OLPSHR04 – COMPENSATION AND ADMINISTRATION

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CHAPTER 2 - COMPENSATION RESPONSIBILITIES, SYSTEM DESIGN ISSUES,
PHILOSOPHIES AND APPROACHES

Objectives:
a.) Define compensation responsibilities;
b.) Understand the compensation objectives;
c.) List different significance of compensation management;
d.) Know the principles of compensation management;
e.) Define compensation design;
f.) Understand the objectives of compensation design;
g.) List different steps in compensation design programme;
h.) Know the components of compensation design; and
i.) Recognize the issues in compensation design;
j.) Define compensation philosophy;
k.) Understand the factors influencing compensation policy;
l.) Know the development of compensation policy;
m.) To identify the factors considered in deciding the compensation;
n.) To know link between compensation philosophy and compensation
policy;
o.) Define compensation approach;
p.) Understand the traditional and total reward approach of
compensation.

A. INTRODUCTION
 A good compensation package is important to motivate the employees to increase the
organizational productivity. Unless compensation is provided no one will come and work
for the organization. Thus, compensation helps in running an organization effectively
and accomplishing its goals. Salary is just a part of the compensation system, the
employees have other psychological and self-actualization needs to fulfill. Thus,
compensation serves the purpose.
 The most competitive compensation will help the organization to attract and sustain the
best talent. The compensation package should be as per industry standards. Human
Resource Management (HRM) has never been as significant as it is today. Companies
want to attract, retain and motivate brains to meet objectives. Today humans are
regarded as one of every company’s assets, so they need to be efficiently and
effectively managed. One of the tools companies use to attract, retain and motivate its
people is Compensation Management.
B. OBJECTIVES OF COMPENSATION MANAGEMENT
 To establish a fair and equitable remuneration
 To attract competent personnel
 To retain the present employees
 To improve productivity
 To control cost
 To improve union management relations
 To improve public image of the company
 To improve job satisfaction
 To motivate employees

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 Peace of mind
 Increases self-confidence
C. SIGNIFICANCE OF COMPENSATION MANAGEMENT
 Compensation and Reward system plays vital role in a business organization. Since,
among four Ms, i.e. Men, Material, Machine and Money, Men has been most important
factor, it is impossible to imagine a business process without Men. Every factor
contributes to the process of production/business. It expects return from the business
process such as rent is the return expected by the landlord, capitalist expects interest
and organizer i.e. entrepreneur expects profits. Similarly the labour expects wages from
the process.
D. PRINCIPLES OF COMPENSATION ADMINISTRATION
 Compensation policy should be developed by taking into consideration of the views of
employers, the employees, the consumers and the community.
 The compensation policy or wage policy should be clearly defined to ensure uniform
and consistent application.
 The compensation plan should be matching with overall plans of the company.
Compensation planning should be part and parcel of financial planning
 Management should inform the wage/salary related policies to their employees.
Workers should be associated in formulation and implementation of wage policy
 All wage and salary related decisions should be checked against the standards set in
advance in the wage/salary policy
 To manage compensation related matters adequate information/data should be
developed and stored for future planning and execution.
 The compensation policy and programme should be reviewed and revised periodically
in conformity with changing needs.
E. ESSENTIALS OF COMPENSATION DESIGN
 Internal Equity - It implies a proper relationship between wages paid for different jobs
within the company. For example salary of a Sr. Manager is lower than a manager;
there is lack of internal equity. Pay differentials should be related directly to differential
in job requirements. Fair pay differentials between jobs can be established with the help
of job evaluation.
 External Competitiveness - Wages and salaries in the organization should be in line
with wages and salaries for comparable jobs in other organization. Otherwise the
organization may not be able to attract and retain competent personnel. Data relating to
pay levels in other organizations can be collected through wage and salary survey.
 Built-in Incentive - Wage or salary plan should contain a built-in incentive so as to
motivate employees to perform better. Such an incentive can be developed through
performance based payment. A part of the total payment should be linked to individual
or group performance. A sound performance appraisal system should be used to
measure accurately and objectively the performance of individual employees.
 Link with Productivity - Some part of the total pay should be linked to productivity.
Such linkage is necessary because workers expect a share in productivity gains. This
will help to control labour costs.
 Maintain Real Wages - At least part of the increase in the cost of living should be
neutralized so as to protect the real wages of labour. Dearness allowances are used in
India for this purpose.
 Increments - Compensation policy can be good motivator if pay increases are linked
with merit. But annual increments should partly be linked to seniority or years of service.
The logic for seniority based increments is that as a person accumulates experience his
skill get sharpened and his efficiency tends to increase.

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 Challenges Faced by Compensation Design - Designing a truly effective
compensation plan is like climbing a mountain. It is a complex, and often difficult,
journey with numerous possibilities for pitfalls along the way, the most common of
which are:
 Using compensation in lieu of sound management: this equates to trying to solve a
problem by throwing money at it. No amount of compensation makes up for poor
management.
 Confusing compensation and benefits with rewards and recognition: the fact is that
employees rarely leave organization for relatively small increases in pay. More often,
they leave for intrinsic reason such as feeling valued by an organization or seeing
opportunity for growth. Compensation, no matter how much, does not fill intrinsic needs.
 Utilizing compensation strategies that are not linked to achieving an organization’s
goals and objectives: the only reason to hire or retail an employee is because he/she
directly or indirectly adds value to the company. Therefore, how much an employee
should be paid, depends solely on how much value he/she adds in reaching the
company’s goals and objectives.
 Designing compensation strategies that are not aligned with business philosophy:
 An effective compensation strategies cannot be designed without answering some key
questions, such as:
 Does the company want to hire younger, less experienced staff so that they can be paid
less, knowing they will have to be replaced in two or three years? Or
 Should an older, more experienced staff be hired and paid more to keep them
 Does the company want to pay the going rate based on competition?
 Does the company want to pay staff in accordance with their level of contribution to the
company?
 Using compensation strategies that are designed to support change: The companies
that stand the test on time are those who are willing and able to embrace change. An
intensively competitive marketplace combined with constant innovations in technology
makes change an ongoing process. As a result, the division that is the star performer
today may be second best tomorrow, or even outdated the day after that. Conversely,
today’s one-person department may become tomorrow’s powerhouse. Therefore,
compensation strategies must be designed to (a) accommodate for increases and
decreases in profit and (b) share wealth with those employees who are providing the
most value at the time. Determine the best total rewards philosophy for the
organization. Reviewing the current compensation and benefits system to see how it
compares to labour market competition and Formulating effective communication
strategies focused on the value of the compensation, performance management and
benefits programme.
 Base Pay to determine the base pay the following is to be taken into consideration
 Conducting job analysis and documenting job content
 Developing systematic base pay structures
 Using market benchmarking or job evaluation methods
 Development of employer specific base pay strategic
 Analysis of employee base pay to new base pay structures and
 Job description development
 Incentive Programme to develop the incentive programme the following is taken into
consideration
 Developing motivating variable pay programmes for production, office, management
and sales employees that tie organizational strategies and goals to individual or team

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performance and Creating pay-for-performance system including performance appraisal
tools and merit increase guidelines
 Benefits Programme to develop benefit programme the following is to be considered
 Assessing employees’ satisfaction with your current benefit package through a
 Benefit Assessment Survey
 Analysis of current benefit offerings and recommendation of effective benefit changes
 Guiding Principles of Compensation Design
 Making salary decisions that are based upon appropriate equity and budget
considerations
 Encouraging and rewarding excellent performance with merit increases whenever
possible
 Providing salary increases within available funding and
 Motivating employees by demonstrating the link between performance and pay

 Compensation System Design Issues

 Compensation must be viewed strategically as a lot of organizational funds are spent
on compensation related activities. Organizations must make a number of important
decisions about the nature of a compensation system. Especially the following things
need to be questioned.
 What philosophy and approach will be taken?
 How will the firm react to market pay levels?
 Will the job be paid or the person’s level of competence?
 Will pay be individual or team based?

F. FACTORS INFLUENCING COMPENSATION PHILOSOPHY

 Some of the factors that influence compensation philosophy include present revenue of
the company and expected profits in the future, market value of the jobs for which the
company is hiring, and degree of competitiveness in the types of jobs a company offers.
The way an organization views its employees and its responsibility to those employees’
factors into the development of a compensation philosophy too. Essentially, many
different elements may contribute to the way an employer determines rate of pay, raises
and bonuses. It may be easy to create a compensation philosophy in some fields. For
instance those that require rising levels of expertise and education usually have set
rates, and they may have a salary range that matches market value prices and that
gives employees something to aim for. Hospitals, for example, can hire employees of
numerous types, and clearly compensation will be different for nurses than it is for
doctors or janitors.

 Types of Compensation Philosophy

 Usually, there are two types of philosophies of compensation rates/wage rates including
the productivity philosophy and purchasing power philosophy.
 Productivity Philosophy: which is relates to high wages and low unit cost of
production which assumes:
 That the employers should provide the best possible tools, machines, goods and
buildings etc., while the management should apply the latest production technique.
 That the production should increase without the uses of commensurate physical efforts
of employees while the unit cost of production should decrease leading to lower prices
of goods.
 That the market for goods should expand leading to enhanced sales volume and

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 That the part of resultant enhanced profits should be used to increase the wages of the
employees and remaining can be ploughed back in the business
 Purchasing Power Philosophy: makes the following propositions:
 That the workers should be paid high wages because they form a large proportion of
the work force and are equipped with a higher propensity to consume. It results in
expansion of the economy’s purchasing power supply
 That effective demand for goods and services produced should enlarge in each
establishment
 That productivity per worker should increase while the unit cost of output should
decrease leading to enhanced profits and
 That increased wages should be paid from this enhanced income to average the cycle.

 Compensation Philosophy to Develop a Compensation Policy

 Once a company compensation philosophy is ready it will continue the process of
developing a compensation policy. A solid compensation policy is the beginning of a
well-constructed, defensible compensation program. The compensation policies are
guidelines for action. They are decisions which are applied to recurring situations.
Therefore, they are called standing decisions. Since they are applied again and again,
they should be designed with great care so that they can remain applicable for fixed
periods of time or until operating conditions demand their alteration. The compensation
policy provides a frame work company compensation program.

 Following are steps to make compensation policy more effective:

o Keep company compensation policy in the format in which other policies are
written.
o This way it is consistent with other company policies.
o Include language reflecting the company’s intent to create equitable and fair pay
practices free from discrimination.
o Before a legal review, company may want to consider asking key stakeholders
and the board to review policy’s language.
o Request sign off on the policy by an executive such as the CEO or president.

 Company compensation Policy Should Include

o Defining the market company will use for external market comparison or
“competitive set.”
o A definition of the process used to determine internal equity (job evaluation).
o The different types or elements of compensation.
o Clearly defined management responsibilities.
o A guide for the administration of the compensation program.
o Minimum wages and salaries
o Methods of wage/salary payment
o Profit sharing and incentive plans
o Non monetary rewards
o Procedure for getting pay
o Whether to pay prevailing or more than prevailing salary scale

 Types of Compensation Policies

o According to Dunn et al compensation policies should be established to cover at
least the following compensation subjects:

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o 1. The general compensation level
o 2. The wage and salary structure and
o 3. Formulas based on time or productivity governing disbursement of wage or salary
funds to individuals Each of these compensation policies should be related to
specific compensation objectives to recruit, retain and motivate individuals and
teams to work towards the achievement of organization goals.
G. TRADITIONAL COMPNESATION APPROACH
 For some organizations, a traditional compensation approach makes sense and offers
certain advantages in specific competitive situations. It may be more legally defensible,
less complex, and viewed as more “fair” by average and below average employees. It
reflects a logical, rational approach to compensating employees.
o Total Rewards Approach - It tries to place a value on individual rather than just the
jobs. Widespread use of various inventive plans, team bonuses, organizational gain
sharing programmes, and other designs serves to link growth in compensation to
results. However, management must address the following two main issues when
using variable pay systems:
o Should performance be measured and rewarded based on individual, group or
organizational performance? Should the length of time for measuring performance
be short term (less than one year) or longer term (more than one year)
o 3 P’s Approach to Compensation Management - There are 3P approach of
developing a compensation policy centered on the fundamentals of paying for
Position, Person and Performance. Drawing from external market information and
internal policies, this approaches helps to establish guidelines for an equitable
grading structure, determine capability requirements and creation of short and long-
term incentive plans. The 3P approach to compensation management supports a
company’s strategy, mission and objectives. It is highly proactive and fully
integrated into a company’s management practices and business strategy. The 3P
system ensures that human resources management plays a central role in
management decision making and the achievement of business goals.
o Paying for position
o Paying for person
o Paying for performance
 Because it is so important to employees, the issue of pay deserves to be clearly
addressed. In spite of their hesitance, managers are capable of dealing with this
sometimes difficult issue in a professional and effective manner. By keeping the
following basic points about pay in mind, they can address virtually any pay-related
topic with the employees in a professional and productive manner.
 Specificity is Key
o Pay is a topic with many different shades and a variety of implications.
Whenever approaching the subject, it is important to work out the details
beforehand so that specifics can be clearly communicated. For the manager,
this means that the increase amount is nailed down before discussing a
promotion with an employee. No chance of misunderstanding or false
expectations can be permitted. Far too often, managers are apt to discuss
generalities. “It will mean a good increase.” What exactly does that mean in
terms of the employee’s monthly budget? If care is not taken here, good news
can become the source of conflict and resentment.
 Pay is Relative
o What one employee considers a fantastic increase maybe an insult to another?
Each individual has a unique set of creativity and competencies. Pay should be

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based on the performance, position and the competencies/skills the person is
having.
 Pay is Not Created Equal
o Various forms of pay have different purposes. The two most common forms of direct
cash compensation in most companies are base pay and bonus. Base pay is the
annual salary or hourly wage paid to an employee given the job he holds, While
bonus is typically (or at least should be) rewarded based on the achievement of a
goal of the organization. Discussions about bonus payments should be as specific
as possible. This is the opportunity to point out particular accomplishments that
contributed to overall team or company success. Even if the bonus is paid to all
employees based on a simple overall company profit target, the manager should
use the opportunity to point out specifically how individual employees helped
achieve that target.
 Pay Based on the Performance
o Even when performance is a factor, the manager is faced with the difficult task of
evaluating an entire year’s worth of activity and then categorizing it according to the
percentage increase options allowed by the budget. It becomes very difficult to
pinpoint specific employee actions or accomplishments as the reason for the
increase. For these reasons, it’s appropriate for the discussion about base pay
increases to be more general and balanced. Both strengths and weaknesses of the
employee should be addressed. The actual increase is then based on an overall
assessment, as opposed to a link with one or two specific outcomes. Any other
factors that impact the increase percent, such as budget or pay range should be
openly discussed as well.

REFERENCES:

Bhatia S.K.(2003), NEW COMPENSATION MANAGEMENT IN CHANGING

ENVIRONMENT, Deep and Deep, Publishers, New Delhi.

Chappra T.N. (2006) ESSENTIALS OF ORGANIZATIONAL BEHAVIOR,

Dhanpat Rai and Company Delhi.

Fisher, Cynthia D, Schoenfeld Lyle F. Shaw James. B (2004) HUMAN

RESOURCE MANAGEMENT, Biztantra, New Delhi p.543.

Flippo, Edwin B. (1989), PERSONNEL MANAGEMENT, Mc-Graw-Hill, Tokyo.

Gupta. C.B. (2005): HUMAN RESOURCE MANAGEMENT, Sultan Chand

Publishers, New Delhi

Khan, S.M. “EFFECT OF LIKING SYNDROME ON COMPENSATION NEED

SATISFACTION” Indian Journal of Industrial Relations, 38 (2) Oct.2002, 199-
210.

Mathis, Robert L. and Jackson Jphn. H (2003), HUMAN RESOURCE

MANAGEMENT, Thomson South Western, Australia

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LINKS
TOPICS LINKS FOR VIDEO

Objectives of Compensation Management https://youtu.be/wZoRId6ADuo

Significance of Compensation Management https://youtu.be/mCwMzL2KGE8
Principles of Compensation Administration https://youtu.be/rb2jUVQwd50
Essentials of Compensation Design https://youtu.be/-zvY3gc4o4A
Factors Influencing Compensation Philosophy https://youtu.be/nfOK2jRfdSk
Traditional Compensation Approach https://youtu.be/CWzylphefss

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