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Running Head: ASSIGNMENT 2

ASSIGNMENT 2: Strategy, the Totality of Decision, Transparency about pay, and Fast-cat Group 3 Amit Admane (6) Goma Rai (17) Kanika Atheya (20) Megha Lal (28) Nimisha Nigam (33) Shilpa Gore (50) Tata Institute of Social Sciences

YOUR TURN: PAY MATTERS (PRODUCTIVITY DOES, TOO):How may seemingly sound past pay decisions become obstacles to future competitive advantage? Competitive advantage is a necessary component for todays organisation. Today, as we are moving towards a knowledge economy, and as conventional sources of competitive advantage are becoming easily imitable by competitors, it is the human resource that provides the competitive advantage to an organisation. Thus, compensation system is one of the most important HR policies that a company has to decide. However the decision is often not so simple. As we saw in the case study of GM and Toyota, a seemingly sound pay model can in the long run become a hindrance in sustaining competitive advantage. It is imperative that all the HR practices are aligned with each other in order to have a competitive advantage. The entire range of HR practices, from training to compensation, must be mutually reinforcing. Unfortunately however, when companies adopt compensation policies that are not an internal fit, then it becomes an obstacle to future competitive advantage. Charles Shwab and Company faced this situation. The company has a reputation in the financial services industry for developing a culture of teamwork that has been important to its strategy. However, when it changed its compensation strategy to provide more rewards to its high-performing brokers, the firm sent negative signal to its employees. The earlier emphasis on teamwork was diluted by the new compensation strategy that encouraged individual performance (George Bolhander, 2010)1. When the management sends conflicting signals, it can erode the competitive advantage by making retention of talented employees difficult. Companies often use compensation as an effective tool in attracting talent. Sometimes managers tend to think that they can beat competition by paying higher salaries and bonuses.

Setting higher position than the median on the pay market is especially common competitive advantage setting in smaller companies, who have to fight for the best talents with the big organizations in the same industry. However, it is quite dangerous to set the pay market position too high as the organization has to carry increased costs which erode more from the margins on the products and services. Michael Porter stressed that managers get into trouble when they attempt to compete head-on with other companies. He calls it the destructive competition (Porter, 2009)2. If recession hits, the organization cannot make quick changes and it can be dangerous for the organization as it carries higher costs to keep the processes operating and functional. The compensation structure should ensure a tighter alignment between executive bonuses and long-term performance. During 2000-2007, the top executives aggregate bonus compensation reached (in 2009 dollars) $300 million at Bear Stearns and $150 million at Lehman. In a report filed with the United States court overseeing the bankruptcy of Lehman Brothers, a court-appointed examiner described how this compensation strategy encouraged Lehmans executives to make deliberate decisions to pursue an aggressive investment strategy and take on greater risks. This ultimately exacerbated the financial problems brought in by the recessionary trends. Therefore, executive compensation schemes are different for bull markets and volatile markets. A research paper by Miles B. Cahill and Alaina C. Geroge suggests how incentive structure of executive pay differs at different times. During volatile market period it is weakened as compared to the robust market. They compared the incentive components of the pay in the bull market of 1990 with the volatile market of 1999-2000. Using principal-agent theory and the study by Rajesh Agarwal and Andrew Samwick, their results provide some tentative support for the claim that the compensation should be tested in declining market (George, 2005)3.

Look at the factors that shape a compensation strategy. How would you try to make a pay strategy more flexible and resilient? Money is a powerful source of motivation, when you reward achievement to the desired organisational results. The compensation Policy must reflect the Strategic Business Objectives. Right Reward to the right employee behaviours is taken as one of the main objectives of Compensation Strategy. Factors that shape a Compensation Strategy are as follows: 1. The objectives of the organisation should be clearly defined: whether it is Profit Oriented or Customer Centric or a combination of both. 2. Communication and penetration of the objectives of Compensation Strategy within the organisation. 3. Right combination of benefits which includes non-cash compensation, can motivate the employees to contribute in organisational success. 4. Effect of Market Forces and Environmental Conditions on Compensation Strategy i.e. competitors and alliances 5. Industry of functioning and industries of impact, and hence their respective growth cycles. 6. Organisational Culture expected out of the company 7. Demography and cost of living of the countries in which the company aspires to start its operation and hence prepare a compensation strategy for. 8. Responding to specific need of unique professionals engaged in high growth organisations. 9. The differentiating factor or the unique factor of the organisation which makes sure that its top talent sticks to the organisation and does not drains out due to its compensation strategy.

10. Compensation Equity: To keep the employees motivated, it is important to keep the compensation structure equitable with those at other similar organisations. This will make sure that the organisations spending on training and development of the employees does not drain out with high attrition. 11. Rates of pay to be determined on the basis of any one or combination of the following: Pay increase based on employee's length of time spent on the job. Performance-based pay is intended to motivate employees to perform better Pay increases based on job-related skills and knowledge.

This is intended to motivate your people to gain additional skills, acquire new competencies and knowledge.

12. Kind of evaluation, i.e. Job Based Evaluation or Person Based System or both to be examined together with individual and group incentive plans. This evaluation will depend upon the growth cycle and the respective sector in which the industry functions. 13. Overall Economic Scenario and placement of present year on the Economic Cycle. Prediction about the upcoming economic conditions and its direct and indirect impact on the industry. 14. The kind of output expected out of the employees. This would be further governed by the innovative nature or normative nature and high technology involved. 15. Achievement of desired behaviours is essential in order to enhance organizations effectiveness. In turn this increases the possibility of success. 16. Salary Reviews- Compensation strategy requires that the appropriate salary review method is adopted, one of the following:

Fixed Date Reviews Anniversary Date Reviews Flexible Date Reviews

17. Working Conditions- Working conditions will definitely drive the compensation strategy, it includes: Risk Comforts Physical Demands Personal Demands

18. Responsibilities related to each individual- it includes: Judgement/ decision Making Internal Business Contacts Consequence of error Degree of influence Supervisory Responsibilities Responsibility for independent action Responsibility for machinery equipment Fiscal Responsibility Responsibility for confidential information

To make pay strategy more flexible and resilient, there should be following incorporations in the companys Compensation Strategy: 1. Differentiation with respect to rewards between top performers, average performers and non-performers.

2. Reward top performers only, so that the average performers will get motivated to move ahead and contribute more 3. Terminate non-performers and not good performers in sectors that are no longer profitable due to downturn. 4. Check the competitiveness of compensation plan with others in the market. 5. Short term plans for continued motivation among employees 6. Proper communication about the compensation package to all the employees.

YOUR TURN: MAPPING COMPENSATION STRATEGIES:The organisation chosen by us is MSD Pharmaceutical. We have chosen this organisation because one of our group members is going to MSD Pharmaceutical for her fieldwork in this semester. Thus the compensation policy details were available to us for detailed analysis. The compensation strategy of MSD Pharmaceutical relative to that of Microsoft and SAS has been shown in the graph below. The comparison has been made on the basis of an assumption. This assumption is that we have assigned certain percentage value to the degree of each parameter that was seen to lie between low and high values for Microsoft and SAS. This was seen necessary to make a comparison between the various values and decide where MSD Pharmaceutical would lie on the graph for various parameters relative to Microsoft and SAS.

Figure: Compensation strategy of MSD Pharmaceutical relative to that of Microsoft and SAS

1. Key Points of Compensation Strategy of MSD Pharmaceutical The key points of the compensation strategy of MSD Pharmaceutical are listed below-

1. The Compensation & Benefits Program at MSD Pharmaceutical is seen to be a key driver and influencer in its transformation into a high-performing global company. It is designed to protect, reward and motivate the employees in order to bolster the companys momentum and deliver shareholders results.

2. MSD Pharmaceutical believes in meritocracy - rewarding those who contribute the most to the success of the company. 3. The Key Objectives of the Compensation & Benefits philosophy are to-

a. Provide Competitive base salaries that help attract, motivate and retain world Class talent. b. Link sustained performance with differentiated levels of pay. c. Reinforce the qualities of leadership d. Ensure equitable pay among employees with comparable skills and performance.

4. The Compensation Program at MSD Pharmaceutical India consists of 3 major components, which are mentioned below: 1) Market PricingMarket Pricing is used for determining the base salary payout. This is done by comparing the base salary of employees to that of other major pharmaceutical company employees. Market Data is the primary driver in determining the Market Pricing 2) BandsThe global banding system supports cross business and cross functional development and movement, resulting in broader workforce skills. It focuses on professional development, linked to expansion of responsibilities and capabilities. 3) Individual SalariesIndividual salaries are given to the following employees: 1) New Hires

2) Current Employees

5. The compensation structure of MSD Pharmaceutical comprises of Basic Pay, House Rent Allowance (HRA), Transport Allowance, Personal Allowance, and Leave Travel Assistance (LTA). 6. In addition to above merit pay is paid when an employee performs well and contributes highly to the companys success. 7. Country Incentive Plan (CIP)/Annual Incentive Plan (AIP) are designed to encourage specific results-oriented actions on the part of employees, and to recognize and reward positive results. Colleagues not covered by Sales Incentive or any other incentive plan are covered under CIP/ AIP. The plan closely aligns employee financial rewards with the achievement of specific business objectives and individual performance. 8. The compensation and benefits team strives to protect the total compensation of an employee. This becomes necessary especially when an employee is promoted from sales to a non-sales job. This reduces the bonus that he earned as a sales employee. At the same time the promotion calls for a significant increase in total compensation. This point is borne in mind while designing his total compensation.

2. Key differences compared to strategies of Microsoft and SAS

The key differences in the compensation strategies of Microsoft, SAS and MSD Pharmaceutical as noted by us are as listed below-

1. Work/Life balance: SAS ranks number 1 on Fortune magazines annual 100 Best Companies to Work For list in America in 2010. It is rated very high in terms of the work/life balance it offers to its employees. Microsoft scores low on work/life balance. This is owing to the fact that the work at Microsoft is mentally challenging and requires putting in long hours of work. In addition to this is the fact that the campus of Microsoft tend to be in isolated places. The same mix has been shown on the graph with SAS scoring high and Microsoft scoring low on work/life balance. In comparison MSD Pharmaceutical is seen to rank low in terms of work/life balance. This is also observable in the employees of the organization who work for long hours and even on weekends.

2. How much is paid relative to the market:

Microsoft is known to give high total compensation to its employees. The emphasis on market competitiveness is extremely high. In SAS, the total compensation is not as high as in Microsoft. But it is such that it supports the work/life balance that SAS as an organization stresses a lot on. For example SAS provides subsidized child care facility to its employees. In MSD Pharmaceutical market pricing is used to decide the pay of employees. The Market Median is established at 50 percentile. This means that 50% of the companies in the pharmaceutical sector pay above MSD and 50% pay lower than MSD. Thus the range for compensation is decided and an employee is paid within that range. Thus MSD Pharmaceutical pays competitively but is not an organization that pays its employees very highly.

3. What forms are payments are used:

Microsoft has in the past provided stock options to its employees and many have become affluent on account of those. Currently employees receive shares of the total stock. We were unable to obtain data on the employee stock options at SAS. Earlier stock options were made available to most employees at MSD. However at present only the very senior level management has stock options. In addition a blackberry phone is made available to managers above a certain level.

4. Hierarchy:

As seen from graph Microsoft ranks high on the hierarchy part in the internal alignment in compensation. There are seven local bands in MSD pharmaceutical, which are further sub divided in 3 sub-bands. The number of bands being high, the pay varies largely at MSD. However there are a number of other determining factors like incentive pay and merit pay that are instrumental in deciding the total compensation that is received by an employee.

5. Stress on group performance vs. individual performance:

Group performance is rewarded highly at SAS while at Microsoft the stress is on individual performance. There is no incentive in terms of cash for the success of a group even though individual performance is rewarded at MSD Pharmaceutical.

TRANSPARENCY ABOUT PAY Transparency as defined in the book refers to openness and communication about pay. As per the research done by Kalyta (2009)4 transparencies about executive compensation plays a major role in deciding how much influence a manager has over his or her pay. To put it simply, more transparency means managers will be less equipped to influence their own pay.

In his paper Deane (2007)5 studied the executive compensation report of 350 corporations submitted to SEC6. Compensation reports are written for three key groups:

Investors and Regulators All Stake holders The business and financial press, which summarizes and interprets compensation

Reports for a wide audience that is unlikely to read the proxy statements themselves. As per SEC every organization should keep following things into considerations while making compensation report 1. To make disclosures easier to understand. 2. To provide investors with a clearer and more complete picture of the compensation earned by executive officers and board directors. 3. To provide better information about key financial relationships among companies, executives, directors and others. 4. To provide a clearer and more logical picture of total compensation and its elements for named executive officers. This study reports that only 34 companies out of 350 have adopted the best practices for disclosure and that too in certain areas of report. Deane (2007) also focused on aspects which make an ideal compensation report

It should be clear, concise and understandable. It should give explanation of the rationale for the pay mix It should clearly describe individual performance goals and how it was linked to executive pay.

COMPENSATION OBJECTIVES: FASTCAT 1. Attain high degree of efficiency and higher quality of customer service through teamwork. Team based performance should be rewarded depending upon the quality and efficiency with which the customers were serviced. This could be measured through achievement of certain preset customer service standards and long term and short term goals.

2. Attracting, developing and retaining employees Ensure that the compensation is at par with the industry standards in order to attract the new talent. Additional forms of compensation in form of benefits could be included. Providing attractive growth paths, career counselling, work life balance programs can be added.

3. Drive innovation This objective could be achieved by providing salaries and a mix of benefits which are competent with those offered by the competitors and would go up with increased skills, knowledge and experience. Special education allowances and high end training programs to build specialised skills, executed in house by the top

performers can be effectively used in order to develop different capabilities. Special rewards in the form of recognition can be given in case of unique accomplishments.

4. Control the operating costs of fastcat. Monetary rewards could be given to the administrative staff or anyone who contributes towards significant reduction in the operating costs.

5. Variable Pay / Annual Bonuses - Acknowledge and reward individual and team contribution to the organisations achievement of goals. Performance based pays rewarded in the form of bonuses/variable pay, linked to attainment of Job based, team based and firm based objectives. Each individual should be rewarded based on his or her contributions in meeting individual, team and organizational objectives For leaders - Performance based pay will be accompanied by promotions and bonus rewards which will be linked to 360 degree evaluation of the leaders.

6. Help and strive to achieve the business strategy of expansion Promotions and inter country mobility can be used as a part of the compensation plan. By developing a fair compensation strategy information would be communicated openly and transparently to all employees.

7. Compliance with government regulations Ensure pay fairness and comply with the government regulations.

References:

George Bolhander, S. S. (2010). Managing Human Resources. George, M. B. (2005). Compensation Incentives in a Volatile Market. Porter, M. (2009). Why do Good Managers Set bad Strategies? Kalyta, P.(2008). Compensation transparency and managerial opportunism: a study of

supplemental retirement plans. Strategic Management Journal, Vol. 30, Iss. 4, pp. 405-423.
5

Deane, S. (2007). Compensation Disclosure: Best Practices and Examples. Risk Metrics

Group. http://www.riskmetrics.com/system/files/private/ExecCompBestDisclosureBestPractices.pdf
6

The Securities and Exchange Commission (SEC) is a federal agency[1] which holds primary

responsibility for enforcing the federal securities laws and regulating the securities industry, the nation's stock and options exchanges, and other electronic securities markets in the United States.