I Table of Contents  

1  Introduction  1

2  Levels of remuneration  2

2.1  Fixed levels of pay  2

2.2  Reward linked to performance of the individual  2

2.3  Reward linked to the results of the company  2

3  Compensation Administration  3

4  Variables influencing compensation strategy  3

4.1  Workforce expectations  4

4.2  Internal Environment  6

4.3  External Environment  6

4.3.1  Excursus minimum wages:  8

5  Pay for Performance Systems  9

5.1  Development of a pay system  9

5.1.1  Merit Pay  10

5.1.2  Bonuses  10

5.1.3  Profit-related pay  10

6  Criticisms about performance related pay systems  11

6.1  Fairness managerial judgment  11

6.2  Design of PFP Systems  12

6.3  Value of compensation  12

6.4  Unhealthy Competition  12

6.5  Teamwork  12

7  Practical Example: How to establish a Compensation Strategy  13

8  Conclusion  14

Compensation and Remuneration

Compensation & Remuneration

1 Introduction

This essay deals with the reward management of companies. Compensation and remuneration are important issues in human resource management. Compensation can be distinguished between direct and indirect compensation. Direct compensation means financial remuneration which includes base salary, overtime pay, bonuses and sales commissions for example. Indirect compensation is defined as benefits for employees like protection programs or insurances.

In the following points we will try to describe the reward management a little bit more in detail in order to give a basic understanding about this topic. First the different levels of remuneration are presented which might be a necessary background information. Furthermore we would like to concentrate on the practical work in the human resource department. We will describe how the operational tasks in compensation management are separated between the staff and how these tasks changed in the last decades due to changes in the business environment. In the following part we will name and explain more in detail important factors which influence the compensation and rewarding strategy. The environment is one main issue which manipulates the decisions taken in the compensation management. The business environment is divided into two parts: internal and external environment. In general, the internal environment consists of demographic factors of the workforce, the size and structure of the company and the organizational culture. The External environment is based on economical, demographic, socio-cultural and political-legal aspects. It is important to understand that cultural influences are divided into cultural characteristics in the host market as well as diverse characteristics in the target markets. We decided to add a short excursus concerning legal minimum wages. This topic is one significant force to control and manipulate the strategic decisions in the reward and compensation strategy.

Moreover we will focus on performance related payment systems. This issue became more and more important in the last year and there are many employees who argue against such a system. We will try to explain it and afterwards we would like to name some arguments which are against this kind of a structure.

Finally we will present a practical example of compensation management. We have chosen a possibility how to structure an overall payment system and we will figure out the link between practical realization and strategic tools we described in theory before.

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2 Levels of remuneration

Payment systems are significant topics for employees as well as for the company – it might be the main reason why people are willing to work. There exist different methods in a company how to classify different positions and how to distribute monthly wages and further factors of compensation. In general, there are three different approaches which are mainly used in the human resource management:

2.1 Fixed levels of pay

A fixed payment consists of salaries and wages which do not change except for general pay increases. This rank is based on the time the employee is working in the company which requires an exact control of absence and presence of the employees. The payment is fixed based on the skills and age of the employee and the position. It is obvious that this system offers low incentives and does not motivate the workers. Neither the performance nor the productivity affect the remuneration or the security of the workplace.

2.2 Reward linked to performance of the individual

In this case, the wages and salaries depend on quantity and quality of work, which might change within a period of time. Mostly, companies use a mixture between these two systems in order to exchange the received workforce of an employee. This system is a good way how to give feedback to the employees. If their performance in the last period was better they will receive a higher salary as in the previous phase.

2.3 Reward linked to the results of the company

The third system is concerned with the payment linked to the results of the company. In this case the employees receive a monthly base wages and get certain bonuses which depend on the successful performance of the company. There exist many varieties how such a system can be implemented. One way to organize such a reward structure is by selling company shares. If the company has a good reputation in the market the value of the share will increase and consequently the employees will receive higher dividends. This method is risky for the employees: on the one hand their performance directly influences the quality of the produced goods and services but on the other hand there are also some external factors which influence the success of an industry. The

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economical conjuncture plays an important role when judging the opportunities and threat of such a structure.

3 Compensation Administration

In the branch of human resource administration there were some significant changes in the last years. In earlier stages payroll administration was a paper intensive process because every transaction required written form. Today, the tasks which should be fulfilled by the administration department have shifted towards a more service orientated position. Additionally, the environmental factors for a company change much faster than some decades ago.

Acting international is one of the main growth-strategy for many companies which require higher knowledge from the administration staff. They have to know the political and legal factors and restrictions which influence the operational as well as the strategic level of compensation administration. But also in general, employees expect the administration staff not only to pay their wages and salaries but also to be competent enough to help if problems in this area occur. Their tasks have increased from pure administration to consultative aspect as well. Moreover they are responsible for health care contributions as well as for savings possibilities and pension funds. Besides, they take care of time-off payments and here again need to know the legal backgrounds and changes which occur every now and then. Their every-day tasks consist of dealing with routine queries, filling in forms and explaining company principles. Their work is composed of repetitive work where procedures should be created to save time and fulfill the tasks efficiently. One way to organize the responsibilities is by sharing them between employees. Then, they are specialized in their field and are able to solve problems within a shorter time. So, payment administration not only includes transaction of money but also many additional services which seem to become even more important in the nearer future.

4 Variables influencing compensation strategy

Basically, the compensation and rewarding strategy of an enterprise is influenced by three determining factors. The workforce expectations as well as internal (e.g. mission,

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targets, strategy, organizational culture) and external variables (e.g. government, certain lobbies, competitors) have an impact on the way how an enterprise remunerate the performance of employees (Figure 1).

Figure 1: Influencing factors of compensation strategy

4.1 Workforce expectations

Payment is an important feature in Human Resource Management, so workforce expectations is the third factor an enterprise has to consider while establishing a compensation system. Besides payment, other determining factors for people to go to work are job motivation and job satisfaction, but after all payment is the main reason why people work.

‘Am I treated fairly and do I get the money I deserve?’ is the essential thought of employees. Unconsciously they are guided by the equity theory and compare the ratio of their output (wages, benefits) and input (contributions) with the ratio of others. When perceiving that the ratios are not equal, the individual senses inequity. In theory the structure of compensation should fulfill the following three criteria:

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1. Internal equity is about the fairness of pay differentials between different jobs within

the organization. It can be established by job ranking, job classification, pointing system and factor comparisons.

2. External equity deals with a job comparison between different enterprises. The

organizational pay strategy should assure a certain fairness of organizational compensation levels relative to external compensation by comparing and collecting salary and wage information among different industry branches. The strategy of a company should be to meet or better to lead the labor market price. Leading the market price make sure that high qualified workers are attracted to become employees in this company and it ensure that the present workforce senses equity regarding external variables.

3. In contrast to internal equity, individual equity means the fairness about pay

differentials among individuals who hold the same job within a company. There are varied opportunities how an enterprise can try to provide individual equity: N Seniority based pay system (reward longevity with the organization) N Merit based pay system (reward employee performance) N Skill based pay system (compensation is based on employees possessing skills) N Incentive plans (part of compensation is based on job performance) N Team based pay system (compensation is not linked to individual performance but rather to targets achievement of the team -> encourages team work and cooperation)

The following chart (Figure 2) shows how equity and workers performance, motivation and commitment are related to each other. A feeling of equity leads to perception of fairness, which results in high motivation and leads to a high performance. In contrast, a feeling of inequity leads to a lack of motivation and decreasing performance. Only if there is a certain perception of fairness regarding payment employees are satisfied with the job and make an effort to increase their performance and the performance of the enterprise. The pay and performance strategy is influenced and determined by the mentioned factors. Because of constantly changes of the external and internal environment as well as changing expectations of employees, the strategy defining process is supposed to be permanent and ongoing. On the one hand the rewarding system should be flexible that it can adapt changes rapidly but on the other hand it is supposed to provide a certain security and stability for employees.

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