An organization's compensation scheme is key to its ability to attract, motivate and retain essential staff members. A number of different compensation systems exist; however, each of these can be categorized as a traditional pay or strategic pay system. The key differentiator between these systems is the degree to which an employee's pay is placed at risk due to the success or failure of an organization in its efforts to accomplish critical business objectives.
The traditional pay system compensates an employee on the basis of either a fixed hourly rate or an annual salary. Under this system, pay hikes are dependent on factors including seniority and performance and occur on a scheduled basis. This model assigns a grade level to each position in light of the education and experience that is required to perform the job, which, in turn, infers a job's relative significance to other positions within an organization.
Edward Lawler's "Strategic Pay" suggests that strategic pay programs support the specific business objectives of the employer in that incentives are aligned with business strategies. As such, the programs may incorporate base pay, variable pay, indirect pay, perks-pay, works-pay, growth pay, advancement opportunities, psychic income and quality of life elements -- each of which is directly linked to the accomplishment of business objectives.
Traditional pay schemes are subject to centralized control, which supports standardization of pay scales. This standardization contributes to the predictability of salary expenditures that, in turn, simplifies budgeting processes. The system uniformity also becomes a tool with which the equity of pay within an organization can be evaluated. In addition, this pay scheme allows pay levels to be based in part on results of market testing. The pay system is consistent and at least appears to provide objective measures of employee performance.
The administrative overhead associated with the annual pay grades review and revision is a disadvantage of the system. In addition, parameters by which employees are judged, such as budget responsibility and staff size, can be manipulated by individual employees. The system also rewards overly inclusive job descriptions which can lead to excessive pay. The individual can also benefit from the transfer to a new position with a higher job grade rather than performing existing responsibilities in an exceptional fashion. This model also encourages vertical career moves and therefore does little to motivate technical staff. Traditional pay practices reinforce bureaucracy in that they assign value to the relative position of individual jobs in the corporate hierarchy.
A strategic pay system enables an organization to improve performance and control costs by linking remuneration to its business objectives. The linkage of pay and performance signals employees as to what specific contributions are valued by the organization. In addition, the model relies on available operational data and therefore generates less overhead than other compensation models. The model is also thought to encourage self-motivation, mutual support, innovation and teamwork.
The primary disadvantage of the strategic pay model is the difficulty of communicating the link between performance and pay to an organization's employees.