Chapter 7 COMPENSATION

Chapter 7 COMPENSATION

IBM’s Pay Plan Supports Its New Strategy

As most everyone knows by now, IBM is a classic example 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 strategy 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, execution, speed, and decisiveness.

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 some of 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, competitive rates of pay. Gerstner knew he had to change the pay plan to drive the new culture he sought to create.

To change this situation, Gerstner’s team made four major changes in IBM’s compensation plan:

1. The marketplace rules. The company switched from its previous single salary structure (for nonsales employees) to different salary structures and merit budgets for different job families. This enabled IBM to take different compensation actions for different job families (for instance, 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 sends the strong cultural signal that “a market-driven company must watch the market closely and act accordingly.”

2. Fewer jobs, evaluated differently, in broadbands. 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 into 10 bands based on just 3 (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 broadbands. This communicated a new organizational model: IBM was to be a flatter organization that could “deliver goods and services to market faster.”

3. Managers manage. The previous compensation plan based raises on a complex comparison that linked performance appraisal scores to salary increases 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 mangers 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.

4. Big stakes for stakeholders. As IBM was floundering in the early 1990s, every nonexecutive 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. By 1997, most IBM’s 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 pensionable earning)”

The changes illustrate how one company used its compensation plan to support its strategic aims. The new pay plan refocused IBM employees’ attention on the values of winning, execution, and speed, and on being better, faster, and more competitive.