Defining Compensation, Compensation Philosophy, and Critical Components of a Compensation Strategy - Essay Example

The paper "Defining Compensation, Compensation Philosophy, and Critical Components of a Compensation Strategy" is an outstanding example of a business essay. Compensation can be defined as the total payment that includes monetary as well as the non-monetary parts made to an employee in lieu of the work performed according to the need of an employer.

Overview of Compensation Philosophy

Compensation policies have been the most controversial topic in human resource management. Greene (2011) argues that compensation policies are framed in such a way that employees display higher commitment and performance, stay longer in the organization, exhibit stronger attendance, and lesser absenteeism. Certain compensation policies can achieve these goals; most of the experts agree that above the scale and piece-rate payments can reduce absenteeism. Incentive schemes can also reduce absenteeism to a large extent. Similarly, pension schemes or similar fringe benefits can enhance employee tenure. Many experts have found that certain fringe benefits such as pension plans can reduce employee turnover by as much as 20 percent. At the same time, fringe benefits other than health and ESOP do not produce any appreciable impact on employee turnover.

Critical Components of a Compensation Strategy

              Greene (2011) argues that before formulating a compensation strategy it is necessary to identify all its components. It can be bifurcated into the direct and indirect components of the compensation. Direct compensation is usually the largest component of the total rewards that an organization pays to the employee. Also, the direct pay component is the most visible component of compensation to employees. It can be further sub-divided as per the following.

Basic Pay

                The basic pay is devised to cover the minimum standard of living and it also takes into account the existing market levels within the same industry group.

Short-term Variable Pay

                This provides an opportunity for the employee to earn additional direct compensation. The objective is to encourage teamwork to achieve organizational goals. This has linkages with the results hence it can be called a variable component of the total direct costs.

Long-term variable Pay

                 The component provides employees with a stake so as to reap long term fruits as the organization progresses.  This also helps an organization to retain key employees with them.

Employee Benefits

                This component of compensation covers retirement needs, protecting employee income against illness or disability or pre-retirement death.

Indirect Compensation Component

                Though direct compensation is the largest cost to the organization currently, indirect compensation has also become quite a significant part of the total cost. Currently, companies spend a lot on employee entertainment, on nice office, furniture, canteen, on group trips, and many more. Though nothing goes in the pocket of an employee yet the company needs to spend a lot on all these activities. In smaller organizations, indirect spending does not help much as the employee wants direct benefits in one way or the other; however, fortune 500 companies are found to be spending a lot on an indirect component such as on training and improving employee skills (Greene, 2012).

Example of an Effective Compensation Practice/Policy

                   Williams (2012) argues about the compensation that is most effective for every member of the company – from sales to administration; from marketing to research and development; from customer support to finance. The compensation that he describes is made of base salary and commission. The commission is not paid at the end of the year but every month so its visibility increases among its employees. Employee motivation is at its highest to achieve organizational objectives. Salient features of the compensation philosophy can be described in the ensuing paragraph.

                   The company's cost rises in direct proportion to the incoming cash and falls when the reverse happens. Thus, the company and its employees both are secured during difficult times, and employees can see their rewards instantaneously as the company’s performance improves. This is ideal for smaller companies where it is not possible to devise a stock option scheme. Since all the employees get a commission, everyone gets motivated to work toward the betterment of the company and its set goals. Since the focus is on revenue and profits, no gaps are seen between departments. This kind of compensation structure brings transparency and team building. The monthly budget is set in advance and a working report is made available to all on daily basis. Beyond the target, profits are distributed in the ratio of one-third and two-third between the company and employees respectively. This kind of structure keeps everyone engaged and the results are stupendous. The advantage is that highly motivated people prefer to join such companies. Employees continue to bring novelty to their workplaces in product design and services. Deploying the above compensation policy, Williams (2012) establishes that the company called Fishbowl could achieve growth of 70% per year beginning from 2007 until date with a staff turnover of less than 10 percent per year. Such a growth pattern is astonishing because the economy of the world and the US, in particular, is in the doldrums since 2008.