STRATEGIC REWARD

MANAGEMENT
 STRATEGIC REWARD
MANAGEMENT DEFINED
 Strategic Compensation/strategic reward management
refers to the design and implementation of
compensation systems to reinforce the objectives of
both HR strategies and competitive business strategies.
 Strategic reward management is an approach to the
development and implementation of reward strategies
and the guiding principles that underpin them.
 As described by Armstrong and Brown (2006), it
provides answers to two basic questions:
 first, where do we want our reward practices to be in
a few years’ time?
 And second, how do we intend to get there?
 Strategic reward mgt deals with both ends and
means.
 As an end it describes a vision of what reward

processes will look like in the future.

 As a means, it shows how it is expected that the

vision will be realized.

 Strategic reward is based on beliefs about what

the organization values and wants to achieve.

 It does this by aligning reward practices with both
business goals and employee values.
 The rationale for strategic reward

 There are four arguments for adopting a strategic

approach to reward management:
 1. You must have some idea where you are going,

or how do you know how to get there?

 2. The real benefit in reward strategies lies in

complex linkages with other human resource

management policies and practices. Isn’t this a
good reason for developing a reward strategic
framework that indicates how reward processes will
be aligned to HR processes so that they are coherent
and mutually supportive?
 3. There can be a positive relationship
between rewards and performance, so
shouldn’t we think about how we can
strengthen that link?
 4. Pay costs in most organizations are by far
the largest item of expense – they can be 60
percent and often much more in labour-
intensive organizations – so doesn’t it make
sense to think about how they should be
managed and invested in the longer term?
Competitive Business Strategy
 The planned use of company resources
 Financial capital
 Equipment capital
 Human capital

 Multiple years of time span

 Competitive strategy choices:
 Low cost strategy
 Differentiation strategy
Competitive Business Strategy Choices

Lowest cost strategy: focus on being lowest

cost producer/seller of goods or services

Differentiation strategy: focus on offering

unique goods or services to the public
Lowest Cost Strategy
Effective when jobs:
 Include predictable behaviors
 Have a short-term focus
 Require autonomous activity
Focus on quantity of output
Ex: Ryanair (reduced operations costs).
Differentiation Strategy
Effective when jobs:
 Require highly creative behaviors
 Have a long-term focus
 Demand cooperation
 Involve risk-taking
Ex: Apple Computer relies on this strategy to
build market demand and loyalty and strives to
establish leading-edge electronic devices.
Human Resource Strategies
The use of multiple HR practices to reinforce
competitive business strategy, for example:
We (Eli Lilly) are a global healthcare leader
headquartered in Indianapolis, IN. Our 39,000
employees around the world work to discover and
bring life-changing medicines to those who need
them, and improve the understanding and
management of disease.
Relationship Between Strategic
Decisions and Compensation Practices
 Pay structure in which different wage scales are set
for senior workers and for new workers. Found
usually in firms with strong union presence.
Broad banding is a job grading structure that falls
between using spot salaries vs. many job grades to
determine what to pay particular positions and
incumbents within those positions. While broad
banding gives the organization using it some broad
job classifications, it does not have as many
distinct job grades as traditional salary structures
do
 Thus, broadbanding reduces the emphasis on ‘status’ or
hierarchy and places more of an emphasis on lateral job
movement within the company. In a broadbanding
structure an employee can be more easily rewarded for
lateral movement or skills development, whereas in
traditional multiple grade salary structures pay
progression happens primarily via job promotion. In this
way, broadbanding is a more flexible pay system. This
flexibility, however, can lead to internal pay relativity
problems as there isn’t as much control over salary
progression as there would be within a traditional multi-level
grading structure.
 Strategic Compensation Decisions

 Compensation professionals provide a strategic

contribution when they can answer yes to 3 questions:
 What are the competitive business strategy options and
does compensation strategy fit well with the objectives
of company competitive business and HR strategies?
 Does the choice and design of compensation practices
fit well to support compensation strategy?
 Does the implementation of compensation practices
effectively direct employee behavior to enhance job
performance that supports the choice of compensation
practices?
Building Blocks and Structures of
Strategic Compensation Systems
 The main building blocks are extrinsic
compensation and intrinsic compensation
 Our focus is on extrinsic compensation:
 Core compensation
 Adjustments to core compensation
 Legally required employee benefits
 Discretionary employee benefits
Fundamental Compensation
System Design Elements
Compensation professionals promote effective
compensation systems by meeting three
important goals:
 Internal consistency
 Market competitiveness
 Recognition of employee contributions
Internal Consistency
 Achieved when the value of each job is clearly
defined
 Represents
 Job structure
 Hierarchy
 Achieved using
 Job analysis
 Job evaluation
Market Competitiveness
 Compensation policies that fit with business
objectives
 Vital in attracting and retaining employees
 Based on:
 Strategic analyses
 Compensation surveys
Individual Contributions

Pay structures: determined by employees’

credentials, job knowledge, and job performance
Pay grades: based on compensable factors
Pay ranges: built on grades, uses midpoint,
minimum, and maximum pay rates
 Guiding principles
 A reward philosophy can be expressed through a
set of guiding principles that define the approach
an organization takes to dealing with reward.
 They are the basis for reward policies and

provide guidelines for the actions contained in

the reward strategy.
 Importantly, they can be used to communicate to

employees how the reward system operates and

takes into account their interests as well as those
of the business.
 Reward guiding principles will be concerned with
matters such as:
 operating the reward system justly, fairly, equitably

and transparently in the interests of all stakeholders;

 developing reward policies and practices that

support the achievement of business goals;

 rewarding people according to their contribution;
 recognizing the value of everyone who is making

an effective contribution, not just the exceptional

performers;
 creating an attractive employee value proposition;
 providing rewards that attract and retain people and
enlist their engagement;
 helping to develop a high-performance culture;
 maintaining competitive rates of pay;
 maintaining equitable rates of pay;
 allowing a reasonable degree of flexibility in the
operation of reward processes and in the choice of
benefits by employees;
 devolving more responsibility for reward decisions to
line managers.
 British Airways
 •Total reward is aligned to the business strategy. It engages and
involves people in the achievement of business goals.
 •Reward is aligned to company performance and supports a
performance culture.
 •Reward helps employees understand how their efforts contribute
to company success.
 •Rewards will be cost effective.
 •Total reward is actively supported in the business.
 •Individual value is recognized through base pay; delivery of
results is linked to variable pay.
 •Reward will take into account market forces and drivers.
 •Total reward policy and practice will be well communicated and
administered.
 THE CONCEPT OF REWARD
STRATEGY

 Reward Strategy defined

 Reward strategy is a business-focused description

of what the organization wants to do about reward

in the next few years and how it intends to do it.
 It constitutes a framework for developing and

putting into effect reward policies, practices and

processes that ensure that people are rewarded for
doing the things that increase the likelihood of the
organization’s business goals being achieved.
 THE CONCEPT OF REWARD
STRATEGY
 The process of strategic reward is
operationalized through overall or specific
reward strategies.
 They generally start with a review of the current

reward arrangements and situation, then a

definition of the desired future state, and the
development of reward initiatives and activities
to close the gap between the two.
 Aim of reward strategy
 The aim of reward strategy is to provide the

organization with a sense of purpose and

direction in delivering reward programmes that
support the achievement of business goals and
meet the needs of stakeholders.
 Reward strategies should have two primary
aims:
 to articulate a distinctive value proposition
that attracts and retains the right people for
the business,
 to provide a framework from which the
company designs, administers and evaluates
effective reward programmes.
 Characteristics of reward strategy
 Reward strategy will be characterized by diversity
and conditioned both by the legacy of the past and
the realities of the future.
 All reward strategies are different, just as all
organizations are different.
 Of course, similar aspects of reward will be

covered in the strategies of different organizations

but they will be treated differently in accordance
with variations in their contexts, business strategies
and cultures.
 The content of reward strategy
 All reward strategies are different just as all

organizations are different.

 Reward strategy often has to be a balancing act

because of potentially conflicting goals.

 For example, it may be necessary to reconcile

the competing claims of being externally

competitive and internally equitable – paying a
specialist more money to reflect market rate
pressures may disrupt internal relativities.
 The content of reward strategy…
 There are two approaches:
 1) a grand design involving the development of
overall strategy, and
 2) a focus on one or two specific strategies.
 Overall strategy
 An overall strategy may cover all aspects of rewards
– valuing roles, the design of grade and pay
structures, contingent pay, non-financial recognition,
and pensions and benefits.
 Specific reward strategies
 Specific reward strategies are more closely focused on
one issue, or two or three linked issues that can be dealt
within a single programme, often over a limited
timescale to respond to pressing needs.
 Examples of such issues include:
 placing reward in a programme for developing a high-

performance work system;

 introducing a substantially revised job evaluation

scheme;
 introducing or revising a contingent pay scheme
 Examples of more closely focused reward
strategies are given below.
 The aims of the reward strategy devised by

Airbus were to introduce performance pay for

all employees, ensure that its rates were
competitive with the external market and deal
with anomalies caused by previous rigidities,
such as grade drift brought about by people
having to be promoted to a higher grade to
receive additional pay.
 The structure of reward strategy
 Reward strategies are diverse and so is the structure used by
different organizations to define and present them.
 Some reward strategies are more complex than others but in one
form or other their structure may contain:
 A declaration of intent: the proposed reward developments.

 A rationale: the reasons why the proposals are being made.

 A definition of guiding principles: the values that it is

believed should be adopted in formulating and implementing

the strategy.
 A plan: how, when and by whom the reward initiatives will

be implemented.
 Criteria for an effective reward
strategy
 It supports the achievement of business goals.
 It takes account of the needs of employees as well as those of
the organization and its other stakeholders.
 It is founded on detailed analysis and study, not just wishful
thinking.
 It has clearly defined and achievable objectives.
 It can be turned into actionable programmes that anticipate
implementation requirements and problems.
 It is coherent and integrated, being composed of components
that fit with and support each other.
 It provides a framework within which consistent reward
decisions can be made.
REWARD POLICIES
 Reward policies set specific guidelines for
decision making and action.
 They indicate what the organization and its

management are expected to do about managing

reward and how they will behave in given
circumstances when dealing with reward issues.
 They can be distinguished from guiding

principles, which usually express a more

generalized philosophy.
 REWARD POLICY HEADINGS
 Reward policies deal with:

the level of rewards;

the relative importance attached to external
competitiveness versus internal equity;
the use of job evaluation;
achieving equal pay ( the degree to which
pay levels should be market-led pay)
 Level of rewards- The policy on the level of rewards
indicates whether the company is a high payer, is
content to pay median or average rates of pay or even,
exceptionally, accepts that it has to pay below the
average.
 External competitiveness versus internal equity
 A policy needs to be formulated on the extent to which
rewards are market-driven rather than equitable. This
policy will be influenced by the culture and reward
philosophies of the organization and the pressures on
the business to obtain and keep high-quality staff.
 Use of job evaluation- Policy on the use of
formal job evaluation procedures to determine
internal relativities will depend on the policies
on equal pay and internal equity referred to
above.
 Achieving equal pay-A policy is required on

the degree to which equal pay considerations

should drive the managmt of z reward system.
 The policy should also cover the use of equal

pay reviews.
 DEVELOPING REWARD
POLICIES
 Reward policies should be developed by:
 taking into account the structure, culture,

management style and values of the organization,

its reward philosophy and its business, HR and
reward strategies.
 consulting with those concerned on what policy

approach is likely to be most relevant to the

business priorities of the organization and the
needs of its employees.
 DEVELOPING REWARD
POLICIES…
 ensuring that the policies are practical
(implementable) and will provide the requisite level
of guidance for decision and action;
 deciding on the amount of training and guidance that
will be required to enable line managers and others to
implement policies with an appropriate degree of
consistency;
 communicating the policies to all affected by them –
ideally, they should be expressed in writing and the
communicatn process should include briefing groups.
FACTORS AFFECTING PAY
LEVELS
 Perhaps the most significant policy decisions
that have to be made by those concerned with
reward management are about levels of pay.
 In making these decisions it is necessary to be

aware of the various factors that influence pay

levels, including the key economic theories that
explain those factors
 ECONOMIC DETERMINANTS OF PAY

 The following economic theories and concepts

provide guidance on the factors that affect pay levels:
 the labour theory of value;
 the nature of the external and internal labour

market;
 the economic ‘laws’ of supply and demand;
 human capital theory;
 efficiency wage theory;
 agency theory (principal agent theory);
 the effort bargain.
 The labor theory of value
 As pointed out by Nielsen(2002),

conventional job evaluation schemes are based

on the labor theory of value in that they are
only concerned with job content and ignore
market rate pressures.
 They make no attempt to price jobs directly.

 The content of labor determines the price of

labor.
 Das Kapital that the value of goods and services is
determined by the amount of labour that goes into them.
It is not the marketplace that sets prices. Thus the
content of labour determines the price of labour.
Mainstream economists have never accepted this
concept and assert the primacy of supply and demand in
the marketplace in setting prices of goods and services.
However, as pointed out by Niels Nielsen(2002),
conventional job evaluation schemes are based on the
labour theory of value in that they are only concerned
with job content and ignore market rate pressures. They
make no attempt to price jobs directly.
 The labour market
 The labour market is a market like any other

market; it has buyers (employers) and sellers

(employees).
 The price of labour is the rate of pay required

to attract and retain people in organizations.

 Pay levels and relativities in the internal

market may differ significantly between firms

in spite of general external market pressures.
 Classical economic theory
 Classical economic competitive theory states that

pay levels in labour markets are determined by

supply and demand considerations.
 Other things being equal, if there is a surplus of

labour and supply exceeds the demand, pay levels

go down; if there is a scarcity of labour and
demand exceeds the supply, pay goes up.
 Pay stabilizes when demand equals supply at the

‘market clearing’ or ‘market equilibrium’ wage

 Classical theory, however, is based on the
premises that ‘other things are equal’ and that
a ‘perfect market’ for labour exists. In the real
world, of course, other things are never equal.
And there is no such thing as a universally
perfect market, that is, one in which everyone
knows what the going rate is and there are no
monopolistic or other forces interfering with
the normal processes of supply and demand.
 Human capital theory
 Human capital theory,=‘conceptualizes workers as
embodying a set of skills which can be “rented out” to
employers.
 The knowledge and skills a worker has – which comes
from education and training, including the training that
experience brings – generate a certain stock of
productive capital.’
 For the employer, the return on investment in human capital is
expected to be the improvements in performance, productivity,
flexibility and capacity to innovate that should result from
enlarging the skill base and increasing levels of competence.
 Efficiency wages theory (the economy of high wages)
 Efficiency wages theory proposes that firms will pay
more than the market rate because they believe that high
levels of pay will contribute to increases in productivity
by motivating superior performance, attracting better
candidates, reducing labour turnover and persuading
workers that they are being treatedfairly.
 Organizations are using efficiency wages theory
(although they will not call it that) when they formulate
pay policies that place them as market leaders or at least
above the average.
 Agency theory
 Agency theory recognizes that in most firms there is a
separation between the owners (principals) and the agents /mgr
 However, the principals may not have complete control over
their agents.
 The latter may therefore act in ways that are not fully revealed
to their principals and that may not be in accordance with the
wishes of those principals.
 This generates what economists call agency costs, which arise
from the difference between what might have been earned if the
principals had been the managers and the earnings achieved
under the stewardship of the actual managers.
 To reduce these agency costs, the principals have to
develop ways of monitoring and controlling the
actions of their agents.
 Agency theory as described above can be extended to
the employment contract within firms. The
employment relationship may be regarded as a
contract between a principal (employer) and an agent
(the employee). The payment aspect of the contract is
the method used by the principal to motivate the agent
to perform work to the satisfaction of employer.
 But according to this theory, the problem of ensuring
that agents do what they are told remains. It is
necessary to clear up ambiguities by setting objectives
and monitoring performance to ensure that those
objectives are achieved.
 Agency theory also indicates that it is desirable to
operate a system of incentives to motivate and reward
acceptable behavior. This process of ‘incentive
alignment’ consists of paying for measurable results
that are deemed to be in the best interests of the
owners.
 The effort bargain
 The concept states that the task of management is to assess
what level and type of inducements it has to offer in return
for the contribution it requires from its workforce.
 The aim of workers is to strike a bargain about the
relationship between what they regard as a reasonable
contribution and what their employer is prepared to offer to
elicit that contribution.
 This is termed the ‘effort bargain’ and is, in effect, an
agreement that lays down the amount of work to be done
for a rate of pay or wage rate, not just the hours to be
worked
 The concept of the effort bargain is referred to less
frequently nowadays and it is not strictly an economic
theory. But it has its uses as a further means of describing
the employment relationship on pay matters.
 This is termed the ‘effort bargain’ and is, in effect, an
agreement that lays down the amount of work to be done
for a rate of pay or wage rate, not just the hours to be
worked. Explicitly or implicitly, all employees are in a
bargaining situation with regard to pay. A system will not
be accepted as effective and workable until it is
recognized as fair and equitable by both parties and unless
it is applied consistently.
 FACTORS AFFECTING PAY
LEVELS WITHIN
ORGANIZATIONS
 Within most organizations there are defined or
generally understood pay levels for jobs. These
are usually set out in the form of a pay structure,
which may cover the whole organization or
groups of related occupations (job families).
There may be different structures at various
levels, for example senior management, other
staff and manual workers. In some organizations,
however, the pay system is highly flexible and
relatively unstructured.
 It may, for example, simply consist of individual
rates for the various jobs (spot rates), which bear no
apparent logical relationship to one another and are
determined by management intuitively. Structures for
manual workers may also consist of spot rates that
are based on negotiations and custom and practice.
Where there are formal structures, pay levels and
ranges may be determined by the processes of job
evaluation, which assesses the relative internal worth
of jobs (internal relativities), and market pricing,
which assesses external relativities.
 Individual rates of pay may be governed by the
structure in the form of a fixed rate for the job
or by movement in the form of fixed
increments up a scale (a fixed increment is a
predetermined addition to an individual’s rate
of pay that is related to service in the job).
 Alternatively, pay progression within brackets

or bands or within job family structures may

vary according to individual performance,
competence or contribution.
The level of pay of employees within
organizations is affected by the economic
factors mentioned above, which impact the
intrinsic value attached to the job, internal
relativities, external relativities and the value of
the person.
 It is also affected by the financial

circumstances of the organization, the ‘market

stance’ it adopts and trade union pressures.
 External relativities
 The rates of pay for jobs and people will be

influenced by market rates in accordance with

the policy of the organization on how it wants
its pay levels to relate to market levels and the
degree to which market forces impact on the
amounts required to attract and retain the
quality of people the organization needs.
 The value of the person
 Individuals are valued by organizations for four

reasons:
 1) the contribution they make to

organizational success;
 2) their skills and competences;
 3) the experience they bring to their roles;

and
 4) their potential.
 Financial circumstances of the organization
 ‘Affordability’ is an important concept in

reward management.
 Pay systems must not cost more than the

organization can afford, and this will influence

the level of pay that can be offered to
employees.
 Pay stance
 Policy decisions on an organization’s pay

stance – whether it should be a high, medium

or even low payer – will depend partly upon
what it can afford but will also be affected by
the extent to which it believes that it must be
competitive in the labour market.
 Trade union pressures
 Pay levels may be determined through

collective bargaining with trade unions

 The amount of pressure they can exert on pay

levels will depend on the relative bargaining

strengths of the employer and the union, and
this will reflect the amount of power either
party can exert in pay negotiations.
THE SIGNIFICANCE OF THE FACTORS
AFFECTING PAY LEVELS
 The factors affecting pay levels described above are
significant because they exert a major influence on
how organizations manage their pay.
 That is why it is important to take them into account
when making pay decisions as discussed below:
 The labour theory of value- It is necessary to take
into account market rates through ‘market pricing’
based on market rate analysis to ensure that pay is
competitive as well as equitable.
 Classical economic theory- The significance
of classical economic theory is that it focuses
attention on external pressures and the
perceived need for ‘competitive pay’, that is,
pay that matches or exceeds market rates.
 Classical theory is used as a justification for

‘market’ pricing rather than job evaluation,

concentrating on external competitiveness at
the expense of internal equity.
 External competitiveness versus internal equity-
Organizations must understand the other factors
besides market pressures that may affect pay levels,
such as perceived needs for equity and for rewarding
individual contribution and competence, long service
and loyalty.
 External competitiveness versus internal equity-
This means appreciating that there will be tension
between pay determination policies based on
external comparisons (market pricing) and those
focusing on internal relativities (job evaluation).
 Labour markets- Organizations must be aware
of the labour markets in which they are operating
so that they can make appropriate decisions on
pay levels in the light of market intelligence and
policies on where they want to be in relation to
the market.
 Human capital theory-Individuals expect a

return on their own investment, and firms

recognize that the increased value of their
employees should be rewarded.
 Human capital theory encourages the use of
competence-related or skill-based pay as a method of
reward. It also underpins the concept of individual
market worth. This indicates that individuals have their
own value in the marketplace, which they acquire and
increase through investments by their employer and
themselves in gaining extra expertise and competence
through training, development and experience. The
market worth of individuals may be considerably higher
than the market rate of their jobs, and if they are not
rewarded accordingly they may market their talents
elsewhere.
 Agency theory-Agency theory performs the
useful function of directing attention to the
ambiguities inherent in the employment
relationship and to the importance of managing
expectations.
 The effort bargain- The notion of an effort

bargain highlights the fact that pay levels are

subject to collective and individual negotiation.
It also draws attention to the need for equity,
fairness and consistency in reward systems.
 THE PSYCHOLOGICAL
CONTRACT
 The employment relationship contains a combination
of beliefs held by individuals and their employers
about what they expect of one another.
 A psychological contract is systems of beliefs that
encompass the actions employees believe are
expected of them and what response they expect in
return from their employer.
 It has also been defined as ‘The set of reciprocal
expectations between an individual employee and the
organization’.
 The psychological contract may provide some indication of
the answers to the two fundamental employment relationship
questions that individuals pose:
 ‘What can I reasonably expect from the organization?’ and

 ‘what should I reasonably be expected to contribute in

return?
 Employees may expect to be treated fairly as human beings,
to be provided with work that uses their abilities, to be
rewarded equitably in accordance with their contribution, to
be able to develop and display competency, to have
opportunities for further growth, to know what is expected of
them and to be given feedback on how they are doing.
THE PSYCHOLOGICAL
CONTRACT…
 As suggested by Spindler (1994), ‘A psychological contract
creates emotions and attitudes which form and control
behavior.’
 A balanced psychological contract is necessary for a
continuing, harmonious relationship between the employee and
the organization.
 However, the violation of the psychological contract can
signal to the participants that the parties no longer share (or
never shared) a common set of values or goals.
 To summarize, the psychological contract lacks many of the
characteristics of the formal contract:
 It is not generally written down, and it cannot be enforced in a court
or tribunal.