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Principles of Management, 6e
P C Tripathi & P N Reddy
Chapter 14
Compensation Plans
1

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2
Learning Objectives
 Examine time as the basis of pay
 Describe internal and external alignment of wages and salaries and
various factors affecting them
 Describe the advantages, disadvantages and the kinds of monetary
incentive compensation
 Present the requisites for the success of monetary incentive
compensation
 Discuss non-monetary incentives
 Explain the statutory and voluntary benefits
 Relate the international compensation
 Describe the wage packet in Indian industry

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Time as Basis for Pay
3
 The oldest and most common system of paying employees is on the
basis of time, i.e., rate per hour, per day, per week, per month or per
year.
 The merits of this system are as under:
 It is simple and straightforward. Workers can easily calculate their
remuneration.
 It is liked by trade unions because it does away with differences of
payments and assures a guaranteed income for a given period of
work.
 It helps in maintaining the quality of output because the worker is
not tempted to increase his speed to produce more sub-standard
output to earn more wages.
Continued….

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Time as Basis for Pay
4
 It helps in maintaining the machines and equipment in good conditions by
avoiding breakage and damage to them, which would otherwise result if
the speed of operations is unduly increased by workers in order to increase
production.
 It does not cause employees to overwork themselves, and hence it results
in fewer accidents and better employee health.
 Following are the demerits of this system:
 As this system does not distinguish between efficient and inefficient
workers, there is no incentive for workers to improve their efficiency.
 As all the workers are paid equal remuneration, irrespective of their
quantity of output, the more efficient among them are tempted either to
reduce their speed and efficiency or to leave the organization.
 As this provides security to the workers, they are tempted to shirk work,
which would lead to loss to the employer.
 To make employees work without wasting time, the employer is obliged to
appoint personnel for supervision, increasing his cost of production.

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Classification of Compensation
5
 Compensation can be classified into three broad categories: (i) primary
(ii) compensation, (iii) incentive compensation and benefits.
Total Compensation
Primary Benefits
Compensation or Pay
Incentive
Compensation
Benefits
Monetary
Non-
Monetary
Statutory
Voluntary

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Primary Compensation
6
 It is the basic pay in the form of wages or salaries.
 The word “wage” is used to denote payments to hourly rated
production workers, and the word “salary” is used to denote payments
to clerical, supervisory and managerial employees.
 For our purpose, however, this distinction is meaningless because
roughly the same problems are involved in the administration of both
wage and salary policies.
Internal Alignment (Job Evaluation)
 A sound primary compensation structure is a function of internal and
external alignments.
 Internal alignment means that there should be a proper relationship
between the wages and salaries of various positions within the
enterprise. Internal alignment is concerned with the concept of equity
and status.
Continued….

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External Alignment (Pricing the Job)
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 This means that the enterprise should fix the wages and
salaries of its people after taking into account the wage rate
prevailing in the community.
 To achieve external alignment, the management must first
know (either through a wage survey or through some other
source) what average rates of its key jobs are prevailing in
the community.
 It can then plot these rates against the point values of those
key jobs.

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Factors Affecting Wages
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 Demand and supply of labor Demand and supply conditions of labor
have considerable influence on the determination of wage rates. If there
is a short supply of labor, the wages may be high; whereas if there is no
dearth of labor, the wages tend to be low.
 Labor unions If the laborers are well organized into strong trade unions,
their bargaining power is high so they can demand higher rates of wages.
But if the laborers are not organized, the management may fix low wages.
 Cost of living The cost of living of workers also has a strong influence on
the rate of wages. If this factor is not considered, the laborers may not be
in a position to make both ends meet, and this will affect their efficiency.
 Competition The degree of competition for the products of an industry is
yet another factor which has influence on the wage rates. If there is
perfect competition, the level of wages may be at par with the value of
the net addition made by the workers to the total output; but if there is
imperfect competition, the wages may not reach this level.
Continued….

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Factors Affecting Wages
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 Prevailing wage rates By considering the prevailing wage level, employers
will come reasonably close to the wage level of competitors, and this will
enable them to retain and attract qualified workers to the organization.
 Ability to pay The wage level, to a large extent, is determined by the
ability of the enterprise to pay its workers. The ability to pay in turn is
determined by the profit-earning capacity of the enterprise.
 Job requirements Job requirements are also an important factor
affecting wages. Jobs requiring specialized knowledge or involving much
mental or manual efforts are priced higher than those which are light or
which do not need any specialized knowledge.
 State regulation As the State assumes responsibility for safeguarding the
interest of citizens, it has to step in to regulate the wage rates of laborers
through legislative measures.

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Factors Affecting Executive Compensation
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 Job complexity
 Employer’s ability to pay
 Employee’s education and experience
 Employee’s performance
 Statutory limits

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Monitory Incentives
11
 Monetary incentive, (which Amitai Etzioni calls “utilitarian power”) is
essentially a managerial device of increasing the workers’ productivity.
 The belief underlying an incentive compensation is that an offer of money in
addition to—rather than in place of—the primary compensation will
motivate workers to work harder and more skilfully, which will result in an
increased rate of output.
 Advantages of monitory incentives include:
 The need for direct supervision is reduced.
 Results in the creation of a feeling of mutual cooperation amongst the workers.
 Rise in workers’ punctuality and attention to work and decrease in absenteeism.
 finding better methods and techniques resulting in higher productivity.

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Monitory Incentives
12
Disadvantages of Monetary Incentives
 The workers to sacrifice quality for the sake of quantity. This calls for a very
strict system of checking and inspection.
 In the absence of adequate provisions, incentive payment brings about a
certain rigidity in the operations. This makes it difficult for management to
revise norms and rates following changes in technology, methods, machines,
materials, etc.
 There is a danger of the workers disregarding safety regulations.
 Unless a maximum ceiling on incentive earnings is fixed, some workers tend
to overwork and undermine their health.

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Kinds of Monetary Incentive Plans
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The number and type of incentive pay plans is legion. Almost every company
has a new “twist” or a added feature to a common basic plan. We may
however classify all incentive plans under the following three broad
categories:
 Individual incentive plans - The simplest of all individual incentives, also
called ‘pay for performance’ popular since the scientific management over a
hundred years ago, is the simple piece-rate system under which the
production worker is paid for each piece produced.
 Several new payment-for-performance techniques have been designed
 Variable Pay
 Merit Pay
 Skill pay
 Competency Pay

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Kinds of Monetary Incentive Plans
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 Group incentive plans - Under this plan, first of all the total earnings for
the group are determined and if all the members are of equal skill, these
earnings are usually divided among them equally.
 Factory wide or plant wide incentive plans - Profit Sharing is a very
common example of a plant wide incentive plan. Under a profit sharing plan,
a certain percentage of profits is distributed at fixed intervals, usually
annually or bi-annually in some definite ratio to all, or the specified
categories of employees, over and above their wages. Profit sharing may be
current or deferred.
 Under current profit sharing, each worker is paid his portion of the profit in cash.
 Under deferred profit sharing, the share of profit due to each worker is either
credited to his provident fund account or to his pension account or is paid in the
form of bonus shares.

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Requisites for the Success of a Monetary Incentive Plan
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 The first requirement for the successful introduction of a monetary
incentive plan is a proper climate wherein the issues can be
dispassionately viewed by all the parties concerned. This means that
relations between the management, the supervisory staff and workers
should be happy and free from suspicion.
 All employees and supervisors must have full knowledge of the details
of the plan. The plan should be explained and discussed with them
before it is installed.
 Employee acceptance and cooperation is much more likely if they
have a part in its inception and development.
Continued….

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 The incentive plan should possess the following characteristics:
 It should be simple and easy to understand. The benefits of the plan
should be quite obvious to the workers concerned. Further, they should
be easily calculable by the workers. Complicated plans and formulas sow
seeds of doubt and distrust in the workers’ minds.
 It should allow for earnings to be in direct proportion to an employee’s
output above the work standard. Employees do not like to share their
earned extra pay with the management; instead they favor plans where
they receive full benefit from their extra effort.
 It should be equitable. This means that the plan should cover and should
provide equal opportunity to all employees whose jobs can be adapted
to the incentive method of payment.
Continued…
Requisites for the Success of a Monetary Incentive Plan

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 It should not be very costly in operation. Actually, besides incentive wages,
there are many other items of expenditure, such as job evaluation, method-
improvement, work measurement, additional supervision, better inventory
control, etc.
 It should be flexible i.e., it should have the elasticity to take care of
technological and other changes taking place from time to time or for
rectifying obvious errors that may have crept in at the time of its initial
introduction.
 A guaranteed base rate should be included in any plan. This constitutes the
element of security that employees want. Employees want to be assured
that they will receive a minimum given wage regardless of their effort or
output. This wage is the minimum base on which they plan their standard of
living and home life.
Continued…
Requisites for the Success of a Monetary Incentive Plan

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 The plan should not be detrimental to the health and welfare of the
employees. This may even involve a ceiling on the maximum earnings by way
of incentives.
 The plan should be instrumental in satisfying as many needs as possible—
other than economic needs—at all levels of hierarchy.
 The work standard set for the payment of wage incentives must have the
following characteristics:
 It should be fair and just: A fair and just standard is the key to any incentive
plan, and employees must have confidence in both the technical capacity
and the integrity of those who establish these standards. A work standard is
usually established by time study.
 It should be of average difficulty: If the employees can beat the standards
easily, they would hardly experience any competition. Similarly, if the
standard is too tight, it makes employees complacent with their pre-
incentive earnings.
Continued…..
Requisites for the Success of a Monetary Incentive Plan

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 It should be consistent and should not be changed, unless (a) an error has
been made in calculation, or (b) a change in work methods, materials or
equipments has been effected.
 It should be based on established and recognized quality requirements.
Employees should not be paid for sub-standard work. In fact, some provision
may be necessary to control waste if it is excessive.
 Standard working conditions should exist. Standard work method, standard
work places, standard materials, standard control procedures, etc. are
necessary for any system of incentives. Standardization is the basis of work
incentives.
 Management must set up a suitable machinery to handle all grievances arising
from the implementation of the incentive plan.
Continued…
Requisites for the Success of a Monetary Incentive Plan

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 An incentive plan once installed should be rigidly maintained.
 Vigilance is the price of success for an incentive plan, which once set up
should not be forgotten.
 Incentive audit system should, therefore, be devised to assess periodically
the effectiveness of the plan against accredited objectives, and to provide
feedback information for the management to take corrective steps.
Non-Monitory Incentives
Non-monetary incentives are necessary to satisfy the social and egoistic
needs of workers. Nowadays, a growing number of companies are
implementing ‘recognition’ as a non-monetary incentive.
Continued….
Requisites for the Success of a Monetary Incentive Plan

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21
Requisites for the Success of a Monetary Incentive Plan
High
Low
Weeks
Motive
towards
doing
work
Physiology
limits
of
the
organism
Pressure
from
foreman
Difficulty
of
work
Desire
to
do
fair
day’s
work
Resentment
of
management
Desire
for
promotion
Social
pressure
of
group
set
rate
Fear
of
loss
of
job
Egoistic
drive
to
accomplish
Fear
of
rate
change
Reluctance
to
work
too
hard
Fear
of
working
self
out
of
job
Rate of
production

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 The feeling of not getting noticed necessarily disappoints the most ardent
desires of human nature. Workers must feel that they are recognized in
accordance with their contribution to successes. It is not necessary that this
recognition is solely in monetary terms.
 Formal recognition system, to be successful, should be:
 Valuable for the employees. This can be due to the superior’s position or
personality or both.
 Tailor-made to meet the specific and changing needs of employees. Like
monetary reward, a particular form of recognition reward, after a while, may
also begin to lose some of its power. So it has to be altered and different one
offered.
 Easy to implement
 Widely communicated and soliciting new ideas from employees.
 Exemplary publishing practices of employees which have earned recognition in
the past so that people know what they should do to earn recognition.
Recognition as a Reward

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 Benefits are an important component of the organizational compensation
system. Benefit costs range between 30 and 35 percent of wages and
salaries. But because they are so common, their value as a reward goes
unnoticed. All benefits can be classified in a number of ways.
 It should be remembered that most of these benefits (better known as
“psychic income” or “fringe benefits”) are system benefits which accrue to
people by virtue of their membership in the system.
 Unlike incentives which are given in acknowledgement of differential
contributions to organizational functioning, these benefits are administered
without any relation to individual effort and performance usually on the
basis of length of service.
 System benefits are most effective for holding members within the
organization although they do not lead to work of higher quality or greater
quantity than is required to stay in the organization.
Benefits

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 Composition of the wage packet of an Indian worker is very complex. Besides
the above benefits its other principal components are: basic pay, dearness
allowance, incentive earnings and statutory bonus.
 The most prevalent wage incentive scheme is the piece-rate plan, under
which workers earn in direct proportion to the work done. Another less
prevalent wage incentive scheme is the production bonus under which
workers are paid at a differential rate for the output produced in excess of
the norms of output fixed for a unit of time.
 The minimum bonus is 8.33% of the worker’s annual wage and the
maximum is 20%. Recent years have seen all-round increase in the wages
and salaries of employees in all sectors in India, particularly IT and finance.
To recruit good employees, many companies are promising fancy
designations, exciting job profile and career paths (with reduced threshold
of experience).
Wage Packet of Indian Worker

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 The objects of international compensation programmes are to:
 To attract and retain qualified employees
 To facilitate transfers between HQ and affiliates
 To create consistency and equity in compensation and
 To maintain competitiveness.
 Expatriate compensation comprises the following:
 Salary—Basic pay plus incentives (merit, profit sharing, bonus plans) determined via
job evaluation or competency-based plans
 Differentials—These are paid to compensate the expatriate for differences in
expenditures between the home and the host country. Housing and hardship
allowances fall in this category.
 Tax equalization—Expatriates face two potential sources of income tax liability—
home and host. Almost all MNEs have some tax protection plan so that the expatriate
does not pay more in taxes than if he were in his own country. Tax equalization is an
adjustment in expatriate’s pay which reflects tax rates in the home country.
 Assistance programmers—These are expenditures commonly incurred by an
expatriate on his relocation, e.g., expenditure incurred on household goods shipping,
legal clearance, prelocation visits, annual home visits, children’s education, etc.
International Compensation