Effective Compensation Management for Competitive Advantages:

Study of Indian IT Sector

Pankaj M Madhani

Associate Professor
IBS, Ahmedabad, India

Introduction
With liberalization of government policies in the 1990s, the Indian information technology (IT)
and IT enabled services (ITeS) industry has prospered and now employs more than three million
people across India and contributes to 6 percent of Indian GDP. IT sector includes packaged
software, IT services and IT training while ITeS includes all business processes being outsourced
or off shored by foreign companies facilitated by Internet, telecom and similar means. 30% of
firms worldwide who have reached Level 5 of Capability Maturity Model Integration (CMMI)
are Indian IT/ITES firms (NASSCOM Deloitte, 2008). From being a mere $2 billion industry in
1994-95, the Indian IT and ITeS industry has grown phenomenally over the years and is
expected to touch $72 billion by 2010. As many as 400 of the Fortune 500 companies now either
have their own business process or IT centers in India or outsource their business processes or
IT to Indian technology firms (NASSCOM, 2005).

Performance of IT firms is negatively influenced by increased market competition, rising wage

bills, reduced IT expenditure due to downturn of business cycle in developed economy such as
US and Europe, and protectionist measures taken by the US government with regard to
outsourcing for safeguarding their local jobs impacted by severe recession in US. Indian IT firms
have stiff competition in the value chain from foreign IT consulting firms present in India like
Accenture, Deloitte, IBM, MphasiS, and Sapient. Since, the beginning of the business cycle
downturn or recession in the US in December 2007, more than 6.5 million jobs have been
‘downsized’, with the number expected to grow in the near future (Krugman, 2009). According
to the U.S. Bureau of Labor Statistics, from December 2007 through July 2010, the total number
of ‘mass layoff’ events (seasonally adjusted) in the US was 63,461. In 2009 alone, 25,695 ‘mass
layoff’ events were recorded, involving more than 2.5 million job losses. To increase local
availability of jobs during recession period (with unemployment rate of over 9 per cent), US
government has taken many protectionist steps which have harmed the interest of Indian IT
firms. Recently, Ohio state government banned IT outsourcing by government departments to
offshore locations such as India. In August 2010, the US has steeply increased the fees (by
almost doubling the application fee to about $4,300 from $2,300) for H-1B and L1 visas, sought
by Indian professionals and IT firms. According to NASSCOM, the hike in fees is expected to
put an additional burden of $250 million annually on the Indian IT firms.
______________________________________________________________________________

Madhani, P. M. (2011), “Effective Compensation Management for Competitive Advantages:

Study of Indian IT Sector”, Journal of Science, Technology and Management, Vol. 3, No. 4, pp.
29-42.

Electronic copy available at: http://ssrn.com/abstract=1881383

Compensation cost accounts for nearly 50 per cent to 60 per cent of total revenue for Indian IT
firms. Increased pressure to enhance performance and profitability have motivated human
resources (HR) managers of IT firms to identify and implement effective compensation plans for
their employees. Restructuring fixed and variable pay in the pay mix helps firms in maintaining
proper leverage ratio for mitigating adverse impact of contraction phase of business cycle such as
recession. The pay mix is defined as the extent of variable pay and base salary in an individual’s
compensation package. This article provides a conceptual framework for properly designing pay
structure and explains with the empirical analysis fixed and variable pay relationship for
effective compensation management in the IT firms.

Significance of Compensation Management in IT Firms

Indian IT sector is a knowledge based industry. Major resources of IT industry are intangible (i.e.
human capital). Human capital has long been considered as a critical resource in most firms
(Pfeffer, 1994) and represents the knowledge, skills and capabilities of individuals (Coleman,
1988). Investment in human capital significantly increases the valuation of the firm over a long
term (Ulrich & Lake 1990). Firms with greater investment in and utilization of human capital,
experience higher level of performance (Hitt et al., 2001). The selection, development, and
retention of human capital, is vital for building and sustaining a firm's inventory of knowledge
(Levinthal & March, 1993).

As HR managers strive to pursue excellence with their recruitment, selection, training, and
compensation interventions, it is increasingly important to demonstrate that their comprehensive
efforts add value to the organization. HR managers are always in search of ways to motivate and
reward employees of the organization, which in turn will increase their motivation, performance,
and productivity level. One primary HR tool that is used to influence motivation and
performance level is compensation management (Lawler, 1971). As compensation plan is a
strong communicator between an organization and its employees, its success or failure can
ultimately have great impact on the overall success of the organization (Hill, 1993). Furthermore,
compensation plan is a powerful communicator of organizational goals and priorities across all
levels in the organization; therefore, organizations that expect to be more successful must make
employees partners in their success (Schuster & Zingheim, 1993).

The main purpose of compensation in any firm is to:

1. Recognize and reward the role fulfilled by the employees.
2. Align the pay opportunities of the employees with the long-term revenue and profit
objectives of the firm by creating an environment of mutual trust and confidence.
3. Attract, retain and motivate the employees in the firm.

Compensation plans are one of the most effective tools to positively influence IT firm
performance and ensure that individual performance is aligned with corporate goals. IT project
team’s performance is affected not only by factors specific to them such as IT specific skills and
aptitude of team members, but also by other organizational factors such as performance based
reward structure. Since, compensation strategy in an IT firm is a complex phenomenon driven by
many internal and external factors, designing a compensation plan is an art and not pure science.

Electronic copy available at: http://ssrn.com/abstract=1881383

It is also strategic in nature since it will affect motivation of the employees and profitability of
the IT firm. Compensation plans of organizations are strategically designed when rewards are
linked to activities, attributes and work outcomes that support the organization’s strategic
direction and strategic goals (Howard & Dougherty, 2004). Properly designed and deployed
compensation plans drive superior performance of employees, thereby achieving and even
surpassing performance targets of firms without crossing compensation budgets.

Consequently, it is not surprising that IT firms spend significant time and effort designing reward
structures to boost performance of employees. The key to motivating employees who help realize
the organization’s goals lies in how the organization’s incentives and pay structure relate to their
goals. The main goal of an HR manager in an IT firm is to hire high quality and competent
employees, who can help the firm to earn as much revenue and profit as possible. Once
employees have been hired, inducted, and trained, HR managers need to find a way to motivate
them. Most organizations motivates their employees, by rewarding their achievement and perfor-
mance through an appropriate compensation strategy.

Indian IT Sector: An Export Driven Business Model

Indian IT industry is characterized by high growth largely through exports to various

international markets (Arora et al., 2001). Exports have been a main focus of the Indian software
industry and a major source of revenues (Sahoo & Patnaik, 2009). At present, the Indian IT
industry gets over 60 per cent of its sales revenue from the US. Europe accounts for about 20 per
cent of its revenue while the rest 20 per cent comes from Latin America, Middle East and other
destinations (NASSCOM). It had an annual compound growth rate of over 50 per cent per year
from 1994- 99 (Nirjar & Tylecote, 2005), and grew 250 per cent between 1999- 05 (Mathur,
2007). IT exports accounted for 72 per cent of total IT industry sales between 2000- 01 which
grew from $131.2 million in 1990 to $7.8 billion in 2001- 02 (D’Costa, 2003). In 2000, more
than two-thirds of the IT industry’s sales were due to export sales, while it climbed to nearly 80
per cent of industry sales in 2001- 02 (Athreye, 2005a). The number of firms in the IT industry
has also grown over time. According to Athreye (2005b), there were 420 firms in 1994-95, 900
firms in 1996-97, 948 firms in 1999-00, and 1,828 firms in 2000-01. According to NASSCOM,
the IT-BPO export revenue could reach to $175 billion by 2020. The growth of domestic and
export revenue of India IT firms between 1993- 06 is given at Table -I.
 Table-I: The Growth of IT / ITeS Revenues in India, 1993- 2006

40.00

30.00 Exports Total $ Billions

IT / ITeS Revenue

20.00

10.00

0.00
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Exports 0.33 0.49 0.73 1.09 1.76 2.60 3.96 6.22 7.65 9.88 12.90 17.70 23.60 31.30

Total 0.56 0.84 1.22 1.76 2.94 4.01 5.54 8.30 9.96 12.46 16.70 22.60 30.30 39.70

Year

(Source: Madhani, 2008)

Enhancing Competitiveness of Indian IT Firms through Effective Compensation

Management

The term ‘cycle’ is used to explain a process that moves in sequences between a series of clearly
identifiable phases in a recurrent or periodic pattern. When such a pattern is exhibited in the
overall level of economic activity, it is called the ‘business cycle’ (Hamilton, 2005). The
business cycle is the upward and downward movements of levels of gross domestic product
(GDP) and refers to the period of expansions (recovery and growth stages) and contractions
(recession and slump stages) in the level of economic activities (business fluctuations) around its
long-term growth trend, as shown in Figure 1.
 Recession
Growth trend
Growth

Output
Recovery
Slump

Time
Figure 1. Typical business cycle and its different stages

(Source: Chart compiled by author)

Business cycle has a significant impact on the sales and profitability of the firms and directly
influences overall compensation costs. Business cycle phases are characterized by changes in the
dynamics of the economy. In particular, expansion phases are periods when economic activity
tends to trend up such as recovery and growth period, whereas contraction phases are periods
when economic activity tends to trend down such as period of recession and slump (Madhani,
2010a). Understanding these phases has been the focus of management researchers to mitigate
negative impacts of business cycle on the IT firms. Indian IT firms need to make sure that their
compensation package will be in line with a continuous changing business environment. A
business cycle portrays the kinds of changes that occur to the performance of the organization in
the terms of product demand and sales revenue, it can become a valid framework for integration
of performance management and compensation strategy of the organization. Business cycle is an
integral part of any IT firm, and coping effectively is also a part of the managerial decision-
making process. An effective compensation plan is not only about making the right decisions
about compensation structure but also about making timely decisions.

According to the competitive theory, firms must use their resources to cope with and exploit their
environment in order to attain competitive advantage (Porter, 1980). One method for moving
towards a competitive advantage is to create strategies that anticipate and respond to
environmental changes. Applying this principle to compensation management, an organizational
strategy for attaining competitive advantage is implementation of variable pay compensation in
pay structure to protect a firm against declining profits (Gomez-Mejia & Balkin, 1992). The
variable compensation strategy follows Porter's framework because it allows the organization to
flexibly respond to anticipated demand variations, rather than be forced into a more radical
response, such as large scale cyclical layoffs by firms during period of recession. The variable
pay compensation strategy may protect employees against cycles of layoffs by providing a buffer
against short-term financial pressure, allowing a firm to cut compensation costs in difficult times
and to pay employees more when it is in a better financial position (Balkin & Gomez-Mejia,
1987).
Significance of Operating Leverage and its Impact on Firm’s Operating Performance

Operating leverage (OL) is the extent to which fixed costs are used in a firm’s operations. OL is
a measure of risk and opportunity. The OL is computed as the contribution margin (CM) divided
by before-tax profit (EBIT). Mathematically,

CM
Operating leverage =
EBIT
Where,

CM = Sales − Variable cost

Hence,

Sales − Variable cost

Operating leverage =
EBIT

If a high percentage of the firm’s total costs are fixed costs, then the firm is said to have a high
degree of operating leverage (DOL). DOL is defined as the percentage changes in earnings
before interest and taxes (EBIT) that result from a percentage change in units sold (Sales). DOL
is the degree to which a firm or project relies on fixed costs (fixed costs act like a lever in the
sense that a small percentage change in operating revenue can be magnified into a large
percentage change in operating cash flow). Mathematically,

% ∆ EBIT
DOL =
% ∆ Sales

Other things being equal, the lower the DOL for the firm, the lower the chances for loss with a
decrease in sales. For example, DOL of 4 will mean a 80 per cent reduction in profits due to 20
per cent decrease in sales, and in that order, DOL of 3 will mean a 60 per cent reduction in
profits due to 20 per cent decrease in sales.

The risk associated with an investment increases as operating leverage (i.e., fixed costs)
increases (Lev, 1974) because the cash flow associated with an investment which is equal to its
total costs (i.e. fixed and variable costs) subtracted from its sales revenue, carries more downside
risk (i.e., risk when sales revenue falls) when fixed costs are high. Business risk is the
uncertainty associated with organization’s operating environment and reflected in the variations
of operating income and hence, has a negative impact on the profitability of a given organization
(Madhani, 2010b). Business risk is greatly influenced by the amount of fixed costs used in a
firms operation. Generally, the greater the reliance on fixed costs, the lower the variable costs
and vice versa. When this concept is applied to compensation management, fixed cost of the
organization increases only when base salary is used in compensation structure. However, when
a portion of employee salary is tied to firm’s performance, employee costs will be lower when
the firm has less ability to pay and higher when ability to pay is higher (Gerhart & Milkovich,
1990). Hence, when a group of employees is paid under a variable, rather than fixed
compensation system, strategy of maintaining employment stability in the firm is a less risky
proposition (Gerhart & Trevor, 1996).

The DOL is directly proportional to a firm’s level of business risk, and therefore it serves as a
proxy for business risk. Hence, as shown in Figure 2, proactive IT firms will employ strategy of
reducing OL when business risk is high especially influenced by external factor such as business
cycle contraction phase or recession.

Fixed pay / Total Pay

High Low

Low High

Proactive

Competitive Advantage
IT firms
Business risk

Passive
IT firms

High Low

High Low
Operating leverage (OL)

Figure 2. Relationship of business risk and operating leverage (OL) during business cycle
(Contraction phase)
(Source: Matrix developed by author)

However, passive IT firms do not change their OL and pay mix by restructuring fixed and
variable pay hence; they continue to misalign OL with business cycle. Passive IT firms continue
to give higher level of pay and higher proportion of fixed pay in pay mix even after economy
enters in recession and revenue of IT firm declines. Hence, passive IT firms have high OL during
recession period. Economic slowdown such as recession necessitates a rapid response, so
proactive IT firms restructure their cost structure by reducing fixed cost and increasing variable
cost. This way, proactive IT firms reduce OL and business risk and hence, enhance competitive
advantage. Passive IT firms, fail to recognize the changing dynamics of external environment
and hence continue to lose value to more nimble, proactive IT firms.
Hence, when a group of employees is paid under a variable, rather than fixed, compensation
system, it provides better fit between pay mix and business cycle contraction phase (i.e.
recession). As variable pay reduces OL, it also reduces misfit between OL and business cycle
contraction phase (i.e. recession). This is shown in matrix of Figure 3.

Low Low
Proactive
Misfit of operating leverage (OL)

IT firms
Low fixed pay &
(Contraction phase)
and business cycle

operating
leverage

Passive
IT firms
High fixed pay &
operating
leverage

High

Low High
Fit of pay structure and business cycle
(Contraction phase)

Figure 3. Relationship between fit of pay structure and business cycle and misfit of
operating leverage (OL) and business cycle (Contraction phase)
(Source: Matrix developed by author)

Rising Cost of Compensation in Indian IT Firms: An Analysis

According to Hewitt Associates, IT salaries in India have experienced phenomenal growth.

Wages of Indian IT professionals are growing rapidly at a time when competitive pressure is
pushing billing rates downwards. In the process, they have been closing the gap between India
and other emerging IT destinations (Madhani, 2008). Other low cost developing nations such as
China, Philippines, Russia and Eastern European countries are aggressively developing their
language and technical skills and looking to replicate the low cost Indian model.

Employee compensation in IT firms has been increasing over the last few years and accounts for
nearly 50 per cent to 60 per cent of total revenue for IT firms. IT sector is badly affected by high
attrition rate. Attrition rate of 20 per cent to 25 per cent is very common in the Indian IT sector.
This problem gets compounded when a firm invests significant resources in training the
employee. High attrition ultimately leads to higher cost to the IT firm for hiring and training of
new employees. As Indian IT firms depend heavily on US economy, recession in the US
economy will have a tremendous impact on the businesses of Indian IT firms as US firms cut IT
budgets during a down cycle. The slowdown in the US financial service dampened the hiring of
employees by top Indian IT firms in 2008-09 but employee cost, which contributes the most to
overall cost of IT firms, rose heftily in the second quarter as shown in Table -II.

Table II: Rising Compensation Cost of Indian IT Firms

IT Firm Compensation Cost Increase Net Employee Increase /

(Rs Millions) (per cent) Addition Decrease
Q2 Q2 Q2 Q2 (per cent)
2008-09 2007-08 2008-09 2007-08
Satyam* 17210 13020 33 1814 3037 -40
Wipro 26170 19520 34 1877 6096 -69
Infosys 27690 21990 26 5927 4530 31
TCS 24690 19350 28 5238 9268 -43
Total 95760 73880 30 14856 22931 -35

* Now Mahindra Satyam

(Source: Summarized by author with data collected from Annual Reports)

The combined employee cost for the top four IT firms increased by nearly 30 per cent to Rs
95760 millions in the second quarter of the 2008-09 with Rs 73880 millions in the corresponding
quarter of 2007-08. On the contrary, net employee addition declined by 35 per cent to 14,856 in
the second quarter of the 2008-09 compared with 22,931 in the corresponding period of 2007-08.
As compensation cost of IT firms has increased considerably, it is imperative for IT firms to
reduce it through effective compensation management.

Enhancing Competitiveness of IT Firms through Effective Compensation Management: An

Illustration

Restructuring of fixed and variable pay in compensation structure offers HR managers enough
flexibility to deal with market variability and economic changes such as business cycles. To
illustrate the impact of variable compensation on OL and Breakeven point (BEP), assume that a
during period of recession, an IT firm employs technical support staff for service contract on a
fixed salary of $80,000 (base case). BEP is a no loss–no profit situation and is computed as total
fixed cost divided by unit contribution margin (CM).

With beginning of recession, proactive IT firm takes proactive actions to change cost structure
from fixed to variable pay. Hence, firm employs an IT employee on a variable pay to reduce
fixed cost. The variable portion of compensation costs grows larger only if the firm’s revenue
grows larger. Accordingly, proactive IT firm employs an IT employee on a commission-only
basis at 20 per cent commission on sales. Hence, the unit variable cost for the proactive IT firm
increases from $3 to $5, whereas its fixed cost decreases from $190,000 to $110,000 (Table III).
 Table III: Restructuring Fixed and Variable Pay of an IT Service Firm: An Illustration

Global Recession
No.
Calculation Proactive Passive
Base case IT Firm IT Firm
1 Annual IT Contracts 4000 3600 3600
2 Decline in annual contracts due to global recession (per
cent) -10 -10
3 Unit charge of annual IT contract ($) 100 100 100
4 IT contract sales revenue ($) = (1) x (3) 400000 360000 360000
5 Unit variable cost ($) 30 30 30
6 Variable cost = (5) x (1) 120000 108000 108000
7 Fixed pay ($) 80000 0 80000
8 Other fixed overhead ($) 110000 110000 110000
9 Total fixed cost ($) = (7) + (8) 190000 110000 190000
10 Sales revenue commission (per cent) 0 20 0
11 Variable pay cost ($) = (4) x (10) 0 72000 0
12 Total variable cost of IT contract ($) = (6) + (11) 120000 180000 108000
13 Total variable cost /IT contract ($) = (12) / (1) 30 50 30
14 Unit contribution margin ($) = (3) – (13) 70 50 70
15 Contribution margin ($) = (14) x (1) 280000 180000 252000
16 Contribution margin ratio = (14) / (3) 0.7 0.5 0.7
17 Total cost ($) = (9) + (12) 310000 290000 298000
18 Before tax profit (EBIT) ($) = (4) – (17) 90000 70000 62000
19 Degree of operating leverage (DOL) = (15) / (18) 3.11 2.57 4.06
20 Break-even point (BEP) ($) = (9) / (16) 271429 220000 271429
21 Break-even point (Contracts) = (20) / (3) 2714 2200 2714
22 Beta (Estimated) Low High
23 Cost of Capital Low High
24 Decline in profitability due to 20 per cent decrease in
contract sales (per cent) = 0.2 x (19) 51 81

(Source: Calculated by author)

Hence, during a period of recession, a proactive firm with a lower DOL, due to higher emphasis
on variable compensation will produce profitability estimates that are more consistent with actual
results and will in turn benefit from more consistent and predictable financial returns. This
results in decreased information asymmetry between firms and other stakeholders, and, with a
decrease in information risk premium, beta, or the market risk of the firm will also decrease.
Decrease in market risk of the firm, will also decrease cost of capital. As explained above,
proactive firm can improve its financial performance by reducing its OL and BEP, as a result of
shifting more compensation costs from a fixed to a variable form. Detailed calculation of
operating leverage and BEP for proactive IT firm is shown in Table III.

As calculated in the above illustration, the shift from fixed pay to variable pay results in an
increase in variable costs, a decrease in fixed costs, along with a decrease in BEP and DOL.
Hence, a low DOL signals the existence of a low portion of fixed costs. The rationale underlying
this computation is that as variable costs are substituted for fixed costs, the contribution margin
as a percentage of income before taxes decreases. With other conditions remaining same, it will
also decrease the beta or market risk of the firm. Shifting to more variable compensation also
helps to reduce proactive IT firm’s BEP as shown in Figure 4, which results in the firm being
able to become profitable more quickly. Hence, proactive IT firm has lower decrease in before-
tax profits, a lower BEP, a lower DOL, lower market risk or beta, lower cost of capital and its
profits vary less with changes in sales volume as shown in Table III.

BEP: 2200 Annual Contracts

Figure 4. BEP Chart for Proactive IT Firm

(Source: Chart developed by author based on calculation of Table III)

On the other hand, passive IT firm do not do anything during the recession period to lower fixed
cost or reduce fixed pay in compensation structure and continue to employ technical support staff
– for service contact on a high pay level of erstwhile growth period that is fixed salary of
$80,000. Hence, it results in higher OL of 4.06 and higher decrease in before-tax profits for the
firm, as calculated in Table III. Also, BEP of passive IT firm does not decrease and remain
unchanged (Table 2). BEP chart for passive IT firm is shown in Figure 5.
 BEP: 2714 Annual Contracts

Figure 5. BEP Chart for Passive IT Firm

(Source: Chart developed by author based on calculation of Table 2)

Limitations of 100 per cent variable pay

However, shifting to 100 per cent variable pay may not be suitable for IT firms. The losses or
disadvantages associated with solely emphasizing the variable component of pay are listed
below:

1. As the variable proportion of total compensation increases, many employees of IT firm

may demand higher levels of pay because of the extra risks they are taking. Also,
employees in the lower-income brackets are less willing to subject their pay to a variable
component (Caroli & Garcia-Penalosa, 2002).
2. Firms emphasizing the variable pay component in certain product categories where
market demand is weak or firm’s services are not well established may have difficulty in
attracting and retaining IT talents for those areas, and it ultimately triggers an exodus of
IT developers and technical support people who do not desire a variable element in their
compensation package.
3. IT developers and programmers working in a large IT project may not be willing to
accept a variable pay package when it is implemented at the group level rather than the
individual level. In other words, IT employees do not mind variable pay schemes if they
are ultimately in control. Therefore, group incentive–pay plans may produce some
element of dissatisfaction, which could eventually translate into lower efficiency (Burke
& Hsieh, 2006).
4. Variable pay plans tends to be less attractive to individuals who are older, risk averse, or
generally lack the confidence to scale up their performance to be able to earn more
through variable pay schemes. In this situation, shift of compensation policy by the firm
 to some form of variable pay, employees will likely to leave their jobs, creating in turn,
sizeable turnover costs.
5. Variable pay plans are not suitable for technical support / services and customer related
support task for existing customers.

In this situation, it is necessary to identify optimal ratio of fixed and variable pay in
compensation structure for the IT firms. According to Madhani (2009), the optimal ratio of fixed
pay and variable pay in compensation structure is firm specific and should occur where the EVA
(economy value added) of the firm is maximized. EVA is described as the gauge that suitably
accounts for all of the complex trade-offs involved in creating value and determining the right
measure to use for setting goals and evaluating performance. Balkin and Mejia (1990) also
addressed the importance of combination of variable pay and fixed pay in pay structure and
discussed the importance of matching of compensation strategy with organizational strategy. If
compensation strategy works well with organizational strategy then the firm will have a better
overall performance. This will also build competitive advantages for the IT firms as described
below:

1. Compensation strategy will attract best talent to the IT firm, retain existing employees,
control cost, stimulate, and motivate employees.
2. The compensation strategy that matches with corporate strategy and HR strategy will be
difficult for competitors to imitate, hence provide competitive advantages to IT firm.

Restructuring Fixed and Variable Pay in Compensation Structure: Indian Scenario

In developed countries, cost of men power is mostly treated as variable cost hence it helps
organization to become flexible, nimble, responsive and ultimately competitive during tough
time of business cycle such as recession. In the Indian scenario, cost of employee is still
considered as fixed cost during the entire span of employment; however, this trend is changing
very fast. With increasing competition, globalization, and changes in the business environment,
firms need to be more proactive, responsive, and dynamic in their compensation strategy. Indian
IT firms have been driven by the pent up demand and cost cutting initiatives by large MNCs
across the world, caused by global recession.

The downturn of business cycle has forced many firms to synchronize salaries based on the
performance of employees, and performance of firm i.e. revenue increase and profits. According
to hiring major ‘Ma Foi management consultants’, the variable pay component in India is likely
to go up to 25-30 per cent on an average from 10-15 per cent. The ratio of fixed to variable pay
in compensation structure depends on the hierarchical level of the employee in an organization,
the responsibility attached to the job and the role an employee plays. In the new economy sectors
like IT and ITeS, where employees engaged in consulting, sales and support activities usually
have a larger variable pay than the employees in execution roles. Major IT firms of India such as
TCS, Wipro, Infosys, and HCL have implemented variable pay schemes. Indian IT firms should
restructure fixed and variable pay in pay mix according to business cycle to gain competitive
advantage and enhance competitiveness.
MphasiS: Restructuring of Fixed and Variable Pay in Compensation Structure
MphasiS, a unit of Hewlett-Packard (HP), is an IT services company and is engaged in providing
IT and business process outsourcing (BPO) services to its customers around the world. It is the
sixth largest IT firm in India with more than 38,000 employees. To enhance competitiveness,
MphasiS implemented a new compensation strategy in November 2009, by restructuring fixed
and variable pay in compensation structure. MphasiS, has lowered its ‘fixed pay’ in pay structure
by deducting 5-20 per cent from the salaries of all its employees and converted it in ‘variable
pay’ by giving this back once in every quarter. Such proactive compensation strategy helped
MphasiS in reducing fixed cost, and operating leverage and thereby making it more competitive
during period of recession. This new compensation strategy tilted towards a higher variable pay
component, will decrease business risk and enhance competitiveness of firm, as explained
earlier. Thus, MphasiS has increased efficiency and effectiveness of compensation management
by restructuring fixed and variable pay in pay mix.

Research Implications and Analysis

A good compensation strategy can be a powerful tool to drive employees direction and
motivation. The right pay mix in compensation strategy attracts and keeps employees with best
skills, capabilities, and expertise that IT firm needed. OL is a key organizational variable
affecting business performance during business cycle. Proactive firms decrease OL when a
business cycle is just entering in recession, hence, the possibility of its negative impact is not
substantial. During weak economic times, if the proportion of variable pay component in
employee compensation structure is increased, it will help IT firms in cutting overall
employment costs and OL as it is related to realized sales. With variable pay, IT firms will be
able to reward their people based on their performance and market dynamics, and not on the
years of experience that they have with the firm.

An IT firm’s ability to weather business cycles stems from effective utilization of an appropriate
level of leverage through restructuring fixed and variable pay in pay mix. These accrued cost
savings are redirected to keep the organization afloat until business conditions turn around.
Reducing employee costs avoids the situation of large-scale retrenchment by the organization.
Low OL results in low variability of profit during periods of lower sales such as recession. With
low OL, any unforeseen negative variation in sales revenue will result into lower downward
variation in profitability. Restructuring cost in terms of appropriate balance of fixed and variable
pay in pay mix of IT employees reduces OL and hence mitigates negative impact of business
cycle on the IT firms.
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