Compensation and benefits: Why the right pay and perks still matter

July 27, 2021 - 17 min read

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What are compensation and benefits in the workplace?

Why are compensation and benefits important?

What are the key components of compensation and benefits?

How can you maintain compensation fairness?

What are the ways to calculate compensation and benefits?

How do compensation and benefits ensure the success of a business?

Hiring the most competent and talented employees and retaining them at a company is a top priority for any human resource (HR) department at an organization.

To attract top talent, one of the most important methods in an HR professional’s arsenal is offering a compensation package that employees find difficult to refuse. According to the Society for Human Resource Management, 63% of U.S. employees said that compensation and benefits are an important factor, second only to respectful treatment when determining job satisfaction.

Compensation and benefits are important aspects of an employee’s satisfaction at a workplace, as they directly impact an employee’s performance and motivation to work. It is, therefore, imperative that an HR department ensure the compensation and benefits offered to their employees are attractive enough to keep morale high. Doing so will ensure that employees know that the company values them and wants to acknowledge the work they do. Humans, after all, are the most important asset for a company.

What are compensation and benefits in the workplace?

While compensation and benefit may seem to be the same—a remuneration from an employer—to an employee, there are some key factors that make them different.

Compensation refers to a reward paid to an employee for the work they do for an organization. When an employee works for an organization, they are paid back in terms of money, perks such as free food, unlimited vacation time, great healthcare, bonuses, etc. for their time and talent. All of this forms a part of the employees’ compensation, which can be financial or non-financial in nature.

Benefits, on the other hand, refer to a non-financial reward given to an employee as a token of appreciation for their work. Some benefits that are popular among employees are flexible work timing, the opportunity to work remotely, access to gym memberships and catered meals, as well as a casual dress code.

While benefits may not offer direct money to an employee, they are important to attract talented employees to a company. Let’s assume an employee receives two job offers. Both the offers have the same monetary compensation, but the first has a superior benefits package compared with the second. The employee is very likely to take the first job offer in this case.

Differences between compensation and benefits

Compensation Benefits
Compensation is an umbrella term used to describe anything that an employer gives an employee in exchange for their labor. Benefits form a subset of compensation.
Compensation is a way for an organization to attract the best talent. Benefits are used as a means to motivate employees to perform better.
Compensation can be monetary or non-monetary. Benefits are always non-monetary.
Compensation is a direct payment for the work an employee performs at a company. Benefits are an indirect payment for their work.
Compensation is usually fully taxable, or a part of it can be exempt from taxation. Benefits can be tax-free or partially exempted from taxation.

Models to explain compensation and benefits

There are many models that explain how companies and HR departments determine an employee’s compensation and benefits package. Let’s take a look at two of those models.

Total Rewards Model

The Total Rewards Model states that the monetary aspects of a job are not the only ones that influence an employee’s well-being at a company. Non-monetary benefits, such as a healthy work-life balance and recognition for their contribution to work, play an important role as well.

Created by World at Work, a global association for HR professionals, this model says that the overall rewards for an employee are made up of five parts: compensation, well-being, benefits, development, and recognition. The monetary reward, fixed or variable, that a company pays to an employee in exchange for their “time, effort, and talent” is classified as compensation.

This model says that the overall rewards for an employee are made up of five parts: compensation, well-being, benefits, development, and recognition.

Well-being comprises the overall state, including emotional, physical, and environmental well-being, of an employee. World at Work defines benefits as the rewards focused on aspects such as healthcare, retirement, and time-off available to an employee. Development focuses on the opportunities that an employee gets for skills development and career advancement. Meanwhile, recognition caters to formal or informal appreciation and validation of an employee’s efforts towards their work and company.

Warr’s Vitamin Model

Peter Warr, a workplace psychologist, developed a model for compensation that compared job characteristics to vitamins. As the human body needs various vitamins to be healthy, Warr said that there were various characteristics such as autonomy, money, and variety in work that were important for an employee to be productive.

The more talented a company’s workers are, the better its output and its bottom line.

Warr put different job characteristics into two groups. The first group he called Constant Effects, characteristics whose excess will neither hamper nor increase productivity. Some examples of these characteristics are the amount of money an employee is paid, safe work practices, job security, and supportive supervision of an employee’s work. He compared these characteristics to the vitamins C and E in the human body, an excess of which neither added to a human body’s health nor hampered it.

The second group Warr called Additional Decrement, characteristics that would hamper an employee’s performance and well-being at work if present in excess. Some examples of these characteristics are the availability of feedback, the difficulty of the work, and the demands made on an employee by his everyday work. He compared these to the vitamins A and D, an excess of which can lead to toxic buildups in the human body, therefore hampering the body’s overall well-being.

Why are compensation and benefits important?

Human resources are the most important aspect of a company. The more talented a company’s workers are, the better its output and its bottom line. A competent approach towards compensation and benefits in the workplace goes a long way to ensuring that a company’s employees are satisfied. Some other reasons why compensation and benefits are important are listed below:

Keep employees motivated

When employees are adequately compensated, they feel motivated to come to work. Their morale remains high, and their job satisfaction levels increase. High morale ensures that employees are motivated enough to come to work every day and deliver work to the best of their abilities. Highly motivated and satisfied employees are also less likely to look for opportunities outside of their current work, and this leads to them staying at the job for a longer period of time.

Attract the best talent in the industry

Any smart and hardworking employee would know their value and would want to maximize that value for the best compensation and benefits package. If an employee feels that they are being underpaid or a competitor is offering the same monetary compensation but a better benefits package, they are likely to jump ship. HR professionals should know what their total compensation packages look like when compared with competitors and try to match them wherever possible to attract and retain the top talent.

What are the key components of compensation and benefits?

As mentioned earlier, compensation and benefits can be divided into various elements such as salary, time off, healthcare, and well-being policies. However, compensation and benefits have three main components:

Fixed pay

Fixed pay is the minimum amount of money an employer pays to their employee, excluding any bonuses or overtime. An employee is paid a fixed pay monthly rather than on an hourly basis. Factors contributing towards setting this amount are minimum wage, the role of the employee, cost of living, industry standard of pay, etc.

Variable pay

Variable pay is a payout from an employer that is based on the individual performance of an employee, as well as the overall performance of the company.

Equity pay

Sometimes companies include stocks and options as part of employee compensation. These are non-cash in nature and represent an ownership of the company. This allows employees to gain a share of the overall profits of the company, apart from their salary and non-monetary benefits. These stocks form a part of an employee’s compensation package as equity pay. However, usually, these stocks vest only after an employee has spent a fixed amount of time with the company.

How can you maintain compensation fairness?

Compensation fairness, essentially, ensures that everyone at a company is paid in accordance with the industry standard and their individual needs. In a scenario where all things are equal, every employee in the same position at a company would be paid an equal compensation package. However, in the real world, all things are rarely equal. And “when it comes to pay, fair doesn’t necessarily mean equal,” according to Harvard Business Review.

One manager may be managing a 10-member team, while another may be managing a 30-member team. One analyst may be dealing with a client that requires specialized knowledge of financial technology, while another analyst may be dealing with a client that does not require specialized knowledge. In both cases, the positions of these employees—manager and analyst—are the same. However, their workloads and the skills required to perform these roles are different.

“When it comes to pay, fair doesn’t necessarily mean equal,” according to Harvard Business Review.

If the goal of an organization is equal pay, both of these employees would have the exact same kind of compensation package. However, if we are looking to build an organization that pays its employees fairly, then the manager with more team members and the analyst with specialized knowledge of financial technology should be paid more.

Clear communication is essential to compensation fairness

While higher pay is an obvious factor in ensuring increased motivation among employees, a Payscale study found that employees were more engaged with their work if they perceived their pay to be fair. In other words, when employees understood where their compensation package stood when compared with the industry standard and their peers, they were motivated to be more engaged with their work.

Therefore, a company must ensure transparency about its salary and benefits information. One way to ensure transparency in communication is distributive fairness  the perception among employees about the amount they are paid as compensation. When employees can see how they are compensated when compared to their peers, they tend to be more engaged with their work.

Another way to ensure higher employee engagement is procedural fairness, or the perception among employees that the method used to determine their compensation was fair. Employees should have visibility into the processes that are used to determine the compensation packages for various roles and individuals at a company. This visibility goes a long way towards ensuring higher employee engagement if they feel they are being compensated less than the input they are providing an organization. If an employee can see that the methods used to determine the compensation packages across their company use a consistent set of criteria, are based on facts, and are ethical, they are less likely to push back.

While both distributive and procedural fairness are important when determining an employee’s compensation, studies have found that procedural fairness leads to a more engaged workforce. When an employee understands how their compensation package stacks against the industry standard and their peers, they are likely to remain more engaged with their work.

Ways to ensure compensation fairness

Clear and transparent communication about the levels of salaries that a company offers and how those salaries and compensation are calculated is essential for any HR professional to ensure that their employees believe they are being compensated fairly. As we read in the earlier section, when employees know how their compensation packages were calculated, it adds to their perception of compensation fairness.

One way that HR professionals can do this is by creating sample compensation and benefits packages for the different roles at their company. For example, a company employs junior analysts, senior analysts, and management. The HR department can then create three sample compensation and benefits packages for each of those roles. This can include their base salaries, any bonuses that they are eligible for, the total value of their healthcare package, retirement savings plans, or any other plans that can incur an annual cost to the company.

The HR department can then publish these sample packages on their recruitment page. Apart from ensuring that the company’s current employees know exactly how they are being compensated, this information can also be used to recruit new talent to the company.

Clear and transparent communication about the levels of salaries that a company offers and how those salaries and compensation are calculated is essential for any HR professional.

HR professionals should also take care to highlight any unique perks, such as a great gym membership or 100% dental and vision coverage that their competitors don’t offer. This will ensure that the company is able to distinguish itself from its competitors, and employees are aware of how their company’s benefits package is better than others in the industry.

What are the ways to calculate compensation and benefits?

While governments ensure that everyone that chooses to work gets paid a minimum wage, companies often adhere to an industry-wide standard when determining what they pay their employees. There are various ways to do that:

Salary surveys

Every industry has set standards for compensation that they need to adhere to if they want to bring in the most talented employees. Salary surveys help companies know this standard of pay.

Companies often hire a compensation specialist to conduct salary surveys. This specialist collects data from different companies about the compensation they offer to their employees. This data is then anonymized and sold back to these companies so that they can estimate an industry standard of pay.

Compensation specialists often determine a pay range for a particular role rather than determining an actual number. This is because the salary of a manager at a Fortune 500 company would be higher than that of a manager at a smaller business. The range helps companies set their own salary offerings in line with their size while also adhering to an industry standard.

Regression analysis

HR professionals often use an algorithmic approach to fixing a salary based on different variables. These variables can include factors such as the current salary of an employee, their highest educational qualification, tenure at a company, and job performance ratings.

How do compensation and benefits ensure the success of a business?

There are many parts that determine an employee’s compensation and benefits package at a company. It is important for an HR professional to establish that their company offers competitive compensation and benefits packages and communicate this to current and potential hires.

Having clear guidelines around compensation and benefits provide two distinct advantages to a company. First, they are able to attract and retain the best talent in their industry, as discussed above. Second, it provides companies a clear look into how much compensation and benefits account in their overall operating expenses and can ensure they are maintaining revenue at a level as to be able to afford to compensate their employees competitively.

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Published July 27, 2021

Maggie Wooll

Head of Insights

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