Compensation and Reward Management: 9 Key Topics

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Unlocking the 9 Secrets of Compensation and Reward Management

The compensation and reward management employees receive are directly related to the effort they exert. However, both internal and external factors also influence an employee’s financial and non-financial compensation. The compensation structure often includes levels that denote an employee’s role and status, primarily based on their skills, knowledge, capabilities, and qualifications. Organizations today dedicate significant human resource efforts to managing and maintaining their compensation and reward management.

Key Topics Covered:

1. Objectives of Compensation and Reward Management
2. Classification of Compensation and Reward Management
3. Determinants of Compensation
4. Evolving Strategy
5. Different Levels for Payments
6. Approaches to Compensation
7. Important and Worthwhile Trends
8. Strategy and Design Issues
9. Emerging Compensation and Reward Systems in an Organisation

Objectives of Compensation and Reward Management

A sound compensation and reward management aims to achieve the following:

1. Develop talent: Encourage the development of employee skills and personality to enable them to earn better compensation.
2. Ensure fairness: Pay fair and justified remuneration based on employee efforts, skills, and competencies.
3. Attract and retain: Obtain able and efficient employees and retain high-performing employees.
4. Improve quality: Enhance the quality of services rendered by employees.
5. Communicate value: Inform employees about their worthwhile and necessary role in the organization.
6. Boost motivation and efficiency: Increase employee efficiency and productivity through motivational techniques.
7. Foster teamwork: Develop and enhance cooperation and collaboration among employees.
8. Drive high performance: Motivate employees toward higher work performance.
9. Improve relations: Establish better employer-employee relations.
10. Provide recognition: Offer employees social recognition and status.
11. Reinforce positive behavior: Reinforce desirable and applicable employee behavior.

Classification of Compensation and Reward Management

Compensation and reward management are broadly divided into two major areas:

1. Financial Methods

Financial compensation and rewards are categorized as:

• Direct Methods: Monetary payments to employees based on their job tenure and negotiations. This includes wages, salaries, allowances, commission, monetary incentives, bonuses, overtime payments, and profit sharing.
• Indirect Methods: Rewards that do not involve immediate cash but provide tangible value based on financial grounds, offering indirect benefits. These are often received after completing a specific tenure and include insurance, pension, provident fund, and travel benefits.

2. Non-Financial Methods

Non-financial components satisfy mental and social needs, acting as intrinsic rewards. They are based on human nature, recognition, and morale.

• Components: Proper service conditions, job enlargement, promotions, rights and responsibilities, opportunities for advancement, recognition, health and maternity leave, gratuity, and medical leave.
• Benefits:
  • Fulfilling employees’ self-actualization needs.
  • Providing better opportunities for personal and career advancement.
  • Helping organizations retain employees.
  • Creating and providing informal relations with employees.
  • Developing praise and recognition for employees.
  • Boosting employee morale and enthusiasm.
  • Developing feelings of reliability and loyalty among employees.
  • Recognizing individual and group work performance.

Determinants of Compensation and Reward Management

Compensation and reward management are influenced by two major categories of factors:

1. Internal Determinants

These are factors within the organization:

• Nature of Work: Hard, complicated, or risky work often results in higher incentive levels.
• Compensation Policy: The organization’s policy determines its ability to pay and sets the framework for systems and methods, linking pay to job and skill levels.
• Employee’s Relative Worth: Compensation levels are determined by an employee’s merit and performance, aiming to link pay to performance.
• Promotional Policy: Policies regarding promotion determine compensation levels, as experienced employees moving to new roles receive new pay scales and incentive systems.
• Technical Knowledge: Employees with high technical skill and knowledgeable experience command higher compensation and reward management.
• Employer’s Ability to Pay: Influenced by factors such as profitability, budgetary situation, financial position, and competition, this determines the employer’s capacity to provide pay and benefits.

2. External Determinants

These are external market and environmental factors:

• Area Wage Rates: Compensation levels are influenced by prevailing rates offered by other organizations in the same area to ensure competitive pay.
• Economic Conditions: The organization’s economic health, profitability, and productivity determine its capacity to pay, influencing the demand for skilled labor and the level of remuneration and facilities.
• Scope of Products’ Market: The potential and profitability of the organization’s products affect its earning capacity, which in turn influences the determination of pay levels.
• Government’s Laws and Policies: Legislation like the Minimum Wages Act 1948 and Payment of Wages Act 1936 sets minimum wage rates and affects allowances and fringe benefits.
• Competition: The competitive environment within the industry affects the level and pattern of pay rates, requiring compensation to be on par with competitors.
• Role of Employees’ Organisation (Unions): Negotiations with employee unions establish wage patterns for a specified region.
• Labour Market Conditions: The demand and supply for qualified people influence wage and salary rates. High demand and limited supply lead to higher compensation to attract and retain skilled employees.

Compensation and Reward Management Strategy and Key Issues

Organizations must link their business strategy to their compensation strategy to gain a competitive advantage through their employees. This alignment, based on a contingency approach, means HR strategies, including compensation, should adapt to variations in business strategy.

Key issues considered when aligning the compensation system with business strategy:

1. Culture and Shared Values: Compensation criteria should reflect organizational values (e.g., ethical behavior, innovation, collaboration). A culture of employee orientation may result in a friendly work environment and work-life balance benefits.
2. Organizational Strategy and Appraisal: A clear, communicated organizational strategy helps employees align their efforts. The appraisal system must be linked to the business strategy and outcomes to assess the executive’s success. Mid-year reviews allow for performance behavior adjustments.
3. Link to Business Performance: Executive compensation is increasingly tied to business performance (profit, growth, market share). Incentive plans, as part of variable pay, offer flexibility to reward talent achieving targets.
4. Measurable Goals: Effective appraisal mechanisms require measurable goals with criterion validity, incorporating both financial and non-financial measures. Clear quantitative measures support incentive plans, while qualitative measures provide context.
5. Compliance, Fairness, and Fit: Strategies must comply with regulatory frameworks and fit the organizational culture in terms of justness, fairness, and transparency.
6. External Competitiveness: Strategies must be competitive with the external environment. Benchmarking and compensation surveys help assess key talent compensation against competitors.
7. Work Design and Individual Needs: Compensation design is influenced by work structure (individual/team performance, experience, skills, cost of living, personal needs, business unit performance). A major challenge is designing flexible systems that allow employees to choose benefits (e.g., younger employees preferring cash, older employees preferring health/pension benefits, dual-career couples preferring flexible schedules).
8. Team Design and Stakeholder Input: The team designing the system should be representative of stakeholders or include external experts. A clearly articulated reward strategy is beneficial for attracting, engaging, and retaining talent.

Different Levels for Payments Based on Work Performance

Compensation levels denote an employee’s status and are based on skill, knowledge, capabilities, and qualifications. The basic level of remuneration is determined by the nature of the job, required skills, and capacity. Common payment levels used are merit-based pay, skill-based pay, variable pay, and competency pay.

The four major levels based on employee work performance:

Level	Name	Description
#1	Merit-Based Pay	Based on employee job appraisal, with merit as a key determinant. The best performers receive the highest merit pay.
#2	Skill-Based Pay	Rewards employees who possess more knowledge and skills. Pay increases as employees acquire and apply additional skills. It motivates employees and requires the organization to provide career orientation facilities.
#3	Variable Pay	Used to control labor costs and maintain high performance. Rewards for good performance are not added to the base pay of a new job. High performers receive fringe benefits and incentives. Pay is reduced if performance falls below a fixed standard, which can lead to financial insecurity and affect morale. It supplements merit and competency-based pay.
#4	Competency-Based Pay	Employees are paid based on their skills, knowledge, motives, and attitudes. Greater emphasis is placed on job content and performance, and the proficiency level is determined for overall competency assessment.

Approaches to Compensation and Reward Management

Viewpoints on compensation have evolved over time, resulting in three major approaches:

1. Bargaining Approach: The compensation structure was determined by a mutual rate agreed upon through the bargaining capacity of workers with their employers (capitalists).
2. Traditional Approach: Compensates employees through a job-based pay system. It relies on the analytical study and job evaluation of a specific job to determine its relative worth and technological factors.
3. Contemporary Compensation Approach: Emphasizes skill, efficiency, and competencies as key determinants of compensation and reward management. It seeks to promote and accommodate skilled and knowledgeable employees, allowing performance to influence compensation.

Important and Worthwhile Trends

Organizations are increasingly focusing personnel efforts on managing and maintaining their compensation and reward management. Key trends include:

1. Mandatory Benefits: Organizations are legally required to provide benefits like provident fund, gratuity, health plans, maternity benefits, and medical leaves.
2. Maintaining Compensation System: Aims to maintain the current market share of talented personnel by offering rewards and policies to retain expertise for a long tenure.
3. Incentive Systems: Play a key motivational role for achieving goals. Examples include profit sharing, bonuses, and fringe benefits, which can dynamicize work performance.
4. Team-Based Pay and Rewards: Increasingly used with self-managed or work teams. Rewards are linked to team performance, and members share in the reward if the team achieves its target. Basic pay may still be determined by individual performance.
5. Competency Pay System: Pays employees based on the skills, knowledge, attitudes, and competencies they bring to the job. It requires identifying relevant competencies, proficiency levels, and the relationship between competencies and performance variations.

Strategy and Design Issues

Effective and attractive compensation and reward management mechanisms motivate, engage, and retain key talent by linking financial security to the compensation received. Design elements must align with the organization’s business strategy, culture, and HR strategies.

• Mechanisms: Include all monetary, non-monetary payments, and benefits.
• Benefits Cost: The rising cost of benefits requires employers to design effective plans that are competitive and aligned with organizational objectives.
• Employee Investment: Employers must recognize the physical, mental, time, and psychological investment employees make and design mechanisms accordingly.
• Diverse Workforce: Crafting flexible strategies is essential for a diverse workforce, as needs differ significantly (e.g., dual-career couples vs. single individuals).
• Affordability: Organizations must consider the affordability of their compensation decisions, as labor costs are a significant factor.
• Next Generation Needs: Traditional systems must be replaced with flexible, sensitive systems that are linked to the achievement of organizational objectives to meet the needs of the next generation of employees.

Emerging Compensation and Reward System in an Organisation

Pay systems are a significant cost factor (about 40% of operating cost). Emerging systems aim to link pay more directly to performance and organizational success:

• Variable Pay Systems: Employee compensation that varies with the organization’s business performance (e.g., sales commission). It is counter-cyclical, being more costly when the organization performs well and less costly when it performs poorly. Most effective when linked to business team or unit performance targets.
• Gain Sharing: Organisation-wide plans rewarding employees for improvements in organizational productivity (not just profits). Bonuses are distributed more frequently.
  • Results: Enhanced teamwork, recognition of social needs, focus on cost savings, greater acceptance of change, demand for efficient management, reduced overtime, generation of ideas, improved labor relations.
  • Limitations: Does not necessarily attract/retain the best performers; pays bonuses even without profit; not suitable for every situation.
• Stock Options: Based on organizational performance in the stock market. Goals include motivating employees to act in the best interest of the organization, enhancing identification with the company, and making labor costs vary with performance. They are becoming more widespread beyond just executives.
• Employee Ownership: Plans (including stock options, stock purchase, and ESOPs) that transfer some or all of the company’s ownership to employees. Effective in small, participative organizations for increasing performance, and can positively affect attraction, retention, and integration in large organizations.
• Competence-Related Pay: Rewards people based on the level of competence they demonstrate and effectively use in their roles to generate added value, not just on acquisition of competence.
• Skill-Based Pay: Links pay to the level of skills used, acquired, and applied, typically for manual workers. Often used interchangeably with competence-related pay, but focuses more on pure skills. Requires rigorous evaluation of costs and benefits before introduction.
• Team-Based Rewards: Payments or non-financial rewards provided to team members, linked to the team’s performance. Shared according to a scheme for exceptional achievements.
• Profit Sharing: A group-based plan to encourage employees to identify with the company’s progress, stimulate interest in company affairs, and encourage better management-employee cooperation. Allows labor costs to vary with the organization’s ability to pay.
• Merit Pay: The most widely used performance payment approach, giving salary increases based on a supervisor’s performance appraisal. Aims to improve motivation and retention, but its effectiveness is often hampered by poor appraisal quality.