The fundamentals of reward strategy
Reward and reward strategy
- Reward – the total of all of the financially valuable related elements received by employees in an organization.
- Remuneration – means the same as reward.
- Compensation – this is commonly used in the US and refers to pay and bonus.
- Benefits – are the non-cash parts of reward.
Total reward has started to be used to mean both reward plus a range of other non-reward items, such as training and development.
- Basic pay/salary will always be the largest part of their reward. The two main exceptions are:
- Senior executives
- Sales people or traders
- Variable pays/bonus
The whole should be greater than the sum of the parts. So above mentioned elements of total reward should be combined in the proper way.
Effective reward management is about both the individual elements of reward and the total cost and value.
We need to have a sense of direction to enable us to develop reward strategies that are relevant, meaningful and will help the organizations.
Reward strategy is an approach to reward based on a set of coherent principles in support of the organization’s aims.
According to the CIPD 2010 Reward Management survey, only 35 per cent of participant organizations had a written reward strategy.
Look for ‘best fit’ not ‘best practices.
- Reward Philosophy – (also Reward Principles) the description of the beliefs of reward and how it should operate within the organization.
- Reward Framework – the broad overview of the related and possibility interlinked elements of reward.
- Reward Policy – the detailed policies on specific elements of reward which give the flexibility, discretion and limits.
- Reward Procedure – the detailed procedure and processes.
Why reward is important and how it can make an impact
If you want to see what an organization values, look at what it pays for, not what it says.
“Monetary rewards may not motivate in the long term, but they certainly symbolize the value corporations attach to specific behaviors.”
You should examine carefully what message each element of reward is carrying and ensure it is what you want. You need to know the aims of the organization to ensure that reward supports them. Reward can have an impact in supporting and delivering the broader HR strategy by being aligned with it and carrying the right message.
Measuring the impact on any HR initiative can be difficult because you are dealing with a large number of independent variables. The other two issues are: the third variable problem and the linking variable issue. Ensure that what is you are going to measure is value added and not just chosen because it is easy to measure.
Aon Hewitt found that higher performing organizations were more likely to define and measure success through a range of employee value and return on investment indicators in addition to budget and cost management.
Relationship between motivation and reward
The most common reference made when the role of reward as a motivator is raised is that Hertzberg said money is hygiene factor. That is something that can cause damage if removed, but does not act as a motivator like achievement and recognition.
Nelson suggest if you only use money to thank people, then money becomes a psychological exchange for enduring a miserable job with no other appreciation.
Kohn, a well-known critic of financial incentives, believes that: “Incentives, a version of what psychologists call extrinsic motivators, do not alter the attitudes that underlie our behaviors. They do not create an enduring commitment to any value or action. Rather, incentives merely – and temporarily – change what we do.”
Behavioral science covers the areas of psychology, cognitive neuroscience and behavioral economics.
Pink concludes that as long as the task involved only mechanical skill, bonuses worked as they would be expected: the higher the pay, the better the performance. But once the task called ‘even rudimentary cognitive skill’, a larger reward ‘led to poorer performance’.
Expectance theory tells us that people will undertake an action if they see that the action will lead to an outcome that they value.
Incentive do not replace management.
Success = talent + luck.
Great success = a little more talent + a lot of luck.
As long as pay is around the market median, all the other things about working for the organization will have a greater impact on retention. But pay well below the market is more likely to have an impact on retention.
McKinsey found that:
- praise from immediate manager;
- leadership attention, e.g., 1:1 conversation;
- chance to lead projects or task force
were equal to or more effective in motivating people than
- cash bonuses;
- increased base pay:
- stock or stock options.
The extent to which employees see their pay as unfair is likely to be a greater demotivator than their perception of their pay against external market.
People should be paid enough to eliminate any dissatisfaction with pay.
For reward to have impact in motivation it has to operate in a context where it is only one, fairly small, part of the motivation mix.
How reward fits together
One of the practical issues to take into account in developing a reward strategy is the range of internal and external influences there will be on it.
- External influences: legislation, taxation, social system, market sector, market pay movement and business sector.
- Internal influences: values of organization, ESG, structure and size of the organization, organizational change, profitability and industrial relations (employee representation).
To maximize the value and impact of reward you need to think about the opportunities for trade-offs between different elements. Some elements: consolidating into salary, benefits as part of pay review, benefit changes, bonus and recognition, shares and salary, salary and bonus.
The role of the reward professional:
- Take a long-term perspective but with short-term actions.
- Recognize holistic HR.
- Use a consulting approach.
- More emphasis on change management and less on reward design.
- Meld the academic with the practical.
- Manage external relationship.
How to get started with a reward strategy
I often find that reward programs exist because of historical rather than strategic reasons.
CIPD research suggest that there are five key requirements in developing an effective and tailored reward strategy:
Clear reward goals and priorities derived from the business strategy and its requirements.
A strong organizational fit of reward policies and practices with the structure and design of the organization.
Alignment of the reward practices with each other in a total-reward approach and with the other HR programs in the organization.
Aligning with and involving employees in the development and delivery of the reward strategy.
Treating the reward strategy development of a process of continuous improvement and interaction between principles and practices.
For changes you can use an approach that Hoffmann developed for how to solve business problems:
- Understanding the central problem.
- Applying a conceptual model. A conceptual model lists the potential causes and solutions of the problem. When combined with business and operational constraints, it can be used to form a hypothesis about cost and benefits of solutions.
- Using the conceptual model to focus data collection.
- Analyzing the data to illuminate the causes and potential answers to the challenges the organization is facing.
- Presenting the findings to stakeholders.
- Enabling the solution so the organization can take effective action.
Agreeing a written reward strategy with the leaders of your organization can be an excellent way to get them to think about what reward can and should be doing in the organization and its implications.
Effective communication is a critical element in bringing any reward strategy to life. If you want to give reward a chance of having an impact, people need to understand it.
Recognizing that most people do not understand the total value of their package has led to the growth of reward statements. Reward statements communicate the total value of all elements of reward (salary, bonus, benefits including pension and shares) to each employee.
Here is a general approach to communicating significant reward changes:
- Establish key messages
- Engaging stakeholders
- Look and feel
- External support
Effective communication is vital to release value from your reward strategy. Employees need to know what they’ve hot and how it works.
Tax and National Insurance
An organization needs to consider how much it will explain and communicate tax issues that remain the responsibility of the employee even though they arise from a company reward. It is not appropriate for an employer to give financial or tax advice.
Reward in practice
Grades and pay structure
While for most organizations a pay structure will be tied to a grade structure, they are not synonymous. A grade structure is a way of grouping broadly similar jobs in an organization into a hierarchy that provides some degree of internal relativity. A pay structure is hierarchy of pay or salary levels showing the rates of pay for employees performing a particular job or function at each level of the organization.
A fundamental concept underpinning a grade structure is ‘job size’. This reflects the relative significance of one role against another. It is not about the individual job holder, but the job itself.
Probably the most well-known analytical system for job evaluation is the Hay Guide Chart Method. It is based on three factors:
- Practical/technical knowledge
- Planning, organizing and integrating (managerial) knowledge
- Communicating and influencing skills
- Thinking environment
- Thinking challenge
- Freedom to act
Unlike the analytical method that breaks down jobs into their component parts, a non-analytical method ranks the whole job. Typically, jobs are matched against a series of profile job descriptions. This is called ‘job classification’.
A less hierarchical organizational structure and culture has meant that the traditional grades have become counter-cultural.
Job families can be used with any form of grade structure. This is not separate from grades but rather establishes a series of families of jobs which are overlaid on the grade structure.
Pay structure are important in helping an organization ensure that pay level differences can be justified and are equitable based on some fair rationale. Pay structures can help an organization manage the total pay bill by providing a clear framework within which an individual’s pay can be changed.
There is normally a stated minimum, mid-point and maximum for each pay range for each grade. The range is normally expressed in one of two ways:
- As a percentage of the mid-point: The minimum and maximum are expressed as percentage of the mid-point.
- As a percentage of the minimum: This is simply the maximum expressed in a percentage of minimum. The percentage is normally in the range 25 per cent to 50 per cent.
The difference between one salary point and the next one is an increment.
The trend regarding grade and pay structures is moving to broader bands and, where appropriate, job families.
Managing pay data and pay reviews
One way or another you need information on the reward market within which you are competing. There are broadly two types of data:
- Changes in pay rates: percentage pay increases in the market.
- Current pay levels: what particular jobs are paid.
There are five main factors that can define a pay market:
- Function or discipline.
- Level of seniority.
- Organizational size.
- Location or region.
One way to help think about the pay markets is to analyze where your employees move to and where new employees come from.
Sources of pay data:
- Win bar source
- Generic surveys
- Treat with caution
- Industrial/occupational surveys
- Recruitment consultants
- Job adverts
- Exit interviews
- Salary surveys
The core of performance management for individuals is the answers to the two questions: What is expected of me? How am I doing?
Bonuses come in all sorts and shapes and sizes, from a weekly low-level prize to annual executive plans paying potentially a multiple of annual salary. Around 64 per cent of organizations pay a bonus to at least some employees.
Main types of bonuses:
- Individual bonus
- Combinational schemes
- Sales commission
- Project bonus
- Total reward
- Profit sharing
- Goal sharing
- Team bonus
- Gain sharing
- Pool base
- Spot bonus
- Deferred bonus
A fairly simple framework of six steps that you can follow to design a bonus plan:
- Aims and context
- Design principles
- Management effectiveness
- Design parameters
- Time span
- Agree design
- Scenario testing
- Management support
- Links to aims
- Supporting messages
- Frequency of review
- Making changes
You need to clarify what is the base pay for and what is bonus for?
The problem is that if you design a bonus plan to incentivize behavior you may well get what you are incentivizing and nothing else.
If you want to see what an organization values, look at what it pays for, not what is says. If the bonus is attractive, people will do what the bonus targets, so it must be what you want.
The design principles are not the bonus plan, but the main agreed principles to which the design should adhere.
Individual incentives, feedback and ranking may damage the essential collaboration needed to optimize overall success.
Time span is important. There are so many cases where there is a complete misalignment between the span of time of impact and the bonus period.
Funding is about where the money comes from. Corporate guidelines now often require part of an executive’s bonus to be deferred.
Distribution of payments:
- Bonus set as a percentage of salary
- Flat payment to all – mostly used for short-term bonuses, such as bonus at the end of a project.
- Minimum bonus – the first year of employment only.
- Maximum bonus or cap
- Target bonus – bonus payable for a set of outcomes.
- Threshold – the minimum performance point that triggers funding or a bonus payment.
- Adder – combining two or more factors by adding them together.
Any bonus plan that covers a year or more must be documented in some form of plan rules. Here is potential outline of sections:
- Plan outline
- Changes in circumstance
- Definition of terms
Bonus design checklist:
- Who is the target group?
- Objectives of the plan.
- Types of plans. Incentive or reward?
- Choice of performance measures.
- Key issues in plan design.
- Scenario planning.
Key issues in plan design:
- Competitive base rates and benefits
- Significant payments
- Simple and clear
- Appropriate to business needs
- Felt fair
- The target mix
- Discretionary element
- Link with performance appraisal
- Level of payments
- Treatment of exceptional circumstances
- Frequency of payment threshold and ceilings on payment
- Plan duration and reviews
Recognition and non-cash reward
Using recognition and/or non-cash can work more effectively than bonus:
- Where the time span of impact is short.
- Where a direct financial incentive is unlikely to work.
- Complement bonus plan with non-cash.
Recognition is a process of acknowledging or giving special attention to a high level of accomplishment or performance, such as customer care or support to colleagues, which is not dependent on achievement against a given target or objective.
A recognition programme seeks to reinforce the great-things people are already doing.
Regarding a recognition:
- Be genuine
- Be timely
- Be personal
- Make it specific
- Be clear
- Make it public
Here are four key elements of recognition that really work: praise, thanks, opportunity (to recognize people and to find them new opportunities) and respect (recognize them not just for what they do, but who they are).
For a non-cash award to be, in any way, effective as an incentive it needs to be desirable.
Gamification is a common element in most online incentive or recognition platforms.
Bonus plans are usually contingent pay for a period of up to one year.
Long-term plans aim to support retention and long-term performance as a balance to an annual plan that, by definition, rewards annual outcomes. There are two main categories of long-term plan: those paying out cash and those using company shares.
Share options gives the recipient the right (option) to buy a certain number of shares in the company at a future date but at a predetermined price, as long as they are still employed.
Share grants (or restricted stock). An executive may be provisionally granted shares that will not be owned by the executive until they vest. Typically, they must be held for two to five years, before they become owned by the executive and may be sold.
Most executive share plans will have some form of performance conditions relating to key measures of corporate success.
Reasons for using cash for the long term:
- No shares
- Share limit reached
- Time or simplicity
- Tax issues
- Set-up cost
- Underpin shares
A phantom share plan is a cash plan that is designed to replicate the main elements of a share plan.
That is evidence that shows that executives will discount the value of a future payment (shares or cash) by over 20 per cent per annum.
Some annual bonus design provides for a percentage of the bonus to be deferred for one to three years before it will be paid out. There are two main reasons for doing this: corporate governance and retention.
Benefits are the non-cash parts of reward that are provided by the employer either to all employees or differentiated by level. Benefits can be a significant part of reward, but even when they are, they are generally poorly understood.
There are only five reasons why an organization chooses to provide particular benefits to its employees:
- Market need.
- Tax efficiency.
- Organization provision: a benefit that the organization can provide much cheaper than can an individual.
- Organization value.
Author recommends grouping benefits into three or four categories, each of which reflects the core aims of the overall benefit provisions. Groupings may be:
- Health and wellbeing.
- Your time and flexible working.
- Security for your family.
- Financial and savings.
Rath and Hartner see five elements of wellbeing:
Flexible benefits (flex) are a system whereby individual employees can choose different benefits and different levels of benefits within a given menu to meet their lifestyle but at a neutral cost to the employer. Some of the main reasons why organizations consider flex:
- Reinforce culture
- Maximize the value of benefits
- Control costs
- Reduce costs
- Improve recruitment
Reward is important as it can cost up to 7.5 per cent of the total cost of the organization and it carries strong messages.
You need to be clear about what you are paying for and be able to explain it to employees.
To meet the challenges of the strategic reward agenda requires a new skill set for the reward professional. The future will be focused on:
- Employee engagement
- Behavioral science
- Millennial and generation Z
- Social networking
- Life expectancy
- Environment issues
- Shareholder pressure
- Pace of change