reward pro- grams and practices, the final stage is to address several important questions to develop the reward strategy. 1. What current programs is the organization primarily using? Which ones are most important to the overall organization and why? 2. How competitive are these programs in the external marketplace for talent? Where does the company need to lead or be distinctive in the market and where does it need to follow or meet basic levels? Why? 3. Which of these programs are the most important to specific groups of employees and why? 4. Where (among the types of programs or services) does the organization spend the most money? Where does it spend the most time and effort, and why? 5. Which of these programs are the most and least effective in supporting the mission, strategy and culture of the organization? Why? Based on this information and insights, the company can develop a strategi- cally based Total Rewards framework that is consistent with its core mission, 28 THE COMPENSATION HANDBOOK business, and strategy. The statement of requirements for each program (or type of program) should include the following elements: The purpose and key objectives of the specific reward program The most important requirements for these programs to be successful The marketplace and desired position the program needs to achieve in order to be meaningful to the relevant individuals How these programs will directly support the needs of the organization and the individual. These strategy statements not only define the purpose and requirements for specific programs, they reinforce the universal principles necessary for achieving alignment with a firm’s core strategy and leadership philosophy. Therefore, the corporate philosophy captures the primary themes that are important to the entire enterprise, while the reward strategy defines the requirements for key programs. The effective implementation of its policies, programs, and practices will significantly strengthen the firm’s competitive advantage and market leadership. Consider another example from a rapidly growing medical devices company: The purpose of our total reward programs and practices is to provide the com- pany with strong competitive advantages to attract, retain and effectively utilize the talent we need to achieve sustained market leadership. The primary principles for all our reward programs are to: Strengthen our ability to drive desired business results Support the growth of our business globally Expand the capabilities of our people, from both attraction of new talent and developing current talent, to sustain high performance Make effective decisions in utilize our people and our resources to the bene- fit of the company, the people we employ and the people we serve. This company went on to define the primary purpose of each category of rewards as follows: Base Pay Programs: They provide the structure and pay guidelines for the company to attract, retain and reinforce the development of personal capabili- ties. The pay structure will enable us to be competitive with the median of our key market, both globally and locally, where the grade level reflects one’s job scope and responsibilities and the pay range reflects the external market for talent. Pay increases are based on both the growth of responsibilities and competencies and the demonstration of these practices in what and how results are achieved. TOTAL REWARDS STRATEGY 29 Variable Pay Programs: We will utilize a weighted blend of individual, team and key business unit goals to provide clear performance expectations, encourage achievement and reward results. Our cash-based variable pay will focus on those results that provide critical contributions to and achievement of key annual business objectives tied to the corporation’s overall objectives; our equity-based awards will reward those who make significant contribu- tions to results that build the long-term value of the corporation—to our shareholders and our customers. Employee Benefits and Services: These are a variety of programs, services and opportunities for individuals that provide needed security to one’s per- sonal obligations and ability to receive highly valued benefits at a lower cost because of our combined participation. Because we as a company value our differences, individuals will have the greatest flexibility possible in selecting those that are most meaningful and important to oneself and