compensation.ppt

TOTAL COMPENSATION
The package of quantifiable returns an
employee receives for his or her labors.
Elements of Total Compensation
Total
Compensation
Pay
Incentives
Indirect
Compensation/
Benefits
Base
Compensation

The relative proportion of each element (known as
the pay mix) varies extensively by firm.
Generally, the largest element of total compensation is base
compensation, the fixed pay an employee receives on a
regular basis. (E.g. monthly paycheck)
Another component of total compensation is pay incentives,
which are programs designed to reward employees for good
performance. (E.g. Bonus or profit sharing)

Benefits is the final component, also called as indirect
compensation. (E.g. health insurance, pension)
A special category of benefits called perquisites or perks,
are available only to employees with some special status
in the organization, usually upper-level managers.
Common perks are company car, special parking space
etc.

The effectiveness with which compensation is allocated
can make a significant difference in gaining or losing a
competitive edge.
E.g. A high tech firm that provides generous
compensation to managerial and marketing personnel
but underpays its research and development staff may
lose its ability to innovate because competitors
constantly pirate away its best talent.
Thus, how much is paid and who gets paid what are
crucial strategic issues for the firm.

Importance of Compensation
Compensation is often considered a reflection of an
individual’s power, prestige, and worth. Compensation
affects a person economically, sociologically, and
psychologically.
For this reason, mishandling compensation issues is
likely to have a strong negative impact on employees
and, ultimately, on the firm’s performance.
The wide variety of pay policies and procedures presents
managers with two challenges: to design a compensation
system, that
1. Enables the firm to achieve its strategic objectives and
2. Is molded to the firm’s unique characteristics and
environment.

The Nine Criteria for Developing a Compensation
Plan
1. Internal versus External Equity
Will the compensation plan be perceived as fair within the
company, or will it be perceived as fair relative to what other
employers are paying for the same type of labor? Fair pay is
considered to be equitable.
2. Fixed versus Variable Pay
Will compensation be paid monthly on a fixed basis —through
base salaries —or will it fluctuate depending on such pre-
established criteria as performance and company profits?
Variable pay can take many forms- individual bonus, team bonus,
profit sharing and stock ownership programs.

3. Performance versus Membership
Will compensation emphasize performance and tie pay
to individual or group contributions (E.g. giving cost-
saving suggestion), or will it emphasize membership in
the organization —logging in a prescribed number of
hours each week and progressing up the organizational
ladder?
4. Job versus Individual Pay
Will compensation be based on how the company values
a particular job, or will it be based on how much skill
and knowledge an employee brings to that job?
Rather than basing pay on a narrowly defined job,
organizations may choose to emphasize an individual’s
abilities, potential, and flexibility to perform multiple
tasks in setting his or her pay

5. Egalitarianism versus Elitism
Will the compensation plan place most employees under the
same compensation system (egalitarianism), or will it
establish different plans by organizational level and/or
employee group (elitism)?
E.g. At Ben & Jerry’s, the compensation system is linked to
company prosperity. When the company does well, everyone
does well. The profit-sharing plan awards the same
percentage to all employees, from the top to the bottom.
The trend in recent years has been toward more egalitarian
compensation systems. This is because, it would give a focus
on more joint task accomplishment, more consultation
between juniors and seniors, and better cooperation among
employees.

6. Below-Market versus Above-Market Compensation
Will employees be compensated at below-market levels,
at market levels, or at above-market levels?
The decision to pay above market for all employee
groups allows the firm to hire the “ cream of the crop”,
minimize voluntary turnover, and create a climate that
makes all employees feel they are part of an elite
organization. E.g. Microsoft, P&G.
However, few companies can afford such a policy.
Instead, most firms recognize the importance of certain groups
explicitly by paying them above market and cover these costs by
paying other groups below market.

7. Monetary versus Non-monetary Awards
Will the compensation plan emphasize motivating
employees through monetary rewards like pay and stock
options, or will it stress non-monetary rewards such as
interesting work and job security?
E.g. Amway emphasizes on monetary awards and
Southwest Airlines on Non-monetary awards.
8. Open versus Secret Pay
Will employees have access to information about other
workers’ compensation levels and how compensation
decisions are made (open pay) or will this knowledge be
withheld from employees (secret pay)?
Open Pay has two advantages: 1. People will not
overestimate other’s pay. 2. Forces managers to be more
fair.

9. Centralization versus Decentralization of Pay Decisions
Organizations must decide where pay decisions will be
made. Will compensation decisions be made in a tightly
controlled central location, or will they be delegated to
managers of the firm’s units?
Large and diversified organizations are better served by a
decentralized pay system. E.g. Mars, a worldwide leader
in the candy market, has only two HR people at corporate
headquarters. Each Mars unit is responsible for its own
pay decisions. This system is part of Mars’s HR resource
strategy to minimize corporate wide rules, regulations,
and red tape.

Compensation Tools
The goal of all these tools is to produce pay systems that
are equitable and that allow the firm to attract, retain,
and motivate workers while keeping labor costs under
control.
Two approaches- Job-based approaches and skill-based
approaches.

When to Use a Job-based Pay Policy
A job-based pay policy tends to work best in situations
where:
1. Technology is stable
2. Employees do not need to cover for one another
frequently
3. Much training is required to learn a given job
4. Turnover is relatively low
5. Employees are expected to move up through the
ranks over time
6. Jobs are fairly standardized within the industry

Job-based Compensation Plans
•Achieving Internal Equity: Job Evaluation
•Achieving External Equity: Market Surveys
•Achieving Individual Equity

© 1998 by Prentice Hall
1. Job Analysis
Job Evaluation for
Internal Equity
2. Job Descriptions
Identify
Compensable Factors
3. Job Specifications
4. Rate Worth of All Jobs
Using a Predetermined
System
5. Job Hierarchy
7. Establish Final Pay
Policy
Individual Pay
Assignment
6. Classify Jobs by
Grade Levels
1. Check Market Value
Using Benchmark or Key
Jobs
Market Surveys for
External Equity
Within-Pay-Range
Positioning Criteria
for Individual Equity
Criteria for Pay
Positioning Within
Range for Each Job
• Experience
• Seniority
• Performance
(Work related criteria
that is valued. E.g.
knowledge)

Pay Structure of a Large Restaurant Developed Using a
Job-Based Approach
Jobs
Number of
Positions Pay
GRADE 6
GRADE 5
GRADE 4
GRADE 3
GRADE 2
GRADE 1
Chef
Manager
Sous-Chef
Assistant Manager
Lead Cook
Office Manager
General Cook
Short Order Cook
Assistant to Lead Cook
Clerk
Server
Hostess
Cashier
Kitchen Helper
Dishwasher
Janitor
Busser
Security Guard
2
1
1
2
2
1
5
2
2
1
45
4
4
2
3
2
6
2
$20.00-$31.00/hr.
$11.50-$21/hr.
$7.50-$12.00/hr.
$6.50-$8.00/hr.
$6.00-$7.00/hr.
$5.50-$6.25/hr.

Skill- Based Compensation Plans
In this compensation plan, skills are used as basis for
compensation. All employees start at the same pay rate and
advance one pay level for each new skill they master.
Three types of skills may be rewarded:
1. Employees acquire depth skills when they learn more about a
specialized area or become expert in a given field.
2. They acquire horizontal or breadth skills when they learn more
and more jobs or tasks within the firm.
3. Vertical skills when they acquire “self management abilities”
such as coordinating, leadership.
E.g. AT&T (telecom), Embassy Suites (hotel) adopt skill-based
compensation plan.

Skill-based compensation offers advantages to firms:
1. It creates a more specific workforce that is not straight
jacketed by job descriptions specifying work
assignments for a given job title.
2. It promotes cross-training, thus preventing absenteeism
and turnover from disrupting the work unit’s ability to
meet deadlines.
3. It calls for fewer supervisors, so management layers can
be cut to produce a leaner organization.
4. It increases employees’ control over their compensation
because they know in advance what it takes to receive a
pay raise (learning new skills)

Skill-based pay poses some risks and that’s why it is the
choice of small portion (5 to 7%) of all firms.
1. Higher compensation and training costs; this is because
once employees master many skills they’ll expect more
pay than they would under job-based system.
2. Employees need to be given opportunity to utilize learnt
skills.

Contemporary Trends in Compensation
1. Broadbanding-The practice of using fewer pay grades
having broader pay ranges that in traditional systems.
Advantages
1. more consistent with downsized, flatter
organizational structures
2. breaks down previous structural pay barriers among
jobs to facilitate empowerment, teamwork, etc.
3. greater flexibility; more useful managerial tool
Disadvantages
1. traditional cost control in pay structure is lost
2. possibly more difficult to communicate to employees

2. Pay for Performance Systems
Pay-for-performance systems, also called incentive
systems, reward employee performance on the basis of
three assumptions:
1. Individual employees and work teams differ in how
much they contribute to the firm—not only in what
they do, but also in how well they do it.
2. The firm’s overall performance depends to a large
degree on the performance of individuals and
groups within the firm.
3. To attract, retain, and motivate high performers
and to be fair to all employees, a company needs to
reward employees on the basis of their relative
performance.

Pay for Performance: The Challenges
1. The “Do Only What You Get Paid For” Syndrome
The closer pay is tied to particular performance indicators,
the more employees tend to focus on those indicators
and neglect other important job components
2. Negative Effects on the Spirit of Cooperation
Employees may withhold information from a colleague if
they believe that it will help the other person get ahead
3. Lack of Control
Employees often cannot control all of the factors affecting
their performance

4. Difficulties in Measuring Performance
Assessing employee performance is one of the thorniest
tasks a manager faces, particularly when the
assessments are used to dispense rewards
5. Psychological Contracts
Once implemented, a pay-for-performance system
creates a psychological contract between the
employee and firm, and it is very resistant to change
6. The Credibility Gap
Employees often do not believe that pay-for-
performance programs are fair or that they truly
reward performance

Meeting the Challenges of Pay for Performance Systems
1. Link Pay and Performance Appropriately
There are few cases in which managers can justify paying
workers according to a pre-established formula or
measure.
Traditional piece-rate system, in which workers are paid
per unit produced, represent the tightest link between pay
and performance. Primary requirement is that the
employee has complete control over the speed and quality
of the work.
E.g. it is appropriate to pay a typist according to number of
pages typed; but what if the same profile handles other
responsibilities such as, handling phone calls?

2.Use Pay for Performance as Part of a Broader HRM
System
Pay-for-performance programs are not likely to
achieve the desired results unless they are
accompanied by complementary HRM programs
E.g. performance appraisals and supervisory training
usually play a major role in the eventual success or
failure of a pay for performance plan

3. Use Multiple Layers of Rewards
Because all pay-for-performance systems have positive
and negative features, providing different types of pay
incentives for different work situations is likely to
produce better results than relying on a single type of
pay incentive.
E.g. AT&T Credit, variable pay (in form of bonus) is
based on 12 measures reflecting the performance of both
regional teams and the entire business unit. Team
members must meet their individual performance goals
to qualify for variable pay.

Pay-for-Performance Programs
Microlevel
Merit pay
Bonuses
Awards
Piece rate
Individual Team
Macrolevel
Business Unit/Plant Organization
Bonuses
Awards
Gainsharing
Bonuses
Awards
Profit sharing
Stock plans
Unit of Analysis

Merit Pay Program (merit raise)
Links an increase in base pay to how successfully an
employee achieved some objective performance
standard.
Individual bonus programs (Lump-sum Merit Program)
Program under which employees receive a year-end
merit payment, which is not added to their base pay.
Advantages
•Provides financial control by maintaining annual
salary expenses and not escalating base salary levels
•Bonuses can be given outside the annual review
cycle
Awards, like bonuses, are one time rewards, but tend to be given
in the form of a tangible prize, such as paid vacation or dinner
at a fancy restaurant etc.

PIECEWORK
Straight Piecework
Pay is determined by multiplying the number of units
produced [such as garments sewn or customers contacted] by
the piece rate for one unit. The rate for each piece does not
change regardless of the number of pieces produced
Differential Piece Rate
This system pays employees one piece-rate wage if they
produce less than a standard output and a higher piece-rate if
they produce more than the standard.

Gain-sharing Plans
Programs under which both employees and the
organization share the financial gains according to a
predetermined formula that reflects improved
productivity and profitability.
Scanlon Plan- Rewards come from employee participation in
improving productivity and reducing costs. A committee is
formed to generate cost saving ideas. If actual labor costs are
lower than expected labor costs over an agreed-upon period, the
difference is shared.
Improshare- Gain-sharing based on increases in productivity of
the standard hour output of work teams.

Profit Sharing
Profit sharing is rewarding employees based on the
entire corporation’s performance.
In this program, no attempt is made to reward workers
for productivity improvements. Many factors that can
affect profits (such as luck, regulatory changes, and
economic conditions) have little to do with productivity,
and the amount of money employees receive depends on
all of these factors.
Employee Stock Ownership plan (ESOP)
A company wide pay for performance plan that rewards employees
with company stocks, either as an outright grant or at a favourable
price that may be below market value.

Benefit- An indirect reward given to an employee or group
of employees as a part of organizational membership.
Fringe Benefits- Benefits were labeled fringe because they
were relatively insignificant or fringe components of
compensation. However they are gaining popularity. They
are usually paid to all employees (unlike incentives which
are paid to specific employees whose work is above
standard) based on their membership in the organization.
Types:
Payment for time not worked
Employee security
Health benefits
Recreational facilities
Retirement benefits

Perquisites- Special benefits given to executives, often
referred to as perks.

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