Managing Reward and Compensation

1 INTRODUCTION
1.1 Reward management defined
Every company needs to develop reward packages that satisfy people. These reward packages,
commonly known as total rewards, include all the monetary and nonmonetary rewards provided
by a company to attract, motivate, and retain employees. The success of a pay system depends on
linking organizational objectives and strategies to compensation so that individuals are
encouraged to work in a manner that benefits the company and its stakeholders. Critical to an
effective total rewards approach to pay is the need to balance the interests and costs of the
employers with the needs and expectations of employees. This can be a difficult process. On the
one hand, employee payroll and benefits represent a large portion of total operating costs in some
industries such as financial services, health care, education, and hospitality. On the other hand,
recent surveys suggest that there is growing concern among HR professionals that total rewards
programs can be used more effectively to obtain good talent in organizations, and that these
programs should be more clearly communicated to employees. Effective management of total
rewards can be accomplished by evaluating expenses and determining the value of
compensation. An optimal relationship between costs and employee impact must be achieved
while considering many financial and operational factors. (Robert L. Mathis and John H.
Jackson 13th Edition)1
Reward management is concerned with the formulation and implementation of strategies and
policies in order to reward people fairly, equitably and consistently in accordance with their
value to the organization (Armstrong 2009 p.736). It deals with the development of reward
strategies and the design, implementation and maintenance of reward systems (reward processes,
practices and procedures) which aim to meet the needs of both the organization and its
stakeholders. Reward can be regarded as the fundamental expression of the employment
relationship.
During the past several years, total rewards have been a significant focus in HR, and different
frameworks have been developed. One prominent approach has been developed by
WorldatWork, a leading professional association that focuses on compensation. The model
shows how a company’s strategic and cultural characteristics influence various elements of
compensation such as work-life, recognition, and career development—all of which ultimately
1
HR-Human Resource

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strengthen the positive nature of the employment relationship and generate increased business
performance.
An equally wide definition of total reward is offered by WorldatWork (2000) who state that total
rewards are ‘all of the employer’s available tools that may be used to attract, retain, motivate and
satisfy employees
Definitions of total reward typically encompass not only traditional, quantifiable elements like
salary, variable pay and benefits, but also more intangible non-cash elements such as scope to
achieve and exercise responsibility, career opportunities, learning and development, the intrinsic
motivation provided by the work itself and the quality of working life provided by the
organization’(Thompson (2002).
The conceptual basis of total rewards is that of configuration or ‘bundling’, so that different
reward processes are interrelated, complementary and mutually reinforcing. Total reward
strategies are vertically integrated with business strategies, but they are also horizontally
integrated with other HR strategies to achieve internal consistency
1.2 Nature of total rewards and compensation
Because so many organizational funds are spent on employees, top management and HR
executives should match total rewards systems and practices with what the organization is trying
to accomplish. To do so, several decisions must be made:
• Legal compliance with all appropriate laws and regulations
• Cost-effectiveness for the organization
• Internal, external, and individual equity for employees
• Performance enhancement for the organization
• Performance recognition and talent management for employees
• Enhanced recruitment, involvement, and retention of employees
Employers must balance their costs at a level that rewards employees sufficiently for their
knowledge, skills, abilities, and performance accomplishments.

1.3. The aims of reward management

 Reward people according to what the organization values and wants to pay for.
 Reward people for the value they create.

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 Reward the right things to convey the right message about what is important in terms of
behaviors and outcomes.
 Develop a performance culture.
 Motivate people and obtain their commitment and engagement.
 Help to attract and retain the high quality people the organization needs.
 Develop a positive employment relationship and psychological contract.
 Align reward practices with both business goals and employee values; as Duncan Brown
(2001) emphasizes, the ‘alignment of your reward practices with employee values and
needs is every bit as important as alignment with business goals, and critical to the
realization of the latter’.
 Operate fairly – people feel that they are treated justly in accordance with what is due to
them because of their value to the organization (the ‘felt-fair’ principle of Eliot Jaques
(1961).
 Apply equitably – people are rewarded appropriately in relation to others within the
organization, relativities between jobs are measured as objectively as possible and equal
pay is provided for work of equal value.
 Function consistently – decisions on pay do not vary arbitrarily and without due cause
between different people or at different times.
 Operate transparently – people understand how reward processes operate and how they
are affected by them
.
1.4 The significance of total reward
Essentially, the notion of total reward says that there is more to rewarding people than throwing
money at them. For O’Neal (1998), a total reward strategy is critical to addressing the issues
created by recruitment and retention as well as providing a means of influencing behavior: ‘It
can help create a work experience that meets the needs of employees and encourages them to
contribute extra effort, by developing a deal that addresses a broad range of issues and by
spending reward dollars where they will be most effective in addressing workers’ shifting values.
A powerful argument for total rewards, Pfeffer (1998b) Creating a fun, challenging, and
empowered work environment in which individuals are able to use their abilities to do
meaningful jobs for which they are shown appreciation is likely to be a more certain way to

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enhance motivation and performance – even though creating such an environment may be more
difficult and take more time than simply turning the reward lever.
1.5 The benefits of a total reward approach are:
 Greater impact – the combined effect of the different types of rewards will make a deeper
and longer-lasting impact on the motivation and commitment of people.
 Enhancing the employment relationship – the employment relationship created by a total
Rewards approach makes the maximum use of relational as well as transactional rewards
and will therefore appeal more to individuals.
 Flexibility to meet individual needs – as pointed out by Milkovich and Bloom (1998):
‘Relational rewards may bind individuals more strongly to the organization because they
can answer those special individual needs’.
 Talent management – relational rewards help to deliver a positive psychological contract
and this can serve as a differentiator in the recruitment market which is much more
difficult to replicate than individual pay practices. The organization can become an
‘employer of choice’ and ‘a great place to work’ thus attracting and retaining the talented
people it needs.

2. Types of total reward (Compensation)

The total rewards concept emphasizes both indirect and direct compensation, which strengthens
a company’s ability to motivate employees, particularly in challenging financial situations such
as those sometimes faced by companies. Show in figure 1

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Figure 1. Components of the reward package (source John Stredwick (2005)

2.1 Direct rewards

Direct rewards consist of the following:
 Basic Pay which is the hourly wage or weekly/monthly salary which is guaranteed to be
paid.
 Pay for performance which is the pay that can vary depending on the performance of
the individual, group or organization as a whole. Adopting skills and competencies come
into this group.
 Benefits which relate to a wide range of ‘extras’ from company cars, private health
insurance and share options to sick pay, pensions and holidays. Most are fixed and there

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is a strong movement towards harmonizing most benefits throughout an organization

rather than separate schemes for different groups of employees.
 Recognition pay, which are special awards for employee achievement, is less common
and is associated with performance but usually operated separately and where many of
the rewards are non-cash
2.2. Indirect rewards.
Indirect rewards consist of the following:
Job satisfaction consisting of the intrinsic rewards of carrying out the job.
Cultural satisfaction which arises from rewarding relationships with colleagues and
working within an ethically satisfying organization or sector.
Security which, although not greatly evident today, still applies in a number of settings
either explicitly through long-term contracts or through the nature of the psychological
contract between the organization and its staff.
Personal growth, including the learning of new skills.
Career development opportunities and the way they are developed. John Stredwick
(2005: PP.338)
Designing basic pay structures
The major part of most employees’ reward is their basic remuneration. As Frans Poels puts it:
‘A systematic framework is required to manage differences in (basic) pay in such a way that they
support the objectives of the organization and result in fair remuneration for the individuals.’
Poels (1997: p. 9)
For individuals, the sense of fairness about their basic pay is related to three key facts. These are,
firstly, the objective value they put on the nature of the job and the way they perform it;
secondly, their perception of how this compares with other jobs in the organization, especially
those jobs and employees with which they are familiar; thirdly, how their pay compares with
their perception of the ‘market rate’ for their job.
In small organizations, the salary structure is informal with the Chief Executive (CE), who will
know each employee, deciding the basic pay on an individual basis. The CE will be able to meet
Poels’ requirements and record it on one sheet of paper. However, when the organization
stretches beyond 60 or 80 employees this becomes increasingly difficult. The CE will find the
individual judgment of comparing of one individual’s worth against another, their comparable

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performance and the market rates for their jobs a complex process. Moreover, if mistakes are
made, they can be costly. If remuneration is increased too much, it is almost impossible to reduce
it subsequently (certainly without complaint) and if it is not increased sufficiently, then the
individual may decide to look elsewhere. When the organization expands beyond 150
or 200 employees the task becomes practically impossible. This is where two remuneration
processes enter. Job evaluation attempts to ensure that the internal pay relativities are objectively
set and market tracking compares the appropriate rates with the marketplace. When the
necessary preparation has been carried out on both these processes, a remuneration structure can
be put together to try to satisfy the requirements for both the organization and the individual.
John Stredwick (2005: PP.339)
Benefits
Extras to the working conditions that have a cash value are categorized as benefits and can be of
great variety. Some have already been mentioned; others include luncheon vouchers, subsidized
meals, discount purchase schemes and the range of welfare provisions such as free chiropody
and cheap hairdressing.
Premia
Where employees work at inconvenient times – or on shifts or permanently at night – they
receive a premium payment as compensation for the inconvenience. This is for inconvenience
rather than additional hours of work. Sometimes this is built into the basic rate or is a regular
feature of the contract of employment so that the payment is unvarying. In other situations shift
working is occasional and short-lived, making the premium a variable element of payment. The
New Earnings Survey records that shift premia are now received by just 11 per cent of UK
workers, but that it accounts on average for as much as 12 per cent of their total pay (Grabham
2003, p. 399).
Overtime
It is customary for employees working more hours than are normal for the working week to be
paid for those hours at an enhanced rate, usually between 10 and 50 per cent more than the
normal rate according to how many hours are involved. Seldom can this element be regarded as
fixed. No matter how regularly overtime is worked, there is always the opportunity for the
employer to withhold the provision of overtime or for the employee to decline the extra hours.

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Overtime is earned by over a quarter of the UK workforce, more than two-thirds of the recipients
being men (Grabham 2003, p. 398).
Incentive
Incentive is here described as an element of payment linked to the working performance of an
individual or working group, as a result of prior arrangement. This includes most of the payment-
by-results schemes that have been produced by work study, as well as commission payments to
salespeople, skills-based pay schemes and performance-related pay schemes based on the
achievement of agreed objectives. The distinguishing feature is that the employee knows what
has to be done to earn the payment, though he or she may feel very dependent on other people, or
on external circumstances, to receive it. One in seven workers receives a portion of their pay via
incentives of one kind or another, more men being rewarded in this way than women. On
average incentive pay contributes 22 per cent towards their overall salaries (Grabham 2003, p.
398).
Bonus
A different type of variable payment is the gratuitous payment by the employer that is not
directly earned by the employee: a bonus. The essential difference between this and an incentive
is that the employee has no entitlement to the payment as a result of a contract of employment
and cannot be assured of receiving it in return for a specific performance. The most common
example of this is the Christmas bonus. We include profit sharing under this general heading
although the ownership of shares confers a clear entitlement. The point is that the level of the
benefit cannot be directly linked to the performance of the individual. Rather, it is linked to the
performance of the business. In some cases the two may be synonymous, with one dominant
individual determining the success of the business, but there are very few instances like this,
even in the most feverish imaginings of tycoons. Share ownership or profit sharing on an agreed
basis can greatly increase the interest of the employees in how the business is run and can
increase their commitment to its success, but the performance of the individual is not directly
rewarded in the same way as in incentive schemes. (Derek,etal,2005:PP,630)

Paying for performance

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The traditional job evaluated pay system with incremental movement is based on a collectivist
approach where employees are all treated the same, regardless of their performance. It is
assumed that employees become increasingly knowledgeable and competent in their job as time
goes by, that is why they receive increments. It is a simple scheme rewarding employees for their
service and loyalty. This picture is fading fast as society changes. As the capitalist, free
enterprise society now dominates most of the world’s economies, employees have come to
accept, expect and mostly approve of pay systems which differentiate between different levels of
performance. As Brown (2001) explains: ‘…we are witnessing a rapid growth in the incidence of
bonus schemes and variable pay as companies attempt to obtain more variability in their total
pay costs and endeavor to create a stronger “line of sight” between what employees do and are
rewarded for, and the strategic goals and performance of the organization.’ Brown (2001: p. 137)
There are many forms of performance pay schemes. The original individual piecework systems
promulgated by Taylor (1911) operated for 50 years or so and have a modicum of apparent
fairness but have fallen into disrepute since the mid-1960s for a number of reasons. Constant
arguments can occur over piecework rates and allowances, especially when new materials,
processes or machinery are introduced; rates of pay may fluctuate through no fault of the
operator due to lack of work or poor materials; individual piecework encourages the employee to
only work for themselves rather than be part of a co-operating team; a costly set of rate-fixers
and work study engineers to maintain the system; workers may be encouraged to cut corners in
health and safety to boost their income. Today, piecework is only in evidence in the remnant of
the textile and other traditional industries, although it still also is operated in some industries
where employees work at home. It has mostly been replaced by group incentives schemes which
operate in a department or unit wide environment. They can take the form of production targets
only or, increasingly, a broader set of targets including quality, on-time production and accident
levels. The objective is to encourage employees to understand the basis of the targets and to aim
to achieve them, working co-operatively as a team. This has been taken further in America
through a system called Gain sharing, where a unit shares the cost-savings achieved through
higher productivity, waste-saving and quality improvement, in the form of quarterly bonuses.
One of the crucial aspects of the system is that employees have full information on the objective-
setting process, are informed of the current performance on a regular basis and are encouraged to

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participate in problem solving and innovation committees to aid the achievement of the
objectives. John Stredwick (2005: PP.354)
Skills-based and competence-based pay
There has been a growing emphasis, especially in manufacturing organizations, to support
initiatives that increase the level of skills and competencies in the workforce. Encouraging
production employees to learn a variety of jobs on their team, or to learn maintenance skills, has
become an essential part of the jigsaw of improving productivity and quality. This
encouragement sometimes takes the form of skills-based pay, where the acquiring of a set of
specific skill levels earns the employee a higher rate of pay. Competency-based pay has many
similarities in that employees are encouraged to develop a set of competencies which, when
obtained leads to the opportunity of higher pay. John Stredwick (2005: PP.361)
3. Compensation philosophies
Two basic compensation philosophies lie on opposite ends of a continuum, as shown in the
following figure. At one end of the continuum is the entitlement philosophy; at the other end is
the performance philosophy. Most compensation systems fall somewhere in between these two
extremes.

Figure 2 Continuums of Compensation Philosophies

3.1. Entitlement Philosophy: - The entitlement philosophy assumes that individuals who have
worked another year are entitled to pay increases, with little regard for performance differences.

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Many traditional organizations that give automatic increases to their employees every year are
practicing the entitlement philosophy.
These automatic increases are often referred to as cost-of living raises, even if they are not tied
specifically to economic indicators.

Further, most of those employees receive the same or nearly the same percentage increase each
year.
One of the challenges associated with cost-of-living increases is that employees are given the
same adjustments without any regard for performance, a process that can undermine the purpose
of compensation.
As such, bonuses in many entitlement-oriented organizations are determined in a manner that
often fails to reflect operating results. Employees “expect” the bonuses, which become another
form of entitlement.
3.2. Performance Philosophy: - A pay-for-performance philosophy requires that compensation
changes reflect performance differences. Organizations operating under this philosophy do not
guarantee additional or increased compensation simply for completing another year of
organizational service.
Instead, they structure pay and incentives to reflect performance differences among employees.
Employees who perform satisfactorily maintain or advance their compensation levels more than
marginal performers.
The bonuses and incentives are based on individual, group, and/or organizational performance.
Few organizations totally follow all performance-oriented compensation practices, but the
overall trend is toward greater use of pay-for- performance systems, with more and more
companies turning to performance criteria to shape rewards for all employees. Such plans may
help to reduce employee turnover and increase employee commitment, motivation, and retention.
However, performance-based plans need to be evaluated periodically to determine whether
performance is being fairly measured and linked to rewards.
Also, merit- and performance-based systems do not always lead to increased employee
performance because of inappropriate pay differentials, equity concerns, and poor teamwork.
As a result, some organizations might consider using more group-based plans.

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The total rewards approach reflects a more performance-oriented philosophy because it tends to
place more value on individuals’ performance, rather than just paying them based on having a
job.
When determining compensation, managers consider elements such as how much an employee
knows or how competent an employee is.
Some organizations use both compensation and variable pay programs as part of a total rewards
approach for all levels of employees.
Widespread use of various incentive plans, team bonuses, organizational gain sharing programs,
and other designs links growth in compensation and variable pay to results.
Regularly communicating to employees and managers the compensation philosophy helps to
reinforce the organizational commitment to it.
A recent study found that communication of profit-sharing information increased knowledge,
which influenced commitment and satisfaction.
Communication also can enhance understanding and perceptions of pay policies, encouraging
greater generalized pay satisfaction and career development.
Finally, establishing a dialogue with employees about total rewards enables them to be more
involved with the development of pay systems that enhance talent and return on investment.
A company’s compensation philosophy can be used to develop individual talent in an
organization, a strategy covered in the HR Best Practices. (Robert L. Mathis &John H. Jackson,
2010, p.362-364)
4. Compensation responsibilities

To administer compensation expenditures wisely, HR specialists and operating managers must

work together. HR specialists guide the development and administration of an organizational
compensation system and conduct job evaluations and wage surveys. Also, because of the
complexity involved, HR specialists typically assume responsibility for developing base pay
programs and salary structures and policies. HR specialists may or may not do actual payroll
processing. This labor-intensive responsibility is typically among the first to be outsourced.
Operating managers evaluate the performance of employees and consider their performance
when deciding compensation increases within the policies and guidelines established by the HR

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unit and upper management. Figure 3 shows Typical Division of Compensation Responsibilities
in HR

MANAGERS
HR UNIT

1. Identify job
1. Develop/administer pay
descriptions/concerns
system
2. Recommend pay rates/increases
2. Evaluate jobs/analyze pay
3. Evaluate employees’ pay
surveys
perceptions
3. Develop pay
structures/policies

Figure 3 Typical Division of Compensation Responsibilities in HR

5. The reward system

A reward system consists of a number of interrelated processes and activities which combine to
ensure that reward management is carried out effectively to the benefit of the organization and
the people who work there. (Armstrong 2009 p.742). These are described below.
Reward strategy
Reward strategy sets out what the organization intends to do in the longer term to develop and
implement reward policies, practices and processes which will further the achievement of its
business goals.
Reward policies
Reward policies address the following broad issues: the level of rewards taking into account
‘market stance’ – how internal rates of pay should compare with market rates
Total reward
Total reward is the combination of financial and non-financial rewards available to employees.
Total remuneration
Total remuneration is the value of all cash payments (total earnings) and benefits received by
employees.
Base or basic pay

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The base rate is the amount of pay (the fixed salary or wage) that constitutes the rate for the job.
It may be varied according to the grade of the job or, for manual 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 are assessed by tracking
market rates. Alternatively, levels of pay may be agreed through collective bargaining with trade
unions or by reaching individual agreements.
Base pay may be expressed as an annual, weekly or hourly rate. For manual workers this may be
an hourly rate which is called a time rate. Allowances for overtime, shift working, unsocial hours
or increased cost of living in London or elsewhere may be added to base pay. The base rate may
be adjusted to reflect increases in the cost of living or market rates by the organization
unilaterally or by agreement with a trade union.
Job evaluation
Job evaluation is a systematic process for defining the relative worth or size of jobs within an
organization in order to establish internal relativities and provide the basis for designing an
equitable grade structure, grading jobs in the structure and managing relativities. It does not
determine the level of pay directly. Job evaluation can be analytical or non-analytical.
Market rate analysis
Market rate analysis is the process of identifying the rates of pay in the labor market for
comparable jobs to inform decisions on levels of pay within the organization. A policy decision
may be made on how internal rates of pay should compare with external rates – an organization’s
market stance.
Grade and pay structures
Jobs may be placed in a graded structure according to their relative size. Pay levels in the
structure are influenced by market rates. The pay structure may consist of pay ranges attached to
grades which provide scope for pay progression based on performance, competence, contribution
or service. Alternatively, ‘spot rates’ or ‘individual job grades’ structure may be used for all or
some jobs in which no provision is made for pay progression in a job.
Contingent pay
Additional financial rewards may be provided that are related to performance, competence,
contribution, skill or service in the grade. These are referred to as ‘contingent pay’. Contingent

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payments may be added to base pay, i.e. ‘consolidated’. If such payments are not consolidated
(i.e. paid as cash bonuses) they are described as ‘variable pay’.
Employee benefits
Employee benefits include pensions, sick pay, insurance cover, company cars and a number of
other ‘perks’. They comprise elements of remuneration additional to the various forms of cash
pay and also include provisions for employees that are not strictly remuneration, such as annual
holidays.
Performance management
Performance management processes define individual performance and contribution
expectations, assess performance against those expectations, provide for regular constructive
feedback and result in agreed plans for performance improvement, learning and personal
development. They are a means of providing non-financial motivation and may also inform
contingent pay decisions.
Non-financial rewards
Rewards which do not involve any direct payments and often arise from the work itself, for
example, achievement, autonomy, recognition, scope to use and develop skills, training, career
development opportunities and high quality leadership.
The interrelationships of these elements of the reward system are shown in Figure 3.

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Figure 4 The reward management system: elements and interrelationships

(Source:Armstrong,2007)

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6. Reward strategy
In the words of Brown (2001): ‘Reward strategy is ultimately a way of thinking that you can
apply to any reward issue arising in your organization, to see how you can create value from it.
Reward strategy is a declaration of intent which defines what the organization wants to do in the
longer term to develop and implement reward policies, practices and processes which will further
the achievement of its business goals and meet the needs of its stakeholders. It provides a sense
of purpose and direction and a framework for developing reward policies, practices and process.
It is based on an understanding of the needs of the organization and its employees and how they
can best be satisfied. It is also concerned with developing the values of the organization on how
people should be rewarded and formulating guiding principles which will ensure that these
values are enacted.
Reward strategies provide answers to two basic questions:
1) Where do we want our reward practices to be in a few years’ time? And
2) How do we intend to get there?
They therefore deal with both ends and means. As an end they describe a vision of what reward
processes will look like in a few years’ time. As a means, they show how it is expected that the
vision will be realized.
Reward strategy is underpinned by a reward philosophy which expresses what the organization
believes should be the basis upon which people are valued and rewarded. Reward philosophies
are often articulated as guiding principles.
6.1 The content of reward strategy
Reward strategy may be a broad-brush affair simply indicating the general direction in which it
is thought reward management should go. Additionally or alternatively, reward strategy may set
out a list of specific intentions dealing with particular aspects of reward management.
A broad-brush reward strategy may commit the organization to the pursuit of a total rewards
policy. The basic aim might be to achieve an appropriate balance between financial and
nonfinancial rewards. A further aim could be to use other approaches to the development of the
employment relationship and the work environment which will enhance commitment and
engagement and provide more opportunities for the contribution of people to be valued and
recognized.

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Examples of other broad strategic aims include: 1) introducing a more integrated approach to
reward management – encouraging continuous personal development and spelling out career
opportunities; 2) developing a more flexible approach to reward which includes the reduction of
artificial barriers as a result of over-emphasis on grading and promotion; 3) generally rewarding
people according to their contribution; 4) supporting the development of a performance culture
and building levels of competence; and 5) clarifying what behaviors will be rewarded and why.
Specific reward initiatives
The selection of reward initiatives and the priorities attached to them will be based on an analysis
of the present circumstances of the organization and an assessment of the needs of the business
and its employees. The following are examples of possible specific reward initiatives, one or
more of which might feature in a reward strategy:
• The replacement of present methods of contingent pay with a pay for contribution scheme;
• The introduction of a new grade and pay structure, example; a broad-graded or career family
structure;
• As Cox and Purcell (1998) write: ‘The real benefit in reward strategies lies in complex linkages
with other human resource management policies and practices’.
Isn’t this a good reason for developing a reward strategic framework which indicates how reward
processes will be associated with HR processes so that they are coherent and mutually
supportive?
6.2. Guiding principles for reward
Guiding principles define the approach an organization takes to dealing with reward. They are
the basis for reward policies and provide guidelines for the actions contained in the reward
strategy. They express the reward philosophy of the organization – its values and beliefs about
how people should be rewarded.
Members of the organization should be involved in the definition of guiding principles which can
then be communicated to everyone to increase understanding of what underpins reward policies
and practices. However, employees will suspend their judgments of the principles until they
experience how they are applied. What matters to them are not the philosophies themselves but
the pay practices emanating from them and the messages about the employment ‘deal’ that they
get as a consequence. It is the reality that is important, not the rhetoric.
Reward guiding principles

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Develop reward policies and practices which support the achievement of business goals.
Provide rewards which attract, retain and motivate staff and help to develop a high
performance culture.
Maintain competitive rates of pay.
Reward people according to their contribution
Recognize the value of everyone who is making an effective contribution, not just the
exceptional performers.
Allow a reasonable degree of flexibility in the operation of reward processes and in the
choice of benefits by employees.
Devolve more responsibility for reward decisions to line managers.
6.3. Developing reward strategy
The formulation of reward strategy can be described as a process for developing and defining a
sense of direction. The main phases are:
1. The diagnosis phase, when reward goals are agreed, current policies and practices
assessed against them, options for improvement considered and any changes agreed.
2. The detailed design phase when improvements and changes are detailed and any changes
tested (pilot testing is important).
3. The final testing and preparation phase.
4. The implementation phase, followed by ongoing review and modification.
A logical step-by-step model for doing this is illustrated in Figure 4. This incorporates ample
provision for consultation, involvement and communication with stakeholders who include
senior managers as the ultimate decision makers as well as employees and line managers.

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Figure .5 A model of the reward strategy development process

(Source:Armstrong,2009)

Reward strategists have to respond to changes in organizational requirements which are happening all the
time. They need to track emerging trends in reward management and may modify their views accordingly, as
long as they do not leap too hastily on the latest bandwagon. It may be helpful to set out reward strategies on
paper for the record and as a basis for planning and communication. But this should be regarded as no more
than a piece of paper that can be torn up when needs change – as they will – not a tablet of stone.
6.4. Components of an effective reward strategy
Brown (2001) has suggested that effective reward strategies have three components:
1. They have to have clearly defined goals and a well-defined link to business objectives.
2. There have to be well-designed pay and reward programmed, tailored to the needs of the organization
and its people, and consistent and integrated with one another.
3. Perhaps most important and most neglected, there needs to be effective and supportive HR and
reward processes in place.
6.5. Implementing reward strategy

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Strategy formulation is what you are going to do and Strategy implementation is doing it. The aim of
implementation is to make the reward strategy an operating reality by building the capacity of the organization
to put into practice the proposals worked out in the development stage. As Armstrong and Brown (2007)
stress: ‘It is always essential to design with implementation in mind’.

Purcell (1999) believes that the focus of strategy should be on implementation. As explained by Thompson and
Strickland (1990): ’Implementation entails converting the strategic plan into action and then into results’. An
effective reward strategy is a living process and, in the words of Rosabeth Moss Kanter (1984), an ‘action
vehicle’. Formulation is easy; implementation is hard. A pragmatic approach is required – what’s good is what
works. Implementing reward strategy is much more about process than design – how it will be done rather than
what will be done. The principles of procedural and distributive justice apply. People must feel that the
procedures used to determine their grades, pay level and pay progression are fair, equitable, applied
consistently and transparent. They must also feel that the awards distributed to them are just in terms of their
contribution and value to the organization.

7. Determinants of compensation system

In a real world a varieties of factors determines compensation plan .these are the organization ,
the labor market, the job and the employee are the major determinants of the individual
financial compensation . ( R .Wayne Mondy, Robert M . Noe, and Shane R. premeaux ,
2002, page 315).

7.1 The organization

Mostly financial compensation viewed as both an expense and an asset .managers view it as an
expense because it reflects the cost of labor while it is viewed as an asset because it has a power
of inducing employers to put their best efforts and to be remaining in their job. In any ways the
organization compensation policies and its ability to pay determines the individual financial
compensation. firstly the company’s compensation policies has a major effect on the
individuals financial compensation . The company may follow a policy of pay leader in which
that pays the higher wages and salaries than other competitors. Higher paying firms usually
attract more and qualified employers than do lower paying companies in the labor market. Or the
company may follow the policy of paying the market rate. The market rate is the average pay
that most employers provide for the similar job in a given industry or aria. Companies that
choose to pay below the market rate are called -pay followers. These pay followers pay below

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the market rate because of poor financial condition or a belief that they do not require highly
capable employees. But generally companies who pays lowest wage do not save money rather
they exposed to the hiring of unproductive workers, may have a high employers turnover rate. If
the company does not treat its employees well, it is difficult to maintain productivity of the
companies. ( ibid , page 316 – 317)

Secondly the organizations ability to pay is also an important factor in the pay level. Firms who
have strong financial performance tend to pay higher than average compensation. ( ibid , page
317)

7.2 The labor market

In different labor market, pay for the same job may vary considerably. In order to compete
successfully for employees the compensation managers must be aware of these differences. The
market rate is taken as standard for judging the fairness of compensation practice by many
employees. The data regarding the market rate can be obtained from the compensation survey
and these labor market in turn determined by expediency, cost of living, society, the economy
and legislation. We will see these concepts in detail below. ( ibid , page 317)

Compensation survey

It is used for getting data regarding what other firms are paying for specific job. the organization
undertake these task either by outsourcing consulting firm or by organization by itself for the
sake of identifying their position with respect to competition in the labor market and to get
data that helps for developing budget and compensation structure . in addition to these
compensation survey helps for organization in order to know the market pay rate within a
given labor market that describes the low , average and high salaries for a given position .
( ibid , page 317)

In addition to these surveys, there other ways of obtaining compensation data For example
organization like world at work and society for human resource management periodically
conduct survey. For example in United States the national compensation survey conducted by the
bureau of labor statistics provides statistically valid data on wages and employee benefit for all
Americans that related to the area wage survey , white collar pay survey ,employee benefit in

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small private establishments ,employee benefit in medium and large private establishments and
in state and local governments .( ibid , page 318)

Expediency

Even though compensation survey helps organization in developing logical pay structure, there
times that the data derived from these surveys is ignored. Mangers use their own device in this
high tech environment to win for the valued employees in the competition .while the decision
these mangers make are likely within certain guideline provided by the firms policies and the
historical pressure to maintain consistency . ( ibid, page 319)

Cost of living

When a price rise over a period of time and pay does not, real pay is actually lowered. It is
necessary to maintain a previous level of real wages by increasing pay that must be equivalent to
the increased cost of living. for example if someone earns $42000 during a year in which the
average rate of inflation is 5% , a $175 per month pay increase will be necessary merely to
maintain that person purchasing ability . Some organizations also sacrifice merit pay to provide
across the broad increase designed to offset the results of inflation. (ibid)

Society

Businesses in a local labor market concerned with the pay practice of new firms locating in their
aria. These results from since the compensation paid to the employees affects a firms pricing
of its goods and services it has an effect of general increase in price of goods and services to the
society. for example local civic leaders confronted the management of a large electronics firm
when it announced plans to locate a branch plant in their small community . They demanded
the companies to keep their wages in line with other wages in the community. ( ibid ,page 320 )

The economy

The state of economy affects the financial compensation decision. For example the depressed
economy generally increases the labor supply .this in turn lower the market rate.( ibid)

Legislation

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The amount of compensation received by a person also affected by the federal and state laws.
Equal employment legislation including _ civil right act, the American disabilities act all
prohibit discrimination against specified groups in employment matters, including
compensation. for our focus we will take one federal legislation that provides broad coverage
and specifically deals with compensation issues called equal pay act of 1963 .( ibid)

Equal pay act of 1966: this act prohibits an employer from paying an employee of one
gender less money than an employee of the opposite gender if both employees do work that
is the same or substantially the same . the substantially the same job are jobs that require
equal skills , effort and responsibility and are performed under similar working conditions .
the act also covers work within the same physical place of business .for example an
employer could pay a female working in san Francisco more than a male working in the same
position in slippery rock ,Pennsylvania , even if the jobs were substantially the same . in
addition to these a male working in a position that requires a five years’ experience may
legally be paid more than a female who is in a position that requires only three years’
experience . generally the equal pay of act 1966 permits pay distinction based on the
following factors : unequal responsibility ,dissimilar working condition ,difference due to
seniority ,difference resulted from the a merit pay system , difference based on quality or
quantity of production .( ibid , 322 – 323 )

7.3 The job as determinant of financial compensation

The job itself is a prominent as wage criteria for firms beyond other factors mentioned above.
The organizations pay for the value they attach to certain duties, responsibilities and other job
related factors such as working conditions. In order to determine the job relative worth the
management applies the following techniques like job analysis, job description and job
evaluation. ( ibid , 323 )

What is job analysis? It is the systematic process of determining the skills and knowledge
required for performing jobs.( ibid)

What is job description? It is the primary by product of jobs analysis. It is a written document
that describes job duties and responsibilities. Job description is helps for many different
purposes, including job evaluation. ( ibid)

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What is job evaluation? It is the part of compensation system that helps for determining the
relative value of one job in relation to the other. Eliminating pay inequalities that exists because
of illogical pay structure is the major objective of the job evaluation. For example pay
inequalities exist if the mailroom supervisor earns more money than the accounting supervisor.
Job evaluation measures job worth in administrative rather than an economic sense. But the
market rate determined only by the market place compensation survey .when the job evaluation
conflicts with market rate, the pay rate is determined by choosing the market rate amount. The
human resource department is responsible for administrating job evaluation program. However,
committees often perform actual evaluations. A typical committee might include the chief human
resource executive and representatives from other functional areas such as finance, production,
information technology and marketing. The committees have the responsibility of keeping
personalities out of the evaluation process and to remember it is the job that should be evaluated,
not the person performing the job. ( ibid , page 324 )

The four traditional method of job evaluation are the ranking, classification, factor comparison,
and point methods. The ranking and classification methods are non-quantitative whereas the
factor comparison and point method are quantitative approaches. We will see it in detail below.
(ibid)

A. RANKING METHOD

Among the four methods of job evaluation ranking method is the simplest among others. The
first step in this method is conducting job analysis and job description and then arranging the
jobs according to their value to the company in order. (ibid , page 325)

B. CLASSIFICATION METHOD

In this method the raters compare the job description with class description .in the classification
method jobs are defined in a group or classes. Class description reflects the difference between
groups of jobs at various difficulty levels. The class description that most closely agrees with the
job description determines the classification for that job. For example, the job description of the
word processing clerk is: entering data from the prepared drafts, deliver completed
correspondence to unit supervisor. If the other remaining job description of the word processing
clerk includes similar routine work, this job most likely to place in the lowest job class. ( ibid)

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C. FACTOR COMPARISON METHOD

In these method raters need not keep the entire job in mind as they evaluate it; instead, they make
decision on separate aspects or factors of the job. The five universal job factors in this method
are:

 Mental requirements, which reflect such as reasoning, intelligence and imagination.

 Skills
 A physical requirement, which evolves like sitting, standing, walking and so on.
 Responsibilities such as money, records and supervision.
 Working conditions which reflect environmental influences of noise, hazards e.t.c.

Ranking each of the selected bench mark jobs on the relative degree of difficulty of each of
the five factors is the first step that committee undertake secondly the committee allocates
the total pay rates for each job to each factor based on the importance of the respective factor
to the job .( ibid , page 325 – 326)

D. THE POINT METHOD

The point method requires selection of job factors according to the nature of the specific group
of jobs or jobs being evaluated .in this method the jobs divided into clusters like production
jobs , clerical jobs , and sales jobs . the first step of undertaking these method is determining
the job to be studied , conduct job analysis and write job description secondly the committee
selects and define the job factors to be used in measuring job value . Examples of job factors
are education, experience, job knowledge, responsibility and e.t.c. Thirdly the committee
establish the factor weight according to the relative importance in the job to be evaluated
.fourthly the committee determines the number of degree for each job factor and define
each degree . Degree represents the number of distinct levels associated with a particular factor.
In fifth step the committee determines the total number of points to be used in the plan. Here the
total points in the plan represent the maximum point that any job can receive. In the six step the
committee distributes point values to the job factor degrees. for example assume that the total
point given for the job is 500 point .and if the education factor have given with a percentage
of 50% this means the maximum point given for the factor of education having the degree
of 5 is 250 .( 50% multiplied with 500 point ) while the minimum point is 50 . In order

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to know the interval for the degree of the factor education we subtract the minimum
number of points from the maximum point and dividing by the number of degree used
minus 1 . This approach of determining the number of points for each degree is called
arithmetic progression. The next step involves preparing the job evaluation manual which
contains introductory section, factor and degree definition and job description. the final step
each job description in a job clusters with factors in the job evaluation manual .the job
evaluation manual is updated if when the job factors change , the weight assigned become
inappropriate or the plan become obsolete . Look the example for the point system below
(ibid, page 327)

Overview of the point system (500 - point system) - table 1

Degree of Factor
Job factor Weight 1 2 3 4 5
Education 50% 50 100 150 200 250
Responsibilit 30% 30 70 110 150
y
Physical 12% 12 24 36 48 60
effort
Working 8% 8 24 40
conditions
7.4 The employee as a determinant of financial compensation
In addition to the other mentioned factors above, factors related to the employee also determine
the pay equity. We will see the impact employee on the pay equity by clearly identifying the
following points : performance based pay , seniority , experience ,membership in the
organization . ( ibid , page 329)

A) Performance based pay : performance is determined by through performance

appraisal. Appraisal data provide the input for the merit pay, variable pay, skill based
pay, and competency based pay. Merit pay is a pay increase given to the employee based
on their level of performance. Variable pay is compensation based on the performance

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that helps for improving productivity. the most common type of the variable pay is the
bonus or lump sum payment : a one-time award that is not added to the employees
base pay . the skill based pay is the system that compensates employees on the basis
of the job related skills and the knowledge they possess , not for their job title . the
purpose of these pay is that to encourage employees to gain additional skill that will
increase their value to the organization and improve its competitive position .
competency based pay reward employees for their demonstrated expertise including
factors like motive , traits , values , attitude . While pay for performance focuses on end
results, competency based pay examines how an employee’s accomplishes the objective.
( ibid , page 330 - 332 )
B) Seniority
The length of time an employee has been associated with the company or job is called
seniority. Companies believe that the use of seniority provides an objective and fair basis
for pay increase. (ibid, 332)
C) Experience
An experience has a potential for enhancing a person’s ability to perform regardless of
the nature of the job if the experience acquired is positive. The person who did job in
autocrat way cannot be said as having a positive experience. ( ibid , page 333)

D) Membership in the organization : These rewards are provided to all employees

simply because they are members of the organization. it helps for the high level degree
of stability in the work force and recognize loyalty . ( ibid)
E) Special employee compensation: compensation for several employee groups has
special attention. These include compensation for the executive, professionals and sales
representative.( ibid , page 334 )
Compensation for executive: a company program for compensating executive is
critical factor in attracting and retaining the best available managers. the marketing
pricing is the best general approach to use in determining the executive pay for several
reason : such jobs are important to the organization and the people involved are highly
skilled and difficult to replace . ( ibid ,page 340 -341 )

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Compensation for professionals : a professional is any person who has received

special training of scientific or intellectual nature and whose jobs does not entail
supervisory responsibility for more than 20 percent of the time . Scientists and
engineers are included in this category. They paid high because of the knowledge they
bring to the organization.( ibid , page 334)
Compensation for the sales employees : sales employees compensated by the
organization in a three approach : straight salary approach , straight commission
approach and bonus approach . In a straight salary approach sales persons receive a
fixed salary regardless of the sales level. In the case of the straight commission the pay is
determined by totally as the percentage of sales. Here , if no sales no pay exists. in the
case of the bonus approach bonus is given for the employers for additional
productivity performed . ( ibid ,page 335)

8. Compensation Fairness and Equity

Most people in organizations work to gain money for their efforts (Robert L. Mathis and John H.
Jackson Human Resource Management, 13th Edition p 366). Whether employees receive base
pay or variable pay, the extent to which they perceive their compensation to be fair often affects
their performance, how they view their jobs, and their employers. This factor may lead to lower
or higher turnover rates. Pay satisfaction also has been found to be linked to organizational level
performance outcomes.
Equity The perceived fairness of what a person does (inputs) and what the person receives
(outcomes) is called equity.
Pay equity is the idea that pays for jobs requiring comparable levels of knowledge, skill, and
ability should be similar, even if actual duties differ significantly. This theory has also been
called comparable worth in earlier cases. A major reason for the development of the pay equity
idea is the continuing gap between the earnings of women and men. For instance, in 1980, the
average annual pay of full-time female workers was 60% of that of full-time male workers. By
2008, the reported rate of about 80% showed some progress but a continuing disparity (Robert L.
Mathis and John H. Jackson Human Resource Management, 13th Edition p 83). Individuals
judge equity in compensation by comparing their input (effort and performance) against the
effort and performance of others and against the outcomes (the rewards received). These

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comparisons are personal and are based on individual perceptions, not just facts. External
Equity If an employer does not provide pay that employees view as equitable compared to other
employees performing similar jobs in other organizations, that employer is likely to experience
higher turnover. Another drawback is greater difficulty in recruiting qualified and high-demand
individuals.
By not being competitive, the employer is more likely to attract and retain individuals with less
knowledge and fewer skills and abilities, resulting in lower overall organizational performance.
Organizations track external equity by using pay surveys, which are discussed later in this
chapter, and by looking at the compensation policies of competing employers.
Internal Equity in Compensation Internal equity means that employees receive compensation
in relation to the knowledge, skills, and abilities (KSAs) they use in their jobs, as well as their
responsibilities and accomplishments. Two key issues—procedural justice and distributive
justice—relate to internal equity
Procedural justice is the perceived fairness of the process and procedures used to make
decisions about employees, including their pay. As it applies to compensation, the entire process
of determining base pay for jobs, allocating pay increases, and measuring performance must be
perceived as fair.
A related issue that must be considered is distributive justice, which is the perceived fairness in
the distribution of outcomes. As one example, if a hardworking employee whose performance is
outstanding receives the same across-the-board raise as an employee with attendance problems
and mediocre performance, then inequity may be perceived. Likewise, if two employees have
similar performance records but one receives a significantly greater pay raise, the other may
perceive an inequity due to supervisory favoritism or other factors not related to the job.
To address concerns about both types of justice, some organizations establish compensation
appeals procedures. Typically, employees are encouraged to contact the HR department after
discussing their concerns with their immediate supervisors and managers.
Pay Secrecy Another equity issue concerns the degree of secrecy that organizations have
regarding their pay systems. Pay information that may be kept secret in “closed” systems
includes how much others make, what raises others have received, and even what pay grades and
ranges exist in the organization.

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Some firms have policies that prohibit employees from discussing their pay with other
employees, and violations of these policies can lead to disciplinary action. Several court
decisions have ruled that these policies violate the National Labor Relations Act, but many
employees simply avoid discussing pay with coworkers because it can make the workplace
uncomfortable
9. Wage and Salary Administration
The development, implementation, and ongoing maintenance of a base pay system usually is
described as wage and salary administration. The purpose of wage and salary administration is
to provide pay that is both competitive and equitable. Underlying the administered activities are
pay policies that set the overall direction of pay within the organization.
Pay Policies; Organizations must develop policies as general guidelines to provide for
coordination, consistency, and fairness in compensating employees. The pay policies are an
outgrowth of the answers to the compensation philosophy issues discussed earlier. For example,
following a pay-for-performance philosophy requires incorporating performance appraisal results
into the pay adjustment process. However more entitlement-oriented philosophy will require
developing policies in automatic step increases based on length of service for hourly employees.
Some questions about pay policy organizations must address. (Mathis & Jackson, 13th edition)

10.Global compensation issues

All of the issues discussed here can become more complex when dealing with global
compensation. The growing world economy has led to many more employees working
internationally. Some are located and work in multiple countries, while others may be based in a
home country such as the Ethiopia or other country, but have international responsibilities.
Therefore, organizations with employees working throughout the world face some special
compensation issues.
Variations in laws, living costs, tax policies, and other factors all must be considered in
establishing the compensation for local employees and managers, as well as managers and
professionals brought in from other countries.

Even fluctuations in the values of various currencies must be tracked and adjustments made as
the currency’s rise or fall in relation to currency rates in other countries.

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With these and numerous other concerns, developing and managing a global compensation
system becomes extremely complex.
The components of one possible global compensation package are illustrated in the following
figure.

Figure 6 possible components of global employee compensation

One significant global issue in compensation design is how to compensate the employees from
different countries. Local wage scales vary significantly between countries. For instance, in some
less-developed countries, pay levels for degreed professionals may range from $15,000 to
$30,000 a year, whereas in Europe and the United States, individuals with the same
qualifications are paid $50,000 to $80,000 a year. Lower-skilled local workers may make as little
as $300 a month in less-developed countries, whereas comparable employees make $1,800 to
$2,500 a month in the United States and Europe. These large compensation differences have led
to significant “international outsourcing” of jobs to lower-wage countries. The movement of call-
center and information technology (IT) jobs to India and manufacturing jobs to China, the
Philippines, and Mexico are examples.
Many organizations have started to globalize many of their pay policies in order to attract and
retain the talent located within the footprint of global operations.

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This process requires custom-tailoring of the compensation approach to suit the needs of the
central organization, while providing the proper incentives and benefits to drive motivation at
local units.
For instance, Cox Communications developed a variable pay framework that provides flexibility
to HR professionals to customize compensation policies to fit the needs of local worksites, and
while this program is used domestically, it serves as a positive benchmark for other international
companies.
Total rewards also can be used to motivate employees in diverse global environments because
HR professionals can combine packages with the best practices of other nations to develop
appropriate compensation strategies.(Robert L. Mathis &John H. Jackson, 2010, p.370-371)

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