UNIT 1

Introduction to the Pay Model and Compensation Strategies

Unit 1 Rationale

Unit 1 discusses compensation as a vital part of an organization’s reward system and examines internal
and external influences on this reward system. The unit provides an overview of the compensation
system and will help you understand that compensation decisions are not made in a vacuum. Such
decisions are affected by the nature of employees and their jobs; by certain organizational features such
as philosophy, size, structure, and location; and by external factors such as legislation, competition,
unionization, labor economics, and major demographic influences.

Unit 1 also presents information on the concept of internal alignment (or internal equity) as it applies
to compensation systems. This term refers to pay relationships within an organization and addresses
the logic underlying these relationships. The relationships form a pay structure that should support the
organization’s strategy, support the work flow, and motivate behavior toward organizational objectives.

Unit 1 Learning Outcomes

Upon completion of this unit, you should be able to

1. Discuss the definition of compensation and the various subsystems and components of an
organization’s employee reward system and their importance in an overall employee reward
system.
2. Analyze the relative importance of the factors that influence pay structures.
3. Use software programs to create job descriptions and critique the effectiveness of those programs.
4. Use information gathered via the observation method of job analysis to create a job description and
critique the effectiveness of the observation method in providing information on jobs.
5. Demonstrate knowledge of the material presented in the unit references by providing correct
responses to true/false, multiple-choice, and short-answer examination questions.

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Lesson 1: The Pay Model and Compensation Strategy

Chapter 1 of the text provides an overview of the key components of a compensation system. The
definition of compensation is initially explored from the perspectives of the society, key stakeholders,
the organization, and the external environment. Next, the various forms of pay are identified and
defined. The major focus is presenting a pay model that provides a structure for understanding
compensation systems.

The three main components of the pay model are (1) compensation objectives, including the importance
given to ethics; (2) policy decisions that guide how the objectives are going to be achieved; and (3)
techniques that make up the pay system. The remaining chapters in the book examine each of the
four policy decisions – internal alignment, external competitiveness, employee performance, and
management – as well as the techniques, new directions, and related research.

Chapter 2 examines the key aspects of decisions taken during strategy creation on compensation. The
key premise is that the way employees are compensated can be a source of sustainable competitive
advantage. Two alternative approaches are highlighted: (1) “best-fit”/contingent business strategy/
environmental context approach and (2) “best practices” approach.

The best-fit approach presumes that one size does not fit all. Managing compensation strategically
means fitting the compensation system to the business and environmental conditions. In contract,
the best-practices approach assumes a universal best way exists. The focus is not on what the best
compensation strategy is but on how to best implement the system. Because the best-fit approach is the
most commonly used, the steps involved are described: (1) assessing conditions; (2) deciding on the
best strategic choices using the pay model (objectives, alignment, competitiveness, contributions, and
management); (3) implementing the strategy through the design of the pay system; and (4) reassessing
the fit.

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Lesson 1 Learning Outcomes

Upon completion of this lesson, you should be able to:

1. Explain how perceptions of compensation differ among society, stockholders, managers and employees.
2. Discuss the difference between cash compensation (direct compensation) and benefits (indirect
compensation) and define each of the direct and indirect forms of compensation.
3. Explain how the employment relationship combines both transactional and relational returns to
form an implicit contract between employers and employees.
4. Identify and describe the three main components of a pay model.
5. Understand how the pay model integrates objectives, policies, and techniques into a compensation
system.
6. Explain the idea of a strategic perspective to compensation.
7. Identify the five dimensions of a compensation strategy and how a compensation strategy can
support an organization’s strategy.
8. Discuss how the pay model guides strategic pay decisions.
9. Understand the four policy choices involved in developing a total compensation strategy.
10. Discuss how three tests can be used to determine if a pay strategy can be a source of competitive
advantage.
11. Describe the key arguments related to the two approaches – best-fit vs. best-practices – in
developing a compensation strategy and system.

Lesson 1 Vocabulary

You should be able to define each of the following terms in your own words
and use it in its proper context in one or two sentences.

compensation cost-of-living adjustments

total compensation incentives
relational returns income protection benefits
merit pay

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Lesson 1 Learning Activities

Required Reading

Read Chapters 1 and 2 in the course text.

Optional Activity

Review the cybercomp resources provided in the text.

Required Written Activity

Without referring to the textbook’s definition of compensation, write your own. Discuss why you
included the information you included in this definition. Next, compare your definition to the one in
the text. Which do you believe is most correct and why? Submit your answer to your instructor for
evaluation. (Worth 6 points)