Compensation philosophy

Compensation philosophy

Compensation has been at the crux of the human resources (HR) function and unless this is mastered, it is difficult to succeed in fulfilling the mandate of the HR function in its entirety. At the end of the day, employees will leave a company for insufficient compensation, but, seldom stay only for high compensation. This is as true for a young startup as it is for an established giant. Compensation is traditionally measured in terms of two comparisons – internal parity and external competitiveness. Contemporary wisdom, a decade ago, dictated that one stayed within market ranges for similar jobs and also ensured similar pay for similar jobs within the firm. Even today, these are well accepted yardsticks to measure pay.

Progressive organisations are beginning to talk of total rewards statements instead of only compensation statements and this could cover anything that is of value to the employee.

In the last decade or so, however, the very nature of business has changed, and with it, HR’s relationship with business has also changed. We have discussed in many ways through the pages of this magazine how HR is now a business partner and thus, needs to take responsibility and ownership in profit and loss (P&L) and factors impacting the P&L. The globalised marketplace has eroded arbitrage opportunity and with rising costs of input and diminishing margins, businesses are forced to evaluate every rupee spent for value or return on investment. In this context let us take a look at how the science and art of compensation is changing.

Pay for performance

The single most important shift is from a fixed compensation to performance linked pay. The basics of this are fairly straightforward – some portion of an employee’s pay is linked to the results he delivers, or the goals he achieves. Typically 15-30 per cent of pay is variable and the payout ranges widely. It is not unusual to hear of companies giving upto 175 – 200 per cent to their top performers. The implications of this are worth considering. This does not mean internal parity has been thrown out the window. What this means is that the difference between fixed pay and performance pay are more openly acknowledged and treated. So, fixed pay is still likely to conform to internal parity norms. However, the variable component can differ starkly between performers and non-performers.

This also has a powerful advantage when an organisation is strapped for budgets – this ensures that the available kitty is distributed such that the message is clear – performance pays.

Incremental change

Closely linked to pay are decisions on increments. India Inc is realising, especially in the information technology (IT) sector, that the high increments of a few years ago are unsustainable. Addressing this has meant looking at how increments impact the entire salary package. One of the trends, as yet uncommon, but, emerging in discussion rooms across the board is the base on which increments are awarded. For instance, an employee who performs well in one year gets an increment of 20 per cent. In the subsequent year, the base for his increment is his base pay + 20 per cent increment. In a case where his performance is average, his increment in the current year may be 8 per cent, but, it will be on a higher base and thus the impact of past performance is inbuilt into the fixed pay as well. The discussion now is to separate the fixed pay and inflation from the performance pay.

This, in turn, has meant that performance pay has morphed into various rewards that are employed to recognise performance. The approach to salary must necessarily now expand to include the employment relationship in totality – pay, benefits, perquisites, career options, self development opportunities, various policies that impact quality of life and so on. Progressive organisations are beginning to talk of total rewards statements instead of only compensation statements and what this could cover is actually anything that is of value to the employee and is a potential differentiator in the market and the decision of what goes into this is really up to the HR manager.

A key fallout of this approach is that increasingly, and driven by rising costs, co-sharing and co-payment of benefits are gaining traction. This works for both the organisation and the employee. For example, it is common now for the employer to provide health insurance for the employee and three dependents as standard and also allow employees to add extra dependents at their own cost, but at company preferred rates. This remains a last resort since this sharing of costs is still to gain acceptance among employees.

A few examples of changes in the Indian scenario are:

  • A large player in the IT professional services space is seriously evaluating a separation of base and performance pay, to the extent that the base pay will see annual increments to account for inflation etc. The performance component will be paid out as one-time payments in terms of awards, bonuses etc., thus, retaining payout to the performance period.
  • At least one diversified multi-national group is starting total rewards statements for employees mentioning fixed pay, variable pay, health benefits, insurance, work-from-home policy, flexi time with the core working hour base, free membership to a gym, subsidised access to training and further education with a reputed university/firm and so on.
  • Rewards now refers to one-off, non-recurring cash and non-cash bonuses, gifts and more, each linked clearly with goal achievement.
  • Performance awards are tied into the values the organisation wants to reinforce and this, when done consistently, goes a long way in building that value into the corporate DNA.
  • In organisations where variable pay is already in place, the changes are being made to ensure there is a link to individual, team and corporate achievement, not just individual performance.

What do these changes mean? In effect, the emphasis is moving compensation away from being the centre of gravity for HR and instead making performance management and capability building the core aims of the function. This is more easily achieved in small and medium size enterprises where the compensation philosophy is normally absent. The key is to link performance to payout and distinguish clearly between how the organisation treats performers and non-performers. With one sweep, this will address issues of retention, pay expectations, job fitment and business satisfaction with HR to name just a few.

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