Ideas for Leaders #501

Promotion Vs Compensation: Managing Employee Careers to Benefit the Organization

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Key Concept

The best companies recognize that personnel policies are interdependent. The decision to promote worthy individuals, for example, cannot be made in a vacuum. Is there room for more managers at the next level? A new mathematical model reveals how decisions on hiring, demoting, promoting, retaining and compensating employees must take into account factors such as the organizational chart and firm size.

Idea Summary

Personnel policies are often considered in the context of the individual — policies related to hiring, promoting, and firing individuals, for example. However, personnel policies must operate within the context of the organization as a whole.

Thus, for example, the ideal career path within a company seems straightforward. The individual is hired, does continuously well, and is steadily promoted up the company’s ‘career ladder’. The metaphor of the career ladder, however, simplifies the process because it depicts one individual on one ladder. The fact is that all employees are scattered up and down the rungs of the ladder — including executives on the top rung. And, to continue with the metaphor, the higher the rung, the smaller its width, which means that the higher rungs quickly become crowded. How then to manage this ambitious, tumultuous crowd scrambling on the company’s career ladder?

Two professors from the Kellogg School of Management and a professor from the Chinese University of Hong Kong joined forces to create a mathematical model that explores the organizational variables in internal labour markets — variables that impact a company’s personnel policies, including policies on hiring, promotions, wages and mandatory retirement.

For example, the model shows that higher-level workers are motivated by their higher wages. Lower-level workers, on the other hand, will accept low wages if they are motivated to work hard by the opportunity to be promoted to higher-level jobs with those higher wages. (In the terminology of the researchers, the pay of the lower-level workers is ‘backloaded’ when they reach the higher positions.)

As the researchers note, employees at the top are (almost) never demoted. Promotion opportunities for employees at lower levels thus depend on employee turnover at the top.

One way organizations can assure this turnover is through forced-turnover policies, such as mandatory retirement ages. The dilemma is obvious, however: how do you keep workers in low-level, low-paid jobs motivated through the chance of promotion, when they know that workers in promoted positions (i.e. later-career positions) are eventually forced out?

The model shows that generous compensation levels at the higher levels and the generous promotion opportunities at the bottom levels (enhanced by the forced turnovers) can disarm the negative impact of forced turnovers.

Another revelation from the model concerns a firm’s optimal ‘hierarchical span’ — that is the ideal ratio of the number of positions at the bottom to the numbers of positions at the top.

It is possible to calculate based on wages and productivity an optimal hierarchical span that leads to maximum productivity efficiency. Productivity numbers, however, don’t take into account worker motivation. Creating another position at the top increases the career opportunities for workers at the bottom, which is a ‘shadow benefit’ that must be added to any marginal revenues from the new position. The reverse is also true: creating another position at the bottom reduces the prospects for promotion, which means that the company benefits less than the marginal revenues generated from the position.

In short, the optimal hierarchical span for a company — the ratio of workers at the bottom to workers at the top — is lower than dictated by productivity efficiency.

Business Application

Managing the careers of your workforce to ensure the most optimal, long-term company productivity and profitability involves personnel decisions that can never be made in isolation. All personnel decisions are linked with your company’s policies, salaries and organizational chart.

This interdependency explains the differences highlighted by the researchers between small companies and large companies. The variables are different — for example, small firms have smaller hierarchical spans. Instead of hundreds of factory workers for each manager, for example, there are only 20 professionals (e.g. computer programmers or real estate agents) per manager. Small spans translate into much greater opportunity for promotions. Wages can thus be lower at the lower levels. In very large companies, wages must be much higher because the motivating factor of promotions is almost irrelevant to bottom-level workers.

For smaller firms, especially, another consideration is that heavy promotion policies can lead to top-heavy organizations as more people are moved up simply to keep them motivated.

The observations generated by the mathematical model offer some guidelines on a variety of policy decisions. The core lesson, however, is the tight link between every decision concerning an individual employee and the overall productivity and operational effectiveness of the firm. No personnel decision is a minor decision.

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Authors

Institutions

Source

Idea conceived

  • March 2015

Idea posted

  • March 2015

DOI number

10.13007/501

Subject

Real Time Analytics