The success or failure of an organization hinges on the ability to attract, develop, retain, empower and reward a diverse array of appropriately skilled employees. Compensation is a systematic approach for providing monetary value to the employees in exchange for work performed by them. It may achieve several purposes such as assisting in recruitment, job performance, and job satisfaction etc. It also supports the achievement of the organizational objectives and is strategic in the sense that it addresses long term issues relating to how employees are to be valued for what they want to achieve.
The focus on managing the effectiveness and maximizing the value of employees is a critical management necessity of the present time for the organizational performance. This, in turn, requires a focus on the fundamentals and management of compensation. Managing compensation is not an easy task, since it involves a variety of job categories and goes far beyond just doling out merit pay. It must address the planning for and management of the many categories of variable compensation used in a modern organization to incentivize improved performance of the employees.
Compensation management, also known as wage and salary administration, remuneration management, or reward management, is concerned with designing and implementing total compensation package. The traditional concept of wage and salary administration emphasized only on the determination of wage and salary structures in organizational settings. However, over the passage of time, many more forms of compensation entered the field of running an organization and this necessitated to take wage and salary administration in comprehensive way with a suitable change in its nomenclature.
Compensation management is based on a well articulated philosophy, a set of beliefs and guiding principles which are consistent with the values of the organization. It recognizes the fact that if human resource management (HRM) is about investing in human capital from which a reasonable return is required, then it is proper to have investment in the skills and competencies of employees in order to increase the resource based capability of the organization.
Compensation management is one of the central pillars of HRM. It is an integral part of HRM approach to managing of the employees and also to productivity improvement in the organization. It deals with the design, implementation and maintenance of compensation system which is geared for the improvement of organizational, team and individual performance. It is concerned with the formulation and implementation of strategies and policies that aim to compensate employees fairly, equitably and consistently in accordance with their value to the organization.
Compensation is a complex subject and has significant impact on the organizational success. For any organization to succeed, it must not look up only to capital investment but also look towards its employees as the fundamental source of improvement with the understanding that the human element and the organization are synonymous.
Compensation management consists of developing a positive employment relationship and psychological contract that adopts a total compensation approach which recognizes that there are a number of ways in which employees can be compensated. Compensation as a concept refers to all forms of financial returns and tangible benefits that employees receive as part of employment relationship.
Compensation may be defined as a package of financial and non-financial benefits that the employee receives for his/her contribution rendered to the organization. It consists of all forms of monetary and non-monetary rewards/pays provided by the employer to the employees for services contributed by them towards organizational objectives.
The design of compensation can be divided into two categories which are mainly direct and indirect forms of compensation (Fig 1). Integrating the two into a package that encourages the achievement of an organizations goal is what compensation is all about.
Fig 1 Design of compensation
Direct compensation is the cash compensation which is the direct pay provided by the employer for work performed by the employee. It is basically the wage and / or salary part of the compensation. Cash compensation has two elements which include basic salary and balance of pay. Basic salary has to do with monthly salary plus overtime pay along with various other allowances, while the balance of pay is concerned with performance allowances such as merit increases, incentive pay, bonuses, and profit sharing etc. Direct compensation that is in line with industry standards provides employees with the assurance that they are getting paid fairly. This helps the employer avoid the costly loss of trained staff to a competitor.
The indirect compensation is the fringe benefits an employee enjoys as a result of working in the organization. Fringe compensation also has two parts to it. First part is benefits which are required to be given as per statutory requirements, and the second part is the discretional benefits. Indirect compensation focuses on the personal motivations of each person to work. Although salary is important, people are most productive in jobs where they share the organizational values and priorities. Fringe compensation refers to employee benefit programs.
The compensation system in an organization has the following objectives.
- To establish compensation levels for positions on the basis of their relative internal worth and external competitiveness within relevant industries.
- To reward employees on the basis of their work performance.
- To administer pay equitably and consistently.
- To establish a compensation policy that is consistent with the judicious expenditure of funds available with the organization.
- To ensure accountability for compliance with the rules and regulations and statutory requirements.
Compensation management is required to establish and implement sound policies and practices of employee compensation. It includes such areas as job evaluation, surveys of wages and salaries, analysis of relevant organizational problems, development and maintenance of salary structure, establishing rules for administering salaries. salary payments, incentives, profit sharing, salary changes and adjustments, supplementary payments, control of compensation costs and other related items.
The increasing competitiveness in the employee market and high turnover of employees results in nightmare in compensation planning. Apart from this, the growing demands of the employees and competitive salaries offered by the competing organizations has almost resulted in a compensation war in certain industries.
Therefore, the human resources managers have to evolve proper compensation planning for the employees. The components of compensation have to be devised in such a way that, it focuses on the growing demands of employees while retaining the competitiveness and profitability of the company. It must attract, motivate and retain competent employees at work, so as to help in minimizing the turnover ratio.
Contingent factors in compensation plan can be internal factors as well as external factors. Internal factors are organizational strategy and attitude, organizational culture, nature and worth of job, capacity to pay, and nature of human resource etc while the external factors are nature of employee market, cost of living, employee union, statutory requirements, and socio-economic factors etc. More specifically, the following six primary but interrelated factors can shape the organizational compensation structure.
- Social customs- Beginning in the thirteenth century, employees began demanding a ‘just’ wage. This idea evolved into the current notion of a statutory mandated minimum wage. Hence, economic forces do not determine wages alone.
- Economic conditions – Demand for labour influences employee wages. Employers pay wages based on the relative contributions employees make to production goals. In addition, supply and demand for knowledge and skills helps determine wages.
- Organizational factors – Pay structures depend on the kind of technology the organization has and on whether the organization uses pay as an incentive to motivate employees to improve job performance and to accept job requirements. Some jobs may require greater skills, knowledge, or experience than others and hence fetch a higher pay rate.
- Employee knowledge and skills – Employees may bring different levels of skills and knowledge to the organization and hence they are qualified to work at different levels of the organizational hierarchy and receive different rates of pay as a result.
- Employee acceptance – Employees expect fair pay rates and determine if they receive fair wages by comparing their wages with their coworkers’ and supervisors’ rates of pay. If employees consider their pay rates unfair, they may seek employment elsewhere or may put forth little effort in their jobs.
In this era of competition, the employees are very careful regarding their pay structure. They do not want anyone to deceive them so they want a transparent pay system. Some organizations are using transparent pay system. This is helpful for them to retain their employees within the organisation. Pay transparency is an important trend in compensation management that warrants both focused discussion and targeted actions. In traditional organizations, the payment system is neither revealed to employees and nor to other organizations. But in the present environment, employees have access to a large amount of information available to them through internet. They today have access to unparalleled amounts of information and in this environment, secrecy in the compensation packages are without meaning and does not help the organization in motivation of the employees. Compensation transparency influences employees in the following way.
- Fosters trust in management
- Increases employees engagement
- Encourages discretionary efforts
- Reduces turnover
- Create competitive advantage
Employees want to work where they understand their value and feel they can trust their employers. In such an environment, they are willing to work harder, offering more of their discretionary effort towards the organizational goals. Employee trust, then, is not an end in itself but a foundation for competitive advantage.
There are also certain industry driven factors which influences the compensation planning. As an example, the compensation packages of employees working in cozy atmosphere of administrative and office buildings are to be different than the compensation package of those working in hot and dusty environment of a production shop.
A good compensation is must for every organization and helps in the following way.
- It tries to give proper return to the employees for their contributions to the organization.
- It imparts a positive control on the efficiency of employees and encourages them to perform better and achieve the specific standards.
- It forms a basis of happiness and satisfaction for the employees and this minimizes the employee turnover and confers a stable organization.
- It augments the job evaluation process which in turn helps in setting up the more realistic and achievable standards.
- It is designed to comply with the various statutory provisions and therefore does not result in disputes between the employees union and the management. This builds up a peaceful relationship between the employer and the employees.
- It arouses an environment of morale, efficiency and cooperation among the employees and provides satisfaction to the employees.
- It stimulates the employees to perform better and show their excellence.
- It provides growth and advancement opportunities to the deserving employees.
Compensation is a crucial factor and has its bearing on performance and satisfaction. It is advisable for an organization to have a clear cut compensation philosophy.
Compensation philosophy is the set of values and beliefs that the organization has with regard to direct and indirect compensation payable to employees. Any compensation philosophy should cover the following aspects.
- Goals of the organizational compensation system.
- Percentage of compensation linked to individual performance and base salary.
- Role of performance appraisal in disbursing compensation.
- The positioning of compensation of employees relative to competing industry.
Compensation philosophy or the set of values and beliefs combined with a set of guidelines further assist in compensation management of the organization. In addition, the organization should have a standard compensation policy. This standard policy of compensation management requires the following.
- The knowledge of employment and taxation laws, customs, cost of living index or rate of inflation, environment, and employment practices in the competing industries.
- The knowledge of employee markets and industry norms regarding benefits and compensations.
- The knowledge and clear conception about the vision and mission of the organization, the corporate philosophy regarding managing human resources, corporate strategy of growth or stability, and strategy of the organization regarding cost, leadership, differentiation and innovation.
Compensation management policy of the organization is to cover the following.
- The policy decisions should be consistent with the overall strategy structure and needs of the organization.
- The policy should be attract and retain the best employees in those areas where the organization has greatest needs and opportunities and where it has core competencies.
- The policy must facilitate the transfer of the employees in a cost effective manner.
- The policy should give due consideration to the administration for its implementation.