Chapter 7

Defining Competitiveness

McGraw-Hill/Irwin Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

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Chapter Topics

Compensation Strategy: External Competitiveness

What Shapes External Competitiveness?

Labor Market Factors

Modifications to the Demand Side

Modifications to the Supply Side

Product Market Factors and Ability to Pay

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Chapter Topics (cont.)

Organization Factors

Relevant Markets

Competitive Pay Policy Alternatives

Consequences of Pay-Level and Mix Decisions: Guidance from the Research

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Compensation Strategy: External Competitiveness

External competitiveness is expressed by:

Setting a pay level that is above, below, or equal to that of competitors

Determining the mix of pay forms relative to those of competitors

External competitiveness refers to the pay relationships among organizationsthe organizations pay relative to its competitors

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Compensation Strategy: External Competitiveness (cont.)

Pay level refers to the average of the array of rates paid by an employer:

(base + bonuses + benefits + value of stock holdings) / number of employees

Pay forms are the various types of payments, or pay mix, that make up total compensation

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Compensation Strategy: External Competitiveness (cont.)

Objectives:

Control costs and increase revenues

Attract and retain employees

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Control Costs and Increase Revenues

Labor costs = (pay level) times (number of employees)

Higher the pay level, the higher the labor costs

Higher the pay level relative to what competitors pay, the greater the relative costs to provide similar products or services

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Labor Market Factors

Two basic types of markets:

Quoted price Example: Stores that label each items price

Bourse Example: eBay allows haggling over the

terms and conditions

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Labor Market Factors (cont.)

In both markets, employers are the buyers and potential employees are the sellers

If inducements offered by the employer and skills offered by the employee are mutually acceptable, a deal is struck

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How Labor Markets Work (cont.)

The market rate is where the lines for labor demand and labor supply cross

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Labor Demand

Analysis of labor demand indicates how many employees will be hired by an employer

In the short run, an employer cannot change any factor of production except human resources

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Labor Demand (cont.)

An employers level of production can change only if it changes the level of human resources

An employers demand labor coincides with the marginal product of labor

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Marginal Product

Marginal product of labor is the additional output associated with employment of one additional person, with other production factors held constant

Diminishing marginal productivity Each additional employee has a progressively

smaller share of the other factors of production with which to work

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Marginal Revenue

Marginal revenue of labor is the additional revenue generated when the firm employs one additional person, with other production factors held constant

A manager using the marginal revenue product model must:

Determine pay level set by market forces

Determine marginal revenue generated by each new hire

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Labor Supply

This model assumes:

Many people are seeking jobs

They possess accurate information about all job openings

No barriers to mobility exist

These assumptions greatly simplify the real world

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Modifications to the Demand Side

Economic theories must frequently be revised to account for reality

When focus changes from all the employers in an economy to a particular employer

Issue for economists:

Why would an employer pay more than what theory states is the market-determined rate?

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Compensating Differentials

According to Adam Smith, If a job has negative characteristics then employers must offer higher wages to compensate for these negative features

For instance, if: Necessary training is very expensive

Job security is tenuous

Working conditions are disagreeable

Chances of success are low

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Efficiency Wage

According to efficiency-wage theory, high wages may increase efficiency and actually lower labor costs if they:

Attract higher-quality applicants

Lower turnover

Increase worker effort

Reduce shirking

Reduce the need to supervise employees

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Efficiency Wage (cont.)

Firms with greater profits than competitors are able to share success with employees via:

Leading competitors pay levels

Bonuses that vary with profitability

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Signaling

Employers deliberately design pay levels and mix as part of a strategy that signals to both prospective and current employees kinds of behaviors sought

On the supply side of the model: Suppliers of labor signal to potential

employers

Characteristics of applicants and organization decisions about pay level and mix act as signals

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Product Market Factors and Ability to Pay

Product Demand

Puts a lid on maximum pay level an employer can set

Degree of competition

In highly competitive markets, employers are less able to raise prices without loss of revenues

Single sellers are able to set whatever price they choose

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Segmented Supplies of Labor and (Different) Going Rates

People flow to the work

A segmented labor supply involves:

Multiple sources of employees

From multiple locations

With multiple employment relationships

Level and mix of cash and benefits paid depends on the source

Work flows to the peopleon site, off-site, offshore

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Segmented Supplies of Labor and (Different) Going Rates (cont.)

Reality is complex; theories abstracts

Segmented sources of labor means that determining pay levels and mix requires understanding market conditions in different locations

Managers need to know: Jobs required to do the work

Tasks to be performed

Knowledge and behaviors required to perform them

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Organization Factors

Industry and technology

Labor-intensive industries tend to pay lower than technology-intensive industries;

New technology within an industry influences pay levels

Employer size

Large organizations tend to pay more than small ones

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Relevant Markets

Three factors determine relevant labor markets:

Occupation

Geography

Competitors

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Relevant Markets (cont.)

Employers choose their relevant markets based on:

Competitors Products, location, and size

Jobs Skills and knowledge required and their importance to organizational success

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Globalization of Relevant Labor Markets:Offshoring and Outsourcing

Factors to consider in deciding where jobs will be:

Countries with lower average labor costs tend to have lower average productivity

Companies must devote resources to systems that monitor worker effort or output (Agency theory)

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Globalization of Relevant Labor Markets:Offshoring and Outsourcing (cont.)

Customers reactions must be considered

How long the labor cost advantage will last

Whether qualified employees will continue to be available as other companies tap into this labor pool

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Pay with Competition (Match) (cont.)

Attempts to ensure that an organizations:

Wage costs are approximately equal to those of its product competitors

Ability to attract potential employees will be approximately equal to its labor market competitors

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Lead Pay-Level Policy

Maximizes the ability to attract and retain quality employees and minimizes employee dissatisfaction with pay

May also offset less attractive features of work

If used only to hire new employees, may lead to dissatisfaction of current employees

May mask negative job attributes that contribute to high turnover later on

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Lag Pay-Level Policy

Paying below-market rates may hinder a firms ability to attract potential employees

Lag pay-level policy coupled with the promise of higher future returns:

May increase employee commitment

Foster teamwork

May possibly increase productivity

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Exhibit 7.16: Some Consequences of Pay Levels

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Consequences of Pay-Level and MixDecisions: Guidance from the Research (cont.)

Fairness

Satisfaction with pay is directly related to pay level

Sense of fairness is related to how others are paid

Compliance

Employers must pay at or above the legal minimum wage

Prevailing wage laws and equal rights legislation must be met

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Consequences of Pay-Level and MixDecisions: Guidance from the Research (cont.)

Pay forms are also regulated

Caution must be exercised when sharing salary information to avoid antitrust violations