What are the various factors affecting the compensation of an organization?

The Compensation is the monetary and non-monetary rewards given to the employees in return for their work done for the organization. Basically, the compensation is in the form of salaries and wages.

Developing suitable compensation policies to meet organizational strategies, while efficiently accommodating different types of employment terms and conditions, poses many distinctive challenges for global HR practitioners, such as:

  • Dealing with diverse standards and costs of living and multiple currencies, exchange rates, inflation/deflation rates, tax systems and tax rates.
  • Maintaining the suitable balance between global consistency and local significance.
  • Addressing organizational business changes (expansions, mergers and acquisitions, joint ventures, Greenfield operations and investitures).
  • Complying with local compensation practices, laws, and regulations.
  • Accommodating varied employee values and expectations stemming from differences in cultures, languages and communication preferences.

The primary objective of a compensation system is to administer an effective and equitable pay system. It can be affected by various factors which are as follows:

  1. Organizational Provisions

The organizational provision states that the level of compensation largely depends upon organizational operating policies and procedures. It is because the policies serve as a guideline for formulating and implementing compensation plans and programs.

  1. Government Regulations

In order to protect the working class from wage exploitation by strong employers, the government enacts various laws and judicial decisions. Such laws and regulations affect compensation management. Because, they emphasize on minimum wage rate, overtime rate, working hours, equal pay for equal work, payment of bonus, etc.

  1. Equity Considerations

Equity considerations hold the philosophy that the compensation system should be fair and equitable. It means the compensation system should be similar for the same type of work within the organization. Similarly, it should be fair relative to what other people get for the similar job in another organization.

  1. Union Pressure

Labor unions are pressure groups that work in the interest of the workers. Such unions lobby the management for the formulation of fair compensation plans. These organized unions can ensure better wages for employees.

  1. Job Analysis And Evaluation Report

Job analysis is a method through which necessary information about the contents and the contexts of the job is made available to determine the value of each job. The job evaluation is a process of determining the value/worth of a job so that a payment system can be specified.

  1. Cost Of Living

Compensation is concerned with an overall return that an employee obtains from the organization for rendering contributions towards organizational objectives. Therefore, the payment should be adequate to maintain the cost of living of the employees.

  1. Organizational Positions

Sometimes, the organization itself evaluates where it is in order to prepare compensation plans. The position of the organization is determined by its productivity i.e., if the productivity of the worker is high, it assesses itself as a higher position. As a consequence of it, the compensation system is determined at a higher level.

  1. Productivity of Workers

Another factor of compensation management is the productivity of workers. This is the new concept of linking pay with employee performance. Under it, if the workers are highly productive, they get high compensation as compared to less productive workers. Productivity is a key factor as it enhances organization’s image and status.

Compensation management is one of the primary functions of HR, as it plays a crucial role in attracting and retaining top talent.

What are the various factors affecting the compensation of an organization?

A compensation package attracts employees towards startups and their decision to stick with them. Several factors, from industry standards to government rules, affect the compensation package.

This article details compensation management, its importance, its types and how you can do an excellent job at it. Let’s get started!

What is compensation management?

It is managing and determining an employer’s compensation to the employees in return for their work.

Compensation management involves managing, analysing, and determining the salary, benefits, and incentives paid to the employees. Compensation management plays a crucial role in attracting and retaining top talent. It includes monetary as well as non-monetary benefits. It also increases employee productivity and reduces employee turnover. 

Additionally, it ensures that every employee gets paid a fair wage based on industry standards, work experience, company budget, etc.

Importance of compensation management in HRM

While the list of reasons why you should focus on compensation management is rather long, here are a few main reasons-

  • Helps Plan Your Budget– Employee salaries are the highest cost for any startup. Compensation management helps determine the costs beforehand and plan the budget accordingly. It also helps plan increments and other benefits based on industry standards.
  • Helps Motivate Employees- Compensation is the key factor influencing an employee’s productivity. A well-paid employee is more likely to work hard for your company and vice versa.
  • Reduces Employee Turnover– Giving adequate monetary and non-monetary benefits helps increase job satisfaction and reduce the rate of employee turnover.
  • Attracts Best Talent– It not only prevents employees from switching jobs but also helps attract top talent. The best talent always looks for a company with a competitive salary and benefits like insurance, paid time off, leave allowance, flexible benefits, etc.

Factors affecting compensation management

What are the various factors affecting the compensation of an organization?

  • Productivity of workers– Productivity-based compensation helps derive the best results. The higher the productivity of employees, the more should be the compensation. 
  • Ability to payIf your company has high profitability, you can pay better compensation and retain your employees and vice versa.
  • Government Policies– Government also has certain policies to protect employee interests. The employer has to pay the employees as per governmental regulations and provide benefits such as PF, medical insurance, gratuity, and pension.
  • Labour Unions– They also play an essential role in ensuring employees get a fair wage. They fight with the employers for the employee’s rights and wage revision.
  • Cost of Living– Cost of living also influences compensation to a large extent. An employee based in a city with a high cost of living needs a higher salary and vice versa.
  • Demand and Supply of Labour– It is one of the most important factors that affect the compensation of employees. If the demand is more than the supply, the compensation will be higher.
  • Industry Standards– No employee would like to join a company whose compensation is below the industry standards. Therefore you need to analyse the standard market rates of different roles and pay your employees accordingly.

Types of compensation 

The types of compensation are broadly classified into direct compensation and indirect compensation. Let us look at them in detail. 

Direct Compensation

It is the monetary benefits provided by the employer to the employees.

  • Hourly pay– Hourly pay is the salary paid for each hour of work that the employee does. 
  • Salary– Salary is the fixed monthly amount that the employer pays to the employee in cash. 
  • Commission– A monetary reward that is paid based on the performance of an individual. It is generally provided in the case of sales jobs as a fixed percentage.
  • Bonus– A bonus is a monetary incentive paid to employees for their good performance. It is paid over and above the employee’s basic salary. 

[Suggested Read: Salary Breakup – Salary Structure, Format, Calculation & More]

Indirect Compensation

Indirect compensation refers to non-monetary benefits like paid holidays, insurance, and retirement benefits. 

  • Insurance– Employers generally provide employees with medical insurance to ensure good health of their employees. If you are an early-stage startup facing difficulties getting employee insurance, check out RazorpayX Payroll. It provides group insurance packages to teams as small as 2!
  • Paid holidays–  Paid holidays are provided to help employees maintain a work-life balance. 
  • ESOPs– Sometimes, companies also provide their employees with their shares at a discounted price, offering them an additional opportunity to earn. 

[Suggested Read: The Complete Guide to ESOPs (Employee Stock Ownership Plans)]

  • Retirement Benefits– Retirement benefits include gratuity, pension, general provident fund, leave encashment, etc. 
  • Leave travel allowance– LTA or leave travel allowance is the non-monetary benefit provided by the employer to the employee where the employer covers the employee’s travel expenses. 
  • Relocation expenses– Relocation expenses are the benefits the employer provides in case the job requires relocation to a different city. 

The huge number of employees makes manual compensation management tiresome and error-prone. The best way to deal with the payroll of a huge number of employees is to use payroll processing software like

What is the main factor affecting the compensation?

Demand and Supply of Labour– It is one of the most important factors that affect the compensation of employees. If the demand is more than the supply, the compensation will be higher.

How compensation affects organizational performance?

The compensation and benefits is very important in increasing the employee motivation to perform well. This is because; it can improve the life of the employee and secure their life in the future. The employee will raise their performance so that they will get the bonus or promotion as the compensation and benefit.

What is the impact of compensation management on an organization?

The Impact of Compensation on Employee Performance A good compensation package ensures: Retention – A compelling compensation plan helps to reduce the turnover rate of the company. Employees will be more incentivized to stay in their role and this saves potential expenses related to turnover.

What are the determinants of compensation?

Job performance, external equity, job families, organisational tenure, and employee skills as determinants of employee compensation.