COMPENSATION MANAGEMENT

COMPENSATION MANAGEMENT

UNIT I

Define Exactly What Compensation Is?

Compensation is a systematic approach to providing monetary Value to employees in exchange for work performed. Compensation may achieve several purposes assisting in Recruitment, job performance, and job satisfaction.

How is Compensation used?

Compensation is a tool used by management for a variety of purposes to further the existence of the company. Compensation may be adjusted according the business needs, goals, and available resources.

Compensation may be used to

· Recruit and retain qualified employees.

· Increase or maintain morale/satisfaction.

· Reward and encourage peak performance.

· Achieve internal and external equity.

· Reduce turnover and encourage company loyalty.

· Modify (through negotiations) practices of unions.

Recruitment and retention of qualified employees is a common goal shared by many employers. To some extent, the availability and cost of qualified applicants for open positions is determined by market factors beyond the control of the employer.

While an employer may set compensation levels for new hires and advertise those salary ranges, it does so in the context of other employers seeking to hire from the same applicant pool. Morale and job satisfaction are affected by compensation. Often there is a balance (equity) that must be reached between the monetary value the employer is willing to pay and the sentiments of worth felt be the employee. In an attempt to save money, employers may opt to freeze salaries or salary levels at the expense of satisfaction and morale. Conversely, an employer wishing to reduce employee turnover may seek to increase salaries and salary levels.

Compensation may also be used as a reward for exceptional job performance. Examples of such plans include: bonuses, commissions, stock, profit sharing, gain sharing.

Employee compensation refers to all forms of pay or rewards going to employees and arising from their employment, and it has two main components. There are direct financial payments in the form of wages, salaries, incentives, commissions and bonuses and there are indirect payments in the form of financial benefits like employee paid insurance and vacations. So in nutshell we can say that employee compensation refers to all the forms of pay or rewards going to employees and arising from their employment Compensation includes direct cash payments, indirect payments in the form of employee benefits & incentives to motivate employees to strive for higher levels of productivity is a critical component of employment relationship. Compensation is affected by many factors like labour market factors, collective bargaining, government legislation & top management philosophy regarding pay benefits.

What is Compensation Management?

Process of compensation management is to establish & maintain an equitable wage & salary structure & an equitable cost structure .it involves job evaluation, wage & salary survey, profit sharing &control of pay costs.

Two important functions of compensation

· Equity function

· Motivation function

Equity is based on past & current performance& motivation with which the work has been performed in the past & current performance.

Nature and Purpose of compensation management?

The basic purpose of compensation management is to establish and maintain an equitable reward system. The other aim is the establishment and maintenance of an equitable compensation structure, i. e, an optimal balancing of conflicting personnel interests so that the satisfaction of employees and employers is maximized and conflicts minimized. The compensation management is concerned with the financial aspects of needs, motivation and rewards. Managers, therefore, analyze and interpret the needs of their employees so that reward can be individually designed to satisfy these needs. For it has been rightly said that people do what they do to satisfy some need. Before they do anything, they look for a reward or pay-off.

The reward may be money or promotion, but more likely it will be some pay-off-a smile, acceptance by a peer, receipt of information, a kind word of recognition etc.

The Significance of Compensation

From individual standpoint -remuneration is a major source of an individual’s purchasing power. It determines his or her status, prestige & worth in society. From enterprise stand point- compensation is a crucial element in the cost of production, which is expected to permit adequate profits leading to increase in new capital, expansion production, and capacity. From national point of view –dissatisfied work force hampers equitable distribution of aggregate real income among various group involved .it causes inflation.

A Sound Compensation Structure Tries to Achieve These Objectives

· To attract manpower in a competitive market.

· To control wages &salaries & labour costs by determining rate change & frequency of increment.

· To maintain satisfaction of employees by exhibiting that

remuneration is fair adequate & equitable.

To induce & reward improved performance, money is an effective motivator.

A For employees

1. Employees are paid according to requirements of their jobs,

i.e., highly skilled jobs are paid more compensation than low skilled jobs. This eliminates inequalities.

2. The chances of favoritism (which creep in when wage rates are assigned) are greatly minimized.

3. Job sequences and lines of promotion are established wherever they are applicable.

4. Employees’ morale and motivation are increased because of the sound compensation structure.

B To Employers

1. They can systematically plan for and control the turnover in the organization.

2. A sound compensation structure reduces the likelihood of friction and grievances over remuneration

3. It enhances an employee’s morale and motivation because adequate and fairly administered incentives are basic to his wants and needs.

4. It attracts qualified employees by ensuring and adequate payment for all the jobs.

Now we come to the principles of Compensation

· Differences in pay should be based on differences in job requirements.

· Wage & salary level should be in line with those prevailing in the job market.

· Follow the principle of equal pay for equal work.

· Recognize individual differences in ability & contributions.

The employees & trade unions should be involved in while establishing wage rates.

· The wages should be sufficient to ensure for the worker &his family reasonable standard of living.

· There should be a clearly established procedure for redressal of grievances concerning wages

· The wage & salary structure should be flexible.

· Wages due to employees should be paid correctly & promptly.

· A wage committee should review & revise wages from time to time.

What are the components of a compensation system?

Employees as fair if based on systematic components will perceive compensation. Various compensation systems have developed to determine the value of positions. These systems utilize many similar components including job descriptions, salary ranges/structures, and written procedures.

The components of a compensation system include:

· Job Descriptions: A critical component of both compensation and selection systems, job descriptions define in writing the responsibilities, requirements, functions, duties, location, environment, conditions, and other aspects of jobs. Descriptions may be developed for jobs individually or for entire job families.

· Job Analysis: The process of analyzing jobs from which job descriptions are developed. Job analysis techniques include the use of interviews, questionnaires, and observation.

· Job Evaluation: A system for comparing jobs for the purpose of determining appropriate compensation levels for individual jobs or job elements. There are four main techniques: Ranking, Classification, Factor Comparison, and Point Method.

· Pay Structures: Useful for standardizing compensation practices. Most pay structures include several grades with each grade containing a minimum salary/wage and either step increments or grade range. Step increments are common with union positions where the pay for each job is pre-determined through collective bargaining.

· Salary Surveys: Collections of salary and market data. May include average salaries, inflation indicators, cost of living indicators, salary budget averages. Companies may purchase results of surveys conducted by survey vendors or may conduct their own salary surveys. When purchasing the results of salary surveys conducted by other vendors, note that surveys may be conducted within a specific industry or across industries as well as within one geographical region or across different geographical regions. Know which industry or geographic location the salary results pertain to before comparing the results to your company.

· Policies and Regulations

What are Different Types of Compensation?

Different types of compensation include:

Base Pay

· Commissions

· Overtime Pay

· Bonuses, Profit Sharing, Merit Pay

· Stock Options

· Travel/Meal/Housing Allowance

Benefits including: dental, insurance, medical, vacation, leaves, retirement, taxes...

In a layman’s language the word Compensation means something, such as money, given or received as payment or reparation, as for a service or loss. On the other hand, the word Reward means something given or received in recompense for worthy behavior or in retribution for evil acts.

Now students let us try to demarcate between compensation and rewards

In a layman’s language the word Compensation means something, such as money, given or received as payment or reparation, as for a service or loss. On the other hand, the word Reward means something given or received in recompense for worthy behavior or in retribution for evil acts.

The word Compensation may be defined as money received in the performance of work, plus the many kinds of benefits and services that organizations provide their employees.

On the other hand, the word Reward or Incentive means anything that attracts an employees’ attention and stimulates him to work. An incentive scheme is a plan or a programme to motivate individual or group performance.

An incentive programme is most frequently built on monetary rewards (incentive pay or monetary bonus), but may also include a variety of non-monetary rewards or prizes.

Compensation or rewards (incentives) can be classified into

1. Direct compensation and

2. Indirect compensation.

Money is included under direct compensation (popularly known as basic salary or wage, i.e. gross pay) where the individual is entitled to for his job, overtime-work and holiday premium, bonuses based on performance, profit sharing and opportunities to purchase stock options.

While benefits come under indirect compensation, and may consist of life, accident, and health insurance, the employer’s contribution to retirement (pensions), pay for vacation or illness, and employer’s required payments for employee welfare as social security. While French says, the term “Incentive system” has a limited meaning that excludes many kinds of inducements offered to people to perform work, or to work up to or beyond acceptable standards. It does not include:

1. Wage and salary payments and merit pay;

2. Over-time payments, pay for holiday work or differential according to shift, i.e. all payments which could be considered incentives to perform work at undesirable times; and

3. Premium pay for performing danger tasks.

It is related with wage payment plans which tie wages directly or indirectly to standards of productivity or to the profitability of the organization or to both criteria. Compensation represents by far the most important and contentious element in the employment relationship, and is of equal interest to the employer, employee and government.

1. To the employer because it represents a significant part of his costs, is increasingly important to his employee’s performance and to competitiveness, and affects his ability to recruit and retain a labor force of quality.

2. To the employee because it is fundamental to his standard of living and is a measure of the value of his services or performance.

3. To the government because it affects aspects of macroeconomic stability such as employment, inflation, purchasing power and socio – economic development in general. While the basic wage or pay is the main component of compensation, fringe benefits and cash and non-cash benefits influence the level of wages or pay because the employer is concerned more about labor costs than wage rates per se. The tendency now is towards an increasing mix of pay element of executive compensation has substantially increased in recent years.

Basic Purpose for Establishment of a Sound Compensation and Reward Administration

The basic purpose of establishment of a sound compensation and reward administration is to establish and maintain an equitable compensation structure. Its secondary objective is the establishment and maintenance of an equitable labor-cost structure, an optimal balancing of conflicting personnel interests so that the satisfaction of employees and employers is maximized and conflicts minimized.

A sound wage and salary administration tries to achieve these objectives

A .For employees

1. Employees are paid according to requirements of their jobs, i.e., highly skilled jobs are paid more compensation than low skilled jobs. This eliminates inequalities.

2. The chances of favoritism (which creep in when wage rates are assigned) are greatly minimized.

3. Job sequences and lines of promotion are established wherever they are applicable.

4. Employees’ morale and motivation are increased because a wage programme can be explained and is based upon facts.

B. To Employers

1. They can systematically plan for and control their labor costs

2. In dealing with a trade union, they can explain the basis of their wage programme because it is based upon a systematic analysis of job and wage facts.

3. A wage and salary administration reduces the likelihood of friction and grievances over wage inequities.

4. It enhances an employee’s morale and motivation because adequate and fairly administered wages are basic to his wants and needs.

5. It attracts qualified employees by ensuring and adequate payment for all the jobs.

UNIT II

OBJECTIVES OF COMPENSATION AND REWARDS

An incentive or reward can be anything that attracts a workers attention and stimulates him to work. An incentive programme is most frequently built on monetary rewards but may also include a variety of non-monetary rewards. The term reward has been used both in the restricted sense of participation and the widest sense of financial motivation. The concept of reward implies the increased wiliness or motivation to work and not the capacity to work. Compensation and Rewards determination may have one or more objectives, which may often be in conflict with each other.

The objectives can be classified under four broad headings.

Objectives of Compensation

1. The first is equity, which may take several forms. They include income distribution through narrowing of inequalities, increasing the wages of the lowest paid employees, protecting real wages (purchasing power), the concept of equal pay for work of equal value compensation management strives for internal and external equity. Internal equity requires that, pay be related to the relative worth of a job so that similar jobs get similar pay. External equity means paying workers what comparable workers are paid by other firms in the labor market. Even compensation differentials based on differences in skills or contribution are all related to the concept of equity.

2. Efficiency, which is often closely related to equity because the two concepts are not antithetical. Efficiency objectives are reflected in attempts to link to link a part of wages to productivity or profit, group or individual performance, acquisition and application of skills and so on.

Arrangements to achieve efficiency may be seen also as being equitable (if they fairly reward performance) or inequitable (if the reward is viewed as unfair).

3. Macroeconomic stability through high employment levels and low inflation, of instance, an inordinately high minimum wage would have an adverse impact on levels of employment, though at what level this consequence would occur is a matter of debate.

Though compensation and compensation policies are only one of the factors which impinge on macro-economic stability, they do contribute to (or impede) balanced and sustainable economic development.

4. Efficient allocation of labor in the labor market. This implies that employees would move to wherever they receive a net gain, such movement may be form one geographical location to another or form on job to another (within or outside an enterprise). The provision or availability of financial incentives causes such movement.

For example, workers may move form a labor surplus or low wage area to a high wage area. They may acquire new skills to benefit from the higher wages paid for skills. When an employer’s wages are below market rates employee turnover increases. When it is above market rates the employer attracts job applicants. When employees move from declining to growing industries, an efficient allocation of labor due to structural changes takes place.

Other Objectives of Compensation

1. Acquire qualified personnel – compensation needs to be high enough to attract applicants. Pay levels must respond to the supply and demand of workers in the labor market since employers compete for workers. Premium wages are sometimes needed to attract applicants already working for others.

2. Retain current employees- Employees may quit when compensation levels are not competitive, resulting in higher turnover.

3. Reward desired behavior- pay should reinforce desired behaviors and act as an incentive for those behaviors to occur in the future. Effective compensation plans reward performance, loyalty, experience, responsibility, and other behaviors.

Control Costs a rational compensation system helps the organization obtain and retain workers at a reasonable cost. Without effective compensation management, workers could be over paid or under paid.

4. Comply with legal regulations- a sound wage and salary system considers the legal challenges imposed by the government and ensures the employer’s compliance.

Facilitate understanding- the compensation management system should be easily understood buy human resource specialists, operating managers and employees.

5. Further administrative efficiency- wage and salary programs should be designed to be managed efficiently, making optimal use of the HRIS, although this objective should be a secondary consideration compared with other objectives.

Rewards

The use of Incentives or Rewards assumes that people’s actions are related to their skills and ability to achieve important longer run goals. Even though many organizations, by choice, or tradition or contract, allocate rewards on non-performance criteria, rewards should be regarded as a “payoff “for performance.

An Incentive Plan has The Following Important

Objectives

1. An incentive plan may consist of both ‘monetary’ and ‘nonmonetary’ elements.

2. Mixed elements can provide the diversity needed to match the needs of individual employees.

3. The timing, accuracy and frequency of incentives are the very basis of a successful incentive plans.

4. The plan requires that it should be properly communicated to the employees to encourage individual performance, provide feedback and encourage redirection.

Determinants of Incentives

These feature are contingencies, which affect the suitability and design of incentives to varying degrees. The effective use of incentives depends on three variables-the individual, work situation, and incentive plan.

i. (I and Ill) the Individual and the Incentives

Different people value things differently. Enlightened managers realize that all people do not attach the same value to monetary incentives, bonuses, prizes or trips. Employees view these things differently because of age, marital status, economic need and future objectives.

However, even though employee reaction to incentives vary greatly, incentives must have some redeeming merits. For example, there might be a number of monetary and nonmonetary incentive programmes to motivate employees.

Money, gift certificates, praises, or merit pay are of the continuous parade of promotion.

ii. The Work Situation

This is made up of four important elements:

A. Technology machine or work system, if speed of equipment operation can be varied, it can establish range of the incentive.

b. Satisfying job assignments, a workers’ job may incorporate a number of activities that he finds satisfying. Incentives may take the form of earned time-off, greater flexibility in hours worked, extended vacation time and other privileges that an individual values. Feedback, a worker needs to be able to see the connection between his work and rewards. These responses provide important reinforcement.

Equity, worker considers fairness or reasonableness as part of the exchange (or his work, Incentives, in general, are important motivators. Their effectiveness depends upon three factors: drives, preference value, and satisfying value of the goal objects. Beyond subsistence level, becoming needs (self-actualization needs) possess greater preference value and are more satisfying than deficiency needs (which are necessary for survival). Below the subsistence level, however, the reverse holds true.” He makes the following generalizations:

I. Incentives, whether they are monetary or non-monetary, tend to increase the level of motivation in a person.

ii. Financial incentives relate more effectively with basic motivation or deficiency needs.

iii. Non-financial incentives are linked more closely with higher motivation, or becoming needs.

iv. The higher the position of a person in an organization’s hierarchy, the greater is his vulnerability to non-financial incentives.

“While budgetary restrictions and’ temporary improvements in performance place a limit on the potency of money as a motivator, non-financial incentives involve only human ingenuity as investment and also insure a relatively stable acceleration in output.

Monetary incentive imply’ external motivation, non-monetary incentives involve internal motivation. Both are important. It is a judicious mix-up of the two that tends to cement incentive with motivation

Components of Compensation

The previous article introduced the topic of compensation management and how the “right” kind of compensation goes a long way in making employees motivated and happier.
Hertzberg’s Hygiene theory refers to how certain factors are necessary to maintain “Hygiene” or ensure that the employees are not dissatisfied.

• These factors alone do not contribute to “quantum” jumps in employee satisfaction. Rather, the absence of these factors makes employees dissatisfied.
• The point here is that if a fair and just compensation is provided, the employee has the “baseline” requirements met which ensures that he or she is now in a position to go for higher things like job satisfaction and fulfilment.
• However, if compensation is found to be lacking, the employee might very well be unhappy and dissatisfied with the company leading to attrition and other such negative outcomes.
• Hence, having the right compensation is the first step in getting the best of employees.

If we take a look at the components of a compensation system, we find that employers decide on what is the right compensation after taking into account the following points.

1. The Job Description of the employee that specifies how much should be paid and the parts of the compensation package.
   1. The Job Description is further made up of responsibilities, functions, duties, location of the job and the other factors like environment etc.
   2. These elements of the job description are taken individually to arrive at the basic compensation along with the other components like benefits, variable pay and bonus.
      • It needs to be remembered that the HRA or the House Rental Allowance is determined by a mix of factors that includes the location of the employee and governmental policies along with the grade of the employee.
      • Hence, it is common to find a minimum level of HRA that is common to all the employees and which increases in proportion to the factors mentioned above.
2. The Job Evaluation that is a system for arriving at the net worth of employees based on comparison with appropriate compensation levels for comparable jobs across the industry as well as within the company.
   1. Factors like Experience, Qualifications, Expertise and Need of the company determine how much the employer is willing to pay for the employee.
3. It is often the case that employers compare the jobs across the industry and arrive at a particular compensation after taking into account the specific needs of their firm and in this respect salary surveys and research results done by market research firms as to how much different companies in the same industry are paying for similar roles.

The components of compensation that have been discussed above are the base requirements for any HR Manager who is in charge of fixing the compensation for potential employees.
There are other variables as well that would be discussed in subsequent articles. This article has introduced several concepts around the topic of components of compensation and these concepts are crucial for HR professionals as well as those aspiring management professionals who want to make a career in the corporate world.
Before concluding this article, it needs to be remembered that exit interviews have shown that over 70% of employees who quit their jobs do so because they are dissatisfied with the compensation that they are getting. Hence, all HR professionals and managers must take this aspect into account when they determine the compensation to be paid to employees.
In the previous article (Part I) we looked at some of the components of compensation that are paid out to employees and the way in which these components are fixed by HR managers and companies. In this article (Part II), we shall look at some components of compensation like Basic and Variable Pay (including the sub-components of variable pay) and discuss how these are fixed by the firms when they sign off on the compensation packages to their employees.
To take the first component that is common to all packages at all levels (hence the term basic - however, it is not the same for all levels).

• Basic pay is the base on which the compensation package rests. This is the equivalent of the base of the pyramid and the other components are usually fixed as a percentage of the basic pay. It is common to find components like HRA (House Rental Allowance) and Additional Pay as a certain percentage (say 20% or 30%) of the Basic.
• There are many companies that have introduced the concept of Variable Pay where this particular component of the compensation is not fixed, but is a percentage of the Basic that is paid out according to the performance of the company, group and the individual. Hence, the term performance linked pay is also used for variable pay. If we take the three sub-components of the Variable Pay -
  
  1. The company performance linked pay is as the term implies paid out as a percentage of the Basic that is tied to the performance of the company as a whole. So, if a company performs exceedingly well in the given quarter, then the employee might get a large percentage (say 100% or 150%) of the base of the component. If a company does do not well or does only moderately better, then the employee might get a lower percentage of the base (say 50% or 75%).
  2. The group performance linked pay is paid out in a similar manner but the point of reference in this case is the performance of the group or the division in which the employee works.
  3. Finally, the most important sub-component is the Individual Performance Linked Pay that is paid out according to the performance of the employee and hence is entirely tied to the way in which the employee performs as determined by the rating that he or she gets at the end of the performance cycle.

The rationale for these components is that an employee would be better motivated to perform individually, contribute to the group to which he or she belongs and finally, perform well keeping in view the overall growth of the company. Hence, these sub components of compensation have been designed to spur the employee to excel not only in an individual capacity but as a team member and finally, a responsible employee of the company. The idea here is to discourage silo based performance and instead concentrate on all round performance.
In the articles to follow, we shall look at how employees can negotiate their compensation by following some tips that we shall provide.

Factors Affecting Compensation

 

In the previous sections, we looked at the components of the compensation and how each is used to assess the relative importance of an employee as far as remuneration is concerned. In this article, we look at some of the factors that determine how much compensation is to be paid out to the employee by looking at the issue from the perspective of the employer. The subsequent article would take a look at how the employee can influence the compensation setting process with negotiation and bargaining.
From the perspective of the employer, the factors that affect compensation are:

• The Overall Macroeconomic situation where in the state of the economy of the country in which the firm is situated plays a major role in determining the compensation to be paid. For instance, if an economy is booming or is in a high growth trajectory, chances are that the employers would pay the employees more and conversely, if the economy is in a downward trajectory, chances are that the employers would pay the employees less. We often hear about how because of the recession, salary hikes have been deferred or cut down. This is a direct result of the linkage between firm performance and the performance of the economy.
• The Demand for a particular skill weighs heavily on the way in which the employer fixes the compensation for the employee. For instance, premium skills like Consulting and Accountancy are paid more as are the Technology Professionals who might be experts in their chosen field. As discussed in earlier articles, it is the expertise and the relative scarcity of such experts that determines how much the employer is willing to pay.
• The Position of the company in the Business Cycle often determines how much the company is willing to offer to the employee. For instance, if a company is a start-up, chances are that the company would pay more because of the need to get the best possible talent into the company. Further, many start-ups give their employees ESOP’s or Employee Stock Option Plans wherein the employees can redeem their stocks after the lock-in period.
• Finally, the urgency of the firm in filling up the position plays an important role in determining how much the employer is willing to pay the employee and in many cases, if the time to get on board the employee is less, staffing managers along with the line manager in charge of hiring the employee might decide to pay more because they want the employee to come on board as quickly as possible.

These are some of the factors that determine the compensation to be paid to the employee from the perspective of the employer. This is not an exhaustive list but an indicative one and as the module progresses, we shall be revisiting some of these factors along with adding additional information. The next article would talk about how employees can negotiate with the employer for better compensation and perks.
In the previous article, we looked at some of the factors that help the employers determine the level of compensation to be given to employees. In this article, we look at the factors that affect compensation from the perspective of the employee. What this means is that the employee should not be constrained by the amount of compensation that the employer provides him or her and can and should negotiate with the prospective employer until he or she is satisfied with the outcome.
Of course, there are several kinds of negotiation with the employer. For instance, the employee can negotiate at the time of the hiring process or can negotiate at the time of the appraisal cycle. In this article, we consider the strategies available to the employee at the time of the hiring process.
There are several parts to the employee’s strategy to negotiate with the employer. Some of them are:

• Plan and Communicate: The most important part of the employee’s strategy must be to research the compensation trends in the market and then negotiate with the employer based on how much the other companies are willing to pay for a similar role combined with the fact that the company hiring him or her pays for the same role. Hence, it is advisable for the employee to keep in touch with compensation trends in the marketplace and also talk to other employees before he or she decides to communicate his or her expectations to the prospective employer.
• Timing makes the difference: In any negotiation process, time is the key element and hence timing the negotiation process is important. The best possible option for the employee would be to wait for the company to make an offer and then pitch in his or her expectations about the compensation. There is something called overkill which must be avoided and the employee must avoid going overboard. At the same time, the employee must also ensure that he or she does not start the negotiation process early on in order not to lose out on the offer. Hence the timing of the pitch makes all the difference.
• Consider the Alternatives: When you are deciding about prospective offers, ensure that you make the pitch for your expected compensation level after taking into account all the alternatives and not simply rush into something that does not value your experience and expertise adequately. At the same time, do not harangue the prospective employers though you might have several alternatives available to you. The point to be noted is that different companies react to compensation negotiations in different ways and hence you must play the field according to these points.

Many a time, prospective employees lost out on compensation either because they asked too high or asked too late. At the same time, they should also remember not to coerce the employers. The best possible strategy is where you are confident about yourself and your worth as measured by the employer must reflect your own sense of self worth. When there is a meeting point between these, then you can rest assured that you have arrived at the ideal compensation for yourself.