There are many compensation tools, approaches and methodologies used which can be different from organization to organization but one thing is same, they are taken to have a competent workforce, which is motivated enough to direct themselves towards the success of the company they work for. Compensation, due to its increasing importance in motivating the employees, has become an integral aspect of the practice of strategic human resource management. At the basic look, compensation is the monetary return that a company gives to the employees in return for their services. It is a general belief that the more the company pays the more satisfied the employee is. But it is not as simple as that. In practice, satisfying the employees with the pay is harder than it looks. There are several factors to take into account when developing a compensation system. Compensation systems are not precise or vague; much thought and planning has to be invested in developing the appropriate plans for the employees of the company.

Role of Compensation

Compensation is required to pay off employees. But why? Of course for their services, but that is not the only reason. A good compensation does wonders for the organization’s overall performance in terms of motivated employees. Following are the impacts of a good compensation plan.

Increase in Productivity

When employees believe they are being paid well enough which satisfies their basic needs, they get motivated to show productivity at work.

Retention of Employees

When employees are not paid well enough, they may go on strikes to slow down productivity or leave the jobs simply, increasing the job turnover of the overall organization which is clearly not a good sign of a healthy organization.

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Serving of Psychological and Self-Actualization Needs

The compensation system allows not only the fulfillment of the basic physical needs, but also once they are crossed over, proper compensation allows the employees to remain happy, and satisfied with how they are being appreciated through the pay and they move towards achieving their self-actualization needs, and throughout the company benefits from their enthusiasm and motivation in their jobs.

Attraction and Sustainment of Talent

When a company pays well, through word of mouth, and another medium of communication, it gets well known, and ends up attracting competent workers and talent from the labor market, which only serves as an additional step towards achieving the targets and maintaining creativity in products (Mathis, 2004).

Benefits of Compensation in HR Area

Companies are now increasingly developing strategic pay plans and the human resource departments are playing a big role in that. Compensation plans are not developed by the human resource department in isolation with the overall organization. Human resource departments have grown ever since their importance has been recognized by the big companies. In small companies, the human resource department constitutes of a single or two individuals, but in big companies, human resource department is as large as any other department, as they are engaged, in recruitment, selection, retention of employees, compensation being part of the retention activities. The human resource department incorporates the employee requirements associated with the successful implementation of the newest strategy into their pay plans to ensure they stay and grow further motivated to make that happen (Mathis, 2004).

Components of Compensation

The human resource managers have to consider several factors before they establish a compensation strategy, because like said, a lot rides on the impact of the compensation upon the employees, where a slight dissatisfaction with the return can cause the employee to lose motivation and end up with bad performance. So what are those factors? They are discussed as follows.

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Competitive Position

The competitive position of the market has to be analyzed beforehand through benchmarking or other research. Based on that benchmarked information, the competency required from the employees can be determined. To further induce the competitive position into the compensation formulation process two important market factors have to be considered: Salary compression and Geographical impacts on the employees.

Cost/Perceived Value

Employees have certain preferences over the pay they expect to get when they are hired. These perceptions are usually developed considering the costs they incur in their living, which they want to be covered with the pay.

Role of Reward Elements

Foremost in the consideration for the role of reward elements is the prominence of the basic pay among the other benefits. Then comes the determination of how much of the pay will compose of variable and fixed pay. The human resource managers also have to consider that if they develop long-term incentives for the employees, what affects they will have on the performance. But before developing the plans, the employees have to qualify eligibility for the increments or the benefits. Thus, there has to be eligibility criteria.

Performance Management

The duty of human resource managers is to ensure the effective functioning of the performance management system which is a process that consolidates goal setting, performance appraisal and development into a single, common system, the aim of which is to ensure that the employee’s performance is supporting the company’s strategic aims.

Communication and Involvement

The human resource managers have to properly communicate the compensation plan to the employee so as to develop a perception that it is fair. Employees get vulnerable when they fear they are being discriminated in their pay or degraded (Mathis, 2004).

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Developing a Compensation Plan

When all of the above factors are considered, there are five more steps that the human resource manager has to follow to ensure the establishment of a successful and effective compensation plan.

Step 1: The Salary Survey

The Salary Survey is a survey aimed at determining prevailing wage rates. A good salary survey provides specific wage rates for specific jobs. Formal written questionnaire surveys are the most comprehensive, but telephone surveys and newspaper ads are also sources of information.

Step 2: Job Evaluation

It is a systematic comparison done in order to determine the worth of one job relative to another. Jobs can be compared using compensable factors, such as skills, efforts etc which can help determine the pay for each job.

Step 3: Group Similar Jobs into Pay Grades

In the third step the human resource manager has to develop pay grades. A pay grade is comprised of jobs of approximately equal difficulty.

Step 4: Price Each Pay Grade

When the pay grades are developed, each one has to be priced to develop the overall pay in ranges. These pay grades are illustrated on to wage curves.

Step 5: Fine tune Pay Rates

When the pay rates are developed, the human resource mangers fine tune the pay ranges to look for flaws and room for improvements (Mathis, 2004).


Using compensation as a tool to satisfy the basic requirement of the employees is surely a major accomplisher of motivation that is required to achieve the targets of the company. But as simple as the concept of compensation is, unfortunately it is not as appears to be. It is not simple because the employee motivation rides on it and there are huge costs to be faced if the compensation results in negative influence upon the employees who get provoked to produce lack of performance required by the company. Thus, the human resource managers are continuously involved in making the compensation plans as effective as possible.

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