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. Includes a case study of how flexible reward structures were introduced at Herts and Hampshire County Councils.

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