Compensation Management: Process & Types

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  • 0:02 Overview of…
  • 0:40 Basic Definitions
  • 1:07 Compensation…
  • 4:21 Types of Compensation
  • 4:59 Lesson Summary
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Lesson Transcript
Instructor: Brianna Whiting
Have you ever wondered how a company decides how much to pay an employee? In this lesson, we'll learn the process of compensation management and the two major categories of compensation. You can take a quiz to test your knowledge when you are finished.

Overview of Compensation Management

Meet Bill! Bill has decided to start his own business selling wood furniture. In order to be successful, he knows that he has to hire some help. He needs someone to pick up the wood at the lumber yard, someone to work in the office, and someone to deliver the finished products. Obviously, Bill knows that he will have to compensate them for their work, but how to begin? How does a compensation system work? How much should he pay each employee? Should he offer benefits?

While we've all been paid at one time or another for a job we did, many of us hardly pay much attention to the process many employers utilize. Let's explore further.

Basic Definitions

First let's take a minute to first define some key terms. Compensation in business is an exchange for services, like getting paid for a job done. Compensation management is overseeing the process of providing pay or other benefits to employees for doing a job. The objective is to use compensation in order to recruit and retain the highest quality employees. Compensation helps motivate employees to work hard and promotes a positive morale.

Compensation Management Process

Let's now look at the process. Once a company is organized and ready to begin hiring employees, they need to develop a process to reward those employees. The following is a list of steps management may take to complete this process:

1. Understand the Budget

First, management must understand the budget. Before a company can pay workers for their services, they need to know how much money they have available to spend. For Bill, he would need to determine how much money he suspects he will have available to pay his new employees. So, if he projects $1000 in sales and has $200 in expenses, he would have $800 left over to use for compensating his employees.

2. Put Someone in Charge

Second, management needs to put someone in charge. Many big companies have a department responsible for paying employees with a management team overseeing the entire process. For a start-up business, like Bill's, often times it's the owner that will be in charge of payroll.This means that he will have to be in charge of the budget and will have to make sure each employee gets paid instead of relying of someone from HR.

3. Analyze the Jobs

Third, management needs to analyze the jobs. Before you can pay employees, you need to know what their job duties and/or position is worth. This can be determined through surveys and data collected from companies within the industry. The tasks the employee will be required to complete also play a role in deciding how much to compensate for each position. For Bill, he might do some research on other furniture businesses and determine how much their employees are getting paid. Using a comparison, he can determine how much he should pay his employees.

4. Decide Levels

Deciding levels is the next step. More specifically, in large companies, there are often different levels of employees. You might have new hires, executives, management, etc. A company with different levels may have a pay range. For example, a new hire might only get paid between $25,000 and $30,000 a year, whereas a higher up executive might be paid more like $120,000 and $140,000.

5. Develop a Compensation Package

Once you have decided how much you want to pay, you need to create a compensation package. Will there be benefits? How often will the employee get paid? When Bill gets to this step, he might decide to pay each employee $15.00/hr with the option of health insurance as a benefit.

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