Prepared by Professor Sunil Kumar Maheshwari, Indian Institute of Management, Ahmedabad.

© 2006 by the Indian Institute of Management, Ahmedabad

Technical Note

Human Resource Management (D): Compensation Management

Compensation decisions are very crucial for the overall health of the organization. Depending on the nature of business, compensation may account for anything from five to 60 per cent of the cost of the ooperations. While some organizations find difficult to survive merely because of high wage bills, others find it difficult to retain people because of low compensation. Components of Compensation: Compensation is the package of quantifiable rewards an employee receives for his or her labour. It includes primarily three components:

• Base salary • Pay incentives • Indirect compensation

Base Salary: Base salary is the fixed component that an employee receives irrespective of his performance. It is an important component of employee compensation as it generally acts as base for deciding other incentives, perks, and privileges. Base salary could be decided either on the basis of the job an employee performs or on the basis of knowledge and skill that an employee possesses. Job-based compensation system is useful when job designs, technological changes, and organizational processes and structure are relatively stable. For job-based compensation, jobs are evaluated. When technology and structure and processes of organization are unstable, the demand for skills and knowledge of employees also changes quickly. Certain existing employee-skills and knowledge may become redundant. Simultaneously, some other skills and knowledge may become more important. In such conditions, organizations tend to develop individual skill-based compensation systems.

A skill-based system may create inequity in the organization. Frequently younger employees, armed with latest skill and knowledge of the profession from colleges, attract higher compensation than older colleagues in the organization. This becomes a source of conflict, stress, and managerial turnover in the organization. Hence, a system with a thrust on continuous enhancement of skills and knowledge of people has to be carefully developed and communicated to employees. Organization and employees both generally share the responsibility for development of people in this system.

Indian Institute of Management Ahmedabad IIMA/P&IR0198(D)TEC

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Pay Incentives Incentives are generally linked with employee performance. They could be in form of bonus, profit-sharing, employee stock options, etc. Though incentives are variable in nature, it is not uncommon when they assume the nature of fixed component in practice. However, organizations often announce payments such as ex-gratia payment to its employees more as a matter of tradition and right of employee than as a profit-sharing measure in true sense. Incentives are also one of the greatest sources of conflict between union and management. Organizations such as Premier Auto Limited and Maruti Udyog Limited faced volatile industrial relations because of high payments through incentive schemes. While it is easier to assign the criteria for incentives to those whose performance could be measures objectively; it is not easy to do so for servicing functions of the organization. This is another source of conflict in organizations. Further, differential earning opportunities in different departments because of nature of work, technological differences, and environmental opportunities also create differences. Managers are required to be careful and sensitive to these sources of conflict while designing incentive schemes. Moreover, such schemes require frequent review to reassess the success. A yielding management may achieve short-term production targets at the cost of long-term sustainability of the organization. Indirect Compensation Indirect compensation consists of benefits that are given for different reasons. These benefits may be health insurance, vacation, leave travel concession, company car, parking space, housing, club membership, etc. Position-linked perks have potential to create hierarchy in the minds of people. While monetary compensation is not visible in the day-to-day functioning of the organization, perks are visible and convey hierarchy. In organizations where discipline and maintenance of organizational systems and processes are important, creating a hierarchical mindset among employees through perks may be useful for managers. For example, hierarchy is important in the armed forces. Officers in such organizations create strong hierarchical mindset primarily through status symbols than through pay differentials. Compensation helps in attracting and retaining employees in the organization. The design of a compensation system influences the ability of organizations to achieve their strategic goals. Choices in the design of compensation system: Important strategic decisions to design compensation systems are:

• Equity: Internal and external • Pay: Fixed and variable • Performance linkage: Performance versus seniority • Criteria: Job and/or individual competencies • Pay differentials: Egalitarian versus elitism • Position in the Industry: Below market versus above market level • Non-monetary rewards • Openness of the policy

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Equity: Organizations need to be concerned about compensation equity between people with similar competence, position and experience. External equity is critical for lateral hiring from the market at senior positions. External equity often creates internal inequity. Such conditions dilutes emotional bond between people and organization. Internal equity is easy to maintain when organizations prefer internal development of people over lateral hiring for senior positions. This creates an atmosphere of security and enhances emotional bond between people and organization. Fixed versus Variable Pay: Organizations are often seen to prefer variable pay to people to ensure performance outcome. However, different people have different preferencs. Persons who are aggressive, confident and ambitious prefer variable pay, provided it enhances the potential earning substantially. Hence, this policy has substantial implications for the culture of the organization. Performance Linkage: Anuual raise in salary could be linked with seniority and performance. Policy of performance linked substantial component raise creates competitive environment in the organizations. Individual based pay: Pay policy where people are paid according to their capabilities irrespective of their job-role in the orgazation creates an environment characterised by low cooperation and competitive. It promotes concern for merit, if implemented carefully. However it is difficult to implement owing to difficulties in accurate assessment of competencies of people at regular interval. Pay Differnetials: Organizations where hierarchy needs to be promoted, high pay differentials are useful. In owner managed organizations it is often seen that few persons at the top draw substantially higher salary than others. Pay Policy: Important factors that influence pay policy are:

Paying capacity of the organization: This determines the maximum pay which an organization can pay to its employees.

Minimum wage rates: This determines the minimum wages which are to be paid

to workers.

Industry wage rates: This influences the retaining ability of employees in the organization.

Prevailing wage structure in the region: This influences the actual wage level

decisions. Business strategy: A cost leadership business strategy would demand moderate fixed

pay, and high linkage of incentives with actual performance. The incentives are likely to be worked out at the individual level. There is likely to be high status related to achieve better control and coordination in such organizations. The strategy of quality enhancement and differentiation might favour high fixed component and group awards for incentives. There are likely to be less status related perks in such organizations.

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Business life cycle: In the high growth rate product stage, organizations are likely to have full capacity utilization. It would be appropriate for organizations to design pay structure characterized by high incentive levels and industry leadership. In the declining stage compensation is more likely to be characterized by low incentives and high fixed pay.

Organizational structure: A centralized structure would require high status related

perks. Formalized organizations are likely to be characterized by low incentives and high fixed pay and job-based pay structure.

Performance appraisal system: Management by Objectives based performance appraisal

system is likely to have high linkage with performance. In such conditions, organizations would prefect closed compensation policy.

Age and size of the organization: Formalization increases with age and size of the

organization, thus the compensation system. Large companies may try to have market leadership role for compensation.

Environment: Job-based pay system works well when conditions are more stable and

the required technical capability in employees is relative moderate. Job-based compensation plan: A large number of organizations prefer job-based compensation plan over person-based compensation plan. To design job-based compensation plan, following steps are followed:

• Conduct job analysis • Write job description • Determine job specification • Rate worth of all jobs using a predetermined system (job evaluation) • Create job hierarchy • Classify jobs by grade levels • Establish final pay policy • Individual pay assignment

Job Evaluation Hay Guide Chart Background: It is one of the most widely used single method of job evaluation. It was conceived in 1950 by the Hay Group. It is based on factor comparison method and places importance on the job and not on the individual. Variaous factors that determine the worth of a bob are:

Know-how Practical procedures, specialized techniques and knowledge within occupational

fields, commercial functions, and professional or scientific discipline Skills in planning, organizing, executive, controlling, and evaluating Interpersonal skills

Problem Solving

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• The environment in which thinking takes place • The challenge presented by the thinking to be done

Accountability

• Freedom to act – the degree of personal or procedural control and guidance • Job impact on end result • Magnitude-reflected by the annual revenue or expense associated with the area

in which the job has its primary emphasis. Evaluation Process

• A set of guide charts are prepared after studying the organization. (A set consists of three charts: accountability, problem solving, and know-how.)

• A benchmark sample of position is selected to cover all organization level, functions, and units where jobs are to be evaluated.

• Position descriptions are prepared jointly by job holder and one level higher authority.

• A job evaluation committee is nominated to evaluate the benchmark sample. Calibration of three charts is done by the committee.

• All other positions are then evaluated, depending on the size, complexity, and culture of the organization.

• Benchmark sample is selected to cover all organizational levels, functions, and units where jobs are to be evaluated.

• Chart values increase at the rate of 15 per cent.

Grading

Jobs Points Grade Pay Range (`) Customer service representatives

300 5 5,000-7,500

Executive secretary 298 Senior secretary 290 Secretary 230 4 4,000-6,000 Senior general clerk 225 Credit and collection 220 Accounting clerk 175 3 3,500-5,500 General clerk 170 Legal secretary 165 Senior word processing operator

160

Word processing operator 125 2 3,000-4,500 Purchasing clerk 120 Payroll clerk 120 Clerk-typist 115 File clerk 95 1 2,500-3,500 Mail clerk 80 Personal clerk 80 Receptionist 60

Some Legislation of Wages

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The Payment of Wages Act, 1936

• Maximum wage period = 1 month • Mode of payment: cash or cheque (after authorization from people), within 7 days

where less than 1000 employees are employed; otherwise within 10 days • Time limit for payment of dues for discharged employees • Procedure for levying fine

The Minimum Wages Act, 1948

• Determines the bare minimum to keep the ‘body and soul’ together • Implemented by both states and central governments • Cost of living allowance, cash value of concessions

The Payment of Bonus Act, 1965

• Minimum 8.33 per cent of wages • Universities and educational institutes excluded from the purview • Bonus is treated as deferred payment as minimum is to be paid in loss conditions as

well.