On The Holistic Approach To Compensation And Business Strategy

CHAPTER 1

INTRODUCTION

The most basic concept of compensation suggests that it is the exchange given by an employer for the hard work of their employees, be it extrinsic, where employees are being granted monetary and non-monetary gains as well as rewards (Martocchio, 2017) that would cover the basics of their human needs as foretold by Abraham Maslow’s hierarchy of needs—food, water, warmth, rest, security, and safety—that would sustain their livelihood and allow them to attain their psychological needs later in the horizon (McLeod, 2018), or intrinsic, where psychological payoffs that would impact one’s motivation, mindsets, and paradigm in a positive manner (Martocchio, 2017) are being used to encourage employees to perform better in their job, fulfil their psychological needs as a human being, and promote individual growth that would eventually have a positive impact to the profitability and the sustainability of the company in the long run. In a way, compensation is a way to keep a business going internally, as employees are the most important pillar of a company—without them, business processes that are in need of various expertise would not be able to be carried out. Compensation creates a positive feedback loop where, when compensation is given accordingly, employees would be able to serve better for the company they work in, and as time goes by would be the main factor as to how their company flourishes in the near future. Then, when the company flourishes all the more as they fulfilled their objectives through various strategies that were implemented beforehand, the employees would be granted more compensation that would, again, motivate them to improve in their jobs.

Ideally, the positive feedback loop shall happen in any organisation with employees, no matter how small. However, without a structure that goes with it, a compensation would be none but a feeble concept. It is important to approach compensation holistically, where compensation is seen as a part of the bigger picture of the business strategy, and as other strategies in the business, a model should be devised in order for a process—in this case, the process of compensation itself—is effective and would help a business reach their objectives. Therefore, when talking about compensation, it would never be separated from the pay model that goes with it. According to (Janse,

2019), this is the structural design of compensation—mainly extrinsic compensation— that is tailored according to the objectives of the company, including what they expect to achieve and the strategies the company would like to implement. First developed by

George T. Milkovich and Jerry M. Newman in 2002, the pay model further shows how compensation is indeed a crucial part of what employee receives for their work as an employee within a company in the form of tangible and financial payments.

In order to design a pay model, one has to keep in mind that there are three main components to a pay model—clear and concise objectives of the model on its own, strong policies that would become the foundation of the model itself, as well as techniques or strategies that would conjoin both objectives and policies together (Milkovich, Newman,

& Gerhart, 2014). When it comes to objectives, a company needs to remember that the objectives of a pay model are tightly linked to the objectives of the company—if anything, these objectives are simultaneous, hand in hand with each other, and therefore shall be achieved together as well. The policies that are being used as the foundation of this pay model serve as the guidelines for one to implement and conduct the pay model and strategy, which includes internal alignment (comparing the jobs and skill levels inside the company), external competitiveness (comparing the payment given to the employees with how neighbouring competitors do it), employee contributions (finding out which part of the work needs emphasis and determining how much they need to be paid), and management (making sure that the right person gets the right amount of compensation according to their contribution to achieving the goals granted to them to be carried out) (Milkovich, Newman, & Gerhart, 2014).

The strategies that would link objectives and policies together, on the other hand, vary depending on the objectives and policies, so that not only are they being linked together, but they also contain considerations as well as general caveats of the strategies that are being implemented. (Berger & Berger, 2008) elaborated in their writings, The Compensation Handbook, a holistic approach to compensation strategy, namely Total Reward strategy, that puts emphasis in the core values of the company and the reason why the strategy needs to be devised in the first place. The process of designing this Total Reward strategy lies on defining the philosophy the company adopts, examining the structure of the organisation as well as its policies, determining which groups of employees have unique reward requirements, creating reward policies that are specific, developing the strategy altogether, applying the strategy, then evaluating the strategy (Berger & Berger, 2008). In addition to that, generally speaking, there are four programs that can be implemented during the design of this compensation strategy: Base Pay (fixed salary; the foundation to all the compensation granted for employees), Variable Pay (bonuses and incentives after carrying out tasks, usually additional), Employee Benefits and Services (opportunities such as health insurance, paid maternal/paternal leave, paid vacation), as well as Performance Recognition (the recognition of the hard work of the people who have contributed to the betterment of the company while reinforcing the values of the company too).

CHAPTER 2

ANALYSIS AND DISCUSSION

In the first chapter, I have prefaced the writing with the importance of having a holistic, all-inclusive approach to compensation in a company. In this chapter, I would like to state that holistic approach shall not only apply to the pay model being devised, but also the business strategy implemented by the company. That being said, in the bigger picture, the pay model is a part of an integrative strategy system that is designed by the company so that it can reach its objectives in a timely manner.

As stated before, when it comes to creating a pay system, it is advised for a company to align it with the business strategy the company adopts. Ensuring that there is a significant synchronicity in between business strategy and the pay model being used is the common belief, as there would be a high effectiveness occurred in the organisation when the compensation system fits the business strategy. To iterate what was also stated in Chapter 1, the relationship between business strategy and compensation strategy, when significant, tend to be positive and resembling that of a positive feedback loop. Given so, when business strategy is closely aligned to the compensation strategy, the more the compensation strategy would benefit the company in both short and long run.

An aligned compensation strategy gives benefits to the company according to what the company stands for—hence why, in Chapter 1, the importance of acknowledging and defining the company’s philosophy and policies first and foremost, before even reaching the analysis of the background and expertise of employees, was mentioned albeit briefly. According to (Berger & Berger, 2008), there are generally three business strategies to which a designed compensation strategy can be tailored to:

1. Innovator: The business strategy that places emphasis on the creation of new products according to the volatile, ever mutable market trends. As its name suggests, the compensation strategy that can be used here is one that would promote new innovations. Some of the programs the company can tailor to this business strategy may include rewards on innovations and market-based pay, where employees are compensated based on what other employers determine their employees’ salaries to be (Blakely-Gray, 2019).
2. Cost Cutter: The business strategy that puts a great emphasis on being cost- effective—spending less funds for the greatest amount of revenue possible— and therefore productivity would be one of their objectives. Through a pay system that also puts emphasis on productivity and the importance of comprehending work specifications, giving a bigger variable pay compared to other employers (bonuses that would reward employees who are able to produce a lot of amount of product at once), and ensuring that the labour costs of competitors are still within the same level as the company’s own, businesses with Cost Cutter strategy would be able to compete with other businesses.

3. Customer-focused: The business strategy which focuses on customers, as the name suggests. With all the emphasis on the satisfaction of the customers, then it would be much fitting to tailor a pay model that would drive employees to do what they could in order to satiate the customers. This includes giving incentives when a customer is satisfied with the services that the employee is giving as well as valuating the skills that the employees have based on the contact they have with the customers.

This hypothesis that business strategy should be tightly linked to their compensation model is supported and consistent through previous studies done throughout the years. A study published by (Chen & Jermias, 2012) on some firms in the United States reveals how there is a significant positive correlation between performance- linked compensation and the business strategy. This indicates that when there is a misfit between the business strategy that is implemented to the company as well as the compensation system that goes with it, the effect would be detrimental to the company. Hence, there is a need to align both systems together in a way that they would be able to answer one another’s objectives—the pay model being able to act as a solution to the business objective and vice versa.

Another study conducted by (Adithipyangkul, Alon, & Zhang, 2011) in China furthermore highlights the importance of having compensation perks to promote performance in the employees, even when they are executives. As executives are usually given the task to carry out strategic planning for the organisation, compensation perks that are well-aligned with the business strategy (in here, encouraging innovative strategic planning in executives) would eventually result in a growth in current and future returns on assets. It is important to highlight that the study observed non-cash compensation perks which are included in employee benefits, suggesting that it is important not to only include an appropriate salary pay to motivate employees, but also to include non-cash benefits employees can reap after their hard work.

Directly echoing the study above is the study done by (Manso, 2017) which discovered that incentives that would reward long-term performance and a pay system that does not punish employees for failing early are more likely to promote innovation that would be beneficial to the company in the long run. Mistakes that are being done early are to be encouraged so that novel innovations can be discovered at a later time, in a way encouraging employees to take risks and embrace the unknown.

In addition, the study that was conducted by (Kryscynski, 2020) across 284 software development companies also echoed the studies I elaborated beforehand. The study had confirmed that higher firm-specific incentives would viably result in lower dysfunctional employee turnover rate, which means that there might be fewer employees quitting the company when there is a high firm-specific incentive. The study also suggests that it is likely that this firm-specific incentive would drive both the selection effect (where employees favoured by the managers are the ones staying) and treatment effect

(employees favoured by managers are the ones being okay with lower wages after being introduced to firm-specific incentives). This shows that there is a correlation between the said firm-specific incentive to human capital-based competitive advantages—in this case stands for having a lower turnover rate, which is also a part of a business objective included in the business strategy.

CHAPTER 3

SUMMARY AND SUGGESTIONS

In Chapter 1, we have covered the basics of compensation—how it is divided into two, generally so: intrinsic compensation and extrinsic compensation. This paper focuses on the advantages companies would be getting when they treat compensation strategy as one of the most important parts of the business. As I have argued before, employees are the reason behind the continuity of a company, and therefore being the most important assets of the company. Utilising a pay model that would be able to encourage employees gives a nod to one of the most fundamental principles of economics by N. Gregory Mankiw—people respond to incentives. Knowing this going forward, putting a great emphasis on providing a compensation strategy in a way that will bring their employees to do what they are expected to do would be beneficial for the company rather than simply breaking the bank.

We also covered about the Total Reward strategy and the pay model that are integrative in nature. Both highlight the importance of acknowledging and determining the company’s philosophy, beliefs, and policies before devising a set of techniques through the perspective of the determination of compensation. And even then, it does not stop there. A holistic compensation strategy does not stop with having big incentives or granting yearly grants—without its purpose, compensation strategy is just as good as a defunct system trying to survive the test of time. Therefore, the purpose of compensation strategy should be, again, tightly conjoined and even enwoven to the very fabric of a company’s business strategy.

There are generally three business strategies a company can tailor their compensation strategy to. The innovation strategy promotes innovation and the invention of new products that is also in accordance with the market trends, the cost cutter strategy emphasises on the importance of spending the less amount of capital for the highest amount of gain possible, and the customer-focused would always put their customer’s interest as their utmost priority. In a way, we can say that business strategy should be supported by the compensation strategy, because just like what I have stated in the first paragraph of this chapter, people respond (almost always positively) to incentives, and having an incentive that would, explicitly or implicitly, guide employees to execute their work in accordance with the business strategy that goes with it would allow the company to attain their objectives relatively easier.

The findings from previous studies echoed this premise. Throughout the years, researchers have proven how having a business strategy that is linked to the compensation strategy would allow companies to prosper. Albeit not served as quick, prosperity and longevity in the long run is almost guaranteed for these companies. There is some emphasis on exercising patience and how companies should plan and strategize their businesses as if it was going to still be there for more than 5 years—while giving incentives may not grant some type of instant gratification for the company, it would be beneficial for the company as the time goes by as their employees grow with the company itself, picking up more skills, and become more of an expert in handling their work, hence becoming a treasured asset for the company itself that would drive growth and profitability.

Whether the company wants to suppress turnover rates, promote innovation, foster productivity, or drive customer satisfaction, an integrative pay model that is tailored based on the company’s business strategy is almost always the answer to that. With the nature of incentives in itself, I suppose it would not be too far-fetched to suggest companies to think of this premise and integrate this to their practice.

However, giving incentives that are closely linked to business strategy should not always be the end of it all. While the paper talks about the importance of extrinsic pay model that pertains to money and tangible goods and services employees can get for working with the company, it is to be remarked that intrinsic compensation is also just as important as the extrinsic. In order to create a holistic approach to compensation that is also integrated to the business strategy of the company, managers must also consider the fact that emotional support and motivation is in the heart of organisation. While appreciation may come in the form of lavish pay models, appreciating employees emotionally, motivating them verbally, including them to the conversation, and allowing them to grow as fully-fledged individuals would boost the growth of the company furthermore. Hence, ideally, there needs to be a balance on the extrinsic and exquisite pay model with the intrinsic motivations given to the employees in a company.

REFERENCES

Adithipyangkul, P., Alon, I., & Zhang, T. (2011). Executive perks: Compensation and corporate performance in China. Asia Pacific Journal of Management, 28(2), 401-

425. doi:10.1007/s10490-009-9162-3

Berger, L. A., & Berger, D. R. (2008). The Compensation Handbook (5 ed.). New York: McGraw-Hill.

Blakely-Gray,  R.  (2019,  April  5).  3  Types  of  Salary  Structure  You  Should  Know.

Retrieved from Patriot: https://www.patriotsoftware.com/blog/payroll/types-of- salary-

structure/#:~:text=Market%2Dbased%20structure,55%25%20of%20businesses

%20using%20it.

Chen, Y., & Jermias, J. (2012). Business strategy, executive compensation and firm performance.  Accounting  and  Finance,  54(1),  113-134.  doi:10.1111/j.1467-

629X.2012.00498.x

Dirks, E. (2020, May 19). How to Link Business Strategy to Compensation Strategy.

Retrieved  from  HRsoft:  https://hrsoft.com/business-strategy-to-compensation- strategy/

Janse, B. (2019). Pay Model of Compensation. Retrieved April 22, 2021, from toolshero:

https://www.toolshero.com/human-resources/pay-model-of-compensation/

Kryscynski,  D.  (2020).  Firm-Specific  Worker  Incentives,  Employee  Retention,  and

Wage–Tenure Slopes. Organization Science, 1-24. doi:10.1287/orsc.2020.1393

Manso, G. (2017). Creating Incentives for Innovation. California Management Review,

60(1), 18-32.

Martocchio, J. J. (2017). Strategic Compensation: A Human Resource Management

Approach (8 ed.). London: Pearson.

McLeod, S. (2018, May 21). Maslow’s Hierarchy of Needs. Retrieved from SimplyPsychology: https://canadacollege.edu/dreamers/docs/Maslows- Hierarchy-of-Needs.pdf

Milkovich, G., Newman, J., & Gerhart, B. (2014). Compensation (11 ed.). New York: McGraw-Hill.