Compensation Management

Compensation Management is an integral part of the management of he organization. Compensation is a systematic approach to providing monetary value to employees in exchange for work performed. It may achieve several purposes assisting in recruitment, job performance, and job satisfaction. It is the remuneration received by an employee in return for his/her contribution to the organization. It is an organized practice that involves balancing the work-employee relation by providing monetary and non-monetary benefits to employees. It is a tool used by management for a variety of purposes to further the existence and growth of the company. It may be attuned according to economic scenario, the business needs, goals, and available resources. Compensation Management contributes to the overall success of the organization in several ways. To be effective, the managers must appreciate the value of competitive pay, their human resources, and have an investment view of payroll costs. We want to maintain pay levels that attract and retain quality employees while recognizing the need to manage payroll costs.

The increasing competitiveness of the labour market and turnover of employees had resulted in nightmare in compensation planning. Apart from this, the growing demands of the employees and competitive salaries offered by multinational companies had almost resulted in a compensation war in certain industries. Therefore, the human resources managers and tax experts have to evolve proper compensation planning for High end and qualified employees. The components of compensation have to be devised in such a way that, it focuses on the growing demands of employees while retaining the competitiveness and profitability of the company.

Compensation management, also known as wage and salary administration, remuneration management, or reward management, is concerned with designing and implementing total compensation package. The traditional concept of wage and salary administration emphasised on only determination of wage and salary structures in organisational settings. Pay is a difficult topic of conversation in most organizations. In fact, the topic is altogether taboo in many workplaces. It simply isn’t discussed unless absolutely necessary. And, when it is necessary, such as when a pay raise (or lack of one) must be explained to an employee, many managers find themselves at a loss for words. As the dreaded date of such a discussion approaches, managers may begin checking their sick time banks to see if they can disappear for a day or two.

While it may be a touchy subject, pay is a critical factor in the work lives of employees. Jobs are accepted or rejected based in part on starting salary and the opportunity for future increases in pay. Employees compare their pay to that of others in the same line of work. They constantly compare their pay level to their level of contribution, trying to determine whether the ratio of give and receive is a fair one. While it may not be a frequent topic of open discussion, employees think about pay often.

Components of compensation:-

Basic wages/Salaries:-

These refer to the cash component of the wage structure based on which other elements of compensation may be structured. It is normally a fixed amount which is subject to changes based on annual increments or subject to periodical pay hikes. Wages represent hourly rates of pay, and salary refers to the monthly rate of pay, irrespective of the number of hours put in by the employee. Wages and salaries are subject to the annual increments. They differ from employee to employee, and depend upon the nature of job, seniority, and merit.

Dearness allowance:-

The payment of dearness allowance facilitates employees and workers to face the price increase or inflation of prices of goods and services consumed by him. The onslaught of price increase has a major bearing on the living conditions of the labour. The increasing prices reduce the compensation to nothing and the money’s worth is coming down based on the level of inflation. The payment of dearness allowance, which may be a fixed percentage on the basic wage, enables the employees to face the increasing prices.


Incentives are paid in addition to wages and salaries and are also called ‘payments by results’. Incentives depend upon productivity, sales, profit, or cost reduction efforts. There are: (a) Individual incentive schemes, and (b) Group incentive programmes. Individual incentives are applicable to specific employee performance. Where a given task demands group efforts for completion, incentives are paid to the group as a whole. The amount is later divided among group members on an equitable basis.


The bonus can be paid in different ways. It can be fixed percentage on the basic wage paid annually or in proportion to the profitability. The Government also prescribes a minimum statutory bonus for all employees and workers. There is also a bonus plan which compensates the Managers and employees based on the sales revenue or Profit margin achieved. Bonus plans can also be based on piece wages but depends upon the productivity of labour.

Non-monetary benefits:-

These benefits give psychological satisfaction to employees even when financial benefit is not available. Such benefits are: (a) Recognition of merit through certificate, etc. (b) Offering challenging job responsibilities, (c) Promoting growth prospects, (d) Comfortable working conditions, (e) Competent supervision, and (f) Job sharing and flexi-time.


Commission to Managers and employees may be based on the sales revenue or profits of the company. It is always a fixed percentage on the target achieved. For taxation purposes, commission is again a taxable component of compensation.The payment of commission as a component of commission is practised heavily on target based sales. Depending upon the targets achieved, companies may pay a commission on a monthly or periodical basis.

Mixed plans:-

Companies may also pay employees and others a combination of pay as well as commissions. This plan is called combination or mixed plan. Apart from the salaries paid, the employees may be eligible for a fixed percentage of commission upon achievement of fixed target of sales or profits or Performance objectives. Nowadays, most of the corporate sector is following this practice. This is also termed as variable component of compensation.

Piece rate wages:-

Piece rate wages are prevalent in the manufacturing wages. The laborers are paid wages for each of the Quantity produced by them. The gross earnings of the labour would be equivalent to number of goods produced by them. Piece rate wages improves productivity and is an absolute measurement of productivity to wage structure. The fairness of compensation is totally based on the productivity and not by other qualitative factors.

Fringe benefits:-

Fringe benefits may be defined as wide range of benefits and services that employees receive as an integral part of their total compensation package. They are based on critical job factors and performance. Fringe benefits constitute indirect compensation as they are usually extended as a condition of employment and not directly related to performance of concerned employee. Fringe benefits are supplements to regular wages received by the workers at a cost of employers. They include benefits such as paid vacation, pension, health and insurance plans, etc. Such benefits are computable in terms of money and the amount of benefit is generally not predetermined. The purpose of fringe benefits is to retain efficient and capable people in the organisation over a long period. They foster loyalty and acts as a security base for the employees.

Profit Sharing: –

Profit-sharing is regarded as a steppingstone to industrial democracy. Profit-sharing is an agreement by which employees receive a share, fixed in advance of the profits. Profit-sharing usually involves the determination of an organisation’s profit at the end of the fiscal year and the distribution of a percentage of the profits to the workers qualified to share in the earnings. The percentage to be shared by the workers is often predetermined at the beginning of the work period and IS often communicated to the workers so that they have some knowledge of their potential gains. To enable the workers to participate in profit-sharing, they are required to work for certain number of years and develop some seniority. The theory behind profit-sharing is that management feels its workers will fulfill their responsibilities more diligently if they realise that their efforts may result in higher profits, which will be returned to the workers through profit-sharing.

Approaches of compensation management

There are 3P approach of developing a compensation policy centered on the fundamentals of paying for Position, Person and Performance. Drawing from external market information and internal policies, this program helps establish guidelines for an equitable grading structure, determine capability requirements and creation of short and long-term incentive plans.

The 3P approach to compensation management supports a company’s strategy, mission and objectives. It is highly proactive and fully integrated into a company’s management practices and business strategy. The 3P system ensures that human resources management plays a central role in management decision making and the achievement of business goals.

Paying for position
Paying for person
Paying for performance

Because it is so important to employees, the issue of pay deserves to be clearly addressed. In spite of their hesitance, managers are capable of dealing with this sometimes difficult issue in a professional and effective manner. By keeping the following basic points about pay in mind, they can address virtually any pay-related topic with their employees in a professional and productive manner.

Specificity is Key

Pay is a topic with many different shades and a variety of implications. Whenever approaching the subject, it is important to work out the details beforehand so that specifics can be clearly communicated. For the manager, this means that the increase amount is nailed down before discussing a promotion with an employee. No chance of misunderstanding or false expectations can be permitted. Far too often, managers are apt to discuss generalities. “It will mean a good increase.” What exactly does that mean in terms of the employee’s monthly budget? If care is not taken here, good news can become the source of conflict and resentment.

By the same token, if asked for a raise, the manager should request that the employee suggest a specific number that he believes reflects his value. Once the employee provides that number, the manager can do his homework and decide what, if anything can be done. The employee can then be given a definitive response.

Pay is Relative

What one employee considers a fantastic increase maybe an insult to another? Each individual has a unique set of creativity and competencies. Pay should be based on the performance, position and the competencies/skills the person is having.

Pay is Not Created Equal

Various forms of pay have different purposes. The two most common forms of direct cash compensation in most companies are base pay and bonus. Base pay is the annual salary or hourly wage paid to an employee given the job he holds, While bonus is typically (or at least should be) rewarded based on the achievement of a goal of the organization. Discussions about bonus payments should be as specific as possible. This is the opportunity to point out particular accomplishments that contributed to overall team or company success. Even if the bonus is paid to all employees based on a simple overall company profit target, the manager should use the opportunity to point out specifically how individual employees helped achieve that target.

Distributing bonus checks presents a unique motivational opportunity for a manager. Handing money to an employee while discussing actions and behaviors he would like to see repeated, creates a powerful link between performance and reward. Discussions about base pay increases can be a bit different. Most companies claim to link their annual base pay increases to performance. In reality, however, base pay decisions take into account a variety of factors, including the relative pay of others in the same job, the company’s increase budget, market practices and where the individual falls within his pay range.

Even when performance is a factor, the manager is faced with the difficult task of evaluating an entire year’s worth of activity and then categorizing it according to the percentage increase options allowed by the budget. It becomes very difficult to pinpoint specific employee actions or accomplishments as the reason for the increase.

For these reasons, it’s appropriate for the discussion about base pay increases to be more general and balanced. Both strengths and weaknesses of the employee should be addressed. The actual increase is then based on an overall assessment, as opposed to a link with one or two specific outcomes. Any other factors that impact the increase percent, such as budget or pay range should be openly discussed as well.

Development of a Compensation Philosophy

All organizations pay according to some underlying philosophy about jobs and the people who do them. This philosophy may not be in writing, but it certainly exists. Pay maybe treated in a formal and structured manner at one company. At another, any appearance of structure is intentionally avoided so that decisions can be made arbitrarily. Either way, the approach taken reflects a fundamental belief about people, motivation and management. Before an organization actually develops a compensation plan, there are several questions that need to be answered. Taking the time to consider and answer these questions will make the both the process of developing and administering a compensation plan much easier and will result in the development of a compensation plan that more closely matches the organization’s goals and objectives. Managers often want to view each individual as a separate case. It is important to understand, however, that employees operate within a compensation system. A manager is wise to take the time to learn as much as possible about his company’s compensation system.

What is the goal of the organization’s compensation system? In addition to attracting and retaining qualified employees, is there an intent to reward employees for good performance, motivate good performance, and/or create or reinforce a particular type of organizational climate?

What is the communication policy? How is the organization going to communicate the compensation plan to employees once it has been developed? Is the organization prepared to evaluate the effectiveness of any such communication? If so, how? How will decisions regarding pay be made? Who will be involved in these decisions? What decision guidelines will need to be developed?

What is the organization’s desired market position relative to pay? Will the organization choose to pay market rates, above market or below market? How does the desired market position fit with other strategic goals? Are there any competitive factors involved that will determine the pay strategy?

What is the desired mix between benefits and cash? Since benefits are an important form of compensation, how does an organization use them to maximize the effectiveness of the compensation plan?

What does the organization pay for? Does it pay for performance or seniority or some combination of the two?

What is the role of performance appraisal in the organization? How important is performance appraisal and why?

How will the organization manage change to the compensation plan once it has been developed? What systems need to be in place to implement any changes including deciding when change is necessary and who will make these decisions?

How does the compensation philosophy and plan fit with the rest of the organization? How can the compensation practices reinforce other overall management philosophies and objectives?

While the answer to “how much?” is of course important to employees, they are also concerned about the “why?” of pay. In other words, while the actual amount of pay is very important, employees also are interested in the rationale used to determine it. Research has shown that pay satisfaction increases with understanding of the pay scheme.

Managers often leave this area to the HR department. Ideally, however, managers themselves will be the primary conduit of information on this topic. If a manager does not know the company’s pay philosophy, he should seek out whomever in the organization is responsible for pay administration and get the answers he needs.

Job seekers who go into the negotiation process with their eyes wide open keep an important fact in mind: A few thousand dollars one way or the other can quickly become a gain or a loss depending on other benefits. Money is important, but it must be put in the context of other pros and cons–some of which have a dollar value and some of which do not.

Managers should be the company’s biggest ambassadors when it comes to the value of benefits and work environment factors. Sharp companies do a good job of showing the value of these items. Smart managers will communicate their value, as well, especially when discussing pay. For example, when offering a promotion to an employee, a manager should consider all the potential benefits. What developmental opportunities are involved? Is there an increase in status? Will the move mean additional interaction with key players? All of these, as well as any increase in tangible pay and benefits should be discussed.

Speaking of Pay with Confidence

Discussions regarding pay do not have to be awkward–they can be clear and productive if managers adhere to the basics outlined above. Rather than a taboo, pay can be addressed in an up-front manner if managers do their homework, get prepared and go into the discussion with the confidence that comes from knowledge. Pay discussions should deal with specifics. In preparing for the discussion, the manager must remember that pay is relative and nothing can be assumed about the employee’s response. The purpose of the particular aspect of pay being addressed is important, and the manager must be able to discuss the issue in the context of the organization’s pay philosophy.


Compensation is a hot potato for the Human Resource Department.The motivation level of the employees to great extent lies in monetary rewards.In the current state of affairs it is indispensable to restructure the pay models. Similar to changes bought about in the other departments the HR should also emphasize on restructuring the costs so as to bring the variable cost close to zilch.

Smaller projects with fast paybacks would be more attractive than a big project with a long payback. The challenge for service providers and consultants would be to deliver the same amount of value to people with a smaller problem set. A satisfied employee is a productive employee and care should be taken that they are fairly paid for their worth in the organization. If managers follow these guidelines, their pay-related communication with employees will result in clarity and respect. In addition, they will avoid the misunderstanding and resentment that results from avoiding this critical issue. If paid well can generate results for the organization, failed can create problems. The major challenges what manager’s face today is retention of the man power and the major cause of it is that they are paid better in the other organizations.

About the author

Farhaan Panagar wrote 16 articles on this Website.

Senior Analyst with Deloitte. Writing posts on the side. Always trying to learn new things.

17 Responses to “Compensation Management”

  1. Andrew says:

    Hi, good post. I have been wondering about this issue,so thanks for posting. I’ll definitely be coming back to your site.

    • Guru says:

      Dear friends,

      nice to see the article. May i request you to give a detailed example for fixing compensation for a new organization, how the grades are decided and how the basic pay is fixed ?. i.e.. if 1000 is the basic pay for Officer, how rs.1000 is fixed ? why cant it be 1200 or 900, or 1050.?
      Please somebody explain with detailed example.
      Also can somebody teach me how compensation is equated with Bonus , and how salary hike is calculated on yearly basis ?.

      I hope and trust that friends will email me :

  2. GarykPatton says:

    Hi. I like the way you write. Will you post some more articles?

  3. Neil Chhetri says:

    Hi, Great piece of information. Please post some more articles or case studies on compensation planning/management which is practical and applicable.

  4. idda says:

    10q for the information. will u post me an articles about why is it necessary for an organisation to have an attractive package of compensation management?

  5. maryium fatima says:

    aslam o alaikum
    its really a good site, kindly send me more articles related to HR practices

  6. richa daniel says:

    hello! thanx for the great effort you took this information helped me a lot will you also post some sample questionnaire on the compensation management project it will give me great help

  7. tuyeimo says:

    it is a very,very interesting articles ,especially to HR graduate students,because it crearly define the concept of compensation management and what it entails as well as the compesation interverntion it self and its importance to the organisation.

  8. questionnaire says:

    plz help me for qhestionnaire of compensation management in IT sector

  9. Saipavan aravelli says:

    Thats a detaild explanation..Im so Lucky to read this.. Keep posting on other HR related topics like Stress management, Employee motivation, competency mapping and etc., as a Mhrm student i need to know these al in deep…
    Thanking you,


    nice article…i wish i could write well like u…

  11. isiodu jeff says:

    what a nice article,looking for u.

  12. bhavna says:

    really a worthy post. can u please what are the exact plans on individual and group incentive, productivity gain sharing and profit sharing plan, measuring ctc

  13. zafarkhan says:

    what are the new trends in Compensation Management (for MBA course)

  14. Gwendolyn Morris says:

    Do you think compensation has any bearing on a company’s performance?

  15. shivute says:

    It is a very nice article.

  16. kim says:

    this is an excellent post but is it possible to get the reference points from where these conclusions where drawn. Thankx

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