1.

INTRODUCTION

WELCOME

- Pay systems are a very important part of every organization. They're not only a major cost,they
determine the performance of an organization. Still, many organizations and managersdon't do a very
good job of pay administration. This isn't because of a lack of research knowledge; it's because of a
lack of education, and applying what we know, works. My name is Ed Lawler, and I've been writing,
consulting, researching, and teaching about compensationand organizational effectiveness for over 50
years.
In this course I'm going to share with you the fundamentals of pay strategy. I'll talk about how to use
pay to attract and retain talent, how pay can motivate performance. We'll also look at how pay effects
an organization's structure and culture, as well as how to determine pay for individuals. Finally, I'll
share an overview of what goes into designing a pay system.Administering pay is challenging, but with
the tools and skills you'll learn in this course you'll be well on your way to understanding how to use
pay to help your organization be more successful.
Let's get started.

WHY PAY MATTERS

- Well, pay matters because it's one of the most important elements of the relationshipbetween an
individual and an organization. From an organization's point of view, first and foremost, it's a major
cost. Increasingly, it represents 60 or 70% or more of the total cost an organization bears as part of
their business model. That's if you include benefits as well as cash in your pay equation. That's
increased over time because increasingly knowledge-work businesses have labor as their major
factor in their cost structure, and that of course means that pay and benefits become a very, very
major part of their business model.
But it shouldn't be looked at just as a cost of doing business which has to be in line with your
competitors, otherwise, of course, your products will be too expensive. It matters because it can
impact behavior and organizational effectiveness in very significant ways. It's not just a matter of
controlling costs, it's a matter of delivering pay in a manner that produces resultsthat contribute to the
bottom line or the performance of the organization. There's an enormous amount of research which
shows that pay affects absenteeism, turnover, the willingness of people to join unions, but perhaps
more important, their productivity and their performance.
And finally, of course, it also impacts their willingness to learn new skills and the kind of skills that they
are able to learn and ultimately end up learning. Well, the first thing I'd suggest in talking to you about
your pay is how big a piece of your total cost structure it is. If it's significant, which it is in almost every
business, you should be very aware of how you're spending it, how your cost structure compares with
that of your competitors, and of course what your return is on the investments you're making in pay.
And as a businessperson, you want to be sure that you're getting a good return on your business pay
structure, and that it's producing the kind of results that you should get from it.And what do I mean by
results? Well, I mean the productivity of your employees, is it influencing that in a positive way? Is it
attracting and retaining the right employees? Is it encouraging them to learn the right things, to
develop, to be agile when the business changes, to do the right things that are required in order for
you to have a successful business? The pay structure of your organization should be both cost-
effective and produce the right behaviors and the right results for the organization.

2. PAY STRATEGY

UNDERSTANDING THE IMPORTANCE OF PAY AND REWARDS

- Pay is important to individuals for a number of reasons. To everybody of course it's
importantbecause it determines their lifestyle and their ability to function effectively really in today's
world. But there's another element to pay that makes it important and that is the prestige and
the esteem factor and the sense of feedback that people get when pay increases are passedout
particularly if they're said to be based on performance. The net result of all that is that pay is actually
one of the most imporant features of the work experience of people.
And if you survey them they will tell you pay is very important. There's a lot of mythologyaround oh it's
only a hygiene factor, it doesn't really ever have a positive feeling for that. But that's not what the
research says, the research says that people do take pay seriously, they do care very much about
how they're paid, particularly how they're paid relative to their peers and co-workers, and that it is an
important part of how they feel about themselves. So an organization which doesn't do a good job of
administering pay, if you're the manager and you're not communicating well, you're not dealing with
pay well, there's significant costs that are accrued, you're missing the opportunity to have a positive
impact on people who work for you, and you're losing an opportunity really, to get them more engaged
in their work, to get them more motivated, and failing to recognize the really centrality of pay to
their whole sense of why they work and why they work for you as a manager.
I think it's important to remember that people judge their pay on a relative basis. It's a social
comparison factor of the workplace. That is they look at what other people are paid, or in most cases
what they think other people are paid, because they may not know accurately,and react to their pay
based on that and of course on what they're told by an organization about why they're paid as much
as they are and how their pay system works. It's very much though of a social reward in the sense
that the comparison with others is very, very important.
It's not just the absolute amount. Sure, if you're really low paid, we're talking about minimum wage,
etc., yes, the absolute level's important. But as you move into knowledge work situations, higher paid
managerial jobs, managers, etc., the social comparison issue becomes critical, so you can't treat pay
as just a one-on-one negotiation or interaction with somebody who works for you. You must look at the
total package of people, the total surround, and think about the relative pay of people in that situation
and how creditable and valid your decisions are going to stand up under the light of comparison

3. HOW PAY AFFECTS BEHAVIOUR AND PERFORMANCE

USING PAY TO ATTRACT AND RETAIN TALENT

- Pay can be a very powerful force in attracting and retaining the right employee. So let me just
underline the right employees. Increasingly organizational effectiveness is determined by the quality of
the employees that you can attract and retain. Why do I say increasingly?Because work in most
instances is becoming more knowledge based, requires more skills,more commitment, in many ways
more self management by employees. So if your employees have some flexiblity about how they do
work, what they do, etc., and how well they produce you need to be very concerned about getting the
right employees and in particular.
Then of course once you get them, retaining the right employees. How do you do that? Well, certainly
yes the work they do is critical, the nature of it, but certainly also very very important is the reward
package that you offer them. That reward package is partly cash, delivered in abundance of different
ways, but often also includes thing like vacation time, benefits, fringe benefits as they're often called,
and flexible work arrangements of various kinds.
That whole package that you create as a manager is critical in both the attraction of the right talent and
the retention of the right talent. And here I'm underlining and using the term Right Talent
because issue is not talent in general. It's talent that can do and perform what you need done at a
level that gives you a competitive advantage in the marketplace. How do you do that? How do you pay
and reward people at a level and in a way that fits what you want to do as a business? Well certainly
you have to know what the market is.
You have to know what other people are doing. Then you have to understand what your employees
want and what will fit the employee population, the right talent, that you need in order to be successful
as a business. You can certainly ask, survey them. Many companies do. Get information about what
they want, and that's valuable input but you can also give them choices. You can give them a choice
of cash, stock, as some companies do instead of cash, bonuses instead of salary.
Various kinds of benefit mixes are available, can be made available and they can choose.That's in
many ways, if you can do it, reasonably the best way to go because it commits them to what they
have decided is the most preferred form of reward for them. Now all of that of course has to be in
alignment with the market. That is what your competitors are payingpeople who have the same skill
set and they're doing the same kind of work. So clearly as a manager you need to be concerned about
the market.
You should be getting data about what other companies or competitors are paying similar
employees and factoring that in. From a retention point of view you may not have to pay more from a
retention point of view but from a attraction point of view almost always have to pay more to get
somebody to come to work for you then they would get paid where they are currently. So that means
perhaps some nuances around attraction and retention. It always means though knowing what's going
on in the labor market and what competitors are paying.
Some companies decided rather than try to be too nuanced simply to pay everybody above
market. The argument is we have the best employees. We want to attract the best employees. So
we're gonna reflect that in the pay rates that we offer. Netflix is one that takes that stance. It says we
want the best employees. We're not gonna fool around with below market pay. If somebody doesn't
warrant above market pay they shouldn't be working here.We don't want them. So we're gonna pay
everybody above market. We're also going to give them some choices as to how they're paid.
If they want bonuses, if they want stock, whatever. So we're tailoring an above market package to the
preferences of individuals as demonstrated by their choices. That's a powerful package. Of course it
requires the ability to identify who the good employees are. That they're performing well because the
worst thing in the world of course is to pay above market pay for below market performers. You're
almost guaranteed to lose. Because your cost structure will be higher than your competitors cost
structure. The right combination the best of all worlds is above market pay for above market
performance.

REWARDING PERFORMANCE

- As a manager, one of the most important things you should think about is the relationshipbetween
pay and performance. There's really two reasons why you can gain a lot by tying pay to
performance. One, of course, is the motivation side, there's an incredible amount of research evidence
that says, if you tie pay effectively to performance, you can get better performance out of people who
work for you, and work with you in the organization. But it's not just that, it goes back to the traction
retention issue that we talked about, and that is, if you pay people for performance, ultimately, you will
end up paying your better performers more than your lesser performers.
That is sensible and good policy, because their market value is higher, and if they leave, you lose a lot
more, you lose a very valuable piece of your organization. So paying for performance simply makes a
lot of sense, but, and here's where you need to think very carefully about what you're going to do, and
how you're going to do it. It's not necessarily easy to decide what type of pay-for-performance fits your
organization, and of course, how to implement it and operate it.
If you look across virtually every developed country, the most common form of pay-for-performance is
a salary increase, often annual, often, in low inflation times, pretty meaningless from a pay-for-
performance point of view, it is so small, and so insignificant, that it really doesn't have a positive
motivational impact, and yet organizations go through great trauma,time investment, et cetera, to
get the pay increases distributed.
In order to be meaningful, a pay increase has to be at least six or seven percent of the person's base
pay. If it isn't in that vicinity, opportunity, at least, for six or seven percent. If it isn't in that area, it's
probably not worth the time and effort put into it. A second issue, of course, in pay-for-performance is
whether you can actually measure the performance of an individual. It may not be easily
measurable. Performance may be much better measured at the group level, or plant level, or an office
level, or a total organization level, then, in fact, it is at the individual level.
So designing an effective pay-for-performance system is quite challenging, it's quite a major factor in
the effectiveness of any pay plan. My advice to somebody who is doing individual pay-for-
performance and a salary increase system, is to be very, very careful what you do, to be sure you
have very good measures of performance, very clear expectations about what somebody should
do from a performance point of view, and tie that to a meaningful increase in pay.
If it doesn't have that relationship, if there isn't clear specification as to what somebody needs to
do, and how much they're going to make, it's probably a waste of time. It will probably cause more
anguish, more discontent than any positive effects on motivation and retention.Pay-for-performance is
a great idea, we'll talk about how it can take place at the corporate level, which it can, through profit
sharing, stock, et cetera, there are many, many ways to do pay-for-performance, but, it has to show
some relationship to the individual's performance,and they need to feel that they see a line of sight
from what they do to the payout they get, in order for it to be an important motivator.

HOW PAY AFFECTS ORGANIZATIONAL DESIGN

- The relationship between the structure of an organization and the pay system is something you
should very carefully attend to and be sure that they're aligned. It's not always obvious what the right
fit is because people tend not to think about pay systems relative to the structure and design of the
organization. So let me just say a minute about organization structure, and then talk about how the
right pay system can support a particular organization design. When I talk about organization
design, I'm thinking of things all the way from what work is like.
Is it individuals basically operating alone? Is it people working in teams or groups to accomplish
something, to service a customer, to build a product? Or is it perhaps even the company that
has multiple divisions that are unrelated in very different businesses, like a General Electric or a
megacorporation that has global reach, different operating models in different countries? All those
have to be taken into account when you're designing the pay system. Now, why? Well, one of the
effects of pay systems is to cause people to cooperate,work together, or work independently.
When you're talking about a team environment, you need a very different kind of pay systemthan
when you're talking about an individual. You need to base the rewards much more on team
performance and much less on individual performance. You might have a whole team reward. In a
plant, you might have a plant-wide, so-called "gainsharing plan," where everybody gets a bonus based
on the operation of the plant. In the division-based organization, you may want to be sure to have a
division bonus plan or reward plan that focuses on division performance.
That may not be the only reward plan you have for performance, but it has to be an important and a
critical one. So in many ways, the pay system needs to support and help facilitate the functioning of
the basic organization's business model and structure. If you ignore this and you don't take it into
account when you design your pay system or operate your pay system, you very much run into
situations where somebody's faced with the dilemma, "You're telling me to work as a team "to service
this customer, but you're rewarding me "for my individual performance." You might see that, for
example, if you're in retail establishments that have group bonuses for sales versus individual.
Sometimes you'll see high attention level of the individual tying up a customer even though they're
saying we should operate as a group. Well usually that's because they have an individual bonus plan
based on sales revenue, but they're saying, "This is a team that's working "in the appliance division,"
or whatever it is. What overrides, of course, is the pay system. People will corner customers, hoard
customers if they're doing sales jobs to be surethat they get the revenue credit.
Team is fine as long as it doesn't cost them any money. Technically, if you really think the team
model is best and you really want people to work together to service a customer, you've got to have a
team bonus plan in that situation, not an individual one. Now it's a word of caution but also a word of
advice. Think about what kind of behavior you want and whether your reward system is reinforcing
that. If it's cooperation, if it's teamwork, if it's interdependency, you've got to reward that.
The best way to reward that in most cases is through collective rewards. "We all get the same
thing. "We all, on a football team, if we win the Super Bowl, "we all get the same amount of payout
from the Super Bowl, "or baseball, or whatever sport it is." That piece is aligned very much with the
team spirit, as it should be.

HOW PAY IMPACTS ORGANIZATIONAL CULTURE

- There's an interesting relationship between pay and culture. Organizations, you as a manager, need
to pay a lot of attention to the interface between what people believe the organization stands for, their
culture. As a culture, what's accepted. And the pay and rewards system. To some degree, the rewards
system influences the culture, and to some degree the culture influences the rewards system. It's not a
simple one causes one, one way relationship.

It's an interactive relationship. It is critical that they be in alignment and that they be functional. So, key
issue is, "What do we want the culture to be?" as a starting point. Do we want it to be one that values
openness? Is it one where we value participation? Do we value people being involved in the
business? Do we value long-term employment or long-term relationship with our employees so that
they're loyal? Or d0 we look at it more as a transactional relationship? Constant turn of employees,
etc. etc.

A culture that, yes, values skills and competencies but doesn't necessarily involve loyalty and long-
term relationships. So there are all of those dimensions of culture which are critical to take into
account. Once we have a good sense of what that is, then we need to align, certainly, the pay system
with that culture. Because it needs to be congruent. If it's conflictual, then neither is going to work very
well. The culture, or the pay system. How might that play out? Well, let's say we believe in openness,
participation, decisions, open financial information.

What does that mean for pay? Well, pretty clearly to me at least, and the research would say, that
means openness about pay. We need to be able to discuss it, we need to be able to understand how
it's computed, we even need to understand how people are paid. Because if they're going to
understand the financial results, if they're going to understand why the organization does certain
things. Very helpful and very consistent, to have them understand the pay system and what's going on
in that area. If we're very secretive and, for whatever reason, we don't want profits to be public, we
don't want anything to be public, OK, then maybe it's not so important to have pay be public.

It's consistent, at least, from a cultural point of view. Let's take another dimension of culture, and that
is performance. If it's a very performance-oriented culture, and we want to have high level
performance throughout the organization, it only makes sense to be sure that the pay system is
consistent with that element of the culture. It also goes, then, to the issue of what kind of
performance? Group performance, individual performance, etc. If we're having group performance as
an important part of our culture, we better reward, financially, team performance, group performance.

That then reinforces and creates a culture of teamwork, mutual support, and a culture which values
cooperation and helping others. Giving up some of your time that may not be rewarded, in order to be
sure that the team performs well. That's a critical element, certainly, in the building of the right kind of
culture. So, just to go back for a second, what I'm really arguing is that we need to know what we want
from a culture point of view and then we need to be sure that the rewards system, particularly the
financial rewards system, benefit package, etc. fits that.

Just to take one last example, if we value long-term employment, long-term commitment, as part of
our culture. We want long term employees for whatever reason. They're important to keep the culture
alive, important to maintain the knowledge base of the organization. The rewards system ought to
reflect that. It ought to have a benefits package that supports long-term employment. It ought to have
seniority-based pay system, etc., etc. We don't do that, we're not going to get the culture of long-term
commitment and long-term employment relationships.
 4. DETERMINING PAY

UNDERSTANDING MARKET

- There is no absolute right about a pay or a way to people. Very much, it majorly reflect what your
organization is about, but that is to be in the context of what's going on in the marketplace because
ultimately, what you're offering to people, from a pay point of view, needs to be in alignment or better
than what your competitors are offering. It's a competitive business, if you will, attracting, retaining the
right talent. It's like any marketplace.

You need information about what's going on in a marketplace in order to win in the marketplace.
Depending upon what kind of employee you're looking at, what kind of talent you're dealing with, there
may be very different sources of information available about what people are paid, how they're paid
and what you'll need to do to attract them. If you're in a pretty large corporation that has a
sophisticated compensation department, they can go to vendors, buy salary data, tell you what other
companies are paying, give you an idea of what you need to pay in order to be reasonably positioned
in the market.

If you're in a small organization, it could be more difficult. You may have to simply try a little bit and
see what happens in terms of market response. But the fundamental point is pay is only as good as its
relationship to the market. That refers both to the total amount of pay that you offer somebody and
rewards and the type of pay that you offer, how you package between bonuses, benefits, salary, et
cetera.

When you're trying to attract and retain talent, it's the market, the market, the market. Now one
subtlety here is historically, the market has been largely calibrated in terms of jobs. When you went to
the market, job information came back. Starting secretary, senior secretary, starting assembly line
person, senior assembly line person, et cetera. Then you had union rates, of course, which were
always public and you could get those.

What's changed very, very dramatically in the last decade or two is the movement away from
somebody's market value, reflecting their job to reflecting their skills. Why is that? Because the nature
of work has changed so much in developed countries. When you went to the market in the past, often,
you were just getting somebody to fill a slot, assembly line worker, a sales clerk, et cetera.

You weren't looking for a skill set. You just needed to know what other people were paying and you
knew what your competition was. Today, if you're going after a software engineer, knowing that you're
going to fill a software job almost tells you nothing about what you have to pay because it's the skill set
of the individual, what kind of software, how advanced they are, et cetera, what their production level
is. That determines the market. It becomes a much more difficult assessment that you need to make
and it often requires knowing what's going in professional associations, situations where people are
talking about or reporting their pay, maybe even going to Glassdoor or somewhere that will give you
the more solid information about the relationship between skill sets and pay rates.

You may have to try some hiring efforts and experiment a little bit with how people react to a particular
offer, see what kind of talent you get with a particular starting salary level or particular package and
then come back and say, "Okay, here's what I learned from that. "I've got a really good pool. "Apple
can pool when I did this. "Not so good when I offered this." Or you may want to be sure you study your
turnover rates. Look at who's leaving or to where they're going.

That's another great source of what individuals are worth, not necessarily what job is worth. A final
note, just to repeat it, it gets really critical not get too tight into job worth in this era when it's really the
individual and their skills that are critical in determining what other people are willing to pay and you
are paying for talent.
PAYING THE JOB

- Paying the Job is a traditional way that organizations determine the amount of pay an individual
makes. If you're a manager what you make most cases and what people who work for you make is
determined by the kind of job, the nature of the job, the characteristics of the job that you have and
they have. It's an important point because it separates you as an individual, your skills, your
inclinations, from what you're paid, it's the job that you are doing. It's not true in all organizations.

It's not true as much as it used to be, but it's still the dominant pay method. The manager know, if
you're talking to people working for you, it's very important to emphasize that the basic level of pay
that they make is primarily determined by the job that they're doing. One implication of that is, they
want to make more money they probably have to move to a higher level job. What do I mean by higher
level job? It means one that somehow or another the scoring system that the organization uses is
seen as having more responsibility, more accountability, more discretion, more value if you will to the
corporation.

And therefore has a higher pay level or pay raise associated with it. Most cases, most traditional
organizations the best way to make your pay increase, get a higher pay rate, is to move to another job
not to perform better within the job that you have. Because you're limited in terms of how much you
can make by the job. - It builds into organizations I think an unfortunate tendency to be pretty
bureaucratic and to define career success as promotion, moving up the hierarchy, if you will, to jobs
that are more highly rated in the quote "job evaluation system", which is the scoring method the
organizations use to determine what a job should be paid.

The biggest advantage of it is that it allows them to relatively easily go to the marketplace and find out
what similar jobs are paid. So there are consulting firms all over the place who will say "Score your job
on this scoring system" "Give us the score and we'll tell "you what that job would be paid in other
companies." That's a convenience but it has a high cost associated with it. One of the things it does
mean though is you can say to people that work for you, if you're managing people on a job pay
system is, "What you're paid is not a reflection "of you, it's a reflection of your job." So you may be
better than the job but we can't, I can't do anything.

So you can kind of opt out of the what might be useful feedback or negative feedback to somebody. In
any case, the alternative is to pay the person that is growing, but that's not where most companies still
are today. And clearly in the public sector it's all job based pay. There's no situation there where
anything different exists and for the foreseeable future they will always have job based pay.

Why? Because it's seen as more defensible to determine pay that way. There's a scoring system,
there's the tradition, there's a rigor to it, at least perceived rigor to it that justifies it, and makes it
acceptable in the public sector. The famous government federal government pay grade level is an
example of that. The federal government there's 18, 19, pay grades, and you go in to one of those pay
grades, not based on you but based on your job. And that largely determines what your public servant
level one, two, three, four, five, and that largely determines your pay.

It doesn't make much room for pay for performance. It doesn't make much room for you to improve
your skills, and get paid for that unless the proven skills leads to a different job or... It also leads to
people wanting to restructure their job descriptions so that they can get a higher score on the job
evaluation system. So they can be eligible for higher pay. Though it's... It is very much of a
commitment to a particular kind of approach to pay that has a number of bureaucratic elements to it.
Some positives but also some very significant negatives.
PAYING THE PERSON

- A fundamental choice in deciding how to structure a pay system is between paying the job, that is,
determining a person's pay by looking at the job they're doing, versus paying them for the skills that
they have. Now, historically, certainly, we've paid people according to their job as the dominant mode.
The alternative, of paying people according to their skill set, makes enormous amount of sense in
situations where skills are a key determinant of how effective the individual is gonna be and can be in
the future.

The issue immediately arises, of course, if you're gonna pay for skills as to what skills are you willing
to pay for. Not any skills that the person has, or all the skills a person has, or any that they might
decide to pay. But, if you want people to develop, and grow, and add more value, it may very well
make sense to say, "If you add this skill set to your package, "we'll pay you more. "If you develop more
on your software engineering skills," or whatever it might be, "We will up your pay. "We won't
necessarily change your job, "but we will pay you more money for that." Now, yes, there is always the
issue of will somebody, if they are encouraged to learn, go elsewhere.

But that's more likely, that it's quit, and leave, but that's more likely to happen in situations where
you're not rewarding them for learning skills. If they go off and learn a skill that you could use, and
don't pay them for that, they're particularly likely to leave and look for another opportunity because
their skills have exceeded the job that they're in. So the trick in managing careers and managing talent
is to tie together skill acquisition of a certain kind and increased pay for acquiring the right skills.

Take a simple example. I've done a lot of work over the years with manufacturing organizations. They
put team type production models in place. That is, teams work on developing, let's say, final assembly
of a car. It used to be that people simply did one step in the assembly process. They were paid a
certain amount for that step, and that's all they could make through their career, and that's where they
spent most of their career. If you look at how cars are made today, that's changed a lot.

They're now assembly teams. Over time people are cross-trained so they can do different steps in the
assembly process. They're much more agile as an organization, as individuals. And ultimately it's been
shown to improve the flexibility of the production process, the quality of the product, because people
see different parts of the production process. And generally to have improved efficiency. It also makes
the jobs more attractive and less boring, because they're not just doing the same old thing every 60
seconds. The pay side of that is to say to the individual, "We will pay you more as you learn more
steps "in the production process, maybe you also "learn how to do quality control, "and now you can
do that, integrate that "into the production job." So you're adding more value, you're making more
money, and the organization ultimately is coming out ahead because it doesn't need an extra person
to do let's say the quality step, or whatever step it is that you've now mastered and built in to the job.

So in many situations, focusing on the skill set of the individuals and encouraging them to learn the
right additional skills can be a win-win for the individual and for the organization. It may not. You have
to be careful. You don't want to reward people for skills that are unimportant and don't add value in the
organization. Let's take one more quick example. You can also encourage people to learn self-
management skills. That is, I already mentioned, qualities and skills they could learn to do, in a
production situation, scheduling, customer relations.

And by learning that, they become more valuable. They can add more to the product, add more to the
customer relationship, and you can afford to pay them more for that extra set of skills because, in fact,
it's showing up in the performance of the organization. As a manager, you may want to think about
adding some skill sets or skills to the portfolio of the skills that people working for you have. Certainly,
if you're going to have them add those skills, you want to be sure that you have support for increasing
their pay, because otherwise they're just going to become more valuable in the labor market and
you're going to lose them.
But if you can, in fact, increase their pay, because they add additional skills can give you much more
flexibility in terms of how you use the people who work for you, in terms of even the skill level that they
have. They would need less supervision, for example, if you progress their control and their self-
management skills. And the important thing about being able to pay for that is you give them an
incentive to do it. It's not just, "Gee. Learn this.That'll be nice." It'll be, "Learn this. You'll be more
valuable, "and we will reward you for it." So it can be a real win-win for the organization.

Lock them in. One other small advantage of skill-based focus in pay is that often people get more
valuable to you than they are to anybody else. So if you pay them, then, for their skill to you, you
almost totally eliminate the risk of them leaving. Because no one else would use the same skill sets
that you've built in to them and that you're utilizing. So they're more valuable to you than to anybody
else. You pay them accordingly. They're happy, because they're using their skills.

They're making more. You're happy, because you're not threatened with them leaving.

USING PERFOMCE APPRAISALS

- You as a manager have responsibilities for appraising the people who report to you. Most managers
frankly hate doing performance appraisals. It's one of the least popular things that managers are
asked to do. There are any number of reasons why managers don't like performance appraisals. I'm
gonna give you some clues as to why that's true as well as some cues as to what might make it
pleasant. But, I have to admit, it's not an easy thing to do, and it's hard to create a system that most
people like.

There's a very fundamental reason for that. It involves some pretty important issues to most human
beings. That is, what they're like, what their worth is, both financially and from a social point of view
and a performance point of view. So you're often having to deliver not very pleasant messages to
people, and guess what? They don't like to hear negative news. I guess that's pretty inevitable. Let me
start just for a moment by saying a little bit about performance appraisals and performance appraisals
relative to pay systems.

In most organizations today, if you are doing a performance appraisal it ultimately drives either the
amount of bonus or the amount of pay someone gets. There's been a recent flurry to disassociate
those to some degree, so the results of the performance appraisal don't necessarily directly track on to
a pay increase or bonus, but most organizations they do. That's probably the situation you're facing in
your organization. A few clues at least, or cues, about how to be sure that discussion and that process
operate smoothly.

Realizing you're under constraint as a manager by what's been written into the rules of performance
management in your company, performance appraisal and how you're supposed to do it. But let me
start with some guidelines as to what I think is the right way to do it. First of all, before any
performance period starts, the beginning of the year, or the beginning of the quarter, very important to
get agreement with the person you're managing on what's going to be appraised. What are we gonna
look at? How are we gonna determine what constitutes successful performance? You may or may not
be able to say, and if you reach certain levels, you'll get a certain amount of pay increase.

The best of all worlds, if you can do it, is to say if you reach these performance levels over the next
three months, six months, whatever it is, you will get this amount of bonus or these stock options, or
whatever the reward or pay increase, whatever the reward might be. But if you can't say that, you
ought to be able to at least say, here's what I'm gonna look at in terms of your performance for the
next... Here's the goals. Let's see if we can agree on these goals, 'cause there's a lot of motivation
research that shows that goal setting at the beginning of a performance period is critical to successful
motivation, regardless of the pay side of it.
So, get clear goals, get, if you can, a clear connection between the goals and the pay. Get those in
place, okay? Then there's quite a bit of evidence that says any feedback you can give individuals
during the performance appraisal period is, of course, helpful whether it's positive or negative. You
may need to update the goals based on changes in the environment or the business model or
something, but constant communication around goals, successful achievement of the goal, is critical
during the performance period.

And then finally at the end, it is absolutely critical before you make any decisions about how well
somebody has performed, is to get input from them as to what they see as their performance. Not
saying you want to ask people to come in and say here's how much of a raise I deserve, or I deserve a
five rating instead of a three rating, but at least say at the beginning of the period, we talked about
performance. We talked about goals. How did you do? You know, what goals did you achieve? What
was your score on this, or your productivity level or your sales target? Where did you go? Explain to
me about it.

So be sure they have an input into the final decision. Not necessarily as to how good they think they
were, but at least as to how they see their activities. Then, and only then, should you come to a
conclusion about how well they performed. Then the evidence says that's best delivered before you
deliver the pay message. Because if you deliver the final judgment, your performance was a C or a B
or an A or whatever it is and talk about pay at the same time, the evidence says all people remember
is the pay decision.

Best to leave the pay decision for the last step in the process. Sit down with a person, say I've heard
what you had to say or you handed me a report that said what you did during the last six months or a
year. I've read it, here's how I see it. Do you agree or disagree? But at least sign off and say that
you've seen it and then I'll go see what the pay action will be. Then, come back and say, okay, here's
how you described your performance. Here's where we finally concluded, or I finally concluded you
performed, and that resulted, given corporate policy, in an x percent bonus or an x percent pay
increase.

That model, that flow, isn't necessarily in place at every organization by any means. In fact, it's far
from in place, but a lot of research evidence that says that's the best way to go, to get that sequence
into the performance appraisal process. Unfortunately, a lot of organizations are moving away from
even doing any kind of formal performance appraisal because they don't want to go through that. But
more importantly, in many cases, they don't feel the managers can execute it very well.

It takes a certain set of interpersonal skills and focus for a manger to execute that. Hopefully you will
have those skills as you do it and if you don't have them, look for training. Look for an opportunity to
learn how to do goal setting, give feedback, etcetera. An organization should be providing that. One of
the failings of many organizations is not training people in how to do performance appraisal. They ask
them to do a pretty difficult thing, activity, but do not give them the training and the skills needed to do
it.

All too often, then, they say, well let's not do it. Well, that's the wrong answer. The right answer is train
managers to do it, give them support, and if you do, the evidence says you'll get a positive result.

INCENTIVE PAY

- As a manager, one of the things you may want to consider is creating an incentive pay package.
There's no question that incentive pay can be a powerful driver of motivation. But it's not easy to set
up, it's complex, and there's a significant downside to it. Let me start by just saying a few words about
what I mean by incentive pay. I mean some kind of system that pays people for small pieces of
performance. Not a six month period, not even a one week period.

An example would be a sales person who gets a certain percent of every sale that they make. That's a
classic incentive pay system, and can be installed in very small organizations. It can be installed in
very large organizations. And it can be fit to sales positions, production positions, marketing jobs, a
really quite wide range of work. The challenge is to be able to clearly identify what it is you're
incenting, that is, be able to measure and specify what constitutes a productive piece of performance.

And then to decide how much money you're going to attach to that. It's pretty easy in many sales
situations, because you have a transaction with a dollar amount, and you can say to somebody, "For
every sweater you sell, we'll give you 20% or 2% "or whatever it is of the revenue." And as a manager
that can be a very, very powerful way to get people to focus on the customer, complete the
transaction, and complete it quickly so they can get on to the next customer and the next sale, and the
next incentive payment for them.

The danger of incentive pay, of course, is that people will not do all that they should do in completing,
let's say, a sale. Like being courteous to the customer, restocking the shelves when somebody needs
to restock the shelves, etc., etc. So it's a powerful way to incent people, but it does have some "watch
outs" attached to it. I think it has a place. An important place, when the situation is right.

And you as a manager really need to think about that, and whether focusing on clearly measurable,
repeatable behaviors that carry with them a certain amount of money is the right way to manage in
your area. And here we're now tied into the overall issue of you as a manager, what are you
responsible for, in terms of performance in your area? What kind of work are people doing? And can
you fit that type of incentive pay system to the work that you have responsibility for? There are
situations where it's good.

There's no question about it. But I'd have to put the cautionary note out that there are a lot of situations
where it doesn't fit. One of the downsides, for example, is flexibility. Suppose you want somebody to
switch for a while, and go over and work on something that isn't part of their incentive package. Now
what do we do from a pay point of view? Well, we may have to say, "OK, I'll pay you anyway a certain
amount, blah blah blah." But it just adds a level of complexity and bureaucracy that may make it not
worth the job. So although it's powerful, and you'll see it well used in some companies, incentive pay is
a tricky route to go down.

A tricky approach. It doesn't have, basically, an always sure pay-off. When it works, you get high
productivity, good quality, assuming you measure quality accurately. When it doesn't work, you end up
making a rather unfortunately misdirected, sometimes bureaucratic organization.

PAYING THE PROFESSIONAL PERFORMANCE

- You as a manager may or may not be in an organization that has a organization wide pay for
performance system. More and more organizations do have one of some type or another. They range
all the way from profit sharing plans through various kinds of stock plans. A common element of these
plans is that individuals are rewarded in some manner or form based on the performance of the
organization. If you're in an organization that doesn't have one, you may want to think about
encouraging people to look at it, consider it, but it could be a long haul to getting them to move toward
one because it is a big transition.

If you're in an organization that has one, that is it has some type of pay out system that's contingent
upon the performance of the organization, there's some important things to think about. First of all, I
think they are positive. I think they create a more oneness culture climate. Secondly, they're probably
not going to be a big driver of motivation and performance to do a job well, particularly if they don't fit
what people in your part of the organization are doing.

They require, and here's the big term from the motivation literature, a line of sight. That is, in order to
be motivational, the individual has to see a connection between what they do and the payout. Of
course, in a large organization, it's going to be difficult to see much of a line of sight from what you do
or your people do to the profitability of the corporation. Nevertheless, as a manager, you can help get
people involved and understanding the organization's business by emphasizing what makes for
profitability, how what goes on around them to some degree does drive the profitability of the
corporation.

It can be a very important piece of bonding people and educating them about the economics of the
business so that they become more intelligent and more informed employees. Admittedly, the direct
motivation impact is going to be relatively small in a large organization. Quite the different situation,
however, can appear in a small organization. A small organization, 30, 40, few hundred people, and
you have, let's say, a gain sharing plan or an employee ownership plan can be a powerful driver
because you can show how their behavior that effects cost, revenue, the company directly pays off for
them in terms of a bonus check, or a stock option increase, or any kind of financial lever that's built in
to the incentive system at the company level.

So I am a big believer in creating plans that reward organization performance, but I have to admit the
payoff from them is probably greatest in smaller organizations where you can make it clearer to
individuals what the connection is between their behavior and the payout they get. The line of sight, if
you will, to use that term again, is much clearer for them, therefore they tend to yield better results. On
the other hand, if you're a successful organization, and you're large, and you get on a roll, you can get
a nice upward spiral of performance out of continued growth and earnings, and therefore, continued
payouts from the plan.

Positive climate, positive culture in the organization, and in that respect, a good retention device and a
good culture builder. So I'm very much a believer in it. I think the evidence is very supportive of
collective, company wide, pay for performance plans, stock options, etc, stock ownership, but with a
caveat that their impact and how they need to be interpreted needs to vary quite a bit depending upon
the kind of business the organization is, and of course, the size of your organization.

5. CREATING EFFECTIVE PAY STRATEGY

DESIGNING A PAY SYSTEM

- Yeah, I've been involved in designing a number of pay systems and it's inevitably a complicated and,
to some degree, a political process lets be honest about it. Because it involves something that's very
important to most people, their income and their self esteem in many cases cause they're getting
feedback about how good they are and how well they've done and how much they're worth. It requires
really bringing together an almost in a political process a group of experts as well as people who have
stakes in the ground.

The biggest mistake I see organizations making in this area is just to call in a consulting firm and turn it
over to them, and have them do it. Consulting firms bring a lot to the party. They have expertise and
technical pay issues. They understand what's going on in the market. But also needing to have a
strong input and be heard is the employees in the organization. The challenge in creating a pay
system or modifying a existing one, which is what most often happens, is getting the right amount of
input from people who are in the organization, doing the work, are gonna be subject to the pay
system.

And of course being sure that fits with the business strategy and the nature of the work that they're
doing. And putting that together with the technical details and the laws and so forth that you have to
adhere to in determining and setting up the pay system is a truly complex process and one where no
one individual can do it obviously. It needs to be a configuration of a task force of some kind or
another that ultimately tries out different models and tests different approaches.

I think it's very important however that we be sure that we get good input. You get good input from
people who are going to be effected by the system. So they understand what it's gonna be when it
comes out. They feel like they have a say. It's not a democracy but at least they had an input
opportunity and that they understand why it fits their situation and why it drives the organization in the
direction of its business strategy. That of course assumes that you can articulate a business strategy
and I would argue that's an important foundation upon which to place any pay system design activity
that you have.

Needs to start with "What are we trying to do?" "What's our business strategy?" "How's the reward
system pay system "gonna support be congruous with "our business strategy and support our
business strategy?" It's hard to say that you can just easily roll out. It's impossible to say or wrong to
say that you can just roll out a business strategy and then roll out a pay system. And it's probably
going to take some changes, some constant updating.

Because it is a very complicated issue. You need to be sure that the compensation system supports
the right kinds of behavior, creates the right kind of culture, and ultimately works in the environment
you're in. An environments full of laws and regulations and political issues. It's not, its not a simple
process, but it's a very important process. And I think it's worse spending a considerable amount of
time on the pay system and on its design.

So that you're sure you're getting a return on what's a substantial investment that the company is
making.

CONCLUSION

WRAPPING UP

- One things for sure when you think about pay, and that is without it most organizations wouldn't exist.
It's a must have, and it's an important have. Getting it right can have a tremendous payback to the
organization, and to you as a manager, it can make your job easier. So it's really worthwhile your
understanding how pay works, why it's important, and what you as a manager can do. Sure you're
constrained by the system, etc., etc., but even in the worst system you can do better than others if you
understand how people react to pay.

Hopefully, what we've done so far in this video and what you've seen gives you some idea at least of
how people react to pay, what you can do to be sure that they get the right message and react most
positively. This is just one source of data or information about what is a very complex topic. If you'd
like to know more about how your organization can improve its pay system, and you can improve your
skills as an administrator of pay and as a manager, let me make a couple of suggestions to you at
least.

There are a number of good books around about pay systems and how they work, and how people
respond to them. I happen to be biased favoring my own, but they're certainly not the only ones. You
don't have to stop there, there are numerable websites, professional associations that can give you
good data about pay. Society for Human Resource Management, for example, has numerous
publications and websites that talk about the law, the practices that organizations have adopted in the
pay area that are accessible both to their members and to non-members.

So that's one source. Another organization called World at Work, is an association of professionals in
the compensation administration, and they publish journals and magazines that talk just about pay
administration and compensation, so that's another source, and a good source of information. They
run seminars, workshops, etc. And finally there are a large number of consulting firms that deal in this
area as well. They run a lot of seminars and executive programs for people interested in
compensation, as well as have their own website.

So there's certainly a wealth of information out there that can be used to learn more about how pay
should be managed and designed. It's challenging to administer pay well. It's not an easy thing. There
are a number of reasons why it's complex, ranging from the legal through the cultural. But it's worth
the effort, it's worth improving and managing pay effectively. Why? Because of what it drives, because
of how important it is as a determinant of performance, attraction and retention.

If you want to have the best talent working for you, performing well, you've got to get the pay system
right.