Copy of chapter 3.

2 (pages 96 to 104)
In The Corporate Guide to Expatriate Employment
Edited by Jonathan Reuvid
Published by Kogan Page, London in 2009

Part 3 - Compensation, benefit and expatriate support

3.2 REMUNERATION STRATEGY FORMULATION AND

DESIGN
Natarajan Sundar, Orgdesign Limited

In an increasingly competitive world, each organisation has to formulate a

unique remuneration strategy aligned with its own business priorities and
human resources agenda. The remuneration structure and the fixed vs.
variable pay mix should address its specific challenges, and enable it to
attract and retain required talent in the context of the relevant market and
help drive performance. Short-term and long-term incentives should
incorporate performance measures that reflect shareholder value creation for
the company. A case study of Unilever at the end of this chapter illustrates
various aspects of remuneration strategy formulation and design.

Remuneration, or the financial returns that people receive from their

employers, is among the most important reasons why they work for an organisation.
For the employers, remuneration is among the biggest costs. The way in which
remuneration is determined and paid has a significant bearing on the quality of
people it attracts and its performance. Even though it is a major cost, the challenge
lies less in controlling it and more in deriving the maximum benefit for the individual
and the organisation. Therefore, within broad limits of the prevalent norms and
practices in the country and the industry, each company has to formulate its own
unique remuneration strategy, structure and design. This chapter focuses on the
financial rewards, fully mindful that non financial rewards, such as career, job
satisfaction, training and felt fairness, are at least as important.
REMUNERATION STRATEGY
A good remuneration strategy has three basic policy objectives.

Attract and retain the quality of people the organisation needs and in the
required numbers: To be able to do so, the organisation has to be
competitive in the market, the relevant market for this purpose being
defined in the context of the companys line of business and its strategy.

Deliver performance: While what matters ultimately is the performance of the

company as a whole, it is the performance as individuals, teams, units and
divisions that add up to corporate performance. Therefore, how performance
is defined, measured at various levels and linked with rewards is the second
crucial element of remuneration. The companys business strategy and the
human resources agenda become important as it is with these that the

remuneration has to be aligned. In turn, this would result in alignment with

shareholder interests. The watchword is alignment.

Enable felt- fairness: The crucial thing about money is not just how much
one is paid but how much in comparison with others, especially those in the
same organisation. People increasingly accept that differentiation in rewards
on the basis of performance is inevitable in the competitive global world, but
they want it done in a fair, transparent and objective way. Ensuring a general
feeling of felt-fairness requires robust systems, processes and
communication, not just in remuneration but in all HR practices.

While external competitiveness, performance link and internal equity are the
three key elements of remuneration, all these need to be achieved at minimal cost.

FORMULATING REMUNERATION STRATEGY

Strategy is about being clear on where one wants to be and, broadly, how to get
there: formulating a unique winning approach that takes account of the opportunities
and risks, core strengths and weaknesses. In todays globally competitive world,
organisations need a strategy that deals with their unique context and challenges in
human resources including, importantly, remuneration as much as in business. The
Remuneration strategy itself should be a differentiating, competitive, advantage for
the organisation.
The industry in which one operates has a major impact on the remuneration
strategy. There is a wide range of scenarios:

At one extreme are industries, heavily skill and knowledge based with
relatively little capital, eg IT consultancies. Efficiency and effectiveness of
human capital are paramount for their success. One of the worlds largest IT
consultancy companies ensures that 85 per cent of employee time is billable.
These companies have to be very closely market aligned and have strong
performance linkages with pay.
At the other extreme are highly capital intensive industries. While they may
need very high skills, in technology and science, the numbers required are
small and the manpower cost modest in comparison with revenue generation.
Oil and Gas exploration, especially in the current high oil price context, are
classic examples. Holding on to top talent is so crucial for them that they
would not mind paying more than the competition.

Horses for Courses

The stage of growth of a company also makes a big difference to
remuneration strategy, even between companies within the same industry. At the
start up stage, there is particular need for successful business innovation. The need
is to attract talent of the highest calibre. A total remuneration position of 75th
percentile of the relevant market may be needed. However, the revenue stream in
the innovation phase of the company is low. Cash remuneration, ie base salary and
bonus needs to be modest. But stock options have to be well above the market. As
innovations pay off and get reflected in the share value, the employees also get their
share in the success of the company.

When a company is at a mature stage the need is to control all costs to

ensure that they deliver current value. The tendency is to aim at market median
position on base pay and higher than median on total pay including incentives,
provided that performance is delivered. However, as spectacular share price
increases are not expected, the emphasis is on annual bonuses and on share grants
rather than share options.

REMUNERATION STRUCTURE
Structure follows strategy this is true of remuneration as much as of business.
Clearly, it is not possible to achieve all the objectives of a good remuneration policy
through one element of pay. It is therefore common to have a mix of pay elements.
Some elements of pay are fixed or guaranteed to be paid during the year, eg base
salary, pension and benefits such as healthcare or a car allowance. Other elements
are dependent on, and indeed aimed at incentivising performance, both short-term
and long-term. The higher one goes up in the organisation, the greater is the
proportion of pay at risk.
Figure 3.2.1 shows the typical mix of pay at different levels in a large FTSE
company in the UK. At the level of a junior manager, the bonus is modest and,
barring exceptions, there is no long-term incentive. At the other extreme, Executive
Directors qualify for a target annual bonus of 100 per cent of the base salary and a
maximum of 125 per cent as the value of shares granted. The actual bonus can be
between 0 and 150 per cent of the target bonus. Likewise, the actual performance
linked vesting of long term incentives can be 0 to 100 per cent of the grant. More
than 2/3rds of their target pay is therefore at risk.

Figure 3.2.1
REMUNERATION STRUCTURE ACROSS LEVELS

Long-term incentives
Short-term incentives
Base salary

325

125

160
110
10 0
100

Junior
manager

20

100

40
100

Senior
manager

100

Executive
Director

REMUNERATION DESIGN
Once there is clarity on the remuneration strategy and structure, one has to
decide on appropriate competitive positioning and actual design of incentives to
translate them into remuneration plans.
Competitive Positioning
Competitive positioning is about deciding whether the remuneration paid by the
company should be at, above, or below the market rate in relation to the market.
First, one has to answer the question what is the appropriate market? This
depends on what the relevant pool of talent is and who else is competing for them.
For most jobs, it is the local or national market and for many jobs it is also the same
industry. However, for some specialist and functional jobs, the competition is beyond
the industry. Also, at the most senior levels, regional and international levels of pay
become relevant.
Second, there is no such thing as a single market rate for the job. However
sophisticated a remuneration survey may be, it makes judgements (albeit informed)
on job matches across companies with different organisation structures and job
profiles and converts the market data into statistical measures such as median,
average, 75th percentile, etc. The median is exactly what it says: it could be that no
one else in the market is actually paid at that rate and half are actually paid higher
and other half lower.
Third, even between two companies with the same total remuneration
package, there may be significant differences in the mix. One company could be
paying relatively higher salary and modest bonuses, another a lower base salary but
higher long term incentives and a third one paying actually less total remuneration
than either but still attracting people because it provides superior non-financial
rewards.
Companies therefore need to look at market data not as a precise
mathematical figure but as a reference point and decide on their own remuneration
strategy and pay mix. This is particularly important for small companies. They do not
necessarily have to match the big companies in each element of pay, or in total
financial remuneration, as they can often offer much better job challenges and
working conditions.
Design of Short-term Incentive Plan
Short-term incentives are designed to include an upside potential, and a
downside risk, linked to performance. Three key design issues are:
What is the performance to be rewarded the individuals, the companys, or,
both?
What will be the measure of company performance?
How will individual performance be assessed?

Performance definition
Ultimately, the companys overall performance is paramount. However,
employee surveys show that paying every one the same bonus does not help: no
one likes free riders. People want rewards to be commensurate with their
performance. Equally, the danger in rewarding only individual performance is that it
can hurt group effort. There are two ways of handling this. The traditional option is to
have two separate elements of bonus, one for business results and the other for
individual performance, and then add the two together to arrive at the total bonus for
the individual. An alternative approach that is increasingly preferred is to link the
overall bonus amount to business performance and within the resulting budget base
individuals differentiation on their contribution.
Organisational Performance measures
Each organization will need to choose those performance measures that best
reflect its shareholder value creation. For annual bonus these will usually include a
profit measure and an efficiency measure, such as return on capital employed. There
could be additional or alternative measures such as cash flow, volume, market share,
business development, innovation, health, safety, security and environment.
Assessing individual performance
The standard practice is to agree explicit individual performance targets for
the year and make an assessment of performance against these targets. This should
not be simply an assessment at the end of the year. Instead, there should be regular
performance reviews during the course of the year, with improvement achieved
through training and coaching.
Design of Long-term Incentive Plans
In the UK, the performance period for vesting is typically three years,
although in the case of stock options employees have a further period of 7 years to
exercise their options. There are two common types of long-term incentives: stock
options and stock grants. A stock option is a right given to an employee to buy the
shares of the company at a future date at a predetermined price. A stock grant is like
a post-dated cheque; the employee will receive a certain number of shares at a
future date. In both cases, there is a requirement that the employee should continue
in the employment of the company until vesting and there are usually performance
conditions.
Share Options vs. Stock Grants
Although stock options dominated throughout the 1990s, in recent years their
popularity has waned. First, share price growth is not dependent just on company
performance but on the industry and overall equity market trends. Second, in a bear
market when options go under water there is little incentive value left. Lastly,
options have to be expensed and the cost reflected in the profit and loss account of
the company: not surprisingly, companies want the best value for money. For all
these reasons, incentive plans based on whole shares rather than share options
have become more prevalent recently, especially for the top executives. In the UK,
they generally tend to be performance shares, ie a promise to grant shares at a
future date, subject to satisfactory corporate performance. Performance shares
always have some value, although the performance conditions have to be met. Stock

options and stock grants are both relevant depending on circumstances. Companies
therefore tend to use them in a flexible and complementary way, with multiple but
relevant performance conditions.
Performance Conditions
Performance conditions should be aligned with shareholder interests and
such that the employees can influence their achievement. Finding measures that
satisfy both these criteria has been the Holy Grail in the last few years. With stock
options, especially as they are often granted across levels of employees in an
organisation, the tendency is to go for simple internal measures such as growth in
earnings per share or return on investment to which all employees can relate.
With stock grants, as they tend to be awarded mostly to the more senior
management, the search is for external and more objective performance measures.
Total shareholder return (TSR) is considered to be most aligned with shareholder
value creation and therefore commonly used. It is the return on investment obtained
by holding a companys shares over a period, mainly determined by the change in
the market value of shares and dividend flow. As the absolute TSR is heavily
influenced by general equity market trends, relative TSR, one that assesses the
TSR of the company against a comparator group, is commonly used.
Tough Choices
Formulating remuneration strategy, deciding on the remuneration structure
and designing incentive plans all imply making tough choices. The processes
followed are therefore as important as the substance. It is a challenge to come up
with a unique, cost efficient remuneration proposition for any organisation within
limits discernible in the market. Understanding what the employees really want and
value, and engaging the line managers in the design will greatly help this greatly.
More importantly, it will help in implementation.
The case study below of how Unilever, a well known multinational company, has
gone about formulating its remuneration strategy illustrates the process.

CASE STUDY
FORMULATION OF UNILEVERS REMUNERATION STRATEGY AND DESIGN
Unilever is one of the worlds largest consumer products companies, operating in
over 100 countries with over 200,000 employees. Several of its brands are household names
in home care, foods and ice cream: Dove, Ponds, Vaseline, Persil, Flora, Lipton, PG Tips,
Hellmanns, Walls, Ben and Jerry. In recent years, its challenge has been growing in both topline and bottom-line at the same time. Volume growth alone can be achieved by sacrificing
profits. Likewise, it is possible to grow profits in the short-run by compromising on marketing
and other investment spends. Sustained growth in profits and, in turn, shareholder value can
only be produced if there is also growth in volume.
During 2007 Unilever carried out a comprehensive review of its remuneration
strategy, as well as the design of its short-term and long-term incentive plans. The overriding
objective of its remuneration policy is to ensure that it recruits and retains the best performers
and effectively incentivises them to achieve superior results. It is also the aim to manage the
differing elements of total remuneration in a fully integrated manner.
Five strategic principles serve as the platform for Unilever's approach to remuneration
for its Executive Directors and other leadership team members:
alignment with shareholders' interests;
robust linkage to performance;
alignment with strategic priorities;
market competitiveness; and
ease of understanding and communication.
These five principles provide the foundation for the level and structure of Unilevers
remuneration. The different elements of pay are complementary to one another. The
remuneration structure shown in Figure 3.2.2 pertains to the Executive Directors and the
leadership team across countries, but the principles are valid for managers worldwide.

Figure 3.2.1 - Unilever Remuneration Structure

Element of
Pay

FIXED
Base Salary
Pension

Payment Vehicle

Cash

Market Median

Annual Bonus

Cash (75%)
Shares (25%)

Global Share
Incentive Long
Term Plan

Shares

Shares

Plan Objectives

Remain in the home

fund or equivalent
value

VARIABLE

Share Matching
Plan

Value
Determination

As % of base
salary
For Executive
Directors (EDs) up
to a maximum of
150%
Grant level for EDs
up to 180%
Vesting 0 -200% of
grant
For EDs 25% of
annual bonus paid
as 3 year deferred
shares with a 1-for1 match

Attract and retain high

performers
Attract and retain high
performers

Economic Value Added

Top-line growth
Individual key deliverables

Shareholder return at upper

half of peer group
Top-line growth
Free cash flow

Alignment with
shareholders interests
through executive
shareholding
Retention

Notes:
The total remuneration package for Executive Directors is intended to be competitive
in a global market, with a strong emphasis on performance related pay.
A significant proportion of their total reward is linked to a number of key measures of
Group performance to create alignment with strategy, business priorities, and
shareholder value.
The Remuneration Committee of the company sets both short-term and long-term
performance targets. In so doing, it is guided by what would be required to deliver
top third shareholder value.
Internal and external comparisons are made with the reward arrangements for other
senior executives within Unilever to support consistent application of Unilevers
executive reward policies.
Source: Unilever Report and Accounts for the year 2007

Author Notes
Sundar has been in the UK since 1995, as the lead global remuneration expert of two
of the largest global companies, Unilever and BG (British Gas) Group. He has led
major global projects in human resources, organization design, and remuneration
intelligence, strategy and design. Between 2002 and 2004, he was the first coordinator
of a remuneration corporate governance group of some of the largest companies in
Europe including BP, Shell, Unilever, GSK, ING, Fortis, Daimler Chrysler, Nestle,
Total and Siemens.
As Director of Orgdesign Limited, Sundar is an independent consultant, based in both
the UK and India. He specializes in Remuneration, Organizational Design and
Performance Management. Recent major projects include Global Reward Strategy,
Framework for Managing People Cost in a Conglomerate, International Assignee and
Pay Policy, and Role Clarity and Performance Management for some of the largest
companies in the UK and India.
Before relocating in the UK, Sundar has had a chequered career in India for nearly 30
years in science, finance, general management and human resources in Bhabha
Atomic Research Centre, Punjab National Bank (PNB) and Hindustan Unilever
Limited (HUL). After being the youngest Principal of Staff Training College of PNB,
he joined HUL in 1975 as their first banking and finance manager. In the late 1980s
he was appointed HULs first national remuneration head and in the wake of Indias
economic liberalization, pioneered adaptation of global remuneration practices to
Indian context. He pilot tested the commercial application of a new approach to
organization design, work level, along with a professor from London School of
Economics. Between 1992 and 1995 he was the Finance and HR Director of Ponds
India Limited. In 1995 he was handpicked by Unilever to design and implement a
new global pay policy and later on to lead their biggest ever global HR project
Integrated Human Resources comprising work levels, new pay policy and systems,
skills and competencies framework and personal development plans.
Sundar is an alumnus of Madras, Delhi (FMS), Stanford and New York Universities.
Currently member, Advisory Board and visiting professor at the LM Business School,
London, he is a regular invitee contributor to Croners British Personnel Management
Newsletter. During 2008-2009 he was on the UK CIPD advisory panel on Shaping
the Future.
Contact Details
Orgdesign Limited, 8A, Malden Park, New Malden, KT3 6AS, UK
Email: nsundar@btinternet.com Phones: (0044) 20 8949 5755 / (0044) 7802782659
When in India:
D2, Ashok Amoga, 46, 1st Main Road, Gandhinagar, Chennai 600020
Phone: (0091) 9840097842