II Shreeram II

Module 2

Compensation Planning

Meaning and Definition of compensation

Concept of Compensation

The literal meaning of compensation is to counter-balance. In the case of human resource

management, compensation is referred to as money and other benefits received by an
employee for providing services to his employer. Money and benefits received may be in
different forms-base compensation in money fonn and various benefits, which may be
associated with employee's service to the employer like provident fund, gratuity, insurance
scheme and any other payment which the employee receives or benefits he enjoys in lieu of
such payment. Cascio has defined compensation as follows:

"Compensation includes direct cash payments, indirect payments in the form of employee
benefits and incentives to motivate employees to strive for higher levels of productivity”

Based on above description of compensation, we may identify its various components as

follows:

Components of compensation

1. Wage and Salary: Wage and salary are the most important component of compensation
and these are essential irrespective of the type of organisation. Wage is referred to as
remuneration to workers particularly, hourly-rated payment. Salary refers to as
remuneration paid to white-collar employees including managerial personnel. Wages
and salary are paid on the basis of fixed period of time and normally not associated with
productivity of an employee at a particular time.
2. Incentives: Incentives are the additional payment to employees besides the payment of
wages and salaries. Often these are linked with productivity, either in terms of higher
production or cost saving or both. These incentives may be given on individual basis or
group basis.
3. Fringe Benefits: Fringe benefits include such benefits which are provided to the
employees either having long-term impact like provident fund, gratuity, pension; or
occurrence of certain events like medical benefits, accident relief, health and life
insurance; or facilitation in performance of job like uniforms, Canteens, recreation, etc.
4. Perquisites: These are normally provided to managerial personnel either to facilitate
their job performance or to retain them in the organisation. Such perquisites include
company car, club membership, free residential accommodation, paid holiday trips,
stock options, etc.
Objectives of Compensation Management

The basic objective of compensation management can be briefly termed as meeting the needs of
both employees and the organisation. Since both these needs emerge from different sources, often,
there is a conflict between the two. This conflict can be understood by agency theory which explains
relationship between employees and employers.

The employers want to pay as little as possible to keep their costs low. Employees want to get as
high as possible. The compensation management tries to strike a balance between these two with
following specific objectives:

1. Attracting and Retaining employees: From organisation's point of view, the compensation
management aims at attracting and retaining right personnel in the organisation. In the
Indian corporate scene, there is no dirth of personnel at operative levels but the problems
come at the managerial and technical levels particularly for growing companies. Not only
they require persons who are well qualified but they are also retained in the organisation.
In the present day context, managerial turnover is a big problem particularly in high
knowledge-based organisations.
2. Motivating employees:
Compensation management aims at motivating personnel for higher productivity. Monetary
compensation has its own limitations in motivating people for superior performance though
to some extent it definitely motivates to work harder.

3. Optimising Cost of Compensation:

Compensation management aims at optimising cost of compensation by establishing some
kind of linkage with performance and compensation. It is not necessary that higher level of
wages and salaries will bring higher performance automatically but depends on the kind of
linkage that is established between performance and wages and salaries. Compensation
management tries to attempt at this.

4. Consistency in Compensation:
Compensation management tries to achieve consistency-both internal and external-in
compensating employees.
Internal consistency involves payment on the basis of criticality of jobs and employees'
performance on jobs. Thus, higher compensation is attached to higher-level jobs. Similarly,
higher compensation is attached to higher performers in the same job.

Linkage to Job Evaluation

Level of jobs within an organisation is determined by job evaluation.
External consistency involves similar compensation for a job in all organisations. Though
there are many factors involved in the determination of wage and salary structure for a job
in an organisation which may result into some kind of disparity in the compensation of a
particular job as compared to other organisations, compensation management tries to
reduce this disparity.
Compensation Management Process

In order to achieve the objectives of compensation management, it should proceed as a process.

This process has various sequential steps as shown:

Organisation’s strategy

Compensation policy

Job analysis and evaluation

Analysis of contingent factors

Design and implementation of compensation plan

Evaluation and review

1. Organisation's Strategy:
Organisation's overall strategy is the starting point in the total human resource
management process including compensation management.

Companies operating in different types of market/product having varying level of maturity,

adopt different strategies and matching compensation strategy and blend of different
compensation methods.

Thus, it can be seen that organisations follow different strategies in different market
situations and align their compensation strategy and contents with these strategies.

In a growing market, an organisation can expand its business through internal expansion
or takeover and merger of other organisations in the same line of business or a
combination of both. In such a growing market, the inputs, particularly human resources,
do not grow in the same proportion as the business expands. Therefore, in order to make
the growth strategy successful, the organisation has to pay high cash to attract talents.

In mature market, the organisation does not grow through additional investment but
stabilises and the growth comes through making the present investment more effective,
known as learning curve growth. In such a situation, average cash and moderate incentives
may work.

In the declining market, the organisation must harvest profit through cash generation and
cost cutting and if this cannot be sustained over the long run, the possible retrenchment of
business to invest somewhere else. In such a case, compensation strategy involves cost
control with below average cash and incentive payment.
2. Compensation Policy:

Compensation policy is derived from organisational strategy and its policy on overall
human resource management.

In order to make compensation management to work effectively, the organisation should

clearly specify its compensation policy, which must include the basis for determining base
compensation, incentives and benefits and various types of perquisites to various levels of
employees.

The policy should be linked with the organisational philosophy on human resources and
strategy. Besides, many external factors which impinge on the policy must also be taken
care of Job Analysis and Evaluation.

3. Job Evaluation

The relative worth of various jobs determines the compensation package attached with
each job. Job Analysis and Evaluation.

Job analysis provides basis for defining job description and job specification with the
former dealing with various characteristics and responsibilities involved in a job and the
latter dealing with qualities and skills required in job performer.

The relative worth of various jobs determines the compensation package attached with
each job and job family and the unique worth of the job role.

4. Analysis of Contingent Factors:

Compensation plan is always formulated in the light of various factors, both external and
internal, which affect the operation of human resource management system.

Various external factors are conditions of human resource market, cost of living, level of
economic development, social factors, pressure of trade unions and various labour laws
dealing with compensation management.

Various internal factors are organisation's ability to pay and employees' related factors
such as work performance, seniority, skills, job family etc.

5. Design and Implementation of Compensation Plan:

After going through the above steps, the organisation may be able to design its
compensation plan incorporating base compensation with provision of wage/salary
increase over the period of time, various incentive plans, benefits and perquisites.

Sometimes, these are determined by external party, for example, pay commissions for
Government employees as well as for public sector enterprises. After designing the
compensation plan, it is implemented. Implementation of compensation plan requires its
communication to employees and putting this into practice.
6. Evaluation and Review:

A compensation plan is not a rigid and fixed one but is dynamic since it is affected by a
variety of factors which are dynamic.

Therefore, compensation management should have a provision for evaluating and

reviewing the compensation plan. After implementation of the plan, it will generate results
either in terms of intervening variables like employee satisfaction and morale or in terms
of end-result variable like increase of productivity. However, this latter variable is more
important.

The evaluation of compensation plan must be done in this light. If it does not work as
intended, there should be review of the plan necessitating a fresh look.
Determinants of compensation

In India, compensation determination involves a combination of factors, including market

practices, legal regulations, industry standards, and individual performance:

 Job role and responsibilities

 Industry and market trends

 Geographical location

 Company size and financial health

 Experience and expertise

 Education and qualifications

 Performance and contributions

 Legal and regulatory factors (mentioned in the above sections)

 Gender equality and non-discrimination

 Collective bargaining and industry standards

 Benefits and perks

 Inflation and economic conditions

Steps in Determination of compensation

The Factors Affecting Compensation

Compensation is one of HR's most important responsibilities. It connects their role directly
to the company's finances and the organization's performance. Compensation is also one
of the biggest areas of dispute between employees and employers, and for a good reason.
Both have much to gain or lose when it comes to compensation.

1. Worker Productivity & Value To The Organization

The main reason that different jobs have different pay rates is that certain workers are
more necessary than others to achieve the organization's goals. Productivity refers to how
much additional value employees provide to the organization by doing their job. A more
productive individual in a more productive role will have an overall higher pay rate.

2. Employer's Ability To Pay

One overlooked factor determining pay rates is how much an employer can actually pay!
An employer can only spend what they can afford. If an employer cannot pay the
employee what they can get elsewhere, the employee will work elsewhere.

3. Labor Union Requirements

Labor union representatives negotiate on behalf of their members to agree to a fair rate of
pay. Employers that hire members of unions may be required to pay the rate set by the
union. These rates may depend on many factors, such as seniority and location.

4. Prevailing Wage Rates

Prevailing wage refers to the going rate of labor for a given profession in a given
geographical area. In some cases, prevailing wages are set by various pieces of legislation,
such as the Davis-Bacon Act and Service Contract Act, to determine how much government
contractors must pay their employees.

5. Cost of Living (COL)

Every location has a different cost of living. If a worker cannot sustain themselves working
a job, they are likely not to work that job. Some areas have higher average wages simply
because their living costs are so high. For example, an employee who might make INR 3
Lakhs a year in Nagpur City might expect to make INR 6 Lakhs in Mumbai simply because
of the disparity in the cost of living.

6. Labor Supply And Labor Demand

In 2022, we have faced a labor shortage. Due to the COVID-19 pandemic and the shift
toward work-from-home, many workers left jobs in specific industries for other jobs that
paid better and offered better benefits. As a result, jobs in those industries have had to
increase their compensation.
7. Government Controls

Several different pieces of legislation can affect how much a company must pay its
employees. The most relevant for many companies is the minimum wage, however, some
laws require additional pay for various reasons. This varies widely by state.

8. Globalization

Globalization and the Internet have made it possible for companies to get work done in
other countries where the cost of living and labor costs are much lower. Regardless of
one's stance on the issue, globalization impacts compensation in many ways. First, it
causes jobs that can easily be outsourced to be compensated at a lower rate locally.
Second, it changes local labor demands, as some labor cannot be outsourced.

Challenges to Compensation Management

Compensation Management is not only an HR issue, rather a business process. There are
multiple challenges which are involved in managing compensation. Some of the major
challenges faced by compensation management executives are as follows:-

Multiplicity of Compensation System:- In India, Many organization employ temporary as

well as permanent employees. The former are basically employed for employment,
flexibility and they are mostly paid indirectly through agencies such as labour contracts.
They are paid minimum wages according to their skill set.

Inequity prevails between permanent and temporary employees in terms of

compensation structure and level. For e.g.:- a carpenter who is a permanent employ may
be paid Rs 20000 per month whereas he may be only paid Rs 12000 per month, if he is
employed on temporary basis. This leads to multiple compensation mechanism which are
difficult to design & administer effectiveness, social justice & equity. It is important to
dispense duality of structure level & systems.

Compensation is wider concept than only salary and wages

Unlike common belief which states that compensation an only means salary or wages, it is
a much wider concept. It includes all monetary as well as non-monetary components.
Because of this misconception, organizations mostly end up focusing only on economic
parameters of employee compensation other vital components such as promotion;
assignments & appreciation are often neglected. Thus, organization must focus on
developing reward systems that cater to social, physical & psychological needs of
individual employees.

Cultural Issues:-

Cultural issues & warns have a direct impact on compensation management.

Compensation is considered as a matter of economics in some cultures whereas in meeting
psychological economic & social needs of the employees.
MNC's have to manage their compensation by considering norms of both home & parent
country. Thus, It becomes a herculean task for companies.

Challenges in International Pay Systems:

Organizations that comprises of work forces from different nationalities face challenges in
relation to compensation and reward in each of the operating countries. Gradually,
international compensation systems are growing complex due to new issues creeping in
day by day, and HR manager find it difficult to apply local compensation practices and also
are not able to fully apply standardized frameworks.
 Module 2.2
Wage Administration