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Rewarding Excellence: Pay Strategies for the New Economy

Edward E. Lawler III · 2000

In a sentence

In the new economy where human capital is the chief source of competitive advantage, organizations must abandon traditional job- and seniority-based pay in favor of reward systems that pay the person, reward excellence, and tie compensation to performance.

Rewarding Excellence makes the case that in a globalized, knowledge-driven economy, an organization's reward system is one of its most powerful—and most underused—levers for competitive advantage. Drawing on four decades of research, Edward E. Lawler III shows why traditional bureaucratic pay practices that reward jobs, seniority, and hierarchy fail in today's environment, and lays out a blueprint for reward systems that attract, retain, develop, and motivate excellent individuals. Treating employees as human capital investors rather than job holders, the book details how to pay people for their skills and knowledge, how to design pay-for-performance systems that actually motivate, how to conduct meaningful performance appraisals, and how to reward individuals, teams, and whole organizations. It offers practical guidance on team-based pay, 360-degree appraisals, stock options, gainsharing, goalsharing, and skill-based pay—and shows how to align all of them with business strategy to create high-performance organizations.

The four lenses

Science
Statistics
Systems
Strategy

The model

A causal framework in which reward system design levers (person-based pay, performance-based pay, market position, reward openness, employee involvement) and contextual conditions (work interdependence, environmental change) shape psychological and behavioral states (motivation, satisfaction, line of sight, skill development) that drive outcomes (attraction, retention, organizational performance / competitive advantage). Grounded in the book's Star Model and expectancy theory.

Person-Based Pay (Skill/Knowledge/Competency)design lever

A reward design lever that bases pay on the value of an individual's skills, knowledge, and competencies and their market value, rather than on the job they hold; includes skill-based, knowledge-based, and competency pay systems.

Performance-Based Paydesign lever

A reward design lever determining how much of pay is tied to performance through variable pay such as bonuses, incentive pay, gainsharing, goalsharing, profit sharing, and stock, as opposed to fixed merit increases or base salary.

Market Position of Rewardsdesign lever

A design lever capturing how an organization's reward levels compare to the external labor market for the relevant skills and individuals, including whether key employees are paid at, above, or below market value.

Reward Information Opennessdesign lever

A design and process lever describing the degree to which information about pay levels, market data, and reward administration is communicated openly versus kept secret within the organization.

Employee Involvementcontextual condition

A contextual and design condition in which information, knowledge, power, and rewards are distributed to lower levels so that employees are involved in the business and in reward system design and administration; central to the new logic of organizing.

Work Interdependencecontextual condition

A contextual condition describing the degree to which work is independent and individually measurable versus interdependent and team-based, which determines whether individual or collective rewards are appropriate.

Environmental Change and Competitioncontextual condition

A contextual condition capturing the rate of change and intensity of competition in the business environment driven by globalization, knowledge growth, and global capital markets, which raises performance demands and the importance of human capital.

Line of Sightpsychological state

A psychological state in which individuals perceive a clear connection between their behavior, a performance measure, and the allocation of valued rewards; the central mechanism of expectancy-theory motivation.

Reward Importancepsychological state

A psychological state reflecting how much an individual values the type and amount of reward offered; a reward must be important to the recipient to function as a motivator.

Performance Motivationpsychological state

A psychological state representing the energization and direction of effort toward performing in ways that lead to valued rewards; a function of reward importance and line of sight per expectancy theory.

Reward Satisfactionpsychological state

A psychological state reflecting how favorably individuals evaluate their rewards relative to a comparison standard based on similar others; affects membership behavior but not directly job performance.

Skill and Knowledge Developmentbehavioral pattern

A behavioral pattern in which individuals learn and develop the skills, knowledge, and competencies that the organization needs, motivated by person-based reward systems.

Attraction of Excellent Employeesoutcome metric

An outcome reflecting the organization's ability to attract a large number of talented, qualified, and properly motivated job applicants whose values fit the reward system.

Retention of the Right Individualsoutcome metric

An outcome reflecting selective retention of employees with the skills, knowledge, and performance critical to organizational capabilities and competencies, while not retaining everyone indiscriminately.

Organizational Performance and Competitive Advantageoutcome metric

The ultimate outcome of effective reward systems: the development of core competencies and organizational capabilities and the motivation to use them, yielding superior financial and strategic performance.

How they connect

person based pay → predicts skill development
person based pay → predicts retention
performance based pay → influences line of sight
line of sight → predicts motivation
reward importance → predicts motivation
reward importance → moderates line of sight
motivation → predicts organizational performance
market position → predicts attraction
market position → predicts retention
market position → influences satisfaction
satisfaction → predicts retention
reward openness → influences satisfaction
employee involvement → moderates line of sight
work interdependence → moderates performance based pay
environmental change → moderates person based pay
skill development → predicts organizational performance
attraction → predicts organizational performance
retention → predicts organizational performance

return on equity; return to shareholders; market value; quality/defect rates; growth

self-report suitability: low

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The story

The reader A manager, HR leader, or executive who wants to design and manage a reward system that gives their organization a competitive advantage by attracting, retaining, and motivating excellent people.

External problem

Traditional job-based, seniority-based, and merit-pay systems no longer attract, retain, or motivate the talent needed to compete in the global knowledge economy.

Internal problem

The reader feels their pay practices are outdated, ineffective, and disconnected from strategy, leaving them unsure how to reward excellence without wasting money or creating dissatisfaction.

Philosophical problem

It is simply wrong to treat people as interchangeable job holders when human capital is the true source of competitive advantage and excellence deserves to be rewarded.

The plan

Adopt the new logic of organizing and recognize human capital as your source of competitive advantage.
Make the key structural and process design choices for your reward system, aligning them with strategy.
Pay the person—reward skills, knowledge, and market value—rather than the job or seniority.
Design pay-for-performance systems with significant variable pay, objective measures, and clear line of sight.
Reward individuals, teams, and the organization appropriately, supported by effective performance appraisal.
Manage the change to the new reward system with employee involvement, openness, and credible leadership.

Success

The organization attracts, retains, and motivates excellent people who provide a sustainable competitive advantage.
Pay is clearly tied to performance and skill development, creating a high-performance, high-trust culture.
Reward systems are aligned with strategy, structure, and people, contributing directly to organizational effectiveness.
Excellent performers are paid above market and stay; poor performers are appropriately compensated or leave.

At stake

The organization loses its best people and competitive advantage to competitors who reward excellence.
Reward systems waste time and money while demotivating employees and reinforcing entitlement cultures.
The company becomes a corporate dinosaur, doing the old things better instead of reinventing itself for the new economy.

Chapter by chapter

ch01Organizational Effectiveness: The New Logic
In an increasingly competitive global landscape, organizations must adapt their management practices and organizational designs to achieve high performance and sustainable competitive advantage.
- Organizations today must meet heightened expectations from customers across all dimensions of performance; mediocrity is no longer acceptable.
- Competitive advantages now stem from effective management practices that integrate human resources, organizational design, and strategic alignment.
- The shift toward a new logic of organizing emphasizes the importance of employee involvement and lateral processes over traditional hierarchies.
- Real-world examples demonstrate that even powerful companies can fail if they cling to outdated management practices that no longer match market demands.
ch02Reward System Design Choices
The design of reward systems is pivotal in aligning organizational strategy with employee motivation, yet effective implementation hinges on a small number of critical design decisions.
- Effective reward systems must harmonize both structural and process elements to ensure they motivate the right behaviors.
- Person-based pay systems can promote a culture of personal growth, while job-based pay may limit employee engagement.
- Relating pay to performance is essential, but execution must be carefully considered to avoid negative consequences.
- Market positioning of pay significantly impacts employee satisfaction and talent attraction while also shaping organizational culture.
ch03Motivating and Satisfying Excellent Individuals
This chapter argues that while pay-for-performance systems are fraught with challenges, they remain essential for motivating excellent employees and achieving organizational effectiveness.
- Effective pay-for-performance systems are crucial for achieving organizational effectiveness, but they require careful design and management.
- No single compensation method will suffice; organizations must recognize the diverse needs and values of their employees.
- Motivation stems from both intrinsic and extrinsic sources; thus, organizations must create systems that acknowledge this duality.
- Expectations about rewards significantly influence employee motivation and satisfaction—clarity is key to maintaining alignment.
ch04Attracting and Selecting Excellent Employees
To build a workforce of exceptional employees, organizations must prioritize attracting a diverse pool of qualified candidates by designing effective reward systems, while also carefully selecting individuals whose motivations align with their unique employment culture.
ch05Job- and Seniority-Based Approaches to Development and Retention
Organizations must effectively balance job-based and seniority-based reward systems to optimize employee development and retention in a rapidly changing business environment.
- Selectively retaining and developing employees who align with strategic objectives is critical for organizations in dynamic environments.
- Engaging reward systems must emphasize external market competitiveness rather than traditional hierarchies or seniority alone.
- Job evaluations and seniority tenure do not adequately capture the true value that individual employees contribute to an organization’s success.
- Adopting broad banding strategies can enhance reward flexibility and accommodate exceptional contributors without being restricted by bureaucratic limitations.
ch06Developing and Retaining the Right Individuals
This chapter argues for a paradigm shift in employee compensation from job- and seniority-based systems to an individualized, skill-based approach that enhances both retention and organizational effectiveness.
ch07Rewarding Individual Performance
This chapter argues that while rewarding individual performance through pay can drive motivation and retention, it requires careful construction and is not universally applicable to all work settings.
ch08Appraising Performance
This chapter argues for a reinvention of performance appraisal systems, highlighting their potential when aligned with organizational goals, rather than the traditional approach that often breeds dysfunction and dissatisfaction.
- Effective performance appraisal systems must be reinvented rather than abandoned to promote skill development and enhance motivation.
- Employees often prefer to hear positive feedback rather than constructive criticism, which complicates the performance appraisal dialogue.
- Separating discussions of pay from development leads to clearer communication and better understanding of performance expectations.
- A collaborative approach to appraisal that includes input from multiple sources helps to ensure fair evaluations and balanced feedback.
ch09Rewarding Team Excellence
This chapter asserts that the effectiveness of different types of teams in organizations hinges on tailored reward systems that align with each team's structure and functions, emphasizing that a one-size-fits-all approach to rewards is counterproductive.
- Tailored reward systems that align with the type of team structure are essential for optimizing performance.
- Knowledge-and-skill-based pay is particularly effective in work teams that require substantial cross-training.
- Parallel teams face unique challenges; to be effective, they need support systems that address their legitimacy and power issues.
- The interdependencies in project teams necessitate careful consideration of rewards tied to collective outcomes to promote collaboration.
ch10Rewarding Organizational Excellence
This chapter examines four distinct approaches to rewarding organizational performance through pay systems, emphasizing the alignment of individual rewards with corporate objectives and exploring the inherent challenges of each system.
- Aligning pay structures with organizational performance fosters a more engaged workforce.
- Organizations benefit from reward systems that promote cooperative effort rather than only individual achievements.
- The effectiveness of gainsharing and goalsharing plans lies in their capacity to tie financial rewards directly to operational improvements.
- Creating a culture of transparency regarding financial performance is crucial for motivating employees.
ch11Strategic Reward System Design
Effective implementation of a business strategy hinges on a well-designed reward system that fosters organizational capabilities and motivates behavior aligned with strategic goals.
- Effective strategy implementation requires aligning reward systems with business objectives to close the strategy-implementation gap.
- Person-based rewards are preferable to job-based compensation as they foster employee development and retention of high-value talent.
- Compensation should reflect external market realities rather than rely solely on internal equity considerations.
- Organizations must embrace a less hierarchical approach to compensation to promote collaboration and technical excellence.
ch12p01Creating High-Performance Organizations (part 1/2)
To unlock high performance, organizations must align their systems—including reward structures—with a holistic approach that fosters employee involvement, creates accountability, and supports continuous knowledge and skill development.
- Effective reward systems hinge on congruence with overarching business goals and strategies.
- Employee involvement in designing reward structures fosters greater buy-in and commitment.
- Transparency in communication regarding reward criteria enhances trust among employees and management.
- Cultural shifts towards high performance necessitate a comprehensive approach, integrating all aspects of employee engagement and empowerment.
ch12p02Creating High-Performance Organizations (part 2/2)
This chapter delves into the intricate design and implementation of reward systems that not only attract top talent but also cultivate high-performance organizations capable of thriving in competitive environments.

Related in the library

Strategic Pay: Aligning Organizational Strategies and Pay Systems