Compensation System: Design, Characteristics, Objectives and Types

Compensation system plays a very vital role in a business organization. Since, among four Ms., i.e. Men, Material, Machine and Money, Men has been the most important factor. It is impossible to imagine a business process without Men.

In any organization, the compensation system is designed and incorporated to streamline the activities.

The activities performed by the human resources earn income to the organization and the organization in turn would reward the efforts of the human resources in terms of monetary gains or in kind.

Compensation system tries to ensure fairness in deciding the worth of the workers and considering promotions or increments.

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In designing a compensation system, an organization must value the equity concept clearly define the wage and salary differentiations and career growth plans, is as to motivate and encourage the human resource to perform better.

It is not uncommon for organizations to establish specific objectives for compensation program me. Formalized compensation goals serve as guidelines for managers to ensure that the compensation system achieves its intended purpose.

Learn about:-

1. Design of Compensation System 2. Characteristics of a Good Compensation System 3. Objectives

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4. Importance 5. Types 6. Essentials of an Equitable and Ideal System 7. New Approaches.

Compensation System: Design, Characteristics and Objectives, Importance, Types, Essentials and New Approaches

Compensation System – Design

Employers receive compensation from a company in return for the work performed. Most people think the pay and compensation to be the same, but the fact is compensation is much more than just the monetary rewards provided by an employer. According to Milkowitch and Newman, “compensation is all forms of financial returns and tangible services and benefits employees receive as a part of an employment relationship”.

The phrase “financial returns” refers to an individual base salary, as well as short and long term incentives. Tangible services and benefits are such things such as insurance, paid vacations and employer discount.

Any organization’s compensation practices and designing have far reaching effects on its competitive advantage. According to Richard Henderson, To develop a competitive advantage in a global economy, the compensation program of the organization must support totally the strategic plans and actions of the organization. An organization compensation system can help to reinforce the key corporate values and facilitate the achievement of organizational objectives. It is important to give a lot of consideration to our business compensation structure because it ultimately reflects how employees are valued.

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A host of laws such as The Equal Pay Act, Fair Labour Standards Act, and The Employment Retirement Income Security Act, regulate corporate compensation practices. Some pertain to pay issues such as discrimination, minimum wages and overtime pay, others pertain to benefits, such as pensions, unemployment compensation and compensation for work related injuries. An organization must understand and fully follow these laws in order to avoid costly lawsuits and design a competency based compensation structure.

The key in designing any compensation is to develop the understating of the forms, vision and direction. As well designed compensation plan becomes one of many tools, a firm can use to help reach its strategic goals. Any failure in compensation design leads to failure to motivate any employee.

A guideline for designing a compensation plan begins at the top by examining the better strategy and ends with a model that is ready to be implemented. There are various steps that help as organization to design a performance based compensation strategy and prepare the organizations design. Inadequate use of incentive plans and problems with compensation design and strategy often fails to motivate performance of an employee.

Behavioural scientists, employee and management surveys experience show that compensation can be a strong driver of employee behaviour under the right circumstances when properly designed. Also in jobs where significant variability in pay occur in compensation and when it is closely related to key performance factor, then pay can be a big motivator.

The good performers prior to new compensation plan implementation remain good performers and may not improve much because they are already giving close to 100% effort, but the middle and the bottom performers are where there is significant opportunity for change.

1. Focusing on the Strategy Objectives:

The most important goal in designing a compensation system is supporting the strategic objectives of the organization and ensuring the system that fit in with the organization structure and strategy.

There are various questions which should be focused before designing compensation strategy such as:

i. What is the rate and mission of the organization?

ii. Why does it exist?

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iii. What are the strategic goals and objectives for the next five years?

iv. Whether current employees have the skills to meet these objectives? If so, will they be rewarded for having them? If not, will internal candidates be trained to gain skills or will the organization recruit externally to fill the goals?

v. What is the organization’s strategy?

vi. Do employees work individually or in teams?

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vii. Are employees seen as costs or investments?

viii. What is the cost to replace employees?

ix. What is the desired turnover rate?

x. What should the organization’s compensation plan accomplish?

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xi. How would you describe the current total compensation package, including benefits retirement time off etc., at the organisation?

xii. How does it compare with that of other employees in the market. What should the organization pay in relation to the market?

xiii. What is the appropriate balance between external market equity and internal worth?

Once there is an understanding of the answer to these questions, the compensation can be developed, policy guidelines are prepared which reflects thinking, values, strategies and the company is set inconsistency by top management.

2. Ensuring Commitment through Communication and Participation:

An organization must plan for making change to its compensation system.

Before beginning to tackle something, it is important that executive management is absolutely committed to the process, the result and the implementation. All important techniques for participation and communication by the clearly defined, advisory or steering committee. A compensation review committee could help identifying current issues with compensation, job clarification or salary administration. It could contribute ideas and feedback provides valuable advice.

3. Analyzing Job Functions:

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A job analyst develops a current and thorough understanding of the work that is being formed by the employee. It is important to undertake a job analysis before making changes to the compensation plan as job analysis provides a collection of relevant information on the type, scope and responsibility of each job. It is the foundation for job description and how they are in the market. It enables the organization to establish baseline information about a job level of responsibility and qualification, and to compare it to the market place. It also ensures and documents our compliance with legal requirement.

4. Writing Job Description:

Once the information is collected through the job analysis process, it can be used for preparation of job description. A job description summarizes the important component like the general nature of the work, specific tasks, responsibilities and outcome competence required to perform the job. A written job description should be considered a final document. Before it is finalized, it should be received and accepted by both the employee and the supervisor.

5. Determining Internal Pay Equity:

It determines fairness within the organization. Fair pay is pay that employees generally view as equitable. Internal equity is determined by job evaluation techniques such as whole job ranking method and factor comparison technique.

6. Determining External Pay Equity:

It is the perceived fairness in pay relative to what other employees are paying for the same type of labour. An externally focused job evaluation method includes the market pricing slotting method. For maximum flexibility, using market pricing is recommended to that of market competitive pay rates. Market competitiveness is more flexible and adaptable than other methods.

To gather competitors pay rates, a survey method is developed which includes the following steps:

i. Establish a timeline

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ii. Select bench-mark positions to survey

iii. Target survey participants

iv. Design questionnaire

v. Use other available market data sources

vi. Follow up and verify answers with participants.

7. Designing Salary Structure:

Once collection of market data and determination of a hierarchical ordering of position, is done a salary structure can be designed. Salary structure consists of jobs of equal value that are grouped into grades with competitive salary ranges. Pay ranges are the rates from the minimum to maximum of each grade. Positions are assigned to grades and pay ranges based on job content, marketing or external equity and internal equity. Each salary range includes minimum, midpoint and maximum salaries, with the midpoint representing the market or going rate for the job.

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Typical compensation design problems include:

i. Failure to tie pay closely to achievement of objective and realistic performance measures.

ii. Failure to regularly measure and provide feedback on performance.

iii. Failure to design variances in pay-related to performance that are large enough to be perceived by the employer as worth the effort.

iv. Over reliance on salary as the only significant method of financial rewards.

Compensation System – Top 20 Characteristics (With Some Other Characteristics)

A system exhibits the good characteristics when it is standing on certain principles. Ultimately the compensation system should be sound and effective.

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The characteristics are as follows:

1. The compensation should be in direct proportion to the efficiency and results. The worker with higher efficiency should be paid high.

2. The standards of efficiency should not be too high. Standards should be fixed by taking into consideration the normal worker and normal working conditions.

3. The compensation should be based on job evaluation.

4. The system should be fair to both the employer and the employee. It should be based upon scientific time-and-motion study to ensure a standard output to the employer and a fair amount of wages to the employee.

5. The employee should be assured of a guaranteed minimum wage at satisfactory level irrespective of the work done by him.

6. The system of compensation should be well defined, uniform, and applicable as a general system.

7. Skilled employees should be paid more as compared to the unskilled employees. Skilled employees are to be compensated for the efforts put in by them to acquire the skill.

8. The System should ensure the equal pay for equal work.

9. Exceptions to the system should be bare minimum.

10. The system should be flexible to allow necessary changes, which may arise from time to time.

11. It should minimise employee turnover, absenteeism and late attendance.

12. It should be clearly communicated to all the employees. It should be ensured that the employees have understood it properly and they can work out the compensation to be received on their own.

13. The system should not be complex so that it can be implemented easily. This is possible only when it is simple.

14. The system should not hit the slow employees but rather induce them to achieve higher efficiency. Efficient employee should be paid proportionate to their efficiency.

15. The system should not penalise the employees for the reasons beyond their control.

16. The system should not stand on the premise of exploitation of the employees.

17. The system should raise the morale, efficiency of the employees. It should augment cooperation among the employees. This is only possible when it is just and fair and renders the satisfaction to employees.

18. It should be consistent with the provisions under various Labour Acts, in force from time to time. The system should not be imposed on the trade union. Before application, the acceptance should be sought from union and should be in form of an agreement.

19. It must not violate any local or national trade union’s agreement.

20. This system should correlate to the capacity of the organisation to pay.

An effective compensation system typically has the following characteristics:

1. It enables an organisation to attract and retain qualified (and necessary) workers.

2. It complies with government regulations.

3. It motivates employees, fosters a feeling of equity, and provides direction to their efforts.

4. It communicates and reinforces an organisation’s culture, values, and competitive strategy.

5. Its cost structure reflects the organisation’s ability to pay.

Traditional approaches to compensation, management focus primarily on enabling an organisation to attract and retain qualified workers, while complying with government mandates concerning pay. “Status, not contribution, was the traditional basis for the numbers on people’s pay checks … pay was cemented to hierarchical position, regardless of performance,” says Professor Kanter newer pay models attempt to balance the traditional objectives with increased attention to motivating employee performance and aligning pay with key organisational performance objectives.

Compensation System – Common and Primary Objectives

In any organization, the compensation system is designed and incorporated to streamline the activities. The activities performed by the human resources earn income to the organization and the organization in turn would reward the efforts of the human resources in terms of monetary gains or in kind.

The system is, therefore, needed to convert, allocate and transfer the portion of the organizational income to its employees to compensate their efforts/offerings effectively.

The system to perform and regulate this process is referred as the compensation system. The system may divide the compensation payments in stages like (a) on hand Wage/Salary, and (b) payments reserved until some future time to hold their commitments and/or to secure their future (retirement/disabilities/future unexpected liabilities). Some portion can be paid extra for extra work or some amount as annual appreciation for the efforts.

Compensation in kind could also be offered to motivate and energise the employees such as medical facilities, free transportation, housing, co-operative societies for economic purchases of essential goods, schools for children, gifts for birthdays/ marriages, etc.

The achievement of the organization mission is directly related to the compensation strategies and tactics that integrate various groups of employees at various levels of the management or operations. Therefore, to increase competitiveness, cooperation and team cohesion, the policy, working culture and strategies play an important role in transmitting message to the employers about how important they are to the organization.

The policy, culture and strategies also communicate to the employees that they are valuable to the organization and that the organization is willing to share the revenue generated.

Therefore, a compensation system tries to ensure fairness in deciding the worth of the workers and considering promotions or increments. In designing a compensation system, an organization must value the equity concept clearly define the wage and salary differentiations and career growth plans, is as to motivate and encourage the human resource to perform better.

Common Objectives:

Some of the common objectives of a sound compensation system include the following:

1. To Attract Qualified Personnel:

Compensation needs to be high enough to attract competent personnel. Pay scales must respond to demand and supply situations in the labour market since employers compete for workers. Premium wages are sometimes needed to attract employees who are already working for others. If fresh MBAs and brilliant engineers, for example, flock around Wipro, Infosys, Reliance, and ANZ Grindlays, it is mainly because these companies offer attractive remuneration packages.

2. To Retain Existing Competent Employees:

Retaining competent employees for long is often more difficult than attracting fresh ones. Employees may quit if compensation levels are not competitive. It is common knowledge that an employee feels satisfied or dissatisfied with his/her remuneration not so much by the total remuneration he/she receives, but by comparing his/her benefits with those enjoyed by others. An employee sticks to an organization when he/she is paid equitably. The company’s compensation structure must, therefore, be equitable and consistent.

3. To Reward Desired Behaviour and Maintain Motivational Levels of Employees:

Employees get motivated to perform better when their past performance is rewarded adequately. It is, therefore, necessary that a company’s compensation system rewards performance, loyalty, experience, and other organizationally desirable behaviours. This will reinforce desired behaviour and will also act as an incentive for that behaviour to continue in the future.

4. To Maintain Salary Equity among Employees:

The compensation system should strive for internal and external equity. Internal equity requires that the remuneration be related to the relative worth of the job so that similar jobs get similar pay in the organization. External equity implies that the remuneration for a job should be equal to the remuneration for a similar job in other organizations.

5. To Control Costs and Keep the Compensation Budget under Check:

A rational compensation system helps the organization in obtaining and retaining employees at a reasonable cost. Without effective compensation management, employees could be over- or underpaid. This helps in keeping the labour and administrative costs under control, and the company can systematically go about payroll budgeting.

6. To Improve Union-Management Relations:

A rational compensation system always finds favour with employees and their unions. This helps in smoothly conducting collective bargaining and negations between the management and unions. It reduces grievances arising out of wage inequities.

7. To Improve the Public and Professional Image of the Company:

A suitable compensation system sends a positive signal to the job market which helps in maintaining and improving the progressive image of the organization in the industry. A rationally administered compensation system creates a good image with the government also as it ensures the employer’s compliance of laws relating to wages and salaries, such as payment of Wages Act, 1936, the Minimum Wages Act, 1948, and the Equal Remuneration Act, 1976.

Primary Objectives:

The two primary objectives of a compensation system are:

1. Equity:

Equal pay for work of equal value.

a. Internal Equity – Requires that pay be related to the relative worth of a job so that similar jobs get similar pay.

b. External Equity – Paying worker what other firms in the labor market are paying to any comparable worker. The external equity is established through wage and salary surveys. The various sources of information may be employer surveys, professional agencies, consulting firms, internet, published literature etc.

2. Efficiency:

The efficiency in a compensation system entails to:

a. Linking compensation to productivity/ profit/ individual performance.

b. Attracting rewarding, motivating and retaining highly capable and efficient.

c. Maintaining market competitiveness.

d. Ensuring compliance with laws and regulations.

e. Building employer brand.

The most important objective of any pay is fairness or equity.

The term equity has three dimensions:

1. Internal Equity- Ensures that more difficult jobs are paid more.

2. External Equity- Ensures that jobs are fairly compensate in comparison to similar jobs in the labor market

3. Individual Equity- Ensures equal pay for equal work.

There are few other objectives of Compensation Planning which are as followings:

1. Attract talent- The salary offered to the competent person must be high enough to motivate them to apply.

2. Retain talent- To retain competent employee, compensation level should not fall below the expectation of employee.

3. Control costs- Compensation should be managed carefully, so that costs can be controlled.

4. Complying with legal rules- Compensation Plan should satisfy governmental rules and regulations.

5. Ease of operation- Compensation programme should be simple to operate.

Compensation System – Importance

Every factor contributes to the process of production /business. It expects return from the business process such as rent is the return expected by the landlord, capitalist expects interest and organizer i.e. entrepreneur expects profits. Similarly the worker expects wages from the process.

Worker plays vital role in bringing about the process of production/business in motion. The other factors being human, has expectations, emotions, ambitions and egos. Worker therefore expects to have fair share in the business/production process.

Therefore, a fair compensation system is a must for every business organization.

The fair compensation system will help in the following ways:

(i) An ideal compensation system will have positive impact on the efficiency and results produced by employees. It will encourage the employees to perform better and to achieve the fixed standards,

(ii) It will enhance the process of job evaluation. It will also help in setting up an ideal job evaluation and the set standards would be more realistic and achievable.

(iii) Such system should be well defined and uniform. It will be applied to all the levels of the organization as a general system.

(iv) The system should be simple and flexible so that every employee would be able to compute his own compensation receivable.

(v) It should be easy to implement, should not result in exploitation of workers,

(vi) It will raise the morale, efficiency and cooperation among the workers. It, being just and fair would provide satisfaction to the workers,

(vii) Such system would help management in complying with the various labour laws,

(viii) Such system should also solve disputes between the employee union and management,

(ix) The system should follow the management principle of equal pay.

(x) It should motivate and encourage those who perform better and should provide opportunities for those who wish to excel.

(xi) Sound compensation/reward system brings peace in the relationship between employer and employees.

(xii) It aims at creating a healthy competition among them and encourages employees to work hard and efficiently.

(xiii) The system provides growth and advancement opportunities to the deserving employees.

(xiv) The perfect compensation system provides platform for happy and satisfied workforce. This minimizes the labour turnover and the organization enjoys the stability.

(xv) The organization is able to retain the best talent by providing them adequate compensation thereby stopping them from switching over to another job.

(xvi) The business organization can think of expansion and growth if it has the support of skillful, talented and happy workforce.

(xvii) The sound compensation system is hallmark of organization’s success and prosperity. The success and stability of organization is measured with pay-package it provides to its employees.

Compensation System – 5 Important Types: Piece Rate System, Commission System, Bonus System, Skill-Based System and Merit Pay System

Organisations mostly compensate employees on an individual basis.

Some of the pay systems used by organisations for compensating individuals are:

1. Piece rate system

2. Commission system

3. Bonus system

4. Skill-based system

5. Merit Pay system

Type # 1. Piece Rate System:

Organisations involved in the production or manufacturing of goods adopt this pay system. In this system, employees are paid on the basis of the number of units manufactured by them during a time period. Organisations use the output data of other companies, along with time and motion studies to arrive at the minimum number of units that must be made by a worker.

A major disadvantage of this system is that employees feel that management is only concerned about productivity and not their welfare. A feeling of distrust may develop between management and workers. As the productivity per worker increases, workers may resort to ‘go-slow’ techniques to prevent management from laying off workers.

The Lincoln Electric plant in Cleveland, has modified the piece rate system of compensation. Their piece rate system is backed by a merit rating based bonus system. This combination of piece rate and bonus system has led to improvement in product quality because workers want to get a good rating to earn a higher bonus.

Type # 2. Commission System:

Employees whose productivity can be quantified are usually paid on a commission basis. For example, sales professionals are paid commission on the basis of sales achieved by them. Salespersons feel motivated when they are paid commission in recognition of their efforts.

The commission system is an objective and efficient system for compensating salespersons. However, such a system may lead to the use of unethical techniques for increasing sales, thereby increasing the commission.

Type # 3. Bonus System:

This refers to a lump-sum payment given to the employees at the end of the year for achieving productivity or performance targets. Since the bonus is paid in the form of a lumpsum, employees feel they have received a large sum of money. Consequently, they feel content about the amount they have received. If the employees were given the same amount spread over twelve months, they may not feel the same sense of contentment. The bonus system is one of the most successful and reliable system for compensating employees.

Type # 4. Skill-Based System:

In this type of compensation system, employees are paid on the basis of the number of the skills they possess. Unlike the merit rating or bonus system where employees are paid for performance, in this system they are paid for the skills they learn on the job. Employees are put through various job activities.

Over a period of time, they are expected to develop expertise in all the activities of the job. The purpose of adopting a skill-based system is to train employees in the various aspects of the job. Organisations having high performance work systems and self-managed work groups adopt a skill-based pay system for compensating employees. An example for skill-based compensation is seen in the IT industry.

Type # 5. Merit Pay System:

Organisations conduct performance reviews at the end of every year. The main purpose of this review is to measure the performance of the employees in the previous year. On the basis of their performance in the previous year, employees receive a hike in pay. This increment is called merit pay because it is commensurate with performance.

The major problem with merit increments is that organisations have to commit themselves to these hikes and cannot withdraw these increments even when the organisation incurs losses. Merit increments are cumulative in nature and prove to be very costly for the organisation in the long run.

Merit pay is dependent on the merit rating one gets from the concerned supervisor. Hence, there may be an element of bias in these ratings. A supervisor’s errors in perception may result in unfair ratings. Although the merit rating system has many inherent problems, it is still used by a large number of organisations.

Compensation System – Essentials of an Equitable and Ideal Compensation System (Factors)

In order to understand the essentials of an equitable and ideal compensation system, it will be necessary to consider following factors, on which the ideal compensation system shall be heavily depending upon –

1. Demand and Supply Position:

Each job demands certain skills, personal qualities and technical education, experience to perform the job. If the demand is more and supply is less then naturally compensation payable will be high and vice versa. For example, if steno typists are scarce in number, compensation offered would be higher.

2. Nature of Business:

If the product or service is having the nature of yielding high profits, naturally the compensation paid is relatively higher than what is paid for in other low profit yielding businesses. For example, compensation paid to employees in companies like Reliance Industries Ltd., Bajaj Auto Limited would be definitely higher as compared to the other industries since these are supposed to be high profit earning industries and as such capable of paying the high and handsome compensation.

3. Size of Business:

Large organisations like multinational companies pay higher compensation than small industries.

4. Government Rules:

In India, there are State and Central Acts for minimising the disparity in wages levels, such as Minimum Wages Act. Similarly, various laws are available for providing social security benefits to the workers.

5. Current State of Industry:

Many units producing the similar product form an industry. It is an unwritten rule that different units falling under the industry follow the current wage level in the industry. Similarly, the pattern of payment i.e. components of pay package is almost similar with little variations among these units.

6. Management Thinking:

Every management has its own philosophy. Every organisation has its own values and beliefs. Some organisations have great concern about the employees and show high sense of social responsibility. They provide non-statutory benefits to their employees, liberally. Although their number is small, the compensation to employees is better irrespective of foregoing factors.

7. Disagreeability of the Job:

Certain jobs in comparison to others are disagreeable e.g., teachers, nurses, social workers, doctors, cleaners, Fire fighters etc. These jobs have different kinds of working environment. Skills and ability of facing stress, high pressure, and long hours of work, continuous alertness and monotony are demanded by these jobs. Due to these factors, the availability of persons for such work is less and therefore the preference is second or third. Compensation has to be attractive for such jobs.

Compensation System – 4 New Approaches: Skill Based Pay, Broad Banding, Variable Pay and Team Rewards

In recent years, many experts in the field have begun calling for major changes to the existing reward systems. Their common argument is that the existing reward systems do not fit with the context and needs of the emerging downsized, flexible, participative, dynamic and diverse organisations. A number of new approaches to compensation rewards have been suggested in the literature and have begun to be adopted.

Four New Approaches to Compensation System are:

i. Skill-Based Pay:

a. Multi-skilled workforce.

b. Job assignment flexibility.

c. Learner staffing levels.

d. Enhanced problem-solving capability.

e. Higher employee satisfaction and commitment.

ii. Broad Banding:

a. Ease in moving employees between jobs/roles.

b. Logical complement to flat organisational structures.

c. Greater scope for recognising individual differences in employee performance.

iii. Variable Pay:

a. Motivation of sustained high performance.

b. Improved cost-effectiveness.

c. Better linkages between individual and organisational goals.

iv. Team Rewards:

a. Support for participative organisational structures

b. Improved effectiveness of work teams.

i. Skill Based Pay:

As technology progresses, newer skills are required. It is important for employee to upgrade their skills. Skill-based pay can help organisations pay its people for skills that are currently in need and what employees are able to use in an organisation. It forms a part of base pay but in the era of ever changing technology, skill-based pay is also used as contingent pay.

One software company paid its people, bonus for acquiring skills that were new and in high demand. The same bonus was withdrawn after its demand decreased. This helped the organisation in keeping the employees focused and upgrading their skills continuously. Such pay schemes work best in project-based organisation and virtual organisations where people group and re-group based on time driven projects.

Skill-based pay is not necessarily contingent and varies from industry to industry. Industries that need its employee to continuously upgrade their skills can make it contingent as otherwise it would continue to pay employees for skill that no longer is in use.

Industries where technology changes are not rapid but people need to upgrade skills in case of changing business focus, can make it a part of base pay It is important that both organisation and the employees are aware of changing technologies and the skills required that would help the organisation in executing projects, improving procedures, products and services.

This is an alternative method of determining base pay earned by employees. Paying employees on the basis of skills they know rather than the job they currently hold in the organisation is not a new idea. Historically, this approach has been mostly used for production employees. What is new is the trend in recent years to also apply this approach to professional and management employees. Perhaps, the use of newer terms such as knowledge-based pay or competency pay is reflective of this extended applicability.

In skills-based pay, employees are paid according to the number of skills they possess. Skills are generally grouped into “skills blocks” and as an employee acquires each block, his/her pay goes up. A “skill block” can include one or more of these three different types of skills; horizontal or breadth skills focusing on all related jobs in an integrated production process; depth skills aimed at increased specialisation in a particular area; and, upwardly vertical skills generally possessed by managers and professionals.

An example of well-established skill-based pay plans is briefly described. The skill-based pay plan of Northern Telecom covers three technical job families. For each job family, skills blocks are separately identified. An employee can move to the next skill block and attain higher pay only after learning all skills in the preceding block.

Skill-based pay plans can offer many advantages to both the organisation and the employee. By encouraging employees to learn more skills, these plans help to create a workforce that can perform multiple tasks. This provides the organisation greater flexibility to rotate employees to cover for absenteeism, overtime, turnover, workflow interruptions due to production bottlenecks and variations in product demand. Such flexibility in workforce assignment can assist the organisation in maintaining learner staffing levels.

Other potential advantages of skill-based pay plans to the organisation are better problem-solving capability, improved productivity and quality of products/services, and stronger employee commitment. These advantages can arise because employees working under these plans become more familiar and involved with the organisation’s operations and also gain better understanding of the value of their own contributions to the organisation. Individual employees, too, can benefit from skill-based pay plans.

They acquire more self-control over their own earnings, develop greater capacity for self-management and experience more varied and enriched task assignments. These can be important contributions to job satisfaction for many, if not all, employees. The application of such plans to professional and management employees remains quite small.

ii. Broad Banding:

A pay structure typically consists of grades and ranges. A grade is a grouping of jobs falling within a certain range of job evaluation points. A grade also has a pay range, i.e., minimum-to-maximum spread attached to it. Successively higher grades, by definition, will have higher minimum and maximum pay rates. The traditional pay structures generally include a tall hierarchy of narrowly defined grades, each with a relatively limited pay range. Such structures create a strong incentive for employees to strive toward upward career mobility as a means to obtain higher compensation rewards.

Broad banding can be defined as delayering of pay structure. It involves consolidation of existing pay grades into a small number of wide bands. This consolidation also automatically results in a broad minimum-to-maximum pay spread for each band. Thus, compared to conventional pay structures, broadband structures have fewer bands and broader pay ranges. Such pay structures are better suited to the needs of today’s flexible, flatter and performance-oriented organisations.

First, they allow flexibility in moving employees between jobs within a band without formal job title and pay grade changes. Second, broad banding is a logical complement to fiat organisational structures. One consequence of flattening of organisational structures is the elimination of the traditional vertical career paths for many jobs. Flat structures place increased emphasis on lateral career moves and skill development, both of which can be supported and rewarded through broad banding.

Third, a broader spread between the minimum and maximum pay rates in a band provides for more opportunities to recognise individual differences in performance. In broadband pay structures, there is a greater scope for pay growth through pay increases within band than through promotions to a higher band.

A leading HR consulting firm has only three bands across the organisations entry level, proficiency level and mastery level. Each band has distinct set of functional and behaviour competencies defined. An entry level would require good quantitative skills, knowledge of excel sheet, ability to analyse and ability to learn fast. The next level requires skills in project management, resource management, problem-solving, mastery in subject knowledge, etc.

The leadership position requires visionary skills and ability to give direction to the organisation. In order to progress to the next level in such a flat organisation, an individual is required to add value that would clearly separate his acceptability and key performance indicator.

The organisation has a pay system that has wide pay range in the same band. The wide pay range in the same band is commensurate to the performance that an individual is able to bring to the table. The employee, however, does not advance to the next band until he is able to add competencies that are required at the next level.

Advancement in career no longer means climbing yet another grade or moving to quasi – supervisory roles, instead, advancement means adding newer competencies that would mean ability to contribute to the organisation in distinct form than the earlier level. As competencies change at different levels in the organisation, in identification of competencies/roles at different levels is essential. So pay has to be more for higher band of competencies.

iii. Variable Pay:

Variable performance linked pay is a financially measurable reward paid to an individual based on his/her overall performance. It is employed as a powerful tool that enhances employee performance/productivity.

iv. Team Rewards:

Companies reward employees for achievement of annual/quarterly results. Here periodic targets are monitored to encourage improved productivity and reward. Thus, there is visible link between performance and incentives for the groups/teams.

Team rewards provide an opportunity for each team member to receive a bonus based on the output of the team as a whole. Team incentives are most appropriate when jobs are highly interrelated. In fact, highly interrelated jobs are the wave of the future and in many cases the wave of the present. In the past, few firms used team incentives. In the future they will need to be more creative in using team reward.

Individual rewards do matter a lot and a high performer has to be rewarded. A fundamental and unresolved problem with the team pay is the extent to which it should recognise individual performance-related pay and the other contentious issue is a model team-based pay system.

For example, XEL uses a team-based variable pay system as part of its compensation plan. For the team-based pay system XEL sets aside a percentage of its total payroll, and payouts are determined by team rankings. A team ranking is based on three criteria – ratings by internal and external customers, achievements of quarterly team objectives, and the management input recognising special circumstances.

In this system, members on the same team do not all receive the same payout, since the final payout is adjusted to reflect peer evaluation. For example, if the overall merit pay budget is 5 per cent of payroll, the top ranked team may get 5 per cent and a bottom ranked team nothing. Further within the top team there may be a spread of 5 to 10 per cent member ratings.

For setting up team-based variable reward system following steps are to be planned:

Appraised Teams:

i. Evaluate the performance of team against preset targets / KRA’s.

ii. Communicate the results to ensure transparency.

iii. Measure the performance of the team (actual vs. targets) every month.

Rewarding Teams:

i. Make the minimum level of performance the benchmark of team reward.

ii. Make team performance mandatory for individual rewards.

iii. Distribute the team reward in proportion to the basic pay of the grade to which each team member belongs.

iv. Build a geometric rate of progression of the award for each successive target.

v. Link the individual award to the basic pay of the grade to which the individual belongs.