Strategic Compensation

In this article we are giving a practical example of IBM as a classic case of an organizational renewal. It dominated its industry through the early 1980s. But by the 1990s, it was failing to exploit new technologies and losing touch with its customers. Its board hired Louis Gerstner. His first strategic aim was to transform IBM from a sluggish giant to a lean winner.

Accomplishing this meant doing more than downsizing and reorganizing the firm; Gerstner had to transform IBM’s culture, the shared values, attitudes, and behavior patterns that guided employees’ behavior. He sought to emphasize winning executive, speed, and decisiveness. He knew he had to use the compensation plan to support IBM’s strategic aims.

IBM’s existing compensation pay plan did the opposite. Everyone in this huge company was in a job whose relative worth was based on a decades-old, point-factor-based job evaluation. What were the implications? For one thing, maintaining the point system for over 100,000 employees required “a massive and cumbersome” attention to point factor manual based evaluations. This structure also cultivated a preoccupation with internal equity rather than with market-driven, competitive rates of pay. This required changes in the pay plan to drive the new culture to be created for an efficient organization.

To change this situation, four major changes were made in what became the firm’s new strategic compensation plan.

The Market place rules: The Company switched from its previous single salary structure (for non-sales employees) to different salary structures and merit budgets for different job families. This enabled IBM to take different compensation action for different job families say for accountants, engineers, programmers, and so on. In particular, this enabled IBM to concentrate on paying employees in different job families in a more market-oriented way. The new approach sent the strong cultural signal that a market-driven company must watch the market closely and act accordingly.

Fewer jobs, evaluated differently, in broad bands: Second, IBM scrapped its point factor job evaluation system and its traditional salary grades. The new system has no points at all. The old system contained 10 different compensable factors; the new one slots jobs into10 bands based on just three (skills, leadership requirements, and scope/impact).

In the United States, the number of separate job titles dropped from over 5,000 to fewer than 1,200 and 24 salary grades dropped to 10 broad bands. This communicated a new organizational model: IBM was to be flatter organization that could “deliver goods and services to market faster.”

Managers manage: The previous compensation plan based raises on a complex comparison that linked performance appraisal scores to salary increase measured in tenths of a percent. The new system is streamlined. Managers get a budget and some coaching, the essence of which is either differentiate the pay you give to stars versus acceptable performers or the stars won’t be around too long. The new approach lets managers rank employees on a variety of factors such as critical skills, and results. The managers decide which factors are used and what weights they’re given.

Big stakes for stakeholders: AS IBM was floundering in the early 1990s, every non-executive employee’s cash compensation (outside the sales division) consisted of base salary plus overtime, shift premiums, and some other adjustments. Pay for performance was a foreign concept. Prior to implementation of change most IBM employees around the world had 10% or more of their total cash compensation tied to performance. In the new system, there are only three performance appraisal ratings. A top-rated employee receives two-and-one half times the award of an employee with the lowest ranking. Awards are calibrated as percentages of pension able earnings.

The changes at IBM illustrate the nuts and bolts of strategic compensation, which means using the compensation plan to support the company’s strategic aims. IBM’s new pay plan refocused its employees’ attention on the values of winning, executive, and speed, and on being better, faster and more competitive.

In this article we have discussed the case of IBM to give clarity to strategic compensation along with simplification of performance rating system.