What is Compensation?

The practice of compensation management goes far beyond the mere concept of attracting and retaining talented employees in the organization. Compensation management is the practice of the organization that involves giving monetary as well as non-monetary rewards to the employees, in order to compensate for the time they allocate to their job.

The use of compensation management is increasing as organizations have started to realize the need for leveraging its human capital in order to gain a competitive edge in the industry. Compensation management involves “maximizing the return on human capital.”

What are the types of Compensation?

Types of compensation include:

  • Base pay (hourly or salary wages) - Base pay is the initial payment you give your employees. The base pay rate is essentially the minimum amount an employee can expect to receive before taxes and other deductions. Base pay includes an employee’s base salary or hourly wages. It also includes shift differentials and pays for special assignments.
  • Sales commission - A sales commission is an additional compensation the employee receives for meeting and exceeding the minimum sales threshold. Employers pay employees a sales commission to incentivize the employees to produce more sales and to reward and recognize people who perform most productively.
  • Overtime wages - Overtime is the amount of time someone works beyond normal working hours. Overtime Wages is the money that is paid for working overtime.
  • Tip income - Tip income is tips received directly from customers. This can include cash tips or tips charged to a debit or credit card.
  • Bonus pay- Bonus pay is money you give employees beyond their existing base wages. Bonus pay is a type of supplemental wage.
  • Recognition or merit pay - Merit pay, also known as pay-for-performance, is defined as a raise in pay based on a set of criteria set by the employer. This usually involves the employer conducting a review meeting with the employee to discuss the employee's work performance during a certain time period.
  • Benefits (insurance, standard vacation policy, retirement) - Employee benefits and benefits in kind include various types of non-wage compensation provided to employees in addition to their normal wages or salaries. Instances where an employee exchanges wages for some other form of benefit is generally referred to as a "salary packaging" or "salary exchange" arrangement.
  • Stock options - A stock option gives an investor the right, but not the obligation, to buy or sell a stock at an agreed-upon price and date. There are two types of options: puts, which is a bet that a stock will fall, or calls, which is a bet that a stock will rise.
  • Other non-cash benefits

What are the components of a compensation structure?

There are 4 main components:

  • Base Pay Structure (Fixed component);
  • Variable Pay Programs;
  • Benefits;
  • Rewards & Recognition.

Component #1: Base Pay

Base Pay is the fixed component and generally consists of the following:

i. Basic Component: 

Normally 40 percent of the base pay is basic and the rest of the base pay falls under various other categories. This breakage is governed by the tax laws of the land. In India, for instance, if everything is given to an employee in the form of basic the whole shall be taxed, whereas if the base pay is broken into sub-components like HRA certain tax-exemptions may be obtained.

ii. HRA (House Rent Allowance):

Calculated as a percentage of basic. HRA limits are fixed by the government and are uniformly applicable. If a company decides to pay more than the limit decided by the company it can however the excess shall be taxed as is the basic. If a company pays HRA component then it must collect proofs of rent-paid (rental receipts) from the employee.

iii. DA (Dearness Allowance):

It is calculated as a percentage of basic. The payment of dearness allowance facilitates employees and workers to face the price increase or inflation of prices of goods and services. The onslaught of price increase has a major bearing on the living conditions of the labor.

The increasing prices reduce the compensation to nothing and the money’s worth comes down based on the level of inflation. The payment of dearness allowance, which may be a fixed percentage of the basic wage, enables the employees to face the increasing prices.

iv. Leave Travel Allowance:

Leave Travel allowance or LTA is paid by certain companies. However, again proof of travel expenses must be collected by the company from the employees.

v. Mobile Expenses:

Medical Allowance/Reimbursements, etc.

Component #2. Variable Pay Programs:

Variable pay programs are generally classified differently for sales and non-sales.

i. Variable Pay Plans for Sales:

Variable pay plans for sales represent a pay-mix that maybe a 70-30 or 60-40 or 50-50 plan. Here the 30, 40 or 50 represents the variable portion of the pay and is linked to the targets. Targets could be product-based, territory-based, revenue-based, and profitability-based or based on new business creation.

However, payment of the variable portion does not always follow a linear scale. Supposedly the target is USD 100 million of sales. It is possible that till USD 50 million there may be no variable pay. If the person achieves USD 75 million (threshold level) then he/she may get 50% of the variable portion growing up to 100% of the variable portion when he/she achieves USD 100 million in sales.

Variable pay plans do not come with an upper cap i.e. if the same guy exceeds USD1 100 million of sales will he get more than the plan as variable pay? Well, the answer is Yes! Generally, a person in a 50-50 plan makes up to 70% or 80% variable pay.

ii. Variable Pay Plans for Non-Sales:

Such pay plans are for those employees who either are those who need incentives to propel their work or are those whose performance can be improved by giving them incentives like insurance plans, credit cards, mutual funds, etc. Generally, the variable portion in non-sales is lesser than in the case of sales.

The variable pay is based on jobs and levels of job. Sometimes such plans may be covered under company-wide plans and the entire variable portion may be broken under employee performance, functional performance (i.e. performance of the function in which that employee works) and organizational performance.

The various variable-pay components very briefly have been discussed below:

a. Bonus:

Bonus is generally post-facto. The bonus can be paid in different ways. It can be a fixed percentage of the basic wage paid annually or in proportion to the profitability. The Government also prescribes a minimum statutory bonus for all employees and workers.

There is also a bonus plan which compensates the Managers and employees based on the sales revenue or Profit margin achieved. Bonus plans can also be based on piece wages but depend upon the productivity of labor.

b. Commissions:

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

c. Mixed Plans:

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

d. Incentives:

The incentive is clearly defined as target-related and upfront. Piece rate wages are prevalent in manufacturing wages. The laborers are paid wages for each of the quantity produced by them. The gross earnings of the labor would be equivalent to the number of goods produced by them.

Piece rate wages improve productivity and are an absolute measurement of productivity to wage structure. The fairness of compensation is totally based on productivity and not by any subjective factor. The CANTT productivity planning and Taylor’s plan of wages are examples of piece-rate wages and the related consequences.

e. Sign-on Bonuses:

The latest trend in compensation planning is the lump sum bonus for the incoming employee. A person, who accepts the offer, is paid a lump sum as a bonus. Even though this practice is not prevalent in most of the industries, Equity research and investment banking companies are paying sign-on-bonuses to attract scarce talent.

f. Profit-Sharing Payments:

Profit-sharing is again a novel concept nowadays. This can be paid through the payment of cash or through ESOPS. The structuring of wages may be done in such a way that, it attracts competitiveness and improved productivity.

g. Stock Options:

Stock options are given to employees for two primary purposes – one to have long-term interest of the employee and second to link individual performance to organizational performance.

Generally, stock options may be given under three categories:

a) ESOPs or Employee Stock Options;

b) RSUs or Restricted Stock Units;

c) ESPP or Employee Stock Purchase Plans.

a) ESOPs or Employee Stock Options:

Suppose an employee is given ESOPS in the following way – ‘A’, an employee is given 2000 stocks of Rs.100 (Grant price). He is allowed to sell 50% of the stocks after 2 years and the rest of the stocks after another 2 years. Let’s say after two years the price of the stock is Rs.110/- (vested price).

Then the employee actually gets only 1000 × 10 = 10000/- rupees only. In such a scenario if the price of the stock fell below 100/- rupees then the employee does not get anything. ESOPs worked well when stock prices were rising continuously. However when share prices started to drop then the relevance of ESOPs declined.

b) RSUs or Restricted Stock Units:

These are different from ESOPs. When stocks are given to the employees it is deemed at zero value. So whatever is the stock price the employee ends-up making some money. Taking forward the earlier example if after two years the price of the stock is Rs.90/- then the employee still gets 90000/- rupees, on trading his options.

c) ESPP or Employee Stock Purchase Plans:

This is more like a benefit. When the company is doing well then it gives an option for employees to purchase shares at a discount.

Component # 3. Benefits:

The benefits could be the ones that are legally-mandated ones or the ones that are ‘good-to-have’ for competitive-edge. The benefits may be monetary or non-monetary, long-term or short-term, free or at concessional rates and may include education, housing, medical, or recreational facilities, provided individually or collectively, inside or outside the organizational premises.

Rewards & Recognition.

1. Give Shout-Outs

Knowing you did a good job is one thing, but hearing it from your boss or the president of the company is even better. Public acknowledgement is a great way to inspire and motivate people while rewarding specific team members for a job well done. Email blasts, announcements at company meetings, and other company-wide correspondence is a great way to recognize employees. Plus, it’s totally free!

2. Offer fun projects or professional/personal development opportunities

There are always going to be some projects that everyone wants to do—but unfortunately, not everyone will be able to take them on. If you’re having a hard time deciding who should get these fun projects, try meeting them out as recognition. Additionally, if a hardworking employee wants to develop new professional skills or explore an interest (augmented reality, woodworking, foreign language, etc.), think about sponsoring them in a continuing education class or send them to a local conference.

3. Take them to lunch

Who doesn’t like a free lunch? Besides showing care, you’ll be giving them some one-on-one time they don’t typically get—a great chance to talk shop or get to know each other a little better. You can also take lunch TO your employees—catering for your team is a great way to show them you appreciate their efforts.

4. Distribute non-cash rewards

Want to thank someone for putting in a few extra hours on a tight deadline? You don’t have to open a can of worms that is monetary incentives to say thank you. Instead, consider giving a gift card to a coffee shop, scratch tickets, movie tickets, or other universally-appreciated gifts that will let them know you appreciate them while giving them a reason to have some fun.

Some managers have a stash of lottery tickets or gift cards on hand for just such occasions. They’re low cost, and your team will love both the recognition and the gift.

5. Loosen the reins

If everyone has been doing a great job lately, loosen up a bit. Test out some casual dress days, or take things a step further and offer some flexible work options. Why not let employees work outside or from home part of the time? Or, if someone has made extra contributions, let them head home a few hours early. This is an especially good gesture during the summer months.

6. Throw a competition, party, or potluck

Appreciation doesn’t have to mean direct praise—it can be a fun break from the norm as well. Consider throwing a baking or some other competition—something that will allow your team to show off their hidden talents. You could throw a pie potluck on March 14 for Pi Day, or allow your employees to bring their pets to work one day (just make sure the building doesn’t object). Team-based games, group baseball outings—get creative, there are so many options!

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