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Compensation Management: A Comprehensive Guide for HR Professionals

14 min read

You have a company. You want to grow. You want to get richer.

But you can’t do this on your own. So you decide to hire some people who can help you out. What kind of people do you want? Like any other business owner/team leader, you want the best.

But here’s the challenge – there are very few people who could be exactly what you need. And even if you find them, how do you know what you must pay them? The answer is a good, robust compensation management strategy.

And that’s what we’re going to dig deep into in this post.

What is compensation management?

Compensation management helps to know how much to pay and to whom. It helps to plan strategies to attract better talent by balancing the cost of hiring and industry compensation standards. Compensation management also takes into consideration the compliance aspects of fair pay.

Compensation can be broadly classified as:

Direct Compensation:

which includes a fixed salary and benefits such as medical allowance, conveyance allowance, vacation pay, bonuses, overtime, etc. Organisations calculate the base salary/wages on an hourly, daily, weekly, or monthly basis.

Indirect Compensation:

which includes all non-monetary benefits that an employee receives as compensation. Payments as required by law, such as provident fund, insurance, paid leave, etc. are part of indirect compensation. It also includes recognition for good performance, promotions, awards, etc.

With compensation management, an organisation can establish legally compliant, competitive and attractive compensation structures. Compensation plans help a business stay cost-efficient, yet financially attractive to the talent pool out there. After all, money is a top motivator for most people. As such, a good compensation strategy can also increase productivity and decrease attrition rates.

The need for compensation management

A well-planned compensation strategy should make employees feel valued. Dissatisfaction with pay can be the single biggest cause of conflict or dispute, resulting in unrest and even attrition.

Smart companies pay special attention to how they pay their people. They’re ready to pay more than the industry standards to attract the best talents. They understand that salaries are investments that can have great returns. And this is what compensation management is supposed to achieve – the best minds working to make you successful.

Here are some more things compensation management does for your business –

  • Guides the compensation norms
  • Sets clear expectations
  • Ensures budgets aren’t overshot
  • Ensures that compensation offered is justified by the revenue that would be generated

The last point above is very important. Hiring the best doesn’t simply mean paying huge sums of money. The business needs to also understand what kind of ROI this investment will bring. Sometimes, the ROI expected is so low, that the compensation offered may simply not be justified!

And so, compensation management helps you stay focused on your business goals, so that your hiring costs are justified.

How is Compensation Fixed?

Companies use different approaches to come up with robust compensation structures. The standard factors include:

Market Standards:

The most common way to fix a salary bracket is to understand the existing market norms. This not only helps set the pay scale for new hires but will also suggest salary corrections for existing employees.

Qualification and Work Experience:

Another way to fix salaries is to consider different kinds of grades. This includes academic qualifications, skills, work experience, soft skills, etc. Companies assign different values for these grades. These values when put together give the hiring party an objective idea of how much salary to offer. Work experience is one of the most important factors to be considered.

Relevant Professional Skills:

Having relevant skills for a role has a significant impact on compensation. After all, you hire people for what they can do for you, not for who they are personally!

Often, companies are willing to pay people higher if they’re already highly skilled. It works out cheaper than having to train new hires instead.

Demand and Supply of Talent:

The salary bracket set for the role depends on the number of individuals applying for the same position. If there are many applicants for the same role, then the employers have a wider choice of candidates to choose from. This can cause the salary bracket to drop.

But, if the number of applicants is few, the selected candidate stands a higher chance to demand a better salary.

The five main components of compensation management

Compensation management includes monetary and non-monetary components:

  1. The fixed component includes Basic Pay, HRA (House Rent Allowance), DA (Dearness Allowance), and LTA ( Leave Travel Allowance). This is designed keeping in mind the income tax laws to help employees get the best tax benefits.
  2. The variable component includes performance or target-linked bonuses, incentives, sign-on bonuses, commissions, employee stock options (like ESOP), etc.
  3. Fringe benefits and perks include holidays and leaves, and insurance coverage, among others. Fringe benefits are extra perks that could be paid vacations, company car, driver’s salary, furnished house, club membership, sickness/pregnancy benefits, etc.
  4. Social security refers to legally mandatory benefits such as Provident Fund, ESIC, and gratuity. These benefits are meant to protect employees from financial risks and hardship both, during the employment period, as well as post-retirement.
  5. Other allowances can be in the forms of allowances for leave travel, conveyance relocation, education, overtime, and so on.

Companies also consider other factors for better compensation management. For example-

  • Market standards
  • Legal compliance
  • Tax benefits
  • Ability to attract top talent

Objectives of compensation management 

  1. Attracting top talent – Compensation that’s on par with, or above the market rates, helps attract the best talent to the organisation.
  2. Retaining employees – Similarly, fair compensation that matches industry standards motivates existing employees. They feel valued and appreciated, and would be more willing to stay with the organisation.
  3. Rewarding desired behavior – When employees feel valued, they’re more likely to go out of their way for the company’s goals. Organisations want good performance, loyalty, etc. in their employees. And fair compensation is one of the best ways to reinforce optimal employee behavior.
  4. Saving cost – Retaining good talents for a longer period is one of the key ways to save costs. One ends up reducing costs on hiring, training, learning curve and adaptation to the organisation, etc.
  5. Being legally compliant – Compensation management includes complying with the existing laws and regulations of the land. This is important for both, employers and employees. The last thing one would want is to land in an unexpected legal suit for oversight of salary payments. It’s always safer to incorporate such laws into the compensation management strategy to avoid legal trouble.
  6. Promoting equity – A fair compensation package ensures equal treatment. The disparity in pay due to gender, race, age, etc., is objectively eliminated by good compensation management strategies.
  7. Improving administrative efficiency – Great compensation structures save HR teams a lot of time. HRs won’t need to spend a lot of time on the negotiations or working out compensation packages for every new joinee.

Ultimately, good compensation management enhances the value and branding of the company internally and externally.

Why is Compensation Management Important for HR Leaders?  

The quality of people working in an organisation can make or break a business. Needless to say, having a good compensation management strategy becomes crucial to a company’s success. Every business owner wants to know how much ROI is being generated from each hire – and this is a question that HR leaders have to answer. This makes compensation management a very important part of an HR leader’s agenda.

Today, businesses expect HR teams to play business facilitator roles as well. Despite the increased automation of low-value transactions, the demand for high-quality human talent hasn’t been reduced. However, the skill requirements of such talents have changed. Naturally, HR leaders must look at these changes when designing compensation management.

Compensation management is integral to modern HR strategy 

Businesses and the job market are becoming more competitive. A business’ success is highly dependent on the talent they have on board. This is true, especially in businesses such as IT, finance, and telecommunications. And this is where compensation management comes in.

Today, employees have access to any information they want – including the pay packages across industries and peer companies. The pace at which each industry is growing makes it necessary for them to have employees with the best skills. Hiring such employees can only happen with a competitive approach to compensation management.

The goals of the organisation are more aligned when compensation management and the HR team work together. As a result, this helps businesses in maintaining the welfare of their employees. When they get fair compensation and raises on schedule, employees feel valued and appreciated. As a result, staff members feel more inspired and involved.

Strategies for effective compensation management

Here are some ideas to help get started on enhancing compensation management. Not all may be applicable to the nature of the business but these are still great tips to get started with. They are:

Have a clear budget allocation:

The budget allocation should define the spending capacity for both, overall and category-wise employee costs. Without this, it is possible to end up over-spending or under-spending on new hires. Either way, it may just not see the desired ROI.

Set salary ranges and total benefit limits:

Salary ranges help the organisation compensate employees on par with/better than the competition. This also helps keep a check on employee costs. This also ensures one doesn’t burn money on going overboard with benefits and spends reasonably.

Conduct compensation audits:

Carry out compensation audits to stay updated with ongoing market changes and prevailing trends. This will help to adopt the required changes in the compensation plans.

Maintain performance appraisal process:

This is an important HR process, critical to ensure that employees are meeting the performance standards set for them. The compensation of employees is reviewed and revised based on the appraisal results.

Enforce strict compliance:

A good compensation strategy will take care of all compliance requirements. This includes adherence to employee and company policies, including time sheets, leave policies, etc. This also means fairness of pay and benefits.

Design an administrative structure:

As with any operational process, compensation management should also have a defined administrative structure.  This will make it more effective.

Final thoughts

Money is not the only drive for employees. However, fair compensation is one of the most important drivers of better employee retention and talent attraction. We’ve discussed the need for compensation management, its definition, its components, and much more in this article. We hope that these insights may help in developing better compensation management strategies.

Want to discuss more on this topic? Looking for ideas or solutions to help manage compensation strategies like a pro? Get in touch with Keka and tell us what you feel – we’d love to hear from you.

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    Meet the author

    Keka Editorial Team

    A bunch of inspired, creative and ambitious youngsters- that’s Keka’s editorial team for you. We have a thirst to learn new subjects and curate diverse pieces for our readers. Our deep understanding and knowledge of Human Resources has enabled us to answer almost every question pertaining to this department. If not seen finding ways to simplify the HR world, they can be found striking conversations with anyone and everyone , petting dogs, obsessing over gadgets, or baking cakes.


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