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Compensation & Benefits / Reward Management

(In addition to textbook and class-notes)

Definition of Reward Management

Reward management is concerned with the formulation and implementation of strategies and policies that aim to reward people fairly, equitably and consistently in accordance with their value to the organization. It deals with the design, implementation and maintenance of reward processes and practices that are geared to the improvement of organizational, team and individual performance. Reward management is not just about pay and employee benefits. It is equally concerned with non-financial rewards such as recognition, learning and development opportunities and increased job responsibility.

The Aims of Reward Management

Reward people according to the value they create; Align reward practices with business goals and with employee values and needs; Reward the right things to convey the right message about what is important in terms of behaviors and outcomes; Help to attract and retain the high-quality people the organization needs; Motivate people and obtain their engagement and commitment; Develop a high-performance culture.

A basic framework for Compensation/Rewards management Two broad divisions: Intrinsic Reward and Extrinsic Reward Within Extrinsic Reward, there are two types of Rewards: Financial (Monetary) and Non-financial (Non-monetary) There are basically two types of Financial Rewards: Performance-based and Membership-based. Examples of Performance-based Financial Rewards : Pay for working overtime; Commission; Incentives (Individual/Group); Performance bonus; Profit sharing; Gain-sharing; Merit-pay plan, etc. Examples of Membership-based Financial Rewards: Basic Pay (Wage/Salary); Special Allowances; House-rent allowances; Pay for time not worked; Retirement Benefits (Provident Fund, Gratuity), etc. Examples of Non-financial Extrinsic Rewards: Preferred office dcor/ furnishing; Accommodation; Flexible workschedule; Preferred leave; job-title; Conveyance facilities; Medical care facilities; Club membership etc. Examples of Intrinsic Rewards: Challenging/interesting job; scope for participation in decision-making; sense of recognition; autonomy; sense of responsibility, opportunity for growth, etc

Sometimes, the terms Direct Compensation/Reward and Indirect Compensation/Reward are used in this context. Commonly, Direct refers to (Wage/Salary + Incentives) and Indirect refers to (Fringe benefits + Perquisites) Page 1 of 19

Total Reward Concept: The concept that is followed in industry today (Class discussion and notes) The Significance of Total Reward
Essentially, the notion of total reward says that there is more to rewarding people than throwing money at them. A total reward strategy is critical to addressing the issues created by recruitment and retention as well as providing a means of influencing behavior: It can help create a work experience that meets the needs of employees and encourages them to contribute extra effort, by developing a deal that addresses a broad range of issues and by spending reward dollars where they will be most effective in addressing workers shifting values. Perhaps the most powerful argument for a total rewards approach was produced by Pfeffer : Creating a fun, challenging, and empowered work environment in which individuals are able to use their abilities to do meaningful jobs for which they are shown appreciation is likely to be a more certain way to enhance motivation and performance even though creating such an environment may be more difficult and take more time than simply turning the reward lever.

Benefits of Total Reward

The benefits of a total reward approach are: Greater impact the combined effect of the different types of rewards will make a deeper and longer-lasting impact on the motivation and commitment of people. Enhancing the employment relationship the employment relationship created by a total rewards approach makes the maximum use of relational as well as transactional rewards and will therefore appeal more to individuals. Flexibility to meet individual needs Relational rewards may bind individuals more strongly to the organization because they can answer those special individual needs. Winning the war for talent relational rewards help to deliver a positive psychological contract and this can serve as a differentiator in the recruitment market, which is much more difficult to replicate than individual pay practices. The organization can become an employer of choice and a great place to work, thus attracting and retaining the talented people it needs.

A well-conceived total rewards strategy should address the following elements:

Strategic perspectiveA total rewards statement begins with an articulation of the organizations values and strategy. A well-crafted reward strategy is clearly linked to the aims of the business. The written statement of total rewards philosophy is the place to be clear about where, when, and how links between business goals and rewards are made. Statement of overall objectivesThe reward philosophy should include statements that describe how the reward system will support the needs of the business and the companys customers, employees, shareholders, and other key stakeholders. This typically includes a delineation of the role of each reward element. ProminenceThe statement of total rewards philosophy describes the overall importance of pay relative to other tools that can focus and affect actions and decisions (e.g., shared values, job design, promotions, clear strategies, feedback, etc.). In addition, a well-crafted reward strategy will describe the degree to which rewards are expected to drive employee actions and decisions through variability, influence over outcomes (controllability), and the explicitness of the pay-for-performance link. Page 2 of 19

Performance measuresA total rewards strategy should clearly identify the performance criteria to be rewarded, the appropriate level of measurement (e.g., corporate, business unit, geographic region, workgroup, individual, etc.) for each and through which reward elements each will be recognized. Competitive market reference pointsThe total rewards strategy should describe the types of companies, industries, or other reference points that will be used as the basis for determining the competitiveness of the reward package. Competitive positioningThe strategy should also clearly describe the desired competitive position relative to the competitive reference points in the labor market. Ideally, the strategy also will define how the competitive positioning is expected to vary with performance or other criteria. Degree of internal equity and consistencyThe statement should address the extent to which the total rewards strategy will be applied uniformly throughout the company (i.e., to each function, team, geography, etc.), both horizontally and vertically. Communication and involvementThe strategy should define how much information about the reward programs will be disclosed and explained to employees. It also should outline the degree of participation that employees will have in the design and ongoing administration of the reward programs. This should include a clear delineation of where human resources responsibility for designing and managing rewards ends and managements accountability begins. The strategy also might define the organizations policy toward employee unions and works councils. GovernanceIf it hasnt already been defined elsewhere, the total rewards strategy should define the roles and responsibilities that various constituents within the organization will have in the ongoing administration and evolution of the reward programs.

Factors Impacting Reward Management Policies and Practices

There are a number of factors (Internal and External) which impact the Reward Management policies and practices of any organization. Some of the most common factors which apply to almost all organizations irrespective of business, size, location and other relevant parameters are: Organizations ability to pay (Financial condition, Business cycle, Growth stage etc) Organizations willingness to pay (Reward philosophy etc) Systems, structures and cultural practices in organization Productivity of workers/employees Bargaining capacity of trade unions Requirements of job Style and characteristics of management Demand of supply of skilled/competent workforce in the employment market Prevailing rate (Going rate) in the market Compliance to legislations (employment and company laws) linked to pay and benefits Prevailing macro-economic environment (PEST factors) Cost of living (Application of the concept of Minimum wage, Living wage, Fair wage) Any other relevant factor applicable to specific cases

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Cost To Company
CTC (Cost To Company) is a term commonly used in compensation/rewards management, in order to denote the amount of money spent by an organization to retain an employee for a specific time period (most commonly, a year). CTC is the total expense of the organization for an employee in terms of direct as well as indirect pay. Ideally, the nonfinancial or non-monetary components of the total compensation/reward package are supposed to be estimated in money terms and added to the financial or monetary components to arrive at a total figure for CTC. Some components of CTC are included in an employees take-home or net pay (after tax deduction and regular deductions) whereas some components are not part of the take-home pay. These are part of cost incurred by the company on an employee to retain the employee mostly in terms of fringe benefits/perquisites. The employees avail these benefits because of their membership to the organization or because of belonging to a certain position. Calculation of CTC is not restricted by any legal condition, so, practically every organization can include different combination of components in CTC offered to employees. Naturally, the manner of calculation might also greatly vary from designation to designation, within an organization, It is crucial for an employee to understand how exactly CTC is calculated for his/her position; otherwise, the quoted/offered CTC figure can be misleading sometimes. It is very important to note that the actual take-home pay at the end of the month can be substantially lower than the CTC, because of the way it is calculated and also, because of particular conditions. In spite of the difference among organizations in the way of calculating CTC, there are certain components which are most commonly included for calculating CTC, irrespective of organizational differences. They are: Base pay Dearness allowance (DA) House rent allowance (HRA) Conveyance allowance Medical allowance Leave Travel Allowance/Assistance or Leave Travel Concession (LTA/LTC) Vehicle allowance Telephone/Mobile allowance Special allowance * (Highly case-specific) Incentive or Bonus (If any, calculated as per company policy and practice)

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Most of the time, the above mentioned components are part of the take home pay (after tax deduction and regular deductions), but there are also some common components in CTC which are included in the calculation but the employees generally dont receive the sum in their pay. They are: Companys contribution to provident fund Reimbursements Insurance premium Medical care and facilities Transport facilities Subsidized meals Others # (Highly customized)

It is difficult to estimate what percentage of the CTC is actually an employees take-home pay, because of the difference and sometimes complications involved in CTC calculation. But, many industry observers and compensation experts advise to focus on take-home pay rather than CTC in order to assess the worth of a pay-package. Links:

Employment Laws Relating to C & B:

Employees Compensation Act,1923 Payment of Wages Act,1936 Minimum Wages Act,1948 Employees State Insurance Act,1948 Employees Provident Fund and Miscellaneous Provisions Act,1952 Maternity Benefit Act,1961 Payment of Bonus Act,1965 Payment of Gratuity Act,1972 Equal Remuneration Act,1976

Please study the basic objectives and stipulations/provisions of each of the above-listed acts from HRM/Law textbook

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Three essential concepts for fixing pay-level:

01. Minimum Wage The one which provides not merely for bare sustenance of life but also for the preservation of the efficiency of the worker. The minimum wage must also provide for some measure of education, medical requirements and amenities. (Regulated by legislation- Minimum Wages Act, 1948) 02. Fair Wage It is considered as fair if it is equal to the rate prevailing in the same trade and in the neighborhood for similar work. In a wider sense, it will be fair if it is equal to predominant rate for similar work throughout the country and for other trades in general. It can be fixed only by comparison with an accepted standard wage. Factors which are important in determining fair wage are: prevailing wage rate, productivity of workers, capacity to pay, level of national income etc. 03. Living Wage Which should enable the wage-earner to provide for himself/herself and his/her family not only the bare essentials like food, clothing and shelter, but a measure of frugal comfort including education for children, protection against ill-health, requirement of essential social needs, and/or measure of insurance against the more important misfortunes including old age.

Perquisite may be defined as any casual emolument or benefit attached to an office or position in addition to salary or wages. In essence, these are usually non-cash benefits given by an employer to employees in addition to cash salary or wages. However, they may include cases where the employer reimburses expenses or pays for obligations incurred by the employee. Perquisites are also referred to as fringe benefits. Broadly, perquisite is defined in the section 17(2) of the Income-tax Act as including: 1) Value of rent-free or concessional rent accommodation provided by the employer. 2) Value of any benefit/amenity granted free or at concessional rate to specified employees etc. 3) Any sum paid by employer in respect of an obligation, which was actually payable by the assessed. 4) Any sum paid by the employer for assurance on life of the employee or to effect a contract for an annuity. 5) Value of any other fringe benefit as may be prescribed.

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Salary income for the purposes of taxation and valuation of perquisites includes the pay, allowances, bonus or commission payable monthly or otherwise or any monetary payment, by whatever name called, from one or more employers, as the case may be, but does not include the following, namely: 1) Dearness allowance or dearness pay unless it enters into the computation of superannuation or retirement benefits of the employee concerned; 2) Employers contribution to the provident fund account of the employee; 3) Allowances which are exempted from the payment of tax; 4) Value of the perquisites specified in the concerned provision; 5) Any payment or expenditure specifically excluded. Source: Valuation of Perquisites By the Income Tax Department

Job-based and Competency-based pay

Source: Compensation (9th Edition) by Milkovich et al (9th Edition), McGraw Hill (2009) Compensation Management in a Knowledge Based World (10th Edition) by Henderson, Pearson India

---------------------------------------------------------------------------------------------------------------------------------------------------------------Development of pay structures follows either job-based or person-based approach. No matter the approach, the process begins by looking at people at work. Job based structures look at what people are doing and the expected outcomes; skill /knowledge/competency-based structures look at the person. However, the underlying purpose of each phase of the process, remains the same for both job based and person-based structures : 1) collect and summarize work content information that identifies similarities and differences, 2) determine what to value, 3) assess the relative value and 4)translate the relative value into an internal structure. If job-based approach is followed, job analysis (systematic process of collecting information about the job) is an essential exercise that has to be performed in the process. This will be followed by job evaluation. (Details omitted) More complex work requires pay systems that support continuous learning, improvement, and flexibility. Person-based structures hold out that promise. The majority of applications of skill-based pay have been manufacturing, where the work often involves teams, multiskills, and flexibility.

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(Details omitted) Competency is a combination of knowledge and skills required to perform an assignment successfully. Its attainment is evidenced by the ability of an individual to gather data, process it into useful information, assess it, and arrive at an appropriate and usable decision in order to initiate the actions necessary to accomplish that assignment in an acceptable manner. Competency based pay systems have been designed and used principally for employees in management and professional employment. In moving upward to the highest level of managerial and professional positions, the work performed becomes more and more influenced by the mission, policies and strategies of the organization. The time dimension related to work assignments moves from tactical, day-to-day operations to long term strategic operations. The work of those whose job influence and in turn, are influenced directly by organizational strategies can be defined only in general or generic terms. Competencies become useful for establishing base pay for employees in these kinds of work settings. To design a competency-based pay plan, it is necessary to identify the compensable factors, sub-factors with them and their respective degrees. Following is a list of universal factors and sub-factors. I. Knowledge Prerequisite for thinking and action for performing assignments necessary to produce acceptable output. A. Education Formal training necessary for the development of sufficient mental capabilities to perform assignments. B. Experience Amount and complexity of direct participation in interaction with and training in use of equipment, materials, technology , processes and systems necessary to perform assignments measured by time. C. Skill Dexterity, accuracy, alertness required relative to the flow of work or to levels of complexity in the use of and interaction with human and non-human resources in performing assignments.

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II. Problem-solving Applying knowledge through interpretation, compliance and communication to solve organizational problems in order to achieve desired levels of performance

A. Interpretation Analyzing and evaluating action-oriented instructional information b. Compliance requirements for following instructions or orders of varying degrees of complexity necessary for implementation and coordination of resources of the organization within limits of existing policies and precedents. C. Communication Transmitting directions, instructions, and suggestions in varying degrees of complexity necessary for the utilization and coordination of resources in the organization. III. Decision making Intensity, scope and complexity of interactions necessary to make decisions in order to achieve acceptable levels of performance. A. Interpersonal Empathetic understanding and effectiveness in interaction with others in such areas as teaching, counseling, coaching, training and development. B. Managerial Quantity and quality of supervision provided and received. C. Assets Degree of accountability for human and non-human resources in the planning, operations and control of the job.

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Designing a base pay structure

(Source: Compensation management in a knowledge based world (10th Ed) by R.I. Henderson, Chapter-11) Decisions that provide guidelines for the compensation manager to follow in developing a pay structure are made at the higher levels of the organization. These policy decisions include guidelines concerning the following: Minimum and maximum levels of pay (taking into consideration ability and willingness to pay, concern for profitability, government regulations, union influences and market pressures) The general relationships among levels of pay (between managerial and non-managerial cadre, among different levels of managementetc) Whether the pay structure should lead the market, lag the market, or lead-lag the market. The division of the total compensation amount (i.e. what portion goes into base pay, what portion into benefits, what portion into merit pay, and portion into pay-for-performance program)

Additionally, senior management decides how much money to allot for the total compensation package-that is, how much will go into pay increases for the next year, who will recommend them, and generally how they will be determined. In other words, will they be based on seniority, on merit, or on cost-of-living adjustments? If they are based on merit, what performance standards will be used and who will make the determination? Last, but, not the least, decisions made at this level determines the extent to which compensation policies are detailed and communicated throughout the organization. Although decisions made at the top seldom determine specific employee pay rates, they do set guidelines for compensation managers. From guidelines, these managers must consider the issues and make acceptable and workable determination concerning the following: 1. What is the lowest rate of pay that can be offered for a job that will entice the quality of employees the organization desires to have as its members? 2. What is the rate of pay that must be offered to incumbents to ensure that they remain with the organization? 3. Does the organization want to recognize seniority and meritorious performance through the base pay schedule? 4. Is it wise or necessary to offer more than one rate of pay to employees performing either identical or similar kinds of work? 5. What is considered to be sufficient difference in base rates of pay among jobs in a class series that require varying levels of knowledge, skills, responsibilities and duties? 6. Does the organization wish to recognize dangerous and distressing working conditions within the base pay schedule? 7. Should there be a difference in changes in base pay progression opportunities among jobs of varying worth? 8. Do employees have significant opportunities to progress to higher level jobs? If so, what should be the relationship between promotion to a higher job and changes in base-pay? 9. Will policies and regulations permit incumbents to earn rates of pay higher than established maximum and lower than established minimum? What should be the reasons for allowing such deviations? 10. How will the pay-structure accommodate across-the-board, cost-of-living, or other adjustments not related to employee tenure, performance, or responsibility and duty changes? With the generation of internal and external pay data and information, managers are able to design a pay structure. To do so, they must: 1) determine a trend or pay policy line, 2) decide on the need of one or more pay structures, 3) display job data, 4) establish the characteristics of the pay structure (number, width and height of pay grades and the overlap among them), 5) lock overlapping pay structures (when using more than one). These five technical features determine to a large degree the unique compensation characteristics of the organization. Above all, they tell employees how the organization values its jobs, what job and compensation advancement opportunities are available, and how competitive the pay practices are with those of other organizations. Page 10 of 19

Each organization must develop its own pay policy line, which is a trend line of best fit that best represents the middle pay value of jobs that have been evaluated or classified to have particular worth. The procedure most organizations normally follow in establishing a pay policy or trend line is to identify the market rates for various benchmark jobs that cover the entire pay spectrum from lowest to highest rates of pay. Whether more than one pay structure is needed must be established early by those responsible for structure design. A number of logical and rational considerations can be given for having multiple pay structures that focus on the forces that Influence the actual pay of the various occupational groups comprising most organizations. It is not unusual for large organizations to have at least three pay structure lines-one for blue-collar manual labor, another for white-collar salaried workers, and a third for managerial, administrative, and professional employees. Some organizations have a fourth pay structure for their highly paid executives. After identifying midpoint or market rates for the jobs of an organization and determining acceptable percentage progression between midpoints, the compensation designer is ready to develop pay grades. Pay grades are nothing more than convenient groupings of a wide variety of jobs or classes similar in work difficulty and complexity requirements but possibly having nothing else in common. Grades provide a connecting link between the evaluation and classification process and the assignment of pay to a particular job or class. A pay grade might provide for a single rate, or it can allow for a range of pay within a certain grade. Pay grades are an integral part of the ay structure. The top or maximum rate of pay in a pay grade states that this is the most that work produced by someone holding a job in this grade is worth to the organization. The bottom, on the other hand, places a minimum value on the contributions of the assigned jobs. The distance between the minimum and the maximum recognizes the range of performance and experience of incumbents in the assigned jobs. The number of pay grades to be included within a pay structure varies with the circumstances- no one number is correct. Therefore, compensation system designers and managers all face the same answer- it all depends. It all depends on the demands of the organization: what is acceptable to top management? What do employees perceive as fair? What is administratively practical? What best recognizes differences in job worth, employee behavior, and the opportunity to maintain a logical and rational control over wage payments? A pay structure with too many pay grades requires extremely fine distinctions among jobs (which probably cannot be made). On the other hand, too few grades result in failure or inability to recognize significant differences in difficulty, responsibility, or knowledge requirements among jobs and classes. Some behavioral scientists today are promoting the idea of using as few as four to six grades. (See the note on Braodbanding) The issues to be considered and the results of using a large number of pay grades versus using a small number are as follows:

1. Is there to be only one pay structure and will it include all jobs from the lowest entry-level job requiring minimum education, experience, and skill to that of the chief executive officer demanding a large amount of knowledge and skills to cope with the responsibilities of the job? 2. Is it desirable to have a small variation between pay grades? If this is the case and the organization has a single pay structure, then it would not be unusual to find 50 to 75 pay grades being used. If the number of pay grades is large, the overlap between pay grades will be large-in the vicinity of 75 to 90 per cent. 3. A small number of pay grades normally will result in less overlap between them. It also will require the assignment of more jobs to the same grade. Having fewer grades permits a greater spread, allowing increased recognition of growth of job knowledge through seniority and merit in grade pay increases. The larger the range is in a pay grade, the greater the opportunity is to vary pay of employees who perform in a different manner while doing the same job or equivalent kinds of work.

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The height (or y-axis dimension) of a pay grade is its spread. When establishing a spread within a pay grade, the first question is what the spread or height of the pay grade should be. As with most other compensation questions of this nature, there is no right or wrong answer. The range or spread of the range of a pay grade is the difference between upper and lower limits of the grade. The range can be expressed in absolute money terms or as a percentage. When expressed as a percentage, the range is: [(max limit- min limit)/min limit]*100= () %. Pay grade spread, like midpoint progression, van vary widely depending on pay policy and business practices. In many cases, the spread from the midpoint to the max rate of a grade and the spread from the midpoint to min rate of a grade are uniform throughout the structure. The major reason for uniformity is ease in explaining and justifying a basic fairness in the structure design. However, many compensation professionals believe that the spread of the grades should increase progressively. At entry levels, a typical spread is 10% on either side of the midpoint. At the middle level of management, the spread can reach 20%. The reasons for a narrow pay spread at entry level and a broader spread at the professional or managerial level are based on several philosophical considerations. (Related to time-span in job, scope to move to higher level, competency required, contribution to organization, criticality of job, influence on the character of job etc.) Procedures for establishing a pay grade width (x-axis dimension) are not as specific or precise as those related to the spread or height of the pay grade (the y-axis). The width dimensions are usually identical for each pay grade. Most organizations set the maximum and minimum rates of pay for grades in relation to demands they wish to make their pay systems. The spread of the pay range provides an opportunity to differentiate the pay received by the newly hired person, the probationary employee, the competent performer, and the excellent performer. The pay range also provides the opportunity to recognize extended and faithful service. The most practical method of establishing lower and upper limits for a pay grade is first to establish a midpoint line at a competitive level and then to determine what percentage of spread is required on either side of the midpoint to accomplish the objectives that can be attained through a well-designed pay grade. With the establishment of minimum, midpoint and maximum rates of pay, the next step is to determine whether the grade itself is to have a more detailed internal structure. Many pay grades have steps (slabs) within each grade. Organizations use in-grade step pay increases for a number of reasons. (Seniority, merit pay, contribution, COLA etc). The spread of a range within a pay grade may vary from 10% to 50% on either side of the midpoint of a pay scale. Normally, a range of 15 to 25 % on either side of the midpoint is common. With pressure to decrease the number of pay grades and to improve recognition of performance, pay ranges of 20 to 50% on either side of the midpoint are becoming more common. The size of each pay step within a pay grade may increase arithmetically (absolutely), geometrically (by a constant percentage) or randomly. In most cases, geometric increases are preferable. A deviation might be found in the percentage of increase between steps at certain points in the structure (the lower half of the structure may have a 30% spread within the pay grades and the upper half 50% or any other way). In this case, the structure may be called a split structure, or it might become two structures or substructures making up the major structure. If the midpoint and the desired percentage spread of the range to the maximum and minimum limits are known, it is a matter of simple arithmetic to identify the upper and lower limits of a pay grade. The actual range of a pay grade is frequently an amount arbitrarily selected by an individual or individuals with compensation policy decision making responsibilities. However, certain issues can affect the final value selected. If the range is small and the min or lower limit relates closely to the market, the entry rate of pay is more attractive to those looking for employment. The unsatisfactory side of the story is that when entry and max limits are too close, long term employees feel that the organization does not recognize their services and loyalty. To individuals in these pay grades, the compression of pay rates within the pay grade is unsatisfactory.

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Following the identification of the midpoint, upper limit, and lower limit of the pay grade, the next step is to establish the relationship between adjacent pay grades. The pay structure may have no overlap between pay grades (special case), or the pay structure can have overlapping pay grades. The overlaps between pay grades are those pay opportunities that are identical in adjacent pay grades. Pay grade 1 (PG1) and pay grade 2 (PG2) being two adjacent pay grades, the overlap percentage between PG1 and PG2 is calculated by the formula [(Max PG1-Min PG2) / (Max PG1-MinPG1)]*100= () % The difference in midpoints and the spread of the pay range then determine the amount of overlap between adjoining grades. An overlap of approximately 70% is not unusual between adjoining pay grades. A theory underlying overlap between pay grades is that the amount of overlap should equal the similarity of responsibilities, duties, knowledge and skills that exist among jobs in the adjacent pay grades. An overlap between pay grades provides an opportunity for the excellent performer in the lower pay grade who has long tenure (high seniority) to earn more than the new, less experienced person in a more senior pay grade. The philosophy here is that the skilled high performer in the lower graded job may be making a greater contribution than the less experienced incumbent in the higher grade. When there is minimal distance between midpoints (less than 5%) and the grades have limited spread (15-25%), overlap will extend for a number of grades. Some experts in pay structure design feel that overlap beyond three adjacent grades four grades in total-should be avoided. A major problem with pay grades that have a large overlap is that an employee already in the upper end of a pay grade who receives a promotion to a job in the next pay grade-even a promotion that results in an advancement two or three grades up the pay structure-may not receive much of pay increase or have an opportunity to increase the amount of future pay. Many compensation policy decision makers feel that in order for a promotion to have a true incentive value, it should carry with it at least a 10% increase in pay. This is one of the major reasons for the warning that in a welldesigned pay structure, no overlaps should occur between pay grades that are four grades apart. An opposite situation arises when there is little or no overlap between pay grades. When an employee receives a promotion from one pay grade to another, the increase in the employees rate of pay to just the minimum of the new grade is so large that it exceed pay policy requirements. Some organizations have a cap (limit) on any pay increase an employee can receive at one time. It is possible for an employee to be promoted to a new job in a pay grade considerably higher than the one occupied at present and have the cap on the pay increase prohibit that employee from immediately receiving the min level of pay for the new job. This same situation can occur when the pay structure has grades with little or no overlap. The term green circle applies to any incumbent receiving a rate of pay below the minimum of the pay grade. It is extremely difficult to explain to a promoted employee why he/she is receiving less than the min rate of pay of the pay grade. Some organizations pay newly hired employees with no experience rates 10 to 20% below the established min rate. Some organizations provide super seniority pay increases to employees with long tenure. These super-seniority pay increases may place the employees in a pay step that extends beyond the max of the pay range. The term silver circle identifies an incumbent in a super-seniority pay step. Some organizations also allow for merit increases that could extend the pay of incumbents beyond the established max. The term gold circle identifies incumbents receiving this kind of in-step pay increase. In cases of changes in pay structure architecture or demotion, some employees may be receiving rates of pay higher than the max of the assigned pay grades. Pay policies may state that these employees should receive no further increases until their rates of pay are within pay structure. Employees receiving these above max rates of pay are called red-circled employees, meaning their rates of pay are red-circled.

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Mature organizations with many high seniority employees frequently encounter a problem called running out of range. In this case, an organization finds that a large number of its employees are at the top of the pay range, and morale suffers as they realize there is little or no opportunity for further increases. This problem has no easy answer. One solution may be some kind of 10-year, 15-year or 20-year seniority cash bonus. Another solution is to ensure real income maintenance by some kind of COLA. Some organizations with many senior employees who are at the top of the pay grade-topping out-feel that these employees are worth more to the organization than their job related skills indicate. At times, organizations facing this issue add one or more super-seniority steps to the pay grade. This pay above the max of pay grade indicates high value of the jobs within the assigned pay grade. Super-seniority payments recognize the value and worth of the individual to the organization. This value and worth can go beyond job-related contribution to organization-related contributions. A possible solution to the market pay demands for the job in high demand-the exotic job-where the internally evaluated worth of the job is out of line with the market demand rate, is to establish a shadow range. If the vertical lines of the pay grade are extended, the exotic job can be paid at a higher rate than that normally paid to jobs of comparable worth to the organization but still can be placed in the proper internal worth dimension (the appropriate pay grade). This response to the pay demands of the exotic job is not a cure-all, but it does provide an alternative way of handling a difficult problem (the jobs having a market worth that is out of line with internally equitable considerations). If and when the demand of the job decreases, administrative efforts can be taken to place it within the proper limits of the pay grade. Current examples of exotic jobs are those found in the information technology field.

(Source: Compensation Management in a Knowledge-Based World, 10th Ed, by Henderson) In the 1990s, broadbanding became a major tool of the compensation specialist involved in the redesign of pay plans. Braodbanding has variety of definitions, but one that is commonly used is that it is the grouping of jobs of significant differences or worth or value within one band. This pay grouping or expanded pay grade might have a range varying from 50 percent to more than 100 percent and include jobs that have responsibilities and duties that vary in complexity and difficulty and require significantly different kinds of knowledge and skills. Through broadbanding, an organization can reduce the number of pay grades included within the pay plan. The rate of the lowest pay grade in the sector to the maximum rate of pay of the highest pay grade in the sector. A major developer and user of broadbanding has been Watson Wyatt Data Services. As they have become more involved in providing wage survey data on a global basis, the ability to perform job matching on a consistent worldwide basis has become a critical issue. Watson Wyatt developed a 25-grade pay structure that they merged into six Broad Grade Band Definitions: Top Management 1, Top Management 2, Middle Management, Professional/Administrative/ Junior Management, Clerical/Technicians, Manual/Junior Clerical. Broadbanding can be useful in designing a pay plan for organizations that make extensive use of teams. New team members with minimum levels of required knowledge and skills could be paid at the lower end of the band and as they acquire more knowledge and skills and perform more and different jobs or assignments or work at different workstations, their pay could be increased upward through the band.

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With the reduction in numbers and levels of management and the expanded authority of non-management workers through the use empowered teams, the authority and concomitant responsibilities of involved employees have expanded. Some management and compensation experts feel that it is unwise, possibly impossible, to identify and define precisely the work of an individual employee because the work requirements can change significantly over a relatively short period. These advocates of broadbanding state that it is not only unwise but impossible to make fine distinctions among jobs. Because the employee, within situational constraints, makes and defines the job, the boundaries of the job become hazy and difficult to establish. Because of the increased flexibility at the workplace, a pay structure that better reorganizes the dynamic situation is one that expands range and pay opportunities for the involved employees. By combining anywhere from three to eight pay grades into one band, workers can expand their knowledge and skill, successfully perform higher levels of assignments and increase their rates of pay with fewer bureaucratic procedures than those that must be followed to be promoted from one job to another in a higher pay grade. Broadbanding also has been used to give an immediate supervisor more authority to assign a rate of pay or give a pay increase to a subordinate. This transfer of authority reduces some of the bureaucratic control of the human resource department. This return of almost complete authority for subordinate pay increases to the immediate supervisor is, in reality, a return to pay practices of 50 or more years ago. The value of broadbanding is yet to be proved. It will take some time to establish its usefulness, cost benefits, and limitations.

How important is variable pay in driving performance?

(Experts comments from Society of Human Resource Management India) Currently variable pay forms a small portion of the overall reward mix in India; except for certain job functions like Sales where it is a large part of the earning by way of incentives and commissions. However, the fundamental change that has taken place in the past years is that in several organizations there is a uniform short term variable pay plan covering all employees (all management levels across functions). That is a remarkable change because firstly it recognizes that each function has a business contribution-direct or indirect and secondly, it reflects the changing mindsets in the direction of pay-for-performance. By designing a variable pay plan that comprises of measurable and valid performance criteria results in Creating a sense of individual responsibility within employees for the organizations progress Communicating that long term sustainable performance from employees will have monetary as well as nonmonetary rewards. Driving the values that the organization stands for, e.g. does it encourage teamwork through a team performance based incentive plan or does it promote individual excellence. Re-alignment the mindset of perceiving the performance linked pay as entitlement Strengthening employee belief that since the organization is focusing on investments in pay-for performance, there is an objective performance measurement process in place. Positioning the organization as a market competitive player which attracts individuals who are achievement oriented and confident of their ability to deliver.

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Source: Compensation Management in a Knowledge-Based World (10th Ed.) By Richard Henderson Pearson Education (2006).

Productivity Gainsharing Programs Productivity gainsharing is basically a sharing by the organization with employees of bottom-line improvements obtained through increased productivity. Gainsharing in this approach involves all or a significant number of employees in some kind of group sharing and total employee involvement. The purpose is to encourage employee involvement and commitment to improving the performance of the organization. Each member has the opportunity to conserve human and material resources. In addition, through the constructive use of innovation and creativity, better ways can be found to perform existing operations. By tapping the ingenuity of the entire workforce, it is possible to reduce costs through elimination of wasted materials and labor and also to develop new or better goods or services that strengthen the company and increase job security. Each cost-reduction plan provides a formula through which workers receive a share of the money saved as a result of improvement in work practices. A first requirement for a gainsharing plan is determination of a standard measure of performance. Once management and the workforce agree to a standard, it is possible to compare actual performances with the standard. The difference between the two is attributed to the efforts of workers and management. Because both groups have a direct impact on cost reduction, most gainsharing plans call for a sharing of savings. Some plans provide for a 50-50 split; others 67-33; and some may require that 75 percent of the total savings go back to the workers and that 25 percent remain in the company. To be successful, a gainsharing plan must have the complete support of senior management. Beyond mere approval of plan development and implementation, senior management must be certain that the plan is well conceived and executed. A gainsgaring plan must relate business objectives to the standards identified as improvement targets. It must recognize the need to provide data that may, in the past, have been considered top secret. The plan must consider the variables that affect these standards and the way the will be managed when they change sufficiently to have an impact on the credibility or viability of the plan. Some of the variables that can have an influence on the operation of a gainsgaring plan are these: New machinery, new equipment, or other technological changes Changes in methods, procedures or processes Product mix Raw material availability, quality and cost Labor cost Customer service requirements Delivery procedures Inventory policy Sales price of good or service Financing and funding patterns

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To develop a plan that has a chance to survive, thoughtful and lengthy planning must precede implementation. Some of the most well-known and widely used plans for gainsharing are- Scanlon Plan, Rucker Plan and Improshare Plan.

Profit Sharing Today, profit sharing is widely accepted as a fundamental part of the compensation program of more than 150,000 American businesses. Profit sharing has been defined by the Council of Profit Sharing Industries as any procedure under which an employer pays or makes available to regular employees, subject to reasonable eligibility rules, in addition to prevailing rates of pay, special current or deferred sums based on the profits of business. Essentially, three different types of profit-sharing plans are in existence today. 1. Cash or current payment plan, which provides for the distribution of profits relative to some predetermined division by either cash or company stock, or both, within a short period following the earning of the profit and the determination of the proportionate shares. 2. Deferred plan, which provides for the placement of earned funds into an escrow account for distribution at a future date (this plan usually provides the financial support for the pension program of the business). 3. Combined plan, which has the features of both. A major philosophical issue behind all profit-sharing programs is the need to educate employees on the importance of profit, the employees effect on profit, and how increased profits benefit them. A major weakness of many profit sharing plans is that once they have been incorporated into the compensation system, they become institutionalized: accepted as permanent, unchanging fixtures: and have little or no motivational impact, the rewards offered to the employee must vary with the success of the business. A clear relationship must exist between rewards and performance. For this reason, payment for effort must have as close a time relationship to the performance period as possible. Monthly or bimonthly bonus payments are excellent; quarterly, semi-annual, or annual payments are acceptable but certainly less a motivator unless the reward is large or has worker recognition and acceptance. Some of the successful profit sharing plans are: Lincolns Incentive System; plans followed at GM, Ford, Chrysler.


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ESOP is one of the monetary benefits offered by a company to its employees, when it offers its shares to employees. The employees, therefore, have an option of purchasing the companys shares, fixed at a price, which is commonly lower than the market price, termed as preferential price. It is a deferred compensation plan, distinct from being just another fringe benefit offered by organizations. It should be noted that sometimes, the companies offering ESOP to employees identify a minimum tenure at the organization (e.g. at least one year) before an employee could opt for ESOP. The organization may also offer ESOP to employees above a certain hierarchical level. It is not essential that ESOP is offered only at a preferential price. An organization can offer a certain volume of its shares to employees at the existing market price as well. If the organization is not a listed company, the management can still offer ESOP to employees at a fixed price. ESOP can be offered in different forms like Employee Stock Option Scheme (ESOS), Employee Share Purchase Scheme (ESPS), Stock Appreciation Rights (SAR) and Sweat Equity. A company can use more than one forms of ESOP for its employees. ESOS involves offering an employee the shares of the company at a predetermined price. As per SEBI regulations, An option is a right but not an obligation granted to an employee under the ESOP to apply for and be allotted shares of the company at a price determined earlier, during or within a specific period of time, subject to the requirement of vesting. IN ESPS, the company directly allots the shares to employees at the time of public issue. When ESOP is offered through SAR mode, employees benefit through the appreciation of companys shares in market after the vesting period is over. Sweat equity is a term referred to shares issued to employees as recognition to their key contribution or value addition to the company. In addition to this, there is one more option known as Phantom Stock. This is basically a bonus plan where employees are rewarded based on the raise in the value of the company stock, the dividend performance, or both. In the application of ESOP, the concepts of vesting period and exercise period are crucial. Vesting refers to the process through which the employees obtains the right to apply for and be issues shares of the company, according to the options allowed/offered to him. The period over which the vesting of the options allowed to the employee takes place is termed as vesting period. The vesting period can be a single time period, as well as a series of time periods. Depending on the nature the industry and company policies, it generally can be anything between two to five years. Exercise period refers to the time period after vesting within which an employee must exercise his right to buy the shares. After the lapse of this period, the employee may lose his right to exercise the options vested on him. When an employee sells or transfers the shares from ESOP, it is taxable. The gain made by the sale of ESOP shares is taxed in the same way as a capital gain is taxed. It can be a short term capital gain tax if sold within 12 months of acquiring the shares) or long-term capital gain tax (after 12 months of acquiring), depending on the time of sale. Obviously, the main impetus for the management of a company behind offering ESOP to employees lies in the conviction that part ownership of the company increases the loyalty and motivation level of the employee. By opting to accept ESOP, an employee becomes a part owner of the company, beyond being just a member of the staff. This should naturally lead to an improved sense of belonging and enhanced commitment on the part of the employee. As a result, organizations offering ESOP expect higher productivity and profitability in the long run. Going by this line of thinking, ESOP is one of the critical mechanisms that a company can exercise in order to retain a highly motivated and committed workforce.

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Six Dangerous Myths about Pay by Jeffrey Pfeffer (HBR, May-June 1998) 01. Labor rates and labor costs are the same things. No, they are not. Labor rate is expressed as wages paid divided by time (Wages /Time). Labor cost denotes how much a company pays its people and how much they produce. 02. You can lower your labor costs by cutting labor rates. Not really. Because Labor cost is a function of the labor rate and productivity of labor. Labor cost=f (Labor rate, Productivity). It is most likely that if you reduce labor rates, productivity will go down as well. So, the final impact on labor cost might not be desirable. Because of reduced productivity, one may have to employ more number of labor units. 03. Labor costs constitute a significant proportion of total costs. True-but only sometimes. In some cases, labor costs happen to be a substantial or even major segment of the total costs of production/operations. But its not the case always. In many cases, cost of capital, technology or any other resource can be higher than labor cost. 04. Low labor cost is a potent and sustainable competitive weapon. In fact, labor cost is perhaps the most slippery and least sustainable way to compete. It is better to compete through quality improvement, innovative products & services, customer care initiatives etc 05. Individual incentive pay improves performance. In reality, it undermines performance-of both individual and organization. It is not effective for long term performance improvement. 06. People work for money. People do work for money-but they work even more for meaning in their lives. Money is not everything in life.

Four decisions that relate to compensation How much to pay employees How much emphasis to place on financial compensation as a part of total reward system How much emphasis to place on attempting to hold down the rate of pay Whether to implement a system of individual incentives to reward differences in performance and productivity, and if so, how much emphasis to place on these incentives.

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