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Compensation management

1. Compensation Management Defined

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. 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 organization and its stakeholders. Reward

can be regarded as the fundamental expression of the employment relationship.

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:

Wage and Salary: Wage and salary are the most important component of

compensation and these are essential irrespective of the type of organization. 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.

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.

Fringe Benefits: Fringe benefits include such benefits which are provided to the

employees either having long-term impact like provident fund, gratuity, pension; or 1

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occurrence of certain events like medical benefits, accident relief, health and life

insurance; or facilitation in performance of job like uniforms, Canteens, recreation,

etc.

Perquisites: These are normally provided to managerial personnel either to facilitate

their job performance or to retain them in the organization. Such perquisites include

company car, club membership, free residential accommodation, paid holiday trips,

stock options, etc.

2. Objectives in compensation management

Acquire qualified personnel.

Compensation needs to be high enough to attract applicants. Pay levels must

respond to the supply and demand of workers in the labor market since

employers compete for workers. Premium wages are sometimes needed to

attract applicants already working for others.

Retain current employees.

Employees may quit when compensation levels are not competitive, resulting

in higher turnover.

Ensure equity.

Compensation management strives for internal and external equity. Internal

equity requires that pay be related to the relative worth of a job so that similar

jobs get similar pay. External equity means paying workers what comparable

workers are paid by other firms in the labor market.

Reward desired behavior.

Pay should reinforce desired behaviors and act as an incentive for those

behaviors to occur in the future. Effective compensation plans reward

performance, loyalty, experience, responsibility, and other behaviors.

Control costs.

A rational compensation system helps the organization obtain and retain

workers at a reasonable cost. Without effective compensation management,

workers could be overpaid or underpaid.

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Comply with legal regulations.

A sound wage and salary system considers the legal challenges imposed by

the government and ensures the employer's compliance.

Relevant legal regulations imposed by the government include followings.

o The Shop and Office Employees (Regulation of employment & remuneration)

Act

o Wages Board Ordinance

o Employees provident Fund

o Employees Trust Fund

o Payment of Gratuity Act

o Factories Ordinance

o Workmen’s Compensation Ordinance

o Industrial Disputes Act

o Termination of Employment (Special provisions) Act

o Trade Union Ordinance

o Employment of Women, Young Persons and Children Act

o Maternity Benefits Ordinance

For example, by ensuring that the organization’s compensation packages meet the minimum

wage requirements as shown below etc.., the organization can prove the employer’s

compliance.

 Industry Worker Category Minimum wages 

Plantation Sector    380 per day

  Plus Attendance Bonus 105 per day

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  Plus productivity incentive 30 per day

 Industrial Sector Unskilled 6500-7500 per month

  Semi Skilled 7000-8000 per month

  Skilled 7500-9500 per month

Service Sector  Unskilled 6500-7500 per month

  Semi Skilled 7500-8000 per month

  Skilled 8400-9500 per month

o Overtime is paid at One and Half times the normal hourly rate of wage.

o Holiday pay for work on weekends (Sundays) and public holidays is paid for

at a higher rate 1 1/2 times the daily rate or double the rate of remuneration.

o Bonuses e.g. project, attendance, festival would vary from company to

company. There is no statule law sourning these payments

3. Importance of a compensation system

A fair compensation system will help in the following:

o An ideal compensation system will have positive impact on the efficiency and results

produced by employees. It will encourage the employees to perform better and

achieve the standards fixed.

o It will enhance the process of job evaluation. It will also help in setting up an ideal job

evaluation and the set standards would be more realistic and achievable.

o Such a system should be well defined and uniform. It will be apply to all the levels of

the organization as a general system.

o The system should be simple and flexible so that every employee would be able to

compute his own compensation receivable.

o It should be easy to implement, should not result in exploitation of workers.

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o It will raise the morale, efficiency and cooperation among the workers. It, being just

and fair would provide satisfaction to the workers.

o Such system would help management in complying with the various labor acts.

o Such system should also solve disputes between the employee union and

management.

o The system should follow the management principle of equal pay.

o It should motivate and encouragement those who perform better and should provide

opportunities for those who wish to excel.

o Sound Compensation/Reward System brings peace in the relationship of employer

and employees.

o It aims at creating a healthy competition among them and encourages employees to

work hard and efficiently.

o The system provides growth and advancement opportunities to the deserving

employees.

o The perfect compensation system provides platform for happy and satisfied

workforce. This minimizes the labour turnover. The organization enjoys the stability.

o The organization is able to retain the best talent by providing them adequate

compensation thereby stopping them from switching over to another job.

o The business organization can think of expansion and growth if it has the support of

skillful, talented and happy workforce.

The sound compensation system is hallmark of organization’s success and prosperity. The

success and stability of organization is measured with pay-package it provides to its

employees.

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4. 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.

The processes and activities includes the following

4.1 Analyze business strategy and business needs

4.2 Develop HR strategy

4.3 Develop and justify Reward Strategy and define guideline principles

Reward strategy is a declaration of intent which defines what the organization wants to do in

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.

4.3.1 Content of Reward Strategy

Broad-brush reward strategy

A Broad-brush reward strategy may commit the organization to the pursuit of a total

reward policy. The basic aim might be to achieve an appropriate balance between

financial and non-financial rewards. This specifically elicits the employee behaviors

that the firm needs to support and to achieve its competitive strategy.

Additionally or alternatively, Reward Strategy may set out a list of specific

intentions dealing with particular aspects of reward management.

4.3.2 Components of an effective reward strategy

They have to have clearly defined goals and a well-defined link to business

objectives.

There have to be well-designed pay and reward programs, tailored to the needs of

the organization and its people, and consistent and integrated with one another.

Perhaps most important and most neglected, there needs to be effective and

supportive HR and reward processes in place.

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4.3.3 Reward guiding principles

Guiding principles define the approach an organization takes to deal with reward.

They are the basis for reward policies and provide guidelines for actions contained

in the reward strategy.

4.3.3.1 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;

Achieving equal pay;

The relative importance attached to external competitiveness and internal

equity;

The approach to total reward;

The scope for the use of contingent rewards relates to performance,

competence, contribution or skill;

The role of line managers:

Transparency- the publication of information on reward structures and

processes to employees

Example Reward policy issues may include;

Pay for performance

Pay for seniority

Salary increases and promotions

Overtime and shift pay

Probationary pay

Paid and unpaid leaves

Paid holidays

Geographic costs of living differences/ hardships

5. Total Reward

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5.1 Components of employee compensation

There two types of rewards; Financial (extrinsic) and Non-Financial (intrinsic). Porter and

Lawler suggest both are necessary for generating job satisfaction related to performance.

Financial rewards/ direct compensation

Direct compensation refers to monetary benefits offered and provided to employees in

return of the services they provide to the organization. The monetary benefits include

basic salary, house rent allowance, conveyance, leave travel allowance, medical

reimbursements, special allowances, bonus, Pf/Gratuity, etc. They are given at a regular

interval at a definite time.

Base Pay is a certain payment connected with a job, usually given on a time basis (hourly,

weekly, monthly or yearly). Variable Pay is dependent on performance of individual,

team or organisation and cannot become a part of the basic pay Employee Benefits are

made up of options like insurance, stock options, company cars, pension-schemes and

holidays.

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Basic Salary

Salary is the amount received by the employee in lieu of the work done by him/her for a

certain period say a day, a week, a month, etc. It is the money an employee receives from

his/her employer by rendering his/her services.

House Rent Allowance

Organizations either provide accommodations to its employees who are from

different state or country or they provide house rent allowances to its employees.

This is done to provide them social security and motivate them to work.

Conveyance

Organizations provide for cab facilities to their employees. Few organizations also

provide vehicles and petrol allowances to their employees to motivate them.

Leave Travel Allowance

These allowances are provided to retain the best talent in the organization. The employees

are given allowances to visit any place they wish with their families. The allowances are

scaled as per the position of employee in the organization.

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Medical Reimbursement

Organizations also look after the health conditions of their employees. The employees are

provided with medi-claims for them and their family members. These medi-claims

include health-insurances and treatment bills reimbursements.

Bonus

Bonus is paid to the employees during festive seasons to motivate them and provide them

the social security. The bonus amount usually amounts to one month’s salary of the

employee.

Special Allowance

Special allowance such as overtime, mobile allowances, meals, commissions, travel

expenses, reduced interest loans; insurance, club memberships, etc are provided to

employees to provide them social security and motivate them which improve the

organizational productivity.

Non Financial Rewards/ Indirect compensation

Indirect compensation refers to non-monetary benefits offered and provided to employees

in lieu of the services provided by them to the organization. They include Leave Policy,

Overtime Policy, Car policy, Hospitalization, Insurance, Leave travel Assistance Limits,

Retirement Benefits, Holiday Homes.

One of the most important aspects of intrinsic rewards is Job satisfaction. If a person is

not satisfied from what he does, his performance gets affected thus damaging the

performance of whole team and in turn, the organization.

Feedback and recognition; the praise and recognition given to an employee for any good

work is viewed positively and for some employees, existence of responsibility and

autonomy in their jobs is a form of intrinsic reward. Development, both at personal level

and career level are important forms on intrinsic rewards.

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Leave Policy

It is the right of employee to get adequate number of leave while working with the

organization. The organizations provide for paid leaves such as, casual leaves, medical

leaves (sick leave), and maternity leaves, statutory pay, etc.

Overtime Policy

Employees should be provided with the adequate allowances and facilities during their

overtime, if they happened to do so, such as transport facilities, overtime pay, etc.

Hospitalization

The employees should be provided allowances to get their regular check-ups, say at an

interval of one year. Even their dependents should be eligible for the medi-claims that

provide them emotional and social security.

Insurance

Organizations also provide for accidental insurance and life insurance for employees.

This gives them the emotional security and they feel themselves valued in the

organization.

Leave Travel

The employees are provided with leaves and travel allowances to go for holiday with their

families. Some organizations arrange for a tour for the employees of the organization.

This is usually done to make the employees stress free.

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Retirement Benefits

Organizations provide for pension plans and other benefits for their employees which

benefits them after they retire from the organization at the prescribed age.

Holiday Homes

Organizations provide for holiday homes and guest house for their employees at different

locations. These holiday homes are usually located in hill station and other most wanted

holiday spots. The organizations make sure that the employees do not face any kind of

difficulties during their stay in the guest house.

Flexible Timings

Organizations provide for flexible timings to the employees who cannot come to work

during normal shifts due to their personal problems and valid reasons.

5.2 The Wage Concept

There are three different concepts of wages: the minimum wage, the fair wage and the living

wage. The minimum wage is the least of them all and the living wage, the highest. Minimum

wage is the base wage that an employee has to be paid to fulfill his basic needs and provide

basic amenities for his family. The fair wage takes into consideration the paying capacity of

the employer.

The living wage, which is the highest of the three, is aimed at providing a comfortable living

for the employee and his family. It includes providing health, educational and social facilities.

Traditional wage plans include the piece-wage plan, based on the units produced by the

employee and the time-wage plan, based on the total working time of the employee. Modern

wage plans include skill-based wage plan, competency-based wage plan and broadbanding.

Wage differentials can be defined as the difference in wages paid for same or similar work

because of various reasons like differences in work schedules, hazards involved, cost of

living, or other factors.

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5.2.1 Factors Affecting Wages

On the basis of above discussion, we may summarise the factors affecting wage rates as

under:

Demand for and supply of labour: Demand and supply conditions of labour have

considerable influence on the determination of wage rates. If there is a short supply of

labour, the wages may be high whereas if there is no dearth of labour, the wages tend

to be low.

Labour unions: If the labourers are well organized into strong trade unions, their

bargaining power would be high and they can demand higher rates of wages. On the

other hand, if the labourers are not organized, the management may fix low wages.

Cost of living: The cost of living of workers also has a strong influence on the rate of

wages. If this factor is not considered, the labourers may not be in a position to make

both ends meet and this will affect their efficiency. Hence progressive employers

consider this factor also.

Prevailing wage rates: Prevailing wages in a particular industry are also taken into

account by the employers while deciding wage levels for their employees. By

considering the prevailing wage level, employers will come reasonable close to the

wage level of competitors, and this will enable them to retain and attract qualified

workers to the organizations.

Ability to pay: The wage level, to a large extent, is determined by the ability of the

enterprise to pay its workers. The ability to pay in turn is determined by the profit-

earning capacity of the enterprise.

Job requirements: Job requirements are also an important factor affecting wages.

Jobs requiring specialized knowledge or involving much mental or manual effort are

priced higher than those which are light or which do not need any specialized

knowledge.

State regulation: State regulation is another important factor influencing wage rtes.

As the State assumes responsibility for safeguarding the interest of citizens, it has to

step in to regulate the wage rates of labourers through legislative measures.

Increment system: In some organizations wages automatically increase annually at a

prescribed rate without any relation to workers’ performance. In some other

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organizations annual increases based on merit. Thus, the prevailing system of granting

increments also affects wages.

6. Requisites of sound primary compensation structure

Internal Equity

External equity and External competitiveness

Performance based payment: Individual equity

Equity issues can be addressed by different methods.

Job analysis and job evaluation can carry out to determine the worth of

each job in the organization to ensure internal equity is achieved.

Can conduct salary surveys to ensure external equity

Make sure individual equity is achieved by performance appraisal and

incentive pay

Proper two way communications, grievance mechanism and employee

participation further address the equity issues

6.1. Internal Equity and Job Evaluation

Internal Equity means that there should be proper relationship between the wages and salaries

of various positions within the enterprise. Mechanism we can use here is job evaluation. Job

valuation is a process of determining the relative worth of a job. It is a process which is

helpful even for framing compensation plans by the personnel manager. Therefore the main

objective of job evaluation is to have external and internal consistency in salary structure so

that inequalities in salaries are reduced.

6.1.1 Job Evaluation is Defined

International Labour Organisation (ILO) has defined job evaluation as follows:

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"Job evaluation is an attempt to determine and compare demands which the normal

performance of a particular job makes on normal workers without taking into account the

individual performance of the workers concerned"

The definition of job evaluation provided by ILO has been adopted by others. For example,

French has defined job evaluation as follows:

"Job evaluation is a process of determining the relative worth of the various jobs within the

organisation. so that differential wages may be paid to jobs of different worth. The relative

worth of a job means relative value produced. The variables which are assumed to be related

to value produced are such factors as responsibilities, skills, efforts and working conditions"

6.1.2 Advantages of Job evaluation

It is an objective and logical method of ranking jobs and removing unjust

differentials.

2. It helps in fitting new jobs at their appropriate plane in the existing wage

structure.

It improves labour- management relations by reducing grievances.

It establishes on objective and clear basis for wage bargaining.

It simplifies wages administration

It reveals the possibilities of more efficient use of the plant labour force.

6.1.3 Methods of Job Evaluation

There are four basic methods of job evaluation: ranking method, job grading method, point

method and factor comparison method.

The first two methods are non-quantitative and also known as traditional, non-analytical or

summary methods. The other two methods are quantitative, also known as analytical

methods, and use various quantitative techniques in evaluating a job.

6.1.3.1 Ranking Method

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In the ranking method, a whole job is compared with others and rank is provided on the basis

of this comparison. The usual process followed in this method is as under:

On the basis of job analysis, each member of the job evaluation committee ranks each

job independently either against the benchmark job or against all other jobs. The

ranking is provided to the job on the basis of this comparison.

In order to increase the reliability of ranking, this exercise is undertaken twice or

thrice by the members.

If there are significant differences of opinions among the members about the ranking

of a particular job, the matter is settled by mutual consultation, or by working out the

average.

Ranking method has certain facial merits and demerits. Some of these are as follows

Merits

The method is comparatively simple, easily understandable, and mostly acceptable by

labour unions. It is suitable for comparatively smaller organisations which may not

like to undertake more laborious exercises.

The method is less costly to undertake and maintain as compared to other systems.

Demerits

Since ranking method of job evaluation is qualitative and non-analytical it suffers from the

following limitations:

Ranking method is judgemental and, therefore, it is affected by personal preferences

of job evaluators.

This method ranks various jobs in order of their relative worth. It does not specify the

real difference between two jobs.. For example, the exact difference between job

ranked at first and the job ranked at second cannot be specified.

6.1.3.2 Grading/ Job Classification Method

This method establishes various grades for different categories of jobs. For example, jobs of

an operative may be classified as unskilled, semi-skilled, skilled and highly-skilled.

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The process followed in this method is as follows:

At the initial stage. a number of job classes or grades is decided on the basis of job

analysis. Job grades can be determined on either of two bases. First, all jobs may first

be ranked and their natural classes may be determined. The description of each job

class is prepared covering all jobs falling in a class. Second, the job evaluation

committee may prepare a series of job class description in advance on the basis of

which various jobs may be graded.

Different characteristics of each job are matched with description of job class and a

job is placed in the class with which it matches best.

Merits

Grading system of job evaluation particularly in government jobs is quite popular as this has

certain merits over the ranking method. These are as follows:

It is quite simple to operate and understand as the relevant information is provided by

job analysis which serves other purposes too.

Job evaluation done on grading method makes wage and salary determination easier

as these are fixed in terms of various grades of jobs.

Demerits

This system of job evaluation suffers with the following limitations:

Job grade description is vague and personal biases may distort job grading as the

method is not based on any scientific analysis.

There are chances of employees' resistance when new clusters of jobs are prepared.

This is evident by the fad that government employees agitate when recommendations

of a new pay commission come.

6.1.3.3 Point Method

Point method of job evaluation is widely used in business organizations. It is an analytical

and quantitative method which determines the relative worth of a job on the basis of points

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allotted to each specific factor of a job. The sum total to these points allotted to various job

factors is the worth of the job. This total is compared with that of other jobs and relative

worth of various jobs is determined.

This process consists;

Identifying the degree to which each compensable factor is present in the job

Awarding points for each degree of each factor

Calculating a total point value for the job by adding up the corresponding points for

each factor

6.1.3.4 Factor Comparison Job Evaluation Method

This method, also known as key job method, was originally developed at the Philadelphia

Rapid Transit Company, USA by Eugene J.Benge in 1926 to overcome two major problems

faced in point method of job evaluation and describing their degrees. In this method, each

factor of a job is compared with the same factor of the other jobs or the key job either defined

or existing one. When all factors are compared, the final rating is arrived at by adding the

value received at each comparison. For this purpose, Benge identified five factors-mental

effort, skill, physical effort, responsibility and working conditions. The procedure for factor

comparison method of job evaluation is as follows:

1st step: Obtain job information

2nd step: Select key benchmark jobs

3rd step: Rank key jobs by factor

4th step: Distribute wage rates by factor

5th step: Rank key jobs according to wages assigned to each factor

6th step: Compare the two sets of rankings to screen out unusable key jobs

7th step: Construct the job- comparison scale

8th step: Use the job comparison scale

Merits

The factor comparison method is more systematic and analytical as compared to any other

method and offers following merits:

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It provides more accurate information about the relative worth of a job as different

comparable factors are compared with key jobs.

Since only limited number of factors relevant for the effective job performance are

compared, there are reduced chances of overlapping.

Since the evaluation is more systematic and analytical, its logic can be accepted by

trade unions and workers.

Demerits

However, factor rating method has its own opera4onal problems which restrict its

adaptability. The major problems are as follows:

This method is quite costly and time consuming to install and difficult to understand

by those not fully conversant with job evaluation process.

If wage rates are adopted for making comparison, the system may become obsolete

very soon as there may not be proportionate increase in wages for all jobs.

This system considers only limited factors of job for comparison. This may be a

positive point so far as avoidance of duplication and simplicity of procedure are

concerned, but may ignore other factors which may be important for the performance

of the job.

6.2 External Competitiveness

To achieve external alignment the management must first know what the average rates of its

key job are prevailing in the community.

Average rates may be decided

when there is abundance of labour.

when the enterprise is incurring losses.

when the cost of living is going down.

when the enterprise has the reputation of being a stable employer with no layoffs.

when the enterprise pays sustained fringe benefits.

when wages are linked to productivity which is constant or falling.

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But at ABC Travels Pvt. Ltd, though there is no abundance of suitable labour nor the

organization is incurring losses etc, set the salaries

6.3 Performance based payment

In the final step, management has to decide whether all individuals in jobs of the same level

should be paid the same pay or different pay and how this should be determined. There are

four basic approaches to the determination of individual pay: the single rate approach, the

informal approach, the automatic approach, and the merit approach.

6.3.1 Approaches to the determination of individual pay

6.3.1.1 Single rates: When employee performance does not vary significantly on the job

because everyone is required to work at about the same pace (e.g. in simple office jobs)

single rates are frequently paid to employees on jobs. If there are any pay differences in such

jobs employees may consider these as favouritism.

6.3.1.2 The informal approach: Sometimes individual pay decisions are made on an

informal basis without formal guides or controls. This is most incorrect because this creates

iniquities and confusion among employees regarding what is expected of them. Lack of

company-wide standards may also result in pay decisions influenced by personal favouritism.

6.3.1.3 The automatic approach: Under this approach both the amount of the pay increase

and the period of review are usually predetermined. In this approach since no consideration is

shown to worker’s individual performance or merit he does not have enough incentive to put

in greater effort.

6.3.1.4 Merit approach: If differences in individual performance and output are important to

a company then some basis for compensating employees for these differences should be

established. Merit rating is a management practice designed to gear the pay of employees to

actual differences in work accomplishments. Merit rating systems assume that performance

can be observed with reasonable accuracy even when it cannot be objectively measured.

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6.3.2 Performance Appraisal and Role of Performance Appraisal in Performance based

payment

In the context of an industrial organization, performance appraisal is a systematic evaluation

of personnel by supervisors or those familiar with their performance. In other words,

performance appraisal is a systematic and objective way of judging the relative worth or

ability of an employee in performing his/her task.

Many authors described and some of them were tried to define the concept of performance

appraisal in their own way. According to Gary Dessler, performance appraisal is an

evaluation of employee’s current or past performance relative to his/her performance

standards. Further he mentioned that the appraisal process involves three steps;

a) Setting work standards,

b) Assessing the employee’s actual performance relative to these standards, and

c) Providing feedback to the employee with the aim of motivating that person to eliminate

performance deficiencies or to continue to perform above par.

McGregor discusses the formal performance appraisal plans in view of meeting three needs.

Out of which one is relating to organization and other two for individual. The first one,

organization level, is to provide systematic judgments to back up salary increases, transfers,

demotions, or terminations.

6.3.3 Incentive Pay

6.3.3.1 What is Incentive Pay ?

Incentives are pay for performance. Alternatively, incentives are called as variable pay or

contingent pay. “Dirideemana” (pay for effort, allowance for encouraging improving job

performance) is the Sinhala meaning for incentives. It link rewards cost and organizational

performance. Employees are rewarded according to their job performance. Incentives are

linked to individual job performance. Also they are linked to group or ream of performance.

They can also be linked with organizational performance. The ultimate purpose of incentives

is to improve performance ( Werther and Davis, 1989)

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Mathis and Jackson, ( 1988) defined Incentives as :

An incentive is a special that drives an employee to perform beyond normal level of

performance. It is an inducement that encourages the employee perform in better way.

Incentives are rewards designed to encourage employee for efforts beyond normal

performance expectations.

Aswathappa ( 2007 ) defined Incentives as :

“Payments by results, incentives are paid in addition to wages and salaries and they depend

on productivity, profit, or cost reduction efforts

There is a clear distinction between incentives (variable pay) and base pay ( Wages and

salaries ). Base pay is based on seniority or length of service.

The philosophical foundation of base pay system rests on the following assumptions :

o Time spent each day is the primary measure of short term contribution.

o In the long term, length of service with the organization is the primary

differentiating factor among people.

o Differences in individual contributions to the organization are recognized

through different base pay levels.

o Giving additional performance rewards to some people but not others is

divisive and hampers employees working together.

The philosophical foundation of incentive rewards system or variable pay system rests on the

following assumptions:

1. Some jobs contribute more to organizational success than others.

2. Some people perform better than others.

3. Employees who perform better should receive more compensation.

4. A portion of some employees’ total compensation should be given to reward

above satisfactory performance.

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Management of incentives can be defined as the process of development, implementation and

maintenance of a fair and adequate system of incentives. All the activities involved in

developing, implementing and maintaining a system of incentives that is appropriate from the

perception of employees and employer as well. The system should be able to give a sufficient

reward for employees’ efforts and it should also be able to increase overall organizational

performance in the way that increases owner’s wealth.

6.3.3.2 Importance of Employee Incentives Plans

The importance of Employee Incentive plan is defining by various experts in the field as

follow:

Snell and Bohlander ( 2008 )

“ Incentive rewards are based on entirely upon a pay for performance philosophy. Incentive

pay programme establish ‘threshold’ a baseline performance level that an employee or group

of employees must reach in order to qualify for incentive payments”.

Armstrong and Murlis ( 2008 )

“ Variable pay has to be re earned. It is “pay at risk” which is awarded for specific

achievements. The employee risks not being paid the bonus again unless the same, or a

higher level of performance is achieved by reaching or exceeding new targets”

Unlike normal pay increments and promotions, incentives do reinforcing performance

quickly and frequently. Each time of paying incentives is generally associated with quick

behaviors and gets incentives for them. Results are quick. Hence it is more likely that the

employee tends to continue putting efforts or engaging in specific behaviors.

6.3.3.3 Advantages of Incentives Programmes

Incentives focus employee efforts on specific performance targets. They provide real

motivation that produces important employee and organizational gains.

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Incentives payouts are variable costs linked to the achievement of results. Base

salaries are fixed costs largely unrelated to output.

Incentives compensation is directly related to operating performance. If performance

objectives ( quantity or quality) are met, incentives are paid. If objectives are not

achieved, incentives are withheld.

Incentives foster teamwork and unit cohesiveness when payments to individuals are

based on team results.

Incentives are a way to distribute success among those responsible for producing that

success.

Incentives are a means to reward or attract top performances when salary budgets are

low.

6.3.3.4 Types of Incentives

Organization may offer different types of incentives plans to motivate employees to perform

to their possible extent. These incentive plans can be grouped in to three broad categories :

a) Individual Incentive Plans

According to the Individual Incentive plan, focuses individual job performance and them

incentives are paid individually. Some plans include piecework, sales performance, bonuses,

merit pay, lump sum merit pay, incentive awards, attendance bonuses etc..They attempts to

admire employees individually. They will increase a competition among the employees being

concerned. Employees who produce higher outcomes will be able to get higher variable pay.

Employees who produce lower outcomes will have to get lower variable pay. Employees who

do not meet the performance threshold ( the minimum level of performance that makes the

employee qualify for incentive payments ) will not be able to receive any variable pay. It

may develop hostile atmosphere among the employees. Some may be jealous over others.

Team performance or team work is discouraged.

Piecework

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This is the oldest incentive plane. There are two types of Piecework:

Straight Piecework

The employee is paid a sum for each unit produced by him or her. Earnings

paid to the employee are in direct proportion to the work done by that

employee.

Differential Piecework

Employee is paid a piece rate for each of the units up to a standard output and

a higher piece rate for each of the units produced over he standard. The

amount of piece rate may e based o data collected through pay surveys.

Standard hour plan

Under this incentive plan, employee is paid an incentive if he or she completes a work

or job in less than the standard time. A standard time is fixed for completing job. If

the employee completes the job in less than the standard time, his or her pay is still

based on the standard time for the job multiplied by his or her hourly rate. This plan is

more appropriate for service organizations such as vehicle repairing or servicing.

When the job or work is non repetive , has a long job cycle and requires a variety of

skills, this plan is appropriate. However, while standard hour plans can motivate

employees to produce more, employers must ensure that equipment maintenance and

product quality do not suffer as employees strive to do their work faster to earn

additional income.

Bonuses

This is a one time payment, usually per year to the employee. It is not a part of the

base pay. It is an additional income to the employee. The employee has the advantage

of getting an additional payment for exerting greater effort to increase performance

while having the security of basic salary or wage. Bonus payments are common

among managerial and executive employees, but recent trends show that they are

increasingly given to employees throughout the organization.

Merit pay

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Merit pay is alternatively called merit raise. Which is a pay increase awarded to an

employee based on his or her individual job performance. Individual job performance

is measured through a performance evaluation system and depending on the level of

the performance merit pay is given to the relevant employee. Unlike bonus, merit pay

usually becomes part of the employee’s base pay.

Lump sum merit pay

Under this, a single lump sum merit pay is given to the employee at the time of job

performance review and this pay is not added to his or her base pay. Unlike merit pay

that is cumulative, lump sum merit pay is not cumulative. It is paid only for the period

concerned and it has to be re earned. Lump sum merit plan freezes base salaries or

wages resulting in controlling cost of base pay.

Nonmonetary incentives

Always we tend to think that incentives as often mean money. But there are

nonmonetary incentives in forms of incentive awards and recognition awards.

Incentive awards include gift certificate, time off, vacation, theatre and film tickets,

personalized clothing, merchandise awards, novelty items, travel awards, and other

non cash incentives. Recognition awards include plaques, employee of the month,

employee of the year, service excellence trophy and other meaningful recognition. It

is important to mention here that these awards should be given to appreciate and

recognize actual job performance which is excellent.

Sales incentives

Sales incentives are differ from other employees in the sense that they bring the

business profits directly by selling goods or services to customers who are consumers

and buyers who have the intention of re selling. Organization pay a special attention

to sales incentives. Due to increase competition, very high level of motivation is

expected form sales employees.

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b) Team Incentive Plans

It focuses on group job performance and then incentives are paid collectively. Some plans

include team rewards, scanlon plan, rucher plan, improshare etc… They attempts to induce

employees collectivity. They will not increase a competition among the employees being

concerned. However they will increase a competition among different teams. When an entire

group is paid with incentives (generally every group member gets an equal amount ) all

members of the group will have to work cooperatively. Hence, the result is most likely

cooperation amount the members. Each group has to meet the performance threshold and

groups, which do not meet the performance threshold , will not be able to receive any

variable pay. When there are employees who prefer working individually to working

collectively team incentive plans may not be successful.

Team Incentive Plan

Under this, gives an incentive bonus to all team members when certain production or

service standard are met. The incentive plan attempts to establish a psychological

climate that fosters team cooperation among all the members of the group.

Scanlon Plan

This is a gainsharing plan based on a philosophy that employees are capable making

suggestion, have willingness to give suggestions and share improvements which

derive from application of suggestions. It aims at reducing costs and then sharing in

the savings.

Rucker Plan

This is a gainsharing plan based on a philosophy that employees are motivated by

economic incentives. Also it has some reliance on employee participation. It is

alternatively called the share of production plan. The plan usually covers production

workers but may be expanded to cover all employees. It expects suggestions from

hourly employees, has a steering committee comprised of hourly employees, union

representative and key managers and has one manager acting as the idea coordinator

for processing all suggestions.

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Improshare

This refers to improved productivity through sharing. This is another group incentive

plan which bonuses are based on the overall productivity of the work team. The plan

is based on a philosophy that group economic incentives increase performance. It has

no suggestion making and therefore there is no attempt at meaningful employee

participation. It ties economic rewards to performance. The bonus is based on

productivity gains that result from reducing the time it takes to produce a finished

product.

c) Organizational Incentive Plans

This focuses on entire organization performance and then incentives are paid

organizationally. Some plans include profit sharing, stock option, employee stock ownership

plans etc.. They attempts to induce employees generally as a whole. They will reduce

competition among the employees and the groups and require that all employees work

together to generate better organizational outcomes which can lead to better financial

performance. These programmes share some of the financial gains to the firm through

payments to employees. As an additional percentage of base pay relating to each employee,

incentives are paid from the organizational financial gains. An equal amount may be paid to

each employee of the organization or different amount may be paid depending on rank or

level of the employee in the organizational hierarchy. Overall business performance is

encouraged.

Profit sharing

Profit sharing is an organizational incentive plan that shares profits with all the

employees of the organization. It distributes a portion of organizational profits to

employees. The employees will have the opportunity to increase their earnings by

contributing to the growth of their organization’s profits. Contributions to growing the

organizational are owing to increase quantity of production and selling, improving

quality of the products, decreasing total costs, introducing new methods to increase

efficiency, minimizing accidents and health problems, minimizing wastage and

enhancing goodwill of the organization. Due to profit sharing, employees think and

feel that they also partners of the organization.

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Stock options

Stock options are a way of achieving employee ownership. It is as an employee

ownership plan that gives employees the opportunity to but the company’s stock at a

previously fixed price. It makes employees to become owners who get dividends.

They will encourage employees to focus on the success of the organization. It is

hoped that they become motivated and loyal to the organization and then work to

improve overall performance of the organization. The use of stock options, as well as

salaried and executive personnel, and this appears true regardless of the industry

surveyed or the organization’s size. It is hoped that employees will work hard and

smart to cause the stock price to rise.

Employee stock ownership plan

Employee ownership plan gives employees certain tax and financial advantages when

stock is granted to employees. A corporation contributes shares of its own stock to a

trust is which additional contributions are made annually and the trust distributes the

stock to employees on retirement or separation from service. According to this, a

company makes tax deductible contribution of stock or cash to a trust fund to by stock

which in then allocated to the employees who acquire and increasing right to stock as

they gain seniority at the time of retirement or resignation, a employee receive their

stock.

6.3.3.5 Requirements of a successful Incentive Plan

Clear Purpose or Purposes

Wide Coverage

Fair and Consistent Means of Measuring Performance

Simplicity

Proper Linkage

No upper Limit

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Definiteness

Recognition of Individual Difference in terms of Performance

Guarantee of Minimum Payment

Separate Identification

Adequacy

Targets of Average Difficulty

Follow up

Use of the Incentive Plan as part of a Broader HRM system

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7. Practical application of compensation management

Compensation management practice at ABC Travels Pvt. Ltd

To gather information on compensation management of ABC Travels Pvt. Ltd, following

questions were asked from Mr.Chameera Botheju, The Human Resource Manager of ABC

Travels Pvt. Ltd.

Q 1: What is the Reward/ Compensation strategy of your organization?

A: We don’t a specific written strategy. But our goal is to attract, motivate and reward high

performers who produce high-quality, innovative and professional work. To achieve these

goals, we have developed compensation packages to each employee based on their

contribution, level and complexity of duties and responsibilities.

Critique: To achieve goals of an organization successfully, every HR practice should align

with business strategy. To be successful in compensation management they have to have

clearly defined goals and a well-defined link to business objectives. Then based on that, it is

required to develop HR strategy and then based on the HR strategy to develop and justify

Reward Strategy and define guideline principles.

Q 2: Who is responsible for setting the total compensation packages?

A: In general, The General Manager set the proposal and sends it to the Managing Director

through Human Resource Manager for MD’s approval.

Q 3: Do you consider market reward levels when you set these packages and/or do you

conduct Salary survey to identify other competitors’ salary levels? If yes, how do you

conduct salary survey? If not, why don’t you do that?

A: Yes we consider, but we do not conduct any market salary surveys. We gather required

information through employees informally. When we set the compensation packages, there

are already set compensation packages at each level but we consider the qualifications of the

candidate and his/ her expected salary level etc. (negotiable) and then set his/her package

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while making sure that it’s aligned with the compensation packages of existing staff such as

their salaries according to the level and complexity of duties and responsibilities etc.

Critique: To achieve external alignment the management must first know what the average

rates of its key job are prevailing in the community. There are formal and informal ways of

gathering required data which includes Surveys made by governments, trade and professional

associations, consultants, voluntary associations of employers, and individual employers. The

Internet is another good source of information on salary surveys but we must ensure that

source is reliable, and it is a must that we carefully analyze those information.

It is good that they are considering market reward levels. Though they do not conduct any

market salary survey or do not hire any consultancy company, they informally gather

information through employees. But, level of reliability of information gathered through

employees is questionable.

Q 4: Do you think your employees getting a fair salary compared with other companies?

A: When we set the compensation packages we make sure that they are receiving a

reasonable amount for the job and it is a fair amount when compared with compensations of

similar jobs in other organizations.

Critique: External equity exists when an employer pays a wage rate commensurate with the

wages prevailing in external labor markets. Assessing external equity requires measuring

these labor markets. There is, however, no single labor market for a particular job. Supply

and demand differ substantially among markets, resulting in significant variation in wages

across labor markets depending on factors like Geographic location, Industry sector, Union

status, Organization size, Product competition, Company prestige, Education and experience

level of available work force, Licensing or certification requirements called for by the job etc.

Some combinations of these factors determine the labor market for a particular job. They

claim that they make sure that their compensation packages are reasonable compared with

other similar jobs in other organizations, thus, good, they ensure that the external equity it

there.

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Q 5: Do you think that achieve external competitiveness through compensation?

A: Though we are a reputed, well established organization, we do not lead the market. We

follow the salaries of other competitive organizations like Walker’s Tours, Aitken Spence

Travels etc. When we set the packages, we always set them at the industry average level.

Critique: That means it is not their strategy to attract or retain good employees through

external competitiveness. It was obvious that the company is experiencing a high labor

turnover. The high performers are attracted by other competitive organizations for higher

compensation packages or they find jobs in abroad for higher compensation packages. Most

of the time, the employee leaves the company with his client base and it is a cost to recruit,

select and train a new employee to replace him.

Q 6: When you set a compensation package, do you consider relative internal value of the job

to make sure that your employee is getting a fair salary compared with others in the same

company?

A: As I said earlier, when we set the compensation packages, we consider the qualifications

of the candidate and his/ her expected salary level etc. it is negotiable but we always make

sure that it’s aligned with existing compensation package levels. It is also possible two people

working in the same job position may be getting two different salaries but within a range for

that job position.

Critique: Question was raised to see whether they are considering ‘internal equity’.

Internal equity exists when an employer pays wages commensurate with the relative internal

value of each job. This is established according to the employer's perception of the

importance of the work performed

At ABC Travels Pvt. Ltd., Compensation packages are designed ensuring that it’s aligned

with existing compensation package levels. I.e. they are aligned with the existing staff

compensation package levels and complexity of duties and responsibilities etc. i.e. relative

internal value of each job is considered i.e. a good practice, which is internal equity, exists.

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Q 7: Do you evaluate the relative importance of each job when designing a compensation

package based on a job evaluation i.e. factors like Education required, Experience required,

Physical demands, Responsibility for equipment/materials, Supervisory/managerial

responsibility, Working conditions etc,?

A: Yes of course, originally we have done job evaluations, and we have job descriptions and

specifications developed based on that. When we recruit and select a new employee, we

consider job specifications and job description and they are communicated to the new

member when he is appointed. All the basic compensation packages have been developed

based on its relative importance.

Critique: "Job evaluation is a process of determining the relative worth of the various jobs

within the organisation. so that differential wages may be paid to jobs of different worth. The

relative worth of a job means relative value produced. The variables which are assumed to be

related to value produced are such factors as responsibilities, skills, efforts and working

conditions".

Job evaluation helps in fitting new jobs at their appropriate plane in the existing

wage structure, improves labour- management relations by reducing grievances,

establishes on objective and clear basis for wage bargaining and simplifies wages

administration. Thus, it is good that they are using job descriptions to see the relative

importance of each job when designing compensation packages.

Q 8: Are employees’ reward connected with competence? If so how?

A: Yes, during the process of performance appraisal, each employee gives a self rating about

existence of each competency, identified and listed in the appraisal form for the purpose. In

the same form, the immediate supervisor (manager) also gives a rating to existence of each

competency of his subordinate. This information is also taken in to consideration for the final

recommendation of reward/ incentive.

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Q 9: How often do you conduct employee performance evaluations? and is Reward

connected with performance?

A: Performance evaluation is an on-going activity with the individual as the focus. The

immediate supervisor continuously evaluates employee job performance. Through regular

interaction between employee and his manager and the continuous feedback, try to give a

sense of how the manager perceives employee performance. However, to avoid haphazard or

incomplete evaluation, we conduct formal reviews and appraisals annually.

Performance reviews are normally conducted twice a year – an informal appraisal in

September and annual appraisal in March. A review may also be conducted in the event of a

promotion or change in role and responsibilities. The outcome of these reviews will be used

for the annual appraisal, which will be conducted in January every year. Compensation

review is also done annually along with the Performance Appraisal once a year.

We believe that it is the employee who is a key player during the review. Hence, it is the

employee who initiates the process by doing the self-assessment and indicating his

development plan for the next year . Based on the inputs received, the line manager

conducts the review .

Yes. We have direct link between performance appraisal and compensation. A final

recommendation of reward/ incentive will be given based on the findings of the Performance

Review .

Critique: In the context of an industrial organization, performance appraisal is a systematic

evaluation of personnel by supervisors or those familiar with their performance. In other

words, performance appraisal is a systematic and objective way of judging the relative worth

or ability of an employee in performing his/her task.

Many authors described and some of them were tried to define the concept of performance

appraisal in their own way. According to Gary Dessler, performance appraisal is an

evaluation of employee’s current or past performance relative to his/her performance

standards.

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McGregor discusses the formal performance appraisal plans in view of meeting three needs.

Out of which one is relating to organization and other two for individual. The first one,

organization level, is to provide systematic judgments to back up salary increases, transfers,

demotions, or terminations. When an employer compensates individuals who are in

similar jobs on the basis of variations in individual performance -so-called pay for

performance, Individual equity exists. Excellent performers, for example, would receive

more compensation than average performers. For reasons that will be explored in greater

detail later, the most important compensation decisions are those that differentiate between

the pay received by individuals within the company who are performing the same job. Since

ABC Travels Pvt. Ltd. Has directly linked compensation with performance appraisal, it

is proved that the compensation management practice of ABC Travels Pvt. Ltd ensures

individual equity as well.

Q 10: Are your staff well communicated the compensation policies about the percentage of

increment for the different levels of performance?

A: We always communicate that the benefits such as performance excellence rewards or

salary increments will be based on performance appraisal. By experience they know that it is

in regular practice. But we don’t have a clear policy to tell that this level performance deserve

this much increment etc. That decision is solely left up to the higher management.

Critique:

Transparency- the publication of information on reward structures and processes to

employees has to be there to achieve expected benefits of compensation management system.

Such a system should be well defined and uniform. It will be apply to all the levels of the

organization as a general system. And also the system should be simple and flexible so that

every employee would be able to compute his own compensation receivable. Here at ABC

Travels Pvt. Ltd, that practice or ‘Transparency’ is not there. The employee knows that

he performed well and an increment will be given, but he don’t have a clear idea about what

is the likely increase for this year? This affect on employee motivation factor as well as may

arise conflicts/ disagreements between management and employees etc.

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Conclusion

ABC Travels Pvt. Ltd has a good compensation management system. They are successful at

achieving equal pay. They ensure that all internal, external and individual equity is achieved

but the relative importance attached to external competitiveness is low which leads them to

lose high performing employees as they leave the company for higher packages, most of the

time with their client base!.

ABC Travels Pvt. Ltd clearly says the compensation is linked with performance; these are the

packages etc. but don’t have a specific written reward strategy. The transparency- the

publication of information on reward structures and processes to employees is also not there

since the final decision on compensation is taken by the higher management and since there

is no written, well defined, uniform, simple and flexible system so that every employee

would be able to compute his own compensation receivable.

Recommendations

It is recommended;

to have a well defined reward strategy developed based on the business strategy and

the HR strategy,

to communicate it to the employees to ensure transparency thus to minimize

misunderstandings and possible conflicts,

to attach higher relative importance to external competitiveness so as to attract and

retain high performers and to minimize possible unnecessary cost on recruitment,

selection and training etc of replacements,

to have more methods to gather information on market compensation package levels

(conduct salary survey, service of such a company or gather published data) other

than the only method currently following, gathering information through employees

informally.

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to continue the well designed performance based and competency based

compensation management systems (see all the annexure) which ensure individual

equity and line manager involvement.

References

Armstrong, M (2009), Armstrongs’s Handbook of human Resource Practice, 11th ed,

Kogan Page, London and Philadelphia

Brown, D and Armstrong, M (1999), Paying for contribution, Kogan Page, London

http://www.citeman.com/13742-wage-and-salary-surveys.html

http://www.eridlc.com/index.cfm?fuseaction=textbook.chpt08

http://www.hr.vt.edu/compensation/compmgt/comp_offers/index.html

http://payroll.naukrihub.com/compensation/

http://www.slideshare.net/sushisonai/homepeerlessdesktop-compensation-

management-1

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Postgraduate Diploma in Tourism Economics and Hospitality Management

Subject: Human Resource Management

Assignment 01

Compensation management practice at ABC Travels Pvt.

Ltd

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