Components of an effective compensation system? How is an underpaid employee likely to behave?Compensation is the reward an employee receives in exchange for performing the organisational tasks. Compensation is Direct and Indirect.

Direct compensations are Wages, Salaries, Bonuses or Commission.

Indirect Compensation is Paid Leave, Insurance, Medical Benefits, Housing Allowance, etc that are not a part of the direct compensation.

Components of effective compensation system:Organisations have to have effective compensation policy to:

Acquire qualified personnel:Compensation should be on par, if not better than prevailing industry rates in order to attract qualified persons.

Retain present employees:Employees quit if compensation levels are not competitive.

Ensure equity:Compensation should ensure internal equity, i.e. compensation should be related to relative worth of jobs. External equity should be maintained by paying wages similar to those paid to persons performing similar tasks in other companies. Internal equity should be maintained by paying the employees with similar responsibilities, qualifications and experience similar salaries.

Reward desired behavior:Compensation should reinforce desired behavior through increments and rewards and act as an incentive for the behavior to occur again. Similarly withholding increments for poor performance will ensure that the employee puts in more efforts.

For example: Many organisations appreciate the employee effort though Thank you cards for the effort they have put in for the month. This invokes a sense of healthy competition among employees and a positive work spirit. Also the methods of “Star of the month” which rate the productivity and efficiency enable measuring the employee efficiency.

Control Costs:A rational compensation plan helps attract and retain employees at a reasonable cost. Without proper structure the organisation may overpay or underpay the employees.

A compensation policy is effective if salaries and perquisites are:A dequate: In line with what is paid in similar companies in the same geographical area.B alanced: A reasonable combination of direct and indirect benefitsC ost effective: What the organisation can afford to pay.E quitable: Commensurate with the effort put in and the ability used.I ncentive: Sufficient incentives are needed to motivate the employees to work effectively.S ecure: Sufficient to satisfy the employee’s basic need and make him feel secure

Factors affecting Compensation:

Supply and Demand:The availability of people and the demand determine the “Going-Wage-Rate”. When the demand is high and the availability low, salaries are high. When the availability exceeds the demand, salaries are low.

Ability to pay:If a company is doing well and has the ability to pay, the tendency is to raise the compensation level. However if a company is highly successful, there is little need to pay far more than the competitive rates to obtain good personnel. The company may choose to pay above competitive rate to attract the best availability in the industry.

Cost of living:The cost of living index does not determine the base compensation. It indicates what the rate of increase in salary should be to keep up with the inflation so that employees’ real wages do not reduce.

Benefits:Indirect benefits are employer provided rewards and services other than wages and salaries. These benefits are provided for various reasons:

1. Keep wages and salaries low and hence obtain tax benefits2. Make the salary package competitive to recruit and retain talent.3. Act as motivators4. Ensure long – term employment as some benefits are linked to time spent in an

organisation.

Some other indirect benefits that companies offer are:Insurance: employees are insured by the company for accident, disability/death.

Medical benefits: medical benefits are provided to the employees by the company through insurance.

Retirement benefits: retirement benefits like provident fund, gratuity, pension are provided for retiring employees who have served for a long term.

Paid leave: Employees are given certain special leave like casual leave, privileged leave, medical leave during which they receive their salary and full benefits. Certain number of days in a year only is allotted for such benefits. Reimbursement for travel is also allotted in certain companies.

Other benefits: Benefits like assistance for housing, children education, marriage loans at low interest are also provided. Other perks’ like telephone reimbursement etc are also some of the benefits that certain organisation avails to the employees.