Employee Compensation Styles by Jim Pinto

Employee Compensation Styles

Click for Jim Pinto Biography

Published May 15, 2007
 
In the age of knowledge work, outsourcing and global competition, many companies still have employee compensation systems rooted in the past. In today’s business environments, pay must be performance based.
 
Production pay systems
 
Most of today’s employee compensation systems were originally developed in the old, factory environment, stemming from how hourly workers were paid and advanced in the labor-orientated hierarchy. Having a job meant a fixed hourly wage (usually including paid-overtime for working beyond normal hours) with annual pay increases based on years of service with the company, the occasional bonus and an expectation of lifetime employment.
 
In a new knowledge-based business environment, many companies still cling to archaic systems – preset pay-ranges, periodic reviews and almost automatic pay increases. Indeed, resentment develops when compensation does not increase, at the very least to keep up with the cost of living. With regular pay increases, employees who've had many years of service tend to get comfortable and overpaid for what they’re doing.
 
The problem with this is the expectation that wages will continue to escalate. It should be recognized that regular increases cause increasing jeopardy for employees whose pay has escalated over the years to a level that simply cannot compete in the modern global work environment. Also, mediocre people who have been around for a long time get paid too highly when compared to new hires or outsourcing alternatives. When cutbacks occur, highly-paid long-term workers are often the first to go.
 
In the old days of factory workers, Labor Unions were formed for collective bargaining over wages, benefits, and working conditions. Unions are much smaller today when compared to their peak membership in the 1950s, and they have much less bargaining power in an environment where work can easily be outsourced to offshore locations with much lower labor rates.
 
Titles in lieu of Pay
 
Let's say you land a new job. The first question your spouse, or friends, may ask is, “What’s the pay?” And then, “What's the title?” This brings up the subject of the hierarchical labels that are often substituted for monetary rewards.
 
In lieu of money, many companies simply have a great proliferation of confusing titles: Supervisor, Manager, Director, Asst. VP, Junior VP, Vice president, Senior VP, Executive VP, etc. In most instances, the title gives no indication at all of pay-scales. In Europe, the title Director is reserved for members of the board of directors; in the US, this is simply a title that is above Manager but not quite a Veep.
 
Then there is the appointment to “staff” level, or weekly or monthly paid, which usually meant forfeiture of overtime pay when working more than a fixed number of hours per week. Most State employment laws have plugged the evident loopholes by controlling “exempt” or “non-exempt” status, based on whether the work (and pay) is clearly time-based.
 
In many companies, valuable employees (especially engineer types) simply cannot be paid more without becoming “managers” – which significantly reduced their productivity. To get around this, many companies (like HP, IBM and GE) have multiple paths towards monetary progress. A productive knowledge-worker can often earn much more than his or her Supervisor or Manager. So titles have only secondary importance, mostly relating only to external relationships.
 
The GE transformation
 
There are two ways to motivate people: the carrot and the stick. Performance-based competitions – prizes (carrots) for the winners – tend not to work. This is because only the top few who see the awards within reach tend to try harder. Most of the others, recognizing that winning is not within reach, simply ignore the competition and continue to plod.
 
Jack Welch of General Electric came up with a solution to this paradox. When he took over GE was very profitable, but it had already become relatively stodgy and too comfortable for people who had been there a long time.
 
To affect change within GE, Jack Welch developed and implemented several strategic initiatives featuring employee involvement, candor, speed, and perhaps most significant, a pay-for-performance matrix which was applied to all GE’s professional employees. In brief, the matrix defined performance in the following categories: outstanding, excellent, fully satisfactory, acceptable and unacceptable. 10-15% of employees would be defined as outstanding or excellent and could receive pay increases up to 8-10% per year; 70% were categorized as fully satisfactory and got a lesser increase; the remaining 10-15% were acceptable or unacceptable depending on budgetary considerations, and could be eliminated.
 
As hard as it seemed, Welch issued an edict to all managers – to systematically eliminate the bottom 10-15 % of the workforce during the annual reviews. When people protested that everybody in their own department was performing well, Welsh’s response was that there are always the bottom performers that needed to be trimmed. Indeed if managers did not trim, that unwillingness became part of their own review and they themselves could be subjected the same rule. Jack Welch became known as “neutron Jack” for his propensity to eliminate a large number of people who had previously been considered marginal performers. Most people agreed that GE needed a driving force like him to generate much needed change.
 
GE and several other forward-looking companies started these kinds of changes in the 1980’s. But sadly, many companies still cling to the archaic factory-worker type wage systems with lax reviews and automatic pay increases across the board. This simply results in increasing jeopardy for employees whose pay has escalated over the years to a level that simply cannot compete in the modern global environment.
 
Measurable objectives
 
The best knowledge-workers can't just be paid for the hours they work – they may always be “working”. They should be stimulated by the freedom to innovate and contribute to the business. That's the wave of the future. This is what's revolutionizing human-resource attitudes in this new century. In the era of knowledge-work, employee compensation styles should adapt to achieve maximum benefits for those who generate results.
 
In today’s business environment, the best form of compensation is performance-based. It gives people immediate and meaningful feedback. But, problems do arise with the human element. Who will judge results? Direct supervisors (the people who do the reviews) may have a personal bias which short-changes some good people and advances others who may simply be currying favor. To minimize lack of fairness, employees must be given measurable objectives with goals that they themselves participate in setting.
 
The easiest targets to quantify are those based on bookings and shipments. Pay is based on whether or not plans or budgets are met – usually monthly, but quarterly and even annually for top managers. However, this often generates an insidious side-effect when results are close to the bonus level. It could encourage people to pad the results – book orders that are “expected any minute”, or make marginal and low-quality shipments early to meet the goal. This causes the usual end-of-the-month (or end-of-the-quarter) “banana” curve – a sad fact of modern business. Once established, the end-of-period rush becomes almost impossible to eradicate. And sooner or later, problems arise when the expected orders do not arrive, when quality problems occur in the last-minute expediting and when unforeseen “credits” occur in following periods.
 
Still, it is my contention that reasonable, measurable goals and performance incentives should be the basis of compensation for almost anyone – engineers, accountants, administrative people – no matter what their job. Objectives should be made achievable and quantifiable to provide the proper incentives for good performance.
 
Individual & Team Rewards
 
The question then arises: Should the performance measurement and reward system be for individuals, or should it include teams, or extended to the entire organization? In my view, it can and should be all of the above. Portions of an individual’s incentives should include broader, team-orientated results to encourage everyone’s involvement in the success of every part of the enterprise. This should demonstrate the clear linkages that occur.
 
Performance based compensation could, and should, result in some higher performing individuals earning more than their direct supervisors or managers. That's not necessarily a bad thing; indeed it's a clear reason for a person who is performing well to be promoted and be given more opportunity to excel.
 
And this brings up the question of ownership. In any capitalistic society it's important for people at all levels to share in the growth and success of the enterprise. Indeed, this has given rise to the spread of employee ownership plans, stock options and other forms of participative involvement. And there’s another element of Capitalism that eventually kicks in – if you own enough stock, you don’t have to work.
 
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 Jim Pinto is an industry analyst and commentator, writer, technology futurist, angel investor. You can email him at: [email protected]. Or review his prognostications and predictions on his website: http://www.jimpinto.com/. Review the contents of his new book “Pinto’s Points – How to Win in the Automation Business” at: http://jimpinto.com/writings/points.html