8. Compensation – Human Resource Management: Text and Cases

8

COMPENSATION

Chapter Objectives

  • To understand the relevance of compensation in the HR strategy of the organization.
  • To learn how to conduct job evaluation to drive internal equity and employee survey to drive external equity.
  • To design and implement compensation programmes and executive compensation.
  • To discuss various kinds of variable pay.

Opening Case

Devising a compensation plan: V TECH Telecom

Since the last two years, up to mid-2010, there seemed to be a fair amount of disappointment regarding the performance bonus payouts, compared to the hefty amounts received in the previous years. Even the pay hikes have taken a beating, though there is a bleak ray of hope; one needs to wait and watch to see how the compensation graph moves in the next two years.

Contemplating on the above article in a daily news paper, Sudip, the vice-president, Human Resources, NBFC, sat on his reclining chair, gaping at the slums outside his window and wondering, ‘what next?’ The company's stock has also not been faring too well in the stock market. Knocking at his cabin door, appears Jhuma, his personal assistant, inquiring if he was free to meet Akhil, the general manager of HR.

Enters Akhil, looking a little shaken. ‘Boss, the worst has happened, 25 employees from Sales and Marketing, Auto division, have put in their papers and expect to be relieved within the next one week.’ Akhil then continues with his conversation with Sudip: ‘On having a casual chat with a couple of them, I have understood that as we have given them only 6 per cent hike and deferred the release of their performance bonus, they have decided to “walk out” of the organization and join a competitor.’ Moreover, most employees are cribbing that their pays are not equitable compared to those of others at the same level.

Akhil then proceeds to discuss that the employees have been considering pay hikes and performance bonuses as a matter of right for being in the organization, more like entitlements. Sudip then gets into a heated argument with Akhil indicating that the HR has not done its job of communicating the ‘compensation philosophy’ well and has not made the compensation objectives clear to the employees.

Unlike all other human resource practices, this company's compensation was unplanned and haphazard. The company went on a massive recruitment drive and picked around 400 employees out of the 1,000 that needed to be recruited for the first phase of the project. The mandate given to the recruitment teams were ‘hire at any cost, even if it means paying a 40–50 per cent higher compensation to get employees from competitions and thereby empty out all the key resources of the competitors’. They had to hire sales coordinators, a business development team, telecom engineers, network engineers, technical managers, project heads, finance and accounts team, credit collection and fraud control teams too. The team gave very little thought to tying general pay levels or creating salary bands. David, the recruitment head, knew that pay practices such as these would only create chaos in the organization in the short run and may actually run counter to what the company wants to achieve strategically in terms of creating an extraordinary work force. David knew that their compensation plan was not designed to support the firm's new strategic goals. He and Akhil knew that they should devise a new compensation plan keeping in mind the latest compensation trends. They got stocks, variable pay plans, incentives and joining bonuses sanctioned too. How can one hire and retain high quality work force, if one does not link performance and pay? He and his team then decided to hand over this assignment to the compensation and benefits team to assess and redesign the compensation plan. Employees who joined earlier were on a different pay plan. Now, after the new pay plan, how would one tackle these employees who were just recruited in the last quarter?

As time flew by, employees learnt that no matter how they performed they would always end up getting paid about the same as employees who performed better or worse than they did. Therefore, the company's compensation plan actually created a rift between the employees who joined in the last quarter and those who joined recently; and now there was this disconnect between pay and performance. Employee morale hit rock bottom in less than a year during which they were on board.

Akhil and David knew they had to institute a new strategic compensation plan. They wanted such a plan that would not only save their face, but also one that would increase morale and also contribute to employee commitment and pay for performance, and help in hiring on merit basis and not with the purpose of ‘clearing out’ a competitor.

However, knowing that they would have to do it did not translate into it being done! Akhil had tried many combinations but no compensation plan seemed to serve all their purposes. If he was satisfied, David said it wasn't attractive enough for hiring and what made David happy seemed to never make financial sense. The more Akhil worked on, the more he was convinced that there was no way out of the mess. Meanwhile to keep the business running, hiring and losing people seemed to have become an everyday affair.

Questions:

  1. What was the problem that the company faced?

  2. What advice would you give the HR/recruitment team to salvage the situation?

I began to realize how simple life could be if one had a regular routine to follow with fixed hours, a fixed salary, and very little original thinking to do.

 

Roald Dahl

Roald Dahl, the British novelist, short story writer and screenwriter, probably realized it long back that fixed salary goes only with fixed hours and very little original thinking. And it has not changed since then. When a young person joins the workforce, we may say that they need to be compensated for the contribution that they are making to the organization. However, the fact is that beyond these basic needs, compensation also plays a very important role in keeping them motivated to do well and also in retaining them within the organization.

8.1 UNDERSTANDING COMPENSATION

The term ‘compensation’ basically refers to all financial returns and tangible benefits that employees receive as part of an employment relationship. As the business environment becomes global and complex, the challenges to create and maintain effective compensation programmes with cost constraints becomes a huge challenge Designing compensation programmes also requires vision, creativity, professional expertise and executive understanding to deal with it.

 

Compensation refers to all financial returns and tangible benefits that employees receive as part of an employment relationship.

The challenge in compensation lies in the balancing act that has to be done in the interest of the employee and the employer. For the employees, pay is one of the most important elements that drive, motivate, compensate and reward them for the work they do. On the other hand, reward systems can sway a company's success in three ways. First, the amount of pay and the way it is packaged and delivered to employees can inspire, strengthen and direct an employee's behaviour. Second, it plays an important role in an organization's capacity to attract and retain qualified, high-performance employees. Finally, the cost of compensation can sway a firm's financial success.

 

Figure 8.1 Total compensation process

 

Figure 8.1 outlines how the entire compensation process ought to work. In Chapter 2, we have learnt that the HR strategy has to be in line with the business strategy. An important part of the HR strategy is the compensation strategy. The compensation strategy entails outlining what strategic HR objective could be achieved the way compensation is designed and administered in the organization, based on the compensation strategy and inputs from the external environment (through market surveys) and internal realities (through job evaluation), compensation is planned. If worked out properly, the compensation design leads the organization towards desired performance levels.

8.2 BASES OF COMPENSATION

Compensation is not only a means of compensating the employee for the services rendered—it also serves as a tool in the hands of the organization to attract the best and also to enhance their performance, reward them and retain them.

FOOD 4 THOUGHT

Studies done by a Neuroscientist Jeffry Schwartz and an executive coach, David Rock, have identified motivators other than money that influence behaviour. People want to elevate their status, they get motivated by autonomy. They are determined more by informal interactions, social networks and daily perceptions than by money or formal promotions. A few years ago, a research was done by them with the elite military units that included the Navy Seals, the Green Berets and the Marines. Money was not the motivating factor, they learned that pride in daily training exercises was, almost as important a motivational force as pride in the unit. And the Marines spend 75 per cent of their military life in training exercises.

 

 

Figure 8.2 Kinds of compensation

8.2.1 Kinds of Compensation

Many studies have brought forth the fact that money is not the only form of compensation that employees expect from a job. Based on this fact, as shown in Figure 8.2, compensation can be classified to be of two kinds: financial compensation and non-financial compensation.

Financial Compensation

Financial compensation can be of two types:

  • Direct financial compensation: It consists of the pay that a person receives in the form of wages, salaries, commissions, incentives and bonuses. This is the money that the employees receive as a part of their compensation.
  • Indirect financial compensation: These are benefits that consist of financial rewards that are not included in the direct financial compensation. This form of compensation includes a wide variety of rewards and benefits received indirectly by the employee. An example is the contribution that the company makes to an employee's housing subsidy or a pension plan.

Non-financial Compensation

Non-financial compensation consists of the satisfaction that a person gets from the job itself or from the physical and psychological environment in which the person works. For example, employees can get great satisfaction from their work and enjoy the environment which they work in.

8.2.2 The Compensation Programme

One needs to first identify the major parts that are to be included within a compensation programme. There are six of them:

  1. Base wage and salaries: This is the most important part of the compensation for most of the employees, it involves the determination and administration of base wage and salaries. The lifestyles and leisure activities of most employees revolve round this component.
  2. Wage and salary add-ons: This includes shift differentials, overtime pay, pay for working on weekends and holidays (if applicable) and other add-ons.
  3. Incentive payments: This is the payment for a specified output. Numerous factory and mill workers did fall into this category in the good old days. Individual activities could be defined precisely, the daily output could be measured and pay could then be tied directly to the measured output. In some jobs, the output can be measured accurately, for example, data entry operator or processing clerks, whereas in some jobs it is difficult to measure the output. Nowadays its usual to have incentive as a part of a salesman's compensation.
  4. Employee benefits and services: This could be legally required programmes (workers compensation) and flexible programmes (health benefits, pension plans and paid time off) such as time off with pay, when employment has been terminated or suspended, pay when unable to work due to sickness or accidents, retirement pay, payments for medical protection, pay to dependants upon the death of the employee. It also includes a variety of goods and services such as company car, child care, recreation activities, benefits and services to add to the current and future standard of living.
  5. Performance-related variable pay: This is purely based on performance of the company and the employees. It is not a committed amount. Employees could receive either the exact amount committied or even less or more than the committed amount (as it is performance based). It could be paid once a year or as per the policy of the company.
  6. Profit sharing, gain sharing, equity plans: These are ways of sharing the successes of the organization with the employees. This could be attained with the help of arrangements to share the profits, sharing ownership through employee stock options etc.

Compensation programme consists of:

  • Base wage and salaries
  • Wage and salary add-ons
  • Incentive payments
  • Employee benefits and services
  • Performance-related variable pay
  • Profit sharing, gain sharing and equity plans

 

In summary, the strategy and structure of compensation and benefit programmes have important implications for business and its ability to create and sustain competitive advantage.

8.2.3 Objectives of Compensation

Total compensation management aims to:

  • Support the achievement of the organization's strategic and short-term objectives by aligning the compensation with the achievement of the organizational objectives through variable pay schemes.
  • Motivate all employees.
  • Support culture management by driving and supporting the desired behaviour.
  • Poise the organization to compete in the employment market.
  • Promote flexibility by replacing the traditionally rigid pay structures with more flexible structures.
  • Provide value for money by evaluating costs as well as benefits in a cost effective manner.
  • Establish pay levels for positions on the basis of their eternal competitiveness with relevant labour markets and their relative internal value.
  • Regularly reward employees on the basis of work performance.
  • Administer pay equitably and consistently.
  • Maximize the effectiveness of compensation funding based on recruiting, retention and employee motivational outcomes.
  • Ensure accountability for compliance within the rules and regulations and statutory requirements.

8.2.4 Determining Compensation: The Wage Mix

As discussed earlier, we have seen that compensation has many components. The success of the compensation strategy lies in the careful design of the mix of compensation. This is influenced by a combination of internal and external factors which have either a direct or indirect control on the rates at which employees are paid.

Internal Factors

The internal factors that control wage rates are the employer's compensation strategy, the worth of the job, the employee's relative worth in meeting job requirements and the employer's ability to pay.

 

Internal factors affecting the wage mix:

  • Employers’ compensation strategy
  • Relative worth of the job
  • Employee's relative worth
  • Employer's ability to pay

Employers’ Compensation Strategy.   The compensation strategy is the posture that the employer takes in the employment market with regards to the compensation of employees in the organization. For example, an organization which follows a cost leadership business strategy cannot afford to be the highest payer in the market. Therefore, the compensation mix will definitely be driven by the compensation strategy of the organization. Employers should set pay policies that mirror the following:

  1. The internal wage relation among jobs and skill levels.
  2. The external competition or an employer's pay position relative to what competitors are paying.
  3. A policy of rewarding employees at work.
  4. Administrative decision regarding fundamentals of the pay system such as overtime, payment periods and short-term or long-term incentives.

Relative Worth of a Job.   Organizations should not base the value of jobs on any kind of subjective opinion. There should be some rationale. The rationale could be based on, and influenced by the market, benchmarking studies or in the case of unionized employers, by collective bargaining. Job evaluation is one method that could be used by organizations with structured compensation programmes. A job's assessment should be based on the total value delivered to the organization. Valuing work provides an insight into how jobs relate to the overall organizational objectives. It also enables organizations to price important jobs effectively.

Employee's Relative Worth.   Do you think every person doing the same job ought to have the same compensation? No! Because every person has a different personal worth which also needs to be recognized. Therefore, every organization must have a compensation range at all levels which would have a maximum and a minimum range and of course, there should also be an average. Superior performance and worth can be rewarded by granting merit increases within the established range for particular class of jobs. Compensation based on the employees’ worth plays a role in motivating employees to increase their worth too.

Employer's Ability to Pay.   An organization's ability to pay is determined, in part, by the performance results of its employees. Based on the company's profits and the financial resources the organization then decides on its ability to pay employees, this also includes the performance bonus and related incentives etc.

External Factors

The external factors that influence wage rates include labour market conditions, area wage rates, cost of living and collective bargaining.

 

External factors affecting the wage mix:

  • Manpower market conditions
  • Area wage rates
  • Cost of living
  • Collective bargaining

Manpower Market Conditions.   The labour or manpower market reflects the forces of supply and demand for competent workforce within a location. These forces help influence the wage rates required to recruit or retain the competent employees. Many times the intrinsic worth of the job may not be high, but demand for the skill may be very high. For example, the compensation of call centre agents in the early years hit the roof, not because of the intrinsic worth of the job, but because most organizations were trying to attract talent by paying slightly higher than what the market was.

Area Wage Rates.   A formal wage arrangement should provide rates that are at par with those being paid by other employers for equivalent jobs within that particular area. Data pertaining to wage rates may be obtained from local wage surveys. For example, a software engineer in the United States has to be paid by the going rate in United States and not that in India. In this lies the biggest challenge in international compensation too.

Cost of Living.   Due to inflation, compensation rates have had to be adjusted upward occasionally to help employees to maintain their standard of living and purchasing power too. Some employers make these changes with the help of consumer price index (CPI). The CPI is a measure of the average change in prices over time in a fixed market of goods and services. The CPI is based on prices of food, clothing, shelter, fuel, transport fares, charges for medical services and prices of goods and services. Changes in CPI can have important effects on pay rates. There are some organizations which have a component called cost of living allowance (COLA) as a part of their fixed salary. Based on the CPI this is adjusted every quarter. The government employees’ DA, i.e., dearness allowance is also based on this.

Collective Bargaining.   The agreements negotiated by unions tend to establish rate patterns within the labour market. As a result, wages are commonly higher in areas where organized labour is strong. This also becomes the prevailing rate that all employers must pay for work performed under negotiations.

8.3 MOTIVATION (BEHAVIOURAL) THEORIES

Compensation fills in some very basic needs in people systems that are aimed at rewarding people for their skill, effort, dependability, working conditions and motivating them for higher performance at work. Every element of compensation has a behavioural objective and seeks to fulfil a need (physiological or psychological) and achieve a goal. It is relevant to know some of the motivational theories to appreciate how compensation also contributes to motivation. Figure 8.3 summarizes some of the important ones.

 

  • Maslow's need hierarchy
  • Alderfer's ERG theory
  • Herzberg's motivation–hygiene theory
  • McCelland's achievement motivation theory
  • Adams’ equity theory
  • Vroom's expectancy theory

8.3.1 Maslow's Need Hierarchy

Maslow's hierarchy of needs theory holds that humans are motivated to satisfy their wants or needs. According to this theory, needs are hierarchical in nature. Dr Abraham Maslow (1943) ranked needs in order of their ascending importance as follows:

 

Maslow's hierarchy of need theory holds that humans are motivated to satisfy their wants or needs. He ranked needs in order of their ascending importance as follows:

  • Physiological
  • Safety
  • Social
  • Esteem
  • Self-actualization

1. Physiological: Food, sleep, air, water

2. Safety: Shelter, clothing, protection from the elements of nature etc.

3. Social: Love, affection, belongingness

4. Esteem: Recognition, status

5. Self-actualization: Achievement, fulfilment

 

Figure 8.3 Motivation theories

 

Figure 8.4 Maslow's hierarchy of needs

 

What this means is that every need once satisfied is accompanied by a higher order need. Therefore, first the lower order needs are to be satisfied, then the individual is motivated to satisfy the next level of needs (Figure 8.4).

Keeping compensation in perspective what this theory means is that salary or base pay is a means of satisfying the lower order needs, i.e., physiological needs, safety needs and social needs, but it cannot go any further than that. Therefore, the wage mix has to be a combination of financial and non-financial components to cater to the different needs of people.

8.3.2 Alderfer's ERG Theory

Alderfer (1969) modified Maslow's five levels of needs to three levels and called them—‘E’ for existence, ‘R’ for relatedness and ‘G’ for growth.

  • ‘Existence’ needs comprise Maslow's physiological as well as safety and security.
  • ‘Relatedness’ is the need for affection.
  • ‘Growth’ needs are the desire for personal development, i.e., self-actualization, and are intrinsic component of Maslow's esteem needs.

Alderfer's theory has three levels of needs—‘E’ for existence, ‘R’ for relatedness and ‘G’ for growth.

 

However, there are certain differences from Maslow's need hierarchy.

  1. ERG needs are not strictly as per the chain of command or hierarchy based. As per the ERG theory, when a high order need level is frustrated, the individual's desire to increase a lower need takes place. Have you heard people saying ‘If the role and profile is not good—the job should have a good salary to compensate’?
  2. ERG theory also suggests that more than one need may be activated at the same time and could be operating simultaneously. Alderfer's theory is appealing and is seen as directly applicable to the motivation of people at work.

8.3.3 Herzberg's Two-factor Theory

Herzberg (1968) developed a motivation–hygiene theory applicable to the work setting. He developed the concepts of hygiene factors and motivators creating the two-factor theory of motivation. According to Herzberg, factors contributing to job satisfaction are called motivators. They are in addition to the hygiene factors whose absence may at times lead to job dissatisfaction. As you can see in Figure 8.5, hygiene factors are those factors which, if not present, will demotivate a person but the presence of which will not motivate a person. For example, getting the salary credited into your account on the last day of the month is no motivation to come to work. However, if not present it will surely demotivate a person. Motivators are those factors which encourage or motivate employees to work better. An example of motivators could be self-esteem and increased accountability coming from a well-designed job.

 

Herzberg developed the concepts of hygiene factors and motivators creating the two-factor theory of motivation.

8.3.4 McCelland's Achievement Motivation Theory

McCelland's (1961) achievement motivation theory deals with the need for achievement, power and affiliation. The theory focuses on three needs (Figure 8.5):

1. Need for achievement (n Ach): This is the drive to excel, to achieve in relation to a set of standards and a desire to succeed. High achievers derive greater satisfaction with the accomplishments from solving complex problems rather than accompanying money rewards. McCelland (1961) also emphasizes that need for achievement can be acquired and increased with training and experience.

2. Affiliation need (motivation) (n Aff): This is the desire for friendly and close interpersonal relations, to belong to and be acknowledged by different groups. It is related to the social aspect which helps in making a job more pleasurable. When such interaction takes place, morale is higher and productivity improves. However, when social interaction is denied, employees tend to fight the system by restricting the output. Allowing employees to fulfil social needs on the job, helps in preventing these negative behaviours.

3. Power need motivation (n Pow): This is the need for power to control and manoeuvre people and situations. It is the drive for authority and influence. Power motivation becomes strong in people who feel themselves insufficient to achieve respect and acknowledgement and then go out of the way to seek attention of others. McCelland emphasizes that ‘n Ach’ correlates positively with high levels of performance and ‘n Pow’ is closely related to managerial success.

 

McCelland deals with the need for achievement, power and affiliation.

 

Figure 8.5 Herzberg's motivation–hygiene theory

 

8.3.5 Adams’ Equity Theory

Adams (1963) put forth the equity theory of job motivation. ‘When employees feel fairly or advantageously treated, they are more likely to be motivated, when they feel unfairly treated they are highly prone to feelings of disaffection and demotivation. The way that people measure this sense of fairness is at the heart of Equity Theory.’

 

Adams’ equity theory:

‘When employees feel fairly or advantageously treated, they are more likely to be motivated, when they feel unfairly treated they are highly prone to feelings of disaffection and demotivation.’

  • Financial equity
  • External equity
  • Internal equity
  • Employee equity
  • Team equity

Employees want to be treated equitably. Equity is the balance between the input that an individual brings to the job and the outcomes they receive from it. The employee inputs include education, experiences, special skills, effort and time spent at work. The outcomes include pay, benefits, achievement, recognition or any other rewards. Employees review their performance and attitudes by comparing both their determination to work and the benefits they derive from it to the contributions and benefits of comparison with others whom they select and who in reality may not be like them. A person is motivated in relation to the perceived fairness of the rewards received for the amount of effort as compared to what others receive. Individuals are motivated to reduce any perceived inequity.

This theory pertains to compensation. Organizations must attract, motivate and retain competent employees. A firm's financial compensation system plays a major role in achieving these goals and the organization ought to strive for a balance in compensation. There can be different kinds of equity, as discussed below:

Financial Equity

This is about the perception of reasonable pay for employees. Firms and individuals view fairness from two perspectives.

External Equity

Employees receive pay equivalent to employees that carry out similar jobs in other organizations. For example, the compensation surveys and the benchmarking studies help organizations to determine the extent to which external equity is present.

Internal Equity

It exists when employees receive pay in comparison to the relative value of their jobs within the same organization. From an employee relation standpoint, the internal pay equity may be more important because the employees have more information to shape the perceptions of equity. They also start comparing themselves with others. On the other hand, the organizations must also be competitive in the market to remain viable. For example, the senior manager will earn more than an executive, who in turn will earn more than a trainee.

Employee Equity

It exists when employees performing comparable jobs for the same firm receive compensation according to factors distinctive to the employee, such as performance level or seniority.

Team Equity

It is achieved when teams are rewarded based on their groups’ productivity. Achieving equity may be a problem when it comes to team equity. If all team members contributed equally there would not likely be a problem. For example, the employees of the same seniority or performance level could receive the same compensation, even if their jobs are different. Employees doing the same job could receive higher or lower compensation than one another, if their performance levels were better or worse.

8.3.6 Vroom's Expectancy Theory

Managers would definitely like to know whether their employees are sincerely working or generally goofing around. Would it not be nice to know whether a planned reward programme will have the desired effect, i.e., motivating them to perform better in their jobs? Would it not be helpful if you could measure the effect of bonuses on employee productivity? This is exactly the basis of the expectancy theory of motivation proposed by psychologist Victor Vroom, it proposes that the employees will work hard to earn rewards they value and consider obtainable. Vroom argues that employees will be motivated to exert a high level of effort to obtain a reward under three conditions:

  1. Their efforts will result in acceptable performance.
  2. Acceptable performance will lead to the desired outcome or reward.
  3. the reward is of value to the employees.

 

Vroom's expectancy theory proposes that employees will work hard to earn rewards they value and consider obtainable.

To apply expectancy theory to a real-world situation, let us analyse an insurance company with 100 agents who work at a call centre. Assume that the firm pays a fixed salary of 20,000 a month, plus a 1,000 commission on each policy sold above ten policies a month. In terms of expectancy theory, under what conditions would an agent be motivated to sell more than ten policies a month?

8.4 COMPENSATION MANAGEMENT

Managing the compensation of employees is a complex process. Consider this—you have started a new business and you have about 50 people working for you. When you started the business, you took on friends with whom you had a clear-cut arrangement of taking a basic salary and sharing the profits. As your business expands, you and your friends invited your team members from your previous organization to join you. Your way of convincing these people to work with you was first having them buy into your vision and then paying them a significantly higher salary than the market. This continued and every person who came in till now has been given a certain raise over their last employer's salary at the time of being hired. Now this ad hoc process is not working because there are too many disparities: (1) within the organization (2) outside the organization. You realize this cannot continue—what would you do? From the above example you can understand how imperative it is to have a compensation strategy. Given below (Figure 8.6) are the phases that have to be followed to decide on a compensation strategy.

8.4.1 Phases of Compensation Management

Job Analysis

Job analysis (please refer to Chapter 3 for a detailed explanation on Job Analysis) yields a lot of information about the job. Two documents which get prepared with this process are job description and job specification.

 

  • Job analysis

    Job description

    Job specification

  • Job evaluation methods

    Job ranking

    Job grading

    Factor comparison

    Point system

  • Salary survey (external): General survey, company survey and published data
  • Matching (internal and external): Grade jobs and compensation structure

 

Job Evaluation

Job evaluation is a process of ascertaining the relative worth of jobs. There are a variety of methods to do this. These are job ranking, job grading, factor comparison and point system. Job evaluation establishes the internal worth of jobs.

 

Figure 8.6 Phases of compensation management

Salary Survey

Compensation can never be divorced from the external realities of the employment market. In order to design an attractive compensation, it is important to know what the trends in the external world are. A salary survey yields information about this.

Matching

Compensation structuring once the information on the worth of jobs within the organization is achieved through the job evaluation process and the trends in the market known through a salary survey, the decision on how to match these together is the next step in compensation management. This involves grading the jobs and deciding how to structure the compensation for these.

8.5 JOB EVALUATION

It is a formal process for determining the relative worth of jobs based on the job content, with emphasis on factors such as skill, effort, responsibility and working conditions. One can determine the worth of one job relative to another and this eventually results in a wage or salary structure or hierarchy. The basic principle of job evaluation is this: jobs that require greater qualifications, more responsibilities and more complex job duties should be paid higher than other jobs.

 

Job evaluation is a formal process for determining the relative worth of jobs based on job content, with emphasis on factors such as skill, effort, responsibility and working conditions.

8.5.1 Objectives of Job Evaluation

Compensation decisions have to be taken on the basis of information and job evaluation is one method to establish information on the basis of which compensation decisions can be made. By design, job evaluation focuses internally and does not take into account market forces, individual skills or individual performance. However, it does:

  • Establish a rational, consistent job structure based on value to the organization in terms of each job's complexity, importance and/or other factors. Create a system of pay rates that result in employees feeling a sense of internal equity.
  • Ensure compliance within the legal framework.
  • Provide a basis for pay-for-performance.
  • Help in establishing pay rates and structures that are competitive.

8.5.2 Job Evaluation Process

Job evaluation is a judgemental process and demands close cooperation among supervisors, HR specialists and employees and union representatives. Figure 8.7 outlines the steps to the job evaluation process. Each step is now explained in detail.

 

Job evaluation process involves:

  • Articulating objective
  • Selecting the most appropriate method
  • Making a project plan
  • Communicating with employees
  • Selecting benchmark jobs
  • Analysing benchmark jobs
  • Evaluating select benchmark jobs

 

Figure 8.7 Job evaluation process

Articulating Objectives

First, one needs to analyse and identify the need for such a system. For example, dissatisfaction reflected in poor compensation may result from paying employees different rates for similar jobs. Supervisors may not be comfortable with an informal way of assigning pay rates.

Selecting a Method

There are a variety of methods through which job evaluation can be done. They are job ranking, job grading, point system and factor comparison.

Making a Project Plan

This method resorts to identifying the need for the programme, getting cooperation and then choosing an evaluation committee. The committee then performs the actual evaluation. A job evaluation committee needs to be chosen and selected.

The committee should comprise four to six members who are familiar with the jobs under consideration. Each committee member would have a different viewpoint regarding the nature and kind of the job. Hence, the composition of the committee is very significant.

Communicating with Employees

Employees must cooperate in the whole evaluation system. A buy-in from employees can be obtained in a manner by informing them that pay decisions will not be made just arbitrarily by the management. None of the employees’ pay slab will be affected as an outcome of this process.

Selecting the Benchmark Jobs

Benchmark jobs are key jobs selected to cover each level and major function in the organization because they are well structured and are representative of those levels and functions. The evaluation committee identifies the key benchmarks jobs. These jobs will be evaluated first and will serve as benchmarks against which the relative significance of all other jobs can be compared. The number of these jobs will depend on the size of the organization and its complexity in the number of different levels and functions. Between 10 and 30 per cent of the total number of jobs can be selected as benchmark jobs.

Analysing the Benchmark Jobs

The analysis of these benchmark jobs is done with the help of the information which gets generated as a result of the job analysis.

Evaluating Select Benchmark Jobs

Finally, the committee evaluates the worth of each job. A test of the benchmark evaluation should also be done to check if it has produced fair relativities between the benchmark jobs.

8.5.3 Job Evaluation Methods

There are four basic methods of job evaluation:

  1. Job ranking method
  2. Job classification method
  3. Factor comparison method
  4. Point system method

While many variations of these methods exist in practice, the four basic approaches are described here. Table 8.1 summarizes their relative advantages and disadvantages.

Ranking Method.   One approach is to simply rank jobs according to the perceived value of each job. The ranking can be done by the committee comprising the management and employee representatives. The basis of ranking the variables could be complexity of the job, criticality to organizational success and the competencies required. The jobs are examined as a whole rather than on the basis of important factors in the job and the job at the top of the list will have the maximum value and evidently the job at the bottom of the list will have the lowest value. Thus, as the number of jobs to be ranked increases, detailed job analysis information becomes more important and input is more likely to be sought from several members of a committee. Jobs also can be arranged according to the relative difficulty in performing them. Jobs are usually ranked in each department and then the department rankings are combined to develop an organizational ranking.

 

Ranking method involves ranking jobs according to the perceived overall market value of each job.

This method is suitable only when few jobs need to be evaluated and when one person is familiar with all of them. As the number of jobs increases, it becomes difficult for one person to know all of them well enough to create a meaningful rank order.

There are several steps in this job ranking method:

  1. Obtain job descriptions: Job descriptions for each job are organized and the information they contain about the job's duties and responsibilities are the cornerstone of the ranking of jobs.
  2. Grouping of jobs: It is not possible to rank all jobs in an organization. The customary procedure is to select jobs and then rank jobs by departments. A direct comparison of jobs will be required then.
  3. Select compensable factors: It is quite common to use just one factor and to rank jobs based on the total job. Irrespective of the number of factors that are chosen one must explain the description of the factor(s) to the evaluators carefully, so that they evaluate the jobs consistently.
  4. Rank jobs: Each rater could be given a set of index cards, each of which contains a concise narration of a job. Then these cards are ranked from the lowest to the highest. One can select the cards, first choosing the highest and then the lowest, then the next highest, the next lowest and so forth until all the cards have been ranked.
  5. Combine ratings: Several assessors rank the jobs individually. Then the rating committee usually averages the assessor's average.

The disparity in payment of salaries depends on the variation of the nature of the job performed by the employees. In large organizations, this could be a cumbersome process, as rankings are difficult to develop in a large, multifaceted organization. Moreover, this kind of ranking is highly subjective in nature and may offend many employees. Therefore, a more scientific and productive way of job evaluation is called for. Since, there is no standard use for comparison, new jobs would have to be compared with the existing jobs to determine its appropriate rank. In essence, the ranking method would have to be repeated each time a new job is added to the organization.

 

Job classification method first establishes job classes, referred to as pay grades and then groups job description within these broader categories.

Job Classification Method. This method first establishes job classes, referred to as pay grades and then groups job description within these broader categories. Classification standards detail the kinds and levels of responsibilities assigned to jobs in each grade, the intricacy of the work performed and the required employee qualification.

The pay grade descriptions serve as the standard against which the job descriptions are compared. The description of a grade captures some of the details of the work that falls within the grade; quite a few jobs can be slotted into one grade. As the number and multiplicity increases, the classification process becomes more subjective. This is true when employees work at several locations and in jobs that have the same title, but with the different job content. Then combine the rankings for each job into an overall numerical rating for the job. In such cases, it is difficult to attend to the true content of each job and so job evaluations tend to rely on the job title for making a job classification.

According to this method, a pre-determined number of job groups or job classes are established and jobs are assigned to these classifications. This places groups of jobs into job classes or job grades.

The following is a brief description of such a classification:

  1. Class I—Executives: Further classification under this category may be the credit manager, the collection, accounts manager, the administration manager, the floor manager etc.
  2. Class II—Skilled employees: Under this category may lie the sales coordinator, the accounts executive, the collection executive, the credit officer etc.
  3. Class III—Semi-skilled employees: Under this category may lie coordinators, steno typists, receptionists, telephone operators etc.
  4. Class IV—Semi-skilled employees: This category comprises clerks, office boys, waiters etc.

There are several steps in this job classification method:

  1. Classification of jobs is done into an existing grade structure. The characteristics which are significant for distinguishing different levels of work are identified and described. They provide a basis for assigning the appropriate grade level to all positions in the occupation to which the standards apply.
  2. Each level in the grade structure has a description and job titles.
  3. Each job is assigned to the grade providing the closest match to the job. The classification of a position is decided by comparing the whole job with the suitable job grading standard. To ensure equity in job grading and wage rates, a common set of job grading standards are used.

The factor comparison method is more scientific and complex than other methods. Instead of ranking complete jobs, each job is ranked according to a series of factors.

Factor Comparison Method.   The factor comparison method is more complex and scientific than the other methods. Instead of ranking complete jobs, each job is ranked according to a series of factors. These factors include mental effort, physical effort, skill needed, supervisory responsibility, working conditions and other relevant factors. The pay will be assigned in this method by comparing the weights of the factors required for each job, i.e., the present wages paid for the key jobs may be divided among the factors weighed by importance (Table 8.1).

The steps involved in factor comparison method are as follows:

  1. Identify a set of compensable factors which determine the worth of jobs. Typically, the number of compensable factors is small (four or five). Examples of compensable factors are:
    • Skill
    • Responsibilities
    • Effort
    • Working conditions
  2. Rank the chosen jobs under each factor (by each and every member of the job evaluation committee) separately. Assign money value or scores to each factor and agree on the wage rates for each key job. Alternatively, once benchmark jobs are identified they should be selected as having certain characteristics:
    • Equitable pay
    • Range of factors (for each factor, some jobs would be at the low end of the factor while others would be at the high end of the factor).
  3. Price the jobs and divide the total pay for each job into pay for each factor.

This process establishes the rate of pay for each factor for each benchmark job. Slight adjustments may need to be made to the matrix to ensure equitable rupee weightage of the factors.

The additional jobs in the organization are then compared with the benchmark jobs and pay rates for each factor are summed to establish the pay rates for each of the other jobs.

Point Method.   This is the most widely used method of job evaluation. The procedure involves using a system of points to assign value to jobs. It involves subjective judgements. Each factor is divided into levels or degrees which are then assigned points. Each job is rated using the job evaluation instrument. The points for each factor are summed up to form a total point score for the job. The jobs are then grouped by total point scores and assigned to wage/salary grades so that similarly rated jobs would be placed in the same wage/salary grade (Table 8.1). Bias or subjectivity can enter at each of the three major steps in the process which are as follows.

  1. Selecting compensable factors: Compensable factors are the dimension of work that an organization chooses to use when establishing the relative value of jobs. The employers compensate the employees more to the degree that their jobs involve tasks and responsibilities that the organization considers valuable. When selecting the compensable factors, the employers can choose whether to develop their own customized set of factors or to use a standardized off the shelf system.

    The most widely used standardized point system is the Hay Guide Chart Profile which was developed by the consulting company Hay Group.

  2. Assigning factor weights: These weights enable the system to allocate more points to factors that are most important to the company's success. One may wish to give more weights to jobs in which people can make a greater contribution to the firm's performance, while giving less weights to the competencies needed to perform a job. Thus it might assign different weights to the three factors listed below.
    • Improvement opportunity: How much opportunity is there for the employees in this job to improve performance?
    • Contribution: How strong are the requirements for the employees in this job to achieve results?
    • Capability: What are the total proficiencies and competencies required for the job?

    These weights are reflected in the point system. A consequence could be that key sales jobs with few educational requirements would be assigned more points than some corporate staff positions that require a formal degree.

  3. Establishing degrees of factors to present jobs: Once factors are selected and weighted, the next step is to construct scales reflecting the different degrees within each factor. Each degree is anchored by an explanation of the distinctive tasks and behaviours associated with that degree. After factors and degrees are delineated a job's worth can be assessed. This involves establishing the degree of each compensable factor associated with the job. A compensation team is chosen to assess the job worth. The committee members usually discuss their evaluations and the discussion continues until a compromise is reached on the value of each job.

    Currently, this method is widely used. Here, jobs are expressed in terms of key factors. Points are assigned to each factor after prioritizing each factor in the order of importance. The points are summed up to determine the wage rate for the job. Jobs with similar point totals are placed in similar pay grades. It accounts for differences in the wage rates for various jobs on the strength of job factors. The established rating scales remain unchanged, though the jobs may change over a period of time.

    The procedure is as follows:

    • Select key jobs. Identify the factors common to all the identified jobs such as skill, effort, responsibility etc.
    • Divide each major factor into a number of sub-factors. Each sub-factor is distinct and articulated clearly in the order of significance, preferably along a scale.

 

The Point Method involves using a system of points to assign value to jobs. It involves subjective judgements. Each factor is divided into levels or degrees which are then assigned points. Each job is rated using the job evaluation instrument. The points for each factor are summed up to form a total point score for the job. Jobs are then grouped by total point scores and assigned to wage/salary grades so that similarly rated jobs would be placed in the same wage/salary grade.

 

The most frequent factors employed in point systems are:

  • Skill: these could be further defined as experience, education and ability.
  • Responsibilities: These could be further defined as supervisory or managerial responsibilities.
  • Effort: This could be further defined as mental or physical effort.
  • Working conditions: These could be further defined as per location, the kind of hazards faced and to what degree.

Each factor is then divided into degrees which are then assigned points. The points for each factor are summed to form a total point score for the job. The jobs are then grouped by total point score and assigned to wage/salary grades, so that similarly rated jobs would be placed in the same wage/salary grade.

  1. Able to carry out simple calculations; basic knowledge of computers—basic level of high school education.
  2. Does all the clerical operations; computer literate—graduate.
  3. Handles independent correspondence, develops contacts, takes initiative and does work independently—postgraduate.
  4. Find the maximum number of points assigned to each job (after adding up the point values of all sub-factors of such a job). This would help in finding the relative worth of a job. Once the worth of a job in terms of total points is expressed, the points are converted into money values keeping in view the hourly/daily wage rates. A wage survey, usually, is undertaken to collect wage rates of certain key jobs in the organization.

 

Table 8.1 Choice of evaluation methods

8.6 WAGE AND SALARY SURVEY

Competitive compensation structures and levels can only be developed and maintained if the external market is systematically monitored by a process of external benchmarking. This can be done by using a range of sources from the salary and benefits survey, the company's annual report, the informal confidential contacts in the market and other forms of data and market intelligence.

 

Wage surveys mean

  • Planning the data collection activities
  • Collecting the survey information
  • Analysing the information

To establish competitive priced wage structure, the organization relies on the wage and salary survey data collected from other organizations. The survey process involves identifying the jobs to be included, selecting the organizations to be surveyed and then actually collecting the data. This data then needs to be interpreted so that the wage rates can be set within the background of the organization's pay policy. Majority of companies regularly use the wage and salary survey data in setting their own pay standards.

 

 

Planning the Data Collection.   The employers usually use the salary survey data to price the benchmark jobs, around which other jobs are then slotted based on the job's relative worth. Companies do market surveys to:

  • Determine the pay rates in the external market
  • Identify the market's pay policy
  • Establish the organization's pay policy

Usually, the survey looks for the following pieces of data or information:

  • Basic (or base) pay: This is the guaranteed salary for the job (including annual benefits too).
  • Cash bonuses: Any performance-related bonus or payment under any cash incentive scheme.
  • Total earning: This is the sum of the base pay and any cash incentives given.
  • Employee benefits: Details of benefits such as paid leave, company cars, pension plans, insurance coverage etc.
  • Other allowances: Any cash payment for special circumstances.
  • Salary structure: Salary scale or range in the structure for particular jobs.

Collecting Survey Information. The following are the main sources of data:

  • General salary surveys: Every year, consulting organizations conduct an industry-wide salary survey and make the survey results available at a price to the companies who would want to buy it. Those companies which participate in the survey are given a free report too. These surveys are undertaken by industry associations, professional associations, consulting organizations etc. (Hay Group, Mercer Consulting, Hewittt Associates and Towers Watson etc.). Numerous annual surveys offer a wide choice of job families and industries.
  • Company surveys: Companies can institute their own salary survey too. These surveys are at times done by a consulting firm for the company or the company does it on its own. The organizations to be covered in a wage survey typically include those that (1) employ workers with the same skills, (2) are within geographic distances and (3) are in the same or similar industry. Moreover, the employers do not seek data on all jobs. Instead, they gather survey information only for key jobs. Key jobs are those whose job content is relatively stable over time, occur frequently both in the organizations and in the surveyed organization, the jobs can be defined quite precisely, the jobs are performed in a similar manner in most organizations.
  • Published data: Routinely there are salary surveys which appear in newspapers, journals or business magazines. The analysis of advertisements is also a good way to do a quick survey—however, this has become increasingly difficult because companies prefer to write either ‘negotiable’ or ‘competitive’ instead of giving any indications of compensation in most places in their recruitment advertisements.

Analysing Information.   In order to interpret the survey data, the benchmark jobs must be identified. Traditionally, the benchmark jobs are those commonly found across a range of organizations. When data is collected as a part of the market survey, the jobs in the survey have brief job descriptions. To determine whether a job is useful as a benchmark, the job description used for this survey is compared with the job description in the employer's organization. If the two descriptions are comparable to a great extent, the employer can feel confident that the market wage data provided by the survey can be applied to the job in the employer's organization. Market information about the compensation levels of the benchmark job is used to establish the market pay policy. For example, ICICI Bank benchmarks with the global best practices to ensure optimum utilization of their resources.

8.7 COMPENSATION STRUCTURING

A compensation structure provides a framework within which an organization defines the different levels of jobs, on the basis of their relative internal value (job evaluation) and external relativities (market rate). This is followed by defining compensation or pay within these job levels.

8.7.1 Grade Structure

Job evaluation provides critical inputs for grading jobs in the company. Job grading in turn helps the organization to determine pay grades. There are many kinds of grade structures, but one of the most popular and prevalent methods of structuring is Broadbanded structures that consist of far fewer and far wider ‘bands’ than the grades in a conventional structure. Broadbanding is explained in greater details below.

HRM in Action

Acclaris Business Solutions Pvt. Ltd., founded in 2001, is a leading software-enabled service provider. The key differentiators which make the compensation systems at Acclaris a best practice are:

  • The compensation budget is created annually and is closely monitored and reviewed by the senior management.
  • Across the organization, compensation bands are created and these are communicated to the employees. They also design a compensation and benefits package, keeping in mind the external and internal requirements.
  • Every two years a benchmark study on compensation is undertaken by a third party. The organization then analyses the findings and necessary modifications are done in the current system.
  • Employee queries on changes made in the compensation are addressed in a comprehensive and timely manner.
  • The company also benefits from having an updated comparative analysis of its pay practices with respect to that of its competitors.

Source: Adapted from ‘Nasscom Right Management Exciting Emerging Companies Survey 2008’, Human Capital, October 2009, 13(5).

8.7.2 Broadbanding

One element of compensation that the majority of companies are struggling with is the layers of hierarchy and issues on how to delayer the layers and the various systems of grading. To counter this growing ‘disalignment’, many companies are adopting a strategy known as ‘broadbanding’, in which the whole lot of grades is now placed with fewer bands or grades. Thus, broadbanding is the compression of a hierarchy of pay grades and job grades or salary ranges into a small number of wide brands. Unlike traditional pay grades, bands can overlap, which thereby adds flexibility to the existing flexible pay programmes. This helps employees to progress in their job roles or in the organization by remaining in the same pay range and the same designation.

 

Broadbanding is the compression of a hierarchy of pay grades and job grades or salary ranges into a small number of wide brands.

Benefits of Broadbanding

The preliminary motivation is to abridge the compensation administration process.

The features that attract organizations to broadbanding include:

  • Competence: Initially, organizations start to look at broadbanding as a way to simplify their salary administration process. By having fewer grades, they expect to spend less time evaluating jobs and defending grade placement decisions.
  • Flexibility: As firms investigate the issues implicated in broadbanding, they realize that having fewer grades enhances the ability of the organization to transfer employees between jobs. Since fewer grades exist, employees are less likely to view the transfer as a demotion. The increased flexibility that the organization gains are useful, predominantly when it is going through swift transformation or downsizing.
  • Decentralization: As the management contemplates how salaries will be controlled within the broader ranges, it realizes that the processes will need to rely more on local managers to make and preserve pay decisions. This is consistent with and can help reinforce, the decentralized decision-making process being adopted by many quality-oriented firms.
  • Result-oriented: Firms begin to focus on the implications of employees receiving fewer promotions during their careers. This may be perceived as a negative at first, but is often changed into a positive. This change occurs when the decision-makers become conscious that broadbanding allows supervisors to provide significant rewards within a broad salary range for those performers who consistently do an outstanding job.

Benefits of broadbanding

  • Competence
  • Flexibility
  • Decentralization
  • Result-oriented

Structure: How Broadbanding Works

Companies adopting a broadband structure generally reduce the number of salary ranges by one-half to two-thirds. The broadband range spread is generally 75–125 per cent. It may be greater. Broadbanding companies use around 8–10 bands, although they could vary from company to company. An example could be 2 for the executive level, 4 for the managerial and professional level, 4 for the non-managerial level.

Pay Spans in a broadband can be 100 per cent or more, i.e., the highest pay can be as high as double the lowest pay in a certain band. There is often an overlap between the pay ranges of the adjacent bands. This means that while one band could have a range from 300,000 to 600,000 the adjacent could be from 500,000 to 1,000,000. This provides for more flexibility on pay provision. Broadbands typically do not have a distinct midpoint; they have a minimum and a maximum. Companies use a range of techniques for control purposes, including a series of reference points relating to career levels in a job family, market-based zones linking a group of benchmark jobs to anchor the structure to the market.

When the compensation grid is formed, it is not unusual to find employees who are currently being paid above the maximum for a range or below the minimum. Those below the range are marked and increased to be within the range. If the gap is large, then the increase could be made over a period of time. If the employees earning more than the maximum qualify for the promotion, they can be moved to a job in a higher range commensurate with their existing pay. If promotion is not feasible, the employee is marked that their pay is frozen at its current level until the range moves up, through annual increases tend to include the employee. No employee's pay is cut as a result of this exercise.

8.8 COMPENSATION STRATEGIES

‘How do you select the right compensation strategies and tactics for your organization?’ is the question most HR managers have to find the answer to. The compensation strategy should group compensation components so that they influence employee motivation in a positive manner and lead to improved organizational performance and profitability.

Compensation strategy conveys the company's commitment to how it values employees and recognizes that competitive compensation is the cornerstone for recruiting, retaining and motivating the type of employees needed to fulfil its mission. It gives the company and the employees a frame of references when discussing salary in a negotiation.

The essential elements of a good compensation strategy are as follows:

  • It should have a strong employee focus.
  • It should be clear, concise and well written.
  • It should follow market practices.
  • It should help the employee in allowing them to choose from amongst the various bouquet of benefits.
  • It should have a mix of fixed and variable pay.
  • It should be easy to administer.
  • It should focus on the reward base.

8.8.1 Traditional Compensation

In the traditional compensation days, employees were paid through increases in base salaries. These salaries were determined by the job itself, parity amongst employees at the same level and parity in the industry to which it belonged. The pay was based on certain skills the employee already had, they were never paid to develop other skills nor were they rewarded for the same. Once initial pay levels were established, performance review increases resulted in the form of promotions, merit increases or increase due to cost of living.

Failures of the Old Pay

Compensation systems are supposed to attract, retain and motivate talent; in the past, most pay systems failed on this count. The system itself failed to ‘walk the talk.’ Some of the problems which were inherent in the manner in which the ‘old pay’ was conceptualized were as follows:

  • Pay became entitlement-driven: Every year, employees felt by right that they were entitled to pay increases and bonuses. There was no connection to their performance.
  • Increase in upper ceiling: Increases used to be the cut off, when the employee reaches the higher end of the job range. The organizations used to put the employees into higher levels of the job classification to give them the benefit of higher pay.
  • Demotivator: In the old pay structure, the amount of effort an employee put was not linked to the payout. All employees got flat bonuses, i.e., a month salary or so. This proved demotivating to superior performers.
  • Employees cost calculations are hidden and partial: The company had very limited ability to ascertain the total cost of employee; as a result the employee never knew what they were getting in totality. Even the replacement cost of an employee was difficult to calculate.
  • Lack of employee involvement: The employees could never decide how and which components they could opt for when deciding their salary components.

Field Guide

Compensation Management: A Checklist

These are the steps that an organization has to follow to arrive at a compensation plan for the organization. This can also be used as a checklist by an HR department to ensure that the basics for articulating a compensation management programme are in place.

  • Compensation objective
    • Do we have our compensation objectives articulated?

    • Are our compensation objectives aligning with our business objective?

    • What is the compensation status in the competitive employment market?

    • Have we done an analysis of costs/ budgets for various scenarios?

  • Organizational structure
    • Is the organizational hierarchy defined?

    • Are job specifications and job descriptions in place?

    • Have job and pay bands been defined?

    • Do we have a definition of the measurable factors for each position?

  • Desired competitive position
    • Has the peer group for the organization in terms of other organizations been defined?

    • What competitive posture would be taken in the market (which percentile do we want to peg our compensation in the market) has been decided?

    • Have we benchmarked our compensation plan competitiveness?

  • Pay elements in the total compensation package. Have we decided…
    • Ratio of fixed versus variable pay

    • Heads of fixed pay

    • Heads of variable pay—Performance-based/skill-based/competency-based

    • Heads of flexi pay

    • Heads of benefits

    • Pay structures for each level in the organizational structure

    • Criteria for pay progression

Source: Adapted from www.shrm.org, accessed on 25 August 2011.

8.8.2 Total Compensation Equation

A research was conducted by John E. Tropman at the University of Michigan Business School. The research asked MBAs what did they want from their workplace. There were also various discussions at the workplace and also discussion with HR professionals. He came out with a new concept of pay based on an equation with 10 variables. He called this the Total Compensation Equation. This holds good even in an Indian scenario. Total compensation combines traditional compensation with the educational, emotional and psychological benefits that can attract the best and brightest. It identifies the 10 elements—including learning, advancement, emotional rewards and quality of life—that job seekers rank highest among desired benefits. Thus, total compensation combines the non-monetary with the monetary benefits to create effective, employee-driven compensation package.

 

TC = (BP + AP + IP) + (WP + PP) + (OA + OG) + (EI + QL) + X

 

Each element is described in Table 8.2.

 

Table 8.2 Total compensation equation

TC

■  Total compensation

BP

■   Base pay or salary

AP

■   Augmented pay, that is, any one-time payment, even if received at regular intervals (such as overtime)

IP

■   Indirect pay (benefits)

WP

■   Works-pay, that is, employer-subsidized equipment, uniforms and so on

PP

■   Perks-pay, that is, special benefits—anything from accessories to employee discounts on the company products

OA

■   Opportunity for role advancement and increased responsibility

OG

■   Opportunity for growth, both through on-the-job training and through off-site training

EI

■   Emotional income, the emotional enhancements provided by the job itself and the employees

QL

■   Quality of life, that is, opportunity to express other important aspects of life (location close to home, flexi time, on-site child care, ski to work or whatever)

X

■   Any unique element that an employee wants that the workplace can facilitate

Source: Adapted from Tropman (2001).

8.9 VARIABLE PAY STRATEGIES

HR executives have now learnt that all these old compensation strategies in majority of the cases have now become a barrier to growth and success. Most employees feel disgruntled at the end of the review. Hence, new compensation solutions have now made their way in to the corporate world. These will, however, focus on quality, customer service, on time delivery, zero defects, productivity and teamwork. The shift has been towards variable pay plan. Such strategies include a whole host of incentives, rewards for the employee and team performance. In other words, the total pay of the employee increases or decreases, depending on how well they perform at work or the skills they have or the competence they show at the job. It also depends on how their division has performed and the organization on the whole has fared. Measures may be tied to increase in market penetrations, increase in market share, overall productivity, customer satisfaction, quality standards, economic value added (EVA), the development of new competencies, creation of new lines of business/products and other related factors.

Now there is a base pay and there is a variable pay. The variable pay is related to performance, competence or skill. These payments are made in the form of cash bonuses which are not consolidated in the basic pay. Different types of variable pay are performance-related pay, skill-based pay and competence-related pay. As shown in Table 8.3, the selection of variable pay is dependant on who it is for and what kind of a time line is being looked at.

8.9.1 Rationale for Variable Pay

There are three basic reasons for using variable pay and they are:

  1. Motivation: Pay related to performance, competence or skill motivates people to achieve higher levels of performance and to increase the range and depth of their competencies and skills.
  2. Message: Variable pay helps in doing important messaging to people. First, it drives home the message that performance, skills and competence are important and enhancement in compensation shall follow enhancement in performance, skill and competence. Second, performance-based pay also helps in driving important business imperatives such as quality, customer service and teamwork.
  3. Equity: It is right and proper that pay should be related to people's performance, contribution, competence or skill.

8.9.2 Different Types of Variable Pay

Performance-based Pay

The objective of performance-based pay is to perk up output. It has been a traditional component of the pay packet of many shop floor workers. Most sales staff are on some form of commission and executive bonus schemes have been the norm in most companies.

 

  • Performance-based pay
  • Pay for knowledge and skill
  • Competency-based pay

 

Early 2000 many organizations felt that they needed employees who were not only reliable but also excellent performers. Faced with profits that were on a downslide, these organizations also felt that they needed to reduce fixed cost, which indicated reducing the fixed pay. They also learnt that other than excellent performance, customer service orientation, innovation, flexibility etc. were also important for the overall growth of the organization. Hence, it was at this juncture that the performance variable pay was gradually introduced by organizations. Some companies kept the same percentage of variable pay at all levels, some divided the employee base into two or three categories and the variable pay percentage was lesser for the junior-level employee and increased for the levels above. For example, in the year 2004, Reliance Communications had constituted performance-based variable pay plan for junior management 10 per cent of CTC, middle management 20 per cent of CTC and for senior management 30 per cent of CTC.

 

Table 8.3 Variable pay choice matrix

 

Different types of variable pay:

  • Merit pay
  • Profit sharing
  • Gain sharing
  • Piecework
  • Incentives

    Small group incentives

    Individual incentives

    Long-term incentives

    Team-based incentives

  • Rewards

    Lump sum payments

    Recognition programmes

The most frequent types of variable pay for performance is the bonus, a one-time annual financial award based on output, that is not added to the base pay. The managers normally assert that performance based pay is a win–win situation because it boosts production and efficiency and give the employees some control over their earning power. With the bonus, there is no carry-over into successive periods, unless employees maintain their performance. It is a widespread feeling the employees fancy cash bonuses and they believe it is the best way to recognize a job well done. For example, Wipro Technologies’ rewards for each position are based on performance, potential, criticality and market value.

Merit Pay.   It is a pay raise given to employees’ base pay, based on their level of performance. Past studies have shown that merit pay is slightly victorious in influencing the pay contentment and performance. If the merit pay increases are small, it makes very little sense to roll it out to employees. From the employer's point of view, a distinct drawback to the merit pay increase is that it increases the wage bill permanently. Although many companies persist with merit pay plans, others seek to control fixed costs by means of variable pay. The merit pay which increases the base salary recognizes long-term assistance of employees. The variable pay as well as the bonuses, recognizes present accomplishments.

Profit Sharing.   This refers to certain employees that share the profits of the company. Employees could have problems in relating their performance vis-à-vis the efforts they have put in. Such kind of variable pay programmes do little to drive performance or directly help in changing the behaviour of the employees or teams.

It is a compensation plan that results in the allocation of a predetermined percentage of the firm's profits to employees. Many firms use this type of plan to incorporate the employees’ welfare with those of the company. Revenue sharing plans can aid in hiring, motivating and retaining employees.

Gain Sharing.   These plans are designed to bind the employees to the firms’ output and offer an incentive payment based on superior company performance. The goal of gain sharing is to focus on improving cost-effectiveness, reducing, costs, improving throughput and improving profitability. Gain sharing helps to align an organization's people strategy with its business strategy.

Gain sharing refers to the achievement of very specific goals for productivity, process improvement, quality improvement, cost-effectiveness and the like. If the predetermined goals are achieved, then the team gets a share of the gain. In other words, gain sharing is a kind of self-funding principle, based on the money the organization would have saved or earned. The gain sharing plan needs to be well designed and communicated. The organization must be able to measure the gains and also help in determining the employee role and efforts they need to put in order to achieve those goals. The payouts could be decided by the company and communicated in advance to the employees, ideally it could be once every six months or annually. They are also known as the productivity incentives and performance-sharing incentives.

Piecework.   This is a motivation pay plan where employees are compensated for each unit they generate. Sometimes a definite base is incorporated in a piece rate plan where a worker would be given the base sum no matter what the output is. Piecework is customary in the production/operations area. Requirements for the plan include developing output standards for the job and being able to gauge the output of a single employee. This would not be realistic for many jobs.

Incentives

Small Group Incentives.   These are mostly built around financial goals, such as a budgeted project, productivity, quality, on-time delivery and customer satisfaction. As the term suggests, it is specifically meant for small groups, i.e., project-based teams and the like. They are project driven and the focus on time is of great importance with results based on successful completion of a particular project. This need not run for a couple of years, it lasts only till the project has ended or the groups have finished the work. The rewards could be the same percentage for all the employees in the group or it could depend on the contribution the employee has made and the roles they performed on the project.

Individual Incentives.   During the early years, individual incentives were reserved for the sales teams, hourly workers and senior executives. They were target and performance driven. They help in driving the performance of the organizations, by incentising the employees who have excelled in their work.

Long-term Incentives.   Long term refers to payout cycles that are for more than a year. These could also refer to employee stocks or any kind of incentives that may range from three to five years. Such kind of programmes can be successful in getting employees at various levels to think about the company and its overall performance. If the employees’ performance is not up to the mark, the team's performance will also not be up to the mark and thereby the division and organization's performance will be on the downslide and will definitely affect the stock market prices.

Team-based Incentives.   Most software companies have the team-based incentives. One needs to understand how to design team-based pay strategies, such as the design of the structure they support, how the teams are organized, how they function, the dynamics of the members and what organizational values and goals they can best support. Once this understanding is in place, then one can begin to determine the appropriate reward architecture. The work teams focus on how work is being performed—normally members are either cross-functional or cross-trained on a set of skills. Software companies have ‘project-based teams’, the teams work on a particular timebound project, that has been given by the client, once the project has been delivered, the team gets the necessary reward based on the role they played in that particular project. Once the project is over, the teams would then get dismantled and every team member would be given some other project. The same applies to a ‘task force’, they also assemble together for a particular assignment, they could be from different levels in the organization and from different functions too and once they have delivered, they then go back to where they came from. Rewards for such team-based performance should be assessed formally or informally by the team members based on their job performance. These on time recognition awards are the most effective means of compensating team performance.

Rewards

Lump Sum Payments.   These are normally paid annually to the employees. By rewarding them, the organization reflects the movement towards a leaner, less competitive market position and the need to keep top performers well paid in the process.

Recognition Programmes.   The size and variety of recognition programmes is almost unlimited. They could refer to cash and non-cash recognition programmes—and one-time awards. The employee names could also feature on the bulletin board or in the ‘in house magazine’ of the company. At times, companies also offer gifts to employees on their annual days.

Knowledge and Skills-based Pay

Pay for Knowledge.   It rewards the professional employees for successfully learning specific curricula. Such a programme is often found in continuous development settings, such as those that use assembly lines where one employee's job depends on the work of at least another employee. They also represent a widespread basis for pay among clerical and skilled employees such as carpenters and fitters. They imply that employees must shift from viewing pay as an entitlement. Pay for knowledge programmes reward employees for their potential to make meaningful contributions to the job.

 

Pay for knowledge rewards professional employees for successfully learning specific curricula.

Skill-based Pay.   Skill-based pay links the pay to the level of skills used in the job and sometimes the acquisition and application of additional skills by the person carrying out the job. The skill-based pay is usually concerned with definite skills used by the worker. Nowadays, it is used for specific knowledge skills too.

 

Skill-based pay is a system that compensates employees for their job-associated skills and knowledge, not for their job titles.

The system assumes that employees who know more are more important to the firm and therefore they merit a reward for their efforts in acquiring their skills. Employees receive both tangible and intangible rewards, for example, pay increases, job security, greater mobility, and the satisfaction of being more valuable. Employees with a broader range of skills provide quality of work with a greater degree of resourcefulness in dealing with turnover and absenteeism.

Skill pay is the most appropriate in environments where the work tends to be regular and less varied, such as skills of a telecom professional or responding to high-end customer queries. The skill-based pay is also popular with independent workgroups or additional job enrichment programmes. In addition, the employees concerned in the skill-based programmes must have the desire to develop and augment their skills.

Some of the challenges of the management include that they need to offer ample training for the employees or else this could be a demotivator. Another point to be noted by the management is that the payroll costs will obviously escalate.

The skill-based pay rewards the employees for the skills they are required to acquire rather than for a specified job. As the employees acquire skills they become flexible in choosing their roles and develop a broader understanding for the work-related processes, thereby gaining a better understanding of the importance of their value to the organization.

They also help the employees to rapidly adapt to the ever-changing market scenario. Another issue the organizations must address in implementing this style of payment is what they will actually pay for. They need to gainfully utilize their skills at their work front in a way that it fits into the division and organizational set objectives too. Then there has to be a close relationship between the value of the skills and market rationalization for the pay.

Competency-based Pay

We can describe competencies as demonstrable knowledge, skills and behaviours that facilitate performance. They not only comprise skills but also involve other factors such as motives, values, attitudes and self-concept that can be associated with performance. The competency-related pay can be defined as a method of compensating and rewarding people wholly or partly by reference to the level of competence they demonstrate in carrying out their roles.

 

Competency-related pay can be defined as a method of compensating and rewarding people wholly or partly with reference to the level of competence they demonstrate in carrying out their roles.

Pay can be related to competence in two ways:

  1. It can be people based, it could link the compensation to the competence of the individual.
  2. It can be job based and use competence to evaluate and define the jobs and then ascertain the pay accordingly.

Usually they are a combination of both.

It is a compensation plan that rewards employees for the capabilities they accomplish. Substantial time must be spent in determining the detailed competencies needed for the different jobs. The blocks of competencies are then priced. The management must devote considerable time in developing, implementing and enduring such a system.

Why Use Competency-based Pay?   Many times, organizations have a competency framework defined and used in the HR process such as recruitment and selection. The logical thing to do next is to use the framework to define and drive the compensation programme also. This is reason enough to use the competency-related pay. However, besides this there can be other compelling reasons too.

  • High-performance organizations need high competence and compensation is an effective way in driving it.
  • It supports a culture devoted to learning, growth and continuous development.
  • It can deliver messages to people about the behaviour aspects of work as are important to the organization.

How Does Competency-related Compensation Work?   The first step in developing a competency-based compensation programme is to identify the competencies that create value for the organization and accordingly after recognizing them, they should be rewarded. One may create a list of attributes that the organization would like the excellent performers to have. Although core competencies may be unique to each company, one service firm identified the following:

  • Team-centred: Develops dynamic working relationships at levels within and outside the organization.
  • Result-driven: Is focused on achieving key objectives.
  • Client-committed: Works as an associate with the internal and external clients
  • Innovative: Generates and implements new thoughts, products, services and solutions to problems.
  • Fast cycle: Exhibits a bias for accomplishment and decisiveness.

Next is to ascertain what qualities, attributes and behaviours mark or help in distinguishing the superior performers from all other employees (What do best performers do that gives them an edge over other employees?). After analysis, the behaviour characteristics that predict this superior performance must be identified.

Once the competencies are identified and tested, they can then be linked to compensation. They could be initially tied to the base pay that the company may have. Under this scheme, the employees are paid up to certain target levels—usually done through benchmarking studies or market comparisons. Once this is accepted as a part of the base pay head, it can then be incorporated into other elements of compensation, such as variable pay.

Needless to say, other things required by a competency-based pay programme include an assessment system that measures the jobs or roles, the market data for setting pay standards and the flexible salary administration system.

8.10 COMPENSATION ADMINISTRATION

8.10.1 Pay Progression

In most organizations, employees are able to move up a pay band or scale. This is known as pay progression. There could be different types of pay progression, i.e., time-based (on a specific date, such as the anniversary of their joining the grade, or at the start of the financial year), performance-based (as the result of having achieved an agreed performance marking or target), development-based (as a result of how many skills they possess or the development of particular skills) and competency-based pay progress (as the result of having attained a particular level of competence, e.g., having completed a training programme, or having attained a job-related qualification) (Table 8.4) captures the different approaches to pay progression their attributes and their challenges, respectively.

 

Table 8.4 Comparison of different approaches

Approach Attributes Challenges

Automatic step progression (pay the job)

  • Easy to administer and explain
  • Particularly appropriate for task–oriented, short-cycle jobs
  • Does not address cooperation and teamwork
  • Can allow the managers and the supervisors to relinquish their performance management responsibility

Merit range (pay the job)

  • Allows flexibility to customize performance measures
  • Range of pay per grade can be more responsive to market pressures in particular job families
  • Assumes the managers and the supervisors are capable of making distribution decisions
  • Performance measurement pressures

Skill-based pay (pay the person)

  • Focuses employees on skill acquisition
  • Identifies clear development paths for the employees to pursue
  • Ensures the employees with broadest skill profiles are rewarded
  • Very individually focused and can be a barrier to teamwork
  • Administrative burden
  • Skill/job obsolescence
  • Per-employee cost of labour higher than traditional approaches

Competency-based pay (pay the person)

  • Focuses employees on developing breadth and depth of knowledge
  • Provides ‘person-based’ versus ‘job-based’ methodologies
  • Provides analysis that leads to competency identification and ensures alignment with business needs
  • Administrative burden
  • Skill/job obsolescence
  • Per-employee cost of labour can become high relative to traditional pay delivery systems
  • Translating ‘job-based’ market data to ‘person-based’ work environment

Team-based pay (pay the results)

  • Reinforces that the whole is greater than the parts
  • Shared risk and reward
  • Assumes high level of trust across teams
  • Relatively easy to administer and to communicate
  • Employee ‘shopping’ for the team that best fits their needs
  • Does not focus on the individual's personal development
  • Difficult to administer when there is fluidity of project assignments

Lump sum distribution (pay the results)

  • Allows lump sum to reward performance on time versus forever
  • Difficult to institutionalize
  • Extreme pressure on performance measurement and evaluation
8.11 EXECUTIVE COMPENSATION

An organization attaches priority to executive compensation because the leader is the backbone of any organization. Executive compensation package is, therefore, designed to suit the employees and benefit them at the maximum level. The compensation package generally includes fixed salary, performance bonus, stock options, some other stocks related to their performance, pension, benefits and perquisites. Most companies have commenced designing their salary in such a way that the fixed component is relatively smaller and the variable component is larger, since the compensation quantum is contingent to the performance of the organization.

Executive compensation should be aligned with the long-term interests of stockholders and the goal and strategies of the organization. A compensation committee should be composed of independent directors and a few key stakeholders from the organization.

 

8.11.1 Who Are Executives?

Employees who play major roles in a company's policy decisions can called executives—highly compensated employees and key role holders. These employees hold key positions of responsibility and accountability. This definition may, however, vary from company to company and the pay structures may vary too. For example, presidents, vice-presidents, functional and technical heads etc. qualify as key executives.

For any executive compensation, having answers to these four elements are of prime importance:

  1. Degree of risks: Are there high stakes involved in this and what are the stakes of the game per se?
  2. Performance measures: Have they been carefully designed and will they be able to get the maximum out from the employee?
  3. Degree of ownership: How much of ownership is the employee expected to have in the organization?
  4. Total remuneration: Does the compensation philosophy have a balance of fixed and variable pay?

8.11.2 Executive Compensation Packages

Executive compensation has both core and fringe compensation elements. The executive compensation emphasizes long-term or deferred rewards over short-term rewards. The main components of executive compensation include the following:

  • Current or annual core compensation
  • Deferred core compensation
  • Fringe compensation

Components of Current or Annual Core Compensation

Such compensation consists of two components—annual base pay and bonuses:

  1. Base pay: It is the fixed element of annual cash compensation. The companies that use formal salary structures may have precise pay grades and pay ranges for non-exempt employees, management, professional and executive jobs.
  2. Bonuses: Bonuses symbolize single pay for performance payments that the companies use to reward employees for the achievement of specific exceptional goals. A company's compensation committee recommends bonuses that are common in executive compensation. Four types of bonuses are common in the executive compensation:
    • Discretionary bonus: Boards of directors award discretionary bonuses to executives on a selective basis. They weigh four factors in determining the amount of discretionary bonus: company profits, the financial conditions of the company, business conditions and prospects for the future.
    • Performance bonus: This is based on the attainment of specific performance criteria. The performance appraisal system for determining bonus awards is often the same appraisal system used for determining merit increases or general performance reviews for salary.
    • Deferred bonus: This type of bonus is paid proportionately to the executives over a period of three to five years, depending on their performance. Once the commitment has been made to the executive, it is very rare that a company goes back on its word.
    • Target plan bonus: This type of bonus ties the executives to their performance. The bonus amounts increases with performance. The executives do not obtain bonuses when their performance falls below minimally acceptable standards.
  3. Short-term incentives: Companies award short-term incentive compensation to the executives to recognize their development towards fulfilling competitive strategy goals. The executive may participate in current profit plans and gain sharing plans, whereas short-term objectives reward non-executive employees for achieving major milestone work objectives. The compensation programme usually applies to a group of select executives within a company. The plan applies to more than one executive because the synergy that results from the efforts and knowledge of top executives influences the corporate performance.

Deferred Core Compensation

Golden parachute.   It is a written agreement between the employer and the employee, indicating that the employee will continue to receive certain benefits even if the employment contract is terminated by the employer. Most executive's employment agreements contain a golden parachute clause. It could also arise after a termination resulting from a change in ownership or corporate takeover. Golden parachutes extend pay and benefits from one to five years, depending on the signed agreement. The benefits could include severance pay, stocks, bonuses, planned retirement, resignation or benefits. It limits executives from risk in the event of unexpected events and it also promotes recruitment and retention of talented executives.

 

Deferred core compensation is a written agreement between the employer and the employee, indicating that the employee will continue to receive certain benefits even if the employment contract is terminated by the employer.

For example, according to a study done by the Hay Group (2006), the French executives golden parachutes are the highest in Europe and equivalent to the funds received by 50 per cent of the Americans executives.

Stock Options.   It refers to an agreement linked between an employee and a company to render payment to an employee at a future date. It is supposed to create a sense of ownership, aligning the interests of the executives with those of the ownership or shareholders of the company over the long term. Company stock shares are the foremost form of deferred compensation. The company shares represent total equity of the firm. The companies design executive stock compensation plans to promote an executive's sense of ownership of the company. A sense of ownership should motivate the executives to strive for outstanding performance. A stock worth increases with increase in company's performance. Some of them could also have a stake in the company profits.

Other Benefits

Executives receive discretionary benefits like other employees—standard benefits, protection programme benefits, paid time off and employee services. It may also include some life insurance plans or retiral plans.

Perquisites.   Executive's perquisites are an integral part of the executive compensation. The perquisites cover an extensive range of benefits such as free lunches, vacations, company cars, leisure facilities, club memberships, holiday homes etc. These benefits recognize the executive's attained status. The executives use these perks for their personal comfort.

Executive skill largely determines whether a firm will prosper, survive or fail. A company's programme for compensating executives is a critical factor in attracting and retaining the best available talent. Designing an executive's compensation package begins with determining the organization's goals, its objectives and the anticipated time for achieving them. It is advisable to obtain advice on tax and accounting implications for both the executive and the company. Organizations prefer to relate salary growth for the highest level managers to market rates and overall corporate performance, including the firm's market value. For the management tier, they tend to integrate overall corporate performance with market rates and internal considerations to come up with appropriate pay. Market pricing may be the best general approach to use in determining executive compensation.

Views in the News

Executive Compensation in India

With IT companies and their stocks emerging strongly from the recession, the focus is shifting to how much their top executives are taking home as salary.

In February 2011, Indian IT majors disclosed their top executives’ remuneration to American stock exchanges.

Cognizant

Francisco D'Souza

6.14 crore (This includes a base salary of 2.44 crore and a bonus of 3.7 crore).

HCL Technologies

Vineet Nayar

4.54 crore out of which 1.2 crore was base salary (as of June 2010).

Tata Consultancy Services (TCS)

Natarajan Chandrasekaran

2.97 crore, which included a bonus of 2 crore.

Infosys

S Gopalakrishnan

1.01 crore.

Polaris Software

Arun Jain

1.62 crore.

On a standalone basis, these salaries are not globally competitive. However, if you combine their other two sources of income—commissions (a percentage of the overall profit as pay) and stock options, the salaries are truly competitive in the global sense.

 

Views in the News

Employee stock options (ESOPs) are being used to lure and retain best performers in the organizations. Companies also offer phantom stocks options, which are performance-based plans with a ‘stimulated’ or ‘ghost’ ownership. Quite a few companies are now hiring consultants to help them out in this activity. These include stock appreciation rights, sweat equity and stock purchase plans, with these bouquet of reward plans, it is possible that this would excite employees and in turn help retaining them. For example, Deloitte has seen a 40 per cent increase in the kinds of stock they offer their employees. Essar, Apollo Hospitals, Thomas Cook, I Gate have also been offering stocks to some of their employees.

 

Source: Adapted from Sengupta (2010).

8.12 INTERNATIONAL COMPENSATION

As organizations have become more skilful in efficiently running global overseas operations, two trends have emerged. First, the availability of well-trained, knowledgeable and host-country nationals who manage businesses within their boundaries has augmented. As organizations have achieved access to larger, broader markets by globalizing, many host countries have increased the number of jobs in their market and enhanced their standard of living. One form of technology move has involved to improve the ability on the part of host-country nationals to direct and administer enterprises. In addition, in almost all cases, it is economical to employ host-country nationals than to use expatriates, predominantly if the reference point for expatriate compensation is the United States, Germany or a similar country that has both high management salaries and a strong currency. The second trend involves the growing recognition that running global operations involves particular expertise.

8.12.1 Preliminary Considerations

There are three kinds of recipients of international compensation:

 

1. Host country nationals (HCNs): These are foreign national citizens who work in Indian companies, its branch offices being located in their home countries. For example, American citizens working for Xerox at America.

2. Third country nationals (TCNs): These are foreign national citizens who work in Indian companies, branch offices in foreign countries—excluding India and their own home countries. For example, American citizens working for Xerox at Singapore.

3. Parent country nationals (PCNs): These are Indian citizens employed in India with work assignments outside India. For example, Indian citizens employed at Coke's Atlanta, USA office are expatriates.

 

Trail Blazers

Chrysler

The company's capability pay progression system rewards the employees for their job knowledge and performance. An employee's rate of pay is determined by the number of skills they demonstrate. An employee gets their first salary increase when they learn 50 per cent skills and their another raise when they acquire 100 per cent skills. Apart from this, Chrysler has a corporate profit sharing plan, according to which all Chrysler employees are awarded a bonus based on annual profits.

GE Fanuc

GE Fanuc was a joint venture of Japanese FANUC Ltd. and General Electric Co., USA.

At GE Fanuc, employees participated in attractive profit sharing programmes that delivered special results for the company. All employees had the responsibility to monitor their own profit sharing performance on a monthly basis. On a regular basis, in fact every month, senior company officials shared the profit figures in a group meeting. During this meeting, profit-sharing payouts were estimated and discussed with all employees. Other than the profit sharing programme, they had reward and recognition programmes to acknowledge individual performance.

Motorola

The compensation system of Motorola has evolved from a traditional time-in-grade pay to a skill-based pay system. At all plants in the company, broad pay range exists, based on the certification of measurable skill competencies. The base pay of employees is determined by this system. The certification is based on skill assessments professionally designed by the psychometric experts. An indirect payoff of the skill-based compensation system is the development of multi-skilling at the workplace. Merit pay is another important part of the pay system. Typically, the merit pay levels for employees are based on the business performance. It is the work teams that make decisions regarding the criteria for allocation of merit pay. Mostly the individual factors and team performance factors are given equal weightage in allocating the merit pay. The criteria for merit pay allocation decisions determined by work teams typically mirror the same criteria prescribed by the managers. Above base and merit pay, Motorola provides for a bonus based on return on net assets (RONA). In order for employees in particular business units to be eligible for the RONA bonus, certain guidelines have been prescribed. First, the organization must have achieved a certain predetermined per cent RONA. Second, the particular business unit must have exceeded a specific RONA figure. The average payout from the bonus incentive is approximately 10 per cent of base pay per year. Before settling on the RONA bonus incentive plan, Motorola tried a variety of different gain-sharing approaches. However, the company decided that the senior managers are primarily judged on RONA, and that the return on net asset was a logical concept for all other employees to be judged on too. The RONA concept has been accepted well throughout the organization. In combination, the trio of skill-based pay, merit and RONA have honed the company focus on pay for performance, and helped sustain growth in a market struggling for competitive advantage.

 

Source: Adapted from ‘Benchmarking HR, Performance Pays’, Human Capital, July 2000.

8.12.2 Components of International Compensation

The following are the key components of an international compensation programme:

Base Salary

The base salary is the primary component of the salary because all other allowances (e.g., hardship allowance) benefits (e.g., housing, healthcare benefits) are a function of the base salary. There are two approaches to decide the base salary:

  1. Going rate approach: According to this approach, the salary is based on the local market rates. This rate is determined by surveying local nationals (HCNs), expatriates of same nationality, as well as expatriates of all nationalities. If the pay and benefits in the host country is a very low pay country, then the base pay will be adjusted by supplementing with additional payments. While the advantage is that there is parity between the employees at the location, this can lead to parity problems between the employees with the same or similar job profile across diverse international locations of the organization. This may specially pose a problem when the expatriate has to return to the home location.
  2. Balance sheet approach: Commonly used by multinational corporations, the basic objective of the balance sheet approach is the maintenance of home country living standard plus a financial inducement. The home country pay and benefits form the foundation of the approach. Adjustments to home package to balance additional expenditure in the host country are done. Financial incentives (such as a hardship allowance) are added to make the package attractive. While this approach covers up all the disadvantages of the going rate approach, it can lead to disparities locally and also be complex to administer.

Allowances

There are different kinds of allowances which are given as a part of expatriate compensation. Some of them are:

  1. COLA (Cost of Living Allowance): This is given to compensate for the differences in expenditure between the home country and the host country. Data for this is very difficult to source and often multinational corporations have to take the help of specialist consulting firms.
  2. Housing allowance: The endeavour is to help the expat maintain the standard of housing from his home country. For this, either the company provides accommodation, or the company provides for a housing allowance in which the employee selects where they want to live.
  3. Home leave allowance (also known as leave passage): Most multinationals pay for one round trip a year for the expat and their family to meet friends and relatives at the home location.
  4. Education allowance: This allowance for the education of the children is a standard part of expat compensation. This is usually in the form of reimbursement of tuition fee for the children's education, reimbursement of expenses towards uniform, books and transportation to and from school.
  5. Relocation allowance: This covers moving, shipping and storage charges, temporary living expenses, down payments for housing lease, expenses for a look and see trip etc. Allowances regarding the perquisites (car, club membership, domestic help, nannies for the children) are also considered at times. But that would depend entirely on case-to-case basis.
  6. Foreign service premiums: These premiums are monetary payments above and beyond base salary that companies offer in order to persuade the employees to acknowledge expatriate assignments. Such premiums normally pertain to assignments that tend to range between 5 and 40 per cent of base pay. The companies usually pay out premiums to expatriates during periodic lump sum payments in order to remind the individual that the payment is directly tied to the international assignment.
  7. Hardship allowances: These allowances are used to reimburse expatriates for extraordinarily hard living and working conditions in some foreign locations. Usually, three criteria are used in identifying hardship:
    • Complicated existing conditions due to insufficient housing, isolation, insufficient transportation facilities and lack of food or consumer services.
    • Physical adversity relating to severe climates and the occurrence of hazardous conditions that might affect physical and psychological well-being.
    • Unhealthy environment, such as diseases and epidemics, lack of civic sanitation and scarce health facilities.
  8. Mobility allowances serve as a reward for the employees relocating from one assignment to another assignment—regularly between foreign posts or between domestic positions to one in a foreign country. Normally this is a lump sum payment.

The complexity inherent in international benefits often brings more difficulties than when dealing with other elements of the compensation. It is very difficult to deal with insurances (personal accident, medical), social security (provident fund, superannuation, gratuity) etc. because none of these are transportable across borders. Various decisions that the organization has to take are whether to continue the home-country programmes or enrol fresh in the host country (if it is allowed) or give a combination of both. Mostly multinational corporations tend to continue the social security programmes at the home locations and treat the others the same as someone on a short-/ long-term contract at the host location.

Taxation

Taxation is a big issue in compensation for expatriates. Often expatriates have to file their taxes in the home and host country and this can be an onerous task. If the tax liability to the employee is very high it can make the pay and benefits not look very attractive. Multinational corporations adopt two kinds of approaches to handle the taxation problem.

  1. Tax equalization: The organization withholds an amount equal to the home-country tax obligation of the PCN and pay all taxes in the host country.
  2. Tax protection: The employee pays up the amount of taxes they would pay on compensation in the home country. In such a situation, the employee is entitled to any windfall received if the total taxes are less in the foreign country than in the home country.

Global Perspective

The trend observed in terms of compensation all across the world is towards paying and rewarding for performance. However, the quantum and criteria are different in different countries. According to Hewitt Associates in 2010 variable pay as a percentage of payroll was 11.8 per cent in the USA, 13 per cent in the Asia Pacific countries, 12.5 per cent in Europe and 17.5 per cent in the Latin American countries. While most of the Asian companies (87 per cent) are offering variable pay to their employees, they have budgeted 13 per cent of the payroll for the same. In comparison, 91 per cent of Latin American countries offer variable pay and budget 17.5 per cent of the payroll for the same.

Similarly, even increment in the salary or pay progression was different in each country. In emerging markets such as India and China, the salary raises have been higher than the inflation. This only proves that the demand for talent also influences the compensation levels. The differentiation between regions is basically driven by the location specific trends. The data that companies use to decide on the differentials are the cost of living, local pay levels (through salary surveys), inflation data (CPI) and employment and unemployment data. Another noteworthy fact is that in the Gulf market where many expats work, the trend in salary increment has also been differential. While Asian and Arab expats have got good raises, their Western counterparts were given little or no raise given that their home market situation was grim.

All in all what could be said is that there is no formula for getting the compensation right. The best thing is to be closely in touch with the market and take the compensation decisions in the background of that knowledge only.

 

Source: Adapted from Miller (2010).

Application Case

TCS started operations in 1969 as a division of Tata Sons Limited. Their initial journey in IT was not that easy and they faced many hurdles due to the rigid government licensing system, which made it difficult for them to import computers.

During the first quarter of the financial year 2005–06, around 1,000 employees whose performance were not up to the mark were asked to leave TCS. Most HR consultants and experts thought it was a decision based on the EVA (Economic Value Add) Model for assessing employees’ contributions at the company. Only two years of the cycle was completed. Those who were told to ‘go’ did obtain low ratings in their appraisal for two years consecutively, despite being under a performance improvement plan and also under a mentor.

The model EVA was used as a basis for giving incentives to all the employees and declared bonus was also a part of the EVA they achieved. In the model, the components of fixed and variable pay were determined. Fixed pay at TCS did comprise wages and pension and the variable pay had components of profit sharing, stock options and bonus. It could also be equal to the fixed portions of the compensation, provided the data had shown that kind of EVA growth. The leadership team wanted their employees to get a feeling of ownership for their own unit and above all its performance. They wanted their employees to feel that they were running a business, they also wanted them to think like entrepreneurs and know the cost attached to their business and how they could add value to the investment.

EVA Model

TCS was looking towards institutionalizing the HR practices in recruitment, training and other related areas with this innovative EVA-based compensation model. The EVA model would offer high performance internal environment to the employees operating in a dynamic work environment. TCS did hope its adoption of EVA in April 1999 would help it survive in the intensely competitive business.

In giving shape to the EVA model, an organization needs to keep its focus on the ultimate goal of aligning its people to the corporate mission, it aimed at creating an entrepreneurial culture by way of an empowered work force, and attempted building ownership with accountability. TCS worked out the EVA framework to align corporate value with the performance of the various strategic business units and the employees who comprised these units.

The model was then translated to a compensation model, where the employee had a share in the corporate pie with add-ons from the profits of the business unit and the individual performance factor. At the individual level, an employee needed to know the drivers which were important to enhance the EVA of the company, of the business unit, and their own contribution, i.e., employee contribution towards all these. There were three basic drivers—revenue, cost and capital charge. Revenue was driven by the rate or license price put into the product, sales, billable hours, response time and domain skills. On-time delivery definitely had an impact on the revenue because the better delivery cycles improved the turnaround time to the customers. Cost is managed through productivity, which is affected by sales and marketing costs, recruitment and other related aspects. Receivables and training are the bulk of the capital charge. Though this list is a representative list, there were many others too.

Each employee works towards the improvement of the benefit package, which essentially has three components—the corporate EVA, the business unit EVA and the individual performance factor (as indicated above). Out of the total EVA payment, a certain percentage goes to each employee on the basis of corporate EVA improvement. Second, if a particular business unit did better than another business unit, then automatically the employee got more than the other business units. Nevertheless, this is a team reward concept. The third one depends on the evaluation of each employee performance and performance indicators set. It had also introduced the concept of bonus bank. Whenever a stipulated corporate target is exceeded, the company declares a potential bonus for the individual. It is accumulated over years and the payout is a function of the cumulative balance. This approach ensures performance improvements and maintains a cumulative relationship between the pay and the performance.

The company faced quite a few challenges while implementing this model, but it successfully overcame them to complete the implementation much ahead of the schedule. Moreover, given the nature of its various software projects, TCS had to design an incentive mechanism that served a dual purpose not only to retain talent but also to reward it.

Question

Critically evaluate the EVA model and what are the potential benefits of such a model?

In a NUTSHELL

  • Compensation refers to all the financial returns and the tangible benefits that the employees receive as part of an employment relationship.
  • Compensation are of two kinds—financial and non-financial. The financial compensation can also be classified as direct financial compensation (pay that a person receives in the form of wages, salaries, commissions, incentives and bonuses) and indirect financial compensation (benefits that consist of financial rewards, it includes a wide variety of rewards and benefits received indirectly by the employee) and non-financial compensation can be the job itself and the job environment.
  • Compensation Programme constitutes the base wage and salaries, wage and salary add ons, incentive payments and employee benefits and services, variable pay, profit sharing, gain sharing and equity plans
  • The employers’ compensation strategy depends on external as well as internal factors. The internal factors would include relative worth of a job, employee's relative worth and the employer's ability to pay. The external factors would be employment market conditions, the area wage rates, the cost of living and collective bargaining by the employee unions.
  • Motivation (Behavioural) theories such as Maslow's need hierarchy, Alderfer's ERG theory, Herzberg's motivation–hygiene theory, McCelland's achievement motivation theory, Adams’ equity theory and Vroom's expectancy theory explain the different factors which lead to satisfaction in a person. This guides in the structuring of compensation.
  • The compensation management can be looked at in four phases—job analysis, job evaluation, salary survey and matching between the two to define the job and the compensation structure. Job analysis yields the job description and the job specification. Job evaluation can be done by four different methods—job ranking, job classification, factor comparison and point system. Salary surveys can be done by the organization itself or obtained from other sources. Internal (job evaluation) and external (salary survey) information is then used to decide on job grades and compensation structure.
  • Job evaluation is a formal process for determining the relative worth of jobs based on job content, with emphasis on such factors as skill, effort, responsibility and working conditions. The job evaluation process includes setting the objective, selecting the most appropriate method, making a project plan, communicating to all concerned, selecting the benchmark jobs, analysing the benchmark jobs and evaluating select benchmark jobs.
  • The job ranking method ranks jobs according to the perceived overall market value of each job. The job classification method first establishes job classes, referred to as pay grades and then groups job description within these broader categories. In the factor comparison method, each job is ranked according to a series of factors. The point method involves using a system of points to assign value to jobs. It involves subjective judgements.
  • When tall structures are replaced by flat structures, there are not many levels to climb at the pyramid of the structure. It is known as broadbanding. Broadbanding enhances competence, flexibility, result orientation and decentralization.
  • The new pay has a cost to company approach, includes variable pay drives, competitive pay, and also includes gain sharing. The different types of variable pay are performance pay, pay for knowledge and skill and competency-based pay. Performance-based compensation includes merit pay, profit sharing, gain sharing and incentives. Pay for knowledge rewards the professional employees for successfully learning specific curricula. Skill-based pay is a system that compensates the employees for their job-associated skills and knowledge, not for their job titles. Competency-related pay can be defined as a method of compensating and rewarding people wholly or partly by reference to the level of competence they demonstrate in carrying out their roles. The concept of total compensation combines traditional compensation with the educational, emotional and psychological benefits that can attract the best and brightest. It identifies the ten elements—including learning, advancement, emotional rewards and quality of life—that job seekers rank highest among desired benefits.
  • Executive compensation, i.e., compensation for the senior management in the organization has both core and fringe compensation elements. The main components of executive compensation include current or annual core compensation, deferred core compensation and fringe compensation.
  • International compensation has specific nuances because of its very nature.

Drill Down

  1. Reward management—‘A Handbook of Remuneration Strategy and Practice’ by Michael Armstrong and Helen Murlis. If you are interested in learning about compensation in detail—this is an essential reading. What makes this book interesting is that it can be read and used at the workplace. It describes all forms of variable pay and pay structuring in detail—two things which are most difficult to get started with.
  2. The Compensation Handbook’ By Lance A. Berger and Dorothy Berger, the book says that the employees looks at pay as if it were ‘A Riddle wrapped in a mystery inside an enigma’ and claims that it can unwrap it. This is an old favourite with HR managers seeking to understand the nuances of compensation.

Review Questions

  1. What are the different elements of the total compensation? Is it all about salary only?
  2. How do the theories of motivation influence compensation decision?
  3. Explain the compensation management process describing each sub-process in detail.
  4. What are the different methods of job evaluation? Explain each with examples.
  5. Explain the concept of broadbanding and the way organizations use it.
  6. What is variable pay? What are the different kinds of variable pay?
  7. How is skill-based compensation different from competency-related compensation?
  8. What are the components of executive compensation?
  9. How is compensation in the international environment different?

Exercises

  1. Individual exercise: Find out a relevant journal article on compensation in any Indian company and discuss the same in the class.
  2. Group exercise: Find out industry-wise compensation trends since the last three to five years for the executives and the workers.
  3. Group exercise: Contact two or three companies and find out their compensation philosophy and objectives and present the same in the class.
  4. Group exercise: Compare the salary template of three companies and find out the one that has the most amount of tax saving schemes.
  5. Individual exercise: Compare and contrast the various kinds of incentives that Indian companies give to their employees (could be segregated industry wise).
  6. Group exercise: Do a web search of Indian companies using the term ‘salary survey’? Find out the most relevant and up-to-date information on the same. You could also glance through magazines such as Business Today and the related ones on the topic. Make a comprehensive document on your findings.

References

 

Adams, J. S. 1965. ‘Inequity in Social Exchange’, Advances in Experimental Social Psychology, 62: 335–43.

Bernardin, H. John. 2007. Human Resource Management: An Experiential Approach (SIE), 4th edition. USA: Tata McGraw-Hill Publication.

‘Benchmarking HR, Performance Pays’, Human Capital, July 2000.

Bennett, David. 2005. ‘Warfare in the Workplace’, Crain's Cleveland Business, 26(February): 3–7.

Bramha, Gautam. 2011. ‘Compensation Trends: Obvious and Otherwise!’ Human Capital, May 2011.

Breneman, John and Coil, Maggi. 1999. ‘Comparing Alternative Base Pay Methods’, ACA News, June: 21–25.

Carlson, Leah. 2005. ‘Complications Abound in Managing Expatriate Benefits’, Employee Benefit News, 19: 28–39.

Cohen, Andy and Rauch, Maggie. 2005. ‘Companies Favor Bonuses Over Pay Raises in 2005’, Incentive, 179(February): 9.

Dessler, Gary and Varkkey, Biju. Human Resource Management, 11th edition. New Delhi, India: Pearson Publication.

‘EVA Story at TCS’, available at http://www.chrmglobal.com/Replies/1478/1/EVA-Story-at-TCS.html, accessed on 12 April 2006.

Flannery, T. P., Hofrichter, D. A. and Platten, P. E. 1996. People Performance and Pay. The Hay Group.

Gasparino, Charles and Joseph, Nicole L. 2005. ‘Good News: You're Fired’, Newsweek (Atlantic Edition), 146(July): 6.

Hay Group. 2006. Available at http://www.haygroup.com/downloads/ww/misc/shearman_and_sterling_-_directors_roundtable_-_06.09.09.pdf

Hay Method of Job Evaluation. http://www.haygroup.com

Hazard Jr., Robert C. 2002. ‘Corporate Ethics, Corporate Pay and the Lodging Industry’, Lodging Hospitality, 58(November): 65.

Henderson, Richard I. 2006. Compensation Management in a Knowledge–Based World. Upper Saddle River, NJ: Prentice Hall, 181.

Herzberg, F. W. 1968. ‘One More Time, How Do You Motivate Employees?’ Harvard Business Review, January–February: 53–62.

Hulme, Virginia A. 2006. ‘Short Staffed’, China Business Review, 33(March/April): 18–56.

Jauhary, Tanmay. 2009. ‘EVA and Compensation Management System at Tata Consultancy System’, ICMR, 8 September.

Krell, Eric. 2005. ‘Evaluating Returns on Expatriates’, HR Magazine, 50(March): 60–65.

Laroche, Lionel. 2002. ‘Hiring Abroad’, CMA Management, 76(March): 57–58.

Marquez, Jessica. 2006. ‘Suite Over Fiorina Severance a Wake—Up on Pay Practices’, Workforce Management, 85(March): 3–4.

Martocchio, J. J. Strategic Compensation: A Human Resource Management Approach, 6th edition. New Delhi, India: Prentice Hall.

Mason-Draffen, Carrie. 1997. ‘Companies Find New Ways to Pay/Worker's Performance Tied to Stock Options, Bonuses, Raises’, Newsday, 5 January: FO8.

McClelland, D. C. 1961. The Achieving Society. Princeton, NJ: Van Nostrand.

Miller, Stephen. 2010. ‘Companies Worldwide Rewarding Performance with Variable Pay’, March, Geographic Pay Differential Practices (www.shrm.org).

Mondy, R. Wayne. Human Resource Management, 10th edition. US: Prenctice Hall.

Remmen, Darrem. 2003. ‘Performance Pays Off’, Strategic Finance, 84(March): 27.

‘Salaries on the Rise: Globalization Brings New Pressures to India’, Published: 07 April 2011 in India Knowledge@Wharton.

Sengupta, Devina. 2010. ‘Phantom Stock Options Are Becoming Increasingly Popular’, The Economic Times, ET Bureau, 15 October.

‘TCS: Double Clicking EVA’, available at http://www.tata.com/company/Articles/inside.aspx?artid=SGJslTdQYEM=, accessed on March 2003.

The following discussion of the point method was adapted from Martocchio, Joseph, J. 2006. Strategic Compensation: A Human Resource Management Approach. Upper Saddle River, NJ: Prentice Hall, 233–37.

Tropman, John E. 2001. The Compensation Solution. San Francisco: Jossey Bass.

Vowler, Julia. 2005. ‘Reaping the Benefits of Bonus Plans’, Computer Weekly, 28 July: 16.

Welch, Jack and Welch, Suzy. 2006. ‘Paying Big-Time for Failure’, Business Week, 10 April: 112.

Web sites

 

http://www.homefair.com/homefair/servlet/actionservlet?pid=200…tool=salarycalculator…previouspage=116…cid=homestoregates…gate=homestore…fromstate=SD…tostate=IL…salary=100000…fromCity=44659020…tocity=171400…ownrent=own, accessed on 9 March 2006.

http://www.hr-guide.com/data/G414.htm