‭Chapter 1 – A Road Map to Effective Compensation‬

‭Introduction:‬
‭●‬ ‭For Employers, compensation systems are used to – help orgs achieve its strategies and‬
‭objectives – help attract, retain and motivate employees – have philosophical and moral‬
‭implications.‬
‭●‬ ‭For Employees, the compensation system – influences standard of living.‬
‭●‬ ‭For shareholders, the financial value of the pay system to the organization’s bottom line is‬
‭important.‬
‭●‬ ‭The wider society tends to view compensation – from an equity perspective – questions justice‬
‭and fairness.‬
‭●‬ ‭There is no “one best” compensation system that fits all firms‬
‭●‬ ‭Understanding why the same compensation system that is successful in one firm fails at another‬
‭firm is an essential precondition to successful compensation design.‬

‭Your Compensation System: Asset or Liability?:‬

‭●‬ C ‭ anadian firms typically spend 40–70 percent of their operating budgets to compensate their‬
‭employees.‬
‭●‬ ‭For many firms, compensation is the single largest operating expenditure.‬
‭●‬ ‭According to Statistics Canada, employers in Canada are now spending nearly a trillion dollars on‬
‭wages, salaries, and benefits.‬
‭●‬ ‭A compensation system is one of the most powerful tools available to an employer for shaping‬
‭employee behaviour and influencing company performance, yet many fail to recognize that.‬
‭●‬ ‭Some compensation systems actually promote unproductive or counterproductive behaviour –‬
‭low employee motivation, poor job performance, high turnover, irresponsible behaviour, and even‬
‭employee dishonesty often have their roots in the compensation system.‬
‭●‬ ‭Problems as varied as organizational rigidity, inability to adapt to change, lack of innovation,‬
‭conflict between organizational units, and poor customer service may also stem, at least in part,‬
‭from the reward system.‬
‭●‬ ‭A compensation system that has worked well in the past can become a serious liability when‬
‭circumstances change.‬
‭●‬ ‭Failure to adapt reward systems to changing circumstances can cause new strategies to falter,‬
‭new organizational structures to collapse, new technologies to malfunction, and entire companies‬
‭to flounder.‬
‭●‬ ‭Many fail to identify the reward system as a major contributor to these problems.‬

‭Role And Purpose Of The Compensation System:‬

‭●‬ T ‭ he purpose of a compensation system is to help create a willingness among qualified persons to‬
‭join the organization and to perform the tasks the organization needs‬
‭●‬ ‭What this means is that employees must perceive that accepting a job with a given employer will‬
‭help them satisfy some of their own important needs.‬
‭●‬ ‭These include economic needs for the basic necessities of life but may also include needs for‬
‭security, social interaction, status, achievement, recognition, and growth and development.‬
 ‭●‬ C
‭ hallenges of the compensation system are more evident in organizations whose products,‬
‭services, and technologies are becoming increasingly complicated, whose environments are‬
‭more dynamic and competitive, who operate in democratic and relatively affluent societies, and‬
‭who require complicated behaviours and high performance levels from their members.‬

‭Extrinsic Vs Intrinsic Rewards:‬

‭Theory of Motivation by Abraham Maslow:‬

‭●‬ ‭Maslow proposed that humans have five levels of needs, with the most basic being physiological‬
‭needs (such as the need for food and shelter),followed by safety and security (e.g., protection‬
‭from physical and emotional harm), social needs (e.g., affection, belongingness), respect and‬
‭self-esteem (e.g., status and recognition), and self-actualization (e.g., growth and self-fulfillment).‬
‭●‬ ‭This hierarchy is usually captured diagrammatically with a pyramid, with the physiological needs‬
‭at the base and self-actualization at the top.‬
‭●‬ ‭The theory suggests that humans tend to first satisfy their basic needs (such as physiological and‬
‭safety) before the higher-order needs such as self-actualization.‬
‭●‬ ‭Each level in the hierarchy must be fairly well satisfied before the next level motivates human‬
‭behaviour; that is, once a lower-order need is satisfied, then the next level takes precedence and‬
‭dominates human behaviour.‬

‭●‬ R ‭ eward‬‭– Anything provided by the job or the organization that satisfies one or more of an‬
‭employee’s needs.‬
‭●‬ ‭Extrinsic rewards‬‭satisfy basic needs for survival and security, as well as social needs and‬
‭needs for recognition – They derive from factors surrounding the job —‬‭the job context‬‭—such as‬
‭pay, supervisory behaviour, coworkers, and general working conditions.‬
‭●‬ ‭Intrinsic rewards‬‭satisfy higher level needs for self-esteem, achievement, growth, and‬
‭development – They derive from factors inherent in the work itself—‬‭the job content‬‭—such as the‬
‭amount of challenge or interest the job provides, the degree of variety in the job, and the extent to‬
‭which it provides feedback and allows autonomy, as well as the meaning or significance of the‬
‭work.‬

‭Rewards vs Incentives:‬
‭●‬ ‭Even though rewards and incentives are often used interchangeably, but they are not‬
‭synonymous.‬
‭●‬ ‭Rewards‬‭are the positive consequences of performing‬‭behaviours desired by the organization,‬
‭and employees normally receive these rewards either‬‭subsequent to performing the behaviour‬‭(in‬
‭the case of extrinsic rewards) or‬‭during performance‬‭of the behaviour‬‭(in the case of intrinsic‬
‭rewards).‬
‭●‬ ‭An‬‭incentive‬‭is a promise that a specified reward‬‭will be provided if the employee performs a‬
‭specified behaviour.‬
‭●‬ ‭Incentives are offered to induce employees to perform behaviours that they might not otherwise‬
‭perform, or to perform these behaviours at a higher level than they otherwise would.‬
‭●‬ ‭Incentives are intended to induce valued behaviour, while rewards serve to recognize these‬
‭valued behaviour.‬
 ‭●‬ H
‭ owever, at a given organization, the two concepts can merge over time; as rewards when used‬
‭consistently to recognize a desired behaviour, often come to be seen as an implied promise for‬
‭performing that behaviour in the future—in other words, as an incentive.‬

‭Reward vs Compensation Strategy:‬

‭●‬ R ‭ eward system –‬‭The mix of intrinsic and extrinsic‬‭rewards that an organization provides to its‬
‭members.‬
‭●‬ ‭Compensation system –‬‭deal with the economic or monetary‬‭part of the reward system.‬
‭●‬ ‭Because behaviour is affected by the total spectrum of rewards provided by the organization and‬
‭not just by compensation,‬‭the compensation system‬‭can never be regarded in isolation from‬
‭the overall reward system‬‭.‬
‭●‬ ‭This practice of looking at the‬‭total spectrum of‬‭rewards‬‭—which include‬‭career advancement‬
‭opportunities, intrinsic characteristics of the job, work/life balance, employee recognition‬
‭programs, and a positive workplace culture‬‭, as well‬‭as‬‭compensation‬‭— is known as the total‬
‭rewards approach to compensation‬
‭●‬ ‭Total rewards –‬‭A compensation philosophy that considers‬‭the entire spectrum of rewards that‬
‭an organization may offer to employees.‬
‭●‬ ‭Reward strategy –‬‭The‬‭plan‬‭for the mix of rewards‬‭– both intrinsic and extrinsic – to be provided‬
‭to members, – along with the‬‭means‬‭through which they‬‭will be provided in order to elicit the‬
‭behaviours necessary for the org’s success.‬
‭●‬ ‭The reward strategy is the blueprint for creating the reward system.‬
‭●‬ ‭The compensation system has three main components‬‭:‬‭(1) base pay, (2) performance pay, and‬
‭(3) indirect pay‬
‭●‬ ‭Base pay –‬‭The foundation pay component for most employees,‬‭usually based on some unit of‬
‭time worked – an hour, a week, a month, or a year.‬
‭●‬ ‭Performance pay –‬‭Relates employee monetary rewards‬‭to some measure of individual, group,‬
‭or organizational performance.‬
‭●‬ ‭Indirect pay –‬‭Noncash items or services that satisfy‬‭a variety of specific employee needs,‬
‭sometimes known as “employee benefits.’’ – such as health protection (e.g., extended medical‬
‭and dental plans) or retirement security (e.g., pension plans).‬
‭●‬ ‭Compensation strategy –‬‭The plan for the mix and total‬‭amount of base pay, performance pay,‬
‭and indirect pay to be paid to various categories of employees.‬
‭●‬ ‭There are two key aspects of a compensation strategy.‬
‭➢‬ ‭One aspect is the mix of the three compensation components, and whether‬
‭and how this mix will vary for different employee groups.‬
‭➢‬ ‭The other is the total amount of compensation to be provided to individuals‬
‭and groups.‬
‭➢‬ ‭In short,“How should compensation be paid?”and“How much compensation‬
‭should be paid?” are the two key questions for compensation strategy.‬
‭●‬ ‭The optimal choices for these two aspects of compensation strategy ultimately depend on the‬
‭organizational context, but the most immediate determinant is the reward strategy.‬
‭●‬ ‭At one extreme, the reward strategy may include none of the three compensation components; at‬
‭the other extreme, compensation may be the only appreciable reward provided by an‬
‭organization.‬
‭Formulating a compensation strategy:‬

‭●‬ T ‭ he first step in formulating a compensation strategy is to determine the role that compensation‬
‭will play in the reward system.‬
‭●‬ ‭Assuming organizations wish to minimize compensation costs whenever possible, we must first‬
‭identify what other rewards are being provided by the organization and determine whether these‬
‭alone are sufficient to elicit the necessary behaviour from organization members.‬
‭●‬ ‭For eg., volunteer work receive hours of labour for no pay as the intrinsic rewards are sufficient.‬
‭●‬ ‭The key point is that the amount of pay needed to attract and retain the appropriate workforce‬
‭varies with the other rewards that the organization can offer.‬
‭●‬ ‭For eg., banks had to change their compensation structures in recent years, as they no longer‬
‭offer job security.‬
‭●‬ ‭Some organizations provide jobs that have high intrinsic rewards that may attract employees‬
‭more easily than those that do not‬
‭●‬ ‭Firms that enjoy a high level of prestige and public esteem often find it less necessary to offer as‬
‭much pay as firms that do not enjoy such prestige. Firms that offer opportunities for learning and‬
‭development may be able to offer less pay than those that do not.‬
‭●‬ ‭Firms that offer many non-compensation rewards may also choose to provide relatively high‬
‭levels of compensation to attract high calibre employees and elicit high commitment and‬
‭performance.‬
‭●‬ ‭Another approach might be to enrich the jobs by making them more interesting, thereby‬
‭increasing intrinsic rewards.‬
‭●‬ ‭However, other factors come into play in this decision-making process – For example job‬
‭enrichment may not only reduce turnover but may also increase work quality. This may tip the‬
‭scales toward job enrichment or a combination approach, rather than simply increased pay‬

‭Optimal Reward System:‬

‭●‬ O ‭ ptimal reward system –‬‭The reward system that adds‬‭the most value to the organization, after‬
‭considering all its costs.​‬
‭●‬ ‭This may not be the cheapest reward system; in some cases a high-wage compensation strategy‬
‭may be optimal.‬
‭●‬ ‭The eight main criteria to achieve an optimal reward and compensation system – i.e.,the goals of‬
‭the reward and compensation system:‬
‭➔‬ ‭First and foremost, a reward system must‬‭help the‬‭organization achieve its‬
‭goals.‬
‭➔‬ ‭Second, it must fit with the organization’s strategy for achieving its goals and‬
‭support its structure for implementing that strategy –‬‭fit with and support the‬
‭organization's strategy and structure.‬
‭➔‬ ‭Third, it must‬‭attract and retain individuals‬‭who‬‭possess the attributes necessary‬
‭to perform the required task behaviours.‬
‭➔‬ ‭Fourth, it should‬‭promote the entire spectrum of desired‬‭task behaviour‬‭for‬
‭every organization member.‬
 ➔
‭ ‬ ‭Fifth, it should be‬‭seen as equitable‬‭by all organization members.‬
‭➔‬ ‭Sixth, it must‬‭comply with all relevant laws‬‭within‬‭the jurisdictions in which the firm‬
‭operates.‬
‭➔‬ ‭Seventh, it must achieve all this at a cost that is‬‭within the financial means of the‬
‭organization‬‭.‬
‭➔‬ ‭Eighth, it should‬‭achieve these objectives in the most cost-effective manner‬
‭possible.‬
‭●‬ ‭Inequitable reward system undesirable consequences for an employer, such as increased‬
‭employee turnover and reduced work motivation.‬
‭●‬ ‭In Canada, the circumstances under which an organization can afford an inequitable reward‬
‭system are disappearing and for most organizations, an equitable reward system is a competitive‬
‭advantage, if not a business necessity.‬
‭‬
● ‭The field of compensation is attracting more and more interest in the business and popular media.‬
‭●‬ ‭Firms with comprehensive and attractive reward and compensation systems may even find‬
‭themselves included among “Canada’s 100 Top Employers” – a significant advantage when it‬
‭comes to employee recruitment.‬

‭Road map to effective compensation:‬

‭‬
● ‭ TEP 1: UNDERSTAND YOUR ORGANIZATION AND YOUR PEOPLE‬
S
‭●‬ ‭STEP 2: FORMULATE YOUR REWARD AND COMPENSATION STRATEGY‬
‭●‬ ‭STEP 3: DETERMINE YOUR COMPENSATION VALUES‬
‭●‬ ‭STEP 4: DESIGN YOUR PERFORMANCE PAY AND INDIRECT PAY PLANS‬
‭●‬ ‭STEP 5: IMPLEMENT, MANAGE, EVALUATE, AND ADAPT THE COMPENSATION SYSTEM‬

‭Managing Compensation in Organizations:‬

‭●‬ I‭n small orgs, the responsibility for compensation strategy usually resides with the owner or CEO‬
‭and the compensation administration is often contracted out to firms that specialize in payroll‬
‭management.‬
‭●‬ ‭In larger orgs, the compensation function normally resides with the HRD, with the head of that‬
‭department bearing ultimate responsibility for the successful operation of the compensation‬
‭system.‬
‭●‬ ‭Typically,‬‭compensation strategy is formulated by the head of HR, based on the‬
‭recommendations of the manager of compensation‬‭, but because it is such a crucial issue for‬
‭most organizations, the‬‭approval of top management (and often the board of directors)‬‭is‬
‭always required for major changes to compensation strategy.‬
‭●‬ ‭Within a large firm, there are many specialized roles for compensation specialists. For example,‬
‭job analysts‬‭develop job descriptions and conduct job evaluations,‬‭benefits specialists‬‭oversee‬
‭benefits plans,‬‭compensation analysts‬‭evaluate market data, and‬‭compensation managers‬
‭oversee the administration of the compensation system and recommend, design, and implement‬
‭compensation policies.‬
‭●‬ ‭Responsibility for specialized aspects of compensation (e.g., evaluating the market or managing‬
‭benefits plans) is often contracted to compensation consulting firms.‬
 ‭●‬ C ‭ ompensation consulting firms‬‭have grown in number as a result of the increasing complexity‬
‭of compensation systems and have become an important source of employment for‬
‭compensation professionals.‬
‭●‬ ‭In recognition of its importance in the Human Resources field, compensation has been‬
‭designated as one of the main categories of professional capabilities required for the Certified‬
‭Human Resources Professional (CHRP) designation in Canada.‬

‭Examples of Jobs That Require Compensation Knowledge:‬

‭‬ C
● ‭ ompensation Analyst‬
‭●‬ ‭Manager of Compensation‬
‭●‬ ‭Vice President of Human Resources‬