Compensation is an important tool that is often under-utilized by managers in today's workplace. Managers use compensation  in the workplace to inspire people to work, both individually and in groups, to produce the best results for business in the most efficient and effective manner. It was once assumed that motivation had to be generated from the outside, but it is now understood that each individual has his own set of motivating forces. It is the duty of the manager to carefully identify and address these compensating forces. This paper will help managers become more effective at creating a positive motivational environment.

Managers may lack knowledge in implementing successful compensation programs that increase production and create a positive work environment. Although there are many types of motivation, management must identify with their associates (employees) on an individual level for successful programs. The goal of every manager is to increase production and efficiency to reach maximum results for the organization. Motivation for better performance depends on job satisfaction, achievement, recognition, and professional growth (Boyett and Boyett, 2000). Providing a positive compensation work environment is a challenging managerial activity. Therefore, managers must understand associates and their professional needs.

Factors Affecting Compensation System

The primary objective of a compensation system is to administer an effective and equitable pay system. It can be affected by various factors which are as follows:
1. Organizational Provisions
Organizational provision states that the level of compensation largely depends upon organizational operating policies and procedures. It is because the policies serve as a guideline for formulating and implementing compensation plans and programs. Moreover, organizational regulations, plans, objectives, ability for pay etc. also affect the level of pay.
2. Government Regulations
In order to protect the working class from wage exploitation by strong employers, the government enacts various laws ans judicial decisions. Such laws and regulations affect compensation management. Because, they emphasize on minimum wage rate, overtime rate, working hours, equal pay for equal work, payment of bonus, etc. So, an organization has to design its pay system as per the government rules and regulations.
3. Equity Considerations
Equity considerations hold the philosophy that the compensation system should be fair and equitable. It means the compensation system should be similar for the same type of work within the organization. Similarly, it should be fair relative to what other people get for the similar job in another organization. It is important because any imbalance between what the employees contribute and what they obtain as return would lead to greater job dissatisfaction, employee turnover and absenteeism.
4. Union Pressure
Labor unions are pressure groups that work in the interest of the workers. Such unions lobby the management for the formulation of fair compensation plans. These organized unions can ensure better wages for employees.
5. Job Analysis And Evaluation Report
Job analysis is a method through which necessary information about the contents and the contexts of the job is made available to determine the value of each job. The job evaluation is a process of determining the value/worth of a job so that a payment system can be specified. Job analysis and job evaluation determine the relative worth of job which ultimately assist for compensation management. Hence, it is regarded as an important factor of compensation management.
6. Cost Of Living
Compensation is concerned with an overall return that an employee obtains from the organization for rendering contributions towards organization objectives. Therefore, the payment should be adequate to maintain the cost of living of the employees. Hence, the employer should manage compensation viewing the cost of living of each individual.
7. Organizational Positions
Sometimes, the organization itself evaluates where it is in order to prepare compensation plans. The position of the organization is determined by its productivity i.e, if the productivity of the worker is high, it assess itself as a higher position. As a consequence of it, the compensation system is determined at a higher level. Contrary to it, in case of lower productivity, wages/salary rates tend to be low. Thus, any shift in productivity and employee performance has direct impact on the wage level of the organization.
8. Productivity of Workers
Another factor of compensation management is the productivity of workers. This is the new concept of linking pay with employee performance. Under it, if the workers are highly productive, they get high compensation as compared to less productive workers. Productivity is a key factor as it enhances organization's image and status.

Six Steps to a Sound Compensation Strategy

Before you think about designing and implementing a compensation plan, you must first develop a clear and compelling compensation strategy. To develop a successful compensation strategy you need to take the following steps:
1.      Define your compensation philosophy.
2.      Link compensation to your overall business strategy.
3.      Change the culture and reinforce it with compensation.
4.      Reward the behaviors that drive the results.
5.      Think total compensation.
6.      Measure your return on invested payroll £s.

1. Define your compensation philosophy  

A sound compensation programmed begins with a clear, focused compensation philosophy that defines and answers fundamental questions such as:
  • What do we want to pay for?
  • How do we want to pay for it?
  • What is our competitive posture?
  • How will we split up the pie?
We recommend developing a total compensation mission statement that clearly specifies the results you want to accomplish, the behaviors necessary to achieve them, what you will pay people for, and how you intend to position your company in the marketplace. This lays the foundation for your entire compensation programmed. It serves as a compass and a beacon to guide you through the difficult task of creating and implementing the programmed.
Who creates the total compensation mission statement? Depending on the size of the company and the management structure, any or all of the following: board of directors, board of advisors, CEO, top management team and representatives from others in the organisation.
Your pay philosophy should:
  • reflect the values and beliefs of the owner/CEO/management team
  • reflect the economic realities of your pricing structure and market share
  • take into account "softer" issues such as corporate culture, industry standards and your growth strategy
  • provide a foundation to make consistent hiring and promotion decisions.

2. Link compensation to your overall business strategy

Most organizations know where they want to go and how to get there. Compensation provides a very effective tool for getting employees to move in the same direction and follow the same path.
For example, suppose a young, growing company wants to increase market share. Its compensation plan needs to reward people for bringing in new customers and clients. In contrast, a more mature company might need a better balance between growth and profit. Accordingly, its compensation plan should equally reward activities that generate growth and profit.
Another company might identify world-class customer service as one of its top strategic objectives. It would need to reward the activities (in all areas of the organization, not just the customer service department) that lead to outstanding customer service.
If compensation doesn't have a direct connection to corporate goals and objectives, employees will take any direction because they don't know which one to take. Compensation strategy starts with identifying your top strategic objectives, defining what they mean in terms of organizational behavior, and designing your compensation plan in a way that rewards and recognizes those behaviors.

3. Change the culture and reinforce it with compensation

A good compensation strategy alone won't get the results you want. In order to get permanent behavior change, you must first change the culture and the environment. Then use compensation to reinforce those changes.
If all you do is dangle money in front of people, you get short-term blips in behavior and then people go right back to the old ways of doing things. You don't get sustained productivity improvements unless you change the culture. That involves identifying the results you want to achieve as an organization, identifying the behaviors that lead to those results, and then designing a compensation programmed to reinforce and reward those behaviors so that they become permanently instilled in the organization.
Compensation provides a very effective tool to reinforce organizational values. Too often, CEOs talk about values but then don't walk their talk. For example, many companies say they value teamwork but continue to reward individual performance. Or they talk about customer service but reward only financial performance.
Compensation sends powerful messages to your employees about who you are as an organization, what you value and what skills and results you reward. If you want to instill certain values in the organizational culture, reward them through your compensation programmed.

4. Reward the behaviors that drive the results

In order to reward behavior that drives results, you have to know what creates value in your company. Value gets created in two ways. First, as an organization you must do the things your customers want, need and desire. This represents the qualitative side of the business. Second, everyone in the company has to help the company to do those things in a profitable manner. This represents the quantitative side of the business. Without both, a company won't survive for the long term.
To get the customer's perspective on value, call your top 20 customers and ask two questions:
  • What are we doing now that is creating value for you and makes you feel good about doing business with us?
  • What can we do to earn more of your business?
Asking these questions will generate some amazing feedback. It will definitely change your thinking, not just in the compensation arena but in almost every area of your business.
Next, look internally to see who is creating value on the financial side. Every employee must do one of two things (or both): create or support sales (revenue side) or keep expenses to a minimum (expense side). If you find that people aren't doing either one, you have to question whether or not their function should continue to exist.
Between the quantitative and qualitative pieces, you can start to work out where value really gets created in your company. Then you can design a compensation plan that will get the results you want because you have identified the specific behaviors that directly lead to those results.

5. Think total compensation

In today's fiercely competitive labor markets, compensation provides a powerful tool for attracting and retaining quality people. Yet, most employees think of compensation as base pay plus the occasional bonus. They forget – or are never told – that anywhere from 30% to 50% of their total compensation comes from other areas, including:
  • profit sharing
  • retirement and pension plans
  • benefits
  • shares or equity
  • incentives and bonuses
  • recognition and rewards
  • holiday and personal time off
  • opportunity income (education reimbursement, professional development programmers, etc.).
If you don't think, talk, market and sell total compensation, you're leaving a lot of money on the table. Talk about compensation frequently and impress upon employees that it includes a lot more than base pay. When comparing compensation for potential employees, always use total compensation, because base pay never tells the whole story.
We recommend providing employees with an annual total compensation statement that lists the complete package of rewards and recognition they receive for working in your organization.
A total compensation statement surprises employees because the bottom-line number always exceeds what they normally think of as their compensation. You can't afford to lose employees who might get lured away by promises of a bigger base pay. Make sure all your people understand and appreciate the full range of compensation and benefits they enjoy in your company.
Don't stick the compensation statement in the salary slip envelope. Instead, sit down with each employee and say: "I want to show you the full extent of our commitment to you." (Don't say: "Here's what you cost us", because that insults the employee.) Thank them for doing a good job and go over all the costs, answering any questions they may have.
This little meeting will get you two weeks' mileage and then employees will forget about it. The real value comes when competitors try to steal your people. They may offer more £s above the line but not as much below the line. Once your employees become aware of all that you pay them, they start to ask the right questions when other employers come hunting.

6. Measure your return on invested payroll #s

How do you know whether you're getting a good return on your invested compensation £s? The answer is simple: measure it. Yet, far too many companies either ignore or overlook this critical practice.
Most companies don't even measure their return on compensation £s, much less determine whether it is a good one or not. To measure your compensation ROI, decide up front what you want to look at: productivity, bottom-line results, employee turnover, ability to recruit and retain key people, morale, customer service or any number of measures.
Identify the measures that come from your overall business strategy, then define and track them to see whether the return on your compensation £s matches your expectations.


Boyett, H. Joseph, and Jimmie T. Boyett. (2000). World-class advice on managing and motivating people. Boyett and Associates. Available on the World Wide Web at Date visited, March 25, 2002.
Howell, Heather. (2000). Motivating and appreciating your staff. A Catanzaro and Associates, Inc. website available on the World Wide Web at Date visited, March 25, 2002.
Kepner, Karl, and Allen Wysocki. (2002). Class lectures and notes from AEB 5757: Strategic agribusiness human resource management. Department of Food and Resource Economics, University of Florida, Gainesville, FL.
Kovach, Kenneth. (1999). Employee motivation: Addressing a crucial factor in your organization's performance. Human Resource Development. Ann Arbor, MI: University of Michigan Press.

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