UNIT-1

The Concept of Compensation:

Compensation may be defined as the total amount of monetary and non monetary pay provided
to an employee by an employer in return for the work done as required. It is paid in the form of
wages, salaries and employee benefits such as paid vacations, insurance maternity leave, free
travel facility, retirement benefits etc. In other words, compensation is what employee receives in
exchange for their contribution to the organization.
Compensation is based on:
1) Market research about the worth of similar jobs in the workplace.
2) Employee contributions and accomplishments
3) The availability of employees with like skills in the market place.
4) The desire of the employer to attract and retain a particular employee for the value they
are perceived to add to the employment relationship.
5) The ability of an employer to pay market rate compensation.

Components of compensation:

1) Monetary /Financial

2) Non-monetary/non-financial

1) MONETARY: It can be classified into direct and indirect compensation.

i) Direct compensation: It is the money directly paid to the employees in exchange for their
labour/work. It comprises of the following components:-

a)Basic Salary/Wage. The main part of pay package is basic pay. 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. They differ from employee to employee, and depend
upon the nature of job, seniority, and merit. Basic pay is generally determined through job
evaluation which is the process of systematically ascertaining the relative worth of a job.

b) Allowances. Several allowances are paid in addition to basic pay. Some of these allowances
are given below:

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 them. Generally,
dearness allowance (DA) is paid as a percentage of basic pay.

House Rent Allowance: Employers who do not provide living accommodation and pay house
rent allowance (HRA) to employees. This allowance is calculated as a percentage of basic pay
City Compensatory Allowance: This allowance is paid generally to employees in metros and
other big cities where cost of living is comparatively high. City compensatory allowance (CCA)
is generally a fixed amount per month.

Transport Allowance/Conveyance Allowance: Some employers pay transport allowance (TA)

to their employees. A fixed sum is paid every month to cover a part of traveling charges.

c) Incentives :
Incentives are paid in addition to wages and salaries and are also called payments by results or
performance-linked remuneration . Incentives depend upon productivity, sales, profit, or cost
reduction efforts. It is paid with the aim to encourage employees to work more and perform
better.
There are:
(a) Individual incentive schemes
(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.

d) Bonus: 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.

ii) Indirect compensation: It is benefits given to an employee that has financial value but is not
direct monetary benefit .These are:

a)Leave Policy
It is the right of employee to get adequate number of leave while working with the organization.
The organizations provide for paid leaves such as, casual leaves, medical leaves (sick leave), and
maternity leaves etc
b)Insurance
Organizations also provide for accidental insurance and life insurance for employees. This gives
them the emotional security and they feel themselves valued in the organization.

c)Retirement Benefits
Organizations provide for pension plans and other benefits for their employees which benefits
them after they retire from the organization at the prescribed age. A retirement plan or a pension
is an arrangement by an employer to provide their employees with an income when they are no
longer earning a regular income from working. . Often retirement plans require both the
employer and employee to contribute money into a fund while employed so that they will receive
benefits upon retirement.

d) Holiday Homes
Organizations provide for holiday homes and guest house for their employees at different
locations. These holiday homes are usually located in hill station and other most wanted holiday
spots. The organizations make sure that the employees do not face any kind of difficulties during
their stay in the guest house.

2) NON-MONETARY /FINANCIAL COMPENSATION:

It does not have any monetary value. These benefits give psychological satisfaction to employees
even when financial benefit is not available. Such benefits are:
a)Satisfaction from job: It includes-
Recognition of merit through certificate, etc.
Offering challenging job responsibilities,
Promoting growth prospects,
Job sharing and flexi-time: Organizations provide for flexible timings to the employees who
cannot come to work during normal shifts due to their personal problems and valid reasons.

b)Satisfaction from Work environment: It includes-

Comfortable working conditions: healthy working conditions such as proper ventilation, proper
lighting and proper sanitation improve the work performance of employees.
Good policies and practices
Competent supervision
Congenial(friendly) Co-worker
Fair and equal treatment

COMPENSATION MANAGEMENT:
It is a process of compensating individuals for the work they perform in such a way that
organization is able to attract,retain,and motivate them to perform well ,keeping in view
organizational and market factors.
Thus, Compensation Management is concerned with designing and implementing total
compensation package. The goal of Compensation Management is to design a lowest cost pay
structures that will attract, retain and motivate the competent employees.

OBJECTIVES OF COMPENSATION MANAGEMENT

1) To Establish a Fair and Equitable Remuneration

Effective compensation management objectives are to maintain internal and external equity in
remuneration paid to employees. Internal equity means organization must pay or compensate
their employees according to their qualification, skills, knowledge, experience, job responsibility
and performance. External equity means organization must pay their employees a compensation
which is at least comparable to their competitors level.
2) To Attract Competent Personnel
A sound wage and salary administration helps to attract qualified and hard-working people by
ensuring an adequate payment for all jobs.
3) To Retain the Present Employees
By paying competitive levels, the company can retain its personnel. It can minimize the
incidence of quitting and increase employee loyalty.

4) To Improve Productivity
Sound wage and salary administration helps to improve the motivation and morale of employees
which in turn lead to higher productivity. Especially private sectors companies offer production
linked compensation packages to their employees which leads to higher productivity.
5) To Improve Union Management Relations
Compensation management based on jobs and prevailing pay levels are more acceptable to trade
unions. Therefore, sound wage and salary administration simplifies collective bargaining and
negotiations over pay. It reduces grievances arising out of wage inequities.
6) To Improve Public Image of the Company
Wage and salary programme also seeks to project the image of the progressive employer and to
company with legal requirements relating to wages and salaries.
7) To Improve Job Satisfaction
Employees would be happy with their jobs and would love to work for the company if they get
fair rewards in exchange of their services.

FACTORS CONSIDERED IN DECIDING THE COMPENSATION or FACTORS AFFECTING

COMPENSATION

1) INTERNAL FACTORS

I) Ability to Pay: Employers ability to pay is an important factor affecting wages not only for
the individual firm, but also for the entire industry. This depends upon the financial position and
profitability of the firm. If the firm is marginal and cannot afford to pay competitive rates, its
employees will generally leave it for better paying jobs in other organizations. If the firm is
highly successful, there is little need to pay more than the competitive rates to obtain personnel.
Ability to pay is an important factor affecting wages, not only for the individual firm but also for
the entire industry.

II) Business Strategy: The organizations strategy also influences the employee compensation.
In case the company wants the skilled workers, so as to outshine the competitor, will offer more
pay as compared to the others. Whereas, if the company wants to go smooth and is managing
with the available workers, will give relatively less pay or equivalent to what others are paying.

III) Employee related factors

Numerous employees related factors also influence his or her compensation. These include rhe
following:

PerformanceIt is always rewarded wirh pay increase and as a result it motivates the workers to
do better in future.
ExperienceThis makes a person perfect by providing valuable insights and thus rewarded also.
Today companies are demanding for 10 to 20 years experience candidates especially for the
executive positions. The companies presume that experience candidate possess leadership skills
which influence the other behavior and performance. Generally experience candidate perform the
job without need of training which is time consuming and deals with matter of cost to company.
Hence the experience candidates demand more pay than an inexperienced candidate.

SeniorityIn today's environment seniority of employee making difference in payment of

compensation compared to Jr employees. Naturally senior employees demands for more salary
than fresher because of their hold on related job and its functions. Today many companies are
demanding senior employees for key positions by offering fat pay and even sometimes retired
employees are offered with handsome salary for key positions which deals with multitasking in
organisation. Trade unions always prefer this objective criterion for pay rises.

PotentialFirms also pay their employees, especially young ones on the basis of their potential.
Software companies are very good example for this, IT graduate just who completed his
education having potential in the subject can gain a good job with high payment anywhere in the
world.

IV)Job requirements

Wages are also influenced by the requirements of a job such as physical and mental requirement.
Jobs, which demand more skill, responsibility, efforts and are of hazardous in nature, will carry
high wage tag with them.

2) EXTERNAL FACTORS:

I) Government:

To protect the working class from the exploitations of powerful employers, the government has
enacted several laws. Laws on minimum wages, hours of work, equal pay for equal work,
payment of dearness and other allowances, payment of bonus, etc., have been enacted and
enforced to bring about a measure of fairness in compensating the working class. Thus, the laws
enacted and the labour policies framed by the government have an important influence on wages
and salaries paid by the employers. Wages and salaries cant be fixed below the level prescribed
by the government.

II)Demand and supply of labour: Demand and supply conditions of labour have considerable
influence on the determination of wage rates. If there is a short supply of labour, the wages may
be high whereas if there is no shortage of labour, the wages tend to be low.

III)Labour unions: If the labourers are well organized into strong trade unions, their bargaining
power would be high and they can demand higher rates of wages. On the other hand, if the
labourers are not organized, the management may fix low wages.

IV)Prevailing Wage Rates:Wages in a firm are influenced by the general wage level or the
wages paid for similar occupations in the industry, region and the economy as a whole. External
alignment of wages is essential because if wages paid by a firm are lower than those paid by
other firms, the firm will not be able to attract and retain efficient employees. For instance, there
is a wide difference between the pay packages offered by multinational and Indian companies. It
is because of this difference that the multinational corporations are able to attract the most
talented workforce

PRINCIPLES OF COMPENSATION MANAGEMENT

1) Ability to pay: Organizations should pay their employees as per their financial capacity
and capability. If the organization pays more than its ability ,then the organization may
get bankrupt .On the other hand, if the organization pays much below its ability to pay
then such organisation is not able to attract and retain competent employees ,which will
ultimately adversely affect the effectiveness of the organisation.
2) Internal and external equity: Organisations must compensate their employees
according to their qualification, knowledge, job responsibilities and performance. This is
called internal equity. If employees are not paid according to their qualification,
knowledge, experience, skills and performance, it will adversely affect their morale,
commitment and competency. Such organsations are likely to witness low employee
productivity, poor quality, high turnover, poor corporate image etc.Organisation must pay
their employees a compensation which is atleast comparable to their competitors
 standards. This is called external equity .If an organization compensation level is lower
than that of its competitors ,then the organization will find it difficult to recruit and retain
talented employees.
3) Performance Orientation: Compensation should be in commensuration with individual
and organizational performance. Employees exhibiting better performance should be
compensated at higher level to maintain enhanced performance and encourage them to
attain excellence. On the other hand, better organizational performance yields higher
profits which can be used to reward employees generously.
4) Non-discriminatory:-Organization must pay their employees without any discrimination
on the ground of race, religion, gender, nationality etc.
5) Legal Compliance:-Organization must pay their employees as per the relevant laws of
the country .For e.g. In India, Minimum wages Act,1948 specifies that the workers in
the unskilled ,Semi-skilled and skilled jobs must be paid a minimum wage.
6) Simplicity and flexibility: Compensation system should be simple to design, understand
and administer. It should be flexible to adapt with ease to the changing profile of the
work-force, needs of the employees, organizational goals and objectives and labour
market conditions.
7) Foster employee development: - Compensation should be able to motivate employees to
acquire, sharpen and develop their skills and competencies with changing technology and
innovation and organizational requirements.

Short notes on:

A)Cost To Company (CTC)

Companies use the term Cost to Company to calculate the total cost to employ i.e. all
the costs associated with an employment contract. Major part of CTC comprises of
compulsory deductibles. These include deductions for provident fund, medical insurance
etc. They form a part of compensation structure but employees do not get them as a part
of in-hand salary. As such, although it increases your CTC, it does not increment your net
salary.

CTC = Direct Benefits + Indirect Benefits + Savings Contributions

 o Direct Benefits refer to amount paid to the employee monthly by the employer
which forms part of his/her take home or net salary and is subject to government
taxes.

o Indirect Benefits refer to the benefits that employees enjoy without paying for
them. The company pays them on behalf of the employee but adds these expenses
to the employees CTC as it is an expense from the companys point of view.

o Savings contribution refers to the monetary value added to the employees CTC
example EPF, Gratuity.

DIRECT BENEFITS
Basic Salary
Dearness Allowance (DA)
Conveyance Allowance
House Rent Allowance (HRA)
Medical Allowance
Leave Travel Allowance (LTA)
Vehicle Allowance
Telephone/ Mobile Phone
Allowance
Incentives or bonuses
Special Allowance/ City
Compensatory allowance, etc.
SAVINGS
INDIRECT BENEFITS
CONTRIBUTION
Interest free loans Superannuation benefits
Employer Provident
Food Coupons/Subsidized meals
Fund (EPF)
Company Leased Accommodation Gratuity
Medical and Life Insurance
premiums paid by employer
Income Tax Savings
Office Space Rent

B) ALLOWANCE:

Allowance is defined as a fixed quantity of money or other substance given regularly in

addition to salary for meeting specific requirements of the employees. Some allowances are
taxable, some are partially taxable and some are tax free. There are various Kinds of Allowances
that one can get under the Head Salary. Some popular Allowances are

House Rent Allowance or HRA : The allowance is for expenses related to rented
accommodation. Salaried individuals who live in a rented house/apartment can claim
House Rent Allowance or HRA .This can be partially or completely exempt from taxes.

Conveyance allowance is given to employees to meet travel expenses from residence to

work.

Leave Travel Allowance: Salaried employees can avail exemption for a trip within India
under Leave Travel Allowance. The exemption is only for shortest distance on a trip. This
 allowance can only be claimed for a trip taken with the spouse, children and parents, but
not with other relatives.

etc