Meaning of compensation

Compensation refers to all forms of financial returns, tangible services, and benefits employees receive as part of employment relationship. Compensation management is one of the main parts of every HRM. It includes all forms of employee’s pay or rewards arising from the employment. Total compensation includes both intrinsic and extrinsic rewards. Extrinsic rewards are pay, promotion,
commission, fringe benefits and working conditions. These rewards are paid the result of management policies and practices. Compensation is one of the important motivating factors for employees, willingness of employees to stay in the job determined by fair compensation practices.

A pay system consists of all the arrangements made in organizations for what and how people should be paid for the jobs they do. The system will also provide rewards for how well they, their team or the organization does, and for what they contribute because of the levels of capability (competence/ or skills they have achieved).

Objectives of Pay System
The objectives of a pay system are to help the organization and its managers to:
  • Compete in the job market-attract and retain high quality people.
  • Motivate people-encourage them to active superior levels of quality performance.
  • Achieve value for money-ensure that expenditure on pay is cost-effective in that it encourage value-added performance without under-expense.
Pay Policies
The pay policies of an organization will be concerned with
  • The achievement of equity: Paying people in accordance with their relative contribution. 
  • Consistency: Paying people consistently according to the level of their job and their performance.
  • Fairness: Ensuring that pay decisions are fair in the sense that they do not discriminate against people, based on objective and unbiased judgment are properly reflect the contribution of the person concerned.
  • Transparency: The pay system are disclosed to people so they know the basis upon which they are awarded.
  • Relationships to market rates: The extent to which the organization intends to match market rates or to pay above average.
  • Pay structure: Pay structure define the different levels of pay for jobs or groups of jobs by reference to internal relativities as established by some form of job evaluation, to external relativities (market rates) and, where appropriate to negotiated rates for jobs. There are a number of different types of structure, but the main ones are:
1. Spot Rates: A spot or individual job rates structure allocates a specific rate for jobs. There is no scope for that rate to progress through a defined pay range or scale. Individual can, however, earn more pay through incentive schemes or bonuses.

Spot rates schemes are typically used for manual worker where, in its simplest form, there are rates for skilled, semi-skilled and unskilled jobs. Payment-by-result schemes may provide for additional earnings over the base rate for the job.

2. Graded structures: A graded pay structure consists of a sequence of job grades into which jobs of broadly equivalent value are slotted. A pay range is attached to each grade that provides for pay to progress through the range in accordance with an individual’s performance, competence or skill. The merit of this system being that it is easy to explain to employee. It allows better control over the fixing of rates of pay and pay progression. It clearly indicates pay relativities. It thus, provides a framework for managing those relativities and for ensuring that jobs of equal value are paid equally.

3. Broad Banded Structures: Broad-banding, so called, has become more popular in recent years as organizations have delay are and operated more flexibly with increased emphasis on continuous development laterally rather than on promotion upwards through an extended hierarchy. The advantage of the system is that it enhances the ability of the organization to reward people for what they bring to the business beyond their job description. It also provides for greater flexibility for rewarding people as they grow in their roles and grow their roles.

4. Job Family Structure: A job family structure consists of separate pay structures for job families. A job family consists of job in a function such as research and development (R&D), marketing, finance, computing or personnel which are related through the basis activities carried out and sills used but will be differentiated by the amount or degree of responsibility, competence or skills which are used at different levels.

Each level in a job family may have its own pay range in a conventional graded structure. The advantages of this type are that they enable special treatment to be given to selected key occupations from the point of view of rates of pay and pay progression. Career progression can be planned on the basis of increases in competence or skill.

5. Pay Spines: Pay spines of a series of incremental pay points extending from the lowest to the highest-paid job in a structure. Pay ranges of so many increments are then superimposed on the pay scale. A typical increment is 3% and grade may be covered by 5 such increments. Thus, someone who starts at the bottom of a grade will gain a pay increment of 3% for each year of service until the top of the grade is reached after five years. This system may be called a service related fixed incremental pay structure. It is based on the assumption that the value of the people to the organization is related directly to their length of service.

Factors/ Determinants Affecting Levels of Pay Systems
Factors/determinants affecting levels of pay systems and decisions in pay have to take account of the following factors affecting pay levels:
  • Supply and demand: If people are in plentiful supply pay levels will be lower, if they are much in demand and therefore scare, pay levels will be higher. This means that the principle of internal equity may have to be sacrificed sometimes to the need to be externally competitive, i.e. to attract and retain people with a higher scarcity value.
  • The value of the job to the organization: Pay levels are related to the size of the ob the relative contribution to the achievement of the organization’s objectives that jobs make. The bigger the job, the more people are paid.
  • The values of the person to the organization individuals are paid in line with their contribution, performance, competence and skill.
  • Affordability: What the organization can afford to pay.
  • Collective bargaining: Negotiations with trade unions can lead to agreements on rates of pay and other item and conditions of employment.

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