Chapter

2
Strategic Perspectives

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Learning Objectives
After studying Chapter 2, students should be able to:
1.

2.
3.
4.

Understand the concept of a compensation strategy,

where it comes from, how it relates to the
organizations situation, and why the concept has
value.
Illustrate the relationship between the pay system and
each of the strategic issues discussed.
Realize there is not yet consensus on the concept of
strategy.
Understand the difference between transactional and
relational returns.
McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Corporate objectives
strategic plans,
vision, and values
What business
should we be in?
How should total
compensation help
us win?

Business unit
strategies

HR strategies

How do we win (gain

competitive advantage) in
those businesses?

How should HR
help us win?

Social, competitive,
and regulatory
environment

Strategic
compensation
decisions

Strategic Choices

Compensation
systems

Employee
attitudes and
behaviors

Competitive
advantage
McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Strategic Perspectives Toward Total Compensation

Internal
Alignment

Objectives

Microsoft

Support the business

objectives

Support business
mission and goals

Support recruiting,
motivation, and retention
of MS-caliber talent

Develop global leaders

at every level

Reinforce team-based
culture

Reduce costs, increase

productivity

Preserve MS core
values

Integral part of MS culture

Support MS performance
driven culture
Business/technologybased organization design
structure
McGraw

Bristol - Myers Squibb

Flexibility for development

and growth
Reflect responsibilities,
required competencies,
and business impact

Firepond

Demonstrate respect
for individual talent and
the limitless potential of
a highly motivated team

Encourage high
standards of excellence,
original thinking, a
passion for the process
of discovery and a
willingness to take risks

Reward fresh ideas,

hard work and a
commitment to
excellence

Value diverse
perspectives as a key to
discovery

Pay differences that

foster a collegial
atmosphere
Reinforce high
expectations

2002 by The McGraw-Hill Companies, Inc. All

Strategic Perspectives Toward Total Compensation

Employee
Contribution

Externally
Competitive

Microsoft

Lead in total
compensation

Lag in base pay

Lead with bonuses,

stock options

Bonuses and options

based on individual
performance

Bristol - Myers Squibb

Administration

Open, transparent
communications
Centralized administration
Software supported
McGraw-

Compare favorably to
higher-performing
competitors

Cash between the 50th

and 75th percentile

Support high
performance, leadership
culture

Team-based increases

Options align employee

and shareholder interest

Firepond

Tailor to business and

team results

Performance and
leadership feedback
everyone is a leader
Administrative ease

(continued)

Demonstrate respect
for individual talent and
the limitless potential of
a highly motivated team

Bonus pool based on

Firepond financial
performance. Individual
share of pool based on
individual performance.

Push stock ownership

deep into company
Goal-focused, teamoriented, and selfmanaged

2002 by The McGraw-Hill Companies, Inc. All

Pay System Objectives

Attract and retain employees
Motivate performance
Promote skills and knowledge development
Shape corporate culture
Reinforce and define structure
Determine pay costs

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Pay-Design Process
Before any new compensation program is

designed, there must be a clear understanding by

the organization of:
its current values
its structure
its people
its goals and vision for the future

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Generic Business-level Strategies

Innovator
Cost Cutter
Customer Focused

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Tailor the Compensation System to the Strategy

Business
Response

Strategy
Innovator:
Increase Product
Complexity and
Shorten Product
Life Cycle

Cost Cutter:
Focus on
Efficiency

Product
Leadership

Shift to Mass
Customization
and Innovation

Cycle Time

Operational
Excellence

Pursue Costeffective
Solutions

HR Program
Alignment

Committed to
Agile, Risk
Taking, Innovative
People

Compensation
System

Reward
Innovation in
Products and
Processes

Market-Based
Pay

Flexible
Generic Job
Descriptions
Focus on
Competitors
Labor Costs
Increase Variable
Pay
Emphasize
Productivity
Focus on System
Control and Work
Specifications

Do More With
Less

Customer
Focused:

Customer
Intimacy

Increase
Customer
Expectations

Deliver Solutions
to Customers

Speed to Market

McGraw-

Delight
Customer,
Exceed
Expectations

Customer
Satisfaction
Incentives

Value of Job and

Skills Based on
Customer
Contact

2002 by The McGraw-Hill Companies, Inc. All

Which Pay Decisions Are Strategic?

A strategic perspective
focuses on those
competitive choices that
help the organization gain
and sustain competitive
advantage.

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Strategic Compensation Decisions

Objectives
Alignment
Competitiveness
Contributions
Administration

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Example: The Strategic Compensation

Decisions Facing Starbucks
1.

Objectives: How should compensation support

business strategy and be adaptive to the cultural and
regulatory environment?
Starbucks objectives:
Grow by making employees feel valued.
Recognize that every dollar earned passes through
employees hands.
Use pay, benefits, and opportunities for personal
development to help gain employee loyalty and become
difficult to imitate.

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Example: The Strategic Compensation

Decisions Facing Starbucks (continued)
2.

Alignment: How differently should the various types

and levels of skills be paid within the organization?
Starbucks:
De-emphasize differences.
Use egalitarian pay structures, cross-train employees
to handle many jobs, and call employees partners.

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Example: The Strategic Compensation

Decisions Facing Starbucks (continued)
3.

Competitiveness: How should total compensation be

positioned against our competitors? What forms of
compensation should we use?
Starbucks:
Pay just slightly above other fast-food employers.
Provide health insurance and stock options for all
employees (including part-timers).
Give everyone a free pound of coffee every week.

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Example: The Strategic Compensation

Decisions Facing Starbucks (continued)
4.

Contributions: Should pay increases be based on

individual and/or team performance, on experience
and/or continuous learning, on improved skills, on
changes in cost of living, on personal needs, and/or on
each business units performance?
Starbucks:
Emphasize team performance and shareholder
returns.
For new managers in Beijing and Prague, provide
training opportunities in the U.S.
McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Example: The Strategic Compensation

Decisions Facing Starbucks (continued)
5.

Administration: How open and transparent should

pay decisions be to all employees? Who should be
involved in designing and managing the system?
Starbucks:
As members of the Starbucks family, our
employees realize what is best for them.
Partners can and do get involved.

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Key Steps to Formulate a Compensation Strategy

1.
1. Assess
Assess Total
Total Compensation
Compensation Implications
Implications

Competitive
Competitive Dynamics
Dynamics
Core
Core Culture
Culture // Values
Values
Social
Social and
and Political
Political Context
Context
Employee
Employee // Union
Union Needs
Needs
Other
Other HR
HR Systems
Systems

4.
4. Reassess
Reassess the
the Fit
Fit

Realign
Realign as
as Conditions
Conditions Change
Change
Realign
Realign as
as Strategy
Strategy Changes
Changes

2.
2. Fit
Fit Policy
Policy Decisions
Decisions to
to Strategy
Strategy
Objectives
Objectives
Alignment
Alignment
Competitiveness
Competitiveness

Contributions
Contributions
Administration
Administration

3.
3. Implement
Implement Strategy
Strategy

Design
Design System
System to
to Translate
Translate Strategy
Strategy
into
into Action
Action
Choose
Choose Techniques
Techniques to
to Fit
Fit Strategy
Strategy
McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Basic Issue: Does Best Fit Pay Off?

Socioeconomic /
Political Environment

Organization
Organization Strategy
Strategy

HR
HR // Compensation
Compensation
Policies
Policies

Competitive
Competitive
Advantage
Advantage

Socioeconomic
Socioeconomic //
Political
Political Environment
Environment

HR
HR // Compensation
Compensation
Policies
Policies

Organization
Organization Strategy
Strategy

Competitive
Competitive
Advantage
Advantage

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Best Practices Options

THE NEW PAY
External market-sensitive-based pay,

not internal alignment

Variable performance-based pay, not
annual increases
Risk-sharing partnership, not
entitlement
Flexible opportunities to contribute, not
jobs
Lateral promotions, not career path
Employability, not job security
Teams, not individual contributors

McGraw-

HIGH COMMITMENT
High wages: You get what you pay for
Guarantee employment security
Apply incentives; share gains, not risks
Employee ownership
Participation and empowerment
Teams, not individuals are base units
Smaller pay differences
Promotion from within
Selective recruiting
Enterprise-wide information sharing
Training, cross-training, and skill

development are crucial

Symbolic egalitarianism adds value
Long-term perspective matters
Measurement matters

2002 by The McGraw-Hill Companies, Inc. All

Virtuous and Vicious Circles

Organization
Performance
INCREASES

Increased PerformanceBased Pay

Virtuous Circle
Risk/Return
BALANCE

Vicious Circle

Organization
Performance
DECREASES
Risk/Return
IMBALANCE

McGraw-

Increased Employee
Performance

Decreased PerformanceBased Pay

Decreased Employee
Performance

2002 by The McGraw-Hill Companies, Inc. All

An implicit contract is an unwritten

understanding between employers and
employees over their reciprocal
obligations and returns; employees
contribute toward achieving the goals of
the employer in exchange for returns
given by the employer and valued by the
employee.

McGraw-

2002 by The McGraw-Hill Companies, Inc. All

HIGH PAY HIGH COMMITMENT

Hired Guns
(Stockbrokers)

Cult - like
(Microsoft)

LOW PAY LOW COMMITMENT

LOW PAY HIGH COMMITMENT

Workers as Commodity
(Employers of Migrant
Farm Workers)

Family
(Starbucks)

High

HIGH PAY LOW COMMITMENT

Low

TRANSACTIONAL

Framework for Analyzing

Different Deals

Low
McGraw-

RELATIONAL

High

2002 by The McGraw-Hill Companies, Inc. All

Summary
A strategic perspective on compensation takes the

position that how employees are compensated can be a

source of sustainable competitive advantage.
Two alternative approaches are highlighted:
A best fit / contingent business strategy / environmental

context approach; and

A best practices approach.
The best fit approach presumes that one size does not

fit all. The art of managing compensation strategically

involves fitting the compensation system to the different
business and environmental conditions.
McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Summary (continued)
The best practices approach assumes that there exists a

universal, best way.

The focus is not on the question of what the best strategy is,

but how best to implement the system.

Agreement on what are the best practices does not exist.
The four-step process for forming and implementing a

compensation strategy includes:

Assessing conditions
Deciding on the best strategic choices following the pay model
Implementing the strategy through design of the pay system
Reassessing the fit
McGraw-

2002 by The McGraw-Hill Companies, Inc. All

Summary (continued)
Recent studies have begun to research what aspect of the

compensation system really does matter, but the answer

is still fuzzy.
An essential point is that the deal (the employment
relationship) includes both transactional and relational
forms of compensation.
It is the total deal, the relationship with people, that
makes an organization successful.

McGraw-

2002 by The McGraw-Hill Companies, Inc. All