What are the factors affecting the compensation structure of a company?

A combination of external and internal factors can influence, directly or indi­rectly, the rates at which employees are paid. Through their interaction these factors constitute the wage mix, the follwing factors can affect the compensation structure of a company:

External Factors

The major external factors that influence wage rates include labor market condi­tions, area wage rates, cost of living, legal requirements, and collective bargain­ing if the employer is unionized.

Labor Market Conditions

The labor market reflects the forces of supply and demand for qualified labor within an area. These forces help to influence the wage rates required to recruit or retain competent employees. It must be recognized, however, that counter-forces can reduce the full impact of supply and demand on the labor market. The economic power of unions, for example, may prevent employers from lowering wage rates even when unemployment is high among union members. Govern­ment regulations also may prevent an employer from paying at a market rate less than an established minimum.

Area Wage Rates

A formal wage structure should provide rates that are in line with those being paid by other employers for comparable jobs within the area. Data pertaining to area wage rates may be obtained from local wage surveys. Wage-survey data may be obtained from a variety of sources, often available on the Internet, Depart­ment of Labor, and Federal Reserve Banks.

         Data from area wage surveys can be used to prevent the rates for certain jobs from drifting too far above or below those of other employers in the region. When rates rise above existing area levels, an employer’s labor costs may become excessive. Conversely, if they drop too far below area levels, it may be difficult to recruit and retain competent personnel. Wage-survey data must also take into account indirect wages paid in the form of benefits.

Cost of Living

Because of inflation, compensation rates have had to be adjusted upward periodically to help employees maintain their purchasing power. This can be achieved through escalator clauses found in various labor agreements. These clauses provide for quarterly cost-of-living adjustments (COLA) in wages based on changes in the consumer price index (CPI). The CPI is a measure of the average change in prices over time in a fixed “market basket” of goods and services.

The CPI is largely used to set wages. The index is based on prices of food, clothing, shelter, and fuels; transportation fares; charges for medical services; and prices of other goods and services that people buy for day-to-day living. The Bureau of Labor Statistics collects price information on a monthly basis and cal­culates the CPI for the nation as a whole and various U.S. city averages. Separate indexes are also published by size of city and by region of the country. Employers in a number of communities monitor changes in the CPI as a basis for compensation decisions.

Collective Bargaining

One of the primary functions of a labor union is to bargain collectively over conditions of employment, the most important of which is compensation. The union’s goal in each new agreement is to achieve increases in real wages--wage increases larger than the increase in the CPI--thereby improving the purchasing power and standard of living of its members. This goal includes gaining wage settlements that equal if not exceed the pattern established by other unions within the area.

The agreements negotiated by unions tend to establish rate patterns within the labor market. As a result, wages are generally higher in areas where orga­nized labor is strong. To recruit and retain competent personnel and avoid unionization, nonunion employers must either meet or exceed these rates. The “union scale” also becomes the prevailing rate that all employers must pay for work performed under government contract. The impact of collective bargaining therefore extends beyond that segment of the labor force that is unionized.

 Internal Factors:

The internal factors that influence wage rates are the employer's compensation policy, the worth of a job, an employee's relative worth in meeting job require­ments, and an employer's ability to pay.

Employer’s Compensation Policy:

The compensation objectives of two organiza­tions can be quite different. One might strive to be an industry pay leader, while another seeks to be wage-competitive by paying employees at the seventy-fifth percentile of their competitors’ wages. Both employers strive to promote a compensation policy that is fair and competitive.

All employers will establish nu­merous compensation objectives that affect the pay employees receive. As a minimum, both large and small employers should set pay policies reflecting:

1.     the internal wage relationship among jobs and skill levels.

2.     the external competition or an employer’s pay position relative to what competitors are paying.

3.     a policy of rewarding employee performance.

4.     administration decisions concerning elements of the pay system such as overtime premiums, payment periods, short-term or long-term incentives.

Worth of a Job

Organizations without a formal compensation program generally base the worth of jobs on the subjective opinions of people familiar with the jobs. In such in­stances, pay rates may be influenced heavily by the labor market or, in the case of unionized employers, by collective bargaining.

Organizations with formal compensation programs, however, are more likely to rely on a system of job eva1uation to aid in rate determination. Even when rates are subject to collective bar­gaining, job evaluation can assist the organization in maintaining some degree of control over its wage structure.

The use of job evaluation is widespread in both the public and the private sector. The jobs covered most frequently by job evaluation comprise clerical, technical, and various blue-collar groups, whereas those jobs covered least frequently are managerial and top-executive positions.

 Employee’s Relative Worth

It is common practice in some industries, notably construction, for unions to negotiate a single rate for jobs in a particular occupation. This egalitarian practice is based on the argument that employees who possess the same qualifications should receive the same rate of pay. Furthermore, the itinerant nature of work in the construction industry usually prevents the accumulation of employment seniority on which pay differentials might be based. Even so, it is not uncommon for employers in the trades to seek to retain their most competent employees by paying them more than the union scale.

         In industrial and office jobs, differences in employee performance can be recognized and rewarded through promotion and with various incentive systems. Superior performance can be rewarded by granting merit raises on the basis of steps within a rate range established for a job class.

If merit raises are to have their intended value, however, they must be determined by an effective performance appraisal system that differentiates between those employees who deserve the raises and those who do not. This system, moreover, must provide a visible and credible relationship between performance and any raises received. Unfortunately, too many so-called merit systems provide for raises to be granted auto­matically. As a result, employees tend to be rewarded more for merely being present than for being productive on the job.

Employer’s Ability to Pay

In the public sector, the amount of pay and benefits employees can receive is lim­ited by the funds budgeted for this purpose and by the willingness of taxpayers to provide them. In the private sector, pay levels are limited by profits and other fi­nancial resources available to employers. Thus an organization's ability to pay is determined in part by the productivity of its employees.

Increased productivity is a result not only of their performance, but also of the amount of capital the orga­nization has invested in labor-saving equipment. Generally, increases in capital investment reduce the number of employees required to perform the work and in­crease an employer's ability to provide higher pay for those it employs.

Economic conditions and competition faced by employers can also signifi­cantly affect the rates they are able to pay. Competition and recessions can force prices down and reduce the income from which compensation payments are derived. In such situations, employers have little choice but to reduce wages and/or lay off employees, or, even worse, to go out of business.