Pay & Salary

What Is Compensation? A Complete Guide

June 10, 2021

Companies give compensation to inform their pay decisions to employees. Every company's actual compensation details differ but the basic components like base pay, incentives and bonus remain the same. Being knowledgeable about what compensation is and how its components work will help you make better decisions about your career growth. In this article, we will discuss the structure, importance and types of compensation and explain the factors that often determine employee compensation.

What is compensation?

Compensation is the remuneration given to the employees for their work or contribution made to the business. The contribution can be as time, knowledge or commitment to the projects they are handling. Compensation comprises regular salary and other non-monetary benefits that an employee gets for their services in the organisation.

Compensation is a part of human resource management, which helps to keep the employees encouraged and improves an organisation's effectiveness. A company's compensation plans also reflect its values and culture. It shows how thoughtful the organisation is towards its employees. Compensation will be fair if it covers basic living expenses, keeps up with inflation and gives some room for savings.

What is compensation structure?

Compensation structures are the pay-based frameworks companies use to establish fair and equitable pay for all employees in an organisation. A compensation structure gives a business clear guidelines for assigning basic pay rates, managing raises and distributing bonuses. An effective compensation structure seeks to dismantle pay practices based on inequitable factors, like past salary history, ineffective negotiation and inherent bias.

There are different compensation structures organisations adopt to design their compensation plan for their employees. Below are a few commonly used compensation structures:

1. Broadband structure

A broadband structure is an older compensation style that some companies still use. In a broadband structure, the company sets pay bands, which can differ dramatically from entry-level pay to top-level pay. The primary purpose of the broadband structure is to reduce the salary range within a particular level but increase the pay range within a job level. Many companies use the broadband structure to support employees who might stay with the company for their entire career, often in the same position.

2. Step structure

The step compensation structure is a tenure-based framework that primarily accounts for an employee's time with the company. Step structures are effective for some roles in particular industries where there is not the substantial opportunity for upward growth, such as teachers. These employees are compensated for their continued commitment and loyalty to the organisation.

3. Grade and range structure

The grade and range structure is one of the most common compensation structures for businesses to use today. The grade structure comprises a hierarchy of grades, levels and bands into which group of jobs that are highly comparable in size is placed. It is similar to the broadband structure in that there is a salary range within each grade, but the range is often much smaller than with the broadband structure and the overall system provides more opportunities for growth and promotion. Usually, a grade and range structure combine both tenure and performance when moving employees from one grade to another.

4. Benchmark structure

The benchmarking compensation structure depends on market research and data to assign competitive salaries to specific roles. In some other systems, there is a clear growth trajectory for employees and their pay, but in benchmarking structure, the dependency is more on current market trends and data. It may also shift from year to year. A benchmarking structure is particularly useful for companies or roles that are highly competitive or challenging to hire for.

What factors determine employee compensation?

Here are a few factors businesses take into consideration while deciding compensation for their employees:

1. Market factors

Organisations research what other businesses in the same area or technology are paying their employees. They also check the similarity of the business and the pay employees with the same designation or similar work get. They can conduct surveys to know this information or check different websites where employees self-report their salaries.

2. Employee perception

Employee perception can influence the overall compensation structure a company chooses for its employees. Most employees want to work for an organisation that is transparent about how its employees are compensated and how those wages are determined. Creating a compensation system that employees feel is straightforward and fair is often in the company's best interest.

3. Cost of living

Cost of living is another important factor in determining the compensation of the employee. If the company's office is in a metro city, then the cost of living an employee will incur will be higher than if they will be allocated to non-metro city. The non-cash benefits like travel expenses, house rent allowance varies according to the area where you are living.

4. Government legislation

Depending on where you live, your state might have specific wage and salary regulations that can affect how your company structures its organisational compensation. Some states regularly increase the minimum wage, which can shift every pay band, step or grade in your company's structure upward.

5. Job competition

The demand for a particular skill in the market also determines the compensation a company will align for a job role. For example, if you have expertise in a skill that is in high demand in the market, you will have the choice to take a job at different companies. In such a scenario, companies offer the best compensation to lure you to accept the job offer.

Related: Salary Negotiation Tips and Examples

6. Industry

There are some industries that give the same compensation to their employees. This is particularly in the public sector, where the compensation is defined based on the grade rather than the work you are entitled to do. For example, in government banks, the compensation given to the employees depends on the grade at which they were hired. Whereas, in the private sector, compensation is dependent on various factors like job competition, previous salary package, skills, certifications and years of experience.

7. Growth opportunities

Growth opportunities that an employee will get in the organisation also determine the compensation they will be offered. Companies can justify the lower pay range by factoring in the growth opportunities a person may get if they join the organisation, the long-term value that the company's brand will add to the career path of the individual.

Related: How To Ask for a Raise (With Script Examples)

Types of compensation

Here are different type of most common components of compensation:

  • Base pay (hourly or salary wages): it is the minimum amount an employee will receive with no deductions or additional benefits. It can be expressed as an hourly rate, monthly rate or annual rate.
  • Overtime allowance: it is the amount an organisation pays if its employee works outside standard business hours.
  • Bonus pay: it is the annual pay an employee gets above their regular earnings. It is basically a reward that an employee gets for their work and goal accomplishments. Bonus pay is basically offered to boost the productivity and morale of the employee.
  • Merit pay: merit pay is performance-based pay. An employee gets merit pay depending on their yearly performance and achievement of the goals set. The criteria for merit pay vary from company to company. In most companies, merit pay depends upon both the employee's and the organisation's performance.
  • Benefits like paid leaves, leave travel allowance (LTA), medical insurance: these are the additional benefits that an employee gets as a part of their compensation. Such benefits are non-monetary benefits. Organisation gives the defined number of earned leaves, sick leaves or vacation leaves. Companies also provide health and medical insurances cover to their employees.
  • Travel allowance: some companies offer a daily travel allowance to their employees like reimburse petrol charges, another mode of travel or provide pick and drop service from their homes. The travel allowances also depend upon the job role you hold in a company.
  • Free meals: many organisations offer free or subsidised breakfast or lunch to their employees. This may not be in all organisations and depends on the company's policies.

Related: Gross Salary and Net Salary: Definitions and Examples

Importance of compensation

Below are the points highlighting the importance of giving the right compensation to the employees:

  • It helps an organisation to stay competitive in the market and run its business
  • It attracts skilled talent
  • It reduces the attrition rate
  • It encourages employees to perform better and achieve specified standards
  • It helps to increase employee engagement
  • It helps to keep employee's morale high and keep them motivated
  • It helps to increase the efficiency of the job evaluation process
  • It ensures job satisfaction amongst employees
  • It helps to stay in compliance with the Federal and State government agencies

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