Compensation and Benefits
Pay is not the central issue for attracting and retaining employees (although some will argue that it is). Pay is still important, but so are other issues. People rarely leave a job for money alone. Instead, they leave for career advancement, technical or career challenge, communication reasons (lack of appreciation by company, inability to have an impact at the company, etc.), or job security. (See the section on Controlling Employee Turnover). Some employees who are money motivated, particularly sales people, and those who are significantly under-employed may leave for money.
Managing pay involves two main issues:
- Controlling costs, and
- Leveraging pay (getting the most "bang for the buck").
This is done by establishing an agile compensation and benefits system that track costs, helps ensure pay equity, is understood by employees, and keeps in touch with employee desires and what's popular in the market.
Managing pay equity is managing employee perception. To do this, you need an agile system. Listed below are the steps to creating such a system.
- Categorize employees by job. Avoid the tendency to define jobs so narrowly that each employee in the company has a unique job. Fewer jobs are better than more. Too many jobs can cause the compensation system to be cumbersome and difficult-to-administer. Considering the speed at which jobs change today, an agile and flexible system is needed. Create a few job levels for each job (e.g. intermediate, senior, etc.).
- Compare your pay to the labor market. There are many commercial salary surveys available. If you are not sure which to purchase or in which to participate, ask your local competitors in which surveys they participate. They will usually be happy to tell you because they want to have the benefit of your data just as much as you would like theirs. Another source is the Internet, although many of the surveys posted on the Internet have validity problems. The survey can tell you a lot. First it provides a basis with which to establish financial values for the jobs. Second, it can tell you how well you pay relative to the labor market. Third, surveys can provide you with information for establishing salary ranges. Fourth, surveys can give you an idea on how many job levels to establish for each job group. You don't have to follow what the market does. For example, you may choose to pay more aggressively for some jobs than others,based on your view of the criticality of a particular job and its vulnerability to turnover. (See also an addendum on job pricing.)
- Manage internal equity. Managing internal equity is more important than external equity. An employee is much more likely to know the salary of the person in the office next to him or her, than the salary of a person at another company. Also, the employee will have a better basis for salary comparison because he or she has a better idea of what that employee's job and job performance is. All this creates a much higher potential for morale problems and turnover. You manage internal equity by paying people within a salary range, and by paying for performance. Sometimes internal equity will tell you not to provide an employee with a salary increase, but business necessity (the employee is leading a key project and is threatening to leave) may lead you to decide to provide the salary increase. In the short run this may be the right answer, but in the long run it can be costly.
pay with job performance. Those employees
who perform their jobs well should receive larger
salary increases than those who do not. A recent
survey indicated that about 80% of managers and
employees believe there ought to be a link between
pay and performance. Yet 55% thought their company
did a poor job of rewarding good performance and
75% thought that bad performance was poorly
managed. There are several reasons for this
perception. First is the poor quality of many
performance evaluation systems. Second is the
limited performance input that a manager receives.
(A 360 degree
performance assessment program can help by
including other valuable perspectives in the
performance evaluation process. Third, there are
other factors that must be considered when
determining pay increases, such as difficulty of
the job assignment and how much the employee is
currently paid, etc. Fourth, employee perception
is usually more severe than reality. So it's an
uphill battle. What an organization needs to do is
establish an adequate performance appraisal system
Performance Management) and establish a
merit pay system. There are many good examples of
merit pay systems in the marketplace ranging from
structured to informal.Variable
pay systems can provide an excellent link
between pay and job performance.
- Communicate how pay works. The amount of communication that is appropriate will vary from company to company. Most companies don't do a good job in communicating how pay works. Managers usually have the responsibility to communicate with their employees about their pay. Managers are often reluctant to say too much for fear that they will have to justify some perceived pay inequity (every organization has some pay inequities - it's inevitable). Yet saying nothing results in employees relying in the rumor mill which is always more severe than reality. There's not an easy solution. What's most important is for the employee to understand how their salary increase was determined, why it was that amount, and what the employee can do to earn more (See Career counseling).
Variable pay is employee compensation that varies with the organization's business performance. The classic type of variable pay is sales commission in which the sales representative receives an award (usually expressed as a percentage of sales) for each sale. The more sales achieved, the higher the total commission income for the sales representative and the higher the revenue and profits for the organization. On the other hand, if the sales representative doesn't sell anything, the organization doesn't earn any revenue, but they also don't have any commission expense. The sales representative doesn't have any commission income. Thus with variable pay systems the interests of the organization are closely linked to the interests of the individual employee. By contrast, the traditional base salary represents fixed compensation. Base salary is paid to employees regardless of how well the organization is performing.
Variable compensation plans are rapidly growing in popularity. Their growth is driven by three factors:
- Variable pay is counter-cyclical. It is more costly to the organization that is performing well; yet the organization that is performing well is better able to afford the expense. It is less costly when the business is not doing well and is less able to afford variable pay. In the past, organizations could only reduce employee compensation by reducing the number of employees (i.e. layoffs). A variable pay system works well when the organization's business performance is equal to or better than the industry average. However, if your organization is performing poorly while the industry is doing well overall, then your employees' total compensation (variable plus fixed pay) will be less than other companies in the industry, which could lead to poor morale and/or increased turnover.
- Variable pay links employee goals with the organization goals. If the organization performs well, then the employee will earn more income. Thus the employee and the organization have mutual interests. Here's where design of the variable pay system is important. To be optimally successful, the employee must understand how their individual performance can impact their variable pay (and therefore the company performance). This is called "line of sight". Line of sight improves as organizations reduce layers of management.
- The employee is motivated to help the organization do well. The most effective variable pay systems have been those that have established team or business unit performance targets. Although the line of sight is better with individual goals than team goals, team goals have the advantage of peer influence, which can be a very strong motivator. On the other end of the continuum is company-wide goals (for a small organization, team goals and company goals are basically the same). These too can be effective, although the line of sight is less and therefore the motivation to achieve the goals may be less.
Formal bonus or incentive plans are common and popular. These plans are typically available for upper management employees although participation in the plans is wider in organizations that have a flatter management structure. The formal bonus award is typically paid on an annual basis. The size of the award is usually based on a combination of the participant's individual job performance, the business performance of the participant's division or department, and/or the performance of the entire company. Typical performance criteria includes profit before tax or operating profit, sales level or sales growth, and/or the achievement of specific company or division goals. These plans provide strong performance motivation for participants.
Profit sharing plans are funded by the
organization's profits based on a specified formula.
The profit sharing pool is then allocated to
employees by some means, usually as a percentage of
their base salary.
Lump sum merit awards provide financial recognition for an individual's job performance in lieu of merit-based salary increases. This is an effective way to provide financial recognition, especially to those individuals whose base salary is already relatively high. The lump sum merit award must be re-earned each year and is usually paid during an annual salary review period.
Spot bonuses are also financial awards to provide recognition for an individual's work accomplishments. Typically these are paid immediately after a significant job performance event, unlike a lump sum merit award which is paid as a part of the annual salary review process.
Gainsharing plans allow employees to share in productivity gains in accordance with a predetermined formula. Typically the plans are established with participant involvement and are typically designed for specific work groups, but company-wide programs also exist.
Alternative pay is a term commonly used. It refers to alternative ways of paying people other than for their time, which is the most common method. Thus alternative pay plans generally include those listed above under Variable Pay Systems . Also included as an alternative pay system is skills-based pay or pay-for-knowledge. Under this pay system, an employee's compensation is based on the number of specified skills or tasks he or she has mastered.
Stock plans are very popular. A mystique surrounds
them, perhaps because a few people have gotten rich
from stock options.
The most common type of stock plan is the stock option plan. In a typical stock option plan, the employee is offered a specific number of shares which he/she can exercise (buy) at some specified time in the future. The price at which the employee can buy the stock is equal to the market price at the time the stock option was granted (grant price). The employee's gain is equal to the market value of the stock at the time it is exercised, less the grant price. If the market price of the stock remains the same or decreases relative to the grant price, then the stock option is worthless (referred to as "under water"). Stock options are typically offered to managers, most technical individual contributors and about half of the other professionals. Smaller organizations offer stock options more widely, in some cases to all employees.
Stock options provide companies with a long term incentive and retention tool. The recipients of stock options are motivated to help the company perform well, so the stock will appreciate in value (although there's a line of sight problem here for most participants). Because they must wait several years to receive the entire stock option grant, employees are motivated to remain with the company, as long as the stock value is increasing.
Employee stock purchase plans are also popular. The stock purchase plan is typically available to all eligible employees in the company. Employees can purchase company stock through payroll deductions (typically up to 10% of pay) at a price that is below the market price (typically 85% of market price).
Retirement plans typically cost organizations 3% of payroll. The cost is substantially higher in companies which offer a pension plan in addition to a defined contribution (generally larger and older companies).
Pension plans are also called "defined benefit plans." The name comes from the fact that employees know up front what the retirement benefit will be given their final salary and years of service with the company. Pension plans are typically company funded. They have lost their popularity because they are highly regulated, difficult to administer, and can be very costly. Second, the cost of pension plans is greater than their value as perceived by employees. Most employees don't think they will stay at a company long enough to earn the benefit of the pension plan. Plus it's difficult for employees to understand how the pension plan will benefit them. Less than 8% of small companies (under 1000 employees), and about 20% of large organizations offer pension plans.
401(k) plans on the other hand, are very popular. They have several advantages over pension plans:
- They are visible to the employees. Quarterly statements are typical. Employees can choose where to invest their funds from among several investments options (usually more than seven) and they can see their investments grow.
- They are portable. Should an employee leave the company they can take the full value of the account with them. A few years of service (usually within four years) are required before the employer matching contributions are vested (which means the employee can take these funds when leaving the company), but the employee's contributions and earnings are always vested. This is valuable to employees because few believe that they will remain at one company for along time.
- They are relatively easy to administer. (The operative word is relative) Many companies are eager to help administer these plans (mutual fund companies are often used) and collect administrative and investment fees. The plan administrator can also help with regulatory compliance. Most offer daily valuation, which allows employees to see how their investments are growing and to make investment changes on a daily basis. (It is generally not a good idea to worry too much about a long term investment like a retirement plan on a daily basis.)
- They are less costly than pension plans. Companies often match a portion of the employee's contributions. A typical company match is 50% of the employee's contribution up to 6% or 8% of the employee's salary. Since there are always some employees who choose not to participate in the 401(k) plan (an 80% employee participation rate is typical), the cost to the company is typically about 3% of payroll. By contrast, a pension plan typically costs a company 5% to 8% of payroll (Although newer pension plans provide a smaller benefit and cost less than traditional plans - approximately 4% of payroll). Yet for the reasons mentioned above, the 401(k) plan is perceived to be more valuable by employees.
Health and welfare plans are costly. For as costly as these plans are, employees often take them for granted. To install health and insurance plans, use insurance brokers. In addition to helping install the plans, they can help negotiate contracts and administer the plans.
Medical insurance is the most costly item in
this category. There are a variety of strategies to
help control costs, which you can discuss with your
Dental plans are equally popular. A typical dental plan includes a deductible and an annual maximum. Routine care is usually fully covered while 50% of cost of major treatment (e.g. bridges, crowns, etc.) is covered. Some companies offer pre-paid dental plans.
Vision care plans subsidize the cost of eye glasses or contact lenses, and eye exams.
Life insurance and AD&D (Accidental Death) insurance are provided by most companies. The amount of insurance can be fixed or a variable based on the employee's pay.
Supplemental life insurance plans and dependent life insurance plans allow employees to purchase additional life insurance coverage through payroll deduction and at group rates, at little or no cost to the company.
Orthodontic plans (subsidies for braces) typically include a lifetime maximum benefit per participant.
Wellness plans include CPR/First aid training, flu shots, discounts on health club memberships, health fair sponsorship, and/or stress management training.
Paying insurance premiums on a pre-tax basis is an option offered by most companies.
Health Care Reimbursement Accounts (HCRA), which allow deductibles and other health expenses to be paid on a pre-tax basis, and Dependent Care Reimbursement Accounts (DCRA), which allow child care expenses to be paid on a pre-tax basis, are both popular.
Companies spend approximately 10% of payroll on paid time off plans. This is money well spent by the organization. Paid time off is highly valued, especially with today's time pressures on employees and their families. To the benefit of companies, paid time off often becomes on-call time, since employees understand that companies may need their services or consultation while they are away. Employees are often willing to provide the company this flexibility, especially if the company provides the same flexibility to employees. More than a third of companies have a formal policy that allows for flexible scheduling.
Holidays are paid days-off provided to all employees in the company (the company closes). The seven most common holidays are New Years day, Memorial day, Independence day, Labor day, Thanksgiving day, the day after Thanksgiving, and Christmas Day. The next most popular days are President's day and Christmas Eve day.
The number of vacation days granted to employees often varies with years of service.
Sick pay is paid time-off for employee
illness or for the illness of a family member.
A personal time-off (PTO) benefit, which
combines vacation and sick leave, is offered by many
companies. Combining the two discourages the abuse
of sick leave. That is, some employees call-in sick
just to use up their sick time. With PTO, there's
no advantage to call in sick just to use up PTO
Short term disability plans or salary continuance plans are offered by many companies. Salary continuance (continue to pay the employee's full salary) may be offered for the first month of disability, then a short term disability benefit that ranges from 60% to 70% of the employee's salary for up to three months of disability.
Long term disability benefits are provided by almost all companies after an employee has been disabled for a period of time, typically three months. The benefit amount ranges from 60% to 70% of the employee's salary.
Sabbaticals are paid time-off in addition to vacation offered by a few companies. The length of the Sabbatical ranges from four to six weeks and is usually granted after every five years of service. Sabbaticals are not very common.
Jury Duty, Military Leave (usually up to 2 weeks per year), and Bereavement (up to 3 days per year) are other widely offered paid time-off benefits.
Government mandated benefits (Social Security, Workers' Compensation, and Unemployment Insurance) also cost employers approximately 10% of payroll.
Social Security provide limited disability, survivor, and retirement benefits. Employee contributions to social security are matched by the employer.
Workers' Compensation provides medical and disability benefits for work related injuries and illnesses.
Unemployment Insurance provides some income
for a temporary period of time, if the employee
looses his or her job due to no fault of their own.
The company pays the premiums.
"The Virtual HR Department" provides detailed step-by-step instructions on how those with HR responsibilities can perform virtually every major task in Human Resources. Here are procedures related to the topics on this page: