Strategic Framework for Compensation

Chapter 2

References:Strategic Compensation in Canada (4th Edition), Richard J. Long, Nelson Education Ltd.

Resource Person: Furqan-ul-haq Siddiqui

The concept of fit The success or failure of any reward system depends on how

well it fits the organizational context and total organizational system.

To successfully design, manage, and modify any reward system, one must understand this context and how it links to the reward system.

In order to understand the aspects of the organizational context, and how it relates to reward strategy one must understand the framework.

This framework consists of three managerial strategies that an organization can adopt.

How each of these strategies relates to organization’s structure Its best fit reward system. The framework then identifies the determinants to adopt the

most appropriate strategy.

Organization as a system

InputsHuman Resources

Information ResourcesPhysical ResourcesFinancial Resources

Transformation Procedures

Outputs

Consumersor

Beneficiaries

ResourceProviders

Organization as a system Organizations are systems that apply procedures to a set

of resources in order to transform input materials into outputs that some one values.

The procedures and resources used to carry out these transformation processes constitute the technology of the organization.

Organizations typically use four types of resources in the transformation process:

Human Information Physical Financial

Organization as a system Management's role is to acquire these resources, combine them and

deploy them to achieve organizational goals and carry on transformation process as efficiently as possible.

Corporate strategy is the organizational plan of how it will achieve its goals

The organization structure is the vehicle for execution of this strategy and is composed of several structural dimensions or variables

The purpose of organization structure is to generate the behavior necessary to carry the organization’s strategy

For the organizational system to be effective, the corporate strategy and organization structure must fit in with certain other key variables, including;

The type of environment in which organization operates, The type of technology it uses, The size of the organization, The nature of employees. This is known as CONTINGENCY APPROACH TO ORGANIZATION

DESIGN

A Strategic Framework for Compensation

Factors in the firm's context that indicate the most appropriate managerial strategy and organizational structure.

The means through which an organization generates the behaviors necessary to execute its corporate strategy.

A Strategic Framework for Compensation

In strategic framework two sets of variables contextual and structural are linked by managerial strategies.

Reward system is one of the variable that make up the organization structure.

To be effective; reward system must fit with other structural variables as well as with the managerial strategy.

Managerial strategy must fit with the contextual variables.

Structural Variables To generate behaviors necessary to execute a corporate

strategy, an organization structure does two main things1. Divides the total task into manageable subtask

(differentiation).2. Coordinates the completion of these subtask so that they fit

together to accomplish the total task of the organization (integration).

An effective organization structure serves to reduce internal and external uncertainty for the organization

It reduces external uncertainty by creating specialized units and bring appropriate information to organizational decision makers( marketing, purchasing, etc.).

It reduces internal uncertainty by structuring and directing employee behavior.

Structural Variables The organization structure consists of number of separate variables

or dimensions These variables are levers that are used to produce behavior desired

by the organization Beside reward system there are five structural variablesI. Job design : describes the manner in which the total task of an

organization is divided into separate tasksII. Coordination and departmentation: describes the methods used to

coordinate the work of individual employees and subunits in the organization

III. Decision making and leadership structure: describes the nature of decision-making and leadership processes used in an organization.

IV. Communication and information structure: describes the nature of and methods for communication in an organization.

V. Control structure: describes the nature of the processes used to control employee behavior in an organization

Managerial Strategy Overtime, three main patterns of structural variables,

known as “ managerial strategies” have been emerged.1. The Classical Managerial Strategy2. Human Relations Managerial Strategy3. High Involvement Managerial Strategy Each of these managerial strategies represent a

particular combination of structural variables that has proved to be successful in the right circumstances.

The particular managerial strategy used by a given firm is the most important single determinant of what will or will not be a successful reward system for that firm.

Managerial Strategies and Reward System

Each of the three main managerial strategies has different implications for how compensation systems should be designed

Each of these strategies also reflect different assumptions about employees and how should they be managed.

Classical Managerial Strategy Assumptions: People are inherently lazy, dislikes work, and would

prefer to get as much as they possibly can from work relationship while giving as little as possible.

The only way to get people to work is to create circumstances under which satisfaction of their economic needs becomes threatened, if they do not behave as the organization wants them.

Essentially, this school of thought views employees as potentially dishonest shirkers who need to be tightly controlled if the organization wants getting any work out of them.

Relationship with structural variables Thinking is completely separated from doing. Jobs are designed with only few elements so that: They can be supervised closely. Employees could be replaced easily if they quit. The specific duties and work methods for each job

are planned and defined in detail by management. Jobs are arranged in strict hierarchical, pyramidal

fashion because of the overriding need for accountability.

Coordination is always handled vertically by a common superior.

Employees are organized by function. The major role of superior is to control and evaluate

subordinates. Decisions are made at a relatively high level of the

organization. Main role of leadership is autocratic, with a high

emphasis on task. Essentially senior management makes the decision,

middle management transmits them, first line management enforces them.

Control is exercised through close supervision and threat of punitive action, if the employee deviate from organizational policies.

Frequently there is often a large body of formal rules and procedures that are strictly enforced.

Communication is quite low with emphasis on downward vertical flow and tends to be formal.

Communication upward from employees is not generally sought and when sought , is likely minimal and distorted , due to adversarial relations.

Since management ‘s key task is to minimize variations in employee behavior from specified behavior, reward system is extrinsic rewards.

Whenever possible, it ties pay directly to output such as piece rate or commissions is used.

Where this not feasible, pay is directly tied to hours of work.

In both cases pay is not higher than absolutely necessary to attract sufficient flow of job applicants.

Little indirect pay is used because it is not tied to individual performance.

Management does not see much value in incurring large benefits cost in order to promote loyalty and reduce turnover.

This is because classical organizations are structured to minimize cost of turnover.

One exception to general rule about poor compensation in classical organizations occurs in unionized classical firms.

Human Relations Managerial Strategy Assumptions: Agree with classical school that people inherently dislike work

but they can be motivated by appealing to their social needs. Classical school of thought frequently creates an adversarial and

unpleasant relationship between management and workers By treating employees with fairness and consideration,

supporting and encouraging peer group of workers (instead of breaking them) positive employee norms could be developed

The human relations view of employees tend towards paternalism. The organization is like a family, in which employees are like children, who need to be treated kindly but firmly by a benevolent employer, who knows what is best for them and the organization.

Relationship with structural variables The approach to job design is similar to classical

approach but attempt to arrange jobs that allow social interaction among employees.

The way to coordinate employees effort is also similar to classical approach but the supervisor’s role is much more complicated.

Leadership is still autocratic in the sense that senior management makes all important decisions, but there is much greater attempt to “sell” the decisions.

Attempt is made to provide a feeling that employees have some control over company’s decisions( although employees have little real influence).

Employees are sometimes asked for their opinions on decisions, or they are permitted to make a number of minor, inconsequential decisions.

The supervisor has the added task of exhibiting high concern for people and fostering a pleasant atmosphere

Overall the role of leader is controlling but employee oriented.

Control is still external but is preferably exercised through work group.

Devote considerable effort towards developing loyal employees who are dedicated to the norms of the organization.

Pressure from the work group is expected to make individual conform to the expectations of the organization.

Punishments are not extensively used because of the fear that it will disrupt the social harmony.

Communications within the informal groups are encouraged.

Management often uses grapevine for communication.

Considerable efforts are made to facilitate social communication.

The flow of work related communication tends to be low whether up or down the hierarchy.

Like classical school, management restricts the flow of important information.

Unlike classical school they make use of suggestion system and newsletter.

Rewards are mainly extrinsic and focus on loyalty to the organization.

Salaries (rather than hourly payment) are often used to foster a feeling of permanence.

Seniority increases are likely provided to encourage work force stability.

A number of noneconomic rewards may also be provided such as long service awards, employee of month citations to show the interest of organization in its employees.

High Involvement Managerial Strategy Assumptions: If the jobs are structured correctly, people can

actually enjoy and be intrinsically motivated by their work.

Adherents believe that people are motivated by needs for interesting work, challenge, autonomy, personal growth, and professional development.

Employees can exercise self control if organization provides these conditions while treating employees fairly.

Relationship with structural variables In designing jobs major effort is made to create jobs that

are: interesting and challenging, Provide workers with considerable autonomy over

planning and executing work, Job based feedback on how well they are performing. Conscious effort is made to combine the thinking and

doing, therefore jobs are; Broader, Attempt to include meaningful cycle of work activities, Joint employee-management planning and goal setting.

Coordination is horizontal as well as vertical. Jobs are often arranged in clusters , in which group

of employees has the responsibility for coordinating the completion of set of tasks among themselves.

These clusters or teams consists of people from various specialties mingled together.

Departmentation is often based on the product, customer, or project, not functional groupings.

The role of supervisor is facilitator rather being a controller or evaluator.

His/her job is to; remove barriers for effective performance, Provide adequate resources and other assistance to

enable subordinates to perform effectively, Because employees are assumed to be able to

exercise self control and self motivation; Supervisor is not required to perform control

function, Decisions can be made at the lowest possible level.

The overall leadership style is participative or democratic in nature.

Need for direct supervision and formalized rules and regulations can be kept to a minimum because;

Identification with the goals of the organization, Intrinsic rewards flowing from the work itself, Having sufficient knowledge and training to behave

responsibly. Since decisions are being made at all levels

throughout the organization: full disclosure of information is necessary.

Great effort is made for communication to flow vertically, horizontally and diagonally.

High involvement organizations use a wide variety of both intrinsic and extrinsic rewards.

Employees are expected to receive substantial intrinsic rewards directly from performing their jobs and participating in decision making.

Extrinsic rewards are geared towards fostering; good performance rather than controlling standard output, Focus on work unit rather than individual. Base pay tends to be salary, augmented by profit-and gain sharing

plans, as well as employee stock ownership. Pay is often person based (i.e. pay for knowledge) rather than job

based. Because of the complex behavior and high performance level

required in high involvement organizations, reward and compensation systems are usually more complex than those in firms using the other two managerial strategies.

Comparison of the Three Managerial Strategies and their Structural Implications

Structural Variable

Classical Managerial Strategy

Human Relations managerial Strategy

High involvement Managerial Strategy

Job design Thinking separate from doing, narrow fragmented jobs

Similar to classical but job design may allow more social contact

Joint planning and goal setting; broader, more meaningful jobs

Coordination and Departmentation

Strict formalized pyramidal hierarchy emphasizing accountability, vertical coordination,( by supervisor) departmentation by function

Similar to classical, possibly use of some work teams

Horizontal as well as vertical coordination, use of work teams, departmentation by product, customer, project or matrix

Control External through supervision, rules, punishments, and some extrinsic rewards

External- through use of social or peer pressure, rules, some extrinsic rewards

Internal through intrinsic rewards from the work itself, self control through internalized commitment

Structural Variable

Classical Managerial Strategy

Human Relations managerial Strategy

High involvement Managerial Strategy

Communication Formal and vertical, restricted

Use of formal and informal communication (grapevine) some restriction

High amount of vertical and horizontal communication, less formal, climate for open communication

Decision making and Leadership

Autocratic decision making; task oriented; controlling supervisory role

Autocratic decision making with minor consultation, employee oriented ; controlling supervisory role

Participative or democratic decision style, both task and employee oriented, facilitator supervisory role

Reward system Extrinsic economic rewards related to individual output or time worked

Extrinsic economic reward unrelated to performance; liberal fringe benefits and loyalty rewards

Intrinsic rewards from job itself, pay for knowledge, extrinsic rewards focusing on group or organization performance

Interrelationship among Structural Variables

There are strong interrelationship among structural variables.

Some elements are complimentary and must occur together for any of them to be effective.

Pushing decision making down to lower level employees in the organization is dangerous if they have not been provided with:

Adequate information with which to make informed decisions

A knowledge base to understand this information A reward system that creates a strong sense of identity

with company

Research has also shown that some structural elements can serve as a substitutes for others.

It has been shown that profit sharing and gain sharing systems can serve as substitutes for managerial control

The study found that firms having gain sharing, or profit sharing were able to operate with 31 percent fewer mangers and supervisors and significantly fewer rules and regulations than firms without these systems.

Organizations that consistently adopt a single managerial strategy are usually more effective than those that have inconsistent mix of structural variables.

Within a given managerial strategy there are different possible combinations of human resource policies.

A firm may choose to hire only experienced workers or it may choose to hire inexperienced workers and train them.

Hiring experienced workers usually costs more in compensation.

Hiring inexperienced workers cost more in training and the risk of losing them once they are trained.

Different managerial perspectives have different preferences.

Classical organizations would prefer not incur high training costs because of high turnover.

They would prefer experienced , trained workers where jobs require training.

Other human resource policies, such as recruitment might fit into managerial strategies.

High involvement organizations have the most sophisticated recruitment and selection procedures because they require workers who have a high potential for growth, self control, and motivation by higher order needs.

Classical organizations demands simple task performance, they the least sophisticated recruitment and selection procedures

Human relations organizations fall in-between because they want to screen out people who would disrupt the social environment of the firm.

Determinants of the Most Appropriate Managerial strategy

The purpose of this section is:

1. To show how each of the contextual variables can be categorized into types

2. How each type relates to managerial strategy

3. A template to understand and identify the most appropriate managerial strategy (hence reward strategy) for any given organization

Environment1. Whether the firm environment is stable or unstable. An unstable dynamic environment exists when: Product or service life cycles are short, Where product or service demand is volatile, Customer needs change quickly and unpredictably, Technologies are changing quickly, New competitors frequently enter the field, Where regulatory environment is unpredictable, Firms have little control over the degree of stability in the

task environment, Because of rigidity classical and human relation firms have

great difficulty in operating successfully in dynamic, unstable environments,

2. Whether the firm’s environment is simple or complex. A firm’s environment is complex if the firm has : Numerous distinct product or service domains, Where the product / service provided is complex, Where technology is complex, Where there are many factors that can influence the firm’s

success, Where as firms do not have much control over the degree of

stability in their environment, they have some control over degree complexity in their task environment,

A firm that chooses to operate in number of unrelated product/service domains creates a more complex environment for itself than a firm that operates only in one product or service domain,

Thus the complexity of a firm’s environment depend in part how broadly it defines its domain(s),

Certain domains are inherently more complex than others,

Environment If a task environment is complex, as long as it is stable, a

classical or human relations approach can be effective. If complexity stems from operating in many domains, either

classical or human relations approach should work. If the complexity is due to domain itself, then human relations

approach work best. Complex domains often require high levels of expertise

among employees, the high turnover that typifies a classical organization will be very costly.

When task environment is dynamic then complexity compounds the uncertainty facing the organization,

Neither classical or human relations organizations are able to adapt quickly to environment change,

In general a high involvement approach is needed whenever environment are highly unstable and dynamic.

Corporate Strategy: Miles and Snow Typology Miles and Snow suggest that corporate strategies can be divided into

three main types (defender, prospector, and analyzer), with a residual type (the reactor) to cover firms that do not practice any distinct overall strategy

1. The defender Corporate Strategy: Seek stability by producing only a limited set of products directed at narrow

segment of total potential market Strives aggressively to prevent competitors entering their turf through

competitive pricing or production of high quality products Ignore developments and trends outside their domains Grow through market penetration or limited product development Little or no scanning of environment to find new opportunities Intensive planning oriented toward cost and other efficiency issues Structure is high on horizontal differentiation, centralized control, and elaborate

formal hierarchy for communication For defenders classical or human relations approaches are suitable. In general, classical works well for manufacturing and human relations for

service enterprises, where there is extensive contacts customers.

2. Prospector Corporate Strategy Their strength is in finding and exploiting new-product and

market opportunities Innovating may be more important than high profitability Their success depends on developing and maintaining the

capacity to survey a wide range of environmental conditions, trends, and events

Invest heavily in personnel who can scan a wide range of environment for potential opportunities

Since flexibility is critical the structure is also flexible Rely on multiple technologies that have a low degree of

routinization and mechanization Numerous decentralized units Structure will be low in formalization and have decentralized

control with lateral as well as vertical communication High involvement managerial strategy is essential

3. Analyzer Corporate Strategy: Capitalize on the best of both the preceding types. They seek to minimize risk and maximize opportunity for profit Move into new products or markets only after viability has been proved by prospectors Analyzers live by imitation. They essentially follow their smaller and more innovative

competitors superior products, but only after their competitors have demonstrated that the market is there

Seek both flexibility and stability. They achieve these goals by developing structure made up of dual components

Parts of these organizations have high levels of standardization, routinization, mechanization for efficiency. Other parts are adaptive to flexibility

In this way they seek structure to accommodate both stable and dynamic areas of operations

Analyzers would likely operate best with something close to high involvement approach for new product development and classical approach for the traditional products

Since it is very difficult to practice two such divergent managerial strategies in the same firm , they tend to end up practicing a compromise human relations approach across the board.

This can be successful as long as the environment is not too dynamic.

4. Reactor corporate strategy: Represents a residual strategy Describe the inconsistent and unstable patterns that arise when

one of the three strategies is pursued improperly In general reactors respond inappropriately, perform poorly, and

as result are reluctant to commit themselves aggressively to a specific strategy for the future

Reasons Top management may have failed to make the organization

strategy clear Management may not have fully shaped the organization’s

structure to fit the chosen strategy Management may have maintained its current strategy –structure

relationship despite overwhelming changes in environmental conditions

Porter’s Typology of Corporate Strategy

1. Low cost leadership Organization be the low cost leader and not merely be

the contender for that position The product and service offered must be perceived as

comparable to that offered by rivals or at least acceptable to buyers

Structural characteristics Strong central authority; tight controls Standard operating procedures Easy to use manufacturing technologies Highly efficient procurement and distribution system Close supervision; limited employee empowerment Frequent, detailed controlled reports

2. Differentiation:Firm seeks to be unique in the industry in ways that are widely valued by the buyersMay emphasize high quality, extraordinary services, innovative design, technological capability, positive brand imageThe key is that the attribute chosen must be different from those offered by rivals and significant enough to justify premium that exceeds the cost of differentiationStructural CharacteristicsActs in an organic, loosely knit way, with strong coordinationCreative flair, thinks “ out of the box”Strong capability in basic researchStrong marketing abilitiesRewards employee innovationCorporate reputation for quality or technological leadership

3. Focus/Segmented Strategies: Either a cost advantage (cost focus) or differentiation ( differentiation focus) in a narrow segmentHigh involvement strategies best suited for differentiation strategies.Classical strategy best suited for low cost leadership strategies.

Technology

Organization’s technology is the set of procedures and resources used to transform input into output

Three typologies of technologies are often used All three can yield different insights on how

technology relates to the most appropriate managerial strategy a firm can adopt

Thompson’s Typology of Technology Classifies technology according to production process1. Long linked Technology: Divides the total task into many small sequential steps, with

each step performed by different employee e.g. assembly line2. Mediating Technology Uses standardized transaction to connect two parties who have

some kind of mutual relationship Banks connect people who want to lend money with people

who want to borrow it Transportation companies connect people who have an item

with people who want that item Real state people connect who want to sell houses with who

want to buy

3. An intensive Technology Requires that each item or case be dealt with individually, based on

feedback from the client or object being worked on General hospital Tailors Legal firms specializing in criminal law Consulting firm An intensive technology requires a high involvement structure A long linked technology would suit a classical structure Most mediating technologies involve contact with people the human

relations strategy is usually most appropriate for them

Perrow’s Typology of Technology Charles Perrow looked at knowledge rather than at

production technology Defined technology as, “ the action that an

individual performs upon an object, with or without the aid of tools or mechanical devices, in order to make some change in that object”

Task Variability Problem Analyzability

Task Variability: Number of exception in the work Frequency of unexpected and novel events that

occur in conversion process Problem Analyzability: When the conversion process is analyzable, the

work can be reduced to mechanical steps Participants can follow an objective,

computational procedure to solve problems Problem solution may involve the use of standard

procedures such as instruction manuals, or technical knowledge such as textbook

When work is not analyzable, when problem arise it is difficult to identify correct solution

No store of techniques or procedure to tell a person exactly what to do

The cause of or solution to problem is not clear , so employee rely on accumulated experience, intuition and judgment

A firm that uses non routine technology requires a high involvement management strategy.

A firm that uses routine technology uses a classical or human relations approach.

Firms with craft or engineering technologies generally depend on the judgment of skilled employees, who prefer autonomy in performing their jobs.

It may not be necessary to have a full high-involvement structure for engineering technology, but strict classical structure would alienate these employees.

For craft technology something close to high involvement approach is probably necessary, since the organization depends on the intuitive judgment of its employees.

Woodward’s Typology of Technology

Woodward suggested that manufacturing technologies can be divided into three main types

i. Unit production: manufacture custom made products

ii. Mass production:, manufacture large batch or mass produced products

iii. Continuous process production: completely automated, no stopping of production process,

Woodward concluded that within each technological category the firms that conformed most nearly to the median for each structural component were most effective

1. The mass production technology firms were: (Mechanistic)- highly differentiated- relied on extensive formalization- did relatively little to delegate authority- classical managerial strategy clearly suits this technology

2. Both unit and continuous process, in contrast were structured more loosely (organic). Flexibility was achieved through:- less vertical differentiation- less division of labor- more group activities- more widely defined roles and responsibilities- decentralized decision making- High involvement technology fits well with these technologies

Organization Size Large organizations generally use classical or

human relations strategy because of the need to coordinate large number of people

In general it is easier to implement high involvement in a small or medium sized organizations, because larger the organization the greater the need for some formal structure

Some large organizations have resolved the problem by segmenting organization into series of small units and then practicing high involvement in these units

The Nature of Work Force Highly skilled, well educated, or professional employees are

more suited to high involvement organizations Classical organizations are specifically designed to utilize

employees with relatively low skill levels Because classical organization are most suited to workers who

badly need the money the job provides Classical motivational approaches work best in poor

economic circumstances and in areas with high unemployment and low standard of living

Human relations organizations often utilize relatively low-skilled workers but do not need to depend on poor economic conditions for motivational policies since they offer both economic and social rewards

Template for Selecting the Most Appropriate Managerial strategy for an Organization to Adopt

Contextual Variables Classical Human Relations High Involvement

EnvironmentStabilityComplexity

StableSimple

StableSimple or complex

UnstableSimple or complex

Corporate StrategyMiles and SnowPorter’s Typology

DefenderLow cost (Mfg)

AnalyzerLow cost (service)

ProspectorDifferentiator

TechnologyThompson’s TypologyPerrow’s typologyWoodward’s TypologyProduct Transformed

Long linkedRoutineMassThings

MediatingRoutine or EngineeringProcessPeople

IntensiveCraft/non routineProcess / unitIdeas

SizeNumber of Employees

Any Size Any Size Small / Medium

WorkforceSkill/ EducationEconomic Circumstances

LowPoor

ModerateModerate

HighGood