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Compensation and Benefits

Objective 10-4 Describe the main components of a compensation and benefits system.

People who work for a business expect to be paid, of course, and most workers today also expect certain benefits from their employers. Indeed, a major factor in retaining talented employees is a company’s compensation system, the total package of rewards that it offers employees in return for their contributions to the organization’s mission. Creating an effective compensation system requires finding the right balance between offering sufficient inducements to attract and retain employees while also keeping labor costs in line with revenues and competing employers.

Wages and Salaries

Wages and salaries are the dollar amounts paid to employees for their labor. Wages are paid for time worked. For example, if your job pays you $10 an hour, that is your wage. A salary, on the other hand, is paid for performing a job. A salaried executive earning $100,000 per year is paid to achieve results even if that means working 5 hours one day and 15 the next. Salaries are usually expressed as an amount paid per month or year.

In setting wage and salary levels, a company may start by looking at its competitors. Firms must also decide how their internal wage and salary levels will compare for different jobs. Some organizations pay everyone doing the same job the same amount. In other organizations, though, an employee with more experience or who consistently performs at a higher level may earn more than another employee doing the same job. This practice is legal and can be motivational so long as the reasons for the pay differential are job-related and not based on bias or favoritism.

The Great Recession of 2008–2011 prompted some firms to reduce the wages and salaries they were paying to lower costs. For example, Hewlett-Packard reduced the salaries of all but its top performers by amounts ranging from 2.5 to 20 percent. CareerBuilder.com reduced all employee pay but also began giving all employees Friday afternoons off to reflect their lower pay.

Incentive Programs

Studies have shown that beyond a certain point, more money will not necessarily result in better performance. Money motivates employees only if it is tied directly to performance. The most common method of establishing this link is the use of incentive programs, special pay programs designed to motivate high performance. Some programs are available to individuals, whereas others are distributed on a companywide basis.

A sales bonus is a typical incentive. Employees receive bonuses, special payments above their salaries, when they sell a certain number or certain dollar amount of goods for a designated period, such as a week, month, quarter, or year. Employees who fail to reach this goal earn no bonuses. Merit salary systems link pay raises to performance levels in nonsales jobs.

Executives commonly receive stock options as incentives. Apple CEO Tim Cook, for example, can buy several thousand shares of company stock each year at a predetermined price. If his managerial talent leads to higher profits and stock prices, he can buy the stock at a price lower than the market value for which, in theory, he is largely responsible. He is then free to sell the stock at market price at a specified future date, keeping the profits for himself.

Another popular incentive plan is called pay for performance (or variable pay). In essence, middle managers are rewarded for especially productive output with earnings that significantly exceed the cost of bonuses. The number of variable pay programs in the United States has been growing consistently for the last decade, and most experts predict that they will continue to grow in popularity. Many firms say that variable pay is a better motivator than merit raises because the range between generous and mediocre merit raises is usually quite small.

Companywide Incentives

Some incentive programs apply to all the employees in a firm. Under profit-sharing plans, for example, profits earned above a certain level are distributed to employees. Also, gainsharing plans distribute bonuses to employees when a company’s costs are reduced through greater work efficiency. Pay-for-knowledge plans pay workers to learn new skills and to become proficient at different jobs.

Benefits Programs

Benefits, compensation other than wages and salaries and other incentives offered by a firm to its workers, account for a substantial percentage of most compensation budgets. Most companies are required by law to pay tax for Social Security retirement benefits and provide workers’ compensation insurance, insurance for compensating workers injured on the job. Most businesses also provide some level of health, life, and disability insurance for their full-time employees, as well as paid time off for vacations and holidays. A few, such as Starbucks and The Container Store, also provide similar benefits, but at a reduced level, to their part-time employees. Some also allow employees to use payroll deductions to buy stock at discounted prices. Counseling services for employees with alcohol, drug, or emotional problems are also provided by some large employers, as are on-site child-care centers. Some companies even provide reduced membership fees at gyms and health clubs, as well as insurance or other protection for identity theft.⁷

Finding a Better Way

Holding True at Nucor Steel

For the most part, the watchwords in U.S. business during the 2008–2011 recession were cutting payroll, reducing headcount, and eliminating jobs. But Nucor, the country’s largest steelmaker, didn’t lay off a single employee. Hit by a 50 percent plunge in output that had begun in September 2008, the U.S. steel industry had laid off some 10,000 workers by January 2009, and the United Steelworkers union projected that the number would double before the recession came to an end. Not only did Nucor retain all of its employees during the recession, the company has not laid off a single employee because of lack of work in more than 40 years.

As far as top management is concerned, the company’s ability to weather the recent economic crisis was based on several factors—most important, the firm’s employees and culture. What’s that culture like? It originated in the 1960s as the result of policies established by Ken Iverson, who brought a radical perspective on how to manage a company’s HR to the job of CEO. Iverson figured that workers would be much more productive if an employer went out of its way to share authority with them, respect what they accomplished, and compensate them as handsomely as possible. Today, the basics of the company’s HR model are summed up in its “Employee Relations Principles”:

Management is obligated to manage Nucor in such a way that employees will have the opportunity to earn according to their productivity.
Employees should feel confident that if they do their jobs properly, they will have a job tomorrow.
Employees have the right to be treated fairly and must believe that they will be.
Employees must have an avenue of appeal when they believe they are being treated unfairly.

The Iverson approach is based on motivation, and the key to that approach is a highly original pay system. Step 1, which calls for base pay below the industry average, probably doesn’t seem like a promising start, but the Nucor compensation plan is designed to get better as the results of the work get better. If a shift, for example, can turn out a defect-free batch of steel, every worker is entitled to a bonus that’s paid weekly and that can potentially triple his or her take-home pay. In addition, there are one-time annual bonuses and profit-sharing payouts.

However, the system cuts both ways. Take that defect-free batch of steel, for example. If there’s a problem with a batch, workers on the shift obviously don’t get any weekly bonus. And that’s if they catch the problem before the batch leaves the plant. If it reaches the customer, they may lose up to three times what they would have received as a bonus. “In average-to-bad years,” adds HR vice president James M. Coblin, “we earn less than our peers in other companies. That’s supposed to teach us that we don’t want to be average or bad. We want to be good.” During fiscal year 2009, total pay at Nucor was down by about 40 percent.

Everybody in the company, from janitors to the CEO, is covered by some form of incentive plan tied to various goals and targets. Nucor’s profit-sharing plan guarantees that the company will contribute 10 percent of all earnings before taxes to the plan. In addition, there are incentives at the level of the work group for production employees and at the departmental and divisional levels for managers.

The company has an unusually flat organizational structure—another Iverson innovation. There are just four layers of personnel between a janitor and senior management: general managers, department managers, line supervisors, and hourly personnel. Most operating decisions are made at the divisional level or lower, and the company is known for its tolerance of honest mistakes made in the line of decision-making duty. The Nucor website points out that workers are allowed to fail if that failure comes as a result of logical initiative and idea sharing. That is, if a worker approaches a problem in a logical manner and makes a sound decision that is defensible but turns out to be wrong, he or she is not punished. The reasoning behind this approach is that it promotes creativity and initiative.

The Nucor system works not only because employees share financial risks and benefits but also because, in sharing risks and benefits, they’re a lot like owners. And people who think like owners are a lot more likely to take the initiative when decisions have to be made or problems solved. What’s more, Nucor has found that teamwork is a good incubator for initiative as well as idea sharing. John J. Ferriola, who managed the Nucor mill in Hickman, Arkansas, before becoming CEO in 2013, remembers an afternoon in March 2006 when the electrical grid at his facility went down. His electricians got on the phone to three other company electricians, one in Alabama and two in North Carolina, who dropped what they were doing and went straight to Arkansas. Working 20-hour shifts, the joint team had the plant up and running again in three days (as opposed to an anticipated full week). There was nothing in it (at least financially) for the visiting electricians, but they knew that maintenance personnel get no bonuses when equipment in their facility isn’t operating. “At Nucor,” says one frontline supervisor, “we’re not ‘you guys’ and ‘us guys.’ It’s all of us guys. Wherever the bottleneck is, we go there, and everyone works on it.”

Retirement Plans

Retirement plans (or pension plans) constitute another important—and sometimes controversial—benefit that is available to many employees. Company-sponsored retirement plans were historically set up to pay pensions to workers when they retire (these are referred to as defined benefit plans). In some cases, the company contributed all the money to the pension fund. In others, both the company and employees made contributions. In recent years, though, some companies have run into problems because they have not set aside enough money to cover the retirement funds they have agreed to provide.

Many companies today are transitioning to what are called defined contributions plans, also called 401(k) plans. Under these plans, contributions from the employee, sometimes matched by the employer, are invested in stock and/or bond funds. The individual’s retirement account is subject to greater risk (as well as potentially greater returns) while the employer incurs less risk. Both FedEx and Goodyear have recently made this shift for all of their employees. Other employers who are also making this transition include Anheuser-Busch, Wells Fargo, General Motors, AT&T, General Electric, and Saks.

Containing the Costs of Benefits

As the range of benefits has increased, so has concern about containing the costs of these benefits. Many companies are experimenting with cost-cutting plans while still attracting and retaining valuable employees. One approach is the cafeteria benefits plan. A certain dollar amount of benefits per employee is set aside so that each employee can choose from a variety of alternatives.

Another area of increasing concern is healthcare costs. Medical expenses have increased insurance premiums, which have increased the cost to employers of maintaining benefits plans. Many employers are looking for new ways to cut those costs. One increasingly popular approach is for organizations to create their own networks of healthcare providers. These providers agree to charge lower fees for services rendered to employees of member organizations. In return, they enjoy established relationships with large employers and, thus, more clients and patients. Insurers also charge less to cover the employees of network members because they make lower reimbursement payments.

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