20140225043514_Topic 7 Compensation Administration

INTRODUCTION Compensation administration is one of the most important functions in human resource management. Even though it is the most difficult and challenging activity, it helps strengthen the culture and the important values of an organisation. Policies and practices in an organisation which emphasise on rewards based on results are able to strengthen employees behaviour so that they are more dedicated to increasing their productivity (Stone, 1998). Indirectly, compensation administration is an important tool to increase employee motivation in improving work performance so that the organisations strategic objectives are achieved. Compensation administration policies should not only be able to motivate employees, but they should also attract and retain competitive employees. Therefore, employees expect that the compensation system of an organisation is just and fair in providing a reward system that is at par with the skills and performance demonstrated.

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Compensation Administration

LEARNING OUTCOMES

By the end of this topic, you should be able to:

1. Explain the types of rewards which exist in the compensation administration system;

2. Describe the compensation administration objectives;

3. Discuss the factors which influence wage setting; and

4. Assess the issues related to compensation administration.

TOPIC 7 COMPENSATION ADMINISTRATION 138

DEFINITION OF COMPENSATION

Compensation is the total of all rewards provided to employees in return for their services (Mondy, 1999). Ivancevich (2001) defines compensation as all forms of financial rewards and benefits as well as clear and apparent services which are accepted by employees as part of work relations. There are two components in compensation administration, which are fixed component and variable component. A fixed component is in the form of basic salary whereas a variable component is the payment based on performance such as bonus or profit sharing and benefits such as health insurance and annual leave.

TYPES OF COMPENSATION

Nankervis (1999) stated that employees will focus on a few compensation factors such as those shown below:

(a) Is my salary equivalent to the performance I demonstrate?

(b) How is my wage compared to other employees in this organisation?

(c) How is my wage rate compared to the market fee rate?

(d) How can I increase my wage rate?

(e) What are the incentives and benefits which I will be able to receive? Based on the employee expectations listed above, compensation administration programmes not only motivate employees, but at the same time save labour cost effectively. Even though wages is the main factor why an individual works, non-monetary rewards are also important as a source to motivate employees to work with more dedication in order to increase their performance. Indirectly, two types of rewards need to be included in an organisations compensation administration programme, as shown in Figure 7.1. Rewards offered to employees can be in the form of monetary or non-monetary rewards.

7.2

7.1

TOPIC 7 COMPENSATION ADMINISTRATION

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Figure 7.1: Types of rewards

Source: Adapted from Stone, R.S. (1998). Human resource management (3rd ed.). Brisbane: John Wiley, Sons Australia.

Monetary rewards can be in the form of cash such as wages, salary, commission and bonus; or benefits such as insurance, annual leave, medical leave and flexible working hours. Non-monetary rewards, on the other hand, can be the satisfaction the employee feels as a result of his or her position or from the work environment mentioned (Mondy, 1999). Direct monetary rewards are in the form of cash, such as wages, salary, commission and bonus, whereas indirect monetary rewards are in the form of benefits and others. Non-monetary rewards from the work aspects are interesting jobs, challenging job responsibilities, acknowledgement and career development. Non-monetary rewards from the work environment aspects are good policies and practices, competent supervisors, congenial colleagues and a safe and healthy work environment. Visit http://www.hr-guide.com/compensation.htm for additional information on compensation administration.


STRATEGIC COMPENSATION PLANNING

Strategic compensation administration is one way of offering a compensation package to employees to increase their motivation and at the same time align their efforts so that they are in line with the organisations objectives, philosophies and culture. A compensation administration policy is one way of supporting strategic compensation administration. The compensation administration policy designed has to:

(a) Focus on business objectives and strategies;

(b) Attract and retain competent, motivated and qualified employees;

(c) Encompass organisational reward principles and philosophies;

(d) Prepare wage allocation outline;

(e) Strengthen work values and culture desired by the organisation; and

(f) Relate to all employees. Each compensation administration policy formed has to benefit both the organisation and its employees. According to Stone (1998), compensation administration objectives are as follows:

(a) Organisation

(i) Attract and retain quality and the desired employee participation.

(ii) Motivate employees to improve their work performance in the effort to achieve the organisations strategic objectives.

(iii) Strengthen the main values and culture desired by the organisation.

(iv) Encourage and strengthen work behaviour as desired by the organisation.

(v) Ensure that compensation is maintained at a competitive level.

(vi) Control compensational cost.

(vii) Ensure optimum returns on each ringgit spent.

(viii) Abide by legal requirements.

(b) Employee

(i) Prepare fair and just rewards.

(ii) Give out rewards equivalent to the performance as demonstrated.

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(iii) Prepare a flexible wage structure based on performance, promotion, transfer and changes in the environment.

(iv) Reassessing compensation structure by taking into account the effect of equity.

The development of compensation policy has to be consistent with the organisations strategic objectives and it involves four phases as shown in Figure 7.2 which are:

(a) Corporate mission;

(b) Business strategies;

(c) Human resource strategies; and

(d) Compensation administration strategies. The compensation administration strategy explains the organisations compensation goals and states rewards which will be given by the organisation based on human resource strategies, business strategies and corporate mission. Corporate mission, business strategies and the compensation administration strategy are directed to the formation of the compensation administration strategy.

Figure 7.2: The relationship between organisation objectives and compensation

administration strategies Source: Adapted from Nankervis, Compton & McCarthy. (1999). Strategic human

resource management (7th ed.). New Jersey: Prentice Hall International.


FACTORS THAT INFLUENCE WAGE RATE

Nankervis (1999) stated that external and internal factors influence the wage rate developed by an organisation. These factors are as shown in Figure 7.3, which include the legal environment, market surveys, work values, compensation administration strategies and personal factors.

Figure 7.3: Factors which influence payment rate

7.4

ACTIVITY 7.1

State your view on whether you agree or disagree on the following issues and give a valid reason for your answer.

1. All employees are eligible for annual salary increment without taking into account their performance. (a) Agree (b) Disagree

2. An unattractive salary and benefit package decreases employee motivation to excel in their work. (a) Agree (b) Disagree

EXERCISE 7.1

Explain two types of compensation which can be offered by an organisation to its employees.


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(a) Legal Environment The compensation policy in every organisation has to be aligned with the legal labour requirements in a country. Among the issues related to wage rate are:

(i) Minimum wage rate;

(ii) Fixed wage component; and

(iii) Variable wage component. For example, in Malaysia, a Salary Reformation System Guideline has been designed to increase efficiency and productivity which in turn will assure the nations competitiveness and increase employees quality of life (Ministry of Human Resources, 2002).

(b) Market Survey Organisations have to conduct environmental scanning in the labour market to review the relationship between demand and qualified manpower supply. Besides, organisations have to take note of other information before a certain salary policy is set. The information includes:

(i) The differences between local wage rate and city and suburban wage rate;

(ii) The different wage rates for works from the same work groups;

(iii) The different wage rates in the same industry; and

(iv) The economic environment including inflation, unemployment, manpower participation level, increase in education status, lack of specific skills and others.

(c) Work Values Each organisation has its own benchmark in recognising and rewarding employee's performance. Incentives can be in various forms which act as motivation factor. In this competitive environment, work values or sometomes known as job worth are mostly grounded on market value or job evaluation programme. However, using total value basis is more objective for the organisation. Among the work values that need to be focused on by an organisation are as follows:

(i) The latest knowledge and experience;

(ii) Complex tasks can be solved easily;

(iii) Problem solving is a path towards excellent work performance;


(iv) Responsibilities in managing resources are important so that all employees are equipped with sufficient sources to carry out their work effectively;

(v) Use people skills to interact effectively; and

(vi) Working effects towards organisation.

(d) Compensation Administration Strategies Compensation administration strategies are formed as a way to achieve organisational strategic objectives. The development of these strategies has to be focused on a few questions such as:

(i) The purpose of giving the rewards to employees the relationship between rewards and results achieved by the organisation;

(ii) The employers ability to give rewards to employees;

(iii) The types of employee desired by employers;

(iv) A combination of rewards that employers want to offer to employees fixed cost such as basic salary and variable cost such as incentive

programmes and bonuses;

(v) The frequency of salary structure revision; and

(vi) Wage management has to be scattered or centralised.

(e) Individual Factors Other factors that need to be considered are factors involving individual performance which are as important in creating more motivated employees to carry out work exceptionally. A few factors that have to be thought of are:

(i) Individual contribution towards the organisation;

(ii) Real performance compared to forecasted performance;

(iii) Skill development or competency; and

(iv) Individual power or collective negotiation in looking out for employee welfare.

ACTIVITY 7.2

How can legal factors influence wage rate in our country?


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COMPENSATION ADMINISTRATION COMPONENTS

There are three important components in setting the salary system as follows:

(a) Internal equity;

(b) External equity; and

(c) Individual equity. Figure 7.4 shows the steps in setting the salary system. The steps in each level are related to one another.

Figure 7.4: Steps in setting a salary system

Source: Adapted from Gomez-Mejia, Balkin & Cardy. (2001). Managing human resources (3rd ed.). New Jersey: Prentice Hall.

7.5


7.5.1 Achieving Internal Equity: Job Evaluation

The element in this first process is job evaluation to determine the relative value of a certain job. The goal of job evaluation is to achieve internal equity during the salary system formation. Job evaluation is a systematic method to determine the relative value of a certain job compared to other jobs to ensure different jobs are given a different wage rate (Stone, 1998). Job evaluation focuses on the high or low of a certain job based on a few pre-determined work factors. Information on job evaluation is set as a basis for the formation of a fair salary system. Theoretically, job evaluation utilises information in job analysis to categorise jobs according to a relative value hierarchy of a specific job compared to other jobs (DeCenzo, 1999). For example, the post of an account manager needs more skills and responsibilities as compared to an account trainee post. By this, the account managers salary will be higher than the account trainees salary. Job evaluation conducted focuses on three main questions, which are:

(a) What does the employee know?

(b) What can the employee do?

(c) What are the results shown by the employee? There are four steps involved in determining internal equity, which are:

(a) Step 1: Carrying Out Job Analysis The purpose of a job analysis is to gather information about tasks, obligations and responsibilities of a particular job. Through the information obtained, job descriptions and specifications are formed to identify the activities that need to be carried out by the person holding the post.

(b) Step 2: Relative Value of a Specific Job The next step is to determine the relative value of a specific job before arranging it according to its importance. In evaluating a specific job, a few basic elements are utilised to determine its relative value, as follows:

(i) Skills;

(ii) Responsibilities;

(iii) Efforts; and

(iv) Work environment

(c) Step 3: Arranging Jobs According to Hierarchy After determining the relative value of a specific job, the next step is to prepare a list of jobs according to their importance to the organisation,


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starting from high to low. The job hierarchy is arranged according to types of task in the same group. For example, the position of a secretary, senior clerk, clerk, typist, receptionist and computer operator can be categorised into one group, which is clerical position.

(d) Step 4: Classifying Jobs According to Grades The final step in the job evaluation component is categorising jobs according to pre-determined grades. Table 7.1 illustrates four basic methods of categorising jobs and determining the relative value of a specific job. The four methods used to evaluate jobs are as follows:

Job arrangement;

Job classification;

Score system; and

Factor comparison.

Table 7.1: Job Evaluation Method

Comparison Scope Comparison Basis

Qualitative Method Quantitative Method

Job vs Job Job Arrangement Method

Factor Comparison Method

Job vs Scale Job Classification Method Score System

Source: Nankervis, Compton & McCarthy (1999). Strategic human resources management (3rd ed.). Australia: Nelsom-Thompson Learning.

(i) Job Arrangement Method

This is a simple qualitative method to evaluate jobs by listing tasks and responsibilities of a particular job according to the importance of the job, from high to low (DeCenzo, 1999). A job comparison will be evaluated based on importance or difficulty of performing a particular job. Even though this method is easy, one of the restrictions faced is difficulty in accurately arranging jobs if there are many types of jobs in a particular organisation. Furthermore, there is no standard and consistent evaluation to explain the importance of a particular job compared to another job whose duties and responsibilities are similar. An example of the job arrangement method is shown in Table 7.2.


Table 7.2: Example of Job Arrangement

Order Job

1

2

3

4

5

6

7

8

General Manager

Marketing Manager

Operations Manager

Accounts Manager

Engineer

Accountant

Sales representative

Supervisor

Source: Adapted from Stone, R. S. (1998). Human resources management (3rd ed.). Brisbane: John Wiley & Sons Australia.

(ii) Job Classification Method This is a simple method where each job is categorised into a particular group or grade. The first step is the formation of the group or grade which is determined by job factors such as knowledge, experience, responsibilities, skills and abilities. The next step is to create a job description that can be benchmarked for each grade or group. After that, the relative value of a particular job will be determined by comparing the job with the benchmark description to determine whether they are categorised under the same grade or group. The most prominent restriction for this method is the difficulty to write an accurate grade classification description and to categorise a particular job which can be included in many grades which have been created (DeCenzo, 1999).

(iii) Score System Method This quantitative method involves evaluation based on main job factors such as education level, skills, knowledge, efforts and responsibilities, and the scores which are allocated for each mentioned factor. The next step is to divide the main factors into sub factors. Each sub factor will be given a specific score to determine the relative value of a particular job. For example, the education level factor such as the one shown in Figure 7.5 has been graded with identified scores.


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Figure 7.5: Score system method

Source: Adapted from Stone, R. S. (1998). Human resources management (3rd ed.). Brisbane: John Wiley & Sons Australia.

(iv) Factor Comparison Method

This is a quantitative method where a few jobs that are already well-known in the market are benchmarked or set as a standard when compared to other jobs which will be evaluated (DeCenzo, 1999). Jobs which are benchmarked have to have these characteristics:

The importance of a particular job to employees and the organisation;

The job requirements differ from other jobs;

The job chosen has a relatively stable work content; and

Utilised in salary research to determine the wage rate.

A few criteria for comparison will be pre-determined such as mental requirements, skills, physical abilities, responsibilities and work environment. For example, Table 7.3 shows that an electricians post is benchmarked against other jobs which are categorised under the same group.


Table 7.3: Factor Comparison Method

The restriction in the factor comparison method is the difficulty in using the pre-determined criteria to compare all jobs against the chosen benchmark. Selection Method Each job evaluation method has its strengths and weaknesses. According to Stone (1998), since there is no one method that can be said as being the best, human resource managers have to evaluate a few factors prior to selecting. These factors are:

(a) Organisations strategic objectives The method chosen has to be in line with the organisations strategic

objectives.

(b) Organisation size A small organisation will utilise a simple method such as job classification

whereas a large organisation will utilise an expensive method such as factor comparison or score system.

(c) Organisation resources Organisations need to consider cost and time to carry out a job evaluation.

Organisations are able to request their own employees or use the services of a consultant to conduct a job evaluation.

(d) Information on the use of specific methods Information obtained about a specific method utilised by an organisation.

(e) Corporate culture The selection of job evaluation has to be in line with the existing corporate

culture so that it is conducted effectively. For example, a small organisation need not choose a complex method utilised by most large organisations.


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(f) Employee behaviour A job evaluation method chosen has to be informed to all employees so that

it can be accepted by them and the chosen method is perceived as just and fair.

Visit http://www.hr-guide.com/ for the definition of job evaluation and the four importance of the job evaluation process. Next, visit http://www.job-analysis.net/ for the four steps involved in the job analysis process.

7.5.2 Achieving External Equity: Market Survey

The purpose of a market survey is to identify the wage range for each grade formed. The steps involved in a market survey are benchmarking and the establishment of wage policy.

(a) Step 1: Benchmark or Key Job Benchmark or key job is utilised to connect job evaluation which has been conducted to market wage. Basically, the comparison of identified key jobs in a payment grade is done inter-organisationally to determine the relative job value according to other employees opinions. Next, the organisation determines the wage rate of other jobs in the same grade and categorises the jobs in the same wage range with key jobs of the same grade. For example, an account clerks post such as in Figure 7.6 is identified as a key job. Posts such as general clerk, assistant secretary and senior data process operator are categorised under the same grade as the account clerk. Next, the wage range for other posts in the same grade will be determined based on the relative position value as compared to the account clerks position. Indirectly, this step is similar to the factor comparison method as stated in the job evaluation.


Figure 7.6: Benchmark rate structure

(b) Step 2: Establishment of Payment Structure Information from the market survey will show the wage differences which are apparent from one to another. Therefore, organisations have to determine the wage structure for a particular job based on the internal and external information present. Job evaluation prepares an internal equity that can be used as a basis to establish wage rate. A wage structure must be developed by creating different wage levels and this wage structure takes into account the following components:

(i) Jobs with similar relative values will be categorised under the same grade; and

(ii) The wage range for each grade is formed by considering market survey information and compensation administration strategies.

The methods that can be utilised to obtain information from outside are wage survey, wage curve and salary grade range.

(i) Wage Survey Wage survey is a set of facts related to practices in wage structure which are obtained from other organisations in the same labour


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market. For example, organisations which are categorised in the electronic industry cannot compare their wage structure with the one in the education industry. A wage survey is done when an organisation has identified the jobs which will be evaluated. Next, the organisations competitors in the same labour market will be identified to perform the survey. Aside from information on wage rate, the organisation can also obtain information on minimum and maximum wage rate, overtime payment practices, holiday allowances, work day duration and work weeks.

(ii) Wage Curve After an organisation has obtained information on wage rate from other organisations, it will connect the information with the result from a specific job relative value. Information on wage rate and job size is based on score marks and is plotted to obtain a wage curve. The plotted graph as shown in Figure 7.7 is a wage rate survey distribution graph. A straight line will be formed to obtain the desired wage curve.

Figure 7.7: Wage curve

Source: Adapted from Bohlander, Snell and Sherman. (2004). Managing human resources (13th ed.). Ohio: South-western College Publishing.

(iii) Salary Grade Range The same job based on class, grade or score marks will be categorised in the same group. Payment rate range will be segregated in one series that determines the lowest and highest salary for each salary grade as shown in Figure 7.8. Employees receive payment up to the maximum level based on merit or service seniority.


Figure 7.8: Salary grade range

Source: Adapted from Bohlander, Snell and Sherman. (2009). Managing human resources (15th ed.). Ohio: South-western College Publishing.

7.5.3 Achieving Individual Equity

After an organisation has structured its wage policy, the organisation has to determine the wage rate that will be received by a particular employee based on the salary grade range according to the position held. Normally, an employees salary rate is determined by taking into account issues such as experience related to his or her service and performance. For example, a clerk with no work experience in other organisations will receive a starting pay of RM520 whereas a clerk who has work experience in another organisation will be offered RM720. The main objective of this step is to achieve individual equity. Individual equity refers to the fairness in determining wage payment for employees in the same position.

ACTIVITY 7.3

Elaborate on the components involved in the formation of a salary system.


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COMPENSATION ADMINISTRATION ISSUES

An organisations compensation administrative system has to consider flexible characteristics towards developing a compensation administrative strategy which is able to retain employees for a longer period. Payment based on flexibility will ensure that the compensation administration system connects employee performance and reacts to economic environment in the organisations external environment. A few issues on compensation administration which should be highlighted to the human resource manager are as follows:

(a) The Influence of Equity on Wage Rate According to Dessler (2000), equity factors whether internal or external are critical factors in determining wage rate. External factors take into account the similarities between an established wage rate and other organisations wage rate to attract and retain capable employees. On the other hand, internal factors stress on fair wage where an employee compares his or her wage with the wage rate of a colleague in the organisation. In general, an established salary grade must take into account both issues in creating equity on the wage rate developed.

(b) Salary Acceptance Culture The main challenge for human resource managers is to change employees perception on salary acceptance. Basically, the rights mentality to accept salary as a result of being present in the workplace has to shift to the contribution mentality, which is payment based on contribution demonstrated. This paradigm shift requires human resource managers, together with other managers and the top management, to show commitment to change in increasing employee productivity.

(c) Wage Assurance A strategic compensation administration is able to motivate employees to increase their performance. Various compensation plans have to be developed to create wage payment assurance including basic salary assurance, service allowance or living expenses, and other financial benefits

7.6

EXERCISE 7.2

What is meant by job evaluation? State the methods which can be used to evaluate a particular job.


that need to be increased from time to time such as housing allowance. The wage rate developed also has to be revised so that an increase in basic salary follows the increase in living costs.

ACTIVITY 7.4

Do you agree or disagree with the following statements? Give a valid reason for your choice.

1. Do you agree that a top executive be given a high salary compared to lower position employees and does this show a fair organisation compensation administration system? (a) Agree (b) Disagree

2. Has the government enforced the minimum wage? (a) No (b) Yes

3. Payment based on performance is only a fantasy in an organisation. (a) Agree (b) Disagree

4. Annual increment has to be based on performance demonstrated. (a) Agree (b) Disagree


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EXERCISE 7.3

Multiple Choice Questions

1. Which one of the following is a direct monetary reward? A. Flexible work timetable B. Bonus C. Insurance D. Annual leave

2. The compensation administration policy developed has to consider the following elements EXCEPT: A. Focuses on organisational objectives. B. Retains employees. C. Connected to all employees. D. Wage structure which does not change.

3. The steps in determining the salary system according to order are _________________. A. Job analysis, job evaluation, determining the basic salary,

market survey on payment practices, producing a salary system

B. Job analysis, job relative value, job arrangement, job grade, market survey, establishing a wage structure, determining individual equity

C. Job evaluation, job analysis, determining individual equity, job arrangement, market survey on payment practices, producing a salary system

D. Job evaluation, job analysis, market survey on payment practices, determining basic salary, producing a salary system

4. Which one of the following is a qualitative method to evaluate jobs? A. Job Arrangement B. Factor Comparison C. Score System D. Job Hierarchy

Essay Questions 1. Explain two key challenges faced by human resource managers

in developing an effective salary structure.

2. What is meant by compensation?


Compensation administration is a critical activity in managing human

resources and has to be more focused on giving consistent rewards to encourage employee behaviour consolidation.

This will then increase employee performance and employee loyalty so that they will remain in the company for a long time.

Therefore, the compensation administration strategy has to be flexible to ensure a rapid response towards change and compensation administration trends in the labour market.

Basically, the purpose of compensation administration is to gain high returns from the investment made by the organisation for its employees, in the form of salary.

The rewards offered have to ensure that organisation as well as employees benefit from it.

An effective compensation administration system impact is when employees practise a work culture that emphasises on contribution compared to payment acceptance for being present in the workplace.

Compensation

External equity

Individual equity

Internal equity

3. List examples of indirect monetary reward.

4. List the factors which need to be considered when developing compensation administration policies.

5. State the two steps which can be used to obtain market information before developing a wage structure.

6. What is meant by individual equity? State factors which need to be considered in individual equity.

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20140225043514_Topic 7 Compensation Administration