EMPLOYEE COMPENSATION

Definition
All forms of pay or reward going to

employees and arising from their employment. It is all form of financial return and tangible benefit that employees receive as part of employment relationship

This has two main components:

Direct financial payments/compensation
Its used to describe the cash received (in the

form of wages, salaries, and incentives, commissions and bonus Indirect payments (In form of financial benefits like employerpaid insurance and vacation)

Direct compensation components

Direct compensation is further divided into

two components

Wages and salaries program (base salary, overtime, shift differentials etc Pay that is contingent on performance ( merit increases, bonus, gain sharing, commission)

Ways to make direct payment

In turn there are basically two ways to make

direct payment:

On increments on time( time based pay On performance Or a combination

Types of indirect payment

There are also two types of indirect payments

Legally required programmes e.g. social

security, workers compensation Discretionary programmes (e.g. medical cover, paid time off)

Challenge of the business in compensation managment

1. As the business environment becomes

increasingly complex and global, the challenge to create and maintain effective compensation, given cost constraints, also requires greater professional expertise, organizational understanding, creativity and vision than ever before.

Trends in Compensation

During the last three decades, three key trends in compensation have occurred
1.

2. 3.

Increase in the diversity of compensation strategies Significant rise in pay inequality Compensation programmes are increasingly being used to communicate major changes and realignment in organization

Increase in the diversity of compensation strategies

First there has been a dramatic increase in

the diversity of compensation strategies and practices Not too long ago, employees received basic salary,( which the organization probably described as competitive) and a set of pre established benefits ( which the organization probably described as comprehensive)

 Today firms are providing variable pay, hiring

bonuses, lump some recognition bonuses, group incentive plans, broad based success sharing programmes, and more broader and flexible selection of employee benefits

2. Significant rise in pay inequalities

The second noteworthy trend has been a

significant rise in pay inequity. Chief executives average compensation has more that tripled sometimes an average CEO earning in a single day what a typical work earns in a year

.
CEOs pay is increasing at a faster rate than

that of an average worker by far but the irony is that the contribution of the individual worker is increasing sometimes faster than the contribution of the CEO.

3. Use of compensation to communicate major changes

Compensation programmes are increasingly

being used to communicate major changes and realignment in organization particularly during and after a major downsizing and reengineering efforts

.
Many changes are often followed by a

complete redesign of the pay system. E.g.

Different methods of appraisal and job evaluation, Scrapping the grading system, Reducing the number of job levels,

Transferring day to day administration of compensation programmes from HR to line manager making compensation more of a management tool than an HR programme

.
Therefore this past decade has seen a

rethinking of the role compensation programmes play in supporting, communication and even leading the way to new organizational values and performance norms

Importance of Compensation does it matter?

To the organization Research suggests that reward system can influence the companys success in three ways:
1.
2.

3.

Motivates, energizes and directs behaviour To attract and retain qualified, high performing workers Cost of compensation can influence success

1. motivate, energize and direct behavior

The amount of pay and the way it is packaged and delivered to employees can motivate, energize and direct behavior. It can change the way employees think about work, can help them refocus their energies and direct their performance

2. To attract and retain qualified, high performing workers

Unless applicants find the job offers to be

appropriate in terms of the amount of compensation, they may not consider employment with a particular firm. Compensation strategies and practices can shape the composition of a workforce and the competences and capabilities they will bring to the organization and ultimately influence the firms performance levels and effectiveness

3. Cost of compensation

Finally the cost of compensation can influence a firms success On average, the overall cost of labour is estimated to be 70% of the firms total costs, but these will differ with the industry. Firms that wish to pursue a strategy based on cost leadership must find a way to reduce these costs without sacrificing quality.

 In summary, then, the strategy and structure

of compensation programmes have an important implication for businesses and their ability to create a competitive advantage

To the individual
Research has shown that:

Employees see money in form of what it can buy. Better houses, better education for children, better vacations, clothes, cars etc
Employees are motivated when reward is related to performance or contribution, and when it is perceived as fair and equitable.

To the individual (cont)

Employees tend to prefer pay based on their own performance and not team or group or company performance. In one study it shows that employees who prefer individualized reward were also the highest performing employees

To the individual (cont)

Research also shows that employees

satisfaction with pay is correlated with organizational commitment and trust in managements, while it is inversely related to absenteeism and lateness, seeking alternative employment opportunities, terminating employment with the organization, pro-union voting, and incidents of theft, and corruption

To the individual (cont..)

Particular components of pay have different

values to different people. For example research indicates that young people tend to focus predominantly on cash compensation. As people age, however, their preference tends to shift to benefits and workplace flexibility

To the individual (cont..)

Research also indicated that pay satisfaction is a

function of comparison of an individual input-outcome ration with his or her perception about the inputoutcome ratio referent to others. In this case input is education, previous work experience, special talent, effort etc. Outcome is what people get out of the jobs, promotion, pay, recognition. It is important to note that these judgments are based on perception and not on any objective or quantifiable measures of actual input or outcome

To the society
Societies that produce more enjoy higher

standards of living. This means that citizens enjoy higher qualities of life, higher levels of education, more luxuries, better health care, and more time off.

To the society (cont..)

In addition, governments tend to use such

standards as platform for social change. Legislations such as labour laws, minimum wages, social benefits, pensions and employee retirements are aimed at ensuring that people are treated justly and that the poor and less powerful members of the society are protected from injustices

To the society (cont..)

The are also laws about taxes on compensation to protect the low paid workers High cost of labour can be detrimental to a country because it will not be able to compete well in the global market.

Aim of reward management

Aim of reward management

To develop and implement reward policies

and practices required to support the achievement of the organizational business goals

The specific aims are to.

1. To create total reward processes that are

based on beliefs about what the organisation values and wants to achieve 2. To reward people for the value they create 3. Align reward practices with both business goals and employee values 4. Reward the right things to convey the right message about what is important in terms of expected behaviour and outcome.

The specific aims are to.

5.Facilitate the attraction and retention of the

skilled and competent people the organisation needs thus winning the war for talent 6. Help in the process of motivating people and gaining their commitment and engagement 7. Support the development of performance culture 8. Develop a positive employment relationship and psychological contract

The specific aims are to.

9. To support, communicate and reinforce an

organizational culture, values and competitive strategy 10. To comply with government regulation

Note: the cost structure of compensation will reflect the companies ability to pay

FACTORS AFFECTING LEVELS OF PAY

Factors affecting pay levels

Pay structures are designed in reference to judgment

about the value of a job as expressed by relativities with other jobs and external market pay for comparable jobs. These judgments are made against the background of factors which influence job values. Bearing these in mind, steps can be taken to establish internal job values by using some form of job evaluation. External job values are also established by surveying and analyzing market rates The information gained from both is used in developing a pay structure

Factors influencing job values

General factors influencing job value, are

intrinsic values, internal values relativities, external relativities, and market practices, inflation, the circumstances of the organisation, and government, and trade union pressures

Intrinsic value
This is based on the belief that the rate for a

job should be determined by reference to the amount of responsibility involved or the degree of skill or level competence required to perform effectively The responsibilities of a job are the particular obligation that have to be assumed by any person who carries out that job Level of responsibility is related to the outputs job holders are expected to achieve and their contribution

Intrinsic value (cont)

Rates of pay are therefore influenced by: The scope of the job in term of impact on results The size of resources controlled The amount of authority job holder possesses The degree of freedom they have to make decisions and to act The extent to which they receive guidance or instruction on what they should do

Intrinsic value (cont)

The intrinsic value of a job may also be

related to the input and process factors of knowledge and skill competences. Knowledge and skill refers to what job holders need to know and are able to do to meet the requirements of their job Competences are the behavioral characteristics which demonstrably/obviously differentiate between levels of performance in a given role.

Internal relativities/equity
This is the perception of the value of the worth of

one job compared to other jobs or its position in a job or carrier family structure Internal equity means that the individual employee perceives that their position is treated fairly within a pay programme in relation to other jobs within the organisation. Internal comparisons are based on inputs made by job holder as reflected by the requirements to use different levels of knowledge or skills, or more importantly comparison may be attached to outputs the added value they create

Internal relativities/equity (cont..)

Pay rates must also be equitable internally:

each employee should view his or her pay as equitable given other rates in the organization. When employees become aware of iniquities in the pay system, disappointment and often conflict can results. Some firms therefore maintain strict secrecy over pay matters.

External relativities/equity
Having pay practices that are similar to the

practice of other organizations that are competing for the same talents. With this then your compensation programme is said to be competitive, or externally equitable Externally, pay must compare favorably with rates in other organizations especially in the same industry or size, or the employer might find it hard to attract and retain good employees.

Inflation and market movement

Inflationary pressures affect general trend in

rates of pay and earning Organisation have been accustomed to taking into account inflation when adjusting their pay structure although organisation have refused to commit themselves in form of policy guidelines to this type of increase

Business performance and or financial circumstances

The results of business performance and

financial circumstance will influence the amount it can afford to pay and its pay and its pay policies on such matters as to how it wants to relate pay to performance, contribution and market rates

Government regulations and policies legal considerations

Various laws specify things like minimum wages, maximum working hours, overtime rates, and benefits, safety and health provisions, compensation for injuries, social securities etc. These can be found in Labour Laws of Kenya, Workmen Compensation Act, NSSF Laws, etc,

Corporate strategy and policies

The compensation plan should further the

firms strategic aims. Management should ask how can I construct a total portfolio of reward program that all link to: Both short and longer term business success Drive shareholders value Encourage the behavior that we need And deliver true value to our employees

Corporate strategy and policies (cont..)

The basic task of an employer is to create a bundle of

reward total reward package specifically aimed at eliciting those employee behaviors the firm needs to support and achieve its competitive strategy. The process recommended for this is using the following questions to develop an aligned reward strategy Developing an aligned reward strategy What are the organization key success factors? What does the firm need to do to be successful in fulfilling ties mission or achieving its desired competitive position?

Corporate strategy and policies (cont..)

What are the behaviors or actions necessary to

successfully implement this competitive strategy What programmes should we use to reinforce those behaviors? What should be the purpose of each programme in reinforcing each desired behavior What requirements should each program meet to be successfully in fulfilling its purpose? What value should it deliver to employees, and how do we know it is valued? How well do the current reward programmes match these requirements?

Corporate strategy and policies (cont..)

Company policy Exactly how the firm will use its pay plan to further its strategic aims will be manifest itself in the firms pay policies The HR will write the policies in conjunction with top management, in a manner that consistent wit the firm strategic aims. Policy considerations include:

Will the firm be a leader or a follower regarding pay? Is the emphasis on seniority or on performance? Is there an emphasis on longevity? Is there emphasis on education and skill?

Corporate strategy and policies (cont..)

How do we reward longer term employees or

highly valued employees Geography also plays in policy? Cost of living in different cities or countries Expatriate employees how should they be compensated?

Trade unions
Union and labour relations laws also

influence pay plans and designs. The laws give unions legal protection and grant employees the right to organize, to bargain collectively and engage in concerted activities for the purpose of collective bargaining or other mutual aid or protection. Negotiations include for wages, for time off with pay, cost of living adjustments, health benefits etc

Compensation management processes and activities

Compensation management processes and activities

The process and activities of compensation

are 1. The business/HR strategy: This is the starting point; all reward policies, practices and process flow from here to achieve the overarching business goals of improving performance

2. reward strategy This determines the direction in which reward management innovations and developments should go to support the business strategy, how they should be integrated, the priority that should be given to initiatives and the pace at which they should be implemented

3. Grade and pay structure policy This deals with the policy on the shape of the grade structure and the elements of pay within that structure. i.e..

Base pay the fixed rate of pay that represents the rate for the job into which pay related to performance, competence, contribution or service may be consolidated. Policies on base pay express the intentions of the organisations on the degree to which it wants pay levels to be competitive and therefore the relationship between those pay levels and market rates (its market stance)

 Contingent pay: pay for individuals that is

related to performance, competence contribution or service. Distinguishes individual conditions Variable pay: pay in form of bonuses or cash payment that will be contingent on individual, team or company performance

3. Market analysis The process of identifying rates of pay in the labour market to inform decisions on level of pay within the organization which will be influenced by its market stand 4. job evaluation The systematic process of establishing the relative size of jobs and roles within the organization

5. Grade structure The sequence of hierarchy of grades, bands or levels which many be divided into jobs or career families and into which, on the basis of job evaluation, groups of jobs or roles that are broadly comparable in size and value are placed

6. Pay structure The range of base pay that are attached to grades or levels in job or career families and the scope for pay progression related to performance, competence, contribution or service. Base pay level will be influenced by equity and market rate considerations

7. employee benefits The provision for employees of pensions, sick pay, various kind of perks such as company cars and entitlement to holidays and other leave 8.Non financial rewards Rewards that do not involve any direct payment and often arise from the work itself, for example achievement, autonomy, recognition, scope to use and develop skills, training, career development opportunities etc

9. performance management Processes involving managers, individuals and teams based on shared understanding, which defines performance and contributions expectations, assess performance against those expectations, provide regular constructive feedback and inform agreed plans for performance improvement, learning, and personal development. Performance management will also inform contingent pay decisions

10. Total remuneration

includes financial rewards and benefits The sum of base pay, contingent pay ( for performance and

competence or contribution), variable pay( cash bonuses) share ownership (incentives) and benefits
11. Total reward The sum of total remuneration and non-financial rewards

those arising from the work itself and the work environment Includes base pay, pay contingent on performance, competence or contribution, employment benefits and non financial rewards which includes intrinsic rewards from the employment and work itself

Total reward (cont)

It is all of the employers available tools that

may be used to attract, retain, motivate and satisfy employees Therefore it includes not only the traditional quantifiable elements like salary, variable pay and benefits, but also more intangible noncash elements such as scope to achieve and exercise responsibility, career opportunities, learning and development, intrinsic motivation provided by the work itself and the quality of working life provided by the organisation

12. Building capability: Building the capability of both the compensation function and line management to understand, work with and communicate the element of reward policy and practice and changes as they occur

Setting Up Your Compensation Structure

Standard Salary Structure

Incentives Benefits

A standard base pay program straight pay ( time based pay)

offers fixed salary ranges for each position type for

employees performing the standard duties of their jobs. Set up minimum and maximum levels within those pay ranges to account for variations in experience and skill levels. When setting the base pay structure, determine where your company falls within your own industry as well as competing industries that may also offer job opportunities for your employees. Set up your pay levels to be competitive, or else you risk losing employees..

TYPES OF REWARDS/INCENTIVES
Incentive plans can be classified in several

ways. They can be classified by

Individual incentive plans Group based incentive plans Organizational wide based incentive plans

Individual based incentive plans

Individual incentive plans provide income over and

above base salary to individual employees who meet specific individual performance standards. This is used when it is possible to measure output on an individual basis. E.g. Incentive pay is based on units produced. There are two types of individual incentive systems: Piece- rate system Standard hourly rate

Group/team based incentive plans

Group incentive programmes pay all

members when a group or team collectively meets its performance standards It is useful when the organization wants to encourage team work but members are competent for a set number or amount of reward. The focus of the pay structure in general is on objectives and results of the team. E.g. in professional athletics or sports.

For managers and executives

Employee Stock Ownership Plan (ESOP): An ESOP

is a defined contribution employee benefit plan that allows employees to become owners of stock in the company they work for. It is equity based deferred compensation plan. Stock allocations are made to the employees account based on their relative pay. Employee Stock Ownership Plans (ESOP) tend to work better when combined with extensive employee involvement and problem solving. ESOPs give the organisation greater flexibility in response to a competitive environment

Organizational wide incentive plans

Profit sharing plans are generally organizational-wide and provided all or most employees with a share of the companys profit in a specified period.

Profit

Sharing: An incentive based compensation program to award employees a percentage of the company's profits.

 Gain sharing: A technique that compensates workers

based on improvements in the company's productivity. Stock Options: The right to purchase stock at a given price at some time in the future: the employee thus hopes to profit by exercising his or her option to buy the shares in the future but at todays price. The assumption is that the price of the stock will go up unfortunately this depends partly on considerations outside the control of the employee e.g. general economic conditions.

EMPLOYEE BENEFITS AND SERVICES types

1. Supplemental pay benefits (pay for time not

worked)

Holidays and vacations Compassionate leave Sick leave Sabbatical leave Maternity leave Retirement leave Compensation for laid off or terminated employees

 2. Insurance benefits

Workers compensation Hospitalization, health and disability insurance Health maintenance Organisations (HMOs) Preferred provides organisations (PPOs) Life insurance

 3. Retirement benefits

Social security Pension plans

Contributory versus non contributory Qualifies versus unqualified plans Defined contribution versus defined benefits plans.

 4. Employee services SACCO, Negotiated loans and loan grantees, Counseling Social and recreational opportunities, Bulk purchases Educational loans and subsidies such as tuition refunds Employee assistance programmes such as counseling and or treatment of problems such as substance abuse and stress Employee transportation Food services let employees purchase meals at relatively low prices

5. Flexible benefit plans - - cafeteria approach

There is a trend towards building flexibility into

benefits programmes by letting employees choose the benefits options they prefer. According to one study, employees age, marital status and sex influence his or her choice of benefits. For example, younger employees significantly favoured a shorter working week. Married workers showed more preference for the pension increase When given opportunity to choose employees do prefer flexibility in their benefit plans. Because of this employers are adopting an individualized benefit plan called the Cafeteria approach