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    Types of Compensation: Explained

    March 29, 2022

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    types of compensation

    In the world of HR, compensation is what companies provide their workers in exchange for their services, effort, skill, labor, time, and knowledge.

    Compensation could be given to employees in the way of wages, salaries, benefits, bonuses, paid leaves, pension funds, stock options, equities, or any other form of payment for their contribution towards the business's growth.

    This blog helps readers understand the different types of compensation. HR professionals can then create smart strategies and compensation structures that are appropriate and attractive to potential employees. 

    Attracting great talent is vital. It is also equally important to ensure that business goals and strategies align with compensation structure and strategy. 

    The key is to understand what specific types of employees find attractive and ensure that you are offering something that your competition isn't.

    Why is understanding different Types of Compensation Important?

    Often sole traders or previously small companies that are experiencing rapid growth don't have an experienced HR team. This means that their compensation packages aren't designed with a strategy in mind.

    Not having a solid compensation strategy and thereby failing to offer the right mix of types of compensation to your employees can result in the following:

    • Attrition
    • De-motivation
    • Reduced Productivity and therefore Reduced Profitability
    • Lack of Satisfaction and Engagement
    • Failure to Attract Top Talent
    • Reduced Employee Loyalty

    Types of Compensation

    Let's look at the different types of compensation that could be offered to employees in this section. The desired types of compensation differ across the globe. In countries where medical expenses are relatively high, it is common to find that attractive health benefits make up a major portion of their compensation.

    There are two types of compensation:

    • Direct compensation (financial)
    • Indirect compensation (combination of financial and non-financial)

    HR professionals, no matter the size of the organization they work for, have to have a clear understanding of the different types of compensation. It is their duty to communicate the details of the compensation package to candidates and new employees. Understanding the different types of compensation also helps HR professionals when they have to conduct performance reviews and give employees increments.

    1. Direct compensation

    Direct compensation refers to the payment made to an employee in the way of money or finances. There are four main types of compensation that come under direct compensation:

    • Hourly

    Gig-workers, unskilled labor, semi-skilled labor, temporary workers, part-time employees, or contract workers often charge their employers by the hour. They get paid for the time they work, irrespective of their output.

    This can be seen in the fields of IT, construction, tourism, and logistics. When hiring labor for hourly pay, employers typically inform them of how much time their services are required. In the event that the time taken to execute the given task takes more time, hourly workers can often get paid overtime.

    In most countries, strict minimum wage standards have to be adhered to.

    • Salary

    Full-time employees, skilled employees, and those who are in senior management positions typically receive salaries. Having a fixed salary generally indicates that the employee's company has plans to invest in this employee and work with them for the foreseeable future.

    Some jobs that usually get paid in annual salaries are teachers, accountants, doctors, managers, and so on.

    • Commission

    The commission is usually a favoured way of paying sales teams. The commission percentage is usually fixed for a certain number of items sold. It may increase if the sales targets are exceeded.

    The commission percentage varies depending on what is being sold and the profit margins involved. Typical industries where commission-based compensations are commonplace are real-estate, automobile sales, software sales, and so on.

    Some employers offer a minimal salary package combined with an attractive commission package, encouraging workers to work harder to earn more.

    • Bonuses

    Many organizations reward their employees for their contribution to the success of the business at the close of a financial year in the way of bonuses. Some companies hand out bonuses to all employees. Others hand out bonuses to those employees that have contributed more than others.

    Bonuses are usually paid annually but can also be paid quarterly or on a project basis.

    • Tips

    Tips also constitute direct pay for a worker's services. In some countries, it is common for waiters to only work for tips paid to them by the customer.

    • Savings Plans and Annuity

    Another type of compensation that comes under direct compensation is savings plans and annuities.

    • Merit-Based Pay

    Merit-based pay is given to employees that have met or exceeded their targets or have performed exceedingly well in their roles.

    • Piecework / Project Work

    Gig-workers and freelancers are often paid based on projects or milestones within a project. Writers, for example, get paid per word.

    2. Indirect compensation

    The other major type of compensation is indirect compensation. Although employees may not receive cash directly, they still stand to gain financially from some types of indirect compensation. In contrast, other types of indirect compensation do not entail specific financial benefits.

    Here are some types of indirect compensation:

    • Equity package

    Equity, or a small part of the company in the way of shares, has become an increasingly popular way of compensating employees. Typically seen in law firms in the past, now even IT firms and large retail organizations have started giving their employees equity.

    Giving equity or shares to an employee makes the employee's loyalty increase, as the success of the company directly ties into the employee receiving more financial benefit from having shares in the company.

    • Stock options

    This type of compensation allows employees to purchase a fixed number of shares at a specified price after a certain tenure. Stock options do not mean that employees have any ownership of the company. 
     

    • Benefits

    Benefits that are given to employees usually entail healthcare benefits, health insurance, mental health benefits, retirement plans, and so on.

    Retirement funds and pension plans are also attractive benefits that could be offered to employees.

    • Non-financial compensation

    Non-financial compensation includes the following:

    • Paid Time Off
    • L&D Opportunities
    • Maternity Leave
    • Childcare Benefits
    • Company Transport
    • Company Equipment
    • Meals at work
    • Flexible Work Schedules

    Companies often offer seemingly small benefits, such as access to the gym, free entertainment tickets, free stay options, or even access to indoor sporting equipment. All these seem like minuscule efforts and even unnecessary; however, when put together, the overall package becomes quite attractive to an employee.

    Small benefits such as free meals at work or game tickets for the family can go a long way in improving an employee's quality of life.

    Keep in mind, there isn't one set formula for the perfect compensation combination. Different kinds of compensation and benefits have to be created for different levels of employees, different regions, and different kinds of occupations.

    A college graduate who is starting out in their career isn't going to give a lot of importance to retirement benefits. However, if their food expenses are covered at work or if the company includes transport in the package, it would be a more attractive proposition.

    Similarly, a management-level candidate with twelve years of experience likely has their own transport and prefers to use it instead of company transport. They would give more importance to perks such as paid leaves, family health benefits, and childcare.

    Each role in your organization probably needs a different compensation strategy. These have to be carefully thought out.

    On the other hand, what the company deems a perk, may not be considered so by an employee. An example of that would be a company laptop or phone. For an employee, this means taking extra care of a piece of equipment they are liable for if damaged. Additionally, it means that the company is likely to call on them for work outside official timings and will probably track all their activity.

    The best way to get a clear idea of what employees want is to ask them. Send out feedback surveys with a variety of types of compensation, and you will soon be able to cross-reference the surveys and choose the most popular options. Again, remember to separate the surveys based on the type of role, as the desired benefits in one bracket are likely to vary vastly.

    • Cost to Company

    Cost to company or an employee's total compensation includes all the different types of compensation that are given to an employee. It is advisable to provide employees with a detailed breakdown of what their different benefits are and what the monetary value (if any) attached to these benefits are.

    This gives employees a clear idea of exactly what they are entitled to, and they are able to use the benefits to improve their lives. Suppose there are incentive or target-based compensations included in the total compensation. In that case, the breakdown will let employees know which compensations they get by default and which ones they have to ensure they meet targets to receive compensation.

    It is always best to be as detailed and transparent about the types of compensation you are offering right from the beginning. Having an HR representative or manager explain the breakdown to every employee further ensures that they know what they are getting.

    How Do You Determine the Compensation You Should Offer?

    There are a lot of different factors that go into deciding the types of compensation and the level of compensation you should offer for a role. Here are some factors that will help you decide:

    • Minimum Wage Regulations
    • Required experience
    • Required Qualifications
    • Type of Job
    • Job Title
    • Responsibilities.
    • Industry Standard Wages
    • Cost of Living at Job Location
    • Available Supply of Required Talent
    • Company Size
    • Company Reputation

    Creating the right kind of compensation package helps you attract and retain great talent.

    Most organizations in the same industry offer similar pay scales. This means that the talent you are trying to attract has to use other criteria to decide which organization to work for. The types of compensation you offer can make a big difference here.

    You need to have a pulse on what is trending and what your target talent is looking for. Remember, when your talent is happy, they are likely to work harder and contribute more to the organization.

    Conclusion

    An organization that is transparent with its compensation management, is bound to have increased employee engagement, reduction in attrition, and overall a much better employer brand. HR has to create strategic compensation plans.

    Keep in mind, depending on where you are located. There are labor laws and compensation guidelines that you will have to follow. You also have to ensure that your compensation plans align with your business goals and your HR budget.

    Having said that, if you are looking for great talent, you have to be willing to offer competitive compensation packages. Like we said earlier, the types of compensation you include are big deciders as well.

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