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Compensation management
1. Compensation Management Defined
Reward management is concerned with the formulation and implementation of strategies and
policies in order to reward people fairly, equitably and consistently in accordance with their
value to the organization. It deals with the development of reward strategies and the design,
implementation and maintenance of reward systems (reward processes, practices and
procedures) which aim to meet the needs of both organization and its stakeholders. Reward
can be regarded as the fundamental expression of the employment relationship.
Cascio has defined compensation as follows:
"Compensation includes direct cash payments, indirect payments in the form of employee
benefits and incentives to motivate employees to strive for higher levels of productivity”
Based on above description of compensation, we may identify its various components as
follows:
Wage and Salary: Wage and salary are the most important component of
compensation and these are essential irrespective of the type of organization. Wage is
referred to as remuneration to workers particularly, hourly-rated payment. Salary
refers to as remuneration paid to white-collar
employees including managerial personnel. Wages and salary are paid on the basis of
fixed period of time and normally not associated with productivity of an employee at
a particular time.
Incentives: Incentives are the additional payment to employees besides the payment
of wages and salaries. Often these are linked with productivity, either in terms of
higher production or cost saving or both. These incentives may be given on individual
basis or group basis.
Fringe Benefits: Fringe benefits include such benefits which are provided to the
employees either having long-term impact like provident fund, gratuity, pension; or 1
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occurrence of certain events like medical benefits, accident relief, health and life
insurance; or facilitation in performance of job like uniforms, Canteens, recreation,
etc.
Perquisites: These are normally provided to managerial personnel either to facilitate
their job performance or to retain them in the organization. Such perquisites include
company car, club membership, free residential accommodation, paid holiday trips,
stock options, etc.
2. Objectives in compensation management
Acquire qualified personnel.
Compensation needs to be high enough to attract applicants. Pay levels must
respond to the supply and demand of workers in the labor market since
employers compete for workers. Premium wages are sometimes needed to
attract applicants already working for others.
Retain current employees.
Employees may quit when compensation levels are not competitive, resulting
in higher turnover.
Ensure equity.
Compensation management strives for internal and external equity. Internal
equity requires that pay be related to the relative worth of a job so that similar
jobs get similar pay. External equity means paying workers what comparable
workers are paid by other firms in the labor market.
Reward desired behavior.
Pay should reinforce desired behaviors and act as an incentive for those
behaviors to occur in the future. Effective compensation plans reward
performance, loyalty, experience, responsibility, and other behaviors.
Control costs.
A rational compensation system helps the organization obtain and retain
workers at a reasonable cost. Without effective compensation management,
workers could be overpaid or underpaid.
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Comply with legal regulations.
A sound wage and salary system considers the legal challenges imposed by
the government and ensures the employer's compliance.
Relevant legal regulations imposed by the government include followings.
o The Shop and Office Employees (Regulation of employment & remuneration)
Act
o Wages Board Ordinance
o Employees provident Fund
o Employees Trust Fund
o Payment of Gratuity Act
o Factories Ordinance
o Workmen’s Compensation Ordinance
o Industrial Disputes Act
o Termination of Employment (Special provisions) Act
o Trade Union Ordinance
o Employment of Women, Young Persons and Children Act
o Maternity Benefits Ordinance
For example, by ensuring that the organization’s compensation packages meet the minimum
wage requirements as shown below etc.., the organization can prove the employer’s
compliance.
Industry Worker Category Minimum wages
Plantation Sector 380 per day
Plus Attendance Bonus 105 per day
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Plus productivity incentive 30 per day
Industrial Sector Unskilled 6500-7500 per month
Semi Skilled 7000-8000 per month
Skilled 7500-9500 per month
Service Sector Unskilled 6500-7500 per month
Semi Skilled 7500-8000 per month
Skilled 8400-9500 per month
o Overtime is paid at One and Half times the normal hourly rate of wage.
o Holiday pay for work on weekends (Sundays) and public holidays is paid for
at a higher rate 1 1/2 times the daily rate or double the rate of remuneration.
o Bonuses e.g. project, attendance, festival would vary from company to
company. There is no statule law sourning these payments
3. Importance of a compensation system
A fair compensation system will help in the following:
o An ideal compensation system will have positive impact on the efficiency and results
produced by employees. It will encourage the employees to perform better and
achieve the standards fixed.
o It will enhance the process of job evaluation. It will also help in setting up an ideal job
evaluation and the set standards would be more realistic and achievable.
o Such a system should be well defined and uniform. It will be apply to all the levels of
the organization as a general system.
o The system should be simple and flexible so that every employee would be able to
compute his own compensation receivable.
o It should be easy to implement, should not result in exploitation of workers.
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o It will raise the morale, efficiency and cooperation among the workers. It, being just
and fair would provide satisfaction to the workers.
o Such system would help management in complying with the various labor acts.
o Such system should also solve disputes between the employee union and
management.
o The system should follow the management principle of equal pay.
o It should motivate and encouragement those who perform better and should provide
opportunities for those who wish to excel.
o Sound Compensation/Reward System brings peace in the relationship of employer
and employees.
o It aims at creating a healthy competition among them and encourages employees to
work hard and efficiently.
o The system provides growth and advancement opportunities to the deserving
employees.
o The perfect compensation system provides platform for happy and satisfied
workforce. This minimizes the labour turnover. The organization enjoys the stability.
o The organization is able to retain the best talent by providing them adequate
compensation thereby stopping them from switching over to another job.
o The business organization can think of expansion and growth if it has the support of
skillful, talented and happy workforce.
The sound compensation system is hallmark of organization’s success and prosperity. The
success and stability of organization is measured with pay-package it provides to its
employees.
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4. The Reward System
A reward system consists of a number of interrelated processes and activities which combine
to ensure that reward management is carried out effectively to the benefit of the organization
and the people who work there.
The processes and activities includes the following
4.1 Analyze business strategy and business needs
4.2 Develop HR strategy
4.3 Develop and justify Reward Strategy and define guideline principles
Reward strategy is a declaration of intent which defines what the organization wants to do in
longer term to develop and implement reward policies, practices and processes which will
further the achievement of its business goals and meet the needs of its stakeholders. It
provides a sense of purpose and direction and a framework for developing reward policies,
practices and process.
4.3.1 Content of Reward Strategy
Broad-brush reward strategy
A Broad-brush reward strategy may commit the organization to the pursuit of a total
reward policy. The basic aim might be to achieve an appropriate balance between
financial and non-financial rewards. This specifically elicits the employee behaviors
that the firm needs to support and to achieve its competitive strategy.
Additionally or alternatively, Reward Strategy may set out a list of specific
intentions dealing with particular aspects of reward management.
4.3.2 Components of an effective reward strategy
They have to have clearly defined goals and a well-defined link to business
objectives.
There have to be well-designed pay and reward programs, tailored to the needs of
the organization and its people, and consistent and integrated with one another.
Perhaps most important and most neglected, there needs to be effective and
supportive HR and reward processes in place.
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4.3.3 Reward guiding principles
Guiding principles define the approach an organization takes to deal with reward.
They are the basis for reward policies and provide guidelines for actions contained
in the reward strategy.
4.3.3.1 Reward policies
Reward policies address the following broad issues:
The level of rewards taking into account ‘market stance’ – how internal rates
of pay should compare with market rates;
Achieving equal pay;
The relative importance attached to external competitiveness and internal
equity;
The approach to total reward;
The scope for the use of contingent rewards relates to performance,
competence, contribution or skill;
The role of line managers:
Transparency- the publication of information on reward structures and
processes to employees
Example Reward policy issues may include;
Pay for performance
Pay for seniority
Salary increases and promotions
Overtime and shift pay
Probationary pay
Paid and unpaid leaves
Paid holidays
Geographic costs of living differences/ hardships
5. Total Reward
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5.1 Components of employee compensation
There two types of rewards; Financial (extrinsic) and Non-Financial (intrinsic). Porter and
Lawler suggest both are necessary for generating job satisfaction related to performance.
Financial rewards/ direct compensation
Direct compensation refers to monetary benefits offered and provided to employees in
return of the services they provide to the organization. The monetary benefits include
basic salary, house rent allowance, conveyance, leave travel allowance, medical
reimbursements, special allowances, bonus, Pf/Gratuity, etc. They are given at a regular
interval at a definite time.
Base Pay is a certain payment connected with a job, usually given on a time basis (hourly,
weekly, monthly or yearly). Variable Pay is dependent on performance of individual,
team or organisation and cannot become a part of the basic pay Employee Benefits are
made up of options like insurance, stock options, company cars, pension-schemes and
holidays.
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Basic Salary
Salary is the amount received by the employee in lieu of the work done by him/her for a
certain period say a day, a week, a month, etc. It is the money an employee receives from
his/her employer by rendering his/her services.
House Rent Allowance
Organizations either provide accommodations to its employees who are from
different state or country or they provide house rent allowances to its employees.
This is done to provide them social security and motivate them to work.
Conveyance
Organizations provide for cab facilities to their employees. Few organizations also
provide vehicles and petrol allowances to their employees to motivate them.
Leave Travel Allowance
These allowances are provided to retain the best talent in the organization. The employees
are given allowances to visit any place they wish with their families. The allowances are
scaled as per the position of employee in the organization.
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Medical Reimbursement
Organizations also look after the health conditions of their employees. The employees are
provided with medi-claims for them and their family members. These medi-claims
include health-insurances and treatment bills reimbursements.
Bonus
Bonus is paid to the employees during festive seasons to motivate them and provide them
the social security. The bonus amount usually amounts to one month’s salary of the
employee.
Special Allowance
Special allowance such as overtime, mobile allowances, meals, commissions, travel
expenses, reduced interest loans; insurance, club memberships, etc are provided to
employees to provide them social security and motivate them which improve the
organizational productivity.
Non Financial Rewards/ Indirect compensation
Indirect compensation refers to non-monetary benefits offered and provided to employees
in lieu of the services provided by them to the organization. They include Leave Policy,
Overtime Policy, Car policy, Hospitalization, Insurance, Leave travel Assistance Limits,
Retirement Benefits, Holiday Homes.
One of the most important aspects of intrinsic rewards is Job satisfaction. If a person is
not satisfied from what he does, his performance gets affected thus damaging the
performance of whole team and in turn, the organization.
Feedback and recognition; the praise and recognition given to an employee for any good
work is viewed positively and for some employees, existence of responsibility and
autonomy in their jobs is a form of intrinsic reward. Development, both at personal level
and career level are important forms on intrinsic rewards.
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Leave Policy
It is the right of employee to get adequate number of leave while working with the
organization. The organizations provide for paid leaves such as, casual leaves, medical
leaves (sick leave), and maternity leaves, statutory pay, etc.
Overtime Policy
Employees should be provided with the adequate allowances and facilities during their
overtime, if they happened to do so, such as transport facilities, overtime pay, etc.
Hospitalization
The employees should be provided allowances to get their regular check-ups, say at an
interval of one year. Even their dependents should be eligible for the medi-claims that
provide them emotional and social security.
Insurance
Organizations also provide for accidental insurance and life insurance for employees.
This gives them the emotional security and they feel themselves valued in the
organization.
Leave Travel
The employees are provided with leaves and travel allowances to go for holiday with their
families. Some organizations arrange for a tour for the employees of the organization.
This is usually done to make the employees stress free.
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Retirement Benefits
Organizations provide for pension plans and other benefits for their employees which
benefits them after they retire from the organization at the prescribed age.
Holiday Homes
Organizations provide for holiday homes and guest house for their employees at different
locations. These holiday homes are usually located in hill station and other most wanted
holiday spots. The organizations make sure that the employees do not face any kind of
difficulties during their stay in the guest house.
Flexible Timings
Organizations provide for flexible timings to the employees who cannot come to work
during normal shifts due to their personal problems and valid reasons.
5.2 The Wage Concept
There are three different concepts of wages: the minimum wage, the fair wage and the living
wage. The minimum wage is the least of them all and the living wage, the highest. Minimum
wage is the base wage that an employee has to be paid to fulfill his basic needs and provide
basic amenities for his family. The fair wage takes into consideration the paying capacity of
the employer.
The living wage, which is the highest of the three, is aimed at providing a comfortable living
for the employee and his family. It includes providing health, educational and social facilities.
Traditional wage plans include the piece-wage plan, based on the units produced by the
employee and the time-wage plan, based on the total working time of the employee. Modern
wage plans include skill-based wage plan, competency-based wage plan and broadbanding.
Wage differentials can be defined as the difference in wages paid for same or similar work
because of various reasons like differences in work schedules, hazards involved, cost of
living, or other factors.
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5.2.1 Factors Affecting Wages
On the basis of above discussion, we may summarise the factors affecting wage rates as
under:
Demand for and supply of labour: Demand and supply conditions of labour have
considerable influence on the determination of wage rates. If there is a short supply of
labour, the wages may be high whereas if there is no dearth of labour, the wages tend
to be low.
Labour unions: If the labourers are well organized into strong trade unions, their
bargaining power would be high and they can demand higher rates of wages. On the
other hand, if the labourers are not organized, the management may fix low wages.
Cost of living: The cost of living of workers also has a strong influence on the rate of
wages. If this factor is not considered, the labourers may not be in a position to make
both ends meet and this will affect their efficiency. Hence progressive employers
consider this factor also.
Prevailing wage rates: Prevailing wages in a particular industry are also taken into
account by the employers while deciding wage levels for their employees. By
considering the prevailing wage level, employers will come reasonable close to the
wage level of competitors, and this will enable them to retain and attract qualified
workers to the organizations.
Ability to pay: The wage level, to a large extent, is determined by the ability of the
enterprise to pay its workers. The ability to pay in turn is determined by the profit-
earning capacity of the enterprise.
Job requirements: Job requirements are also an important factor affecting wages.
Jobs requiring specialized knowledge or involving much mental or manual effort are
priced higher than those which are light or which do not need any specialized
knowledge.
State regulation: State regulation is another important factor influencing wage rtes.
As the State assumes responsibility for safeguarding the interest of citizens, it has to
step in to regulate the wage rates of labourers through legislative measures.
Increment system: In some organizations wages automatically increase annually at a
prescribed rate without any relation to workers’ performance. In some other
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organizations annual increases based on merit. Thus, the prevailing system of granting
increments also affects wages.
6. Requisites of sound primary compensation structure
Internal Equity
External equity and External competitiveness
Performance based payment: Individual equity
Equity issues can be addressed by different methods.
Job analysis and job evaluation can carry out to determine the worth of
each job in the organization to ensure internal equity is achieved.
Can conduct salary surveys to ensure external equity
Make sure individual equity is achieved by performance appraisal and
incentive pay
Proper two way communications, grievance mechanism and employee
participation further address the equity issues
6.1. Internal Equity and Job Evaluation
Internal Equity means that there should be proper relationship between the wages and salaries
of various positions within the enterprise. Mechanism we can use here is job evaluation. Job
valuation is a process of determining the relative worth of a job. It is a process which is
helpful even for framing compensation plans by the personnel manager. Therefore the main
objective of job evaluation is to have external and internal consistency in salary structure so
that inequalities in salaries are reduced.
6.1.1 Job Evaluation is Defined
International Labour Organisation (ILO) has defined job evaluation as follows:
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"Job evaluation is an attempt to determine and compare demands which the normal
performance of a particular job makes on normal workers without taking into account the
individual performance of the workers concerned"
The definition of job evaluation provided by ILO has been adopted by others. For example,
French has defined job evaluation as follows:
"Job evaluation is a process of determining the relative worth of the various jobs within the
organisation. so that differential wages may be paid to jobs of different worth. The relative
worth of a job means relative value produced. The variables which are assumed to be related
to value produced are such factors as responsibilities, skills, efforts and working conditions"
6.1.2 Advantages of Job evaluation
It is an objective and logical method of ranking jobs and removing unjust
differentials.
2. It helps in fitting new jobs at their appropriate plane in the existing wage
structure.
It improves labour- management relations by reducing grievances.
It establishes on objective and clear basis for wage bargaining.
It simplifies wages administration
It reveals the possibilities of more efficient use of the plant labour force.
6.1.3 Methods of Job Evaluation
There are four basic methods of job evaluation: ranking method, job grading method, point
method and factor comparison method.
The first two methods are non-quantitative and also known as traditional, non-analytical or
summary methods. The other two methods are quantitative, also known as analytical
methods, and use various quantitative techniques in evaluating a job.
6.1.3.1 Ranking Method
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In the ranking method, a whole job is compared with others and rank is provided on the basis
of this comparison. The usual process followed in this method is as under:
On the basis of job analysis, each member of the job evaluation committee ranks each
job independently either against the benchmark job or against all other jobs. The
ranking is provided to the job on the basis of this comparison.
In order to increase the reliability of ranking, this exercise is undertaken twice or
thrice by the members.
If there are significant differences of opinions among the members about the ranking
of a particular job, the matter is settled by mutual consultation, or by working out the
average.
Ranking method has certain facial merits and demerits. Some of these are as follows
Merits
The method is comparatively simple, easily understandable, and mostly acceptable by
labour unions. It is suitable for comparatively smaller organisations which may not
like to undertake more laborious exercises.
The method is less costly to undertake and maintain as compared to other systems.
Demerits
Since ranking method of job evaluation is qualitative and non-analytical it suffers from the
following limitations:
Ranking method is judgemental and, therefore, it is affected by personal preferences
of job evaluators.
This method ranks various jobs in order of their relative worth. It does not specify the
real difference between two jobs.. For example, the exact difference between job
ranked at first and the job ranked at second cannot be specified.
6.1.3.2 Grading/ Job Classification Method
This method establishes various grades for different categories of jobs. For example, jobs of
an operative may be classified as unskilled, semi-skilled, skilled and highly-skilled.
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The process followed in this method is as follows:
At the initial stage. a number of job classes or grades is decided on the basis of job
analysis. Job grades can be determined on either of two bases. First, all jobs may first
be ranked and their natural classes may be determined. The description of each job
class is prepared covering all jobs falling in a class. Second, the job evaluation
committee may prepare a series of job class description in advance on the basis of
which various jobs may be graded.
Different characteristics of each job are matched with description of job class and a
job is placed in the class with which it matches best.
Merits
Grading system of job evaluation particularly in government jobs is quite popular as this has
certain merits over the ranking method. These are as follows:
It is quite simple to operate and understand as the relevant information is provided by
job analysis which serves other purposes too.
Job evaluation done on grading method makes wage and salary determination easier
as these are fixed in terms of various grades of jobs.
Demerits
This system of job evaluation suffers with the following limitations:
Job grade description is vague and personal biases may distort job grading as the
method is not based on any scientific analysis.
There are chances of employees' resistance when new clusters of jobs are prepared.
This is evident by the fad that government employees agitate when recommendations
of a new pay commission come.
6.1.3.3 Point Method
Point method of job evaluation is widely used in business organizations. It is an analytical
and quantitative method which determines the relative worth of a job on the basis of points
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allotted to each specific factor of a job. The sum total to these points allotted to various job
factors is the worth of the job. This total is compared with that of other jobs and relative
worth of various jobs is determined.
This process consists;
Identifying the degree to which each compensable factor is present in the job
Awarding points for each degree of each factor
Calculating a total point value for the job by adding up the corresponding points for
each factor
6.1.3.4 Factor Comparison Job Evaluation Method
This method, also known as key job method, was originally developed at the Philadelphia
Rapid Transit Company, USA by Eugene J.Benge in 1926 to overcome two major problems
faced in point method of job evaluation and describing their degrees. In this method, each
factor of a job is compared with the same factor of the other jobs or the key job either defined
or existing one. When all factors are compared, the final rating is arrived at by adding the
value received at each comparison. For this purpose, Benge identified five factors-mental
effort, skill, physical effort, responsibility and working conditions. The procedure for factor
comparison method of job evaluation is as follows:
1st step: Obtain job information
2nd step: Select key benchmark jobs
3rd step: Rank key jobs by factor
4th step: Distribute wage rates by factor
5th step: Rank key jobs according to wages assigned to each factor
6th step: Compare the two sets of rankings to screen out unusable key jobs
7th step: Construct the job- comparison scale
8th step: Use the job comparison scale
Merits
The factor comparison method is more systematic and analytical as compared to any other
method and offers following merits:
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It provides more accurate information about the relative worth of a job as different
comparable factors are compared with key jobs.
Since only limited number of factors relevant for the effective job performance are
compared, there are reduced chances of overlapping.
Since the evaluation is more systematic and analytical, its logic can be accepted by
trade unions and workers.
Demerits
However, factor rating method has its own opera4onal problems which restrict its
adaptability. The major problems are as follows:
This method is quite costly and time consuming to install and difficult to understand
by those not fully conversant with job evaluation process.
If wage rates are adopted for making comparison, the system may become obsolete
very soon as there may not be proportionate increase in wages for all jobs.
This system considers only limited factors of job for comparison. This may be a
positive point so far as avoidance of duplication and simplicity of procedure are
concerned, but may ignore other factors which may be important for the performance
of the job.
6.2 External Competitiveness
To achieve external alignment the management must first know what the average rates of its
key job are prevailing in the community.
Average rates may be decided
when there is abundance of labour.
when the enterprise is incurring losses.
when the cost of living is going down.
when the enterprise has the reputation of being a stable employer with no layoffs.
when the enterprise pays sustained fringe benefits.
when wages are linked to productivity which is constant or falling.
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But at ABC Travels Pvt. Ltd, though there is no abundance of suitable labour nor the
organization is incurring losses etc, set the salaries
6.3 Performance based payment
In the final step, management has to decide whether all individuals in jobs of the same level
should be paid the same pay or different pay and how this should be determined. There are
four basic approaches to the determination of individual pay: the single rate approach, the
informal approach, the automatic approach, and the merit approach.
6.3.1 Approaches to the determination of individual pay
6.3.1.1 Single rates: When employee performance does not vary significantly on the job
because everyone is required to work at about the same pace (e.g. in simple office jobs)
single rates are frequently paid to employees on jobs. If there are any pay differences in such
jobs employees may consider these as favouritism.
6.3.1.2 The informal approach: Sometimes individual pay decisions are made on an
informal basis without formal guides or controls. This is most incorrect because this creates
iniquities and confusion among employees regarding what is expected of them. Lack of
company-wide standards may also result in pay decisions influenced by personal favouritism.
6.3.1.3 The automatic approach: Under this approach both the amount of the pay increase
and the period of review are usually predetermined. In this approach since no consideration is
shown to worker’s individual performance or merit he does not have enough incentive to put
in greater effort.
6.3.1.4 Merit approach: If differences in individual performance and output are important to
a company then some basis for compensating employees for these differences should be
established. Merit rating is a management practice designed to gear the pay of employees to
actual differences in work accomplishments. Merit rating systems assume that performance
can be observed with reasonable accuracy even when it cannot be objectively measured.
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6.3.2 Performance Appraisal and Role of Performance Appraisal in Performance based
payment
In the context of an industrial organization, performance appraisal is a systematic evaluation
of personnel by supervisors or those familiar with their performance. In other words,
performance appraisal is a systematic and objective way of judging the relative worth or
ability of an employee in performing his/her task.
Many authors described and some of them were tried to define the concept of performance
appraisal in their own way. According to Gary Dessler, performance appraisal is an
evaluation of employee’s current or past performance relative to his/her performance
standards. Further he mentioned that the appraisal process involves three steps;
a) Setting work standards,
b) Assessing the employee’s actual performance relative to these standards, and
c) Providing feedback to the employee with the aim of motivating that person to eliminate
performance deficiencies or to continue to perform above par.
McGregor discusses the formal performance appraisal plans in view of meeting three needs.
Out of which one is relating to organization and other two for individual. The first one,
organization level, is to provide systematic judgments to back up salary increases, transfers,
demotions, or terminations.
6.3.3 Incentive Pay
6.3.3.1 What is Incentive Pay ?
Incentives are pay for performance. Alternatively, incentives are called as variable pay or
contingent pay. “Dirideemana” (pay for effort, allowance for encouraging improving job
performance) is the Sinhala meaning for incentives. It link rewards cost and organizational
performance. Employees are rewarded according to their job performance. Incentives are
linked to individual job performance. Also they are linked to group or ream of performance.
They can also be linked with organizational performance. The ultimate purpose of incentives
is to improve performance ( Werther and Davis, 1989)
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Mathis and Jackson, ( 1988) defined Incentives as :
An incentive is a special that drives an employee to perform beyond normal level of
performance. It is an inducement that encourages the employee perform in better way.
Incentives are rewards designed to encourage employee for efforts beyond normal
performance expectations.
Aswathappa ( 2007 ) defined Incentives as :
“Payments by results, incentives are paid in addition to wages and salaries and they depend
on productivity, profit, or cost reduction efforts
There is a clear distinction between incentives (variable pay) and base pay ( Wages and
salaries ). Base pay is based on seniority or length of service.
The philosophical foundation of base pay system rests on the following assumptions :
o Time spent each day is the primary measure of short term contribution.
o In the long term, length of service with the organization is the primary
differentiating factor among people.
o Differences in individual contributions to the organization are recognized
through different base pay levels.
o Giving additional performance rewards to some people but not others is
divisive and hampers employees working together.
The philosophical foundation of incentive rewards system or variable pay system rests on the
following assumptions:
1. Some jobs contribute more to organizational success than others.
2. Some people perform better than others.
3. Employees who perform better should receive more compensation.
4. A portion of some employees’ total compensation should be given to reward
above satisfactory performance.
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Management of incentives can be defined as the process of development, implementation and
maintenance of a fair and adequate system of incentives. All the activities involved in
developing, implementing and maintaining a system of incentives that is appropriate from the
perception of employees and employer as well. The system should be able to give a sufficient
reward for employees’ efforts and it should also be able to increase overall organizational
performance in the way that increases owner’s wealth.
6.3.3.2 Importance of Employee Incentives Plans
The importance of Employee Incentive plan is defining by various experts in the field as
follow:
Snell and Bohlander ( 2008 )
“ Incentive rewards are based on entirely upon a pay for performance philosophy. Incentive
pay programme establish ‘threshold’ a baseline performance level that an employee or group
of employees must reach in order to qualify for incentive payments”.
Armstrong and Murlis ( 2008 )
“ Variable pay has to be re earned. It is “pay at risk” which is awarded for specific
achievements. The employee risks not being paid the bonus again unless the same, or a
higher level of performance is achieved by reaching or exceeding new targets”
Unlike normal pay increments and promotions, incentives do reinforcing performance
quickly and frequently. Each time of paying incentives is generally associated with quick
behaviors and gets incentives for them. Results are quick. Hence it is more likely that the
employee tends to continue putting efforts or engaging in specific behaviors.
6.3.3.3 Advantages of Incentives Programmes
Incentives focus employee efforts on specific performance targets. They provide real
motivation that produces important employee and organizational gains.
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Incentives payouts are variable costs linked to the achievement of results. Base
salaries are fixed costs largely unrelated to output.
Incentives compensation is directly related to operating performance. If performance
objectives ( quantity or quality) are met, incentives are paid. If objectives are not
achieved, incentives are withheld.
Incentives foster teamwork and unit cohesiveness when payments to individuals are
based on team results.
Incentives are a way to distribute success among those responsible for producing that
success.
Incentives are a means to reward or attract top performances when salary budgets are
low.
6.3.3.4 Types of Incentives
Organization may offer different types of incentives plans to motivate employees to perform
to their possible extent. These incentive plans can be grouped in to three broad categories :
a) Individual Incentive Plans
According to the Individual Incentive plan, focuses individual job performance and them
incentives are paid individually. Some plans include piecework, sales performance, bonuses,
merit pay, lump sum merit pay, incentive awards, attendance bonuses etc..They attempts to
admire employees individually. They will increase a competition among the employees being
concerned. Employees who produce higher outcomes will be able to get higher variable pay.
Employees who produce lower outcomes will have to get lower variable pay. Employees who
do not meet the performance threshold ( the minimum level of performance that makes the
employee qualify for incentive payments ) will not be able to receive any variable pay. It
may develop hostile atmosphere among the employees. Some may be jealous over others.
Team performance or team work is discouraged.
Piecework
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This is the oldest incentive plane. There are two types of Piecework:
Straight Piecework
The employee is paid a sum for each unit produced by him or her. Earnings
paid to the employee are in direct proportion to the work done by that
employee.
Differential Piecework
Employee is paid a piece rate for each of the units up to a standard output and
a higher piece rate for each of the units produced over he standard. The
amount of piece rate may e based o data collected through pay surveys.
Standard hour plan
Under this incentive plan, employee is paid an incentive if he or she completes a work
or job in less than the standard time. A standard time is fixed for completing job. If
the employee completes the job in less than the standard time, his or her pay is still
based on the standard time for the job multiplied by his or her hourly rate. This plan is
more appropriate for service organizations such as vehicle repairing or servicing.
When the job or work is non repetive , has a long job cycle and requires a variety of
skills, this plan is appropriate. However, while standard hour plans can motivate
employees to produce more, employers must ensure that equipment maintenance and
product quality do not suffer as employees strive to do their work faster to earn
additional income.
Bonuses
This is a one time payment, usually per year to the employee. It is not a part of the
base pay. It is an additional income to the employee. The employee has the advantage
of getting an additional payment for exerting greater effort to increase performance
while having the security of basic salary or wage. Bonus payments are common
among managerial and executive employees, but recent trends show that they are
increasingly given to employees throughout the organization.
Merit pay
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Merit pay is alternatively called merit raise. Which is a pay increase awarded to an
employee based on his or her individual job performance. Individual job performance
is measured through a performance evaluation system and depending on the level of
the performance merit pay is given to the relevant employee. Unlike bonus, merit pay
usually becomes part of the employee’s base pay.
Lump sum merit pay
Under this, a single lump sum merit pay is given to the employee at the time of job
performance review and this pay is not added to his or her base pay. Unlike merit pay
that is cumulative, lump sum merit pay is not cumulative. It is paid only for the period
concerned and it has to be re earned. Lump sum merit plan freezes base salaries or
wages resulting in controlling cost of base pay.
Nonmonetary incentives
Always we tend to think that incentives as often mean money. But there are
nonmonetary incentives in forms of incentive awards and recognition awards.
Incentive awards include gift certificate, time off, vacation, theatre and film tickets,
personalized clothing, merchandise awards, novelty items, travel awards, and other
non cash incentives. Recognition awards include plaques, employee of the month,
employee of the year, service excellence trophy and other meaningful recognition. It
is important to mention here that these awards should be given to appreciate and
recognize actual job performance which is excellent.
Sales incentives
Sales incentives are differ from other employees in the sense that they bring the
business profits directly by selling goods or services to customers who are consumers
and buyers who have the intention of re selling. Organization pay a special attention
to sales incentives. Due to increase competition, very high level of motivation is
expected form sales employees.
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b) Team Incentive Plans
It focuses on group job performance and then incentives are paid collectively. Some plans
include team rewards, scanlon plan, rucher plan, improshare etc… They attempts to induce
employees collectivity. They will not increase a competition among the employees being
concerned. However they will increase a competition among different teams. When an entire
group is paid with incentives (generally every group member gets an equal amount ) all
members of the group will have to work cooperatively. Hence, the result is most likely
cooperation amount the members. Each group has to meet the performance threshold and
groups, which do not meet the performance threshold , will not be able to receive any
variable pay. When there are employees who prefer working individually to working
collectively team incentive plans may not be successful.
Team Incentive Plan
Under this, gives an incentive bonus to all team members when certain production or
service standard are met. The incentive plan attempts to establish a psychological
climate that fosters team cooperation among all the members of the group.
Scanlon Plan
This is a gainsharing plan based on a philosophy that employees are capable making
suggestion, have willingness to give suggestions and share improvements which
derive from application of suggestions. It aims at reducing costs and then sharing in
the savings.
Rucker Plan
This is a gainsharing plan based on a philosophy that employees are motivated by
economic incentives. Also it has some reliance on employee participation. It is
alternatively called the share of production plan. The plan usually covers production
workers but may be expanded to cover all employees. It expects suggestions from
hourly employees, has a steering committee comprised of hourly employees, union
representative and key managers and has one manager acting as the idea coordinator
for processing all suggestions.
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Improshare
This refers to improved productivity through sharing. This is another group incentive
plan which bonuses are based on the overall productivity of the work team. The plan
is based on a philosophy that group economic incentives increase performance. It has
no suggestion making and therefore there is no attempt at meaningful employee
participation. It ties economic rewards to performance. The bonus is based on
productivity gains that result from reducing the time it takes to produce a finished
product.
c) Organizational Incentive Plans
This focuses on entire organization performance and then incentives are paid
organizationally. Some plans include profit sharing, stock option, employee stock ownership
plans etc.. They attempts to induce employees generally as a whole. They will reduce
competition among the employees and the groups and require that all employees work
together to generate better organizational outcomes which can lead to better financial
performance. These programmes share some of the financial gains to the firm through
payments to employees. As an additional percentage of base pay relating to each employee,
incentives are paid from the organizational financial gains. An equal amount may be paid to
each employee of the organization or different amount may be paid depending on rank or
level of the employee in the organizational hierarchy. Overall business performance is
encouraged.
Profit sharing
Profit sharing is an organizational incentive plan that shares profits with all the
employees of the organization. It distributes a portion of organizational profits to
employees. The employees will have the opportunity to increase their earnings by
contributing to the growth of their organization’s profits. Contributions to growing the
organizational are owing to increase quantity of production and selling, improving
quality of the products, decreasing total costs, introducing new methods to increase
efficiency, minimizing accidents and health problems, minimizing wastage and
enhancing goodwill of the organization. Due to profit sharing, employees think and
feel that they also partners of the organization.
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Stock options
Stock options are a way of achieving employee ownership. It is as an employee
ownership plan that gives employees the opportunity to but the company’s stock at a
previously fixed price. It makes employees to become owners who get dividends.
They will encourage employees to focus on the success of the organization. It is
hoped that they become motivated and loyal to the organization and then work to
improve overall performance of the organization. The use of stock options, as well as
salaried and executive personnel, and this appears true regardless of the industry
surveyed or the organization’s size. It is hoped that employees will work hard and
smart to cause the stock price to rise.
Employee stock ownership plan
Employee ownership plan gives employees certain tax and financial advantages when
stock is granted to employees. A corporation contributes shares of its own stock to a
trust is which additional contributions are made annually and the trust distributes the
stock to employees on retirement or separation from service. According to this, a
company makes tax deductible contribution of stock or cash to a trust fund to by stock
which in then allocated to the employees who acquire and increasing right to stock as
they gain seniority at the time of retirement or resignation, a employee receive their
stock.
6.3.3.5 Requirements of a successful Incentive Plan
Clear Purpose or Purposes
Wide Coverage
Fair and Consistent Means of Measuring Performance
Simplicity
Proper Linkage
No upper Limit
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Definiteness
Recognition of Individual Difference in terms of Performance
Guarantee of Minimum Payment
Separate Identification
Adequacy
Targets of Average Difficulty
Follow up
Use of the Incentive Plan as part of a Broader HRM system
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7. Practical application of compensation management
Compensation management practice at ABC Travels Pvt. Ltd
To gather information on compensation management of ABC Travels Pvt. Ltd, following
questions were asked from Mr.Chameera Botheju, The Human Resource Manager of ABC
Travels Pvt. Ltd.
Q 1: What is the Reward/ Compensation strategy of your organization?
A: We don’t a specific written strategy. But our goal is to attract, motivate and reward high
performers who produce high-quality, innovative and professional work. To achieve these
goals, we have developed compensation packages to each employee based on their
contribution, level and complexity of duties and responsibilities.
Critique: To achieve goals of an organization successfully, every HR practice should align
with business strategy. To be successful in compensation management they have to have
clearly defined goals and a well-defined link to business objectives. Then based on that, it is
required to develop HR strategy and then based on the HR strategy to develop and justify
Reward Strategy and define guideline principles.
Q 2: Who is responsible for setting the total compensation packages?
A: In general, The General Manager set the proposal and sends it to the Managing Director
through Human Resource Manager for MD’s approval.
Q 3: Do you consider market reward levels when you set these packages and/or do you
conduct Salary survey to identify other competitors’ salary levels? If yes, how do you
conduct salary survey? If not, why don’t you do that?
A: Yes we consider, but we do not conduct any market salary surveys. We gather required
information through employees informally. When we set the compensation packages, there
are already set compensation packages at each level but we consider the qualifications of the
candidate and his/ her expected salary level etc. (negotiable) and then set his/her package
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while making sure that it’s aligned with the compensation packages of existing staff such as
their salaries according to the level and complexity of duties and responsibilities etc.
Critique: To achieve external alignment the management must first know what the average
rates of its key job are prevailing in the community. There are formal and informal ways of
gathering required data which includes Surveys made by governments, trade and professional
associations, consultants, voluntary associations of employers, and individual employers. The
Internet is another good source of information on salary surveys but we must ensure that
source is reliable, and it is a must that we carefully analyze those information.
It is good that they are considering market reward levels. Though they do not conduct any
market salary survey or do not hire any consultancy company, they informally gather
information through employees. But, level of reliability of information gathered through
employees is questionable.
Q 4: Do you think your employees getting a fair salary compared with other companies?
A: When we set the compensation packages we make sure that they are receiving a
reasonable amount for the job and it is a fair amount when compared with compensations of
similar jobs in other organizations.
Critique: External equity exists when an employer pays a wage rate commensurate with the
wages prevailing in external labor markets. Assessing external equity requires measuring
these labor markets. There is, however, no single labor market for a particular job. Supply
and demand differ substantially among markets, resulting in significant variation in wages
across labor markets depending on factors like Geographic location, Industry sector, Union
status, Organization size, Product competition, Company prestige, Education and experience
level of available work force, Licensing or certification requirements called for by the job etc.
Some combinations of these factors determine the labor market for a particular job. They
claim that they make sure that their compensation packages are reasonable compared with
other similar jobs in other organizations, thus, good, they ensure that the external equity it
there.
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Q 5: Do you think that achieve external competitiveness through compensation?
A: Though we are a reputed, well established organization, we do not lead the market. We
follow the salaries of other competitive organizations like Walker’s Tours, Aitken Spence
Travels etc. When we set the packages, we always set them at the industry average level.
Critique: That means it is not their strategy to attract or retain good employees through
external competitiveness. It was obvious that the company is experiencing a high labor
turnover. The high performers are attracted by other competitive organizations for higher
compensation packages or they find jobs in abroad for higher compensation packages. Most
of the time, the employee leaves the company with his client base and it is a cost to recruit,
select and train a new employee to replace him.
Q 6: When you set a compensation package, do you consider relative internal value of the job
to make sure that your employee is getting a fair salary compared with others in the same
company?
A: As I said earlier, when we set the compensation packages, we consider the qualifications
of the candidate and his/ her expected salary level etc. it is negotiable but we always make
sure that it’s aligned with existing compensation package levels. It is also possible two people
working in the same job position may be getting two different salaries but within a range for
that job position.
Critique: Question was raised to see whether they are considering ‘internal equity’.
Internal equity exists when an employer pays wages commensurate with the relative internal
value of each job. This is established according to the employer's perception of the
importance of the work performed
At ABC Travels Pvt. Ltd., Compensation packages are designed ensuring that it’s aligned
with existing compensation package levels. I.e. they are aligned with the existing staff
compensation package levels and complexity of duties and responsibilities etc. i.e. relative
internal value of each job is considered i.e. a good practice, which is internal equity, exists.
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Q 7: Do you evaluate the relative importance of each job when designing a compensation
package based on a job evaluation i.e. factors like Education required, Experience required,
Physical demands, Responsibility for equipment/materials, Supervisory/managerial
responsibility, Working conditions etc,?
A: Yes of course, originally we have done job evaluations, and we have job descriptions and
specifications developed based on that. When we recruit and select a new employee, we
consider job specifications and job description and they are communicated to the new
member when he is appointed. All the basic compensation packages have been developed
based on its relative importance.
Critique: "Job evaluation is a process of determining the relative worth of the various jobs
within the organisation. so that differential wages may be paid to jobs of different worth. The
relative worth of a job means relative value produced. The variables which are assumed to be
related to value produced are such factors as responsibilities, skills, efforts and working
conditions".
Job evaluation helps in fitting new jobs at their appropriate plane in the existing
wage structure, improves labour- management relations by reducing grievances,
establishes on objective and clear basis for wage bargaining and simplifies wages
administration. Thus, it is good that they are using job descriptions to see the relative
importance of each job when designing compensation packages.
Q 8: Are employees’ reward connected with competence? If so how?
A: Yes, during the process of performance appraisal, each employee gives a self rating about
existence of each competency, identified and listed in the appraisal form for the purpose. In
the same form, the immediate supervisor (manager) also gives a rating to existence of each
competency of his subordinate. This information is also taken in to consideration for the final
recommendation of reward/ incentive.
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Q 9: How often do you conduct employee performance evaluations? and is Reward
connected with performance?
A: Performance evaluation is an on-going activity with the individual as the focus. The
immediate supervisor continuously evaluates employee job performance. Through regular
interaction between employee and his manager and the continuous feedback, try to give a
sense of how the manager perceives employee performance. However, to avoid haphazard or
incomplete evaluation, we conduct formal reviews and appraisals annually.
Performance reviews are normally conducted twice a year – an informal appraisal in
September and annual appraisal in March. A review may also be conducted in the event of a
promotion or change in role and responsibilities. The outcome of these reviews will be used
for the annual appraisal, which will be conducted in January every year. Compensation
review is also done annually along with the Performance Appraisal once a year.
We believe that it is the employee who is a key player during the review. Hence, it is the
employee who initiates the process by doing the self-assessment and indicating his
development plan for the next year . Based on the inputs received, the line manager
conducts the review .
Yes. We have direct link between performance appraisal and compensation. A final
recommendation of reward/ incentive will be given based on the findings of the Performance
Review .
Critique: In the context of an industrial organization, performance appraisal is a systematic
evaluation of personnel by supervisors or those familiar with their performance. In other
words, performance appraisal is a systematic and objective way of judging the relative worth
or ability of an employee in performing his/her task.
Many authors described and some of them were tried to define the concept of performance
appraisal in their own way. According to Gary Dessler, performance appraisal is an
evaluation of employee’s current or past performance relative to his/her performance
standards.
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McGregor discusses the formal performance appraisal plans in view of meeting three needs.
Out of which one is relating to organization and other two for individual. The first one,
organization level, is to provide systematic judgments to back up salary increases, transfers,
demotions, or terminations. When an employer compensates individuals who are in
similar jobs on the basis of variations in individual performance -so-called pay for
performance, Individual equity exists. Excellent performers, for example, would receive
more compensation than average performers. For reasons that will be explored in greater
detail later, the most important compensation decisions are those that differentiate between
the pay received by individuals within the company who are performing the same job. Since
ABC Travels Pvt. Ltd. Has directly linked compensation with performance appraisal, it
is proved that the compensation management practice of ABC Travels Pvt. Ltd ensures
individual equity as well.
Q 10: Are your staff well communicated the compensation policies about the percentage of
increment for the different levels of performance?
A: We always communicate that the benefits such as performance excellence rewards or
salary increments will be based on performance appraisal. By experience they know that it is
in regular practice. But we don’t have a clear policy to tell that this level performance deserve
this much increment etc. That decision is solely left up to the higher management.
Critique:
Transparency- the publication of information on reward structures and processes to
employees has to be there to achieve expected benefits of compensation management system.
Such a system should be well defined and uniform. It will be apply to all the levels of the
organization as a general system. And also the system should be simple and flexible so that
every employee would be able to compute his own compensation receivable. Here at ABC
Travels Pvt. Ltd, that practice or ‘Transparency’ is not there. The employee knows that
he performed well and an increment will be given, but he don’t have a clear idea about what
is the likely increase for this year? This affect on employee motivation factor as well as may
arise conflicts/ disagreements between management and employees etc.
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Conclusion
ABC Travels Pvt. Ltd has a good compensation management system. They are successful at
achieving equal pay. They ensure that all internal, external and individual equity is achieved
but the relative importance attached to external competitiveness is low which leads them to
lose high performing employees as they leave the company for higher packages, most of the
time with their client base!.
ABC Travels Pvt. Ltd clearly says the compensation is linked with performance; these are the
packages etc. but don’t have a specific written reward strategy. The transparency- the
publication of information on reward structures and processes to employees is also not there
since the final decision on compensation is taken by the higher management and since there
is no written, well defined, uniform, simple and flexible system so that every employee
would be able to compute his own compensation receivable.
Recommendations
It is recommended;
to have a well defined reward strategy developed based on the business strategy and
the HR strategy,
to communicate it to the employees to ensure transparency thus to minimize
misunderstandings and possible conflicts,
to attach higher relative importance to external competitiveness so as to attract and
retain high performers and to minimize possible unnecessary cost on recruitment,
selection and training etc of replacements,
to have more methods to gather information on market compensation package levels
(conduct salary survey, service of such a company or gather published data) other
than the only method currently following, gathering information through employees
informally.
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to continue the well designed performance based and competency based
compensation management systems (see all the annexure) which ensure individual
equity and line manager involvement.
References
Armstrong, M (2009), Armstrongs’s Handbook of human Resource Practice, 11th ed,
Kogan Page, London and Philadelphia
Brown, D and Armstrong, M (1999), Paying for contribution, Kogan Page, London
http://www.citeman.com/13742-wage-and-salary-surveys.html
http://www.eridlc.com/index.cfm?fuseaction=textbook.chpt08
http://www.hr.vt.edu/compensation/compmgt/comp_offers/index.html
http://payroll.naukrihub.com/compensation/
http://www.slideshare.net/sushisonai/homepeerlessdesktop-compensation-
management-1
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Postgraduate Diploma in Tourism Economics and Hospitality Management
Subject: Human Resource Management
Assignment 01
Compensation management practice at ABC Travels Pvt.
Ltd
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