Critical Issues Concerning Total Employee Compensation
written by: N Nayab•edited by: Jean Scheid•updated: 5/19/2011
Employee compensation ranks among the most critical functions of an enterprise. Apparently a straightforward exercise, this exercise is complicated and contains many underlying issues. Read on for critical issues concerning total employee compensation.
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Total employee compensation is the sum of all rewards, compensation, and benefits, both direct and indirect enjoyed by the employee. The critical issues concerning total employee compensation are establishing a base compensation package, differentiating between costs to the company and employee pay, inclusion of variable pay components, and legal compliance.
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Base Compensation Package
The primary issue concerning total employee compensation is developing base compensation. Unless a pay system already exists, the process has to start from job design, followed by evaluating the job and fixing total pay, and instituting a system of performance appraisals and evaluations to determine the extent of payout.
Total pay includes direct monetary compensation and indirect pay such as benefits. Direct remuneration includes basic pay, increments, merit pay, incentives, bonus, and other pay for performance. Indirect monetary remuneration includes benefits such as medical insurance, dental insurance, paid time off for vacations, company contribution to voluntary pension plans, tuition reimbursement, housing or rent, and others. Indirect non-monetary benefits include providing training for the employees and investing in employee professional development programs.
The most critical issues concerning total employee compensation is determining the proportion of each such compensation element.
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Cost to Company vs. Salary
One critical issue concerning total employee compensation is an understanding of Cost to Company (CTC) versus gross salary or employee remuneration.
Cost to company is the sum total of what the company spends on an employee. This includes cost of the physical infrastructure and equipment used by the company, costs of recruitment and training, employers’ contribution to social security, Medicare, and pension plans, payment of unemployment tax and other payroll taxes, cost of benefits provided, value of paid leaves, and all other expenses for the employee, besides the employees’ gross salary.
Employers look at the cost to the company when considering the value the employee adds to the company whereas, the employee primarily looks at the total pay plus benefits, and more specifically, take home pay when considering whether working in the company is worthwhile.
The difference between the cost to company and gross salary varies from company to company, and there is no fixed standard. Generally, the more benefits enjoyed by the employee, the greater the difference between cost to company and total salary.
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Variable Pay and Pay for Performance
Variable pay, or remuneration based on specific performance standards or company profitability is a significant element of the total reward strategies of many organizations. Types of variable pay includes piece rates, commission, gain sharing, incentives, bonuses, commissions, cash awards, lump sums, profit sharing, and stock options.
Administering variable pay programs ranks among the top critical issues concerning total employee compensation. The major challenge relates to linking the payouts to specific performance standards. The best approach is to link the variable pay plan to a performance evaluation program that measures the employees’ mastery of the job, development of critical skills, and increases in knowledge over time.
Effective variable pay programs that reward performance based on set goals, motivates employees to perform, allows companies to ensure employee performance remains aligned with company goals and objectives, and allows companies to cope without pay cuts or layoffs during recessionary periods.
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Legislations govern almost all aspects related to total employee compensation, and a critical issue concerning total employee compensation is ensuring compliance with all such legislations.
The Fair Labor Standards Act, for instance, states that incentive awards raise the base rate computation of the overtime pay rate. The National Labor Relations Act requires covered organizations negotiate wages, hours, and working conditions with trade unions, usually through collective bargaining.
Legislations also govern deductions on gross employee salary to arrive at net pays. The statutory deductions include federal income tax, social security, Medicare, state income tax, and local tax, wherever applicable and in that order. Voluntary deductions such as loan recovery, 401(k) plans, and others come after the statutory deductions.
The challenge for the employer is making deductions in the correct order, and ensuring compliance with other laws not normally applicable, such as garnish wage laws.
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Another of the critical issues concerning total employee compensation is reconciling cultural and other differences in compensation plans to ensure a standardized and uniform total compensation package across all units. This challenge is more for large companies spread over different and diverse geographical units, especially multinationals.
An one-size-fits-all total compensation package remains the most equitable approach, but comes with certain latent dangers. Some cultures or countries, for instance might perceive a particular compensation as unfair. For instance, some cultures consider pay for performance as unfair on old employees who have "spend their youth working for the company" and insist on pay for seniority. Again, certain rewards, such as tips already in use may be embedded in the culture and difficult to overcome. Such divergent cultural issues may also have legal backing in respective countries. The challenge for companies is to maintain pay equity while accommodating such unique norms.
The trend of total compensation in recent years is to include more variable pay plans, and include personal and professional growth opportunities and a motivating work environment such as recognition and work life balance as part of total compensation.
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Greene, Robert, J. “Variable Pay Plan. How to Manage it Effectively." http://www.shrmindia.org/variable-pay-how-manage-it-effectively. Retrieved 14 February 2011.
Robert L. Heneman. "Implementing Total Reward Strategies." SHRM Foundation. http://www.shrmindia.org/sites/default/files/Implementing%20Total%20Rewards%20Strategy.pdf. Retrieved 14 february 2011.