Principles of compensation formulation

Principles of compensation formulation- Designing compensation packages take into account several other factors in addition to the ones mentioned above. External factors such as supply & demand of labor, technology, level of economic development and social influences, and internal factors such as business strategy, organizational culture, and internal equity also influence an organization’s policy to a great extent. An effective and fair compensation package looks at all of these factors in order to fulfill the strategic objective of delivering best-in-class talent at competitive prices to the organization.

Formulating a policy takes the following factors into account:

• Labor laws: A question the organization must ask before finalizing a policy is whether elements of the compensation package that must be included under governing laws are included. Legal compliance forms the basic pillar upon which a good compensation strategy is built.
• Internal organizational structure: The way the organizational chart looks also plays an important role in formulating policies for an organization. The number of unique jobs within the organization, the different levels (from executives to line staff) and the total number of staff required to meet the organization’s business goals must be taken into account when creating compensation plans. For example, an organization that requires a large number of workers with a wide range of skills will necessarily have a different strategy than an organization that requires a smaller staff and is more reliant on automation. An evaluation of the internal structure leads to the creation of job descriptions, which is the key to the creation of any compensation policy.
• Line of business: The industry of the organization has a direct link with the labor market that the organization operates in and consequently impacts its compensation strategy. For example, a retail organization would pay its people in a vastly different manner than a software services firm.
• Competitiveness with external markets: The organization must decide where it stands in terms of external market rates. The three pay strategies with regard to market competitiveness are to pay below-market, at the market or above market. Anyone or a combination of these strategies may apply to the entire organization depending on the structure of its workforce and/or labor market conditions. An organization may choose to pay below-market especially if the supply of labor is ample and a particular job does not require specialized skills or education. For example, a retail organization may decide to pay below market for all floor staff. An organization may also choose to pay above market, typically where the supply of labor is scarce and the job is highly specialized. For example, a research lab may choose to pay significantly above market in order to attract and retain the best scientists. Many organizations will simply have more than one strategy incorporated into a compensation plan. This typically happens when different jobs within the same organization have different external and internal factors affecting them.
• Administration or execution: Whether compensation administration will be centralized or decentralized is an important question that must be answered before creating an organization’s overall compensation plan. Thus, how a particular strategy will best be executed while aligning with the overarching business goals is very important. Most organizations naturally gravitate towards a combination of centralization and decentralization. Typically, benefits decisions may remain centralized as they are applicable to the vast majority of the employees in the exact same manner whereas base salary and variable pay decisions, including bonuses, may be decentralized allowing business units to manage employee performance and productivity by using compensation decisions as motivators.

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