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CHAPTER 10: COMPENSATION AND BENEFIT LEVEL STRATEGIES Overview:Pay tactics of low-wage and high-wage organizations.“How much do we have to pay in order to attract more machinists for the new project?” “The policy of this company is to be 10 percent above the market. You make sure that we are!”“But this survey in our professional journal indicates that we are 15 percent below the market. How can you say we are paying market rates?”“Boy, this pay raise isn't even up to rise in the cost of living!”“With whom should we compete for workers?”“Do we need the best workers, or can we get along with average ones?”All these questions and comments have to do with how the compensation practices, levels, and strategies of an organization are decided. The compensation and benefit level is the average compensation paid to employees. This has two implications. The first is external: how does the organization compare with other organizations? This question is a strategic one of how the organization wishes to position itself in the marketplace. The second implication is internal. The average compensation is a reflection of the total compensation bill of the organization. Labor is one of the claimants on organizational resources. The size of the compensation and benefits bill is a reflection of who gets what within the organization.The decision on compensation levels (how much will the organization pay?) may be the most important pay decision the organization makes. A potential employee's acceptance usually turns on this decision, and a large segment of the employer's costs are determined by it.ORGANIZATION COMPENSATION DECISIONSCompensation decisions are typically micro (individual) or macro (total organization) focused. Although organizations are under no constraint to separate these decisions, a course of study should. In practice, most unsophisticated organizations make the decision on compensation level (how much to pay) and compensation structure (relationships to competitors) at the same time. More administratively advanced organizations realize that individual decisions within a proper administrative structure are more consistent, fair, and cost-effective over time.The compensation level decision may be considered the most important one for individuals. In terms of both employee attraction and cost considerations, it is often considered by most managers as a primary consideration. Also, it seems essential to recognize that compensation level decisions can never be completely separate from job-mix, hiring standards, personal decisions, and internal labor markets/relationships. For these reasons, compensation level decisions are typically the focus of a managers attention. From the organizations perspective, however, one individuals compensation decision typically goes unnoticed at the end of the year. Structure decisions (and the level of those structures) are what show up on an income statement.The term compensation level simply means the average compensation paid to workers at some level of analysis, e.g. the job, the department, the employing organization, an industry, or the economy. The importance of the compensation level decision to organizations rests on its influence in getting and perhaps keeping the desired quantity and quality of employees. If the compensation level is too low, the applicant pool may dry up and recruitment efforts may meet with little success. Equally serious, some employees (often the best ones) may leave. At the extreme, the organization may experience difficulties with state and federal regulatory bodies administering minimum compensation laws and prevailing wage laws. Also, the organization may be confronted with concerted organizing drives if no union is present, or pressing compensation demands from existing unions. It is less apparent, but equally real, that a low compensation level may attract only less efficient workers, with the result that labor costs per unit of output rise.If, on the other hand, the compensation level is too high, equally undesirable results are likely. The competitive position of the organization may suffer. Turnover rates may drop below some desirable minimum so that the organization tends toward inflexibility or stagnation. Also, if compensation and salary levels are too high during periods of compensation controls by federal authorities, trouble may be forthcoming from these officials. Frequently, compensation and benefit level decisions are hidden in the type and structure of benefit, fringe, and retirement plans.Changes in compensation levels have the most drastic effects on total payroll. Of course, other compensation decisions have payroll effects, but usually not nearly as great. Substantial sums of money can be involved, and for this reason alone an organization must pay close attention to compensation levels (both competitively and internally).Nor are employees and their representatives any less concerned with compensation level decisions. It is here that the absolute amount of the compensation or salary rate is determined. Also, it is here that unions exert their major effect, and here that member loyalty is built or lost.Finally, consumers and the general public have major interests in compensation level decisions, the consumer because wages are a major element in prices, and the general public because wages and salaries represent the major portion of national income. Also, too frequent or too drastic changes in compensation levels affect the health of our economy.STRATEGIC COMPENSATION LEVEL DECISIONSMost employees are aware that some employers pay more than others for the same type of skill in the same market.1 The actual cost to employers of employee service is total hourly compensation plus benefits.Unfortunately, labor cost per unit is not information that is easily obtained by employers. It must be estimated from in-house information on the average productivity of employee groups and organization units and from the average pay of these groups.The information available on what other employers pay comes only as a result of search. This search takes the form of compensation surveys conducted or purchased by the organization. These surveys invariably show a range of compensation paid for the same job by different employers. This range tends to be narrower for the skilled occupations and wider for the semiskilled. One reason for this is the difficulty of job comparisons. Another is difference in employee quality. But these differences are never as wide as compensation differences.The major reason for finding out what others are paying for jobs is to decide how to position your organization in relation to others and the labor market.High-Compensation EmployersHigh-pay organizations tend to share a number of characteristics: larger size, higher profits, a lower ratio of labor costs to total cost, few industry competitors, and unionization. Larger organizations tend to pay higher wages and benefits for a number of reasons. One is that they usually are able to. Large organizations often tend to have some financial surplus, which they can use in various ways. Another reason is that they may be willing to pay more to attract a pool of competent applicants. Still another may be a perceived obligation to counter lower job satisfaction. Finally, those large organizations that are not unionized are continuing targets of union organizers.In addition, higher-profit organizations are better able and perhaps more willing to pay. A lower ratio of labor costs to other costs may mean that high wages are a less significant cost item. As a consequence, organizations with such a ratio can pay high wages in the hopes of forestalling labor problems and devote their attention to high-cost items.Few industry competitors may mean that the organization faces an inelastic demand for its product or service, so that it can pass on cost pressures as price increases without reducing sales. Also, especially under union conditions, the few competitors may tend to pay equal compensation rates to "take labor out of competition."2Because of their policy of the "standard rate," unions try to equalize wages in the same product market. Unions dont necessarily do this for business purposes and the goals that drive a profit-oriented business. Often union policies are based upon equity considerations as well as practical ones.Note that all of these reasons, except for size, suggest that high-wage employers tend to group by industry (product market). Thus there is a compensation hierarchy among companies that is related at least partially to the industry to which the companies belong.The high-wage employer may be part of a national organization whose major compensation decisions are made at the corporate level. For example, New York headquartered corporations often appear to pay higher than local competitors. Also, unionized employers may have a uniform compensation scale, dictated by the labor agreement, in all company establishments. Quite naturally, high-wage employers hope to gain several advantages from their high-wage position: higher worker quality as a result of higher hiring standards, ability to insist on higher performance standards, lower turnover, time savings for management because compensation changes do not have to be considered as frequently, insurance against unionization, fewer labor disputes in unionized companies, and company prestige. It is conceivable that the last of these (which appears to be non-economic) may bear more weight than economic advantages.Low-Compensation EmployersLow-pay employers tend to be relatively small, to occupy competitive product markets, to have low profit margins, and to be typically nonunion. They have low-paying ability because of the constraints of their product market. Most of their compensation decisions may be explained by this low ability to pay.Low-pay employers may gauge their position by comparing themselves with the largest and most visible employers. Using compensation surveys, they usually pay attention to rates for specific jobs for which there is an active outside market. The starting rate for new production workers may be particularly significant. Jobs on which attention is focused obviously varies by industry.The minimum feasible compensation is one that will obtain just enough employees to maintain desired employee levels for some period, typically six months. But often organizations pay above this minimum, hoping to obtain employees of higher quality; lower their turnover rates; and lower their recruitment, hiring, and training costs.Market Rate EmployersProbably the most common compensation level strategy followed by organizations is to "pay the market." These organizations wish to treat their employees fairly and yet not to raise their costs significantly more than their competitors. In short, these organizations are trying to average out the advantages and disadvantages of the high- and low-paying strategies by staying in between. This strategy should enable the organization to recruit and retain an adequate but not outstanding work force. In a tight labor market, they are likely to be affected more like the low-paying organization and need to engage in concerted recruitment activities to obtain new employees. At the same time, internal adjustments must be made to retain current employees. Often this adjustment is made after some of the best employees have already left.The types of organizations that choose to “pay the market rate” are harder to identify than high- and low-paying organizations. Many organizations with the characteristics of high-paying organizations will choose to pay the market instead since this strategy will still supply them with an adequate work force. High-paying organizations are more likely to be those in which it is clear to management that human effort can make a difference in organizational success. Low-paying organizations may wish to pay market rates but often are unable to do so.To pay the market rate an organization must collect compensation data and determine from that data exactly what the market rate is. This strategy can be characterized as being reactive to the market, so the organization needs to keep constantly in touch with other organizations to find out what changes are occurring in employee pay. This strategy also requires that the organization carefully identify where to obtain compensation information; that is, the organization must identify what the market is.Because employing organizations differ in employment-expansion plans, non-salary/wage characteristics of jobs, quit rates, and recruitment and training efforts, compensation levels will always differ from company to company.LABOR MARKETS AND COMPENSATION LEVEL STRATEGIESLabor markets fluctuate in terms of the number of employees and employee hours needed. These swings in labor demand affect employer compensation decisions and compensation differentials among companies. High-pay employers are less affected by these swings because their compensation is high enough above the area level so that they are little affected by short-run changes. They try to limit compensation level changes to once a year and tend to set prices by a percentage markup over average unit costs of production.Low-pay organizations adjust to changes in labor demand by deciding how far they can lag behind high-paying organizations. During an economic upswing, high-pay employers will be increasing wages, salaries, benefits, and employment. Low-pay employers, to hold down turnover and to increase employment, will have to raise compensation more than high-paying firms. The compensation gap between high-paying and low-paying firms thereby narrows during an upswing.During a downswing, high-pay firms stop hiring and may lay off employees. Low-pay firms find that they have more and better applicants and less turnover. This means they can lag further behind the compensation leaders and that the inter-company differential widens.But although these swings in labor demand compress and expand the differential, it never disappears. The reason is that although some labor markets are tight in upswings, most are quite loose (they have more unemployment than job vacancies) most of the time.Fluctuations in demand also change hiring standards. When an employer's pool of applicants begins to dry up, the employer may raise compensation or lower hiring standards. Pressure to lower hiring standards is felt first by low-pay firms. During a downswing, hiring standards are raised. It is usually easier, quicker and perhaps less costly to change hiring standards than to change wages. As a result employers may prefer changing hiring standards in the short run to changing wages.Obviously, swings in labor demand have their greatest effects on the less-preferred members of the la
