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Defining Competitiveness

External Competitiveness: Determining the Pay Level

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COMPENSATION

TWELFTH EDITION

Part Three

Chapter Seven

MILKOVICH │ NEWMAN │ GERHART

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Overview

Chapter seven explores the second part of the pay model, external competitiveness.

What shapes external competitiveness?

Labor markets, modifications to supply and demand, product market factors and organization factors.

Competitive pay policy alternatives are discussed as well as consequences of pay level and pay mix decisions.

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External Competitiveness

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External competitiveness

The pay relationships among organizations – the organization’s pay relative to its competitors.

Pay level

The average of the array of rates paid by an employer: (base + bonuses + benefits + value of stock holdings) number of employees

Pay mix

The various types of payments, or pay forms, that make up total compensation.

Compensation Strategy: External Competiveness

External competitiveness is expressed by:

setting a pay level that is above, below, or equal to that of competitors; and

determining the pay mix relative to those of competitors.

Pay level and pay mix decisions focus on two objectives:

control costs and increase revenues, and

attract and retain employees.

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Control Costs and Increase Revenues

Labor costs = (pay level) X (# of employees)

As pay level increases, labor costs increase.

Not all organizations pay the same rate.

The pay strategy should translate into revenues exceeding the cost of the strategy.

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Attract and Retain the Right Employees

There is no “going rate” in the labor market for a specific job.

A single company may differ pay levels for different job families.

How a company compares to the market depends on:

what competitors it compares to, and

what pay forms are included.

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EXHIBIT 7.5

What Shapes External Competitiveness?

These factors act in concert to influence pay-level and pay-mix decisions.

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Labor Market Factors

Economists label two market types:

The quoted price.

Example – stores that label each item’s price or ads that list job opening’s starting wage.

The bourse.

Example – stores that allow haggling until an agreement is reached, ebay is an example.

In both market types, employers are buyers and potential employees are sellers.

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How Labor Markets Work

Four basic assumptions:

Employers always seek to maximize profits.

People are homogeneous and therefore interchangeable.

Pay rates reflect all costs associated with employment.

Markets faced by employers are competitive.

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EXHIBIT 7.6

Supply and Demand for Business School Graduates in the Short Run

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Labor Demand

If $40,000 is the market rate for business graduates, how many will a specific employer hire?

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The answer requires an analysis of labor demand

The marginal product of labor is the additional output associated with the employment of one additional person, with other production factors held constant.

The marginal revenue of labor is the additional revenue generated when the firm employs one additional person, with other production factors held constant.

Marginal Product

Diminishing marginal productivity means

each additional employee has a progressively smaller share of production factors to work with.

e.g., office space, number of computers, telephone lines and hours of clerical support.

Until these factors change, each new hire produces less than the previous hire.

The amount each hire produces is the marginal product.

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Marginal Revenue

Marginal revenue is the money generated by the sale of the marginal product.

Employers seek to maximize profits.

So, the employer will hire until the marginal revenue equals the costs associated with the most recent hire.

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EXHIBIT 7.7

Supply and Demand at the Market and Individual Employer Level

This shows the connection between the labor market and the conditions facing a single employer.

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Marginal Revenue

Managers using the marginal revenue product model must do two things.

Determine the pay level set by market forces, and

Determine the marginal revenue generated by each new hire.

The model provides an analytical framework, but it oversimplifies.

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Labor Supply

The assumptions about the behavior of potential employees are oversimplified.

Many people are seeking jobs,

they possess accurate information about all job openings, and

there are no barriers to mobility.

As assumptions change, supply changes.

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Modifications to the Demand Side

Economic theories must be revised frequently to account for reality.

At issue for economists:

Why would an employer pay more than what theory states is the market-determined rate?

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EXHIBIT 7.8

Labor Demand Theories and Implications

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EXHIBIT 7.8

Labor Demand Theories and Implications

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Compensating Differentials

If a job has negative characteristics, then employers must offer higher wages.

Such compensating differentials explains the presence of various pay rates in the market.

Difficult to document.

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Efficiency Wage

According to efficiency-wage theory, high wages may increase efficiency and actually lower labor.

The underlying assumption is that pay level determines effort.

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Attracts higher-quality applicants

Lowers turnover

Increases worker effort

Reduces “shirking”

Reduces the need for supervision

Efficiency Wage

An organization’s ability to pay means firms with greater profits than competitors can share this success with employees.

Rent is a return (profits) received from activities in excess of the minimum (pay level) needed to attract people to those activities.

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Sorting and Signaling

Designing pay levels and mix as a strategy that signals to employees what is sought.

Employer signals include pay level and mix.

Employee signals include better training, education, and work experience.

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EXHIBIT 7.9

Labor Supply Theories and Implications

These theories focus on understanding employee behavior: the supply side of the model.

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Modifications to the Supply Side

Additional factors affecting labor supply:

geographic barriers,

union requirements,

lack of information about job openings,

the degree of risk involved,

the degree of unemployment, and

nonmonetary aspects of the job.

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Product Market Factors and Ability to Pay

Product market conditions determine what an organization can afford to pay.

Two key product market factors are:

Product demand – caps maximum pay level.

Degree of competition – highly competitive markets are less able to raise prices.

Other factors include the productivity of labor, the technology employed, and the level of production relative to capacity.

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A Different View: What Managers Say

Level of unemployment made no difference.

Profitability is considered when budgeting pay but not considered for individual pay adjustments.

Poor management disrupts attracting and keeping employees, not inadequate compensation.

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Exhibit 7.10

Sources of Nurses

This is a case of people flowing to the work. The hospital cannot send its nursing work to other cities or other nations.

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Work Flows to the People On-site, Off-site, Offshore

Organizations can source employees from on-site, off-site or offshore.

Which source depends on:

customer preferences, time schedules, and the nature of the work.

Three points to remember:

Reality is complex.

Understand market conditions to set pay level.

Managers must bundle tasks to different locations.

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Organization Factors

Industry and technology.

Labor intense industries pay lower than technology intense industries.

New technology influences pay level.

Employer size.

Large firms pay more than small firms.

People’s preferences.

Difficult to measure.

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Organization Factors

Organization strategy.

Low-wage, no-services strategy.

Low-wage, high-services strategy.

High-wage, high services strategy.

May differ within a single organization.

Higher wages must bring something in return.

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Relevant Markets

Managers define relevant markets by:

occupation, geography, and competitors.

Data from product market competitors receives more weight when:

employee skills are specific to product market,

labor costs are a large share of total costs,

product demand is responsive to price change,

labor supply is unresponsive to pay changes.

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Globalization of Relevant Labor Markets

Some jobs lend themselves to offshoring.

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Consider these factors when deciding job location

Assure labor savings are not neutralized by lower productivity.

Devote resources to monitor output.

Consider customers’ reactions.

How long will the labor cost advantage last?

Competitive Pay Policy Alternatives

Conventional pay-level policies are to:

lead, meet, or follow competition.

Newer policies emphasize flexibility.

What difference does the pay-level policy make?

The basic premise is it affects performance.

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EXHIBIT 7.12

Probable Relationships Between External Pay Policies and Objectives

The problem with much pay-level research is the focus on base pay, ignoring other forms of pay.

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Pay with Competition (Match)

The most common policy is to match rates paid by competitors.

A pay-with-competition policy tries to:

match wage costs to product competitors, and

attract applicants equal to the labor market competitors.

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Lead Pay-Level Policy

Maximizes the ability to attract and retain quality employees, and

minimize dissatisfaction with pay.

It may offset less attractive job features.

Linked to reduced turnover, quit rates and absenteeism.

Negative effects include the need to increase current employees wages and it may mask negative job attributes.

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Lag Pay-Level Policy

Paying below market rates may not attract employees unless coupled with higher future returns.

The combination may:

increase employee commitment, and

foster teamwork,

which may increase productivity.

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Different Policies for Different Employee Groups

Employers may vary policy for:

different occupational families,

different forms of pay, or

different business units.

Pay-mix strategies may be:

performance driven,

market match,

work/life balance, and

security.

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EXHIBIT 7.16

Pay-Mix Policy Alternatives

How managers position their organization’s pay against competitors is changing.

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Employer of Choice/Shared Choice

Risks include employees making the “wrong” choices and offering too many choices causes confusion, mistakes, and dissatisfaction.

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Employer of Choice

Corresponds to the brand the company projects as an employer.

Shared Choice

Begins with traditional options of lead, meet, or lag.

Offers employees choices in the pay mix.

EXHIBIT 7.17

Volatility of Stock Value Changes Total Pay Mix

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EXHIBIT 7.18

Dashboard: Total Pay Mix Breakdown vs. Competitors*

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EXHIBIT 7.20

Some Consequences of Pay Levels

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Consequences of Pay-Level and -Mix Decisions: Guidance from the Research

Efficiency.

No research suggests under what circumstances managers should choose which pay-mix.

Pay level may not gain any competitive advantage.

Wrong pay level may be a serious disadvantage.

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Consequences of Pay-Level and -Mix Decisions: Guidance from the Research

Fairness.

Satisfaction with pay is directly related to pay level.

A sense of fairness is related to how others are paid.

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Consequences of Pay-Level and -Mix Decisions: Guidance from the Research

Compliance.

Employers must pay at or above the legal minimum wage.

Prevailing wage laws and equal rights legislation must be met.

Pay forms are regulated.

Caution must be exercised when sharing salary information.

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Summary

Chapter seven explored the second part of the pay model, external competitiveness.

What shapes external competitiveness?

Labor markets, modifications to supply and demand, product market factors and organization factors.

Competitive pay policy alternatives were discussed as well as consequences of pay level and pay mix decisions.

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Discussion 1 – 4

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CONTACT US

E MAIL:

Archive

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