The term compensation is frequently thrown around among the working population, but most think it only pertains to salaries. Compensation management is a vast and dynamic field with its own design principles and terminology. So, what does compensation actually mean?
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In this article, we’ll simplify the definition of compensation and explain its types, components and regulatory issues.
This is the place to start if you’re looking to design fair wage plans or want to understand the pay programs you’re eligible for at work.
Table of Contents:
- What Is Compensation?
- Planning Objectives
- Types
- Specialized Types
- Components
- How Technology Aids Compensation Management
- Conclusion
What Is Compensation?
Compensation is the system of supplementing employees with monetary and non-monetary rewards in exchange for the services they render. That includes salaries, bonuses, profit sharing and sales commissions. Some companies offer non-financial perks like vacation days, health insurance, company-sponsored cars, retirement benefits and more.
A top priority for HR managers is designing a compensation plan with the maximum number of benefits to attract the best hires.
Besides recruitment, compensation has the following uses:
- Boost employee morale
- Reward excellent performances
- Negotiate with trade unions
- Prevent and reduce job turnovers
- Strengthen Recruitment
Compensation is a vital element of human resource management because 40% to 80% of a company’s revenue typically goes into compensating employees and providing them with various benefits. In a word, companies leverage compensation as a way of furthering their existence. So HR managers should take the utmost care while planning compensation plans.
Here are a few factors influencing compensation planning:
- Level of expertise
- Operational budget of the organization
- Availability of labor
- Cost of living
- Current market rates
Planning Objectives
Now that we’ve dealt with the meaning of compensation, let’s discuss the objectives that HR managers aspire to while designing wage plans.
Equity
Equity is the buzzword of the payroll wing of HR management. Exemplary compensation plans aim for internal and external equity. What does it mean to be equitable?
Viewed externally, equitable compensation refers to competitive wages. It means that the company is paying at a scale above the market average and at par with other firms’ payments for the same role.
Internal equity means cutting down pay inequalities in the workplace. This principle reinforces the equal pay for equal work model, regardless of gender, race or class considerations.
Regrettably, women earn $0.82 for every $1 earned by men in 2022. Additionally, only 38% of organizations define their compensation strategy as equitable.
Here are a few policies for HR managers to reinstate to ensure equitable pay:
- Bonafide Business Factors: Employers should consider such factors as education, relevant experience, location, certifications and performance while deciding on compensation packages.
- Nondiscrimination: Only bona fide business factors should influence compensation decisions; characteristics unrelated to the job are irrelevant. Employees should feel empowered to address discrepancies in payments.
- Federal Standards: Instead of exploring several state, local and federal regulations, employees should get a single standard for gauging pay equity.
- Pay History: In no case should pay history color the choices of employers. Current market rates, level of expertise, performance and other bona fide factors are the only markers of compensation decisions.
- Payment Transparency: Employees should be able to discuss payment structures for select positions, pay range and appraisals with prospective employees. Moreover, such disclosure should not invite retaliation from authorities.
Flexibility
Compensation, by definition, should be flexible to volatile markets and employee expectations. A flexible plan should be free of excess administrative costs.
Economic Stability
Companies aim for balanced and sustainable economic development by hiring human resources. Low inflation is ideal, but compensation plans should be designed to tackle inflation, labor shortages or high competition.
Gartner reports that voluntary employee turnover in the U.S. will likely jump to 37.4 million quitting in 2022.
Compensation policies should strike the right balance between achieving macroeconomic stability and properly remunerating employees to tackle this trend.
Balance
Recent studies have found that the motivator for Gen Z and millennials is not high compensation, meaning they’re eyeing non-wage benefits. The ideal compensation package won’t tip over to the benefits side but will include them in the right proportion.
Types
Base Pay
Base pay constitutes the foundation of the compensation structure; it is the wages or salary paid directly to an employee.
Effective base pay is internally equitable and externally competitive.
It determines the employees’ standard of living, so HR managers must be agile and flexible in revising this type of compensation to attract new employees and retain existing ones.
Base pay reflects the significance that the company attaches to the selected position. Finally, base pay should be legal and defensible.
Variable Pay
When it comes to variable pay, companies can opt for short-term incentives (up to one year) or long-term packages (two years or more). A small percentage of the base pay goes into making up short-term incentives.
They’re paid out to individuals or teams when a goal is accomplished.
These are the kinds of short-term bonuses:
- Profit sharing schemes
- Commissions
- Cash rewards
Long-term variable payments are designed by vesting a portion of the intended reward over many years. This type of variable compensation goes into retaining long-term employees.
Long-term incentives can take many forms, like restricted and performance-based stock options.
Differential Pay
Some companies might need employees to work beyond their duty hours, handle hazardous equipment or work at harsh locations. That’s when a differential pay comes in. It’s a premium over the employee’s base pay.
Specialized Types
Executive
This form of compensation is paid to the top 2-5% of the workforce at an organization. These perks may include a dedicated parking space, first-class air travel, a company car and more.
Global
Following an understanding of the cultures, payment practices and labor laws of different countries, HR managers can offer global compensation to employees worldwide. So this form of pay program applies to domestic employees and ex-pats.
Components
The ideal compensation infrastructure consists of essential elements that count as guiding principles for planners.
Philosophy
The HR and executive teams work out the compensation philosophy in tandem, and this framework answers the “why” behind the employees’ pay. It reflects the worth placed by the organization on the role and helps keep it consistent.
Many factors influence the philosophy, including the company’s financial stance, the size of the organization, the industry, corporate strategy, pay ranges in the market and the ease of finding qualified individuals.
Job Description
It is a vital component of every wage plan, and it should fully and clearly disclose the following:
- Responsibilities
- Required Qualifications
- Desirable Skills/Certifications
- Location
- Timings
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Job Analysis
A well-rounded description is possible only after a methodical analysis of jobs to discern their responsibilities and tasks, their relative importance in the market, the specific qualifications required for job performance and the working conditions.
Job analyses also assist HR in deciding on criteria for selection, promotion and setting training programs.
Some effective ways in which HR professionals conduct job analysis are:
- Deriving information from successful incumbent candidates
- Interviews
- Logging details of a position in a journal
Job Evaluation
The next step is deciding whether to prioritize internal or external equity. If the former is the first in line, then job evaluation is the answer.
This step determines the worth of a role within the organization by placing it in a hierarchy and then determining the compensation.
Naturally, job evaluations can be qualitative, quantitative or a mix of both.
Among numerous evaluation methodologies, a few are point method, factor comparison, ranking and slotting.
Payment Surveys
To ensure that the compensation is externally equitable, HR professionals conduct salary surveys of the market.
The objective is to collect valuable information about average salaries, inflation indicators, bonus eligibility and cost of living.
Compensation specialists use survey reports to decide job prices, forecast wage volatility, determine incentive matrices and prepare budgets.
Presently, post-pandemic adjustments are worthy of consideration in the job market.
A 2021 workplace survey indicated that 81% of US-based companies do not have a compensation strategy for remote work.
Pre-pandemic strategies included compensating according to the regulations in the organization’s headquarters (32%). Now, payment surveys have yielded newer compensation strategies, namely, geographical pay zones.
Laws and Regulations
Lastly, a sound compensation strategy complies with labor laws and other regulations. The Fair Labor Standards Act regulates the following:
Minimum wage
As of July 24, 2009, the federal minimum wage is $7.25 per hour. Many states have minimum wage laws as well. Some state laws provide greater employee protections than others; employers must follow both.
Overtime
Overtime pay is available to employees protected by the Act for hours worked beyond the 40-hour workweek. The FLSA extends this coverage to employees aged 16 and above. The Act does not specify a limit of extra hours worked.
Prohibition of Child Labor
The child labor regulations under FLSA are intended to protect youth educational opportunities and prevent them from taking jobs that could jeopardize their safety or health.
Provisions include restrictions on work hours for minors under the age of 16 and a list of occupations that are too risky for youths to undertake.
Compensation packages should comply with FLSA and other laws passed by the US Department of Labor, such as The Equal Pay Act of 1963, which prohibits employers from discriminating against employees doing similar work based on gender.
How Technology Aids Compensation Management
As we’ve said before, a sizeable chunk of the company revenue goes into employee compensation alone. Today, more and more companies are looking to automate payroll processes to prevent costly errors.
The many dynamic parts of employment onboarding, maintenance, promotion and resignation cannot be taken on manually. Intelligent compensation management software helps HR manage these crucial parts of compensation:
- Tracking resignations
- Ensuring fair payments
- Generating performance reports for promotions or incentives
- Establishing compliance with regulations
- Increasing transparency in payouts
- Boosting employee engagement and satisfaction
That being said, amateur deployment of these tools can cause strategic compensation mishaps like:
- Data breaches
- Identity theft
- Unwarranted expenses
Conclusion
We’ve just covered a fair rundown of the meaning of compensation, its types and the guiding principles to design an equitable strategy. This discipline of HR management is responding well to growing technological innovation.
Do you feel equipped with a working understanding of what compensation means and ways of designing equitable compensation plans?
If your answer is a resounding yes, you are prepared to organize your organization’s labor force efficiently.
How is compensation set up in your company? In what ways could software make the process easier? Let us know in the comments.
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