Diploma in Business Management

The compensation decisions that have been discussed and described in this book are very important organizational decisions since all employees of the organization are vitally affected by them, as is the economic health of the organization itself. Thus, it is extremely important that these decisions be made professionally and that as a whole the compensation program achieve the goals set out for it. Like all organizational activity, the compensation program needs to be well thought out and planned and then followed up on and controlled in order to insure that the activities that take place are those that were intended. Also these activities must, in fact, lead toward accomplishing the organization's goals. This chapter covers the tools and techniques required to carry out this important and final aspect of compensation administration.

One of the most difficult aspects of management is to put an activity in the context of the overall functioning of the organization, particularly when the activity requires many sub activities. Compensation is just such an activity.

Employees find compensation decisions both important and frightening. How much one is paid by the organization is of extreme importance, but often how the decision is arrived at seems mystical. Supervisors need compensation to create 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 is to make it difficult to optimize the potential of compensation to energize organizational activity toward organizational goals.

Organizations are collectives of people brought together to accomplish goals that an individual would not be able to accomplish alone. Organizations must accomplish goals of these individuals as well in order to be attractive to the individual. In order to accomplish organizational goals the people must channel their energies toward activities that are important to the organization. Thus, the primary goal of compensation is the control of behavior of organizational participants. This behavior is of two types, membership and performance.

Membership is a behavior required in order to provide a continuity of activity over time. Without it the resources of the organization would be constantly expended in recruitment, selection, training, and development of employees. Organizations require long-term membership from most employees but only short-term membership from others. Regardless, the requirements are the same. Individuals must perceive that their rewards at least equal and preferably exceed their contributions. Likewise the organization must perceive these individuals' contributions as at least equal to their rewards.

To obtain this continuity in membership organizations must see that individuals obtain the rewards that they desire and are able to make the contributions that are needed. �Are able� means both that the person is capable and that the organization creates the circumstances that allow the person to express that capability. These rewards and contributions can be expected to differ among employee groups. Some groups may want only economic rewards in exchange for minimal effort on their part, while others may want intrinsic rewards and be willing to contribute not only continuity but commitment. Short-term employees often fall into the former category and managers and professionals the latter.

Organizations that require continuing membership must ensure that employees perceive that rewards do exceed contributions on a continuing basis. Because the employment exchange is perceptual, changes real or imagined in the environment can strengthen or weaken it. In the extreme, an employee who perceives much better opportunities for his or her contributions in the labor market will quit. Also, a cumulative effect can take place: little irritations and changes can build up until the perceptual field of the employees takes a turn around; although nothing dramatic has changed externally, the employee's perceptions have changed dramatically. On the other hand, employees who perceive that other jobs are not readily available will increase the perceived value of their rewards, making the exchange stronger.

A positive change in the employment-exchange balance � that is, rewards perceived as exceeding contributions � causes the person to wish to continue the exchange. But it goes beyond this simple fact. It also increases or broadens what Barnard calls the zone of indifference. This means that the employee is more willing to perceive a wider variety and intensity of demands or contributions as legitimate parts of the employment exchange. The effect can be a positive spiral in which more contributions lead to higher rewards, which again strengthens the exchange in the eyes of the employee.

A negative change in the perceived balance of contributions and rewards leads to an uncomfortable feeling in the employee, which he or she attempts to alleviate either by direct action, ranging from asking for a raise in pay to quitting, or by perceptually manipulating either contributions or rewards in such a way as to realign the balance. Direct action is used where the employee feels that there is a positive environment outside the organization, and perceptual manipulation is more likely in a situation where movement is unlikely as an alternative. Even if the employee perceptually manipulates the exchange to create a positive balance, there is likely to be a feeling of resentment that can carry over into future changes in the employment exchange.

In summary, a perception of fairness in the employment exchange can lead to a strengthening of the exchange and continuing employment of the person. The organization gets continuing membership. Reductions in the perceptions of fairness in the exchange lead to dysfunctional behaviors on the employee's part, ending in a severance of the employment exchange. Employee groups may differ in what they desire and in how they perceive the environment for themselves, so the organization must be sensitive to how each of these groups is seeing its relationship to the organization. The reward to the organization for this vigilance is a continuing group of employees who understand the terms of the exchange under which they operate.

Organizations also require performance from employees. But obtaining performance behavior involves different requirements than obtaining membership does. The simplest way is to build performance requirements into the job: the specific contributions and rewards are spelled out in the employment exchange at the time of its inception. This approach is most commonly seen in collective bargaining, although it is also seen in most-assembly-line situations, where management defines rather precisely what is to be done and how.

A second way of achieving desired performance levels was discussed in Chapter 4 in terms of expectancy theory. The requirements of this method are that the organization:

1.	provide to the employee rewards that he or she wants;
2.	make a connection between these rewards and the desired performance in such a way that more performance leads to more reward; and
3.	make a connection between the employee's effort and performance, so that the employee is sure that it is he or she that has influenced the outcome.

The second and third steps emphasize the need to make the definition of performance clear to the employee. Although this method of obtaining performance is currently becoming more popular, it should be noted that it greatly increases the level of complexity of compensation administration.

From the viewpoint of the organization, using this method of obtaining performance implies an additional employment exchange beyond membership. Applying this method to all employees may be difficult. Organizationally, it may be impossible to define performance standards as clearly as this method requires. Performance must be measured, and often the measurement is not a close fit with the desired outcome. Organizations typically require a number of contributions, not one or two, and establishing performance standards for all contributions that do not conflict and that are all measurable is at best difficult. Further, convincing employees of the intended connections may also be very difficult.

Employees differ in their desire to engage in this further exchange. There is a range of how interested various employees are in the rewards that the organization is offering, and some find it hard to contribute the further effort required to engage in this exchange. The requirements demanded may not be "worth it" to some employees, and trying to change them may lead to what they perceive as continual haggle over the terms of employment. However, if the zone of indifference discussed above is operative, then the attractiveness of this second exchange is enhanced and this new commitment welcomed. For those employees who find their job intrinsically satisfying, the second exchange operates unconsciously, at least on the part of the organization.

Within limits, organizations can influence individuals to accept a broader definition of the employment exchange just as individuals can influence the organization to offer broader exchanges. Organizations can teach employees to value rewards that they have to offer and to contribute what they need. Likewise, individuals can influence organizations to offer things that they need and accept contributions that they are willing to make.

Despite the behavioral overtones to the employment exchange, it is still an exchange that has instrumental aspects to it on both sides. The organization needs the employee's contribution in order to create something that is desired by society and that therefore allows the organization to survive. Likewise, with the exception of intrinsic rewards, the employee values the outcomes of the exchange for what these outcomes provide him or her outside of the workplace.

Thus, like all exchanges, both parties attempt to gain the maximum for themselves while providing the minimum to the other. This is possible to some extent because each party places different values on the respective contributions and rewards. In the case of the organization, and examining the exchange in economic terms, further contributions required to gain higher outcomes from employees increase the cost of labor to the organization. There is a trade-off point between costs and the additional value received by the organization from the employee. As with all things, there is a point of diminishing returns in attempts to improve the employment exchange of the employee. The compensation planning and control process should be designed to deal with this trade-off and to balance the costs of compensation with the contributions received from employees.

Compensation administrators should keep clearly in mind the objectives of compensation 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.

There is no "one best" compensation program. Each organization's compensation program must match the circumstances of that particular organization. This process is one of matching organizational and environmental characteristics with the numerous options that have been presented in this book. Here are some of these options.

We have suggested that organizations could choose to pay above market, lower than market, or at the market level. Organizations differ in their ability and desire to use these options.

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 turnover at a minimum. Organizations choosing this option are likely to be large organizations, that have high profit margins, produce well-differentiated products, maintain 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.

In contrast, some organizations choose or are forced to pay less than others for the same workers. 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.

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.

Strategic options in the design of wage structures are not as clearly defined as for the wage level, but two such areas can be identified: (1) market versus internal orientation and (2) design of the wage structure.

Some organizations find that they must be or choose to be responsive to the marketplace over the total range of organizational jobs. These organizations tend to have jobs that are common in the marketplace, and they choose to recruit at all levels from the market. These organizations often pay less attention to internal movement-of employees and do not have clearly defined career ladders. In these circumstances, the organization usually designs its wage structure in such a way as to respond to the market first or, in the extreme, not to use job evaluation at all but to establish a wage structure that has market rates on both the horizontal and vertical dimensions.

Other organizations find that the internal structure of jobs as derived through job evaluation is an important variable on the wage structure that they develop. Organizations that have jobs for which there is no labor market comparison must pay more attention to internally developed structures. These organizations also tend to have staffing strategies that limit recruitment from outside to a few entry points and use internal promotion as the major way that positions are filled within the organization. In these organizations, market rates become guides for the overall structure and determinants only for those positions where recruitment from the outside is done.

Wage structures can be designed so that they have many levels, often with narrow rate ranges and a considerable overlap between levels. They can also be designed with the opposite characteristics. Organizations that have a highly developed promotion ladder and a narrow definition of jobs tend to go for the first option. These organizations are often more mechanistic and are concerned with bureaucratic procedures. Organizations that are in a dynamic environment, are more organic in nature. Where careful job definition is not possible given the rapid change that occurs, these organizations will tend to have wage structures that have fewer grades, wider rate ranges, and less overlap between levels.

The basic option in the development of wage systems is how much the organization is going to pay for performance. It might seem that all organizations would opt for pay for performance but this may not be possible or desirable; reasons for this were discussed in Chapter 17. In contrast to the options in wage level and structure, the determinants here are much more internal than external. While outside influences affect this choice in organizations today (particularly the focus on competition in American industry), most of the forces that decide the emphasis on performance are internal.

A major influence is the ability to define performance and to isolate the performance effects of a particular job. Organizations are becoming more complex and interdependent. This makes the determination of individual performance more difficult. Within organizations there is also considerable ambivalence about the use of variable performance as a guide to assigning different wage rates to employees. Unions have always opposed this on the grounds that it is a judgment that leads to management favoritism. But even supervisors find it hard to place a heavy emphasis on relative performance, partly because this is hard to define and partly because this emphasis gets in the way of the cooperation needed in the organizational unit.

A renewed emphasis on incentive plans is a symbol of the increased emphasis on performance. Interestingly, in this area one sees that there is a stronger emphasis on plans that focus on or at least include organizational performance in the measurement of performance. These options do not exhaust the choices open to those designing compensation programs. This section is intended to suggest that one needs to look at most of the decisions elucidated in this book as opportunities to accomplish the goals of the organization by matching the compensation program to the environmental and organizational circumstances that exist.

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 recent and necessary addition to compensation administration.

Determining what to accomplish and how to accomplish it has two concerns. The first is that the environment outside may make achieving goals either more or less difficult. So the planner must have some estimate of the interaction between the organization's actions and the 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.

Compensation planning must answer four questions: (1) What is the current status of the program? (2) What do we want the program to do? (3) What is likely to happen? and (4) What action do we take to get the program to do what we want?

This first question might be considered an audit of the present compensation program. It is necessary because in order to know where you wish to go you first need to know where you presently are. This question in turn has a number of aspects. The planner needs to know where the compensation program is in relation to the market, the job and wage structures, and individual wage rates.

The organization is always in some sort of relationship to the market in regards to wages. It is necessary to have a wage survey to determine the current position of the organization vis-à-vis the market. 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.

Another 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 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 the membership decision. Everyone at the top of the range may dictate a slowdown of intergrade progression within the organization.

A major tool in compensation planning and control is a statistic called the compa-ratio. The compa-ratio tells the planner how the distribution of jobs or people's wages in the pay range compares with the midpoint of the range. A compa-ratio of 1 indicates that the average of the pay rates is the same as the midpoint of the range. Here is the formula for the compa-ratio:

If the compa-ratio is a figure such as 1.06, the average of the wages paid in that pay range exceeds the midpoint. By itself this tells the planner very little. The reason to focus on this statistic goes back to the assumption made in Chapter 16 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. Actually a compa-ratio of more than 1 can be the result of a conscious decision by the organization to pay above average, a long tenure of people in the pay range, superior performance of these people, or a number of other reasons. A high compa-ratio is a signal that things need to be looked at and not that things are wrong.

Compa-ratios may be used at a number of levels besides examination of the wage structure if we simply replace the numerator in the preceding equation. For instance, replacing the average pay rate with any individual pay rate allows the planner to see how each person's wage relates to the pay range. Or the numerator could be replaced with the market rate to examine competitiveness. So compa-ratios can be calculated for organizations, for any subunit of the organization, for job categories, or for individual jobs.

This information is the pay rate and actual pay received by employees in the organization. This is necessary both in aggregate amounts and individual amounts. At this point, the planning process moves from an internal examination of the way in which compensation operates to how compensation decisions relate to the rest of the organization. The actual pay rates are necessary for budgeting the amounts required in the future at all levels, from the individual employee to the total wage cost of the organization.

This second question of the planning process involves the policy decisions that have been discussed throughout this book. They are at three levels: wage levels, wage structure, and individual pay decisions.

Wage level policies deal with the relationship between the organization and the external labor market. The basic decision is whether the organization wishes to lead, lag, or meet the market (Chapter 15). The higher the organization is willing to go against the market, the better the quality of employee the organization can expect to attract and retain.

This basic pay level decision may be made for the organization as a whole, for subunits of the organization, or for particular job categories. Some jobs may be considered more important to the success of the organization, so those are paid higher relative to the market than are other jobs in the organization. Such a policy, however, can lead to feelings of inequity in the nonfavored groups in the organization; if the groups were separated by race or gender, this could lead to charges of discrimination.

In the establishment of the wage structure the major policy decision deals with the weight that market and organizational factors will have in determining the shape of the wage structure. As indicated in Chapter 15, the wage structure is a combination of the job structure and the labor-market data. Which will prevail when there is a disagreement is a policy question. Organizations that are market-sensitive probably have to put the market first, whereas organizations that are insulated from the market (such as those that rely on internal labor markets to fill positions) will probably put the job structure first.

A second major policy decision involves the number of pay ranges and the overlap between them. This decision reflects the attitudes of the organization toward promotion and transfer within the organization. Wide pay ranges and few grades mean that employees will spend a long time in a particular pay grade before being promoted. The number of grades should also be coordinated with the shape of the organization. A tall, thin organization with many organizational levels calls for a wage structure that looks the same way.

Adjusting the wage structure also involves some policy considerations. When a new wage structure is being implemented the survey data must be updated. The decision as to how to do this affects the true degree to which the wage level decision is implemented. In addition, the wage level decision is interpreted in terms of when during the year the organization will maintain its chosen competitive stance. A decision to match the market at the beginning of the year is very different from matching the market at the end of the year.

Individual pay determination deals with two questions: how much to pay a new hire and how much of a pay increase to give an employee this year. The answer to the latter question is based upon what determines movement within the pay range-performance, seniority, or other contributions. The answer to the first question is greatly affected by the labor-market conditions. These conditions, in turn, affect the internal pay system if hiring rates must be raised to close to or above the pay rates of current employees, creating a compression problem.

As discussed in Chapter 7, another policy consideration is what proportion of total pay goes to direct wages and what to benefits. In addition, the individual pay decision criteria are likely to differ with employee groups.

To develop an idea of what will happen is to forecast. As indicated, two types of forecasts are required. The first is of environmental conditions that will influence the compensation plan and the other is whether the actions under the plan accord with the policy statements developed above. These two types of forecasts may be considered external and internal forecasting.

A wage survey presents a picture of the labor market at the time the survey is taken. But by the time the organization adjusts its wage structure those data may be out of date. Therefore, in adjusting the wage structure one must take into account the expected changes in the labor market during the period the wage structure will be in effect. As pointed out in Chapter 15, this is done in two ways. The first is to age the survey data from the time the survey was taken until the time the wage survey is effective. This means that upward or downward movements in wages, either observed or predicted, are included in the wage structure by adjusting the pay-policy line by the amount of the change in the labor market.

At this point the wage structure would be accurate as of the moment it was put into effect. But it is to be used for some period of time, typically one year. During this year the labor market will continue to change, and it is this forecast that is most important and most difficult. The planner must estimate the amount of change that will occur in the labor market during the next year and again change the pay-policy line by that amount. This may involve both an overall percentage change and/or a change in specific job categories that will change the slope of the pay-policy line or bring some jobs into or out of line with the wage structure. Last, the adjustment for the pay level policy decided upon in the second stage of planning above needs to be built in before a finished wage structure can be developed. Thus, an operational wage structure is not just a reflection of the wage survey that was done but is also a sophisticated forecast of the labor market and organizational goals for the next time period.

This discussion assumes that the organization adjusts its wage structure based upon labor-market information in the form of wage surveys. But what employees often see and hear about is the change in the cost of living. During times of high inflation, when the news bombards everyone with the large and rapid changes in the cost of living, employees can feel that they are falling behind considerably if the wage structure adjustments are not of the same magnitude as the changes in the cost of living. The wage structure appears to get out of date quickly and by quite a bit. In response, many organizations adjust their wage structures by changes in the cost of living and not by wage survey data. In many collective bargaining contracts, this is built in through cost-of-living-adjustment (COLA) clauses.

The basic purpose of adjusting the wage structure is to remain competitive for the type of workers that the organization wishes to recruit and retain. Does adjusting the wage structure using the cost of living do this? Milkovich and Newman point out that there are three different but overlapping concepts here: the cost of living, changes in the prices of products and services, and changes in wages in the labor market. Changes in wages in the labor market are measured by wage surveys, as discussed in Chapter 11, and, as indicated above, are ordinarily used to adjust the wage structure. This is reasonable if the goal is to be competitive in the labor market.

But employees do not feel changes in others' wages as directly as they do changes in the prices they pay for groceries. Changes in prices of goods and services are measured by the Consumer Price Index (CPI), and it is this figure that the press picks up and that is seen on television and in newspapers.

The CPI is a government-developed figure intended to record changes in a hypothetical market basket of the goods and services most likely to be used by an average family. The current index was developed in 1972-1973 from a study of the buying habits of a sample of 30,000 individuals. From this study the percentage of total expenditures for a number of categories of goods and services was developed. As surveys were run over time of the changes in the cost of these items, the change is recorded in the overall change of the CPI.

The accuracy of the CPI has come under attack, as it has been used more and more to adjust wages and other payments, such as retirement benefits and Social Security. Does it accurately reflect changes in the cost of living? Three criticisms have been made.

1.	There is a substitution effect that is not recorded in the CPI. If an item goes up dramatically in price, as beef did a few years ago, people substitute cheaper goods for it. But the CPI keeps the previous weight of the expensive item.
2.	The weights given items has been challenged. For instance, housing prices in recent years rose dramatically, and for a person who had to buy a new home these increases were traumatic. But for those who did not buy a new home, there was less change in housing costs. The CPI, until recently, measured housing prices rather than costs.
3.	The group used to develop the weights of items and the items themselves may not be representative of the buying public today.

In general, these criticisms may suggest that the use of the CPI to adjust wages or other payments overstates the change in the living costs of the people affected. Given those criticisms, it is apparent that changes in the CPI will only imperfectly reflect changes in the employee's cost of living. For some groups, such as middle-age employees whose children are grown and have paid of their mortgages, changes in the CPI may have almost no effect. On the other hand, young employees starting families may be very affected by changes in the CPI, particularly when the change is caused by factors such as food.

Inside the organization, forecasting is concerned with the effects of individual wage determination. The organization is concerned with the costs of the total wage bill created by hiring and retaining employees. In order to do 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 is essentially the function of human-resource planning, a topic in personnel administration that can take up a whole book of its own.

The reason this information is required is changes: growth, decline, and turnover change the average wage bill of the organization and its subunits. In general, growth and turnover will 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. So replacing or adding people lower in the range will lower the average of that group of employees. Decline and slow turnover have the opposite effects. 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.

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.

This final step of compensation planning involves implementing the policies developed. The product is a pay rate for each employee developed within the framework of the pay level policies and the newly adjusted wage structure. The latter provides a framework for the determination of the actual pay rates to be assigned but allows a great deal of judgment as to these rates. It is these rates that in the aggregate make up the total wage costs of the organization.

By adjusting the wage structure in line with the pay level policies the organization has indicated the total amount by which it wishes to adjust its wage costs either up or down. On the other end of the spectrum there are a myriad decisions to be made about what wage rate to assign to each employee, again within the constraints of the wage structure and the policies of governing individual pay determination. These two approaches may not lead to the same amount of change in the total wage costs unless the two approaches are coordinated. This is the function of the compensation budget.

From the above it is clear that there can be two approaches to developing a compensation budget. The first is from the 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.

In practice the process is not this simple, mainly because of the factors discussed in the section on internal forecasting. It is not enough to indicate the new wage rate for each current employee. There are a number of other factors to consider:

1.	When will the change in wage rate be made? Assuming a yearly budget starting the first of the year, a 5 percent increase on January 1 amounts to a 5 percent increase for the year in that employee's salary. But a 5 percent increase given on July 1 is a 2.5 percent increase for the year. Note, however, that although the increase given in the middle of the year is 2.5 percent the first year, it builds in 5 percent for the next year.
2.	Whose wages will be adjusted? This is the participation rate. If all employees are to receive an increase in wages, this will lead either to less for each employee or to a higher overall increase for the organization. New employees are often not eligible for an increase for a period such as six months, or, conversely, they must be given an automatic increase at some similar period depending on organizational policy.
3.	Will the organization (or unit) grow or decline? And when? The number of employees in the unit has an obvious effect on the total wage costs of the organization. But when changes take place also affects how the change must be accounted for in estimating wage costs.
4.	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 ones are hired at lower rates than the old employees had attained, and thus turnover lowers the average wage costs.
5.	What changes in the types of jobs will occur in the organization (or unit)? Higher skills lead to more employees at higher pay grades, and lower skills the opposite. But changing current employees to new job titles may not have its full effect immediately; wage increases for upgrades may not be much more than regular pay increases in the first year, and a downward movement is often restricted entirely.

These questions can be answered in each organizational unit and the adjusted figures passed upward, or rough estimates can be made in the subunits and then adjustments made at the organizational level.

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 immediately 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. So 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 I and others under 1 for reasons such as importance of the function to the organization or competition for the skills in the labor market.

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 with 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. 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 the 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 never to be violated.

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.

Control is not easy to achieve in organizations. There are a number of forces that make maintaining control difficult and at times dysfunctional. These problems center on the different control processes, the effects of control on people, and measurement dysfunctions.

To a degree, everyone attempts to control everyone else. In an organization where people have to interact to get their work done and each participant is also there to achieve his or her personal needs, there is considerable pressure being applied by everyone on others and on the organization itself. No small part of this is the need and desire of all of us to feel in control of our environment. Actually, there are three major types of control operating in organizations: (1) formal organizational controls, such as those proposed above; (2) social control by groups or by one person on another; and (3) self-control, in which the other is one's self and the control is internalized. Good control would require all three of these types of control to be congruent and to direct the same thing for the person. The chances of this are small so that the person is in the position of having to choose between conflicting forces. The result is less-than-perfect organizational control. Resistance to control is often in reality a reaction to these cross-pressures on the person.

Organization controls work better on some groups of employees and jobs than on others. For example, if tasks can be programmed and performed independently and have a short time cycle, organization controls can work very well. They also work better if the person wants and needs control, as in the case of a new employee who does not know the job well. But if the job requires years of training and interdependent action over an extended period before results appear, then organization controls do not work well. It is in these circumstances, however, that social control and self-control are most likely to be congruent and provide good guides. Also, these controls are not seen as controls by the individual, so the negative aspect of feeling that one is not in control is not present. This puts a premium on hiring or developing employees who have a built-in control system.

It is often hard or impossible to observe the actual behavior desired, such as making a proper decision. Therefore, organizations develop measures of the desired behavior. This is functional for control purposes but leads to the employee focusing on the measurement and not on the goal. For instance, a manager may rate all employees as outstanding, not because they are but because only those employees rated as outstanding are eligible to receive a 10 percent raise and he or she wishes to give a 10 percent raise.

The advantage of developing a performance standard is measurement is that it is precise. But sometimes it is not desirable to make things clear and unambiguous. Vagueness also has its value. Where flexibility is required, a vague standard is more useful than a precise one. Also, where there are conflicting standards to be achieved, vagueness allows the manager to pursue both without failure.

Organization control of the compensation program emphasizes the three decision areas of wage level, wage structure, and individual wage determination.

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 overexpenditures, if the organization were to insist on a return to the original budget levels, would require lower expenditures than planned for the remainder of the budget period.

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 audits 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, grade creep, is a 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.

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.

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. 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 of policies about pay level, pay structure, and individual pay determination. In the last category in particular, the criteria for movement within grade (Chapter 16) 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 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 16.)

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.

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 carry out this connection between performance and reward successfully. 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.

A properly designed incentive plan 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.

No area of compensation has as great a need for control as benefits. The problems of benefit costs were discussed in Chapters 7, 8 and 9. 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).

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 have 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 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.

A budget allows top management to delegate the day-today decisions while retaining a say in the overall impact of these decisions. 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 look at each decision.

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 taken place.

Internal control involves helping 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 varies widely by organization. Organizations where employees seek to expand the employment exchange can probably rely heavily on internal control. But even here, budgets and statistics play a major role. 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. The problem of maintaining consistency is probably best approached through the internal control procedure.

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 are 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 last decade 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 the line manager can easily feel frustrated unless he or she understands what it is the compensation specialist is doing.

The compensation staff have 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 is 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 have 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. So other parts of personnel are important information sources 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 are 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.

Figure 25-1. Relationships of top management, line management, and the compensation staff in compensation decisions

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