Compensation HRM 3

Establishing pay and incentives plans for employees
Chapter-8
What is compensation?
▪ Compensation is what employees receive in exchange for their work.
▪ Compensation is a set of rewards that organizations provide to individuals in return for

their willingness to perform various jobs and tasks
▪ Employee compensation refers to all forms of pay or rewards going to employees
and arising from their employment.
It has two main component, a) Direct financial plan and b)Indirect payments
a) Direct financial plan – pay in the form of rewards going to employees and arising from
their employment.
b)Indirect payments- Pay in the form of financial benefits such as insurance.
The basic purpose of compensation management is to establish and maintain an equitable wage
and salary structure. It is concerned with the financial aspects of needs, motivation, and rewards.
▪ Wages: Compensation in the form of money paid for time worked
▪ Salary: Compensation in the form of money paid for discharging the responsibilities of a
job
Strategic Compensation Planning

Strategic compensation planning is the compensation of employees in ways that enhance
motivation and growth, while at the same time aligning their efforts with the objectives,
philosophies, and culture of the organization.
Strategic compensation planning goes beyond determining what market rates to pay
employees-although market rates are one element of compensation planning-to purposefully
linking compensation to the organization’s mission and general business objectives. The more
common goals of a strategic compensation policy include the following:
1. To reward employees’ past performance

2. To remain competitive in the labor market
3. To maintain salary equity among employees
4. To mesh employees’ future performance with organizational goals
5. To control the compensation budget
6. To attract new employees
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7. To reduce unnecessary turnover.

To achieve these goals, policies must be established to guide management in making decisions.
Formal statements of compensation policies typically include the following:
1. The rate of pay within the organization and whether it is to be above, below, or at
prevailing market rate
2. The ability of the pay program to gain employee acceptance while motivating employees
to perform to the best of their abilities
3. The pay level at which employees may be recruited and the pay differential between new
and more senior employees
4. The intervals at which pay raises are to be granted and the extent to which merit and/or
seniority will influence the raises
5. The pay levels needed to facilitate the achievement of a sound financial position in
relation to the products or services offered.
Determining Compensation-The Wage Mix

Employees may inquire of their managers , “ how are the wages for my job determined?” In
practice, a combination of internal and external factors can influence, directly or indirectly, the
rates at which employees are paid. Through this interaction these factors constitute the wage mix,
as shown in the figure:
Internal Factors
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1. Compensation strategy of organization- As a minimum, both large and small

employers should set pay policies reflecting, (1) the internal wage relationship among
jobs and skill levels, (2) the external competition or an employer’s pay position relative
to what competitors are paying, (3) a policy of rewarding employee performance, and (4)
administrative decisions concerning elements of the pay system such as overtime
premiums, payment periods, and short-term or long-term incentives.
2. Worth of a job-Determining appropriate worth of a job not only properly enables

organizations to price “ important” jobs effectively, but also provides insight into how a
job relates to overall organizational success. Additionally, valuing work properly serves
to attract and retain the right talent to drive organizational performance.
3. Employee’s relative worth-In both hourly and salary jobs, employee performance can be
recognized and rewarded through promotion and with various incentive systems.
4. Employer’s ability to pay- Pay levels are limited by earned profits and other financial
resources available to employers. Furthermore, an organization’s ability to pay is
determined in part by the productivity of its employees. Besides those, organization’s
amount of capital investment, economic conditions, competition faced by the employers
also determines employer’s ability to pay.
External Factors
1.Labor market conditions- The labor market reflects the forces of supply and demand for
qualified labor within an area. These forces help influence the wage rates required to recruit or
retain competent employees.
2. Area wage rate- A formal wage structure should provide rates that are in line with those
being paid by other employers for comparable jobs within the area. Data pertaining to area wage
rates may be obtained from local wage surveys.
3. Cost of living-Because of inflation, compensation rates have had to be adjusted upward

periodically to help employees maintain their purchasing power.
4. Collective bargaining-One of the primary functions of a labor union, is to bargain

collectively over conditions of employment, the most important of which is compensation.
Wages are generally higher in areas where organized labor is strong.
5. Legal requirements- Government wage structure and employment law in a particular country
also determines wage plan.
Types of wage plans:

There are two major kinds of wage and salary payment plans. These are:
l. Time plan
2. Incentive plans.
1. Time Plan:
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According to time plan remuneration are computed in terms of some time unit. The time unit
may be: Hour, Day, Week or month.
This system is very popular among white-collar employees. Year-end annual increment, merit
increments, bonus and promotion chances are means of motivation in this system.
o Formula:
No of hours worked X Rate per hour
2. Incentive plans:
Remuneration depends on output or some other measure of productivity during a given time
period. To earn more, an employee must expend effort to produce more, to sell more or to reduce
cost, or to utilize various resources more effectively, as the case may be. The major types of
incentives plans are-
♦Piece-Rate Incentive Plan

Incentive-based pay plan that provides payment for each unit produced
♦Individual Incentive Plan
Incentive-based pay plan that rewards individual performance on a real-time basis
♦Sales Commission
Individual incentive plan rewarding employees with a percentage of sales volume that they
generate
♦Team & Group Incentive Plan
▪ Gainsharing Program
Group-based incentive plan that gives rewards for productivity improvements
▪ Profit Sharing
Group-based incentive plan in which employees are paid a share of company profits
♦Performance-Based Compensation Plan
▪ Merit Pay Plan
Performance-based pay plan basing part of compensation on employee merit
▪ Skill-Based or Knowledge-Based Pay
Performance-based pay plan rewarding employees for acquiring new skills or knowledge
Indirect Compensation & Benefits

Benefits
Compensation other than wages and salaries
♦Mandated Protection Plans

▪ Unemployment Insurance: Mandated coverage protecting employees who are laid off
▪ Social Security: Mandated federal retirement program
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▪ Worker’s Compensation Insurance: Legally required insurance covering workers who are

injured or become ill on the job
♦Optional Protection Plans

▪ Private Pension Plan: Prearranged company pensions provided to retired employees
♦Paid Time Off

Paid holidays, paid vacations, sick leave, & personal leave
♦Other Types of Benefits
▪ Wellness Program: Benefit in the form of programs designed to help employees from
becoming sick
▪ Childcare: These plans might include scheduling help, referrals to various types of
services, or reimbursement accounts for childcare expenses. In many cases, they actually
include company-paid day care.
▪ Cafeteria Benefit Plan: Benefit plan that sets limits on benefits per employee, each of
whom may choose from a variety of alternative benefits.
Fringe benefits
The remuneration that employees receive for their contribution cannot be measured by the mere
estimation of wages and salaries paid to them. Certain supplementary benefits and services
known as “fringe benefits” are also available to them. The characteristics of fringe benefits are:
1. These benefits are distinctly additional to the regular wages and salaries paid to the
workers. As such they are not provided as a substitute for wages or salaries of the
employees.
2. These benefits are meant primarily to be of advantage to the employees.
3. The advantages accrued to the employees through the provision of fringe benefits are
such that cannot be secured through their own individual efforts.
4. Only those benefits fall within the purview of fringe benefits, which are or can be
expressed in cash terms.
5. The scope of fringe benefits is different from that of welfare services. Fringe benefits are
provided by the employers alone, whereas welfare services may be provided by other
agencies as well. Benefits that have no relation to employment should be regarded as
fringe benefits.

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Establishing pay and incentives plans for employees

▪ Compensation is a set of rewards that organizations provide to individuals in return for

Strategic Compensation Planning

1. To reward employees’ past performance

7. To reduce unnecessary turnover.

Determining Compensation-The Wage Mix

1. Compensation strategy of organization- As a minimum, both large and small

2. Worth of a job-Determining appropriate worth of a job not only properly enables

3. Cost of living-Because of inflation, compensation rates have had to be adjusted upward

4. Collective bargaining-One of the primary functions of a labor union, is to bargain

Types of wage plans:

♦Piece-Rate Incentive Plan

Indirect Compensation & Benefits

♦Mandated Protection Plans

▪ Social Security: Mandated federal retirement program

▪ Worker’s Compensation Insurance: Legally required insurance covering workers who are

♦Optional Protection Plans

♦Paid Time Off

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