Compensation Policy - Macro and Micro Level Organizations
- A Framework


N. Venkateswaran
Asst. Professor
Department of MBA
Panimalar Engineering College

The compensation and benefit level is the average compensation paid to employees. This has two implications. The first is external: how does the organization compare with other organizations? This question is a strategic one of how the organization wishes to position itself in the marketplace. The second implication is internal. The average compensation is a reflection of the total compensation bill of the organization. Labor is one of the claimants on organizational resources. The size of the compensation and benefits bill is a reflection of who gets what within the organization.

The decision on compensation levels (how much will the organization pay?) may be the most important pay decision the organization makes. A potential employee's acceptance usually turns on this decision, and a large segment of the employer's costs are determined by it.

Compensation decisions are typically micro (individual) or macro (total organization) focused. Although organizations are under no constraint to separate these decisions, a course of study should. In practice, most unsophisticated organizations make the decision on compensation level (how much to pay) and compensation structure (relationships to competitors) at the same time. More administratively advanced organizations realize that individual decisions within a proper administrative structure are more consistent, fair, and cost-effective over time.

The compensation level decision may be considered the most important one for individuals. In terms of both employee attraction and cost considerations, it is often considered by most managers as a primary consideration. Also, it seems essential to recognize that compensation level decisions can never be completely separate from job-mix, hiring standards, personal decisions, and internal labor markets/relationships. For these reasons, compensation level decisions are typically the focus of a manager's attention. From the organization's perspective, however, one individual's compensation decision typically goes unnoticed at the end of the year. Structure decisions (and the level of those structures) are what show up on an income statement.

The term compensation level simply means the average compensation paid to workers at some level of analysis, e.g. the job, the department, the employing organization, an industry, or the economy. The importance of the compensation level decision to organizations rests on its influence in getting and perhaps keeping the desired quantity and quality of employees. If the compensation level is too low, the applicant pool may dry up and recruitment efforts may meet with little success. Equally serious, some employees (often the best ones) may leave. At the extreme, the organization may experience difficulties with state and federal regulatory bodies administering minimum compensation laws and prevailing wage laws. Also, the organization may be confronted with concerted organizing drives if no union is present, or pressing compensation demands from existing unions. It is less apparent, but equally real, that a low compensation level may attract only less efficient workers, with the result that labor costs per unit of output rise.


Most employees are aware that some employers pay more than others for the same type of skill in the same market.

The actual cost to employers of employee service is total hourly compensation plus benefits.

Unfortunately, labor cost per unit is not information that is easily obtained by employers. It must be estimated from in-house information on the average productivity of employee groups and organization units and from the average pay of these groups.

The information available on what other employers pay comes only as a result of search. This search takes the form of compensation surveys conducted or purchased by the organization. These surveys invariably show a range of compensation paid for the same job by different employers. This range tends to be narrower for the skilled occupations and wider for the semiskilled. One reason for this is the difficulty of job comparisons. Another is difference in employee quality. But these differences are never as wide as compensation differences.

The major reason for finding out what others are paying for jobs is to decide how to position your organization in relation to others and the labor market.

High-Compensation Employers

High-pay organizations tend to share a number of characteristics: larger size, higher profits, and a lower ratio of labor costs to total cost, few industry competitors, and unionization. Larger organizations tend to pay higher wages and benefits for a number of reasons. One is that they usually are able to. Large organizations often tend to have some financial surplus, which they can use in various ways. Another reason is that they may be willing to pay more to attract a pool of competent applicants. Still another may be a perceived obligation to counter lower job satisfaction. Finally, those large organizations that are not unionized are continuing targets of union organizers.

Low-Compensation Employers

Low-pay employers tend to be relatively small, to occupy competitive product markets, to have low profit margins, and to be typically nonunion. They have low-paying ability because of the constraints of their product market. Most of their compensation decisions may be explained by this low ability to pay.

Low-pay employers may gauge their position by comparing themselves with the largest and most visible employers. Using compensation surveys, they usually pay attention to rates for specific jobs for which there is an active outside market. The starting rate for new production workers may be particularly significant. Jobs on which attention is focused obviously varies by industry.

The minimum feasible compensation is one that will obtain just enough employees to maintain desired employee levels for some period, typically six months. But often organizations pay above this minimum, hoping to obtain employees of higher quality; lower their turnover rates; and lower their recruitment, hiring, and training costs.


Labor markets fluctuate in terms of the number of employees and employee hours needed. These swings in labor demand affect employer compensation decisions and compensation differentials among companies. High-pay employers are less affected by these swings because their compensation is high enough above the area level so that they are little affected by short-run changes. They try to limit compensation level changes to once a year and tend to set prices by a percentage markup over average unit costs of production.

Low-pay organizations adjust to changes in labor demand by deciding how far they can lag behind high-paying organizations. During an economic upswing, high-pay employers will be increasing wages, salaries, benefits, and employment. Low-pay employers, to hold down turnover and to increase employment, will have to raise compensation more than high-paying firms. The compensation gap between high-paying and low-paying firms thereby narrows during an upswing.

N. Venkateswaran
Asst. Professor
Department of MBA
Panimalar Engineering College

Source: E-mail February 14, 2007


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