Milkovich/Newman: Compensation, Ninth Edition

Chapter 7
Defining
Competitiveness

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Topics
 Compensation Strategy: External
Competitiveness
 What Shapes External Competitiveness?
 Labor Market Factors
 Modifications to the Demand Side
 Modifications to the Supply Side
 Product Market Factors and Ability to Pay

7-2
 Chapter Topics (cont.)
 Organization Factors
 Relevant Markets
 Competitive Pay Policy Alternatives
 Consequences of Pay-Level and Mix Decisions:
Guidance from the Research
 Your Turn: Sled Dog Software

 Still Your Turn: Fit the Pay Mix Policy to the

Compensation Strategy

7-3
 Compensation Strategy: External
Competitiveness
 External competitiveness is expressed in
practice by:
– Setting a pay level that is above, below, or equal to
that of competitors
– Determining mix of pay forms relative to those of
competitors
 Pay level and pay mix decisions focus on:
– Controlling costs
– Attracting and retaining employees

7-4
What Is External Competitiveness?

External competitiveness
refers to pay relationships
among organizations - an
organization’s pay relative
to its competitors.

7-5
 What is Pay Level?

Pay level refers to the

average of the array of rates
paid by an employer: (base +
bonuses + benefits + value of
stocks) / number of
employees.

7-6
 What are Pay Forms?

Pay forms are the various

types of payments, or pay
mix, that make up total
compensation.

7-7
Pay Level and Pay Mix: Two
Objectives

Control Costs

Attract and Retain

Employees
7-8
Exhibit 7.2: Two Companies: Same Total Compensation,
Different Mixes

7-9
 Exhibit 7.3: What Shapes
External Competitiveness?
LABOR MARKET FACTORS
Nature of Demand
Nature of Supply

PRODUCT MARKET FACTORS

Degree of Competition EXTERNAL
COMPETITIVENESS
Level of Product Demand

ORGANIZATION FACTORS
Industry, Strategy, Size
Individual Manager
7-10
 How Labor Markets Work
 Theories of labor markets begin with four
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
 Demand and supply for business school
graduates

7-11
 Labor Demand
Analysis of labor demand indicates how many
employees will be hired by an employer
In the short run, an employer cannot change any
factor of production except human resources
– An employer’s level of production can change only if
it changes the level of human resources
– An employer’s demand labor coincides with the
marginal product of labor

7-12
 Labor Demand (cont.)
 Marginal product of labor
– Additional output associated with employment of
one additional human resources unit, with other
production factors held constant
 Marginal revenue of labor
– Additional revenue generated when firm employs
one additional unit of human resources, with other
production factors held constant

7-13
 Exhibit 7.4: Supply and Demand for
Business School Graduates in the Short Run

7-14
 Labor Demand (cont.)
 Marginal revenue of labor (cont.)

– A manager using the marginal revenue product

model must:
 Determine pay level set by market forces
 Determine marginal revenue generated by each new hire

7-15
 Labor Supply
 Assumptions on behavior of potential
employees
– Several job seekers
– Possess accurate information about all job openings
– No barriers exist to mobility among jobs
 Upward sloping supply curve:
– More people willing to take a job as pay increases
 If unemployment rates are low, offers of higher
pay may not increase supply
7-16
Exhibit 7.6: Labor Demand
Theories and Implications

7-17
 Compensating Differentials
 According to Adam Smith, “If a job has
negative characteristics then employers must
offer higher wages to compensate for these
negative features”
 For instance, if:
– Necessary training is very expensive
– Job security is tenuous
– Working conditions are disagreeable
– Chances of success are low

7-18
 Efficiency Wage
 According to efficiency-wage theory, high
wages may increase efficiency and actually
lower labor costs if they:
– Attract higher-quality applicants
– Lower turnover
– Increase worker effort
– Reduce “shirking”
– Reduce the need to supervise employees

7-19
 Efficiency Wage (cont.)
 Research evidence states:
– Higher wages associated with lower shirking
(measured as number of disciplinary layoffs)
 Inconclusive evidence on if it was cut enough to offset
higher wage bill
– Higher wages do attract more qualified applicants
 Also attract more unqualified applicants
 Above-market wage allows organizations to
operate with fewer supervisors

7-20
 Signaling
 Employers deliberately design pay levels and
mix as part of a strategy that signals to both
prospective and current employees kinds of
behaviors sought
– Policy of paying below the market for base pay yet
offering generous bonuses or training opportunities
 On the supply side of the model:
– Suppliers of labor signal to potential employers
– Characteristics of applicants, and organization
decisions about pay level and mix act as signals that
help communicate

7-21
Exhibit 7.7: Supply Side
Theories and Implications

7-22
 Product Market Factors and Ability to
Pay
 Two key product market factors affect ability of
a firm to change price of its products or services
– Product Demand – Puts a lid on maximum pay level
an employer can set
– Degree of competition – In highly competitive
markets, employers are less able to raise prices
without loss of revenues
 Dose of reality: What managers say
– Provides insight into how all the economic factors
translate into actual pay decisions

7-23
 Organization Factors
 Industry and Technology
 Employer size
 People’s preferences
 Organization strategy

7-24
 Relevant Markets
 Three factors determine relevant labor markets
– Occupation
– Geography
– Competitors
 Employers choose their relevant markets based
on
– Competitors – Products, location, and size
– Jobs – Skills and knowledge required and their
importance to organizational success

7-25
 Competitive Pay Policy Alternatives
 Three conventional pay-level policies:
– To lead
– To meet
– To follow competition
 Newer policies emphasize flexibility among:
– Policies for different employee groups
– Pay forms for individual employees
– Elements of the employee relationship that company
wishes to emphasize in its external competitiveness
policy
7-26
Competitive Pay Policy Alternatives
Pay with
Competition
(Match) Lead Policy

Lag Policy

Flexible Policies

Employer of
Shared Choice Choice

7-27
Exhibit 7.8: Probable Relationships Between
External Pay Policies and Objectives

7-28
 Pay with Competition (Match)
 Attempts to ensure an organization’s

– Wage costs are approximately equal to those of its

product competitors
– Ability to attract potential employees will be
approximately equal to its labor market competitors
 Avoids placing an employer at a disadvantage in
pricing products or in maintaining a qualified
work force

7-29
 Lead Policy
 Maximizes the ability to attract and retain
quality employees and minimizes employee
dissatisfaction with pay

 May also offset less attractive features of work

 If used only to hire new employees, may lead to

dissatisfaction of current employees

7-30
 Lag Policy
 May hinder a firm’s ability to attract potential
employees
 If pay level is lagged in return for promise of
higher future returns
– May increase employee commitment
– Foster teamwork
– May possibly increase productivity

7-31
 Flexible Policies
 Employers have more than one pay policy
 Policy may vary for different occupational
families
 Alternative policies include
– Performance driven
– Market match
– Work/life balance
– Security

7-32
Exhibit 7.9: Pay-Mix Policy Alternatives

7-33
Exhibit 7.13: Some Consequences of
Pay Levels

7-34
Consequences of Pay-Level and Mix
Decisions
 Efficiency

 Fairness

 Compliance

7-35