CHAPTER 25: COMPENSATION PLANNING AND CONTROL
Overview: This chapter instructs you in how to incorporate all compensation and benefit decisions into one cohesive program.
For the vast majority of organizations the largest expense item is their payroll and any other costs related to compensating their employees. Thus planning for this expense affects both the efficiency and effectiveness of the organization. Like all organizational activity, the compensation program needs to be well thought out, organized, planned, evaluated and controlled in order to insure that the desired effects are achieved. These activities must, in fact, lead toward accomplishing the organization's goals. This chapter covers the tools and techniques required to carry out this overarching aspect of compensation administration.
Employees find compensation decisions both important and intimidating. How much one is paid by the organization is of extreme importance, but often how the decision is arrived at seems mystical. Supervisors need a compensation plan that creates a climate in their work unit that is individually and collectively conducive to completing that unit's work. The organization needs to be competitive both in the labor market and the product market, and these two things may not be consistent. The force of all these pressures on compensation makes it difficult to optimize the potential of compensation to energize organizational activity toward organizational goals.
To start with a bit of a review, there are three main goals for a compensation program:
- To attract and retain the best possible work force considering the resources of the organization
- To motivate this work force to achieve a high level of performance
- To keep labor costs within the capabilities of the organization
The pursuit of these goals is costly, but as the largest single expense of just about any organization, the planning for this expenditure and control of it is of fundamental importance. Compensation administrators should keep the objectives of compensation at the forefront of their minds while they are engaged in the everyday activities of compensation. There is a tendency to evaluate an activity on its own merits without examining how it fits into the overall scheme. The result of this is a great number of activities that fragment the efforts of the organization rather than focus and conserve activity to achieve organization goals.
Through most of this text the focus has been upon wage rates and their comparison either externally with other organizations or internally between jobs. At this point the focus shifts to examining the cost of labor to the organization itself, and to placing that particular cost in context with other expenses and the revenues of the organization. On average, labor costs are 2/3 of total costs for companies making the forecasting of labor costs very important. Planning and control of these factors is critical to continuing success. The factors that go into labor costs vary in the amount of power the organization has to control those factors.
Employment. The starting point for calculating labor costs is the number of employees working and the number of hours that they work. The first thing that most organizations think about when they want to reduce labor costs, is to lay off workers. This is an effective tactic but often does not reduce costs as much as expected. Further, there are negative side effects that create further problems for the organization.
Most organizations create a buffer for variation in labor demand by having two groups of employees, core and contingent. Viewed as two circles, one inside the other, the core consists of employees that that are most important to the organization's operations and who are hardest to replace. These employees would have a relatively permanent employment and full benefits. The contingent group of employees would be ones who are expected to be with the organization for a limited time period or are part time employees. This group may have few or no benefits.1
There is also a class of employees that are under contract. They may be persons considered to be independent contractors as individuals, or employed by a company that provides workers in various categories. Even this does not cover all employment alternatives. Outsourcing is also an option in which the organization receives the output of labor but the workers are employees of other organizations and may be located anywhere in the world.2
Hours. In labor economics the base unit of labor is the hour. Many organizations use the same definition. Hours are an important unit of measure because employees work different hours. A prospective wage increase may or may not increase labor costs per unit. If employees are expected to be more productive, then paying higher wages may not actually raise the organization's labor costs. However, if a pay raise does raise labor costs, you must determine whether the increase can be passed on to customers or offset by a reduction in other costs. Success in either effort meets the requirements of ability to pay.
The Wage Level
The wage level decision determines the organization's competitive stance vis-à-vis the labor market. We have suggested that organizations can choose to pay above market, lower than market, or at the market level. Organizations differ in their ability and desire to use these options. Regardless, this is the first major decision that needs to be made in compensation planning. Actually, reviewing their wage level is a way for an organization to see if their past decisions are still correct and whether those decisions are being followed.
High-wage option. Organizations can choose to pay, on average, better than their competitors for employees. They may wish to do so expecting to get better employees and keep their turnover at a minimum. Organizations choosing this option are likely to be large organizations that have high profit margins, produce well-differentiated products, have lower than average labor costs as a low percentage of total costs, and occupy a market niche such that keeping costs low is not a major consideration. Human resources are usually important in a high paying organization. Often they are highly technological in nature and use many professional employees. Obtaining and retaining this group of employees is difficult, both because they have less organizational commitment and because the labor market is so dynamic that there are many opportunities for them.
Low-wage option. In contrast, some organizations choose or are forced to pay less than others for the same jobs. Such organizations can expect to obtain a lower quality of employee and to be more subject to fluctuations in the labor market. Thus, in a tight labor market these organizations must spend more time recruiting employees and may have to train people for even low-level jobs.
Low-paying organizations tend to be in industries where there are undifferentiated products, considerable competition, easy entry for firms into the field, high wage costs to total costs, and low profit margins. But organizations operating at the fringe of any market are likely to fall into this category. The employees sought by these organizations tend to be less technical and often represent the secondary labor market. The minimum wage is a constraint on these organizations since they may wish to pay less for labor than they are allowed.
Market-wage option. Most organizations claim that they attempt to pay market rates to their employees. Organizations possessing the characteristics of either of the two previously mentioned groups may choose to pay market rate for a number of reasons. They may feel that maintaining this position will allow them to attract and retain adequate employees while at the same time not raise labor costs too high. This strategy must work well because it is very popular, but it does seem to place the organization in a catch-up position when the labor market becomes tight. By the time that the organization recognizes that the market is tightening up, it may have lost many good employees.
Salary planning is a process by which the organization examines the labor market and compares the results of that examination with the current pay offered within the organization. For most organizations salary planning is an annual affair. Planning for this major expense affects both the efficiency and effectiveness of the organization. This planning process covers how much of the organization's resources will go into salaries and details the salary rate for each employee. This is an extensive process but it is required if the organization is to optimize its expenditure for human resources.
Salary increases are a never-ending problem. No other action associated with an employee's salary undergoes more scrutiny. Likewise, no other action has such a cumulative, year-after-year effect on an employer's cash flow and financial well-being. Salary planning is an integral part of any organization's budgetary process. That's why its planning is often started far in advance of any fiscal year. The unwary manager who does not carefully consider what salary-increase method to use faces many pitfalls, all of which can lead to disaster: uncontrolled expenses, bypassing of the companys approval and oversight processes, changing market conditions, and disgruntled employees.
Planning is the process of determining what you want to do and how you are going to get it done. It is a process that is done all the time in order to keep the organization moving toward its goals. But the process may not be a conscious one or well thought out. In compensation, formal planning processes are a very necessary addition to compensation administration.
Determining what to accomplish and how to accomplish it has two concerns. The first is that the environment outside the company may make achieving goals either more or less difficult. The planner must have some estimate of the interaction between the organization's actions and the current employment environment. Second, there is an interaction between the what and the how. The planner must estimate whether the actions taken – the how – will in fact create the desired state-the what.
Salary planning starts by collecting data on the organization – the jobs, the salaries and the wage structure. Then wage survey data is collected and compared with current salaries, and a competitive analysis is made. This leads to determining the increases to be made to both salaries and structures. Finally this is put into a budgetary format for control purposes.
The knowledge of the work of an organization is the starting point for just about any Human Resources activity and compensation is no exception. The point where work and the worker come together is the role played by the worker in the organization that we call a job. Information about jobs is usually contained in job descriptions. In some organizations, however, these are not used. There are, however, usually some general roles or occupational information used to categorize employees.3 This information is needed to make comparisons to the labor market through wage surveys.
The organization's wage structure consists of a series of progressive pay grades. Each grade has a range, which can be viewed in terms of its maximum, midpoint, and minimum. The planner needs to know how these ranges are working. For the ranges in general, it is useful to know how many jobs are being paid out of range. For each rate range, it is necessary to know what the distribution of people is within the range. For instance, if everyone is at the bottom of the range it may indicate high turnover rates and problems with membership decisions. Everyone falling at the top of the range may dictate a slowdown of inter-grade progression within the organization.
Knowledge of the Market
The organization is always in some sort of relationship to the market in regard to wages. Organizations need wage information about the labor market to make decisions about what their wage level and structure should be. Having this information gives them the edge to remain competitive and retain high quality employees. The way this is done is through the use of wage surveys. A wage survey is a compilation of wage data collected from other organizations that are perceived as comparable to your organization in some regard. In this way the organization can determines the competitive market rate for its own jobs. By all accounts the most common analysis activity in compensation administration is the collection, analysis, and use of information on compensation paid by other employing organizations. The main thing that this will tell the planner is the current pay level of the organization. It can also identify particular jobs that seem to be out of line with the market such that the job or wage structure needs to be altered. See Chapter 8 for a more complete discussion.
Choosing an appropriate wage survey is a difficult task as they come in all shapes and sizes. The following are some things to consider when selecting a wage survey.
Organizational Fit. This question of fit has to do with whether the survey source has data that is appropriate for what your organization needs. For instance, if the source provides only average wages for jobs and the organization's wage level strategy is to pay at the 65th percentile the data will not fit. This highlights the necessity of developing a plan prior to ever starting to collect wage data. The plan needs to outline exactly what data is needed and for what purpose.
In addition, the jobs that are in the survey need to be ones that are important to your organization. This goes beyond just the job titles to comparing the job descriptions used in the survey with your organization's descriptions to see if they match.
A corollary of organizational fit is Analyst fit. The analyst must be able to understand and know what to do with the data that is provided from the survey. The surveys vary considerably as to how complex their data are, how it is analyzed and presented, and how much support the source can or will provide the analyst.
Data Provider. The reputation of the data provider is important: the data needs to be reliable. The government has a reputation for good data but also a reputation for providing it in an untimely manner. Professional and trade organizations can vary greatly, depending upon how and when they collect data. It is the national compensation consultants that have the best reputations for good data, analysis and support.
The question of accuracy and scope of the data provider is of critical importance when the organization uses the Internet. When getting wage information from the Internet look closely at the purpose of the web site and who is the host of the web site. An important part of this is to determine who the customers are for the data and whether the wage data is central to the site or is presented in order to sell something else. In addition the site should provide information about who is in the sample and its size as well as information about the methodology used to analyze the data.
Data Base. The figures that underlie the wage rates presented as the market rates by wage surveys are the data base. Where did this data base come from? For instance, in an Internet site, is the data from some survey done somewhere else or is it collected from people who enter the web site? Most industry and consultant based surveys clearly indicate survey participants, the size of the sample, types and locations of participants, and how the data was handled.
Job descriptions should be included in the data presented. Without a job description to go along with the job title it is not possible to know if your jobs are the same as those in the survey even if they use the same title.
The data output may be very simple or it may be quite complex. Internet sites that present "one job at a time" often give just a single average salary figure. Is this a mean or a median figure? What does it include, base salary, bonus, all or just some benefits? The ERI Salary Assessor provides both mean and median as well as pay for percentiles, adjustments for years of experience, location, industry and organizational size.
Methodology. In determining whether to use a particular survey one of the most important things to know is how it has been analyzed. Here are some questions to consider about methodology:
- Does the survey organization have the expertise to analyze the data?
- How have jobs been matched up in the survey to prevent mismatching? [For instance, in the O'Net survey, both technicians and first line supervisors are included in many job families.]
- Has a single survey been used or is this an aggregation of surveys? If so, how are they aggregated?
- What statistical processes have been used and were they appropriate? Even simple things are complex. For instance, there are seven different ways to calculate an average. All are correct in their place.
- Is the data adjusted for when the data was collected? Therefore what is the effective date of the data? Is it adjusted for location, industry or any other basis?
Cost. The cost of obtaining wage data may vary from zero to thousands of dollars. Some Internet sites will provide a single wage rate for free or for a nominal sum. A compensation consultant could well cost in the thousands of dollars for a complete wage survey of all or most of the organization's jobs. The best thing to say is that you will get what you pay for. Free data may prove to be very expensive if the figures are high and wages rates in the organization consequently get set above the market rate.
Cost comes not only in money but time. Using a number of surveys requires the analyst to take time to integrate the data into a coherent whole. Some surveys, typically industry or geographical, require the organization to contribute the organization's data to the survey. This takes a lot of the analyst's time.
An internal source of information is the recruiting and retention information within the organization. If the discussion at the beginning of this chapter is accurate, then turnover and retention rates should be a good indication of the labor market and of employees' knowledge of and response to changes in it. It may be necessary not only to find out the turnover statistics but to get a picture of the ability of the organization to recruit and retain the quality of personnel that the organization needs.
The first thing to do is to look at the job descriptions in the surveys and compare them to your job descriptions. The purpose is to find a match between your jobs and those of the wage surveys. This is a judgmental process; the descriptions are not likely to be exactly alike. You need to find the job in the survey that most resembles yours. The rule is that if the two are 70% the same they can be considered a match. What you are looking for is a match of the work activities along with the knowledge, skills and experience required to perform the job. This step may be the most important one for ensuring you arrive at the going wage for the job.
There are times when you may find two jobs that look like they would match the organization's job. Experts are divided on whether you can look at both and blend their wage rates or whether you must pick the most likely job. It is possible to adjust wages rates where the organization's job is somewhat above or below that of the wage survey as we will discuss a little later.
Extract Data. For each job the wage survey provides some data. At a minimum this would be one or more measures of central tendency. So the first decision might be which of these figures you wish to use. The most common measures are a median [the middle value of the data] or the mean [the arithmetic average]. The mean is reported as either weighted or unweighted. An unweighted mean is the average of what the companies in the survey pay. The weighted mean is the average of each person's wage that is included in the survey. A second part of this average is whether it is the average of base pay or of total cash compensation. The latter would include any bonuses.
There are, in addition, other data on each job that may be useful:
- Percentiles. These are particularly useful if you have a wage level determination that is higher or lower than the average.
- Experience. If your organization has a group of employees on a job that is either new or old, their wage should be different from the average of the wage survey.
- Job Levels. Some jobs have levels, such as beginning or senior levels, with substantially different wages.
- Organization size. Larger organizations tend to pay higher wages than smaller organizations
- Wage Spread. Knowing the 10th and 90th percentiles can be helpful. A more sophisticated measure of wage dispersion would be the standard deviation.
Aging Data. Your wage surveys were most likely conducted and collated at different times making comparisons difficult. To correct this, all the surveys need to be aged to a common date. This most appropriate date is the one on which you plan to implement the new wage structure. This can be done by adjusting the wage rates from the date of the survey to the present using average annual salary adjustments that can be found in salary increase surveys such as provided by www.salariesreview.com. These salary increase figures may need to be collected for different types of jobs within the organization as all jobs do not increase in value the same.
Weighting Data. At this point you may have a number of average wage figures for each job depending on how many wage surveys you are using. The question now is whether these various figures should be weighted differently. If not, then the averages can be simply averaged to get the job average. If so, then there are some criteria for determining the weights to apply.
- Compensation Strategy. Wage surveys that focus upon your organizations industry will probably be seen as more important as the purpose of market pricing is to be competitive. Different jobs may have different weighting in this regard, as the appropriate labor market may change by the type of job.
- Quality of the job match. Those surveys whose jobs look most like your jobs should be weighted higher than ones that are merely acceptable
- Quality of Survey. Surveys with higher numbers of both companies and data points are better than those with small numbers. This is particularly true if the number of cases gets below 10 for any job.
Composite Market Rate
What then is the figure you want to put down for each job? You have gotten an average figure for each job from each of the surveys you are using. You have made sure that these averages are for the same time frame, the same job position and you have weighted the averages. These averages can now be averaged to produce what is called the composite market rate.
The purpose of salary planning is to pay a competitive wage. So what we need to do is to compare the various market wages developed from your wage surveys with the average wage paid to incumbents of the various jobs in your organization. In order to do this the first thing to do is to record the salary rate for each job in your organization; if there is a single incumbent it is their rate, or the average salary rate if there are a number of incumbents.
Comparing your average wages with the wage survey data is best accomplished by developing an index figure for each job. This market index would be the average wage for the job, divided by the market wage as indicated by the various salary surveys. This will provide an index number where 1 is a perfect match, any figure less than 1 is an indication that the job is paid lower than the market rate and any index value higher than 1 that the average wage in the organization is higher than the market rate. This index number needs to be examined in the light of a number of factors to determine the competitiveness of the organization's wages.
Job Characteristics. A few questions need to be answered about the job under consideration. These have to do with whether you expect to pay the job under consideration the composite market rate. The circumstances under which you may not wish to do so are:
- The job is very important to the organization in which case you may choose to pay over the average wage.
- The job is of little importance and you are willing to pay less than average and take the consequences.
- The job has high turnover, as in an entry level job where employees move up and do not stay long enough to be paid the composite market rate,
- The job has little turnover and the organizational training required is high, in which case paying the composite market rate or higher tends to guard your significant investment in these employees
Number of Incumbents on the Job. If there are only a few employees in the job, the chance of their average being an accurate average is low. So it is important to look at where the employees are in the wage range to adapt the composite wage rate.
Incumbent Characteristics. Where employees are in the wage range for a job should depend on a number of their personal factors such as seniority, performance, education and training, skill and ability. These variables will affect the index figure.
Salary Increase Analysis
The heart of salary planning is calculating the change, usually an increase in salaries, which the organization can plan for a future time period. The results of the competitive analysis discussed above are the basis for this decision process, and it shows how your organization stands vis-à-vis the labor market for your organizations jobs. A further source of information is to use a Salary Increase or Salary Budget survey for comparison. These types of surveys were described in Chapter 8. Adjustments to the organization's payroll costs can be done in a number of ways as discussed below.
General Increases. The competitive analysis provides information about average increases of other organizations. These figures could be used in two ways. The first would be to increase the salary of all jobs by that percentage. This would be the simple way out but probably not the best either competitively or equitably. A look at the data will probably indicate that this approach would give too much of an increase to some jobs and too little to others. So the second way to look at these figures is to say that the average increase in the organization will be this percentage, with some given more and some less. These variations may come from the competitive data already provided or from the characteristics and performance of individual employees.
Structure Adjustment. This average increase factor may also relate to adjusting the organization's wage structure. In general that change in the wage structure is less than the total salary increase percentage. This makes room in the salary increases for the time period of merit pay increases as well as general increases. Adjusting the wage structure means moving the pay policy line that in turn changes the minimum, midpoint and maximum of each pay grades' range by a set percentage. Employee increases would have to be at least the percentage of the structure adjustment in order to maintain their position within the pay grade.
Compa-Ratio. This method incorporates the ability to give varying amounts to different organizational units as well as individual employees. The compa-ratio indicates how the salary level of an employee or group of employees compares with the midpoint of the pay range OR with the average wage for a position in the general labor market.
A compa-ratio of 1 indicates that the employee's pay is the same as the midpoint of the range. The formula for the compa-ratio is:
Compa-ratio = average rate actually paid / midpoint of the range
If the compa-ratio is a figure such as 1.06, the average of the wages paid in that pay range exceeds the midpoint. The reason to focus on this statistic comes from the assumption that the midpoint of the pay range is where the "average" performer is to be paid. Given a number of people in a pay range, the average should therefore be the midpoint of the range.
A compa-ratio of more than 1 can be the result of:
- a conscious decision by the organization to pay above average
- long tenure of people in the pay range
- superior performance of these people
- a number of other reasons
A high compa-ratio is a signal that things need to be looked at not that things are wrong.
A compa-ratio strategy assumes that each organizational unit should have an overall average wage rate, and that this rate should be the midpoint of the pay range. So, those units with a compa-ratio lower than 1 would be allowed to receive higher increases than those with current compa-ratios of more than 1. However, it isn't necessary to strive for or to achieve a compa-ratio of 1 in all organizational units. The organization as a whole may wish to have a compa-ratio of more or less than 1, depending on its pay-level policies. In addition, the organization may wish to keep one or more units' compa-ratios over 1 and others under 1 for reasons such as importance of the function to the organization or competition for those skills in the labor market.
Merit Pay. The remainder of the salary increase percentage goes into merit pay. There are two very different connotations of merit pay.
- Pay-for-Performance. This form of merit pay is based upon the organization's performance appraisal system. Those employees whose performance is very good receive higher increases than those whose performance is not as good. Place in the pay range also affects the size of the increase. The higher the employee is in the pay range the harder it is to get a substantial increase. Using Pay-for Performance has the same characteristics as general increases, the increase is built into base pay and becomes a fixed cost. See Chapter 13, for a more complete discussion.
- Variable Pay. This alternative consists of paying bonuses and other incentives that organizations develop to reward individual and organizational success. These rewards are a variable cost in that they're high when the organization is doing well and low or non-existent when the organization does poorly. Bonuses are paid based upon measurable performance standards, so the possibility of gain is tied to the possibility of loss. If things go well, the employee earns more money; but if things go poorly, the employee's pay suffers. This alternative is the subject of Chapter 15. Organizations that stress variable pay usually devote a larger portion of their salary increase amount to it and have smaller general increases.
Cost of Living. Another alternative to determine wage rates is to use the cost-of-living to grant salary increases. The cost of living is determined by the demand for and supply of goods and services as opposed to the supply and demand for labor. When demand is high, the cost of that good or service goes up and the opposite occurs when supply is high. But not everyone uses the same goods and services thus the cost of living for a particular person or family depends upon where they spend their money. A person who has lived in a house for over 30 years and has paid off the mortgage has a very different cost of living than a person who has just purchased a new home. Each geographical area has a different cost of living. One can find these differences in ERI's Relocation Assessor or the combination of wage rates and cost of living in the Geographic Assessor.
Consumer Price Index (CPI). The government keeps track of the cost of living through the Consumer Price Index (CPI). This index is a market basket of goods and services most likely to be used by the average family. The CPI is also the figure most likely to be seen or used by someone who feels that wages should be adjusted by the cost of living. But as pointed out, each person differs in how the factors in the market basket affect their personal cost of living. The change in the CPI during a set time period determines what the salary increase percentage is to be used if cost-of-living is the standard to use.
To re-iterate, the cost-of-living and the cost of labor are not the same thing. They are based on different data and there is no consistent relationship between the two. So if the goal of doing the salary planning is being competitive in the labor market using the cost-of-living is not an accurate measure. In times of high inflation there is considerable pressure to use the cost-of living as a measure but that is exactly the wrong time to do so as it makes the organization non-competitive in the marketplace.
Internal Organizational Forecasting
To start the process of calculating the costs of increases in the budget and the practicality of the proposed increases, a number of internal organizational factors need to be considered.
When determining salary raises, you should first look back at your organization's past and present salary increases. Employees develop expectations based on what the organization has done in the past. Providing employees with at least the same increase amount as they received in past years will probably be satisfactory to them.
However, the organization may choose to make a statement about the future by changing the amount of the salary increase. This may be related to the realities of the economy or the company's financial condition. Larger increases signal that the organization wants to retain employees and (depending on how the increases are distributed) is interested in high performance. A review of past salary increases can also identify errors that need to be corrected through future salary adjustments.
Ability to Pay
Most organizations claim that the ability to pay is the crucial variable in determining salary increases. The problem with this is that there is no common definition of what the ability to pay is. As one Human Resource executive said:
"Ability to pay is whatever the financial officer says we can afford."
The point is that there is no common measure of the ability to pay.
Actually ability to pay is a composite of the economic forces facing a firm. As such, it involves decisions on how profits should be measured, against what standard (net worth or sales), and over what period of time. It also involves determining an appropriate rate of return and resolving any issues, such as product development, product mix, and pricing policy, that most affect profits.
Labor Costs. The organization is concerned with the costs of the total wage bill created by hiring and retaining employees. In order to determine this, the organization must make estimates of which employees will stay with the organization, which job rates these employees will have, which employees will leave the organization, their pay rates, and which new employees will have to be hired and the pay rates of these employees. This information is required due to how growth, decline, and turnover change the average wage bill of the organization and its subunits.
Growth and turnover
Decline and slow turnover
Growth and turnover generally lower the average wage. This is because new employees are hired at or near the bottom of the pay range, whereas senior employees are at or above the midpoint of the pay range.
Decline and slow turnover have the opposite effect. If there is no growth and no turnover, the average wage of the group will move upward by at least the amount that the wage structure was adjusted.
Turnover. What turnover will take place? This is hard to estimate in each organizational unit, but easier to do at the overall organizational level. In general, new employees brought in to replace old employees are hired at lower rates than the former employees had attained. So, turnover tends to lower average wage costs. This factor is called churn or slippage.
Here's the calculation:
annual turnover x planned average increase = slippage
Here is an example of slippage:
An organization's annual labor cost is $2,300,000, and its planned salary increase rate is 4%.
annual labor cost X planned increase % = planned salary increase
$2,300,000 x 4% = $92,000
The turnover rate is 20%. So, the turnover effect or slippage is 0.8%.
annual turnover X planned average increase = slippage
20% x 4% = 0.8%
This means that the planned increase of $92,000 can be reduced by $18,400 to equal $73,600.
annual labor cost X slippage = reduction in salary increase
$2,300,000 x 0.8% = $18,400
planned salary increase - reduction in salary increase = true salary increase
$92,000 - $18,400 = $73,600
Technological Change. Another set of changes that can have a considerable effect on the average wage bill are technological changes. Growth and decline resulting from technological change is like any other change unless the skills now required are different. If skill levels rise with the technological change, the average wage bill may rise even if the total number of employees declines. Typically, however, the average skill level does not change dramatically with technological change, but the distribution of skill changes considerably. Computerization in particular seems to have more higher- and lower-skill requirements and fewer midrange requirements. Thus, even if the average wage of the group does not change, the pressures placed upon the wage structure increase.4
Salary saving. Some organizations also engage in a budget practice called salary saving. Each time an employee quits, it takes a certain amount of time to replace him or her. During that time, that particular position isn't costing the organization any money. Since you can calculate the average time it takes to replace an employee, this savings can be used to reduce the total cost of salary increases.
In hard times, organizations sometimes purposely force jobs to be held open for a planned period of time to reduce overall labor costs.
Retirement. Labor costs also may be impacted both negatively and positively by an early retirement plan that reduces employment. Early retirement increases retirement program costs, while average wage and benefit costs may go down as a younger workforce remains.
New employees are often not eligible for a wage increase for a certain time period (such as six months). Conversely, some employment contracts state the individual must be given an automatic increase at some similar period depending on organizational policy.
Another major decision is whether this increase covers only core employees or includes contingent employees. If all employees receive a wage increase, division of the available funds must be spread further and each employee must receive only from the available portion or the organization will experience a higher overall increase.
To refine the salary increases to be given and to fit them into a coherent whole that is consistent with the organizations operations requires the development of a salary budget. This budget can be developed from the bottom up or top down.
Bottom up. In this approach the organization has each supervisor indicate the wage change that will be assigned to each employee during the year. These changes are then reviewed up the organizational ladder for congruence with pay level and structure policies and the amounts summed to find out the total change in wage costs.
Top-Down. A second approach to budgeting is from the top down. In this approach an overall amount of change is dictated for the organization as a whole, and this change in turn is apportioned to each organizational unit. This may, in fact, take place through a number of organizational levels so that the allocation process may be done a number of times with smaller and smaller amounts. Each manager ends up with a given amount of money to allocate to wages, or more likely a percentage by which last year's wage costs may change. The product is again the proposed wage rate for each employee. When the product is a percentage, the organization starts with the change in wage structure and accounts for the factors that were discussed above in adjusting the percentage to a planned level rise.
An alternative to this method that incorporates the ability to give varying amounts to different organizational units is to budget by using each organizational unit's compa-ratio. This approach assumes that each organizational unit should have an overall average wage rate, and that this rate should be the midpoint of the pay range. Those units whose compa-ratio is lower than 1 would be allowed to give higher increases than those who at present have a compa-ratio of more than 1. However, it is not necessary to strive for or achieve a compa-ratio of 1 in all organizational units. The organization as a whole may wish to have a compa-ratio of more or less than 1 depending on its pay level policies. In addition, the organization may wish to keep one or more units' compa-ratio over 1 and others under 1 for reasons such as importance of the function to the organization or competition for the skills in the labor market.
The last decision is the Action Date, the date the increases are to be implemented. The timing of these increases affects both the competitiveness of the organization in the labor market and the cost of salary increases for the year. In this salary planning process there have been two types of wage information. The first is from wage surveys, mainly of current wage rates for jobs. As you have seen, even these have had to be updated to a specified salary planning date. Responding to this set of data will make the organization competitive at this point in time.
A second set of wage data is the planned organizational increases of other organizations for the coming year. These data indicate what changes your organization needs to take to be competitive throughout the year. This is a bit more complicated and leads to three possible strategies for making salary increases. These three strategies, varying from lagging the market to leading the market, have been discussed as wage level strategies.
The cost of the salary increases is also affected by the date used. Assuming a yearly budget starting the first of the year, a 5% increase on January 1 amounts to a 5% increase for the year in that employee's salary. But a 5% increase given on July 1 provides just a 2.5% increase for the year. It would build, however, to 5% for the next year.
Not all organizations give all salary increases at the same time. Some give increases once each year, while others give increases on anniversary dates of when employees were hired or placed on the current job. Giving increases at the same time can simplify things considerably in terms of budgeting. However, this approach can also create problems when employees are hired or placed on jobs at different times during the year.
A final reminder needs to be interjected here. This discussion has dealt with direct wage costs, and the budgets are for those costs. In order to develop total wage costs of the organization, the indirect or benefit costs must be added in. These are often hard to coordinate with the direct costs at the unit level because benefits are not allocated in the same manner as are direct costs. Managers in this situation often feel that an added burden is being placed on them over which they have no control.
Control is the process of seeing that the plans that have been developed are carried out. It is an after-the-fact process in that it reviews what went on to see if it conformed to the plan. The formal control process in organizations involves (1) establishing a standard of performance and a measure of that performance, (2) comparing actual behavior with the standard, and (3) taking corrective action if there proves to be a difference between the two.5 The first step, establishing standards, is what was done in our discussion of planning; the plan is the standard since that is what we want to have happen. If the plan has been formalized there should be sufficient measurement standards to provide for comparisons.
Actual behavior that needs to be monitored is of two types, external and internal. In developing the compensation plan, a number of assumptions or forecasts were made of the labor market, particularly the rate and type of change in wage rates. The actual changes need to be monitored to see if the predictions were accurate. The internal information is of two types: 1) that dealing with the accuracy of internal forecast assumptions, such as turnover, and 2) that dealing with the behaviors that take place as a result of acting upon the plan. These two sets of internal information also need to be monitored.
The purpose of the monitoring is to make a comparison between the plan and the action. But any further action to take, assuming that the two do not match, depends on where the differential occurs. If the action that is supposed to take place under the plan is not occurring, then the behavior in question needs changing. But if at the same time the assumptions upon which the plan was devised also show a differential, it is most probable that the behavior is correct and that it is the plan that needs to be changed. Plans should be guides to action and not rigid prescriptions set in stone.
Finally, this change in the plan represents a closing of the planning and control cycle. The examination of what has happened is, in fact, the same as the first step in the planning process. So planning and control are not done once a year and then forgotten, but rather constitute a continuing process carried out along with the daily activity of compensation.
Methods of Control
Organization control of the compensation program emphasizes the three decision areas of wage level, wage structure, and individual wage determination.
Wage level control
Control measures for wage level are both external and internal. The external control standards have to do with whether the organization is remaining competitive. In some cases this means doing spot checks of a wage survey to see if the market is behaving as expected. An internal indicator that is often used as a signal is the turnover rate, overall or particularly in important job titles. The beginning of a rise in these turnover figures is a signal to find out what the changes in wage rates really are. The problem with this is that it is unidirectional; it tells the organization when the market has gone up faster than planned but not when it is going up slower than planned.
Internal wage level control takes place through total payroll expenditures and comparisons between the budgeted payroll amounts and actual payroll expenditures. As indicated, a discrepancy does not necessarily mean that expenditures must be reduced; it can mean that the assumptions of the plan were inaccurate. One problem here is that expenditures can be brought down in the future but not in the past. So over-expenditures, if the organization were to insist on a return to the original budget levels, would logically require lower expenditures than planned for the remainder of the budget period.
Job and wage structure control
Wage structure control involves determining if the relationships between jobs in the organization are proper and reflect the values intended by the organization. Perhaps the ultimate standard for wage structure control is employee acceptance of internal pay relationships.
Measurement of wage structure control is not as easy as that of wage level control since the wage structure, being predicated upon the job structure of the organization, provides a framework for the planning process but is not a direct part of the planning.
Periodic audit of job evaluation is one way of finding out if job relationships are sound. Wage survey results may be signals that the nature of jobs has changed or that relationships need altering due to market forces. Complaints about job evaluation in the form of requests for reclassification of jobs or grievances in a union setting are signals of wage structure anomalies.
Perhaps the biggest problem in the job structure is grade creep. This is a direct result of these requests for reclassification. This is often used by managers to pay a valuable employee more money than the structure allows. But as one job is reclassified, another manager will decide his or her jobs are underpaid in relation to the newly reclassified job and so request reclassification. This leads to a spiral of changes in the evaluation of jobs, which eventually moves all jobs into a higher grade. On the other hand, requests for re-classification may represent honest changes in the job that need to be recorded and rewarded.6
Two final aspects of control, having to do with jobs, are the total number and types of jobs. Both have a considerable influence over the total wage bill. Organizations appear to have an inevitable drift toward overstaffing. Control of this can be done mainly through examining the relative percentages of expense devoted to different organizational activities over time.7
Control of individual pay
Control of individual pay rates involves ensuring that employee's pay is fair and within the guidelines established through the budgeting process. Most of budgeting has to do with individual pay determination, making this area the most developed for control purposes. The reasons for this are that (1) this part of the control process is clearly distinct from general management controls, (2) uncontrolled individual pay decisions have large cost and equity implications, and (3) this is an area that is rather easy to control.
Decisions about individual pay occur both when the employee is first hired and at the time of subsequent changes. These decisions include both the amount and the timing of such changes. The amount of pay the person is offered at the time of hiring is governed partially by the job, particularly the minimum of the pay range for the job, as well as conditions/constraints of the local job market. But this is also a time when the personal qualifications of the individual are a prominent consideration.
Decisions regarding pay after hire are a result of a complex set of policies about pay level, pay structure, and individual pay determination. In the last category in particular, the criteria for movement within grade (Chapter 13) are important. The measurement of control of individual pay is the position of the individual in relation to the pay range. Again the compa-ratio is a useful measure when the individual's pay is used as the numerator.
Most organizations have specific rules for employee pay raises. These can include not only periodic pay adjustments but also hiring rates and all pay movements within the organization. These guidelines usually specify minimum increases, sometimes maximum increases, and the frequency of these increases. The higher the level of the job in the organization, the larger and more frequent the pay increases.
Most organizations also have policies regarding wage increases as a function of promotion. These guidelines usually specify that the new rate be at least the minimum of the pay grade and a specified minimum and/or maximum over current salary. Many organizations also have ground rules for demotion. One alternative is to reduce the employee's pay to the maximum of the new pay grade immediately. Another is to freeze the employee's present pay rate as a red-circle rate and wait for the adjustments of the pay structure to bring the employee's pay into range. (See Chapter 13)
Although organizations appear to believe that individual pay increases are designed to provide performance motivation, a review of the control process for these increases shows mixed evidence of channeling employee behavior toward increased performance. Although most organizations use the term merit to describe the basis of pay adjustments, there is little in the control process to ensure that large pay increases go to the best performers and small or no increases to poor performers. Even if this is the case, there is no way of knowing if the employees perceive this connection.8
These individual pay decisions are most often the purview of the individual manager. There are a number of pressures on managers that make it difficult for them to successfully carry out this connection between performance and reward. In particular, there is the problem that under the budget process, giving a large increase to one employee automatically means a reduction in the amounts available to others. This competitive situation is antithetical to the development of cooperation within the work group.9
Variable Pay Plan Control
A properly designed incentive plan that utilizes variable pay, makes control easier because the control is built into the program and can rely less on organization control and more on self-control. The mechanism for feedback to the employee is immediate, so there is no trouble with perceptions of the performance-reward connection. Performance standards and the measurement of the standard are an integral part of the design of the incentive program and so are much more advanced than in other compensation practices. In addition, most incentive plans develop further standards for monitoring the program on an ongoing basis. It is important to point out that variable pay plans are contracts with employees that need to be met both for morale and legal purposes.10
No area of compensation has as great a need for control as benefits. The problems of benefit costs were discussed in Chapters 20 and 21. Most of the problems in this area have been perceived as uncontrollable. That is, they are a function of the environment and not of the organization. However, as pointed out, much of the current situation in benefits derives from the unplanned way in which they were developed in the past. So, much of the problem of control is more correctly seen as a failure to plan. Benefits are not technically difficult to control from a measurement standpoint. It is the forecasting and acceptance of the forecasts that are difficult. Where forecasts are unacceptable, the organization is required to take a proactive stance and make changes. This is exactly what is happening in the field of benefits, as organizations seek alternatives that reduce the cost of benefits (such as splitting the cost of employee health insurance premiums with the employees).
RESPONSIBILITY FOR COMPENSATION ADMINISTRATION
Compensating employees is a managerial process that requires considerable expertise. This skill is not typically one that most managers possess. Thus, it is likely that much of the work and decisions of compensation in any good-sized organization will be performed by a compensation staff. On the other hand, compensation requires many decisions that a staff group is not in a position to make. Since the goal is to determine a pay rate for the employee, it is the employee's manager who has the necessary information. Also, since compensation is a major motivational tool, the determination of compensation should be seen as emanating from the manager.
Further, many compensation decisions involve considerable costs that affect the economic health of the entire organization. For these decisions top management needs to be involved so that compensation is integrated into the overall planning of the organization. Compensation, then, requires decisions to be made by staff and all levels of management working together for an optimum program to operate in the organization.
As in all staff-line situations, compensation can create a good deal of organizational conflict. The goals of line managers and the compensation staff are quite different, and this can lead to each party feeling that the other does not understand the situation. The compensation staff members are assigned the task of collecting the necessary labor-market information in order to decide the wage structure and the task of administering the policies of top management. Line management, on the other hand, while given compensation policies, is directed to accomplish the mission of its organizational unit. These two different sets of direction from top management invariably conflict with each other, creating the feeling among managers that compensation is some sort of black magic done behind closed doors and a corresponding feeling among the compensation staff that line managers are trying to subvert the compensation program to solve their short-run motivation problems.
Although this staff-line conflict can never be completely solved, it can be lessened and controlled. First, the roles of each party can be spelled out, and in the rest of this section this is further explored. Second, all parties need to recognize that each has special knowledge that the others do not, and that decisions are best made where the information comes together. Third, the compensation staff has a greater burden in reducing this conflict, by educating line management so that compensation decision making is a less mysterious process.
Top management has ultimate responsibility for the total compensation program. But this is delegated partially to line management and partially to the compensation staff. Typically, the compensation staff are delegated the task of developing and maintaining a compensation program, whereas line management makes the pay decisions within the program's guidelines. Top management is more involved in certain aspects of compensation decisions than in others. All policy areas are, or should be, the decision of top management. Thus, top management will be more involved with pay level considerations than with wage structure or individual pay decisions, since the pay level decision sets the framework for these other decisions.
Even if top management does not directly make all compensation decisions it needs to exercise a control function. This is done in a number of ways.
Approval. Obtaining approval calls for assent to action before the action is to take place. The chief advantage of this approach is that it ensures that policies are followed as top management wishes them to be. Clearly this approach is limited, since if all decisions in organizations were made in this manner there would be little need for support staff or lower-level managers, and top management would be completely overwhelmed with decisions to approve. Also top management does not always have the appropriate information, such as individual performance data. This approach should be reserved for those decisions top management feels are most important and of a policy nature.
Statistics. A function of the compensation staff is to provide statistical information to top management, which records compensation activities and results. Analysis of these reports can often be a source of standards. Even in the absence of standards, reports often suggest problem areas to be explored before they get out of hand. These reports are best at appraising actions that have already taken place.
Budgets. The budget allows top management to delegate the day-to-day decisions while maintaining the all important control over the cost of labor. Budgetary controls permit measurement against a standard before decisions are made. Budgets are the best way to control the individual pay decisions without having to scrutinize each decision.
Compensation Policies and Procedures. These instructions are intended to help individual managers make sound and consistent compensation decisions regarding their employees. This approach requires carefully developed policies and procedures known and understood by line managers. It also requires training managers in the organization's objectives in compensation. Furthermore, all line managers are provided information they need to make compensation decisions, the time to make them, and the staff to help them. Finally, all line managers are held accountable for the compensation decisions they make.
The emphasis that top management places on these various approaches differs widely by organization. Budgets and policies can be viewed as opposite methods. Some organizations require both be followed by all managers. Others focus upon one method or the other. Since control of labor costs is so important, budgetary enforcement is probably dominant and policies more often are viewed as the best way to stay within budget. In compensation it is extremely important that the employees receive consistent signals as to what is desired and what to expect. So coordination and consistency are important goals.
The major decisions made by the line managers are the individual pay decisions for their employees. In addition, where there is a bottom-up budgeting system, the line manager is involved in establishing the budget for his or her unit. These decisions are constrained by the policies and procedures established by top management and the compensation staff. Very often these constraints leave line managers feeling that it is impossible to reward their employees in a way that will obtain the motivational results they desire.
The major problem with line managers making these individual pay decisions is consistency. If the policies and other control techniques are strong enough to ensure consistency, then the individual manager does not have enough discretion to adequately discriminate among the various performances that take place in his or her unit. But unless there are very clear performance standards established and communicated in the organization, each manager is free to interpret performance as he or she sees fit. Given the state of the art in performance appraisal, consistency will continue to be a problem and the discretion of line managers will not be highly compromised.
Line managers are also concerned with job evaluation, because this has a major impact upon the wage rates of their employees. In this area, however, it is not typical for the line manager to have the final decision. The manager's job is most often that of designing the job; the compensation staff then determines the appropriate pay range for the job. This can lead to considerable jockeying of job tasks in an organizational unit solely to obtain the job rates that are desired.
The compensation staff is the people who have expertise in compensation and can carry out the technical functions of the area. These technical functions are expanding each year and becoming more complex. Nowhere is this more evident than in benefits administration. The passing of time has seen this area go from a neglected one to an area that, well managed, can save the organization millions of dollars a year in costs. Further, changing legal patterns are making it necessary for organizations to have compensation expertise available in order to make sure that decisions made about compensation are legal.
The technical functions that compensation professionals typically carry out are performing job analysis and evaluation, conducting and analyzing wage surveys, developing and adjusting the wage structure, and of course advising line and top management on compensation matters. Clearly these decisions involve mainly the job and wage structure decisions of the compensation program. They set the framework for the decisions made by the line managers, so line managers can easily feel frustrated unless they understand what it is the compensation specialist is doing.
The compensation staff has a large role in the planning and control processes. The information needed for developing compensation plans is centralized in the compensation staff. They are also the group that has the time for and interest in developing these plans. Often the policies of top management are results of the compensation staff's efforts. Most statistics and other information about compensation are provided by the compensation staff. To the degree that information is power, the compensation staff can develop power by the way they handle the information available to them. Control in the area of job structure is the most noticeable, since the standards are well developed, usually by the compensation staff. Control in the area of individual pay decisions is possible but for political reasons is often not well developed.
The compensation staff also has an important role in coordinating efforts with other staff groups. In particular three groups are important. The first is the financial staff. This is a result of the budgetary process, since the finance department is ordinarily in charge of budgets and the financial resources of the organization are controlled by this staff group. Second, as indicated earlier in this chapter, much of the information for internal forecasting comes from human-resource planning. These other parts of personnel are important information resources for the compensation staff. This relationship is reciprocal, since employment needs the input of compensation in order to carry out its function. Lastly, in those organizations that have a union, coordination between the compensation staff and labor relations is very important. The union contract represents one more level of constraint on how compensation decisions are made in the organization.
Clearly managers and staff have different roles in different compensation decisions. Top management is most concerned with pay level decisions in order to maintain organizational competitiveness, oversee workers and generally control other decision areas. Line managers are most concerned with the actual pay rates of their employees in order to keep and motivate them. The compensation staff is concerned mainly with developing a framework within which to make compensation decisions, collect information for use in compensation decisions, and oversee the total process within the organization. These different roles are summarized in the figure below.
Relationships of top management, line management, and the compensation staff in compensation decisions
The pieces of the organization's compensation program and the various influences on those parts have been discussed in each chapter of this book. These pieces must be put together into a coherent whole that accomplishes the goals of compensation. The goals of any compensation program must be to provide a system that is perceived as fair, and that can attract and retain quality employees. It must also motivate those employees to produce and contribute extra efforts at a level required by the organization. All this needs to be done with an eye to keeping costs at a minimum.
Compensation programs of different organizations will and should be different. Each organization must develop a compensation strategy and practices that fits its circumstances. Compensation planning takes off from the strategic decision of the wage level and the goal of controlling labor cost.
Salary planning is at the heart of compensation planning. This is usually a yearly process in which the organization examines the labor market through wage surveys and compares this to the current wages being paid in the organization. The comparison usually leads to a plan that increases wages by some percentage. This may not be a standard for each and every job, however, so there is a process to distribute increases that try to meet the motivational and equitable needs of employees and supervisors while keeping control of labor costs.
Control of compensation is needed to see that things go as planned or that plans can be changed to accommodate changes in the environment. Achieving control is difficult, since there are so many different control procedures and the information needed is not always present. Control processes differ considerably depending on whether the control is on wage level, wage structure, or individual wage rates. Control of this latter entity is particularly difficult, since it is so decentralized within the organization.
The compensation program is not the total responsibility of any one group in the organization. Top management must be involved in establishing the goals and policies of compensation. The compensation staff provides the expertise and can do the technical aspects of compensation. The supervisors are the people who see that the system is perceived as fair and motivates their employees. All three must be working together for a compensation program to achieve its goals.
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||The four categories that follow were taken from R. E. Sibson, Compensation, 5th ed. (New York: American Management Assn., 1990.
Internet Based Benefits & Compensation Administration
Thomas J. Atchison
David W. Belcher
David J. Thomsen
ERI Economic Research Institute
Copyright © 2000 - 2013
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HF5549.5.C67B45 1987 658.3'2 86-25494 ISBN 0-13-154790-9
Previously published under the title of Wage and Salary Administration.
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reverted rights from the Belcher Scholarship Foundation and Thomas Atchison.
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