What is Compensation Management?


By: Site Engineer, Staff

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Compensation is one of the important tasks of the entrepreneur which he needs to determine the rates of monetary compensation for his workers.

It is important because a good compensation policy not only influences the performance and productivity of the worker but also determines whether the worker would stay long in the organization. A qualified worker with a small pay is likely going to leave an organization and join a competing one where he would be guaranteed better pay.

Employee compensation is therefore designed to:

  • This creates a healthy employer and employee relationship by eliminating grievances. This is because a well-paid employee would have no cause to complain about the company.
  • Retain the services of the employees.
  • Attract capable employees to the organization.
  • Motivate employees to perform.

Remuneration Methods

There are three main components of good remuneration policy.

These are:

1. Incentive Pay

The desire of every entrepreneur should be that each of his workers should usually perform above average. The best way to achieve this is to link his payment with results. If a worker knows that there is a reward for high performance, then he is likely to perform above average. Getting the workers to achieve above average through commensurate reward system is what the incentive pay scheme is aimed to achieve. The incentive pay is done by giving an appropriate commission and/or bonuses for extra work.

To be able to successfully create and implement an incentive pay scheme, the average amount of output necessary for adequate job performance must be determined. The amount of money that the average worker deserves as pay (that is, the base pay) is also to be determined beforehand. It is extra work done above this average that is compensated.

There are 2 types of incentive pay scheme-price rates and bonuses/commission.

  • Price Rate: Assuming the standard average performance of workers in an organization is 20 units per hour with a rate of $5 per hour, that is, a price rate of 25 cents per unit. If an individual produces 24 units in an hour, he should be paid $6 instead of $5 for the hour. If another employee produces 28 units, then he will receive $7.00. By this, high productivity is rewarded.
  • Bonus/Commission: After paying the employee his basic pay, a commission and/or bonus is also paid for extra efforts. The commission/bonus is meant for the results over and above a certain satisfactory level.

For instance, a salesman working in an organization let us assume that the average of usual sales of the salesman per month is $100,000. If the salesman sells $125,000 worth of goods for a particular month, then the bonus is paid for his extra efforts which brought in an additional $25,000 for the month. So the bonus which could be a certain percentage is paid on the extra $25,000.

The price rate and commission/bonus payment methods are individual incentive plans. But just as an organization would want each worker to work above average, so is it important for the workers of the organization to be encouraged to improve their productivity and general performance. It is therefore good for group efforts to also be recognized and rewarded. This is done through profit sharing.

Profit sharing is a situation whereby all the workers of the firm partake in the profit of the firm. A certain percentage of the profit is set aside by the firm which is distributed to the personnel. It is distributed in proportion to their pay.

The profit sharing scheme has a lot of advantages.

These include:

  • Reduction in labor turnover
  • Employee morale
  • Increase in productivity
  • Reduction in strikes or reduction in labor and management dispute

2. Fringe Benefits

Fringe benefits are effectively used in maintaining and retaining a workforce. It is not enough to motivate the workers’ higher level of performance. They must also be trained. This is what fringe benefits aim to achieve.

The fringe benefits usually administered by firms are:

The hope that one would be paid gratuity and pension after a certain number of years (for example 15 years of service) would encourage employees to remain in the organization. So the fringe benefits can be used to retain employees in the organization on a long-term basis.

3. Base Pay

The base pay involves the determination of the basic pay of an employee. To get good basic pay for an employee, it is good to evaluate his job very well so that one knows the contents and nature of the job. The qualifications and experience of the employee are to be taken into consideration.

Also, one has to make a study of the base pay of firms in the same industry (competitors). It is not encouraging to pay below the average amount of competitors for a similar position. Where that is the case, the entrepreneur would not be able to attract enough qualified personnel to the organization.


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