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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.

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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:


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.Keep in mind that for a larger company with many departments, the compensation package will generally go through approval. This is when management decides if they need to make any changes and determine if current data from around the industry is in line with the compensation package they will be offering.


Offer the Compensation to the Employee

Once the compensation is finalized, the company will then offer the compensation to the actual employee. The employer will decide if they will pay their employees every two weeks, or perhaps they only pay them once a month. For Bill, he has decided to pay his employees every two weeks on the 1st and the 15th, like many companies today do.

7. Monitor

From time to time, changes may need to be made.

Keeping an eye on the process and acknowledging what works well and what needs improvement will help a company strengthen their compensation process. Bill might realize that his company is growing large and trying to maintain the HR duties as well as building the furniture, might be overwhelming. During this monitoring stage, he may decide to hire an employee to be in charge of HR.

Types of Compensation

There are many forms of compensation. In this section we will look at some of the more common types. Direct compensation refers to monetary benefits and includes things like salaries and hourly wages.

Medical, dental, and vision insurance also fall under direct compensation. Some other types of direct compensation include vacation and sick days, a company vehicle, and travel expenses.Indirect compensation is a type of compensation that revolves around praise and motivation. Recognizing an employee for their hard work is an example of indirect compensation.

Offering free training, handshakes, or verbal praise are other examples.

Lesson Summary

Compensation in business is a reward in exchange for services. Compensation management is the overseeing of that reward, usually in the form of pay for a job. When management decides to compensate an employee, there are several steps to consider during the process.Those steps include:

  1. Understanding the budget
  2. Assigning an individual to oversee the process
  3. Analyzing the job duties
  4. Deciding levels
  5. Developing a package
  6. Offering the package
  7. Monitoring

Some different types of compensation include direct compensation, which are things like salary and health insurance, and indirect compensation, which includes things like verbal praise and recognition.

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