Choices in Designing a Compensation System

The compensation system that is followed by a firm should be in tune with its own unique character and culture and allow the firm to achieve its strategic objectives. A wide variety of options confront a firm while designing such a system.
Internal and external pay: Pay equity as stated previously is achieved when the compensation received is equal to the value of the work done. Compensation policies are internally equitable when employees believe that the wage rates for their jobs approximate the job’s worth to the organization’s. Perceptions of external equity exist when the firm pays wages that are relatively equal to what other firms are paying for similar type of work.
Fixed versus variable pay: Now-a-days variable pay programs are widely followed throughout many organizations and for all levels of employees. Widespread use of various incentive plans, team bonuses, profit sharing programs have been implemented with a view to link growth in compensation to results. Of course, while using variable pay systems, management must look into two issues carefully:
1) Should performance be measured and rewarded based on individual, group or organizational performance?
2) Should the length of time for measuring performance be short term or long term?
Performance versus membership: Knowledge based organizations these days follow a performance based payment plan offering awards to employees for cost saving suggestions, bonuses for perfect attendance or merit pay based on supervisory appraisals. 3M’s encouragement of innovation through this route for example has paid off in what has become a legend in the field of product development (one of the chemists developed the immensely popular product). Post it, when 3M gave time for the employees and announced a handsome bonus for the final result. Most organizations however still pay their employees based on the number of hours of work per week coupled with certain benefits for serving the company loyally for a particular period.
Guidelines for effective performance based pay system:
To be fair to employees, organizations should keep the following guidelines in mind while instituting merit pay systems.
1) Establish high standards of performance so that the truly outstanding employees emerge as winners.
2) Develop accurate performance appraisal systems. The focus must be on job specific result oriented criteria as well as employee behaviours
3) Train supervisors in the mechanics of carrying out appraisals and offering feedback to employees in a proper way
4) To reward closely to performance.
5) Use a wide range of increases. Also, make pay increase meaningful.
Job versus individual pay: Most traditional organizations even today decide the minimum and maximum values of each job independently of individual workers (who are placed in between these two extremes) ignoring their abilities potential and the ability to take up multiple jobs. Such job based pay systems may, in the need, compel capable workers to leave the company in frustration. To avoid such unfortunate situations, knowledge based pay systems (or skilled based ones) have been followed increasingly in modern organizations. In this case employees are paid on the basis of the jobs they can handle or the talents they have that can be successfully exploited in various jobs and situations.
Organizations will grant an increase in pay after the employee masters various skills and demonstrates these according to a pre-determined standard. One of the important limitations of this method is that employees can became discouraged when they acquire new skills but find very few rewarding growth opportunities or high rated jobs where they can use their talents successfully.
Source: HRM Book