Definition: Compensation is the reward an employee receives in return for their valuable efforts while performing various jobs in the organization. Compensation management deals with every type of reward and its allocation in the most desirable way. These compensations are managed effectively to achieve equity, transparency and consistency across the organization.
It is an essential tool for managers in Human Resource Management. Organizations can offer these compensations directly and indirectly to the employees. They may pay directly in monetary form and indirectly in a non-monetary form which is discussed in detail further.
Compensation management can also be termed as:
- Wage and Salary Administration
- Remuneration Management
- Reward Management
A variety of Internal and External factors affects the compensation strategy of the organization.
Internal factors include:
- Business Strategy
- Job Evaluation
- Performance Appraisal
External factors include:
- Labour Market
- Government Legislations
Content: Compensation Management
- To administer wages and salary.
- To attract new and skilled employees.
- To retain current employees.
- To acknowledge and recognize good work.
- To control unnecessary costs.
- To blend individual goals with organizational goals.
- To adhere to the Government laws related to remuneration.
Types of Compensation Management
Employers can make use of different components for compensating their employees. These components or types of compensation are discussed below:
- Financial Compensation
- Non-Financial Compensation
In this form of compensation, the payment of rewards is made in monetary terms. It is further divided into:
- Direct Compensation
- Indirect Compensation
- Wages and Salary: The compensation paid daily is called wages. When the payment is made monthly, it is known as a salary.
- Incentives: Incentives is the money received by the employees other than wages or salary based on individual performance.
- Allowances: Different types of allowances are part of compensation management like:
- Dearness Allowance
- House Rent Allowance
- Conveyance Allowance
- Leave Travel Allowance, etc.
- Claims: Claims are the reimbursement of bills. It is paid along with the monthly salary. These include:
- Telephone/Mobile Allowance
- Internet Allowance
- Medical Allowance, etc.
- Fringe Benefits: These are the financial benefits received by the employees. Fringe Benefits include:
- Provident Fund
- Medical Care
- Accident Relief
- Insurances, etc.
- Perquisites: These are the benefits allowed to the executives above salary. Perquisites include:
- Company Car
- Club Membership
- Paid Holiday
- Furnished House
- Stock option schemes
In this form of compensation, the employees receive non-monetary rewards. Non-Financial compensation consists of:
- Challenging Job Responsibilities
- Recognition of Merit
- Growth Prospects
- Competent Supervision
- Comfortable Working Conditions
- Job Sharing
- Flexitime, etc.
Process of Compensation Management
Step 1: Business Strategy
The compensation design largely depends upon the business strategy like expansion, new product line, no expansion, etc. The need for human resources is assessed according to the objective of the organization. The compensation is designed based on these strategies, i.e. acquiring skilled resources or retaining the existing ones.
Step 2: HR Strategy
HR managers use compensation as a motivational tool towards organizational objectives. They offer a variety of financial and non-financial incentives, like high risk and return rewards for encouraging employees.
Step 3: Compensation Policy
The compensation policies are developed in a flexible, performance-oriented and easy form. The entire compensation structure is designed considering internal and external factors.
Step 4: Job Evaluation and Analysis
The managers perform a detailed analysis of the job. The rewards or combination of rewards are structured according to the particular job and its elements.
Step 5: Design and Implementation of Compensation Plan
The rewards are designed according to the need and different levels in the organization. It is implemented keeping in mind certain factors like performance, skill development, etc. These rewards have a significant impact on the employer-employee relationship.
Step 6: Evaluation and Review
The compensation designed and implemented must be evaluated and reviewed periodically. The employee must be satisfied with the compensation, and the employer must fulfil their business goals.
- The company should pay compensation according to its ability to pay. If they spend more or less than their ability, they may suffer bankruptcy, or competitors may take advantage of it.
- Organizations must keep in mind internal and external equity at the time of compensating.
- There should be a performance-based rewarding system. It will result in maintaining fairness and justice in the organization.
- Remuneration paid to employees should be non-discriminatory, i.e. irrespective of factors like religion, gender, etc.
- Organizations must pay minimum wage to distinct categories specified by law.
- The compensation scheme should be flexible and simple. It should be easy to understand and update according to requirements.
Importance of Compensation Management
- It integrates employees efforts towards organizational goals.
- Helps in acquiring, maintaining, and creating a motivated workforce.
- Compensation is an essential tool for managers in human resource management.
- Helpful in attracting talented workforce and creating organizational brand value.
- It enables enhanced work efficiency and job satisfaction among employees.
- Compensation management helps in the creation of talent pools.
Theories of Compensation Management
Theories help to find out the most suitable components of compensation. These are discussed below in detail:
- Equity Theory
- Reinforcement Theory
- Agency Theory
This theory focuses on the equity in remuneration among employees. Adam’s equity theory suggests that the employee tries to gain equity who don’t find equity in their rewards.
Equity is of three types:
- Internal Equity– The fairness and difference in remuneration between different job roles & responsibilities within the organization.
- External Equity– The fairness and difference in remuneration between the same job roles outside the organization.
- Individual Equity– The fairness and difference in remuneration between the same job roles within the organization.
The following can be the results of the inequity in the organization:
- Decreased Productivity
- Increased Absenteeism
- Increased Employee Turnover
According to reinforcement theory, the employees are most likely to repeat their rewarding experience.
Suppose one received a monetary benefit for high performance, he would repeat the same in future. Similarly, if he doesn’t receive the financial rewards in the future, it may decrease his performance.
This theory aims to align the individual interests and goals with the organizational goals by using compensation.
The employer (principal) and employee (agent) are the two stakeholders of the organization. The rewards paid to the employees are agency costs.
The agent tries to maximise this cost while the principal attempts to minimise it. The principal chooses a contract scheme to align interests and goals. These contact can be either Behaviour Oriented or Outcome Oriented.
Example of Compensation Management
Microsoft Corporation is a technology-based multinational company. They provide a set of monetary and non-monetary benefits to their employees.
At Microsoft, they aim at a healthy life and investment in personnel’s future. They organize a specific set of programs, events, services and better human connections. Some of them are listed below:
- Flexibility to care for employees and their families.
- Paid leaves to the family caregiver and new parents.
- Promotes family support programs and organizes parenting classes.
- Work schedules flexibility to the employees.
- Microsoft focuses on the growth and career progress of the employees.
- The company also provides a car lease policy.
- They offer competitive pay to their employees.
- Stock awards to employees based on their performance.
- Bonuses other than salary for different purposes.
Compensation is the value offered to the employee for their efforts in the organization. It can be provided in monetary and non-monetary forms.
The managers design the compensation according to the job roles and responsibilities. The objective of compensation management is to provide fair wages, a motivated and talented workforce, etc.