CHAPTER ONE

INTRODUCTION

1.1 Background information

In any profit-oriented organization, employment relationship is seen as an exchange process where employees provide inputs in terms of skills and expertise in return for various compensations from the employer. From the perspective of the employee, pay has an important influence on Standard of living, status, and security. Less direct forms of compensation such as health care, pensions and other benefits also have an important impact on employees' well-being. From the employer’s point of view, compensation is both a major cost of doing business that needs to be controlled, and an investment that must generate adequate returns in terms of employee attitudes, skills, behaviors, and organization performance (Heery & Noon, 2001).

Many organizations have now recognized that human resources play an important role in gaining a competitive advantage in today’s highly competitive global business environment. While all aspects of managing human resources are important, employee retention continues to be an essential Human Resource Management activity that helps organizations in their quest to achieve their goals and objectives (Mello,2007). As such, researchers and practitioners alike are interested in addressing the key issues and challenges relating to employee retention. Retaining productive employees is critical to running a successful business. Retaining employees saves companies money in training costs and helps maintain an efficient and knowledgeable workforce. Health insurance and retirement packages are benefits that many employees desire from their employers. Companies that offer these benefits have a much better chance of retaining workers than businesses that fail to offer benefit packages. No business can enjoy and sustain

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the success until it deals with the problem of employee turnover efficiently and successfully and this calls for a strategic approach to the management of employees in order to motivate them to stay (Ongori, 2008).

The strength of any financial service providing company also depends on the contentment and inspiration of its employees. Banks are the biggest financial service providers of any nation. Bottorff (1999) argues that banks have to respond to increased competition by rewarding not only performance but also efficiency. He further argues that by rewarding employees for finding more efficient ways to process work, rather than measuring output, banks might generate a structural solution to the banking industry’s productivity challenges

1.1.1     Compensation systems

A compensation system is a system that is designed to determine amount of pay given to an employee in return for their contribution to production(Erasmus, et. al.,2001). On its simplest level, a manager simply makes his or her best guess as to what an individual should be paid and what he or she will accept. In its most complex form, a compensation system contains many different decision rules, guidelines, and processes for determining pay level and pay structure. A compensation system includes various components such as: Pay Structure which is the relative pay differential among various jobs within the organization and how this is determined. Pay Level which is the relative amount of pay assigned to each job compared to the job market. Pay Form which is the makeup of the pay this individual receives. Basis for pay increases which illustrate how pay changes from year to year (Erasmus et al., 2001).

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Compensation and benefits are the most critical factors in attracting and retaining high quality employees. The employees' commitment and motivation are directly tied to this aspect of the employment relationship. Great employers provide generous monetary and non-monetary compensation and benefits to their workforce. Money is considered as the reward which is given to employees against work, to support their family, and payment for the work which is done. Barton (2002) suggested that organization should take into account financial rewards like salary because it has strong influence on employee motivation and retention.

An organization's compensation system can have far-reaching effects on its competitive advantage. As compensation expert Richard Henderson (1961) noted, to develop a competitive advantage in a global economy, the compensation program of the organization must support totally the strategic plans and actions of the organization. Labor costs greatly affect competitive advantage because they represent a large portion of a company's operating budget. By effectively controlling these costs, a firm can achieve cost leadership. The impact of labor costs on competitive advantage is particularly strong in service and other labor-intensive organizations. Equity considerations hold the philosophy that the compensation system should be fair and equitable. It means that compensation system should be similar for the same type of work within the organization. Similarly, it should be fair relative to what other people get for the similar job in another organization. It is important because any imbalance between what the employees contribute and what they obtain as return would lead to greater job dissatisfaction, employee turnover and absenteeism.

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1.1.2     Determinants of Compensation systems

Compensation is a primary motivator for employees. People look for jobs that not only suit their creativity and talents, but compensate them both in terms of salary and other benefits accordingly. According to Henderson (2003), the level of compensation largely depends upon organizational performance as well as operating policies and strategies. He asserted that organization ability to pay, demand and supply of labour, management philosophy and government regulations as follows: Sometimes, the organization itself evaluates where it is in order to prepare compensation plans. The position of the organization is determined by its productivity, when the productivity of the worker is high, it assess itself as a higher position. As a consequence of it, the compensation system is determined at a higher level. Contrary to it, in case of lower productivity, wages/salary rates tend to be low. Thus, any shift in productivity and employee performance has direct impact on the wage level of the organization. Large organizations can often pay at a higher wage rate than smaller ones. Organizations typically increase in size because their services and products are in demand. With increased size comes an economy of scale and the opportunity to increase profits with each additional product or unit of service provided.

Market Forces of demand for and supply of labour: Any job is worth what the marketplace will bear. Individuals with certain skills may be in varying degrees of demand. Sometimes the demands vary across specific locations. At other times, they are national in scope. Those who have the particular knowledge, skills, and credentials that are in high demand. For instance, the U.S. Bureau of Labor Statistics (BLS) monitors the supply and demand for more than 800

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occupations. According to the BLS, 1,200 additional audiologists jobs and 12,000 additional speech-language pathologists needed to fill the demand through 2016. The majority of firms pay at the market rate, which is the rate offered by most of the competitors for labor. Those paying above market are referred to as market leaders. These typically are companies with the ability to pay and the desire to attract and retain top-notch employees (e.g., "cream of the crop"). Those paying below market market laggards generally do so because they are unable to pay higher salaries.Such companies often attempt to attract employees by linking pay to productivity or profits so that the employees can earn more if the company does well (Milkovich, & Newman, 2005). Internal equity: The single most important factor influencing an individual's rate of pay is the kind of work performed. In order to practice in most settings, there is a requisite credential, states license and or otherwise regulate the professions supply. It is not unusual to see a range of a +/-10% percent salary differential for individuals in the same job depending on their performance. To achieve internal consistency, a firm's employees must believe that all jobs are paid what they are worth. In other words, they must be confident that company pay rates reflect the overall importance of each person's job to the success of the organization. Because some jobs afford a greater opportunity than others to contribute, those holding such jobs should receive greater pay. For pay rates to be internally consistent, an organization first must determine the overall importance or worth of each job through a job evaluation. Job evaluation is based on informed judgments regarding such things as the amount of skill and effort required to perform the job, the difficulty of the job, and the amount of responsibility assumed by the jobholder (Stewart, 2001).

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External equity: Equity considerations hold the philosophy that the compensation system should be fair and equitable. It means the compensation system should be similar for the same type of work within the organization. Similarly, it should be fair relative to what other people get for the similar job in another organization. A firm achieves external competitiveness when employees perceive that their pay is fair in relation to what their counterparts in other organizations earn. To become externally competitive, organizations must first learn what other employers are paying and then make a decision regarding just how competitive they want to be. They then establish pay rates consistent with this decision. The firm begins by conducting or acquiring a salary survey. This survey provides information on pay rates offered by a firm's competitors for certain benchmark jobs. Some firms gather this information from existing surveys already conducted by others, such as those produced by the Bureau of Labor Statistics. Trade associations also conduct surveys routinely for their members, or companies may hire consulting firms to gather such information. It is important because any imbalance between what the employees contribute and what they obtain as return would lead to greater job dissatisfaction, employee turnover and absenteeism (Henderson, 2003).

Management philosophy: For many employers, the goal now is to integrate the organization's compensation and reward philosophy with its strategic initiatives regarding customers, profitability, and the development of a strong, competitive work force focused on the success of the organization. As a result, employers are using more sophisticated performance evaluation systems (e. g., 360-degree feedback that includes input from one's supervisor, colleagues, and direct reports) in an attempt to identify and recognize their top performers. Some employers are committed to a philosophy of paying their employees above industry or area standards in order to

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attract and retain the very best pool of skilled workers available. Others pay at the 50th percentile; still others pay as little as they can.

Government legislation or policy: In order to protect the working class from wage exploitation by strong employers, the government enacts various laws and judicial decisions. Such laws and regulations affect compensation management. Because, they emphasize on minimum wa