Definition of Compensation System Design Issues

Learning Objectives

After reading this chapter you should be able to:

➢➢                     Define Compensation Design

➢➢                     Understand the Objectives of compensation Design

➢➢                     List different steps in Compensation Design Programme

➢➢                     Know the Components of Compensation Design

➢➢                     Recognize the Issues in Compensation Design

Introduction

Compensation design determines the value of specific, properly executed accomplishments toward the achievement of desired outcomes. The value of the accomplishment, not the level of activity, is used to establish the nature and amount of compensation. Ultimately, compensation design should foster a productive and equitable, long-term relationship among members, and between each member and the organization. The process begins by identifying desired outcomes for the organization or operating unit. Importance and value are attached to the results people achieve with reference to the need of the organization. Compensation is based on the achievement of results that are organizational success. Attracting, retaining and motivating employees in today’s business environment requires utilizing a host of tools including base pay, incentives, equity, performance management, and benefits. Balancing these tools in an equitable, affordable and real manner can present difficulties for even the most dedicated employers. No universal, standard programme exists that can meet every organization’s needs. In order for the total rewards programme to work, it must fit the organization’s culture and strategic initiatives and compensation objectives.

These objectives are as follows

➢➢                     External competitiveness to recruit and retail

➢➢                     To reward performance through salary without grade promotions

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Process of Compensation Design

Essentials of a Sound 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.

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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.

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:

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➢➢                     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.

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Factors Considered in Designing Compensation Package/ Compensation System Design Components

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 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

1.     Making salary decisions that are based upon appropriate equity and budget considerations

2.     Encouraging and rewarding excellent performance with merit increases whenever possible

3.     Providing salary increases within available funding and

4.     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?

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