A proper compensation plan is expected to drive the success of business strategy (O’Connell, 2007). A properly planned and executed compensation plan has the potential to improve organizational effectiveness, motivate and reward employees and achieve corporate strategic and financial goals (Jerez-Gomez, Cespedes-Lorente, & Valle-Cabrera, 2005). Compensation is the key to recruiting and retaining good employees and, motivating them to achieve organizational strategic goals.
Given the strategic importance of compensation plans, it is essential to make a well-thought-out plan. The requirements in a compensation plan change with changes in level and type of job. As noted by O’Connell:
“he executive team needs to be compensated one way, the sales team requires a different approach, and the company’s core personnel are compensated using yet another set of rules. The “one-size-fits-all” approach to compensation is ineffective and antiquated in today’s business environment.” (2007, p. 21).
While building a strategic compensation system it is essential to look at the organization’s external environment, the nature of demand for a particular skill, and the industry and business cycle. Further, today compensation is not just negotiating a salary figure, but it involves many cash as well as non-cash components, retirement plans, stock options, bonuses, etc. in addition, a compensation plan must also look for internal as well as external equity (Bingham, Blitstein, Hawk, & Sellers).
The paper aims to devise a compensation plan for a manufacturing plant with 120 employees. The paper will first look at various compensation strategies and then adopt the best-suited strategy for the organization. Then the compensation strategy is exemplified and its effectiveness to a manufacturing company is analyzed. The paper ends with recommendations for the company regarding its future compensation plan.
Types of Compensation Plans
Traditionally, compensation strategy was set by fixing a base salary. The structure of the plan was decided upon depending on various options:
- Single Pay Structure: A pay structure based on roles of employees; where the employees who perform the same work receive the same pay.
- Tenure-Based Approach: this structure will depend on the employee’s tenure in a job. The greater the tenure, the higher is the pay.
- Combination Pay: A combination of tenure-based and merit-based pay structure.
- Performance-Based Pay: Pay system based on the performance of the employee or group or company.
- Base Pay plus Incentive: An increasing option is to fix a base pay for a particular position, and have an incentive system based on individual, team, or company performance.
Contemporary approaches in determining the salary are as follows:
- Broadbanding: This is an approach to the structuring of the base salary. Here the base salary is banded in wider bands with a higher degree of spread, i.e. salary ranges. The advantages of this band are that it allows flatter and flexible organizations and does away with the structural pay barriers. The disadvantages are problems of communication of salary to the employees and lack of cost control.
- Skill-based pay: here employees are paid based on possession of a certain inventory of skills or technical knowledge. This pay system enhances workforce flexibility and strengthens employee empowerment. The disadvantages of this system are that it increases cost, pay is done for inputs rather than outcomes, and unused skills become corroded.
- Team Pay: The pay is based on team performance and outcomes. This pay system is highly effective in team-based organizational structures. Here the payment system is based on group productivity on a gainsharing basis.
Suggested Compensation Plan
The above discussion on the types of salary systems provides a plethora of opportunities to plan a salary system for a manufacturing organization. In the following section, the compensation plan for the company will be devised. First, a few assumptions need to be taken regarding the company’s structure. The organizational structure of the company is functional who works as groups as is the case for most manufacturing companies in the UK and the US (Quail, 2008; Veilleux & Petro, 1988).
External Environment: Before any suggestion is made regarding the compensation plan, it must be noted that the external environment of the company presently is undergoing a recession. According to Mercer, most manufacturing firms are expected to increase salary by just 0.5 percent due to the recession in 2010 (Survey Forecasts: Early look at ‘10 Pay, 2009). There have been instances where the trade union has negotiated a 12 percent pay cut in lieu of no lay-offs in the US (Economist, 2009). Given this recessionary situation and pay cuts, a competitive pay system must be devised to suit the company.
Pay-for-Performance: The compensation plan aims to devise a system, which will motivate the hygiene factors of the employees to work as well as be cost-effective to employees. The answer is by setting a pay-for-performance compensation system (Chen & Fu, 2008; Cordero, Walsh, & Kirchhoff, 2005) Base salaries are usually fixed on a band or broadband, based on seniority. For the company in question, it is suggested that the base salary be pegged to performance.
Why do we adopt a pay for performance strategy for compensation? The main advantages of taking this strategy are: (1) cost-saving, (2) increased retention of good employees, and (3) increases motivation (Workforce Management, 2008). It is believed that pay-for-performance compensation strategy increases retention by almost 27 percent (Workforce Management, 2008). This strategy also helps in attracting talented employees (Hersch, 2008). Further, this model of performance helps employees excel to the maximum level of their potential. In addition, cost-saving is of utmost priority in this recessionary phase.
According to Workforce Management (2008), three steps must be taken to forms is pay for performance system in an organization: (1) compensation planning, (2) goal alignment, and (3) performance management.
In compensation planning, we propose a system of annual bonuses and merit-based salary increases. This would be based on the characteristic performance review cycle of the company and will be linked to organizational goals. The compensation plan must be associated with an individual or team goal. The performance should be measured based on individual or team performance or the outcome of the business unit (Bates, 2003). Pay increases will be linked to increases in performance and will be set as a reward given to the employees in form of incentives like an annual bonus. The idea here is to pay top performers more instead of waiting for a merit increase across the base (Bates, 2003). Industry experts have stated that even in the recessionary phase, pay-for-performance is the best option that companies have to employ a compensation strategy.
Even though there are various compensation plans, pay-for-performance is the best option to be adopted in a recessionary phase (Bates, 2003). This strategy is cost-effective as well as makes employees who perform well happy. This system helps in increasing job satisfaction through the satisfaction of the hygiene as well as the motivational factors of employees (Chen & Fu, 2008). Even though many have criticized the effectiveness of pay-for-performance (Economist, 2002), proponents of the strategy believe that it is the best plan to retain employees and attain organizational goals.
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