HRM 7 - Compensation

Compensation: An Overview

• Compensation - Total of all rewards provided employees in return for services

• Direct financial compensation - Pay received in form of wages, salaries, bonuses, and commissions

• Indirect financial compensation (benefits) - All financial rewards not included in direct compensation

• Nonfinancial compensation - Satisfaction person receives from job itself or from psychological and/or physical environment in which person works

Equity in Financial Compensation

• Financial equity - Perception of fair pay treatment for employees

• External equity - Employees are paid comparably to workers who perform similar jobs in other firms

• Internal equity - Employees are paid according to relative value of jobs within same organization

• Employee equity - Individuals performing similar jobs for same firm are paid according to factors unique to employee, such as performance level or seniority

• Team equity - More productive teams are rewarded more than less productive groups

Primary Determinants of Direct Financial Compensation Organization Compensation Policies Organizational Level Ability to Pay

Labor Market Compensation Surveys Cost of Living Labor Unions Economy Legislation

Employee Job Performance Skills Competencies Seniority Experience Organization Membership Potential Political Influence

Job

Pricing

Direct Financial Compensation

Job Job Analysis Job Descriptions Job Evaluation

Organization as a Determinant of Direct Financial Compensation

• Compensation Policies Pay leaders - Pay higher wages and salariesMarket rate, or going rate - Pay what most

employers pay for same jobPay followers - Pay below market rate because

poor financial condition or believe that they do not require highly capable employees

• Organizational Level Top management often makes decisions to ensure

consistency across levels Extreme pressure to retain top performers may

override desire to maintain consistency in pay structure

• Ability to Pay Organization’s assessment of ability to pay is

important factor in determining pay levels

Labor Market as Determinant of Direct Financial Compensation

• Potential employees located within geographic area from which employees are recruited

• Pay for same jobs in different labor markets may vary considerably

• Compensation Surveys What are other firms paying?Geographic area of survey Jobs to include• The Economy & cost of living

Employee as Determinant of Direct Financial Compensation

• Performance• Skills• Competencies• Seniority• Experience• Membership in the organization• Potential• Political Influence

Job as Determinant of Direct Financial Compensation

• Job itself continues to be factor, especially in firms that have internal pay equity as primary consideration

• Organizations pay for value they attach to certain duties, responsibilities, and other job-related factors such as working conditions.

• Before organization can determine relative difficulty or value of jobs, must first define content.

• Done by job analysis/job descriptions.

Job Evaluation

• Firm determines relative value of one job in relation to another

• Ranking • Classification• Factor comparison• Point

• Ranking Method Simplest methodRaters examine description of each jobJobs arranged in order according to value• Classification Method • Jobs are classified and grouped according to a

series of predetermined gradesDefine number of classes or grades to describe

group of jobsCompare job description with class descriptionClass description that most closely agrees with

job description determines job classification

• Factor Comparison Method Compensable factors of the jobs to be evaluated

are compared against compensable factors of key jobs within the organization that serve as the job evaluation scale

Five universal job factors - Mental requirements, skills, physical requirements, responsibilities, and working conditions

• Point MethodNumerical values assigned to specific job

componentsSum of values gives quantitative assessment of

job’s relative worthJob factors selected according to nature of specific

group of jobs

Job Pricing• Placing rupee value on worth of job • Pay grades - Grouping of similar jobs to simplify

pricing jobs• Wage curve - Fitting of plotted points to create

smooth progression between pay grades• Pay ranges - Minimum and maximum pay rate

with enough variance between to allow for significant pay difference

• Broadbanding - Collapses many pay grades into few wide bands to improve effectiveness by developing employee skills and encouraging team focus. The employee attention directed away from vertical promotional opportunities

• Single rate system - Pay ranges not appropriate for some workplace conditions such as some assembly lines

• Adjusting pay rates - Overpaid and underpaid jobs

Broadbanding and Its Relationship to Traditional Pay Grades and Ranges

Ave

rage

Pay

Per

Hou

r Grade 5

Grade 4

Grade 1

Grade 2

Grade 3

Job WorthLow High

Band A

Band B

Competency-Based Pay

• Competencies– Demonstrable characteristics of a person,

including knowledge, skills, and behaviors, that enable performance.

• What is Competency-Based Pay?– Paying for the employee’s range, depth, and

types of skills and knowledge, rather than for the job title he or she holds.

• Main elements of skill/competency/knowledge–based pay programs:

1. A system that defines specific skills, and a process for tying the person’s pay to his or her skill.

2. A training system that lets employees seek and acquire skills.

3. A formal competency testing system.

4. A work design that lets employees move among jobs to permit work assignment flexibility.

Competency-Based Pay: Pros and Cons

• Pros

– Higher quality

– Lower absenteeism

– Fewer accidents

• Cons– Pay program

implementation problems– Costs of paying for

unused knowledge, skills, and behaviors

– Complexity of program– Uncertainty that the

program improves productivity

Strategic reasons for incentive plans

• A clear trend in strategic compensation management is the growth of incentive plans/variable pay programs.

• Incentive plans tie up pay to some measure of individual/group or organizational performance

• By meshing compensation and organizational objectives, managers believe that employees will assume “ownership” of their jobs thereby improving their effort and overall job performance

• Some specific reasons/advantages of incentive plans can be cited as follows :

They focus employee efforts on specific performance targets; provide real motivation resulting in critical employee and organizational gains.

Variable costs are directly related to operating performance and achievement of results. If performance objectives are met incentives are paid otherwise withheld.

Foster teamwork and unit cohesiveness when payments to individuals are based on team results

A way to distribute success among those responsible for success.

• Characteristics of a successful incentive plan are as follows :

Financial incentives are linked to valued behaviour

The incentive program seems fair to employeesProductivity/quality standards are challenging

but achievablePayout formulas are simple and understandable

Types of incentive plans

Individual Group Enterprise

Piece work Team compensation

Profit sharing

Standard hour plan

Scanlon plan ESOP’s

Bonuses Rucker plan

Lump sum merit pay

Improshare

Sales incentives

Individual incentive plans• Pieceworka. Straight piecework – Eee’s receive a certain rate for

each unit producedb. Differential piece rate – eee’s whose production

exceeds the std. amt. of output receive a higher rate for all their work than the rate paid to the others who do not exceed the std. amt.

• Standard hour plan – Incentive plan that sets rates based upon the completion of a job in a predetermined std. time

• Bonus – Incentive payment that is supplemental to the base wage ( generally yearly). May be determined on the basis cost reduction, quality improvement or any other perf. criteria established by the organization.

• Lump-sum merit program – Under this eee’s receive a year end merit payment not added to their base pay. Merit increases granted on a lump-sum basis do not contribute to escalating base salary levels.

• Sales incentives Straight salary plan – permits salespeople to be

compensated for performing various duties not reflected immediately in their sales volume. (enables them to devote more time to providing services and building up the goodwill of the organization without jeopardizing their income)

Straight commission – Compensation plan based upon a % of sales, provides direct incentive and is easy to compute and understand. Eg Total cash compensation = 2% x total volume quota + 4% x volume over quota

Most organizations use a combination of salary and commission incentive to compensate their salespeople.

Group incentive plans• Team compensation – A plan where all team

members receive an incentive bonus payment when production or service standards are met or exceeded.

• Gain sharing plans – Programs under which both employees and the organization share the financial gains according to a predetermined formula that reflects improved productivity and profitability.

• Scanlon plan – Bonus incentive plan using employee and management committees to gain cost reduction improvements

• Rucker plan - Bonus incentive plan based on the relationship between the total earnings of employees and the production value generated by them.

• Improshare - IMproved PROductvity through SHARing is a gain sharing plan where –

Standard time to produce an acceptable level of outcome is identified.

Any savings that arise from producing that outcome in a shorter time frame is shared by the firm and the worker.

Enterprise Incentive plans

• Profit sharing – Any procedure by which an employer pays, or makes available to all regular employees, in addition to base pay, special current or deferred sums based on the profits of the enterprise. Profit sharing plans differ in the proportion of profits shared with employees and in the distribution and form of payment.

• ESOP’s ??

Indirect Compensation : Benefits

• Indirect compensation includes a broad range benefits and services that employees receive as part of their total compensation package.

• May enhance employee morale, mitigate fatigue, reduce turnover and build a good corporate image.

• Some benefits are non taxable, employees get the tax advantage; retirement and health care benefits may allow workers to be more productive; group health and life insurance can be done by employer at a lower price.

Types of Fringe Benefits

• Pay for time not worked• Employee security• Safety and health• Welfare and recreation• Old age and retirement• These include such employee benefits as

provident fund, gratuity, medical care, hospitalization, accident relief, health and group insurance, canteen, uniform, recreation and the like.

Flexible Benefits Plans (Cafeteria Plans)

• Benefit plans that enable individual employees to choose the benefits that are best suited to their particular needs

• Advantages– more appreciation of benefits offered– better match between benefits and employee

preference• Disadvantages

– increased design and administrative costs