HRM

Chapter Five

Compensation Management
 CHAPTER OBJECTIVES
After studying this chapter, you should be able to
• Explain the concept of Compensation Management and its
objectives,

• Describe the compensation management process in relation to

an organization‘s strategy and policy

• Define job evaluation and elaborate its linkage with

performance appraisal, and compensation,

• Discuss the different types of incentives with their respective

merits and demerits,

• Discuss the different types of fringe benefits along with their

2
advantages and disadvantage
 Introduction
 For most employees, pay is a necessity of life.
 Compensation level determines one’s lifestyle, status. And
feelings toward one’s employer.

 Well-designed pay or compensation system enables the

organization:
 To attract qualified employees/personnel required

 To retain and motivate the existing workforce toward its

goal achievement

 To ensure equity: ‘Equal pay for equal work’

 To reward desired behaviour

3
 5.1. Concept of Compensation
Literal meaning of Compensation: Counter-balance
From HRM:
Compensation: money and other benefits received by an
employee for providing services to his/her employer.
 is the total of all reward provided to employees in return for
their services/performance
• All forms of
– financial return,
– tangible services,
– Benefits,
– Non-financial components
• that employees receive as part of their employment
relationship
4
 Concept of Compensation-Cont’d

The components of a total compensation program:

Financial Non-Financial

The job
Direct
content

Job
Indirect
environment

5
 Concept of Compensation-Cont’d
Financial
• Direct: monetary rewards for work done
– Base pay (wages-based on the No. of hours the employee has worked or the
No. of units the employee has produced- or salaries-fixed weekly, monthly, or
yearly cash compensation for work), commissions, bonuses.

• Indirect:-to everyone simply for being members of the organization, and actual
cash is not received-----Indirect Benefits/Fringe benefits
– insurance plans
• life, health, dental, disability
– social assistance benefits
• retirement plans ( pension &provident fund), social security,
– facilitation in performance of job like uniforms, Canteens, recreation, tuition
reimbursement provided for employees either entirely or in part at the
company’s expense
– Perquisite: attractive benefits, over and above a regular salary, granted to
executives
– paid absences
• vacations, holidays, sick leave 6
 Concept of Compensation-Cont’d

Non-Financial
• The Job
– interesting, Job security, challenging, delegation of
responsibility
– opportunity for recognition, advancement
– feeling of achievement
• Job Environment
– policies, supervision, co-workers, status symbols,
working conditions, flextime, compressed work
week, job sharing, telecommuting, flexible benefits
programs

7
 Concept of compensation-Cont’d

Compensation Management
• Process of determining cost-effective pay structure
Objectives of Compensation Management
 Attracting and Retaining Personnel
 Motivating Personnel
 Optimizing Cost of Compensation
 Consistency in Compensation
 5.2 Compensation Management Process
Step 1 - Establish General Wage Level for Organization
Factors to consider:
• Other firm’s rates
• Union demands
• Cost-of-living changes
• Firm’s ability to pay
 Alternative payment strategies could be: the high-pay strategy/pay
leaders, the low pay- level/pay-followers, and the comparable pay-level
Step 2 - Establish Wage Structure (The Pay for Each Job)
• Employ a job evaluation system
– Ranking
– Job Classification
– Point System
– Factor Comparison
• Results:
– pay grades
– rate ranges
 Compensation Management Process-Cont’d
Step 3 - Establish Pay for Each Individual on Each Job

Inputs:
• Performance appraisal information
• Seniority system
 Nonmonetary compensation: the many forms
of social and psychological rewards, such as
recognition and respect from others and
opportunities for self-development

 Monetary compensation: the direct payments

such as salary, wages, and bonuses, as well as
benefits such as covering the costs of insurance bonus
plans
11
Factors that Influence Wage Levels-Internal &external

Conditions of
Labor Market
DD for &supply of labor
Compensation
Policy of
Organization
Area Wage
Rates Worth of
Job:
compensable
Cost of WAGE factors

Living
MIX Employee’s
Relative Worth
Collective
Bargaining
Employer’s
Legal Ability to Pay
Requirements
12
 5.4 Job Evaluation
• The process of determining how much a job should be paid,
balancing two goals:
– Internal Equity: Paying different jobs differently, based on what the job
entails/compensable factors: mental, physical, skill requirements, responsibility &working conditions
– External Competitiveness: Paying satisfactory performers what the
market is paying
• “system for comparing different jobs systematically to assess
their relative worth, so providing a basis for a grading and
reward structure”.
• outcome: a hierarchy of organizational jobs according to
their content and value to the organization
• Methods:
– ranking
– classification
– factor comparison
13
– point method
 Job Evaluation-Cont’d
Objectives

• To maintain internal pay equity among jobs in the

organization
• To identify the organization’s job structure
• To maintain , accurate and impersonal description of
each distinct job.
• To provide standard procedure for determining the
relative worth of each job: this would create a consensus
among managers and employees regarding jobs and
pay within the firm.
• To set wages and salary.
• To determine wage for the job and not for the man.
14
Job Evaluation Advantages

 Provides a systematic and rational procedure for

valuing each job
 Ensures a degree of equity and objectiveness in
remuneration
 Job descriptions generated are useful for other
activities
 Helps motivation and morale
 Both employee and employer needs are
addressed
 Scope for union/employee involvement
15
 Problems in Job Evaluation

Technical Operational
• Subjectivity • Difficulty to actually link
• Time consuming: it jobs with wages and
should be undertaken at salaries
regular intervals. • It may face resistance
• Job evaluation is a costly from employees
and technical exercise • Job evaluation is,
generally, suited to large
organizations

16
 5.5 Process of job evaluation

1. Analyze and prepare job description.

2. Select and prepare a job evaluation plan,
3. Classify jobs into different categories,
4. Install the job evaluation program, and
5. Maintain the program.

17
Process Of JE-Cont’d
Objective of JE

JOB ANALYSIS

Job Description Job Specification

JE Program

18
 Methods of job evaluation

• JE Methods
– Whole Job Approach/Non-analytical approach:
(1) Ranking; (2) Classification
• Ranking - most basic; used for small firms
• Classification - mainly used for Government jobs.
– Quantitative Job Approach/Analytical approach:
 Factor-comparison
 Point Factor
• Point Factor - more complex - uses points assigned
to compensable factors, and sub-factors.

19
 Job Evaluation Methods-Cont’d
A. Ranking method:
•Jobs are arranged or ranked in their importance or in order of
complexity i.e. from lowest to highest/ from the simplest to most
challenging job in the organization/ or vice versa.
•Committee assesses the worth of each job on the basis of its
title or on its content.
•Job Description can be used for ranking different jobs.

• Compensation for each job will be based on the job hierarchy

• More suitable for small organizations
 The job ranking method arranges jobs in numerical order on
the basis of the importance of the job's duties and
responsibilities to the organization.
 This method, though easy to understand, is highly
subjective in nature.
 Job Evaluation Methods-Cont’d
B. Classification method/ Job grading method:
• It involves the establishment of job classes or grades as yardsticks
• For each grade or class, there is a different rate of pay
•Facts about the job are collected and matched with the grades
which have been established by the raters (Committee)

• Grades are arranged in the order of their importance

•Lowest grade may cover jobs requiring greater physical work

under close supervision, but carrying little responsibility.

 The job classification method slots jobs into pre-established

grades.
 Higher-rated grades demand more responsibilities, tougher
working conditions and varied job duties. 21
 Job Evaluation Methods-Cont’d
B. Classification method:
Example: Job classification in Civil Sector

No. Job classification

0. Professional works
1. Technical and sub-professional
2. Administrative and management works
3. Clerical
4. Service provision
5. Manual works

22
 Job Evaluation Methods-Cont’d
C. Factor comparison method:
 This method begins by finding out the major factors which
are present in more or less degree in all the jobs in a
particular organization.
 A basic underlying assumption is that there are five
universal job factors/ Compensable factors/: Mental
requirements, skills, physical requirements, responsibilities
and working conditions
 In this method, jobs are ranked according to the
compensable factors and then the job evaluator assigns a
monetary value to each factor.
 pay will be assigned in this method by comparing the
weights of the factors required for each job.

23
 Example

For Job ‘A’:

Factors Monetary value (Birr)

1. Physical requirements 320
2. Working conditions 200
3. Skills 80
4. Responsibilities 60
5. Mental requirements 40
Total 700 Birr

24
 Job Evaluation Methods-Cont’d
D. Point method: The point system of job evaluation uses a point
scheme based on the compensable job factors of skill, effort,
responsibility and working conditions.
 Points are assigned to the compensable factors; they are then
totaled, and compensation values are assigned to the jobs.
 The more compensable factors a job possesses, the more
points are assigned to it. Jobs with higher accumulated points
are considered more valuable to the organization.
 Select key jobs
 Identify the factors to all identified jobs such as skill, effort,
responsibility etc.
 Divide each major factor into a number of sub factors. Each sub
factor is defined and expressed in order of importance.
 Find the maximum number of points assigned to each job
 Once the worth of a job in terms of total points is known, the points
are converted into money values, keeping the wage rates in mind. 25
 Example
• Job title:________

Compensable factors
Education Experience Responsibility Physical efforts Working Total
(300 points) (200 pts) (100 pts) conditions
(300 pts) (100 pts)
(1000 pts)
8th grade:
20
High school
certificate:
90
Two year
college
Diploma: 160
First degree:
230
2nd degree:
300

26
 Components of compensation
• Wages: cash payment based on the number of hours the employee has
worked or the number of units the employee has produced.
• Salaries: fixed weekly, monthly, or yearly cash compensation for work.
• Incentives: cash payments to employees who produce at a desired level.
Incentive programs include:
 Bonus: cash payment, in addition to the regular wage or salary, that serves as
a reward for achievement.

 Commissions: payments to employees equal to a certain percentage of sales

made.

 Profit sharing: system for distributing a portion of company's profits to

employees.

– Employee benefits: compensation other than wages, salaries, and incentive

programs

 Retirement pay: Pension plan & provident pay

 Vacation and holiday pay, insurance pay 27

28