Pay tactics of low-wage and high-wage organizations.
"How much do we have to pay in order to attract more machinists for the
new project?"
"The policy of this
company is to be 10 percent above the market. You make sure that we
are!"
"But this survey in our
professional journal indicates that we are 15 percent below the market.
How can you say we are paying market rates?"
"Boy, this pay raise isn't
even up to rise in the cost of living!"
"With whom should we
compete for workers?"
"Do we need the best
workers, or can we get along with average ones?"
All these questions and
comments have to do with how the compensation practices, levels, and
strategies of an organization are decided.
The compensation and benefit
level is the average compensation paid to employees. This has two
implications. The first is external: how does the organization compare
with other organizations? This question is a strategic one of how the
organization wishes to position itself in the marketplace. The second
implication is internal. The average compensation is a reflection of the
total compensation bill of the organization. Labor is one of the
claimants on organizational resources. The size of the compensation and
benefits bill is a reflection of who gets what within the organization.
The decision on compensation
levels (how much will the organization pay?) may be the most important
pay decision the organization makes. A potential employee's acceptance
usually turns on this decision, and a large segment of the employer's
costs are determined by it.
ORGANIZATION COMPENSATION
DECISIONS
Compensation decisions are
typically micro (individual) or macro (total organization) focused.
Although organizations are under no constraint to separate these
decisions, a course of study should. In practice, most unsophisticated
organizations make the decision on compensation level (how much to pay)
and compensation structure (relationships to competitors) at the same
time. More administratively advanced organizations realize that
individual decisions within a proper administrative structure are more
consistent, fair, and cost-effective over time.
The compensation level
decision may be considered the most important one for individuals. In
terms of both employee attraction and cost considerations, it is often
considered by most managers as a primary consideration. Also, it seems
essential to recognize that compensation level decisions can never be
completely separate from job-mix, hiring standards, personal decisions,
and internal labor markets/relationships. For these reasons,
compensation level decisions are typically the focus of a manager's
attention. From the organization's perspective, however, one
individual's compensation decision typically goes unnoticed at the end
of the year. Structure decisions (and the level of those structures) are
what show up on an income statement.
The term compensation level
simply means the average compensation paid to workers at some level of
analysis, e.g. the job, the department, the employing organization, an
industry, or the economy. The importance of the compensation level
decision to organizations rests on its influence in getting and perhaps
keeping the desired quantity and quality of employees. If the
compensation level is too low, the applicant pool may dry up and
recruitment efforts may meet with little success. Equally serious, some
employees (often the best ones) may leave. At the extreme, the
organization may experience difficulties with state and federal
regulatory bodies administering minimum compensation laws and prevailing
wage laws. Also, the organization may be confronted with concerted
organizing drives if no union is present, or pressing compensation
demands from existing unions. It is less apparent, but equally real,
that a low compensation level may attract only less efficient workers,
with the result that labor costs per unit of output rise.
If, on the other hand, the
compensation level is too high, equally undesirable results are likely.
The competitive position of the organization may suffer. Turnover rates
may drop below some desirable minimum so that the organization tends
toward inflexibility or stagnation. Also, if compensation and salary
levels are too high during periods of compensation controls by federal
authorities, trouble may be forthcoming from these officials.
Frequently, compensation and benefit level decisions are hidden in the
type and structure of benefit, fringe, and retirement plans.
Changes in compensation
levels have the most drastic effects on total payroll. Of course, other
compensation decisions have payroll effects, but usually not nearly as
great. Substantial sums of money can be involved, and for this reason
alone an organization must pay close attention to compensation levels
(both competitively and internally).
Nor are employees and their
representatives any less concerned with compensation level decisions. It
is here that the absolute amount of the compensation or salary rate is
determined. Also, it is here that unions exert their major effect, and
here that member loyalty is built or lost.
Finally, consumers and the
general public have major interests in compensation level decisions, the
consumer because wages are a major element in prices, and the general
public because wages and salaries represent the major portion of
national income. Also, too frequent or too drastic changes in
compensation levels affect the health of our economy.
STRATEGIC COMPENSATION LEVEL DECISIONS
Most employees are aware
that some employers pay more than others for the same type of skill in
the same market.
The actual cost to employers
of employee service is total hourly compensation plus benefits.
Unfortunately, labor cost
per unit is not information that is easily obtained by employers. It
must be estimated from in-house information on the average productivity
of employee groups and organization units and from the average pay of
these groups.
The information available on
what other employers pay comes only as a result of search. This search
takes the form of compensation surveys conducted or purchased by the
organization. These surveys invariably show a range of compensation paid
for the same job by different employers. This range tends to be narrower
for the skilled occupations and wider for the semiskilled. One reason
for this is the difficulty of job comparisons. Another is difference in
employee quality. But these differences are never as wide as
compensation differences.
The major reason for finding
out what others are paying for jobs is to decide how to position your
organization in relation to others and the labor market.
High-Compensation
Employers
High-pay organizations tend
to share a number of characteristics: larger size, higher profits, a
lower ratio of labor costs to total cost, few industry competitors, and
unionization. Larger organizations tend to pay higher wages and benefits
for a number of reasons. One is that they usually are able to. Large
organizations often tend to have some financial surplus, which they can
use in various ways. Another reason is that they may be willing to pay
more to attract a pool of competent applicants. Still another may be a
perceived obligation to counter lower job satisfaction. Finally, those
large organizations that are not unionized are continuing targets of
union organizers.
In addition, higher-profit
organizations are better able and perhaps more willing to pay.
A lower ratio of labor costs
to other costs may mean that high wages are a less significant cost
item. As a consequence, organizations with such a ratio can pay high
wages in the hopes of forestalling labor problems and devote their
attention to high-cost items.
Few industry competitors may
mean that the organization faces an inelastic demand for its product or
service, so that it can pass on cost pressures as price increases
without reducing sales. Also, especially under union conditions, the few
competitors may tend to pay equal compensation rates to "take labor out
of competition.
Because of their policy of
the "standard rate," unions try to equalize wages in the same product
market. Unions don't necessarily do this for business purposes and the
goals that drive a profit-oriented business. Often union policies are
based upon equity considerations as well as practical ones.
Note that all of these
reasons, except for size, suggest that high-wage employers tend to group
by industry (product market). Thus there is a compensation hierarchy
among companies that is related at least partially to the industry to
which the companies belong.
The high-wage employer may
be part of a national organization whose major compensation decisions
are made at the corporate level. For example, New York headquartered
corporations often appear to pay higher than local competitors. Also,
unionized employers may have a uniform compensation scale, dictated by
the labor agreement, in all company establishments.
Quite naturally, high-wage
employers hope to gain several advantages from their high-wage position:
higher worker quality as a result of higher hiring standards, ability to
insist on higher performance standards, lower turnover, time savings for
management because compensation changes do not have to be considered as
frequently, insurance against unionization, fewer labor disputes in
unionized companies, and company prestige. It is conceivable that the
last of these (which appears to be non-economic) may bear more weight
than economic advantages.
Low-Compensation
Employers
Low-pay employers tend to be
relatively small, to occupy competitive product markets, to have low
profit margins, and to be typically nonunion. They have low-paying
ability because of the constraints of their product market. Most of
their compensation decisions may be explained by this low ability to
pay.
Low-pay employers may gauge
their position by comparing themselves with the largest and most visible
employers. Using compensation surveys, they usually pay attention to
rates for specific jobs for which there is an active outside market. The
starting rate for new production workers may be particularly
significant. Jobs on which attention is focused obviously varies by
industry.
The minimum feasible
compensation is one that will obtain just enough employees to maintain
desired employee levels for some period, typically six months. But often
organizations pay above this minimum, hoping to obtain employees of
higher quality; lower their turnover rates; and lower their recruitment,
hiring, and training costs.
Market Rate Employers
Probably the most common
compensation level strategy followed by organizations is to "pay the
market." These organizations wish to treat their employees fairly and
yet not to raise their costs significantly more than their competitors.
In short, these organizations are trying to average out the advantages
and disadvantages of the high- and low-paying strategies by staying in
between. This strategy should enable the organization to recruit and
retain an adequate but not outstanding work force. In a tight labor
market, they are likely to be affected more like the low-paying
organization and need to engage in concerted recruitment activities to
obtain new employees. At the same time, internal adjustments must be
made to retain current employees. Often this adjustment is made after
some of the best employees have already left.
The types of organizations
that choose to "pay the market rate" are harder to identify than high-
and low-paying organizations. Many organizations with the
characteristics of high-paying organizations will choose to pay the
market instead since this strategy will still supply them with an
adequate work force. High-paying organizations are more likely to be
those in which it is clear to management that human effort can make a
difference in organizational success. Low-paying organizations may wish
to pay market rates but often are unable to do so.
To pay the market rate an
organization must collect compensation data and determine from that data
exactly what the market rate is. This strategy can be characterized as
being reactive to the market, so the organization needs to keep
constantly in touch with other organizations to find out what changes
are occurring in employee pay. This strategy also requires that the
organization carefully identify where to obtain compensation
information; that is, the organization must identify what the market is.
Because employing
organizations differ in employment-expansion plans, non-salary/wage
characteristics of jobs, quit rates, and recruitment and training
efforts, compensation levels will always differ from company to company.
LABOR MARKETS AND
COMPENSATION LEVEL STRATEGIES
Labor markets fluctuate in
terms of the number of employees and employee hours needed. These swings
in labor demand affect employer compensation decisions and compensation
differentials among companies. High-pay employers are less affected by
these swings because their compensation is high enough above the area
level so that they are little affected by short-run changes. They try to
limit compensation level changes to once a year and tend to set prices
by a percentage markup over average unit costs of production.
Low-pay organizations adjust
to changes in labor demand by deciding how far they can lag behind
high-paying organizations. During an economic upswing, high-pay
employers will be increasing wages, salaries, benefits, and employment.
Low-pay employers, to hold down turnover and to increase employment,
will have to raise compensation more than high-paying firms. The
compensation gap between high-paying and low-paying firms thereby
narrows during an upswing.
During a downswing, high-pay
firms stop hiring and may lay off employees. Low-pay firms find that
they have more and better applicants and less turnover. This means they
can lag further behind the compensation leaders and that the
inter-company differential widens.
But although these swings in
labor demand compress and expand the differential, it never disappears.
The reason is that although some labor markets are tight in upswings,
most are quite loose (they have more unemployment than job vacancies)
most of the time.
Fluctuations in demand also
change hiring standards. When an employer's pool of applicants begins to
dry up, the employer may raise compensation or lower hiring standards.
Pressure to lower hiring standards is felt first by low-pay firms.
During a downswing, hiring standards are raised. It is usually easier,
quicker and perhaps less costly to change hiring standards than to
change wages. As a result employers may prefer changing hiring standards
in the short run to changing wages.
Obviously, swings in labor
demand have their greatest effects on the less-preferred members of the
labor force. Tight labor markets increase the hiring of these groups.
Loose labor markets discourage it. Organizations paying market rates can
expect to have to react to most of these changes like the low-paying
organizations but not to the same degree.
An employer's compensation
level is typically, in the final analysis, a matter of policy.
Organizations take positions in labor markets and try to maintain them,
at the market or so much above or below it. Most companies most of the
time pay more than they would need to in order to meet their employment
objectives, but they ration jobs through hiring standards. Preferred
groups are hired first, less-preferred groups next. Many firms can
quickly expand employment at present compensation levels by merely
announcing openings. In this way, employees can flow from lower-wage to
higher-wage employers and sectors with no change in differentials.
During an upswing, low-pay
employers will try to expand employment just as high-pay employers do.
People are attracted from low-paying to high-paying firms. At some
point, the low-pay employer must raise compensation and probably also
lower hiring standards. Eventually all employers must do the same. The
reverse process occurs in a downswing.
INTERNAL LABOR MARKETS
So far we have been
describing the process of determining or adjusting the (average)
compensation level of an organization. But most companies have many
different jobs, each with its own compensation rate. Some kinds of
employees are hired from an outside market, typically for jobs at the
bottom and top of the skill ladder and for standard clerical jobs. But
most employers have only a limited number of entry points. Most jobs are
specific to the industry or company and are filled from within. These
jobs have no outside market, and their compensation rates are determined
by administrative decision or collective bargaining. It is useful to
describe employers as having either open or closed internal labor
markets. Employers with open markets (construction companies, for
example) fill most jobs from the outside. Employers with closed markets
fill most jobs from within. Open markets are strongly influenced by all
the forces in the environment that bear on the organization. Closed
markets, in the final analysis, like closed bureaucracies, can determine
wages administratively by manipulating both demand and supply.
Obviously, open and closed internal labor markets constitute not a
dichotomy but a continuum. But most organizations tend toward closed
internal labor markets, because they are advantageous to both employers
and employees.
A closed internal labor
market does not mean that the organization does not have to have a
compensation level policy. Entry-level jobs are exceedingly important to
this type of organization and they must be competitive in the labor
markets from which they recruit their organizational entrants. Failure
to be competitive at this point will lead to sub-standard hires, and
this deficiency will stay with the organization for many years as these
employees move within the organization. Closed internal market
organizations pay close attention to compensation survey trends both to
recruit through their entry points and to retain current employees who
are moving upward in the organizational hierarchy.
Compensation levels can be
too low and they can be too high. The floor is determined by what
labor-market competitors are paying to attract people to their jobs.
Thus employers with relatively open internal labor markets need to
attend to the hiring rates of relevant labor-market competitors for
almost all jobs. Employers with relatively closed internal labor
markets, however, need be concerned only with the hiring rates of jobs
they fill from the outside.
Ceilings on compensation
levels are another matter. Employers in the same product market
(industry) must not exceed the labor cost per unit (wage costs divided
by productivity) of competitors if they wish to remain competitive. But
such information is not available. Average compensation rates for jobs
and organizations are, but not productivity levels. One suggestion is to
use the average compensation of product-market competitors using similar
technology. Employers with relatively open
internal labor markets could use this figure as a ceiling and adjust, if
necessary, by changing their job mix (substituting lower-paid jobs for
higher-paid jobs) or recruiting in lower-wage markets. Employers using
global surveys (exchanging payroll data with frequency distributions of
jobs) may be using the job-mix approach. Employers with relatively
closed internal labor markets could meet the average compensation of
product-market competitors by setting rates for entry jobs at the
external-market level and controlling the rates of internally filled
jobs to compensate.
Of course, the importance of
the product market as a ceiling depends on competition in the product
market. In highly competitive industries, organizations follow the
practice of low-pay employers discussed earlier. In less competitive
industries, the high-pay employer will always serve as a useful
reference point. Product-market competitors could also seek competitive
advantage through increased productivity of employees. Although
compensation levels alone are not expected to achieve increased
productivity, they may attract better candidates and encourage them to
stay.
WAGE LEVEL STRATEGIES FOR
EMPLOYER GROUPS
As indicated, a compensation
level strategy may be for an organization or for any subpart thereof,
such as groups of employees. An organization may have a number of
compensation level strategies for different organizational units,
locations, or employee groups. The importance of the organizational unit
or group of employees may call for a compensation level strategy higher
than that of other parts of the organization. The characteristics of
particular labor markets or competitors may call for a selective
compensation level strategy in parts of the organization. Non-tight
labor markets, where there is a constant supply of adequate employees,
encourages a low-paying strategy for those employee groups. All these
conditions can apply in a single organization, making it useful to have
a number of policies rather than a single one. A major concern in
employing different compensation level strategies within an organization
is to ensure that the differences do not create discrimination in
compensation rates within the organization. Establishing low-paying
strategies only for employee groups that are predominantly minority or
female can lead to charges of discrimination. (See Chapter 26.)
REPORTING
One might think that since
compensation consumes 40% of the average employer's expense budget, that
significant reporting is required. Except for the case where employers
pay expenses for benefits (retirement, health, cafeteria plans, dental,
etc.) where these expenditures are made to a third party and claimed as
an operating expense, this is not the case.
Benefit reporting on the
first day of any plan year is an annual requirement within the U.S. for
organizations with more than 100 employees on the first day of any plan
year (and more than 10 employees if a cafeteria plan is used). Because
of the Internet, organizations now have the ability to utilize the Web
for this reporting. (See Course 24.)
One might also think that
the compensation strategy of an organization would be of interest to the
stockholders and be reported in annual reports or in proxies. This, too,
is not the case. Except for specific expense reporting and issues that
affect top management pay, little is ever reported regarding an
organization's compensation and benefits strategy.
