COMPENSATION MANAGEMENT

Prof S P Singh Bhalla

PGP/FW/2009-11/T3

COMPENSATION PLANNINGIntroduction:-

• Why Semi-skilled get more than unskilled and skilled get more than semi-skilled?

• Employees exchange work for rewards – obviously Money.

• GOALS: To design lowest cost compensation to attract, motivate and retain competent workforce; also to be fair for demands and requirements of the job. Fairness is a two way traffic.

• Compensation systems are designed around jobs; i.e. responsibilities and demands of job determine the compensation.

• Govt. influences, statutory interventions, parameters of Industry cum region patterns to play a role.

•

• AN OVERVIEW – WHY ‘COMPENSATION PLANNING ? ’:-

• RISING GLOBAL MARKETS REQUIRE ORGANIZATIONS TO COMPETE AND BE PROFITABLE AND EVEN FOR SURVIVAL. TO BE SUCCESSFUL, ORGANZATIONS MUST PROVIDE HIGH QUALITY GOODS AND SERVICES TO CONSUMERS IN A COST-EFFECTIVE MANNER - MAJOR COST WHEREOF GOES TO ‘LABOUR COSTS.’

• PRESSURE ON COST EFFECTIVENESS KEEPS THE ORGANIZATIONS CONSTANTLY SEARCHING WAYS TO KEEP LABOUR COSTS WITHIN ACCEPTABLE PARAMETERS VIZ. AFFORDABILITY, EMPLOYEES’ SATISFACTION IN PROPORTION TO THE INCOME THESE EMPLOYEES GIVE IN RETURN TO EMPLOYERS, MOTIVATING LABOUR, UPGRADING THEIR SKILLS, AND MEETING THEIR LIFE STYLES, AMBITIONS AND ASPIRATIONS.

• RESEARCHES CONSTANTLY PROVE ‘MONEY’ IS THE BIGGEST MOTIVATOR BRINGING ‘HONOURS, FRIENDS, CONQUESTS AND RICHES’, AS PER CELEBRATED POET, JOHN MILTON, ‘EXERTING POWERFUL INFLUENCE ON THEIR BEHAVIOUR.’ NOW REALISATION DAWNS UPON US, “WHY WE HAVE BEEN CRAMMING DURING SCHOOL DAYS, ‘MONEY MAKES THE MARE GO’.

• Many Organizations embark on significant change in business strategies to remain competitive.

•These changes bring about Organizational restructuring, downsizing and increases in use of state-of-the-art technology.

• Labour Economics encompass many a most important issues in Economics. People Earn income by selling their Labour time.

•DEFINITION:-

•Compensation is a systematic approach to providing monetary value to employees in exchange for work performed. Compensation may achieve several purposes such as assisting in recruitment, job performance and job satisfaction.

•In other words, Compensation may be defined as ‘MONEY’ received in performance of work + kinds of benefits and services that Organisations provide their employees. “MONEY” part is Direct Compensation – also called wages while benefits form Indirect compensation.

• MAJOR CLASSICAL THEORIES ON COMPENSATION:-

•SUBSISTENCE THEORY – by David Ricardo (1772-1823) – also known as “IRON LAW OF WAGES’ conceptualised as :- Labourers are paid to enable them to subsist and perpetuate the race without increase or diminution – on the assumption that if they are paid more than subsistence wages, their numbers would increase as they would procreate more and this would bring down the rates of wages as a result of ‘Supply and Demand’. If wages fall below subsistence level, no. of workers would decrease, many would die of hunger, malnutrition, disease, cold etc., and many would not marry – when that happened the wage rates would go up again affecting ‘Supply and Demand’. THIS THEOERY MEETS BARE PHYSICAL NEEDS OF WORKERS AND HIS FAMILY. WAGES TEND TO SETTLE AT THE LEVEL JUST SUFFICIENT TO MAINTAIN LTHE WORKER AND HIS FAMILY AT A MINIMUM LSUSBSTENCE LEVEL.

• WAGE FUND THEORY –BY Adam Smith ( 1723-1790); later on advanced by John Stuart Mill in 1830s – draws a basic assumption that wages are paid out of a pre-determined fund of wealth, presumably collected from operations of previous years, by wealthy persons – as a result of savings. This fund could be utilized for employing labour for work. If the fund was large, wages would be high; If small - would be at subsistence level. Demand for labour and wages were determined by the size of funds.

•SURPLUS VALUE THEORY OF WAGES: - Developed by KARL MARX (1818-1883) – This theory takes labour as an article of commerce – could be purchased on payment of ‘subsistence price’ – Price of any product was determined by Labour and time needed for producing it. Labour was not paid in proportion to the time spent on work but much less and the surplus went over to to be utilized for paying other expenses. Marks suggested that Labour is the only source of economic value and therefore, Labour should exercise prime claim on the revenue suggesting the price of an article consists of labour value and any other value collected by the entrepreneur represents unacceptable exploitation of labour.

• RESIDUAL CLAIMANT THEORY - - Francis A. Walker (1840-1897) propounded this theory. There were four factors of production – viz. land, labour, capital and entrepreneurship. Wages represent amount of value created in production which remains after payment has been made for all these factors of production. In other words, labour is the residual claimant.

• MARGINAL PRODUCTIVITY THEORY - - developed by Philips Henry wicksteed, Marshal and John Bates Clark . It assumes - wages depend upon demand and Supply of labour. Resultanty, workers get what they are economically worth. Employer thus has a larger share in profit. As long as each additional worker contributes more to the total value than the cost in wages, it pays the employer to continue hiring; where this becomes un-economic, employer may resort to superior technology. It assumes that wages depend upon the demand and Supply of Labour. If demand for certain skills is high and supply is less, wages will rise.

• BARGAINING THEORY OF WAGES – John Davidson propounded this theory vide which wages are determined by relative bargaining power of workers or trade unions and that of employers. When a trade Union is involved, basic wages, fringe benefits, job differentials and individual differences tend to be determined by relative strength of the Organization and the trade union.

• BEHAVIOURAL THEORIES – Notable industrial psychologists and sociologists like Marsh and Simon, Trobert Dubin, Elio Jacques have presented their views on basis of research studies and action programmes conducted by them. Briefly such theories are:-

a. EMPLOYEE’S ACCEPTANCE OF A WAGE LEVEL:- This takes into consideration factors which may induce an employee to stay on with a company. Size and prestige of Company, Power of Union, Wages and benefits that employee receives in proportion to contributions made by him – all have their impact.

• b. INTERNAL WAGE STRUCTURE: - : - Social norms, traditions, customs of the Organization and psychological pressures on Management, prestige attached to certain jobs in terms of social status, need to maintain internal consistency in wages at higher levels, ration of maximum and minimum wage differentials and norms of span of control and demand for specialised labour all affect internal wage structure of an Organization.

• c. WAGE/SALARIES AND MOTIVATORS: - Money often is looked upon as means of fulfilling basic needs of man. Food, clothing, shelter, transportation, Insurance, pension plans, education and other physical maintenance and security factors are made available through purchasing power provided by monetary income – wages and salaries. Merit increases, bonuses based on performance and other forms of money recognition for achievement are genuine motivators. However, basic pay, cost of living increases and other wage increases un-related to an individual’s own productivity typically, may fall into maintenance category.

• d. MINIMUM, FAIR AND LIVING WEAGE - are of recent trends – around 1948 – conceptualised by Govt of India in next slide:-

• MINIMUM WAGE has been defined as “

“the wage which must provide not only for the bare sustenance of life but for preservation of efficiency of the worker. Minimum wage must provide for some measure of education, medical requirements and amenities.”

Determining the minimum wage is difficult one for more than one reason such as:-

a. Conditions vary from place to place, industry to industry and from worker to worker.b. Standard of living can’t be determined accurately.c. What should be the minimum wage? d. What size of the family should be taken?e. Who should determine these and the related factors?

However, certain principles for determining minimum wages have been evolved and incorporated in ‘MINIMUM WAGES ACT, 1948’; important being that minimum wages should provide not only for the bare sustenance life but also for preservation of efficiency of the workers by way of education, medical care and other amenities.

It, however, needs to be mentioned that this Act is applicable only for the scheduled employments and NOT FOR EXECUTIVE/PROFESSIONALS.

• FAIR WAGE is:-

“ THE WAGE WHICH IS ABOVE THE MINIMUM WAGE BUT BELOW THE LIVING WGE”.

Lower limit of fair wage is obviously the minimum wage; upper limit is set by the Capacity of the Industry to pay. Between thse two limits, actual wages should depend on considerations of such factors such as:-

a. Productivity of labour;b. Prevailing rates of wages in same or neighbouring localities; i.e. region.c. Level of National Income and its distribution; and d. Place of industry in the economy of the country.

• MODERN THEORY OF WAGES:- Demand for Labour: - 1. It reflects labour Productivity and the market value of the product at different levels of production. 2. Increase in expected demand for a commodity increases the demand for labour.

• SUPPLY OF LABOUR:- 1. No. of workers employed at various wage rates. 2. No. of hours per day/ No. of days per week they are willing to work. 3. Different for Firm, Industry, Economy.

• STATUTORY MINIMUM WAGES:- under Minimum Wages Act, 1948 - rules and Notifications. Statutorily binding effect regardless of their capacity to pay. Pay and DA are revised periodically say 3-6 months. This statute covers only certain scheduled employments (Non-executive levels) and not applicable other categories of employments.

• BARE OR BASIC MINIMUM WAGES - also fixed by Industrial Tribunals, Courts and other judicial pronouncements notwithstanding that these are in the scheduled employments or not. But this is not as a rule but only exception.

• LIVING WAGE is defined as:-

“one which should enable the earner to provide for himself

and his family not only the bare essentials of food, clothing

and shelter but a measure of frugal comfort, including

education for his children, protection against ill-health,

requirements of essential social needs and a measure of

insurance against the more important misfortunes including old age.”

• NEED FOR A SEPARATE THEORY OF WAGES:-

• Human Resource is an important asset of the Organization.

• Ordinary Demand & Supply theory is not fully applicable.

• Labour and his labour are inseparable.

• Weak bargaining power of labourers.

• Exploitation of labour.

• Comparatively inelastic supply.

• ELEMENTS OF LABOUR ECONOMICS:-

•Introduction: - One of the most important ideas in Labour Economics is a set of Marketable skills of employees as a form of Capital in which employees make a variety of investment incentives. This perspective is important to understand both investment incentives and the structure of wages.

Human Capital corresponds to any stock of knowledge and characteristics of theEmployee that contributes to his/her productivity.

Labour Economics thus deals with Income, what determines it and why it differs for different individuals. It also deals allocation of most important in-puts of productionProcesses.

Labour Market thus with the buyers and sellers of labour Services and the Institutions facilitating the buying and selling. Labour services are the direct in-putof human muscle and brainpower into production including many tasks and Occupations – distinct from other puts such as raw material and capital services.

• QUANTITY AND PRICE IN THE LABOUR MARKET:- Quantity is the amount of of Labour input – measured in no. of workers. Amount of labour time is worker hour.Price is measured by the amount workers are paid per unit of labour time; the wageor earnings.

• Since workers care about more than just the pay, there are non-wage benefits and working conditions.

• Measures of Pay:-

• Wage Rate: per unit of time worked e.g. Rs. 50/- per hour. It could be per day or even weekly or monthly too.

• Time Wage:- Wages paid according to time are called Time Wages referring to daily wages, monthly wages. Where the work done is snot considered, the time taken for doing f the work is considered is called time wages. This type of Wage payment is soften used where quality of production is most important than it’s quantity.

• Total compensation: earnings + fringe benefits etc.

•Supply and Demand: - Demand side is business Employers. Supply side is represented by Individual workers/Labour.

• Scale or output effect:- As wage increases, cost increases; firm may typically choose to produce less. It therefore needs less labour.

•Substitution Effect:- As wage increases; business may try to substitute labour by technology/machinery. Again this reduces quantity of labour.

• PIECE WAGE: Payment of the wages is made on the basis of quantity Work. In type of wage payment, quality of work is not considered. In other words, this type of wage payment is good only where the quality of good is not affected by making them in haste. This mode of wage payment helps in increasing the size of production.

•TASK WAGES:- In this type of wage payment, wages for the services of labour is fixed at first. He is given the wages for the completion of work. He does the work from the start till the end. These are also called Contractual payments.

• Cash Wages: - Wages paid in cash i.e. in money are called the cash wages.

• Kind Wages:- Wages paid to workers for their services in the form of commodities is called kind wages.

• Service Wages: Some times workers are neither paid in cash nor in kind. They are paid through a service called the Service Wage.

• Other compulsions in the Labour Market in the real world:-

•a. Demand and Supply of Labour is adversely impacted by Unions acting Cartel or monopoly. They usually impose a wage above the competitive equilibrium through negotiations with the Managements.

• Wage rigidity: Wages can’t be reduced even when demand of labour falls.• MINIMUM WAGES ACT, 1928 – Statutory binding effect.

• CHARACTERISTICS OF HUMAN CAPITAL include skill, academia and other professional attributes/in-puts viz. quality of academics, training, attitudes towards work. This helps us to understand wage differentials in earnings across workers.

Human Capital thus increases firm’s prospects which will pay higher wages to educated workers as they would be more useful for employers by their better understanding business requirements and complexities; forming the ‘hub’ of the knowledge and hierarchy.

Human Capital possesses (A) Innate quality. Workers can have different amounts of skills due to innate differences.

(B) There is component of IQ.

•C. Heterogeneity in Human Capital.

•We have to search for these differences and correlate with other variables of interests.

•Academics/Professional attributes – most easily observable component.

•Skill/Training for a particular Industry or useful for a particular set of Technologies. Industry also hires with exposure to more specific and specialised training/exposures.

HUMAN CAPITRAL IS THUS A VITAL IN-PUT IN THE PRODUCTION PROCESS.

• KEY ISSUES IN ALL ORGANIZATIONS IS HOW TO GIVE RIGHT INCENTIVESTO EMPLOYEES.

•DETERMINING FACTORS INCLUDE: -

• Multi-tasking.• Relative Performance evaluations.• Career Progressions.• Team Productions.• Wage Differentials.• Upgradation of Skills. •Firm specific skills and attributes.

• ESTABLISHING PAY RATE, IMPORTANCE OF AN IDEAL COMPENSATION PLAN.

• We had a look at the supply and demand sides of Labour Market. Putting them together in a competitive market gives us theory of equilibrium wages subject to compulsions of Monopoly of Employers, Collectives, Govt regulations/Acts etc.

• Establishing Pay Rate:-

• An Organization has a specific mission. To accomplish this, it must attract and hire requisite skills with attitudes and aptitudes. It has, therefore, to reward to retain the skills and accordingly designs a system to focus staff’s attention to specific behaviours to accomplish its objectives.

The critical or base reasons for compensation differentials for different categories of skills relate to the following determinants:-

1. Kinds and levels of required knowledge and skills.2. Kind of Business. 3. Union or non-Union status.4. Capital intensive or Labour intensive. 5. Size of Business.6. Philosophy of Management. 7. Total compensation package. 8. Geographic location. 9. Supply and demand of skills.10. Profitability of the firm. 11. Employment stability.

• NEED FOR COMPENSATION MANAGEMENT:-

•A. THE MANAGERIAL ENVIRONMENT.

•B. THE ACQUISITION, ALLOCATION, DEVELOPMENT AND SANCTION OF HUMAN RESOURCES; AND

• CHANGE AND STHE FUTURE.

•Major concepts: - COMPENSATION, REWARDS, INCENTIVES AND BENEFITS.

• TYPES OF COMPENSATION:-

•1. direct compensation. 2. indirect compensation.

• Money (also known as basic salary or wage i.e. gross pay.

• Benefits (Insurance, Pensions, pay for vacation or illness, Welfare and Social Security and the like fringe benefits are called Indirect Comensation.

• BASIC OBJECTIVES FOR ESTABLISHMENT OF A SOUND COMPENSATION REWARD SYSTEM:-

• To establish and maintain an equitable compensation structure.

• Establishment and maintenance of an equitable labour-cost structure, an optimal balancing of conflicting personnel interests so that of employees and employees is maximized and conflicts minimized.

• Incentives: - PERFORMANCE; JOB ASSIGNMENTS; RETENTION & TRAINING.

COST, FAIRNESS AND LEGAL COMPLIANCE.

BENEFITS OF A SOUND COMPENSATION MANAGEMENT PLAN:-

For Employees:

1. Employees are paid according to requirements of their Jobs i.e. highly skilled Jobs are paid more compensation than low skilled jobs. This eliminates inequalities.

2. Chances of favouritism are greately minized.

3. Careet progressions are estabnlished.

4. Employees’ morale and motivation are increased.

5. Compensation Management meets scientific and logical explanations and Validity.

FOR EMPLOYERS:-

1. They can systematically plan for and control their labour costs.

2. They can explain the basis of compensation worked out based on systematic analysis of job and wage facts.

3. Wage and salary administration reduces friction, wage inequities and grievances, if any.

4. It enhances employee’s morale and motivation because adequate and fairly administrered wages are basic to his wants and needs.

5. It attrracts qualified employees by ensuring and adequate payment for jobs.

• Other objectives of Compensation Management::-

1. To induct qualified personnel for the Organization.

2. Retain the Skills and control the paryroll costs.

3. Reward desired behaviour.

4. To motivate staff to perform better.

5. Helps in compliance with legal requirements.

6. To further enhance administrative efficiency – making optimal use of HRIS.

• COMPONENTS OF COMPENSATION.

• BASIC WAGES/SALRIES:- These refer to component of wage structure based on which other elements of compensation be structured. It could be a fixed compensation or a running scale of pay followed by annual increments or subject to periodical pay hikes.

• DEARNESS ALLOWANCE: - This is intended to insulate against price increase or inflation of prices of goods and services. This has a major bearing on the living conditions of the labour. In the absence of DA, compensation gets dent and the very objectives are frustrated.

• COMMISSIONS: - are based on the sales revenue or profits of the Company. It is always a fixed %age on the target achieved. Commission is pegged to sales. Depending upon targets achieved, firms pay commission on monthly or periodical basis.

• Bonus:- can be paid on %age basis on basic pay – annually or in proportion to the profitability. Payment of Bonus Act regulates payment of Bonus. Besides, there is also a bonus plan compensating Managers and employees on sales reveneue or profit margin achieved.

• Mixed Plans:- Companies may also pay combination of pay as well as Commissions. This system is called combination or mixed plan. Apart from other compensation, employees may be eligible for fixed %age of commission upon achievement of fixed target of sales or profits or performance objectives.

• Profit sharing payments: - This a novel concept . This is paid through payment aiming to generate competitiveness and improved productivity.

• Fringe benefits:- includes Company cars, Paid vacations, Membership of Social, Professional and cultural clubs, Entertainment tickets/allowances, Leave Travel concessions, Family vacation packages, spouses accompanying officers on tour/ vacations.

• REIMBURSEMENTS on expenses incurred on Newspapers, Accommodations hired, conveyances used, children’s tuition fee, Travel expenses, entertainment , medical, refreshments and entertainments.

•

• INFLUENCING FACTORS OF REMUNERATION.

Remuneration External Internal

• Labour Market Business Strategy.

• Cost of living. Job Evaluation.

• Labour Unions. The employee.

• Govt. Legislations.

• Society.

• Economy.

DEVISING A REMUNERATION PLAN:-

JOB DESCRIPTION

JOB EVALUATION

JOB HIERARCHY

PAY SURVEY

PRICING JOBS

Remuneration

Financial Non financial

Basic Wages

Incentive,Individual plans

Group Plan

Fringe benefits, PF, Medical care

Accident relief Health and Group

Insurance.

PerquisitesCar, Club, Paid

Holidays, FurnishedHouse, Stock

Option scheme

Job Context Challenging Job

Responsibilities. GrowthProspects. Supervision

Working conditionsJob sharing.

Components of employee remuneration.

Job description& specification

Performance Standard

Job Evaluation

Wage Surveys & Analysis of relevant

Organizational problems

Wage Legislations.

Wage Structure

Rules of Administration

Differential Employee Appraisal

Wage Payments

Job Analysis

The Wage Determination Process.

• COMPENSATION PLAN AS A BUSINESS STRATATEGY: -

• Compensation is used as a Business Strategy to achieve Organizational objectives in particular:-

• It helps in tracking cost control of the Products and services. Un-checked and un-related compensation adversely affects Business objectives and profitability.

• Compensation planning helps in Proper Budgeting Company’s Business expenses and ultimately profitability.

• Compensation is central to supporting the company culture and Business strategy.

• Compensation is central to motivating the employees who have ultimately to pursue Business strategies for enhancing organizational objectives.

• Compensation is based on job evaluations. The latter is a monitoring system as a Business strategy including planning, organizational control, critical human skills and the evolving sizes and worth of the Jobs in view of fast changing profile of Business and ever evolving strategies.

• Compensation helps in bringing about clarity in the roles and responsibilities

which are directly related to Business strategies.

• Compensation processes help in evaluation of Performance appraisal which is a tool as a business strategy.

• Compensation is aligned to share holders’s rewards and company’s objectives.

• Financial performance of the Organization comes from talent and skills of

an Individual

• CHALLENGES AFFECTING COMPENSATION: -

• PRESSURE FROM COLLECTIVES FOR INCREASE IN COMPENSATION.

• PRESSURE FROM MANAGEMENT TO REDUCE COST.

• PRESSURE FROM RIVAL BUSSINESS HOUSES.

• PRESSURE TO RETAIN THE SKILLS.

• PRESSURE TO STAY IN COMPETITIVE ERA ESPECIALLY FROM THE HEAT GENERATED BY GLOBALISATION, PRIVATISATION AND LIBERALISTION.

• STATUTORY COMPULSIONS THROUGH:-

1. The Payment of Wages Act, 1936. 2. The Minimum Wages Act, 1948.3. The Maternity Benefit Act, 1961.4. The Payment of Gratuity Act, 1972.5. The Payment of Bonus Act, 1965.6. The Employees State Insurance Act, 1948.

• PRESSURE FROM LATEST TECHNOLOGICAL FACTORS.

• ONSLAUGHT LET LOOSE BY MOBILTY OF WORK FORCE.

• LACK OF STRONG MESSAGE TO EMPLOYEES ABOUT ORGANIZATION

VALUES, EXPECTATIONS FROM EMPLOYEES FOR ACHIEVING GOALS.

• LACK OF REGULAR AND PROPER TRACKING THE COMPENSATION PLANS..

• LACK OF TRANSPARENCY – AT TIMES IT IS CLOUDED WITH SECRECY.

Skill based pay.Salary reviews

Remuneration

Pay Secrecy.Comparable

worth

Employee participation

CHALLENGES OF REMUNERATION

Salary & WageCriteria.

Living Wage.

8.

Job Requirements.

5.

.Supply & Demand

6.

Cost of Living.

7.

Productivity.

3.

Ability to Pay.

1.

Going Rate.

2.

Collectives’ Bargaining

Power4.

CRETERIA OF WAGE FIXATION