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Employee reward man AW:Layout 121/6/0709:45Page 1A Handbook ofCovering the conceptual framework of reward management and its practical application, thebook is packed with essential information on key theories and best practice for employeereward. Written in a highly readable style and containing many checklists, diagrams andsummaries, it includes: the fundamentals of reward management and its conceptual framework;establishing job values and relativities;grade and pay structures;contingent rewards;reward management for special groups;employee benefits and pensions;reward management procedures and cases.This new edition contains new research conducted by e-reward, as well as over 30 new bestpractice case examples, up-to-date guidance on current legislation, and brand new coverage ofkey topics such as engagement and commitment, bonus schemes and rewarding knowledgeworkers. A Handbook of Employee Reward Management and Practice is also an essential guide forCIPD students of employee reward as it is based on the unique experience of its author asformer CIPD Chief Examiner in employee reward.FREE CD ROM FOR LECTURERSMichael Armstrong has created a unique CD ROM containing lecture presentation slides.This CD is available from the publisher on request. 29.99US 60.00Kogan Page120 Pentonville RoadLondon N1 9JNUnited Kingdomwww.kogan-page.co.ukKogan Page US525 South 4th Street, #241Philadelphia PA 19147USAISBN-10: 0-7494-4962-4ISBN-13: 978-0-7494-4962-9Human resource managementA Handbook of2ND EDITIONEMPLOYEE REWARDMANAGEMENTAND PRACTICE2NDEDITIONArmstrongMichael Armstrong is an independent management consultant, Joint Managing Partner ofe-reward, and former Chief Examiner for the Chartered Institute of Personnel and Development(CIPD). He is the author of many internationally best-selling titles published by Kogan Pageincluding A Handbook of Human Resource Management Practice, Strategic Human ResourceManagement, A Handbook of Management Techniques, Reward Management (with Helen Murlis),Human Capital Management (with Angela Baron) and A Handbook of Management andLeadership (with Tina Stephens).EMPLOYEE REWARDMANAGEMENT AND PRACTICEA Handbook of Employee Reward Management and Practice is the definitive guide for practitionersinvolved in developing and managing reward strategies, policies and procedures, and for studentsof employee reward. Aligned with the Chartered Institute of Personnel and Development’sprofessional standards for employee reward, this book is an essential aid for students andlecturers as well as a practical guide for human resource and reward management professionals.Michael Armstrong

A Handbook ofEMPLOYEE REWARDMANAGEMENTAND PRACTICE

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A Handbook ofEMPLOYEE REWARDMANAGEMENTAND PRACTICE2ND EDITIONMichael ArmstrongLondon and Philadelphia

Publisher’s noteEvery possible effort has been made to ensure that the information contained in this book isaccurate at the time of going to press, and the publishers and author cannot accept responsibilityfor any errors or omissions, however caused. No responsibility for loss or damage occasionedto any person acting, or refraining from action, as a result of the material in this publication canbe accepted by the editor, the publisher or any of the authors.First published in Great Britain and the United States in 2005 by Kogan Page LimitedSecond edition 2007Apart from any fair dealing for the purposes of research or private study, or criticism or review,as permitted under the Copyright, Designs and Patents Act 1988, this publication may only bereproduced, stored or transmitted, in any form or by any means, with the prior permission inwriting of the publishers, or in the case of reprographic reproduction in accordance with theterms and licences issued by the CLA. Enquiries concerning reproduction outside these termsshould be sent to the publishers at the undermentioned addresses:120 Pentonville RoadLondon N1 9JNUnited Kingdomwww.kogan-page.co.uk525 South 4th Street, #241Philadelphia PA 19147USA Michael Armstrong and Tina Stephens, 2005 Michael Armstrong, 2007The right of Michael Armstrong to be identified as the author of this work has been asserted byhim in accordance with the Copyright, Designs and Patents Act 1988.ISBN-10 0 7494 4962 4ISBN-13 978 0 7494 4962 9British Library Cataloguing-in-Publication DataA CIP record for this book is available from the British Library.Library of Congress Cataloging-in-Publication DataArmstrong, Michael, 1928–A handbook of employee reward management and practice / Michael Armstrong. –2nd ed.p. cm.ISBN-13: 978-0-7494-4962-9ISBN-10: 0-7494-4962-41. Incentives in industry. 2. Employee motivation. I. Title.HF5549.5.I5A668 2007658.3’142–dc222006039560Typeset by JS Typesetting Ltd, Porthcawl, Mid GlamorganPrinted and bound in Great Britain by Bell & Bain, Glasgow

ContentsPrefacexiPART 1 THE FUNDAMENTALS OF REWARD MANAGEMENT1Reward management: an overviewReward management defined 3; The aims of reward management 4;Achieving the aims 4; The reward system 7; Elements of a rewardsystem 8; Factors affecting reward management policy and practice 12;The development of reward management 14; References 1832The context of reward managementThe internal environment 19; The external environment 24; Impact ofthe environment 28; References 30193Total rewardTotal reward defined 31; The significance of total reward 33; Benefits oftotal reward 33; Model of total reward 34; Relational rewards 35;Developing a total reward approach 40; Approaches to total reward 41;Turning rhetoric into reality 46; References 47314Strategic rewardStrategic reward management defined 48; The rationale for strategicreward 49; Guiding principles 49; The concept of reward strategy 52;References 5948

viContents5Developing and implementing reward strategyGeneral considerations 60; The reward strategy development sequence 62;Implementation 83; References 94606Reward policiesThe purpose of reward policies 96; Reward policy headings 96; Level ofrewards 97; Developing reward policies 101; Examples of rewardpolicies 10296PART 2 THE CONCEPTUAL FRAMEWORK7Factors affecting pay levelsEconomic determinants of pay 107; Factors affecting pay levels withinorganizations 112; The significance of the factors affecting pay levels 114;Application of the factors 117; References 1181078Motivation and rewardThe process of motivation 119; Motivation theories 122; Motivation andfinancial incentives and rewards 127; Factors affecting satisfaction withpay 129; Motivation and job satisfaction and performance 130; The keymessages of motivation theory 131; References 1341199Engagement and organizational commitmentDefinitions 135; Engagement 137; Organizational commitment 144;References 14613510The psychological contractThe psychological contract defined 147; The significance of thepsychological contract 148; Developing and maintaining a positivepsychological contract 149; References 150147PART 3 ESTABLISHING JOB VALUES AND RELATIVITIES11Job evaluation schemesDefinition of job evaluation 153; Aims 154; Features 154; The case for andagainst job evaluation 155; Categories of job evaluation 157; Types ofanalytical schemes 158; Types of non-analytical schemes 161; Marketpricing 163; Computer-assisted job evaluation 164; Examples of the use ofjob evaluation 165; Conclusion 166; References 167153

Contentsvii12Developing and maintaining job evaluation schemesDeveloping a job evaluation scheme: initial stages 168; Designing apoint-factor job evaluation scheme 180; Designing a job classificationscheme 192; Developing an analytical matching scheme 193; Developingmanagement procedures 196; Introducing job evaluation 198; Maintaininga job evaluation scheme 198; References 19916813Equal pay for work of equal valueWhy discrimination takes place 200; The legal framework 203; TheEOC Code of Practice on Equal Pay 207; Equal pay claims 208; Avoidingdiscrimination in job evaluation 210; Discriminatory pay structures 212;References 21320014Equal pay reviewsPurpose of equal pay reviews 214; Planning a review 215; The equalpay review process 216; Analysing pay 222; Conclusion 225;References 22621415Market rate analysis227Market rate analysis defined 227; Aims of market rate analysis 228; Theproblem of defining the market rate 228; The process of market rateanalysis 231; Initial decision to conduct market rate analysis 231; Decide onbenchmark jobs 232; Sources of market data 232; Analyse data 240; Prepareinformation on the jobs to be surveyed 243; Interpret and present marketdata 243; Using market data 245; A final word 247; Reference 24816Role analysisDefinitions 249; Role analysis and reward management 250;Methodology 251; Role profile definition 253; Examples of roleprofiles 255249PART 4 GRADE AND PAY STRUCTURES17Types of grade and pay structuresGrade structures 263; Pay structures 264; Incidence of grade and paystructures 266; Narrow-graded structures 266; Broad-gradedstructures 269; Broad-banded structures 273; Career family structures 281;Job family structures 285; Combined career/job family and broad-bandedstructures 288; Pay spines 289; Spot rates 291; Individual jobgrades 291; References 292263

viii18ContentsDeveloping grade and pay structuresGuiding principles for grade and pay structures 293; The designprogramme 294; The design process 297; Define guiding principles andobjectives 297; Analyse present arrangements 297; Selecting thestructure 299; Criteria for choice 299; Design options 302; Use of jobevaluation 304; Graded pay structure design 304; Broad-banded structuredesign 316; Career family structure design 320; Job family structuredesign 325; Designing non-discriminatory pay structures 325;Implementing new grade and pay structures 326; References 331293PART 5 REWARDING AND REVIEWING CONTRIBUTION ANDPERFORMANCE19Individual contingent payIndividual contingent pay defined 336; The incidence of contingentpay 336; Contingent pay as a motivator 336; Arguments for and againstcontingent pay 337; Alternatives to contingent pay 339; Criteria forsuccess 340; Performance-related pay 341; Competency-related pay 343;Contribution-related pay 345; Skill-based pay 354; Service-relatedpay 355; Choice of approach 356; Readiness for contribution pay 357;Developing and implementing contribution pay 357; References 36033520Bonus schemesBonus schemes defined 362; Aims of bonus schemes 363; Rationale forbonus schemes 363; Types of scheme 363; Category of staff covered 364;The business case for bonus schemes 365; Designing a bonus scheme 365;Introducing a bonus scheme 370; Reference 37036221Team payTeam pay defined 372; Aim of team pay 373; How team pay works 374;Requirements for team pay 376; Advantages and disadvantages of teampay 376; Developing team pay 377; NHS case study 378; References 37937122Paying for organizational performanceTypes of schemes 380; Aims 381; Profit sharing 382; Share ownershipschemes 383; Gain sharing 384; References 38438023Recognition schemesRecognition schemes defined 385; Principles of recognition 386; Typesof recognition 387; Examples of non-cash awards 388; Designing a385

Contentsixrecognition scheme 389; Example of a recognition scheme atCamelot 389; References 39024Performance management and rewardPerformance management defined 391; Purpose of performancemanagement 392; Principles of performance management 392; Theperformance management cycle 393; Key features of performancemanagement 394; Performance management as a motivatingprocess 395; Performance management and non-financialmotivation 396; Performance management and pay 397;References 403391PART 6 REWARD MANAGEMENT FOR SPECIAL GROUPS25Rewarding directors and senior executivesThe background 407; Governance reviews and remuneration 408;Remuneration committees 409; Directors’ and senior executives’remuneration 41040726International rewardThe international scene 414; International reward strategy 416;Rewards for expatriates 419; References 42241427Rewarding sales and customer service staffRewarding sales representatives 424; Rewarding customer servicestaff 431; References 43342428Rewarding knowledge workersWhat motivates knowledge workers? 436; Managing knowledgeworkers 436; Approaches to rewarding knowledge workers 437;References 44343529Shop floor payFactors affecting shop floor pay 445; Time rates 446; Incentiveschemes 447; Single status and harmonization 454; References 455445PART 7 EMPLOYEE BENEFITS AND PENSION SCHEMES30Employee benefitsRationale for employee benefits 460; Employee benefit strategies andpolicies 460; Types of benefit 460; Incidence of benefits 463; Choice of459

xContentsbenefits 463; Administering employee benefits 464; Taxconsiderations 464; Reference 46731Flexible benefitsReasons for introducing flexible benefits 468; Types of flexible benefitsschemes 469; Introducing flexible benefits 472; Example – LloydsTSB 474; References 47546832Pension schemesWhy pensions are provided 477; What pension schemes provide 477;The two main types of schemes 477; Other types of pensionschemes 481; The state pension scheme 483; Advising employees onpensions 484; Developing and communicating pensions policies 484;Government proposals on the future of pensions 485; References 485476PART 8 REWARD MANAGEMENT PROCEDURES33Managing rewardReward procedures 489; Controlling reward 491; Conducting generalpay reviews 494; Conducting individual reviews 495; Communicatingto employees 499; Managing the development of reward systems 500;The use of computers in reward management 504; References 50748934Responsibility for rewardThe role of the reward specialist 508; Role of the front-line managerin managing reward 511; Using reward consultants 516; References 517508Appendix A Reward bibliographyAppendix B Alignment of CIPD Professional Standards for EmployeeReward to textIndex518530533

PrefaceThis is a practical handbook designed to provide guidance on the approaches that canbe adopted in developing and managing reward strategies, policies and processes. Itis aligned to the professional standards of the Chartered Institute of Personnel andDevelopment for employee reward. The plan of the book is shown in Figure 0.1.

xiiPrefaceThe fundamentals of rewardmanagement1 An overview of rewardmanagement2 The context of reward management3 Total reward4 Strategic reward5 Developing reward strategy6 Reward policiesEstablishing job valuesand relativities11 Job evaluation schemes12 Developing and maintaining job evaluationschemes13 Equal pay for work ofequal value14 Equal pay reviews15 Market rate analysis16 Role analysisGrade and pay structures17 Types of grade and paystructures18 Developing grade andpay structuresRewarding and reviewingcontribution andperformance19 Individual contingent pay20 Bonus schemes21 Team rewards22 Paying for organizationalperformance23 Recognition schemes24 Performance management and rewardEmployee benefits,allowances andpension schemes30 Employee benefitsand allowances31 Flexible benefits32 Pension schemesReward managementfor special groups25 Rewarding directorsand senior executives26 International reward27 Rewarding sales andservice staff28 Rewarding knowledgeworkers29 Shop floor payReward managementprocedures33 Managing reward34 Responsibility forrewardFigure 0.1 Plan of the bookThe conceptualframework7 Factors affecting levelsof pay8 Motivation and reward9 Engagement andcommitment10 The psychologicalcontract

Part 1The fundamentals of rewardmanagement

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1Reward management:an overviewThis chapter starts with an introductory discussion of the concept of reward management and its aims. This is followed by an assessment of how these aims can be achieved,a description of the elements of a reward system and an analysis of the factors thataffect reward management. The chapter concludes with a survey of developments inreward management.REWARD MANAGEMENT DEFINEDReward management deals with the strategies, policies and processes required to ensurethat the contribution of people to the organization is recognized by both financial andnon-financial means. It is about the design, implementation and maintenance of rewardsystems (reward processes, practices and procedures), which aim to meet the needs ofboth the organization and its stakeholders. The overall objective is to reward peoplefairly, equitably and consistently in accordance with their value to the organization inorder to further the achievement of the organization’s strategic goals.Reward management is not just about pay and employee benefits. It is equallyconcerned with non-financial rewards such as recognition, learning and developmentopportunities and increased job responsibility.

4The fundamentals of reward managementTHE AIMS OF REWARD MANAGEMENTThe aims of reward management are to: reward people according to the value they create; align reward practices with business goals and with employee values and needs; reward the right things to convey the right message about what is important interms of behaviours and outcomes; help to attract and retain the high-quality people the organization needs; motivate people and obtain their engagement and commitment; develop a high-performance culture.ACHIEVING THE AIMSThe aims of reward management are achieved by developing and implementingstrategies, policies, processes and practices that are founded on a philosophy, operatein accordance with the principles of distributive and natural justice, function fairly,equitably, consistently and transparently, are aligned to the business strategy, fit thecontext and culture of the organization, are fit for purpose and help to develop a highperformance culture.Reward philosophyReward management is based on a well-articulated philosophy – a set of beliefs andguiding principles that are consistent with the values of the organization and help toenact them. The philosophy recognizes that, if human resource management (HRM)is about investing in human capital from which a reasonable return is required, then itis proper to reward people differentially according to their contribution (ie the returnon investment they generate).The philosophy of reward management also recognizes that it must be strategic inthe sense that it addresses longer-term issues relating to how people should be valuedfor what they do and what they achieve. Reward strategies and the processes that arerequired to implement them have to flow from the business strategy.Reward management adopts a ‘total reward’ approach, which emphasizes theimportance of considering all aspects of reward as a coherent whole that is linked toother HR initiatives designed to achieve the motivation, commitment, engagementand development of employees. This requires the integration of reward strategies withother HRM strategies, including talent management and human resource development.Reward management is an integral part of an HRM approach to managing people.

Reward management: an overview5Distributive justiceAs defined by Leventhal (1), distributive justice refers to how rewards are provided topeople. They will feel that they have been treated justly if they believe that the rewardshave been distributed in accordance with the value of their contribution, that theyreceive what was promised to them and that they get what they need.Procedural justiceProcedural justice refers to the ways in which managerial decisions are made andreward policies are put into practice. The five factors that affect perceptions of procedural justice as identified by Tyler and Bies (2) are:1.2.3.4.5.The viewpoint of employees is given proper consideration.Personal bias towards employees is suppressed.The criteria for decisions are applied consistently to all employees.Employees are provided with early feedback about the outcome of decisions.Employees are provided with adequate explanations of why decisions have beenmade.FairnessA fair reward system is one that operates in accordance with the principles of distributiveand procedural justice. It also conforms to the ‘felt-fair’ principle formulated byEliot Jaques (3). This states that pay systems will be fair if they are felt to be fair. Theassumptions underpinning the theory are that: there is an unrecognized standard of fair payment for any level of work;unconscious knowledge of the standard is shared among the population at work;pay must match the level of work and the capacity of the individual to do it;people should not receive less pay than they deserve by comparison with theirfellow workers.This felt-fair principle has passed into the common language of those involved inreward management. It is sometimes used as the final arbiter of how a job should begraded, possibly overriding the conclusions reached by an analytical job evaluationexercise (the so-called ‘felt-fair test’). Such tests are in danger of simply reproducingexisting prejudices about relative job values.

6The fundamentals of reward managementEquityEquity is achieved when people are rewarded appropriately in relation to otherswithin the organization. Equitable reward processes ensure that relativities betweenjobs are measured as objectively as possible and that equal pay is provided for workof equal value.ConsistencyA consistent approach to reward management means that decisions on pay do notvary arbitrarily – without due cause – between different people or at different times.They do not deviate irrationally from what would generally be regarded as fair andequitable.TransparencyTransparency exists when people understand how reward processes function andhow they are affected by them. The reasons for pay decisions are explained at the timethey are made. Employees have a voice in the development of reward policies andpractices.Strategic alignmentThe strategic alignment of reward practices ensures that reward initiatives are plannedby reference to the requirements of the business strategy and are designed to supportthe achievement of business goals.Contextual and culture fitThe design of reward processes should be governed by the context (the characteristics of the organization, its business strategy and the type of employees) and theorganization’s culture (its values and behavioural norms). Account should be taken ofgood practice elsewhere, but this should not be regarded as best practice, ie universallyapplicable. Best fit is more important than best practice.Fit for purposeThe formulation of reward strategy and the design of the reward system should bebased on an understanding of the objectives of reward management and should bedeveloped to achieve that purpose.

Reward management: an overview7Developing a high-performance cultureA high-performance culture is one in which people are aware of the need to performwell and behave accordingly in order to meet or exceed expectations. Employees willbe engaged in their work and committed to the organization. Such a culture embracesa number of interrelated processes that together make an impact on the performanceof the organization through its people in such areas as productivity, quality, levels ofcustomer service, growth, profits and, ultimately in profit-making firms, the deliveryof increased shareholder value. In our more heavily service- and knowledge-basedeconomy, employees have become the most important determinant of organizationalsuccess.Lloyds TSB has produced the following definition of what they mean by a highperformance organization: People know what’s expected of them – they are clear about their goals andaccountabilities. They have the skills and competencies to achieve their goals. High performance is recognized and rewarded accordingly. People feel that their job is worth doing, and that there’s a strong fit between thejob and their capabilities. Managers act as supportive leaders and coaches, providing regular feedback, performance reviews and development. A pool of talent ensures a continuous supply of high performers in key roles. There’s a climate of trust and teamwork, aimed at delivering a distinctive serviceto the customer.A high-performance culture can be developed by taking into account characteristicssuch as those listed above and applying an integrated set of processes, of which rewardis an important part. Besides reward, the processes will include those concerned withresourcing and talent management (ensuring that the organization has the highperforming people it needs), learning and development, performance management,the enhancement of the working environment (for example, work design and work/life balance) and communication.THE REWARD SYSTEMThe approaches to achieving the aims of reward management as described above areincorporated in the reward system of an organization. This consists of:

8The fundamentals of reward management Reward strategies, which set out what the organization intends to do in the longerterm to develop and implement reward policies, practices, processes and procedures that will further the achievement of its business goals. For example, anorganization may have a strategy to maintain competitive rates of pay. Reward policies, which set guidelines for decision making and action. For example,an organization may have a policy that sets the levels of pay in the organizationcompared with median market rates. Reward practices, which consist of the grade and pay structures, techniques suchas job evaluation, and schemes such as contingent pay used to implement rewardstrategy and policy. For example, the policy on pay levels will lead to the practiceof collecting and analysing market rate data, and making pay adjustments thatreflect market rates of increase. Reward processes, which consist of the ways in which policies are implemented andpractices carried out, for example the way in which the outcomes of surveys areapplied and how managers manage the pay adjustment and review process. Reward procedures, which are operated in order to maintain the system and toensure that it operates efficiently and flexibly and provides value for money. Forexample, a procedure will be used for conducting the annual pay review.ELEMENTS OF A REWARD SYSTEMThe elements of a reward system and the interrelationships between them are shownin Figure 1.1. A brief description of each element follows.Business strategyThe starting point of the reward system is the business strategy of the organization.This identifies the business drivers and sets out the business goals. The drivers areunique to any organization but will often include items such as high performance,profitability, productivity, innovation, customer service, quality, price/cost leadershipand the need to satisfy stakeholders – investors, shareholders, employees and, in localauthorities, elected representatives.Reward strategy and policyThe reward strategy flows from an analysis of the business drivers. The question is:‘How can these be supported by reward in order to achieve the goals of the business?’The reward strategy will define longer-term intentions in such areas as pay structures,contingent pay, employee benefits, steps to increase engagement and commitmentand adopting a total reward approach.

Reward management: an overviewNon-financialrewardsRecognition, responsibility,achievement, autonomy,development, growthJob evaluationGrade and paystructureMarket sBase payTotalremunerationContingent Figure 1.1 Reward system elements and interrelationshipsTotal reward9

10The fundamentals of reward managementReward policy will cover such matters as levels of pay, achieving equal pay,approaches to contingent pay, the use of job evaluation and market surveys and flexingbenefits.Base or basic payThe base rate is the amount of pay (the fixed salary or wage) that constitutes the ratefor the job. It may be varied according to the grade of the job or, for shop floor workers,the level of skill required.Base pay will be influenced by internal and external relativities. The internal relativities may be measured by some form of job evaluation. External relativities (goingrates) are assessed by tracking market rates. Alternatively, levels of pay may beagreed through collective bargaining with trade unions or by reaching individualagreements.Base pay may be expressed as an annual, weekly or hourly rate. This is sometimesreferred to as a time rate system of payment. Contingent pay or allowances as describedlater may be added to base pay. The rate may be adjusted to reflect increases in thecost of living or market rates by the organization unilaterally or by agreement with atrade union.Contingent payAdditional financial rewards may be provided that are related to performance,competence, contribution, skill or experience. These are referred to as ‘contingent pay’.Contingent payments may be added to base pay, ie ‘consolidated’. If such paymentsare not consolidated (ie paid as cash bonuses) they are described as ‘variable pay’.Contingent pay schemes are described in Chapters 19 to 22.Employee benefitsEmployee benefits include pensions, sick pay, insurance cover, company cars anda number of other ‘perks’. They consist of elements of remuneration additional tothe various forms of cash pay and also include provisions for employees that are notstrictly remuneration, such as annual holidays (see Chapters 30 to 32).AllowancesAllowances are paid in addition to basic pay for special circumstances (eg living inLondon) or features of employment (eg working unsocial hours). They may be determined unilaterally by the organization but they are often the subject of negotiation. The

Reward management: an overview11main types of allowances are location allowances, overtime payments, shift payments,working conditions allowances and stand-by or call-out allowances made to thosewho have to be available to come in to work when required.Total earningsTotal earnings (financial rewards) consist of the value of a

Michael Armstrong EMPLOYEE REWARD MANAGEMENT AND PRACTICE A Handbook of 2ND EDITION A Handbook of Employee Reward Management and Practice is the definitive guide for practitioners involved in developing and managing reward strategies, policies and procedures, and for students of employee reward.

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