Direct and Indirect Compensation

Topics: Economics

Question: “If employee undervalue the cost of benefit, why should a company not drop benefit and simply add more direct compensation” Do you agree or disagree with this statement? Explain using relevant organizational examples. CONTENTS 1. Introduction3 2. Findings and Analysis 2. 1 What is employee benefit? 4 2. 2 What is compensation? —- Critical analysis of compensation components and its function in an organization? 6 2. 3 Total Reward Management8 2. Critical analysis of motivation. 10 3. Conclusion12 References. 14 Bibliographies15 1. Introduction There is a common phenomenon in the workforce—-employee underestimates his or her cost of benefit, for some employers they will still retain the benefits and easily supplement more direct compensation to the unsatisfied employees in order to attract them.

Actually, benefits are forms of value, other than payment, that are provided to the employee in return for their contribution to the organization, that is, for doing their jobs.

Employee benefits typically refers to insurance, (Example 1)such as retirement insurance, health life insurance, disability insurance, vacation, employee stock ownership plans, etc . The reason why employees are unhappy of their cost of benefit is associated with company’s total reward management.

Firstly, it will probably relate with employee’s misunderstanding or lack of communication of benefit value. (Example 2) “Too many employees today don’t really understand their benefits packages,” says Marianne Adams, assistant vice president of enrollment services at Colonial Life & Accident Insurance Company. Example 3) “With more costs and decision-making being shifted to employees, benefits communication and education is more important than ever,” says Randy Horn, president & CEO of Colonial Life. Secondly, benefit undervaluation is also likely related to the thorough understanding and flexible application of compensation program.

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Generally, compensation categorized into direct and indirect, both of them have different function and motivation effect. Direct compensation is a remuneration provided to employees in exchange for their labor and services for the company.

These include base pay, variable pay, performance-related payments and any retroactive pay, and employees can use it for the purchase of goods and services at their will. To the opposite of direct compensation is indirect compensation, it means the employee is the beneficiary, but does not receive directly. (Example 4) contributions to retirement pension, medical insurance, training and education opportunities, and child care voucher and other forms of indirect benefit. Furthermore, it is likely what we think is a valuable benefit will not just satisfy other employee.

This has something to do with employee motivation, we can take Maslow’s hierarchy of needs for reference, which means every human being has different motivation requirement from their work, for some employees, the basic needs, such as food, house, safety, for some others maybe higher to self-esteem or self-actualization. Thus, employer should establish reasonable and flexible total reward management policy under thorough understanding of compensation program along successful application of motivation strategy.

Just like an old Chinese saying goes, know the enemy, know yourself, you will never know defeat. In this case, we can say know total reward management, know employee’s motivation requirement, you will never know benefit undervaluation. 2. Findings and Analysis 2. 1 What is employee benefit? Benefit—-indirect financial and nonfinancial payments employees receive for continuing their employment with the company (Dessler, 2011). It is a form of value provided to the employee in return for their contribution to the company, that is, for doing their jobs. Example 5) benefits are insurance (medical, life, dental, disability, unemployment and worker’s compensation), vacation pay, holiday pay, and maternity leave, pension pay, profit sharing, stock options, and bonuses and so on. Furthermore, there is another interpretation of benefits that is tangible or intangible. The benefits listed above are tangible benefits. Intangible benefits are less direct, (Example 6) appreciation from a boss, opportunity for promotion, nice working environment, etc.

According to Gary Dessler’s benefit classification, he classifies them into 4 categories, which are: (1) pay for time not worked, (2) insurance benefits, (3) retirement benefit, (4) services. (Dessler, 2011) 2. 1. 1 Pay for time not worked The definition of pay for time not worked is the time not worked by an employee, which included to the paying working time field. Normally, companies give a certain period of time to employee to deal with non-work related affairs.

Pay for time not worked generally including holiday, vacations, jury duty, funeral leave, military duty, personal days, sick leave, sabbatical leave, maternity leave, and unemployment insurance payments for laid-off or terminated employees. (Dessler, 2011) Although pay for time not worked is a highly cost for companies, they still provide this employee-friendly benefit, aiming to attract and keep competitive employees. (Example 7) McDonald normally provides 28 days holiday a year. (Example 8) Barclay usually gives up to 30 days a year to their employees who worked in their company for one year. www. barclays. co. uk) (Example 9) All pregnant in UK can get 52 weeks of maternity leave, of which 39 weeks is paid, and it increased to 52 weeks from April 2010. 2. 1. 2 Insurance benefits Insurance benefit means payments or services provided according to certain situation under the conditions of an insurance policy. Many employers are required or voluntarily to provide certain insurance to their employees. Normally, insurance benefit in UK including National Insurance, Social Security Insurance, life insurance, health care insurance, worker’s compensation, disable insurance, and so on. Example 10) National Insurance in UK is mandatory, which shared by employee and employer together. Some other companies in order to improve their benefit attraction will add additional insurance categories, such as disable insurance. (Example 11) IBM U. S. provides U. S employees with 100 percent coverage for primary health care beginning in 2010, employees who worked in IBM will obtain full coverage of the whole year primary health care insurance. It is the first company that provides 100 percent primary care to its employees in U. S. (www. bm. com) 2. 1. 3 Retirement Benefit In US, the retirement benefit mainly including federal social security and employer pension/retirement plans (Dessler, 2011). In UK, the retirement benefits generally manifested in National Insurance which was firstly a beneficial system of insurance against disease and unemployment, and gradually cover retirement benefit. The contributions of National Insurance paid according to how much you earn and whether you’re employed or self-employed. Its contribution is borne by employees and employer together.

Furthermore, you stop paying National Insurance contributions when you meet State Pension age which is 65 in U. K. Besides the standard operational requirement, many companies conduct flexible retirement policies. (Example 12) O2 Company allows its employee put their pension benefits into payment without leaving the company. (www. o2. co. uk). (Example 13) Barclay, which is famous for its excellent benefit, in a position to allow their employees use fund to buy company annuity pension and then put it as a tax-free lump sum. (www. group. barclays. com/Home) 4. Services

In order to recruit and retain talented employee along with consideration of different employee’s specific situations, (Example 14) some of the employees are single-parents, some are female women workers, or workers old than 55, or workers with very older age parents at home, and so on, thus the company adopt personal flexible policies not only facilitate employees but also keep their better working performance. Such kind of service is including “family-friendly” policies, childcare vouchers, and training or education opportunities, flexible work time, the cafeteria approach, career break and so on. Example 15) Sainsbury choose childcare vouchers as their benefit package, vouchers are non-taxable and exempt from National Insurance contributions and therefore represent a saving for colleagues who receive them as part of their total reward package. (www. sainsburys. co. uk) (Example 16)Employees prefer choice in their benefit plans. In one survey of working couples, 83% took advantage of flexible hours (when available); 69% took advantage of the flexible style benefits; and 75% said that prefer flexible benefit plans. (Dessler, 2011) 2. 2 What is compensation?

Critical analysis of compensation components and its function in an organization. 2. 2. 1 What is compensation? Practically, the manager get used to define compensation in a simply financial perspective, (Example 17) they think compensation is just about wages, salaries, vacation pay, and various insurance and other kinds of indirect benefits. On another hand, employee think compensation in a more narrowly way, they hold the point that compensation is just about salary along with insurance given by the company for exchange of their work for the company.

However, in order to understand compensation completely and deeply for the sake of both employer to satisfy their employee at a larger extent and to motivate employee to keep loyalty and profitable for the company, we should comprehend compensation in its broadest sense. Compensation is defined as the total reward package offered by an organization to its employees. It encompasses all of the rewards or payments—-tangible and intangible, monetary and nonmonetary, physical and psychological—that an organization provides its employees in exchange for the work they perform. Caruth,N. L. and Handlogten,G. D. 2001, p1) In my opinion, compensation is a form of deal between employer and employee. Employee work for the company, and then the company gives them they deserved and wanted compensation. Whether it is a good deal or not depends on their mutual satisfaction. However, in general, the main purpose of compensation is to attract, retain, motivate and satisfy employees as long as possible for the normal and efficient operation of an organization 2. 2. 2 Critical analysis of compensation components and its function in an organization?

Normally, compensation is consisting of direct and indirect compensation. Elements of a total compensation program include both direct and indirect compensation. Direct compensation refers to salaries, bonuses, and other forms of incentive payments. Indirect compensation refers to employee benefits and perquisites, items that an employee typically receives in forms other than cash payments. ( Fallon,L. F. and Zgodzinski,E. J. 2005) Compensation is commonly divided into direct and indirect pay.

Direct pay includes the following types of pay: salary (exempt employees), hourly rate (nonexempt employees), bonuses, incentives, and stock options in some cases. Indirect pay includes the following: vacation time, holiday time, sick time, benefits, and discounts. (Rodenhauser,P 2000) However, besides direct and indirect compensation, Caruth and Handlogten enriched compensation scope with psychological satisfaction. Any organization’s total compensation or reward package is comprised of three major components: direct monetary rewards, indirect monetary payments and psychological satisfaction.

In designing an effective compensation package, all three elements must be carefully considered. (Caruth,N. L. and Handlogten, G. D. 2001, p2). Direct monetary rewards are the most obvious compensation component. Sometimes referred to as cash compensation, these rewards encompass all those items involving the payment of dollars to employees for work accomplished or effect expanded(e. g. wage, a salary, a commission). Whether paid by the hour, by the month, or by another method, direct compensation is discretionary income to the employee.

He or she is able to spend it in whatever way desired for the purchase of goods and services. (Caruth, N. L. and Handlogten, G. D. 2001, p2). Indirect monetary payments include those items of financial value the organization provide to employees that do not result directly in employee’s receiving spendable dollars. This compensation component is usually referred to as benefits. Including in this category are various forms of protection (health insurance, life insurance, disability insurance) and services (financial counseling, employer subsidized cafeterias, uniforms, free parking). Caruth,N. L. and Handlogten, G. D. 2001,p3). Psychological Satisfactions consists of the psychological satisfactions — sometimes called psychic income—which a worker derives from the work he or she performs and the environment in which it is performed. This form of compensation includes opportunities to perform meaningful work, social interactions with others in the workplace, job training, advancement possibilities, recognition, and a host of similar factors. Caruth,N. L. and Handlogten, G. D. 2001). In my opinion, Caruth and Handlogten’s three compensation components are more acceptable and with better practice guarding value compared with Fallon et al. and Rodenhauser’s summarization of compensation. Since the latter two authors’ understanding about compensation are mainly focus on general reward management which less of unique competitive advantage compared with other companies which provide more psychological satisfaction.

Because psychological satisfaction is related with a broader concept, such as company’s management model, company culture and individual’s life value, harmonious interpersonal relationship and so on. (Example 18) If a talented chip engineer wants his innovation protected and applied properly, he will choose to work for Intel rather than HP, although maybe HP provides better direct and indirect compensation, because Intel is famous for R&D, vertical management which will give his innovation a very good research and patent protection environment. Example 19) In1983, Apple CEO Jobs invited Pepsi former CEO John Sculley to join with him together as combined CEO of Apple, Jobs just said a word to Sculley : “Whether you want to sell soda water all your life or instead to change the world? ”. Last, Sculley moved by Jobs’s personal magnetism charisma and joined Apple which has fiercer market competition. 2. 3 Total Reward Management 2. 3. 1 Definition of total reward management

The terminology ‘reward management’ was first introduced by Armstrong and Murlis in 1988 with the aim to meet the flexible, diverse and innovative reward management for a better employee performance. The activity ‘reward management’, has been described as encompassing not only the development, maintenance, communication, and evaluation of reward processes, but also concerned with the development of appropriate organizational cultures, underpinning core values and increasing the commitment and motivation of employees(Armstrong and Murlis,1998 quoted in Beardwell& Claydon. 010. p502) In my opinion, total reward management firstly it is holistic and comprehensive, as for the means of reward, it is almost including all the categories of reward, such as direct as well as indirect, psychological satisfaction, tangible and intangible, intrinsic along with extrinsic from which employee can obtain satisfaction through their work. Secondly, company environment, such as the company pursuit, fundamental value orientation, humanistic concern are also an influential factor for employee’s career consideration.

Only by successful application of the above rewards categories, organization can maximize its business performance and leads to sustained competitive advantage. However, every above step needs employer’s sound mastering of reward function, strategic pay, efficient communication rate and correct motivation choice. 2. 3. 2 The Tovers Perrin Model of Total Reward In order for us to choose correct reward program in a diverse situation, we should firstly familiar with the possible classification of total reward. Please refer to the next figure 1 of Tovers Perrin total reward model; Transactional (tangible) | | Pay | Benefits | |Base Pay | | |Contingent pay |Pensions | |Cash bonuses |Holidays | |Long-term incentives |Health care | |Shares |Other Perks | |Profit sharing |Flexibility | |Individual |Learning and development |Work environment |Communal | | | | | | | |Workplace learning and development |Core values of the organization | | | |Training |Leadership | | | |Performance management |Employee voice | | | |Career development Recognition | | | | |Achievement | | | | |Job design and role development(responsibility, autonomy, | | | | |meaningful work, the scope to use and develop skills) | | | | |Quality of working life | | | | |Work-life balance | | | | |Talent management | | | | Relational (intangible) Figure 1 Model of total reward (Armstrong 2009, p745) The upper transactional rewards is similar with tangible reward, it could be regarded as a transaction between the employer and employee in the form of payment or benefit. Example 20) base pay, variable pay, long term incentives, and so on is belonging to this category. The below relational, also is intangible refers to indirect or psychological satisfaction of employee. (Example 21) Such as job autonomy, career opportunities, involvement and employee voice and so on. The transactional rewards are basic components of total reward; most of the companies will conduct various transactional rewards to recruit, keep and motivate their employee. In the contrary, the relational rewards has plenty significance, except its specific function of motivating employee, it also plays as an intensive role for the above transactional rewards.

If we say the transactional rewards satisfied with employee’s material requirement, then we can say the relational rewards meets their spiritual demand. Thus, a successful total reward management should be combine both transactional and relational rewards. 2. 4 Critical analysis of motivation After understanding of what employer should know, next we should also clear of what the employee wants? This is involving with what motivates employee most? The most useful motivation model is provided by a psychologist, Professor Abraham Maslow, which is known as Maslow’s Hierarchy of Needs. In this model, human needs for survival are primary; the need for safety is secondary.

Following in sequence are needs related to love and belonging, the need for esteem, and the need for self-actualization. These five levels of human needs are shown in hierarchical arrangement in the below diagram figure 2. Each level of need must be satisfied before an individual is ready to strive for satisfaction of the next higher level of need. The highest level refers to full development of one’s human potential. (Milliken,M. E. and Honeycuttt ,A. 2004, pp72-73) (Example 22) Only we have food to eat and house to live, then we can consider love or recreation. [pic] Figure 2: Maslow’s Hierarchy of Needs However, Maslow’s hierarchy of needs has certain limitations when confronts with specific situation. Example 23) Many successful billionaires’ first priorities are not always self-actualization, on the contrary, they will pay much attention on their safety in case of murder or kidnapping arise from their huge wealth. (Example 24) A newly graduated ambitious student will probably choose a low salary and low self-esteem work which is of great help of their self-actualization in the future, for instance, during those years, certain Chinese university graduate choose to work beginning as a manual labor, such as planting vegetable or butcher. They aim to grow better and more nutritious vegetable using their knowledge learnt in school and by advanced management to operate a famous butcher chain in China.

Thus, we cannot explain the above cases use Maslow’s hierarchy of needs, because they are actually not abide by one low needs satisfied than move to another higher need. However, Clayton Alderfer covered the shortage of Malslow ‘s theory with his ERG theory. Alderfer think Malsow’s hierarchy have some overlap in middle levels, so he reduced Malsow’s five levels of need into three which are
• Existence: Physiological and safety needs
• Relatedness: Social and external esteem needs
• Growth: Self-actualization and internal esteem needs. As ERG is based on Malsow’s Hierarchy, so it has similarity, that is also in hierarchical—existence is the first consideration, then moves to relatedness needs, the last and also highest is growth.

Their difference is ERG allows people to pursue the different levels at the same time. (Example 25)We doing our job, except obtaining the payment for the basic existence need, we still desire to achieve social and external esteem as well. Another difference is ERG allows the different needs for different people, which means taking consideration of every one’s specific condition. Just like the above cases show, billionaire may probably choose existence; a poor student will be interested in growth firstly. Last difference is when an employee failed to obtain a higher level of need, then they will probably regress to a lower level, which he or she can reach at present, this is known as “frustration-regression principle”. Example 26) If an employee cannot reach growth need, then they will move to relatedness instead, so in such situation, employer should try to provide relatedness needs to motivate employee until the growth change come. Thus, under ERG theory, managers should know that every employee has different motivation requirement or several needs at the same time, thus we should apply the motivation step flexibly and distinctively. 3. Conclusion Last, let’s come back to our question. After understanding the compensation program and total reward management as well as motivation theories, I do agree that employer still keep benefit, as benefit is a crucial part of total compensation.

It is a dispensable value of employee’s payment from their service for the company. (Example 27), such as national insurance, compensation, retirement benefit is an important element of a family’s financial condition and also beneficial for social stability. Furthermore, if other competitor companies provide better benefit, it will definitely reduce our company’s advantage to attract experienced employees thus affect the company’s performance and sustainable development in the long term. However, I disagree that the employer simply adds more direct compensation. Just as this thesis mentioned above, when we establish or adjust reward management policy, we should take the following factors into consideration.

Firstly, clearly define direct and indirect compensation package, let employee understand what benefit that they can get from them. Secondly, establish total reward management according to the employee’s specific situation, such as the application of cafeteria benefits plan, (Example 28) a child-care voucher will be unappealing for a single young employee but is a competitive benefit for a single parent. (Example 29) A VIP club membership discount card would be meaningless for a just graduated poor student compared with a valuable training or a good employer to guide him. (Example 30) An employee with two elderly and weak parents at home will be more motivated by elder care or flexible work schedule arrangements rather than increased mileage allowance.

Thus, we can conclude that a successful and effective reward management should be based on a thorough understanding of employee’s motivation incentive and choose and establish the appropriate combination of transactional and relational rewards program, and then our reward management will not be undervalued by employees. References: Books: 1. Armstrong, M. (2009) Armstrong’s Handbook of Human Resouce Management Practice (11th ed). London, Kogan Page. Pp 742-743. 2. Baron, A. and Armstrong, M. (2007) Human Capital Management —Achieving Added Value through People. London, Kogan Page Limited, pp. 114-116 p. 192. 3. Beardwell, J. and Claydon,T (2010) Human Resource Management A Contemporary Approach(6th ed). England, Prentice Hall, p501. 4. Bogardus, A. M. 2009) PHR/SPHR Professional in Human Resources Certification Study Guide (3rd ed). Indianapolis,Wiley Publishing, p275. 5. Caruth, N. L. and Handlogten,G. D. (2001) Managing Compensation (and Understanding It Too): A hand book for the perplexed. American, Greenwood Publishing Group, pp1-3 6. Dessler,G. (2011) Human Resource Management (12th ed) New Jersey, Pearson Education, pp490-518. 7. Fallon,L. F. and Zgodzinski,E. J. (2005) Essentials of Public Health Management (2nd ed) London, Jones and Bartlett Publishers, p 184. 8. Harzing, A-W and Ruysseveldt, J. V (2006) International Human Resource Management (2nd ed) London, SAGE Publications Ltd. pp. 306 -325. . Milliken,M. E. and Honeycuttt,A. (2004)Understanding Human Behavior: A guide for health care providers (7th ed). USA,Thomson Delmar Learning, p73 10. Nieto,M. L. (2006) An Introduction to Human Resource Management—An Integrated Approach. New York, Palgrave Macmillan. pp. 183-186 pp. 194-195. 11. Rodenhauser, P (2000) Mental Health Care Administration: a Guide for Practitioners. (4th ed) Michigan, University of Michigan, p 218. Bibliographies: Internet: 1, Barclay employee benefit http://group. barclays. com/Careers/Personal-development/Rewards-and-benefits [Accessed on April 16] 2. Befenit Management http://www. bmshealth. com/company. sp [Accessed on April 8] 3. Colonial life (Spring 2009) http://www. coloniallife. com/en/Newsroom/~/media/acrobat/newsroom/white%20papers/NS-10681_white_paper. ashx [Accessed on April 12] 4. Contingent pay http://www. jrank. org/business/pages/280/contingent-pay. html April 19 [Accessed on April 19] 5. Critical analysis http://library. bcu. ac. uk/learner/Study%20Skills%20Guides/4%20Critical%20analysis. htm [Accessed on April 20] 6. Difference between direct and indirect compensation [Accessed on March 5th] 7. Direct compensation http://payroll. naukrihub. com/compensation/direct-compensation. html [Accessed on March5th] 8. ERG http://www. netmba. om/mgmt/ob/motivation/erg/ [Accessed on April 21] 9. Harward style of refering http://www. library. dmu. ac. uk/Images/Selfstudy/Harvard. pdf [Accessed on April 9] 10. Harward style of referring (September 2008) http://libraryonline. leedsmet. ac. uk/lco/publications/pdf/subj/is-9. pdf [Accessed on April 9] 11. Herzberg http://changingminds. org/explanations/needs/herzberg_needs. htm [Accessed on April 19] 12. IBM insurance http://www-03. ibm. com/press/us/en/pressrelease/28728. wss#release [Accessed on April 16] 13. Jobs and soda water http://www. garden-cn. com/bbs/ShowPost. asp? ThreadID=70 [Assessed on April 20] 14. Nicholson. J. Direct compensation http://www. ehow. om/facts_5863432_included-direct-compensation_. html [Accessed on March 5th] 15. Retirement age of U. K (January 13, 2011) http://www. bbc. co. uk/news/business-12177927 [Accessed on April 16] 16. Sainsburys employee insurance http://www2. sainsburys. co. uk/aboutus/recruitment/Store+Roles+overview/Reward+and+Benefits/Reward+and+Benefits. htm? WT. svl=2&WT. seg_1=nav_secondary [Accessed on April 16] 17. What is an introduction of an essay http://www. customessays. co. uk/blog/essay/essay-introduction/ [Accessed on April 9] 18. Woodward-Kron, R. et el. (2000) Introduction to en essay http://unilearning. uow. edu. au/essay/4bii. html [Accessed on April 9]

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Direct and Indirect Compensation
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