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