Developing HR strategy: Making money is the ultimate goal

In the seventh part of our series on delivering HR strategy, Keith Rodgers
looks at how compensation has to be linked to individual and organisational
goals

Although it is one of the most sensitive elements of HR strategy,
compensation doesn’t always receive the attention it merits, particularly in a
tough economic environment. Rather than assessing their compensation policies
from the perspective of long-term employee acquisition and retention,
organisations invariably find themselves focusing on the short-term cost
implications instead.

But regardless of the economic conditions, compensation has major strategic
implications that reach well beyond the size of the monthly payroll. A crucial
part of business strategy, effective compensation is both a tool to incentivise
and the link between individual and corporate performance.

1 Compensation

Any HR department that sets out to build a corporate reward structure in
isolation is opening itself up to problems. While many external factors
contribute to building pay structures – not least benchmarking against similar
organisations – the most important point is that they need to reflect internal
goals.

Compensation schemes are a powerful tool for both rewarding and influencing
behaviour, but they need to influence in a way that delivers the right results
for the organisation as a whole. As such, compensation should be regarded as an
integrated component of an overall HR strategy, reflecting a wide range of
factors, including: business targets; organisational design goals; development
targets (such as key employee acquisition, training and skills development,
succession planning etc); and culture.

Rather than focusing on operational issues such as setting individual sales
targets, organisations need to start with a bigger question: What is the reward
scheme going to achieve for the business?

2 Measuring performance

Having designed their compensation packages in the context of overall goals,
the next point of reference is performance – in other words, how successfully
those goals have been achieved.

Although the principle of performance-related reward is firmly established
in departments such as sales, that doesn’t mean it is executed as effectively
as it could be.

Many sales people, for example, are commissioned against revenue targets.
While that provides a relatively simple and transparent framework for
individual employees, it does not take into account the fact that different
types of sales can make different contributions to the bottom line.

Margin-based compensation is often a better alternative because it
encourages sales staff to focus on pushing their most profitable products.
Defining margins can be complicated because it requires costs that are often lumped
together as ‘overheads’ to be divided up and assigned to individual product
lines and activities.

But even if it is only carried out at rudimentary level, this approach helps
to align individual performance more closely to corporate objectives. Relationship-building
should also enter the sales compensation equation – ideally, reward strategies
will reflect the fact that repeated sales to existing customers are usually
cheaper to make (and therefore more profitable) than those to new customers.

Performance-related compensation is frequently attacked on the basis that
some jobs or tasks are too difficult to measure. It is true that contribution
can sometimes be hard to define – just how much impact, for example, does a
marketing department’s brand-building efforts have on corporate performance?

But that doesn’t mean those departments can’t be measured. If it is accepted
that brand-building is an important part of corporate development, then it is
entirely possible to measure whether brand awareness has grown or fallen among
target audiences.

3 Is it a reward or an incentive?

Terms like reward and incentive are loosely applied in the compensation
field, but the differences between the two are very important. Incentive-based
pay is best established within the higher echelons of organisations, where
compensation for senior executives is commonly tied to achieving broad
performance goals, such as increasing shareholder value.

The goals tend to become more localised as they cascade down the
organisation. Below board level, for example, the next tier of executives will
typically be assessed on a combination of group results and the performance of
their own division, while further down the hierarchy, sales staff may be
measured on targets linked entirely to their own customer pool.

But as Martin Lutyens, consultant at Watson Wyatt, points out, in the bottom
pay levels of large organisations, it is often difficult to tie meaningful
incentives to specific tasks. That’s not to say these employees don’t affect performance
– they have a huge impact, but primarily at an aggregate level. In those
environments, team-based incentives are more likely to work than highly-focused
individual plans. As such, they become more of a post-event reward than an
inducement to change individual behaviour.

Team-based goals can be highly effective tools if they are properly
deployed, especially where they are used to encourage more effective
inter-departmental working and break down organisational silos. To be
effective, however, it is important that every individual can see how their own
performance contributes to the overall team effort. It is also important that
both individual and team goals are kept up-to-date, as performance-related
targets are often set at the start of the year and become less meaningful as
business needs change.

4 Putting together the right package

Because base pay, bonuses, profit share and other cash-related components
are the most visible element of compensation, many organisations find that the
‘hidden’ elements within their total packages are overlooked. Yet pensions,
medical insurance, company cars and long-term incentives such as share options,
are significant elements of an overall compensation package.

In areas where organisations find it hard to compete on core salary alone,
these types of investments become critically important. This is particularly
true in the public sector, where organisations such as Hampshire County Council
are striving to demonstrate the value of the overall compensation mix (see case
study below). Many companies now give employees a total compensation statement
to promote awareness of these lower-profile elements.

Lutyens at Watson Wyatt recommends that organisations should attempt to give
employees as much flexibility as possible in the way that these compensation
elements are delivered, allowing individuals to tailor packages for their
unique circumstances within defined parameters. In most instances, the
organisation will be able to leverage its greater buying power to secure better
benefits than an individual could achieve alone, so employees that decide to
tilt the balance in favour of benefits may ultimately be better off.

Flexibility also applies in stock options, especially following the global
stock market decline. Although regulatory restraints and shareholder concerns
limit employers’ ability to re-price options, companies can widen the appeal of
share-based incentives by incorporating, for example, long-term incentive
plans.

Multinational organisations must also take account of regional differences
when they build their compensation portfolios. Benefits such as medical care
will have greater value in some countries and cultural expectations will vary.

5 Keeping it in perspective

Finally, organisations should be conscious of the limitations of pay-related
incentives. Although compensation can be a strong negative factor –
demoralising employees who feel they are being under-compensated for their
efforts – it is not necessarily a motivator even where it is deemed to be fair.
Numerous other factors must be taken into account, including work environment,
job satisfaction, and the strength of the relationship between employees and
their immediate boss. Just as compensation is one element of HR strategy from
the organisation’s perspective, pay is only one element of the reward equation
for employees.

Case study: Herts and Hampshire county councils
Councils pull together to find a way ahead

With its history of national pay
bargaining and the traditional link between salary and length of service, local
government hasn’t exactly been at the forefront of developing flexible reward
structures. But like the private sector, skills shortages have begun to bite in
many authorities, and several county councils are making changes to their
compensation practices. Although some of the challenges they face are unique to
the public sector, their efforts to retain and reward high-performers are
consistent with the goals of private companies – and the problems they
encounter are just as common.

In the South East of England, where five county councils formed
a consortium to examine a wide range of HR issues, several far-reaching
approaches to the reward process are now being discussed with trade unions and
executive management.

The consortium, which includes Herts and Hampshire county
councils, worked with external consultants to examine the way that roles are
both structured and compensated. Four core issues came under examination:

Job families Organisational
structure provides the comparators and hierarchies that underpin any reward
programme, and the huge variety of different jobs in local government means it
can become highly complex. The consortium investigated building job
"families" that span different departments, with jobs grouped together
according to accountability and competency. Herts, for example, favours
building seven families, such as ‘resources’ (including HR and finance), care
services, environmental and so forth. By emphasising commonality in roles, this
process improves inter-departmental movement and helps overcome organisational
silos.

Broad pay-bands In line with
many highly-structured organisations, senior practitioners in local government
often reach a ceiling within their salary bands and can only be rewarded by
being regraded – a process that sometimes results in them being promoted
outside their area of expertise. By reducing the number of grades and creating
seven to 10 broader bands, the consortium believed councils would have greater
flexibility to reward individuals for their specialist skills.

Closer links to the market
Gillian Hibberd, assistant director of personnel at Herts, points out that with
1,500 separate job types among its 28,000 employees, the council couldn’t do
pay comparisons across the board. Instead, it investigated the idea of creating
three ‘anchor’ jobs within each pay band that would be benchmarked against the
external market, with every other job clustered around them.  

Progression pay The consortium
looked at different models of pay progression within the salary bands. For
example, if 100 per cent represents a ‘proficient’ employee, 80 per cent would
apply to entry-level starters and 120 per cent would reflect a high-performing
employee’s ability to grow in their role. In addition, it also examined how
contribution-based pay might be used to reward short-term performance.

Having analysed these issues in detail, the consortium members
examined how they might be applied in their own environments – and discovered
the full cost implications. For Herts, which tested one department’s model, a
‘big bang’ approach to implementing this kind of structure was simply out of
the question.

Instead, the authority is focusing on two elements over the
next 12 months – linking pay to the market and introducing a ‘career grade
structure’. The latter is a variant of the job family model. In personnel, for
example, the 238 different jobs that exist today within different departments
would be amalgamated into one core grading structure, making it easier to
transfer from one department to another and win a pay rise in the process.

At Hampshire County Council, meanwhile, the authority is
planning to implement significant changes along the lines of the review during
the next two and a half years, including the introduction of job families,
banding and market-related pay. According to Rita Sammons, county personnel and
training officer, the council is in a high-cost, low-unemployment geographical
area, and the biggest issue it faces is competing against high-profile, high-paying
private companies. To an extent this may be a perception issue, where the full
benefits of the council’s existing packages aren’t sufficiently visible –
employees tend to focus on pay, without taking into account other factors such
as sickness benefits and pension schemes.

Ideally, the council would like to replace today’s ‘one-size
fits all’ philosophy with a ‘cafeteria’ approach, allowing employees to pick
and choose a mix of pay and benefits within the constraints of centralised
agreements.

Both Herts and Hants are aware of the major challenges these
new reward models throw forward across the board. Sammons points out that while
the new flexibility will allow managers to recognise differences in individual
contributions, it also presents a major challenge in terms of their assessment
skills.

Hibberd, meanwhile, points out that one of the biggest concerns
for the trade unions is consistency, particularly in ensuring that the
principle of market-related pay is applied across the organisation and not just
to senior roles.

"There is massive cultural change," she adds.
"Moving away from an ‘expectation’ culture is a big shock."

Take-home points…

1 Focus on what the benefits scheme will provide for the
business

2 Lower down the chain, team-based incentives are more
effective than highly targeted individual plans

3 Don’t overlook the ‘hidden’ elements within total packages –
such as pensions, medical insurance and company cars

4 Give employees as much flexibility as possible in terms of
delivering compensation

5 Take account of regional differences when developing
compensation portfolios

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