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LESSON 2

Introduction to Compensation and Rewards

Chapter 1: Objectives of Compensation and Rewards

Learning Objective

• Objectives of Compensation and Rewards

• Determinants of Incentives

Introduction to objectives of Compensation and Rewards:

After having discussed in the first Chapter the role of compensation and rewards, ij this
chapter we will study the objectives of rewards. Compensation and Rewards
determination may have one or more objectives, which may often be in conflict with each
other. The objectives can be classified under four broad headings.

Objectives of Compensation:

(1) The first is equity, which may take several forms. They include income
distribution through narrowing of inequalities, increasing the wages of the lowest
paid employees, protecting real wages (purchasing power), the concept of equal
pay for work of equal value compensation management strives for internal and
external equity.

Internal equity requires that, pay be related to the relative worth of a job so that
similar jobs get similar pay. External equity means paying workers what comparable
workers are paid by other firms in the labor market. Even compensation differentials
based on differences in skills or contribution are all related to the concept of equity.

(2) Efficiency which is often closely related to equity because the two concepts are
not antithetical. Efficiency objectives are reflected in attempts to link to link a part
of wages to productivity or profit, group or individual performance, acquisition
and application of skills and so on. Arrangements to achieve efficiency may be
seen also as being equitable (if they fairly reward performance) or inequitable (if
the reward is viewed as unfair).

(3) Macro economic stability through high employment levels and low inflation, of
instance, an inordinately high minimum wage would have an adverse impact on
levels of employment, though at what level this consequence would occur is a
matter of debate.
Though compensation and compensation policies are only one of the factors which
impinge on macro-economic stability, they do contribute to (or impede) balanced and
sustainable economic development.

(4) Efficient allocation of labor in the labor market. This implies that employees
would move to wherever they receive a net gain, such movement may be form one
geographical location to another or form on job to another (within or outside an
enterprise). The provision or availability of financial incentives causes such
movement.

For example, workers may move form a labor surplus or low wage area to a high
wage area. They may acquire new skills to benefit form the higher wages paid for
skills. When an employer’s wages are below market rates employee turnover
increases. When it is above market rates the employer attracts job applicants. When
employees move from declining to growing industries, an efficient allocation of labor
due to structural changes takes place.

Other Objectives of Compensation:

(1) Acquire qualified personnel – compensation needs to be high enough to attract


applicants. Pay levels must respond to the supply and demand of workers in the labor
market since employers compete for workers. Premium wages are sometimes needed to
attract applicants already working for others.

(2) Retain current employees- Employees may quit when compensation levels are not
competitive, resulting in higher turnover.

(3) Reward desired behaviour- pay should reinforce desired behaviors and act as an
incentive for those behaviors to occur in the future. Effective compensation plans reward
performance, loyalty, experience, responsibility, and other behaviors.

Control costs- a rational compensation system helps the organization obtain and retain
workers at a reasonable cost. Without effective compensation management, workers
could be over paid or under paid.

(4) Comply with legal regulations- a sound wage and salary system considers the legal
challenges imposed by the government and ensures the employer’s compliance.
Facilitate understanding- the compensation management system should be easily
understood buy human resource specialists, operating managers and employees.

(5) Further administrative efficiency- wage and salary programs should be designed to be
managed efficiently, making optimal use of the HRIS , although this objective should be
a secondary consideration compared with other objectives.

Rewards:
The use of Incentives or Rewards assumes that people's actions are related to their skills
and ability to achieve important longer-run goals. Even though many organizations, by
choice, or tradition or contract, allocate rewards on non-performance criteria, rewards
should be regarded as a "payoff" for performance.

An Incentive Plan has the following important objectives:

(1) An incentive plan may consist of both 'monetary' and 'non-monetary' elements.

(2) Mixed elements can provide the diversity needed to match the needs of
individual employees.

(3) The timing, accuracy and frequency of incentives are the very basis of a
successful incentive plans.

(4) The plan requires that it should be properly communicated to the employees
to encourage individual performance, provide feedback and encourage
redirection.

Determinants of Incentives

These feature are contingencies, which affect the suitability and design of incentives to
varying degrees. The effective use of incentives depends on three variables-the
individual, work situation, and incentive plan.

(I and Ill) The Individual and the Incentives: Different people value things differently.
Enlightened managers realize that all people do not attach the same value to monetary
incentives, bonuses, prizes or trips. Employees view these things differently because of
age, marital status, economic need and future objectives.

However, even though employee reaction to incentives vary greatly, incentives must
have some redeeming merits. For example, there might be a number of monetary and
non-monetary incentive programmes to motivate employees. Money, gift certificates,
praises, or merit pay are of the continuous parade of promotion.

(ii) The Work Situation: This is made up of four important elements:


Technology machine or work system, if speed of equipment operation can be varied, it
can establish range of the incentive.

(b) Satisfying job assignments, a workers' job may incorporate a number of activities that
he finds satisfying. Incentives may take the form of earned time-off, greater flexibility in
hours worked, extended vacation time and other privileges that an individual values.
Feedback, a worker needs to be able to see the connection between his work and rewards.
These responses provide important reinforcement.

Equity, worker considers fairness or reasonableness as part of the exchange (or his work,
Incentives, in general, are important motivators. Their effectiveness depends upon three
factors: drives, preference value, and. satisfying value of the goal objects.

Misra says: "Beyond subsistence level, becoming needs (self-actualization needs) possess
greater preference value and are more satisfying than deficiency needs (which are
necessary for survival). Below the subsistence level, however, the reverse holds true." He
makes the following generalizations:

(i) Incentives, whether they are monetary or non-monetary, tend to increase the
level of motivation in a person.

(ii) Financial incentives relate more effectively with basic motivation or deficiency
needs.

(iii) Non-financial incentives are linked more closely with higher motivation, or
becoming needs.

(iv) The higher the position of a person in an organization’s hierarchy, the


greater is his vulnerability to non-financial incentives.

"While budgetary restrictions and' temporary improvements in performance place a limit


on the potency of money as a motivator, non-financial incentives involve only human
ingenuity as investment and also insure a relatively stable acceleration in output.

Monetary incentive imply' external motivation, non-monetary incentives involve internal


motivation. Both are important. It is a judicious mix-up of the two that tends to cement
incentives with motivation. “

Tutorial Activity 1.1

(1) Discuss the objectives of compensation and Rewards.

(2) Discuss the determinants of compensation and Rewards.

Tutorial Activity 1.2

Let us study the reason that why doesn't pay motivate?

Most companies have some form of incentive plan. However, one of the most frequent
comments heard is that "my employees aren't performing any better with the incentive
plan than they were before. Am I wasting my money?" Chances are you are.

To provide effective motivation, incentives must:

1. Flow from the business process


2. Provide sufficient opportunity to retain attention

3. Directly link actor and the action

4. Be timely

Most plans out there violate at least one, and often all four of these rules:

1. Business Process

Whether it is manufacturing the proverbial widget, processing credit card charges or


overseeing a multi-product line business, those creating the compensation system must
understand the customer chain, the work process, and how and where employees add
value.

Failure to do so results in a "one size fits all" mentality where all employees are treated
similarly, or where we base our pay on what everyone else is doing. Although this may
be seen as "administration savings" or "being competitive in our industry", it really
means we are accepting a competitive disadvantage - we are actively forgoing a tool of
competitive advantage.

2. Pay Opportunity

Although people talk about competitive pay based on scope of job, or number of salary
points, the ultimate determinant of the pay opportunity is the value created by the job. To
the extent a job does not create value, employees are a drain on capital.
The extent to which value is added (or lost) should be shared with employees to provide
motivation. How much is to be shared is a company-by-company (or business-unit-by-
business-unit) judgment based on three factors:

a. What is the minimum amount of opportunity that must be paid to attract and retain
employees both in boom and bust times?

b. How much compensation is necessary to provide a meaningful link between the


employee and the business goals?

c. How much of the value added can we afford to share while maintaining a viable
business with adequate shareholder return?

An example of how incentives have consistently worked to the good is the steel maker
Nucor. Base pay for most employees is less than "competitive" market levels. However,
because of variable pay systems linked to the value created by the system, Nucor's
employees are both paid above the "market" and receive constant feedback as to their,
and their company's performance.
3. Link the Employee and the Action

By tying compensation directly to these the controllable employee actions we provide a


critical feedback link. For example, a work group which is rewarded based on the number
of units shipped, less a holdback for defective widgets returned will (ideally): seek ways
to speed throughput and shipping; provide feedback to earlier teams to eliminate defects
and, seek product improvements which will increase demand.

If these are in line with the business process and the goals of the business are
communicated, then, the feedback will reinforce the actors to align with the business.
If there is no clear linkage—no "line of sight" - the money spent is, at best, sub
optimized, at worst, wasted. This is the flaw in program such as all employee stock
options or company wide profit sharing plans. There is no direct, meaningful, measurable
link between, for example, the actions of a soda truck driver and the price of the
company's stock.

4. Timeliness

As Pavlov demonstrated, timeliness is critical to rewards. As results become measurable,


feedback pay should follow, with a minimum of administrative delay. In many broad-
based incentive plans, payout happens quarterly, monthly, or even, as at Nucor, weekly.
This provides rapid reinforcement feedback. As a rule of thumb, the longer the delay, the
less useful the reward.

In come situations, this rapidity is not possible because the process is both uncertain and
long – for example a researcher working on a new drug. In these cases, feedback can still
be provided on a milestone basis – rewards linked to clinical trials, FDA approval, sales
past a profitability milestone, etc.

Unfortunately, the area where there is historically the least timeliness is executive pay.
Executive pay is historically focused on "annual incentives: requiring executives to
categorize their performance into discrete, one-year segments, regardless of business
cycle.

Depending upon the structure of the plan, this results in executives either setting goals
which do not clearly relate to adding value, but which are measurable in a one-year time
frame (e.g., "by November create a training program for 1995 implementation."), or
measuring financial results without regard to product cycles (e.g., we release a new
edition of the product every six months, with a six month life. An annual award cycle
eliminates the opportunity to provide feedback on every edition of the product.)

Conclusion

Pay has the potential to drive performance – in the best companies, it does. However, too
often, pay is designed in a vacuum, without focus on either the underlying objectives of
the company or the actions employees can actually control to achieve those goals.
Compensation must be seen as part of the total business process to be successful.
Ted Buyniski is a Principal with Quantic, Inc., a compensation and strategic HR
consulting firm headquartered in San Francisco. He manages the East Coast practice from
Chester, NJ.

Theodore R. Buyniski

Tutorial Activity 1.3

From the case below let us understand the Reward system of this organization:

The Employers’ Organization

Company background:

The Employers' Organisation for local government's (EO) role is to help councils achieve
the high standards of people management needed to ensure the continuous improvement
of services.

We offer a range of services to local authorities, from free telephone advice and specialist
guides to tailor made consultancy services.

Essex – Our approach to pay progression

Essex County Council has been going through radical change. Some of that change has
been structural but the more important aspect of the change is cultural. We are seeking to
move the organisation to a much more customer focused and facing organisation.

Situation

One of the mechanisms to support this move has been our approach to pay strategy. We
also wanted to implement the Single Status Agreement, which removes the employment
conditions divide between some of our staff. The Agreement and the approach we used
affected our 9,000 staff.

The cornerstone of our approach was to develop the Essex Competency Framework. This
sets out the skills and abilities that our staff need to deliver best quality services for the
Council. We then incorporated this into our individual performance management system.
This formed the foundation on which we could build our new approach. The principles of
the approach are:

(1) It is simple and consistent

(2) A member of staff meeting the objectives of their job and their competency
statements can expect pay progression
(3) It fits with the service planning cycle

(4) Development opportunities are available

(5) Staff at their maximum pay point undergo performance review and competency
development so that further development opportunities can be explored.

Process

The new system for these staff moves away from automatic service based increments,
although it still uses the national pay spine up to point thirty-four. It is based on four
Broad Band Grades that have been determined by using the National Job Evaluation
Scheme.

Within each Band the first increment is automatic, then performance is assessed against
delivery of objectives - i.e. what needs to be delivered - and the demonstration of
competencies - i.e. how it needs to be delivered. Objectives come from the job profile for
the individual and the service objectives for the service area.

Around six objectives are required for each job and they need to be constructed in a way
that is easily measurable. We provide guidance and training for managers and staff on
how to do this effectively. The objectives are set at the beginning of each review year and
can be reviewed and amended. We also use statements from the appropriate four
Competency Headings from the Competency Framework plus the Technical Professional
Competency.

A statement from the Competency Framework sets out what needs to be demonstrated by
the individual in their role. An example is: “Seeks regular feedback from customers about
services provided and uses this to recommend continuous improvements to the service”.
This statement comes under the Competency Heading 2 “Customer/Client Orientation”
and is the appropriate statement for spinal column point twenty two.

Each of the generic competencies has a defined and prescribed statement for every spinal
column point. A few of the statements remain the same at all spinal column points; for
example, those around equality and diversity, but most become more demanding the
higher the spinal column point.

The selection of the Competency Headings from the Essex Competency Framework may
be for individual posts where there are no other similar posts but job families have
commonly agreed Competency Headings across the organisation in order that we have
consistent levels of service delivery for that function.

There is also a Competency Heading entitled Professional and Technical so that job
specific competencies are included e.g. social workers. This framework is flexible
enough to cover all jobs and roles within the Council including the Member role. For jobs
above spinal column point thirty-four and for Members the Competency Framework is
used in a different way.

Each year, the manager will identify the spinal column point for their member of staff as
at the first of April. A database will produce all of the appropriate statements under the
selected Competency Heading for that spinal column point. These will be recorded on the
appropriate form for the individual together with their agreed objectives for the year. The
professional technical statements are not prescribed because they relate directly to the
area of work and the manager will draft these with the individual, although there is
general guidance in place to assist the process.

Questions:

(1) What do you understand by the term People Management.

(2) What is pay progression and discuss it’s relevance to this case.

Tutorial Activity 1.4

Let us understand the rewarding strategy of an another company below-

FRONT RANGE SOLUTIONS

Company Information:

Founded in 1989, FrontRange Solutions Inc. is a privately held company, delivering


software that facilitates extraordinary relationship solutions. An international leader in
business relationship software for nearly 15 years, FrontRange Solutions employs more
than 500 people worldwide.

FrontRange Solutions' products address the needs of customer service and support (help
desk), sales force automation (SFA), knowledge management and customer relationship
management. FrontRange's expertise lies in delivering the highest value, industry-
specific, integrated software solutions for the complete lifecycle of business relationships.

And FrontRange puts its knowledge into practice by providing outstanding customer
service to the over 100,000 customers and one million plus users. One result: HEAT, the
service and support solution from FrontRange, has a 98% customer satisfaction rating as
indicated by an independent survey.

We have a reputation for providing big-company solutions at prices that don’t exclude
small organizations. FrontRange has earned more than 60 major industry awards,
including: Software Magazine “Hot 500,” Windows Magazine "Win 100," Call Center
CRM Solutions Magazine Editor's Choice, RealWare Award for CRM, WinMag.com
WinList Award, Entrepreneur Magazine Best Software, Call Center Solutions Product of
the Year, and InformationWeek Top 50 Application Service Providers.

Rewarding strategy of FrontRange

FrontRange Solutions rewards its employees…

FrontRange Solutions' Total Rewards Strategy contains four key components to attract,
motivate and retain the best talent available in the marketplace:

Compensation:

FrontRange Solutions offers its employees a competitive pay package that provides:

- Compensation for satisfactory work (base salary, merit pay);

- Short and long-term incentives for achieving strategic business objectives;

- Rewards for specific individual or team achievements (bonuses, awards).

- Total compensation for an individual employee is determined by


four considerations: Internal value of an individual's position, as determined
through the position evaluation process. To ensure internal equity, positions of similar
or equal responsibility will be grouped in the same salary range or band. External
competitiveness, as established through market surveys of companies we compete
with for customers and talent.

Individual performance, as measured by the annual Performance Development Process


(PDP), which identifies individuals who should be considered for higher levels of
responsibility and pay.

Business performance, as measured through strategic business goals, such as earnings per
share, profit or cash flow. Local programs should complement FrontRange Solutions
overall pay philosophy and avoid duplication of global initiatives.

Benefits:

FrontRange Solutions aims to provide private benefits programs that supplement or


enhance mandatory plans available in the various locations where we do business. Our
programs serve two main objectives:

(1) To protect employees from risks (sickness, accidents, disability) that may result in
substantial economic loss; and

(2) To provide employees with retirement benefits (pension plans, savings plans, retiree
health care) that offer economic security after employment.
Our goal is to give employees a variety of benefits choices and to deliver these benefits in
a tax-effective, economical manner.

Development:

We believe in helping employees develop to their utmost potential. Given the unique
nature of FrontRange Solutions' business, we cannot rely on external recruiting as a
primary source of talent- so we have developed those critical skills internally.

Workplace Environment

FrontRange Solutions is committed to creating an environment that attracts and rewards


talented, ambitious people. Employment with our company is an enriching experience
that enables employees to achieve their highest potential. To that end, we will recognize
and reward teamwork, excellence and innovation, and will provide opportunities
consistent with these contributions.

We also foster diversity among our employees and value the broad spectrum of thought
and skills each person brings to FrontRange Solutions. Performance is measured in ways
that encourage reasonable risk-taking, foster an awareness of personal accountability, and
support standards and competencies consistent with FrontRange Solutions' basic values.

Overall, the relationship between our company and our employees is governed by respect
for the individual and a sense of personal integrity. FrontRange Solutions recognizes that
only when a company truly values people can it expect to be prized as an employer.

To the extent permitted by applicable law, FrontRange Solutions retains employees on an


at-will basis. Nothing in this website is intended to alter an employee's at-will status, or
create an offer or contract of employment.

Questions:

(1) Discuss the Rewarding Strategy of FrontRange.

(2) Discuss on the nature of pay package offered by FrontRange.

(3) What do you understand by the term employee benefits and throw light on the
nature of benefits provided by FrontRange to it’s employees.

(4) Discuss the importance of Workplace Environment with regard to reward


management.