Compensation Management: Meaning, Components, Objectives and Factors Influencing It


Compensation management refers to proper management of compensation paid by company to its group of employees. It is a management concept where systematic and scientific approach is utilized for deciding employee’s compensation in fair, equitable and appropriate manner. The term ‘compensation management’ is all about establishing and implementing sound policies, practices and programmes of employee compensation. It mainly works on management, analysis as well determination of amount that employee will receive in the form of salary, incentives and benefit. Compensation management is many times also known as reward management, wage and salary administration, and renumeration management. This is key function performed by HR professionals and helps in attracting, retaining and motivating required personnel’s for any business enterprise. 

Compensation means the amount employees get in exchange for their contribution towards business organization. It is composed of both monetary as well as non-monetary benefits received by employees from their respective employer for providing services. Amount of compensation is major factor considered by employees for either staying with current employer or look for a new one. If employees do not receive right compensation for their jobs, then they tend to feel dissatisfied, demotivated and do not actively engage towards company operations. An effective compensation management ensures right payment of compensation that boost employee morale and engagement, ultimately resulting in organizational success. 

Components of Compensation

The compensation amount is made up of different components that are offered to employee for providing aid by employer. Such components are: 

  1. Wage and Salary- Wages and salary are two important components of compensation payable to employees. It is essential and found in renumeration package of every business organization. Wages mean renumeration paid to workers on hourly basis, whereas salaries mean renumeration paid to white-collar employees on monthly basis. Both of these are paid on the basis of fixed time period and are not associated with employee’s performance at particular time. 
  2. Allowances- Allowance refers to amount given by company to its employees within the set of rule and guidelines or for specific purpose. These are of various types and are paid in addition to basic pay. 
  • Dearness Allowance: Dearness allowance is meant to provide shield for employee real income against the rise in prices. It is paid as a percentage of basic pay. 
  • House Rent Allowance: It is paid by companies who do not offer living accommodation facility to their group of employees. This allowance is computed as percentage of salary.  
  • Transport Allowance/ Conveyance Allowance: Transport allowance is paid by company for accommodating travel expenses of employee from his house to work place. These are paid on monthly basis for covering up the travelling expenses. 
  • City Compensatory Allowance: This type of allowance is given to employees residing in big cities and metros where cost of loving is comparatively very high. It is generally a fixed amount paid on monthly basis such as 30% of basis pay for employees on government duties. 
  1. Incentives- Incentives are basically performance-based renumeration paid to employees with the motive of encouraging them to work harder and do better. These are paid on both individual as well as group basis. Sales commission, gain-sharing and bonus are few of the examples of incentive compensation. 
  2. Perquisites/ Fringe benefits- Fringe benefits include distinct types of benefits such as accident relief, medical care, canteen, heath and group insurance, pension, gratuity and provident fund. All of these are provided to enhance satisfaction level of employees working within the organization. Perquisites, on other hand, are facilities provided to personnel serving at managerial positions for facilitating them in job delivery or retaining them for longer period. It comprises company car, paid holiday trips, club membership, free accommodation, stock options and many more.  

Objectives of Compensation Management

Different objectives of compensation management are well-described in points given below: – 

  1. Acquire qualified personnel- Compensation serve as an important tool for attracting qualified personnel by business organization. Every employee before joining any organization gives top-most priority to their compensation policies. Level of pay should be decided in such a way that it should corresponds to demand and supply of workers in labour market. Also, many times companies need to come up with premium wages in order to attract employees working for some other venture. 
  2. Retaining current employees- Employees tend to shift their job more frequently if they are not happy with their compensation amount. Companies not maintaining a competitive level of compensation may face high rate of employee turnover. All employees provide their services to organization in return for a reward, and if it is not adequate then they may quit their job. Therefore, for retaining employees for longer term, it is must for business organization to keep its compensation level competitive in market. 
  3. Motivating personnel- Proper management of compensation helps in boosting the morale of employees. When workers get enough reward for their services then then feel satisfied and are motivated towards higher productivity. But in addition to benefits, monetary compensation also carries its own limitations in motivating peoples for higher productivity. Peoples for motivation also need promotion, acceptance, praise, recognition, status etc. besides money. 
  4. Controlling cost- A rational compensation system assists business enterprises in controlling their cost. The human resource department is able to obtain and retain workers at reasonable costs via proper management of compensation. There may be instances of workers getting overpaid or underpaid in absence of effective compensation management. 
  5. Ensure equity- Employee compensation need to be fair for retaining and motivating employees. Wage and salary administration, in order to attain fairness in wages, need to implement the principle of equity. The compensation management strives for attaining both internal as well as external equity. Internal equity implies paying as per the relative worth of job such that similar jobs get similar pay. On the other hand, external equity refers to doing payments to workers as per what other comparable workers are getting in another firms. 
  6. Comply with legal regulations- The compensation management of company need to mandatorily comply with all legal regulations. A sound wage and salary system always take into consideration the legal challenges posed by government and make sure that employees also comply with the same.  
  7. Reward desired behaviour- A compensation plan should be designed in such manner that it reinforces the desired behaviour of employees. It should serve as incentive for all such behaviours to reoccur in future. Right compensation plan always rewards performance, experience, responsibility, loyalty and other behaviours. Therefore, effective management of compensation is must for rewarding all desirable behaviours of worker.
  8. Consistency in compensation- Compensation management enable companies to attain consistency (both internally and externally) in compensating employees. Internal consistency involves paying employees on the basis of their performance level and job criticality. It means higher compensation will be paid to high-level jobs and also who are high performers in the same job.

Factors influencing the management of compensation 

The factors influencing the compensation management are as follows: – 

  1. Organization’s ability to pay- Business organizations pay wages to employees in accordance with their ability to pay. Higher the sales of company, higher will be its profit level and will tend to pay high wages as compared to those earning low level of profits. The economic influence on pay ability is nil, in short run. All employers regardless of their profit level, must not pay employees less than their competitors and also not pay more if they are willing keep and attract workers. The ability to pay is of utmost importance in long run.  
  2. Demand and Supply of labour- The demand and supply of labour carries great influence on the price to be paid to workers. When demand for particular set of skills is high and demand is low, then there will be rise in price to be paid for these skills. On the other hand, if demand for workforce skill is low and supply is high, then wages will be relatively low.  
  3. Cost of living- Cost of living implies payment of wages as per the cost-of-living index. It is termed as automatic minimum equity pay criterion. According to this pay criteria, adjustments need to be done in wages as per the increase or decrease in acceptable cost of living index. With the rise in cost of living, trade union and workers make demands for adjusted wages for offsetting the real wages erosion.   
  4. Prevailing market rate- This pay criterion is also known as ‘going wage rate’ or ‘comparable wage’ and is mostly widely used by companies nowadays. Organization adopting this pay criteria tends to conform to wage rate payable by community and industry. It is done for several reasons. Firstly, competitors need to adhere to same relative wage level prevailing in market competition. Secondly, the adoption of uniform pay rate is made attractive proposition by distinct government laws and judicial decisions. Thirdly, it is also encouraged by trade unions so that all members get equal pay, equal work and all geographical variations get eliminated. Forth, firms engaging in same industry and carrying related functions need to have same quality of workforce having similar skills set and experience. This results in consideration of wages and salary rate uniformity. Therefore, if companies do not adhere to same wage rate as adopted by their competitors in market, then they won’t be able to attract and retain sufficient quality as well as quantity of workforce. 
  1. Bargaining power of Trade unions- The wage rate also gets affected by trade unions. Generally, stronger the power of unions, higher will be the wages. The power of trade union is measured in terms of its membership, nature of leadership and its financial strength. Strike or threat of strike is regarded as most powerful weapon of employee’s union. Manytimes the trade unions force wages up much faster as compared to rise in productivity and may leads to unemployment, high prices and inflation.
  2. Job requirements- The wage rate is generally decided according to the criticality of jobs. More difficult the job is, higher will be the payment of wages. Organizations utilize the measures of job difficulty for ascertaining relative value of job to another. The jobs need to be grade in accordance with relative skills set, responsibility, efforts and job conditions requirement.    

Leave a Comment