COMPENSATION MANAGEMENT:

Definition, Objectives, Importance

Compensation management, also known as wage and salary administration, remuneration
management, or reward management, is concerned with designing and implementing total compensation
package. Compensation is the human resource management function that deals with every type of reward
individuals receive in exchange for performing an organizational task. The consideration for which labor is
exchanged is called compensation. Compensation is what employees receive in exchange for their work. It is a
particular kind of price, that is, the price of labor. Like any other price, remuneration is set at the point where
the demand curve for labor crosses the supply curve of labor.
What is Compensation and Compensation Management?
Compensation is referred to as money and other benefits received by an employee for providing
services to his employer. Compensation refers to all forms of financial returns: tangible services and benefits
employees receive as part an employment relationship, which may be associated with employee’s service to the
employer like provident fund, gratuity, insurance scheme and any other payment which the employee receives
or benefits he enjoys in lieu of such payment.
According to Dale Yoder, “Compensation is paying people for work.”
“Compensation is what employees receive in exchange for their contribution to the organization.” –
Keith Davis
In the words of Edwin B. Flippo, “The function compensation is defining as adequate and equitable
remuneration of personnel for their contributions to the organizational objectives.”
Cascio has defined compensation as follows; “Compensation includes direct cash payments, indirect
payments in the form of employee benefits, and incentives to motivate employees to strive for higher levels of
productivity.”
Beach has defined wage and salary administration as follows; “Wage and salary’ administration refers
to the establishment and implementation of sound policies and practices of employee compensation.
It includes such areas as job valuation, surveys of wages and salaries, analysis of relevant organizational
problems, development, and maintenance of wage structure, establishing rules for administering wages, wage
payments, incentives, profit sharing, wage changes and adjustments, supplementary payments, control of
compensation costs and other related items.”
Compensation can be in the form of cash or kind. Compensation may be defined as money received in
the performance of works, plus the many kinds of benefits and services that organizations provide their
employees.
Different Types of Compensation
There are different types of compensation. Schuler identified three major types of compensation, which are
mentioned below;
1. Non-monetary Compensation.
2. Direct Compensation.
3. Indirect Compensation.
Non-monetary Compensation
It includes any benefit that an employee receives from an employer or a job that does not involve
tangible value. Examples are career development and advancement opportunities, opportunities for recognition,
as well as work environment and conditions.
Direct Compensation
Direct compensation comprises of the salary that is paid to the employees along with the other health
benefits. Money is included under direct compensation. It is an employee’s base wage, which can be an annual
salary or hourly wage and any performance-based pay that an employee receives.
Direct compensation consisting of pay received in the form of wages, salaries, bonuses, and commissions
provided at regular and consistent intervals.
These include the basic salary, house rent allowances, medical benefits, city allowances, conveyance, provident
funds, etc. It also includes bonuses, payments for holidays, etc.
Indirect Compensation
Indirect compensation can be thought of as the nonmonetary benefits an employee gets from the
organization. It includes everything from legally required public protection programs such as Social Security to
health insurance, retirement programs, paid leave, childcare, or moving expenses. While benefits come under
indirect compensation and may consist of life, accident, health insurance, the employer’s contribution to
retirement, pay for a vacation, employer’s required payment for employee welfare as social security. Rewards
and recognitions, promotions, responsibility, etc., are some factors that induce confidence in the employees and
motivate them to perform better. It also instills the faith in them that their good work is being recognized, and
they can boost their career opportunities if they continue to work harder.
Objectives of Compensation Management
The basic objective of compensation management can be briefly termed as meeting the needs of both
employees and the organization.
Employers want to pay as little as possible to keep their costs low. Employees want to get as high as possible.
Objectives of compensation management are;
1. Acquire qualified personnel
2. Retain current employees.
3. Ensure equity.
 4. Reward desired behavior.
5. Control costs.
6. Comply with legal regulations.
7. Facilitate understanding.
8. Further administrative efficiency.
9. Motivating Personnel.
10. Consistency in Compensation.
11. To be adequate.
Compensation management tries to strike a balance between these two with specific objectives;
Acquire qualified personnel
Compensation needs to be high enough to attract applicants. Pay levels must respond to the supply and
demand of workers in the labor market since employees compare for workers.
Premium wages are sometimes needed to attract applicants working for others.
Retain current employees
Employees may quit when compensation levels are not competitive, resulting in higher turnover.
Employees serve organizations in exchange for a reward. If pay levels are not competitive, some employees quit
the firm. To retain these employees, pay levels must be competitive with that of other employers.
Ensure equity
To retain and motivate employees, employee compensation must be fair. Fairness requires wage and
salary administration to be directed to achieving equity. Compensation management strives for internal and
external equity.
Internal equity requires that pay be related to the relative worth of a job so that similar jobs get similar pay.
External equity means paying workers what comparable workers are paid by other firms in the labor market.
Reward desired behavior
Pay should reinforce desired behaviors and act as an incentive for those behaviors to occur in the future.
Effective compensation plans reward performance, loyalty, experience, responsibility, and other behaviors.
Good performance, experience, loyalty, new responsibilities, and other behaviors can be rewarded through an
effective compensation plan.
Control costs
A rational compensation system helps the organization obtain and retain workers’ reasonable costs.
Without effective compensation management, workers could be overpaid or underpaid.
Comply with legal regulations
A sound wage and salary system considers the legal challenges imposed by the government and ensures
employers comply.
Facilitate understanding
The compensation management system should be easily understood by human resource specialists,
operating managers, and employees.
Further administrative efficiency
Wage and salary programs should be designed to be managed efficiently, making optimal use of the
HRIS, although this objective should be a secondary consideration with other objectives.
Motivating Personnel
Compensation management aims at motivating personnel for higher productivity.
Monetary compensation has its own limitations in motivating people for superior performance. Besides money,
people also want praise, promotion, recognition, acceptance, status, etc. for motivation.
Consistency in Compensation
Compensation management tries to achieve consistency-both internal and external in compensating
employees. Internal consistency involves payment on the basis of the criticality of jobs and employees’
performance on jobs.
Thus, higher compensation is attached to higher-level jobs. Similarly, higher compensation is attached to higher
performers in the same job.
To be adequate
Compensation must be sufficient so that the needs of the employee are fulfilled substantially.
Pre-requisites for Effective Compensation Management
An effective compensation system should fulfill the following criteria:
1. Adequate: Minimum governmental, union, and managerial pay level positions must be met by the
compensation system.
2. Equitable: Care should be taken so that each employee is paid fairly, in line with his/her abilities,
efforts, education, training, experiences, competencies, and so on.
3. Balanced: Pay, benefits, and other rewards must provide a reasonable compensation package.
4. Secure: Employees’ security needs must be adequately covered by the compensation package.
5. Cost-Effective: Pay must be neither excessive nor inadequate, considering what the enterprise can
afford to pay.
6. Incentive Providing: The compensation package should be such that it generates motivation for
effective and productive work.
7. Acceptable to all Employees: All employees understand the pay system well and feel it is reasonable
for the enterprise and the individual.
Importance of Sound Wage Structure
A sound wage policy is to adopt a job evaluation program in order to establish fair differentials in wages
based upon differences in job contents.
Besides the basic factors provided by a job description and job evaluation, those that are usually taken into
consideration for wage and salary administration are;
1. The organizations’ ability to pay.
2. Supply and demand of labor.
3. Prevailing market rate.
4. The cost of living.
5. The living wage.
6. Psychological and Social Factors
7. Skill Levels Available in the Market
1. The organizations’ ability to pay
Wage increases should be given by those organizations which can afford them.
Companies that have good sales and, therefore, high profits tend to pay higher those who are running at a loss or
earning low profits because of a higher cost of production or low sales. In the short run, the economic influence
on the ability to pay is practically nil.
All employers, irrespective of their profits or losses, must pay no less than their competitors and need to pay no
more if they wish to attract and keep workers. In the long run, the ability to pay is important.
2. Supply and demand of labor
If the demand for certain skills is high and supply is low, the result is a rise in the price to be paid to these skills.
The other alternative is to pay higher wages if the labor supply is scarce and lower wages when it is excessive.
Similarly, if there is a great demand for labor expertise, wages rise; but if the demand for workforce skills is
minimal, the wages will be relatively low.
3. Prevailing market rate
This is known as the ‘comparable wage’ or ‘going wage rate’, and is the widely used criterion.
An organization compensation policy generally tends to conform to the wage rate payable by the industry and
the community. This is done for several reasons.
First, competition demands that competitors adhere to the same relative wage level.
Second, various government laws and judicial decisions make the adoption of uniform wage rates an attractive
proposition.
Third, trade union encourages this practice so that their members can have equal pay, equal work, and
geographical differences may be eliminated.
Fourth, a functionally related firm in the same industry requires essentially the same quality of employees, with
the same skill and experience. This results in a considerable uniformity in wage and salary rates.
Finally, if the same or about the same general rates of wages are not paid to the employees as are paid by the
organizations’ competitors, it will not be able to attract and maintain a sufficient quantity and quality of
workforce.
4. Cost of living
The cost of living pay criterion is usually regarded as an automatic minimum equity pay criterion. This
criterion calls for pay adjustments based on increases or decreases in an acceptable cost of living index. When
the cost of living increases, workers and trade unions demand adjusted wages to offset the erosion of real
wages.
5 Living wage
The living wage criterion means that wages paid should be adequate to enable an employee to maintain
himself and his family at a reasonable level of existence. However, employers do not generally favor using the
concepts of a living wage as a guide to wage determination because they prefer to base the wages of an
employee on his contribution rather than on his need.
6. Psychological and Social Factors
Psychologically, persons perceive the level of wages as a measure of success in life; people may feel
secure; have an inferiority complex, seem inadequate, or feel the reverse of all these. They may not take pride in
their work, or in the wages they get. Therefore, these things should not be overlooked by the management in
establishing a wage rate. Sociologically and ethically, people feel that “equal work should carry equal that
wages should be commensurate with their efforts, that they are not exploited, and that no distinction is made on
the basis of caste, color, sex or religion.” To satisfy the conditions of equity, fairness, and justice, management
should take these factors into consideration.
7. Skill Levels Available in the Market
With the rapid growth of industries’ business trade, there is a shortage of skilled resources. The
technological development, automation has been affecting the skill levels at faster rates. Thus the wage levels of
skilled employees are constantly changing, and an organization has to keep its level up to suit the market needs.
Challenges or Problems of Compensation Management
Even the most rational methods of determining pay must be tempered by good judgment when
challenges arise.
The implications of these demands may cause analysts to make further adjustments to compensation.
1. Strategic Objectives.
2. Prevailing Wage Rates.
3. Union Power.
4. Government Constraints.
5. Comparable Worth and Equal Pay.
6. Compensation Strategies and Adjustments
 7. International Compensation Challenges.
8. Productivity and costs.
1. Strategic Objectives
Compensation management is not limited to internal and external equity. It also can be used to further an
employer’s strategy. Employee compensation might have been initially anchored by the relative worth of jobs
and the prevailing wage rates in the local market.
2. Prevailing Wage Rates
Market forces may cause some jobs to be paid more than their relative worth. Demographic shifts and
relative supply and demand relationships affect compensation.
3. Union Power
When unions represent a portion of the workforce, they may be able to obtain wage rates that are out of
proportion to the relative worth of the jobs.
Unions may also limit management’s flexibility in administering merit increases since unions often argue for
raises that are based on seniority and are applied across the board equally.
4. Government Constraints
The government sets minimum wage, overtime pay, equal pay, child labor, and record-keeping
requirements. The minimum-wage and overtime provisions require employers to pay at least a minimum hourly
rate regardless of the worth of the job.
5. Comparable Worth and Equal Pay
Beyond “equal pay for equal work” is the idea of “comparable pay for comparable work” called
comparable worth. It requires employers to pay equal wages for jobs of comparable values.
Comparable worth is used to eliminate the historical gap between the incomes of men and women.
6. Compensation Strategies and Adjustments
Most organizations have compensation strategies and policies that cause wages and salaries to be
adjusted. A common strategy is to give nonunion workers the same raises that are given to unionized
employees; this often is done to prevent further unionization.
7. International Compensation Challenges
The globalization of business affects compensation management. Compensation analysts must focus not
only on equity but on competitiveness too. The growing globalization of business also means a greater
movement of employees among countries. As employees are relocated, compensation specialists are challenged
to make adjustments that are fair to the employee and the company while keeping competitiveness in mind.
8. Productivity and costs
Regardless of the company or social policies, employers must make a profit to survive. Without profits,
they cannot attract enough investors to remain competitive. Therefore, a company cannot pay its workers more
than the workers give back to the firm through their productivity. The company needs some creative
techniques for compensation.

Compensation to Employees:
Concept, Significance and Components
Concept of Employee Compensation:
According to the viewpoint of the economist, labour only sells its services to the entrepreneur for
productive purposes; does not sell itself.
As such, any payment made to this factor of production (i.e. labour) is only in the nature of
compensation for its services. Moreover, the services provided by labour are invaluable, in the sense that
without such services, the productive machinery is like a body without any soul. Therefore, labour could not be
paid exactly for its services; any payment to it is only a mere compensation of the value provided by it to the
production mechanism. Payment or compensation to labour for its services is popularly known as personnel
remuneration. This payment is variously called either wages or salaries. Though in reality, the concept of wages
and salaries are not much different so far as their determination and significance are concerned; yet it would be
an interesting academic exercise to differentiate the two.
Wages are usually associated with a payment made to workmen who are actually engaged in physical
production of goods and services; and payment of wages being made on both bases-time rate and piece rate
systems. Salaries, on the other hand, represent a payment made to office employees, managerial personnel and
technical personnel like engineers, cost accountants, etc.; and salaries usually being paid only on a time-basis
i.e. according to time-rate system of payment.
Disregarding the above technical distinction between the concepts of wages and salaries; it would be
useful to consider their determining factors and other allied issues, from a common standpoint.
Significance of Employee Compensation (Or Personnel Remuneration):
The issue of personnel remuneration, whether in the form of wages or salaries, is highly significant from
the viewpoint of industrial relations, social peace and economic implications. In fact, it is the centre from which
the circle of industrial relations is drawn; it being the crux of industrial conflicts.
Following are some of the points which highlight the significance of personnel remuneration:
(i) Wages/ salaries constitute the primary source of income to employees. Their adequacy or otherwise
would very much determine their standard of living.
(ii) Adequate remuneration is a source of motivation to employees. It makes them committed and loyal to
the organisation; and paves way for excellent industrial relations.
(iii) Through making adequate and timely payment of employee remuneration, an employer can attract
and retain good personnel to and in the organisation. This helps to ensure a stability of labour force –
bringing several valuable advantages in the its wake for the organisation.
 (iv) Specially, in labour-intensive industries, wages constitute a substantial part of the cost of production.
As such wage payments affects the cost and price-structures of an industrial enterprise. Prices of
goods and services, in turn, have social implications; as these directly affect the purchasing power of
money held by the society.
Suitability of piece-rate system:
Piece-rate system of wage payment is suitable under the following circumstances:
(i) Where production is of a routine nature; and quantity of work is more important than quality of work.
(ii) Where the work is of a personal nature; and efforts and rewards could be easily correlated.
(iii) Where the work is of a standardized nature; and standard work, standard time and standard methods
of performance could be easily ascertained.
(iv) Where, in an organisation, there is no proper system of supervision over workers.
(v) Where workers have a tendency to shirk work.
(vi) Where record-keeping for labour cost is needed imperatively, for costing purposes.
(vii) Where there is a scope for more work on the part of workers within the facilities provided for
production and time allowed for production purposes. (Piece rate system would drive them
towards more production).
Components of Employee Compensation:
Components of employee compensation could be divided into two categories viz. basic compensation and
supplementary compensation. Again supplementary compensation comprises allowances and perquisites or
perks.

Let us describe the various components of employee compensation:

(a) Basic Compensation:
Basic compensation refers to the basic pay of an employee which is usually expressed in terms of a pay
scale e.g. 5,000-200-10,000- 500 -20000 etc. This pay scale implies that an employee will get a basic pay of Rs.
5000 per month on joining the organization.
The employee will get an increment of Rs. 200 per year till he/ she reaches the basic pay of Rs. 10,000 and after
wards will be entitled to an increment of Rs.500 per year till he / she reaches the pay of Rs. 20,000 per month
and so on. Basic pay for a job is decided though a process of systematic job evaluation. In many cases,
Government fixed pay scales apply which employers have to accept and implement.
(b) Supplementary Compensation:
Supplementary compensation refers to payment of allowances and provision of perks or perquisites.
Allowances refers to amounts of money which are given to employees regularly for particular purposes; while
perks refer to privileges enjoyed by a person because of his/her organizational status and paid/provided in
addition to wages/ salaries.
Following is an account of popular types of allowances and perks:
Allowances:
(i) House Rent Allowances (HRA):
HRA is given by the employers to the employee to meet the expenses in connection with the rent of the
accommodation, which the employee might have to take.
(ii) Dearness Allowances (DA):
DA is paid to employees to compensate them, at least partially, against the phenomenon of rising prices.
DA is decided as per an agreed formula, taking into account the increase, in the cost of living.
(iii) City Compensatory Allowance (CCA):
CCA is paid to employees to compensate them partly for higher cost of living in cities, which differs
from one type of city to another.
(iv) Conveyance Allowance:
Conveyance allowance is an allowance granted to employees to meet the expenditure incurred on
conveyance in performance of duties of job; when free conveyance is not provided by the employer.
(v) Uniform Allowance:
It is an allowance which is granted to meet the expenditure incurred on the purchase or maintenance of
uniform for wear during the performance of duties of job.
(vi) Children Education Allowance:
Amount paid at the rate of certain amount per child to meet the cost of education of children (subject to
a maximum of two children or more as per rules of the organisation) is called children education allowance.,
(vii) Underground Allowance:
This allowance is granted to an employee who is working in uncongenial, unnatural climate in
underground coal mines.
(viii) Miscellaneous Allowances:
Some other allowances payable to employees may be:
1. Medical allowance
 2. Lunch / Tiffin allowance
3. Overtime allowance
4. Non-practicing allowance (in case of doctors)
5. Servant allowance etc.
Perquisites/Perks:
(i) Rent free accommodation or accommodation provided to employees at concessional rate. The
accommodation may be furnished or unfurnished.
(ii) Gas, electricity bill of employees paid or reimbursed.
(iii) Interest free or concessional loans to employees.
(iv) Leave Travel Concession (LTC) to employees.
(v) Free meals, tea and snacks, provided to employees.
(vi) Payment or reimbursement by the employer of club membership of the employee and expenses
incurred in a club by the employee.
(vii) Use of laptops and computers by employees, belonging to the employer.
(viii) Motor car/ other vehicles, provided by the employer to specified employees.
(ix) Provision by the employer of services of a sweeper, a gardener, a watchman or a personal attendant
to specified employees.
(x) Re-imbursement of medical treatment expenses, incurred on employee or members of his / her
family.
(xi) Contribution by the employer to recognised provident fund, kept for the benefit of employees.
Performance Appraisal in HRM
Performance appraisal is a systematic evaluation of the employee’s present job capabilities and also his
potential for growth and development by his superiors. It can be either informal or formal. The informal
appraisals are unplanned while formal appraisal system is set up by the organisation to regularly and
systematically evaluate employee performance. It reduces the chance of bias and snap judgment but bound to
yield better results. As per the views of C. Heyel (1973), “performance appraisal is the process of evaluating the
performance and qualifications of the employees in terms of the requirements of the job for which he is
employed, for the purposes of administration including placement, selection for promotions, providing financial
rewards and other actions which require differential treatment among the members of a group as distinguished
from actions affecting all members equally”.
Performance Appraisal in HRM –
Meaning
After placed and trained as an employee on the job, the next important and essential step in the
management of human resources of an organisation is to evaluate the performance of an employee on the job.
The management must be able to recognize the level of an employee’s job performance and then they can be
rewarded on the basis of their contributions to organizational goals. It is the process of deciding how employees
do their jobs and if any problems are identified, then immediately steps are taken to remedy them.
As per the views of C. Heyel (1973), “performance appraisal is the process of evaluating the
performance and qualifications of the employees in terms of the requirements of the job for which he is
employed, for the purposes of administration including placement, selection for promotions, providing financial
rewards and other actions which require differential treatment among the members of a group as distinguished
from actions affecting all members equally”. It is organized on the principle of goals and management by
objectives.
The performance appraisal of employees has been used for the first time during the First World War
when Walter Dill Scott, the US Army adopted the ‘Man-to-Man’ rating system for evaluating the performance
of military personnel. During the 1920-30, the merit rating programmes were used for employees of industrial
units. In the early fifties, attention began to the performance appraisal of technical, professional and managerial
personnel.
According to Wonston Oberg (1972), Common descriptions include performance appraisal, merit rating,
behavioural assessment, employee evaluation, personnel review, progress report, staff assessment, service rating
and fitness report. However, the term performance appraisal or evaluation is most widely used. Performance
appraisal is a systematic evaluation of the employee’s present job capabilities and also his potential for growth
and development by his superiors. It can be either informal or formal. The informal appraisals are unplanned
while formal appraisal system is set up by the organisation to regularly and systematically evaluate employee
performance. It reduces the chance of bias and snap judgment but bound to yield better results. “Formal
appraisal of an individual’s performance began in the Weidymasty (A.D. 221-265) in China, where an Imperial
Rater appraised the performance of members of the official. In 1883, the New York City Civil Service in
U.S.A., introduced a formal appraisal programme shortly before First World War”. A. Monappa and M.S.
Saiyadain Douglas Mc Gregor (1957) says – Formal performance appraisal plans are designed to meet three
needs, one of the organisation and other two of the individual, namely –
(i) They provide systematic judgments to back up salary increase, transfers, demotions or
terminations.
(ii) They are means of telling a subordinate how he is doing, and suggesting needed changes in
his behaviour, attitudes, skills or job knowledge. They let him know ‘where he stands’ with
the boss
(iii) They are used as a base for coaching and counselling the individual by the superior.
Performance appraisal is the systematic evaluation of employee’s behaviour in the work place
which includes employee’s job performance and his potential for growth and development.
Actually the performance appraisal is not the evaluation of performance of job but the
evaluation of performance of employee on the job. Its focus is on employee’s development.
 The performance appraisal system may be formal or informal. The formal system is to be fair
and objective while informal system is to be subjective and influenced by personal factors.
In this system there may be two type of persons involved:
1. Appraise – The person whose performance is going to be appraised by other person.
2. Appraiser – The person who is going to evaluate the performance of appraise. The appraiser may be
a superior, subordinate, peers, self-appraisal, and group.
Performance Appraisal in HRM – Characteristics
A system which may have the following qualities or characteristics may become sound appraisal
system:
1. It should be simple and understandable by the employees. Any complications need to be
avoidable.
2. It should be suitable to be adopted for appraisal at regular intervals because periodic appraisal
enables the employees to improve.
3. It should create the atmosphere of mutual understanding and confidence.
4. The system should be capable of giving equitable justice to all employees. Therefore it should be
objective and free from personal bias.
5. The employees should be taken in confidence while preparing performance appraisal.
6. The system should be suitable to the organisation from the points of its structure, needs and more
essentially based on latest development in the area.
7. It should be able to fulfill the desired purpose by locating potential for promotion, increments,
placements, transfers etc.
8. Special training is given to evaluated” for making him more impartial and free from bias.
9. Negative appraisal of any employee should be immediately communicated to him so that he can
adopt measures for improvement.
10. The employee should be allowed to go in appeal in case his performance appraisal is negative if
he is not satisfied. By this the management will win the confidence of the employees.
11. The performance appraisal system should not be aimed at harassing the employees who are vital
human resources and play very important role in achieving organisational goals. On the other
hand the top bosses should be made aware that performance appraisal is aimed at improving
performance, organisational effectiveness and to accomplish organisational goals.
Performance Appraisal in HRM – 8 Main Objectives
Performance appraisal plans are designed to meet the needs of the organisation and the individual. It is
viewed as core to good human resource management. According to Cummings, “the overall objective of
performance appraisal is to improve the efficiency of an enterprise by attempting to mobilize the best possible
efforts from individuals employed in it. Such appraisals achieve four objectives including the salary reviews,
the development and training of individuals, planning job rotation and assistance promotions.”
The following main objectives of employee performance appraisal are:
i. To identify employee weaknesses and strengths;
ii. To identify and meet training needs and aspirations;
iii. To generate significant, relevant and valid information about employee;
iv. To provide inputs to increments of rewards, transfers, promotion and salary administration.
v. To help in improving employee’s performance if he is not found to be suitable during the review
period;
vi. To create a desirable culture and tradition in the organisation;
vii. To help in planning career development and human resources planning based on potentialities.
viii. To provide ‘deadlock’ and research data for improving overall human resources information
system.
Performance Appraisal in HRM – Process
Performance appraisal is planned, developed and implemented in the following manner:
1. Establish Performance Standards:
The performance standards for each and every job should be developed and discussed with the
superiors after thorough analysis of the job. These standards should be clear and not vague. They must
be measurable after certain period.
2. Communicate the Standards:
After setting the performance standards of job, the next activity is to communicate these
standards to all concerned; at least two parties –
(a) appraiser
(b) appraisee.
It is necessary, these standards must be modified. The appraiser must ensure that the information
communicated by him has been received by appraisee and understood clearly. As per opinion De Cenzo
and Robbins, “too many jobs have vague performance standards and the problem is compound when
these standards are set in isolation and do not involve the employee.”
3. Measure Actual Performance:
Now the next activity is to measure actual performance of appraisee on the job after certain
period. Generally four common sources are used by appraiser to measure actual performance, personal
observation, statistical reports, oral reports and written reports.
4. Compare Actual Performance with Standards:
The fourth activity is the comparison of actual performance with standards. Sometimes actual
performance may be better than standards and sometimes it may go off the track. Any deviations
between actual performance and standard performance may be noted carefully for next activity.
5. Feedback to the Employee:
In this activity the results of stage forth are discussed with employee. The information which is
received by appraisee about his assessment has a great impact on his performance. Communicating poor
performance is difficult task of appraiser.
6. Taking Corrective Action, if Necessary:
This is the final or last activity of the performance appraisal process. In this stage two types of
corrective action may be recommended by the appraiser. One is positive means salary increase or
promotion if actual performance of appraisee is up to the mark and second is negative means coaching
and counselling may be done if the performance is poor. If necessary appraisee may be deputed for
formal training courses.
Performance Appraisal in HRM – Top 8 Methods:
There are various methods for conducting performance appraisal to identify areas of performance that
should be modified or improved and to provide information to management for specific actions such as
promotion, transfers and compensation adjustment. Various methods of conducting performance
appraisal are explained below:
1. Ranking Method:
This method requires the evaluator to list all sales people in order of their performance,
beginning with the top performer. A number of ranking methods are used for conducting the
performance appraisal of employees. Some of the important ones are listed as under:
(I) Simple Ranking Method: In this method all the employees are rated on the same set of
factors and ranks as given to them on the basis of their performance in relation to others
in the group. They are all rated from the first to the last in order of their performance.
(II) Paired Comparison Method: In this method all the employees’ performances are
compared with other employees but comparison is made with only one member at a time.
The number of times each member is preferred over the other is recorded. These numbers
determine the ranks of members and obviously the top performers will be those with
highest ranks for more number of times.
(III) Forced Distribution Method: It is a method to evaluate employee performance
according to a predetermined distribution scale. Generally the organisations use five
grade scales where one end of the scale represents the best job performance and the other
 represents the poorest job performance. All the employees are rated somewhere on the
scale according to their level of performance in comparison to other employees. The
biggest advantage of using ranking method is its low cost, little time and effort, and
simplicity. But the ranking method is not considered a very scientific and objective
method because there is lots of ambiguity and vagueness involved in ranking the various
employees. Chances of personal biasness and favouritism are many in this case as ranks
are being assigned by supervisors as per their own opinion and judgment.
2. Graphic Rating Scale Method:
Graphic rating scale method identifies specific desired traits, behaviour factors or performance
criteria, such as, quality and quantity of work, cooperativeness, analytical ability, decisiveness,
initiative, emotional stability, etc. Employees are rated on a scale based on the extent to which they
exhibit the desired behaviour or the extent to which they meet the desired performance criteria. The
rating for each factor will be done on the basis of numbers (1, 2, 3, 4, and 5) or descriptions
(excellent, very good, average, poor, etc.) The central idea behind using rating scales is to provide
the appraiser with a continuous representation of various degrees of particular qualities or
characteristics being present in employees. The total of the points obtained by an employee on all the
rating factors constitutes the overall ratings score of that employee in comparison to other employees
in the organisation. Many organisations use graphic rating scales because they are practical and cost
little to develop. As traits are defined in advance, there is less ambiguity in this technique of
evaluation. While, unfortunately, rating scales suffer from a major weakness, that is, the uneven
interpretation of performance criteria and rating. Unless each evaluator clearly understands what
each criterion means and what the rating means, confusion and dissatisfaction can result.
3. Critical Incidents Method:
Under this method the immediate supervisor tries to make a continuous record of all the good or
bad incidents of a person’s work-related behaviour. Whenever employees are found doing something
good or positive which contribute towards increasing the overall productivity of the organisation or
creating a healthy work atmosphere it is recorded as their positive contribution. At the same time
whenever they commit a mistake, a blunder or an error because of which damage has been incurred
to machinery or the overall productivity of the organisation gets adversely affected it adds to their
negative contributions. At the end of the rating period, these recorded critical incidents whether
positive or negative are used in the evaluation of the employee’s performance. The biggest positive
feature of this technique is that it measures behaviours which are critical to the effective
performance of the job. Using this method facilitates a feedback by providing the employees. with
concrete examples of actual behaviours committed by them. If proper records are maintained of
these critical incidents it provides the most realistic measurement of an employee’s performance on
 the job. Although this method is an improvement and it tries to minimise the subjectivity problems
associated with other appraisal systems, it also suffers from certain limitations. As employees are
aware of the fact that they are being noticed by their supervisors, it might add to their level of
anxiety and hostility. Others tend to hide those behaviours which they feel will adversely affect their
performance reviews. In either case, the end results are distorted performance reviews.
4. Checklist Method:
In this method the employer starts with a list of factors in their checklist, such as, does the
employee cooperate with other co-workers, do they keep their work place neat and clean, do they
follow their supervisors instructions closely, do they reach on their workplace in time, and are they
able to achieve the work targets assigned to them properly. Each factor or item receives a numerical
value based on its perceived importance to successful job performance. Those items that are deemed
more important are assigned higher values. The actual performance of all the employees on the job is
measured and is compared against the checklist. Their scores on the appraisal are determined by
summing the scores of the factors checked by the rater. One of the biggest advantages of using the
checklist method is the convenience to the supervisors as they simply have to say yes or no in front
of the statements or the factors provided to them. It saves their time and the same checklist can be
discussed with the employees and a feedback can be given to them. However developing an effective
checklist, measuring the performance against the checklist and finally interpreting the results might
not be very simple for the supervisors.
5. Essay Method:
Brief narratives by the manager describe the performance of an employee. A manager may write
a detailed write-up on the job knowledge and potential of the employee; employees understanding of
the company’s programs, policies, and objectives; employees promotability; overall appraisal of the
employees performance; and employees relation with their co-workers and superiors; and so forth.
Essay method provides detailed information about the employee’s performance by the managers
who have seen them closely on the job. The essay method provides a great deal of information about
the employee, which provides a useful feedback to the employee for further improvement in the job
performance. Although this method allows more flexibility and appears to be simple, it is not
consistent and tends to be subjective as each supervisor has a different writing style and emphasis.
They might evaluate the employee’s performance from altogether a different perspective. Sometimes
even the problem of halo effect can enter into their subjective evaluation, where the evaluators may
be biased by a generalized overall impression or image of the person they are evaluating. If the
manager does not like the way an employee dresses, for instance, that attitude may bias all aspects of
the manager’s evaluation.
6. Management by Objectives Method:
Management by objectives (MBO) is a comprehensive management approach which is used for
conducting performance appraisal. It is considered as one of the most scientific and objective
method as a set procedure is followed. The primary focus in this method is on developing a set of
objectives which are to be realised by the employees. These objectives are later used as criteria for
measuring the performance of the employees, or in other words the extent to which these objectives
have been achieved by the employees. So in this method at the first stage detailed objectives for the
employees are clearly set. In the light of these objectives the individual employees’ responsibilities
and tasks are clearly laid down. At the time of performance appraisal, a supervisor will measure the
actual performance of the employee on the job and the realisation of objectives by them. In case the
employees have been able to successfully realise the objectives they are rewarded accordingly and in
case they are not able to achieve the objectives, reasons for their shortcomings are identified. Later
in the light of these findings the objectives might be redefined for future. MBO is considered a very
objective approach because goals and objectives are clearly determined before the appraisal begins.
This gives employees clear-cut directions as to what is expected of them and the standards against
which their actual performance will be measured and compared at a later date. If the objectives are
unattainable they are redefined and reset for future. However this method also suffers from the
limitation of involving lots of time and effort on the part of the supervisor and the subordinate.
7. 360° Feedback Appraisal:
The term 360° feedback appraisal is also known as multi-rater feedback, multisource feedback,
full circle appraisal and group performance review. This concept was developed in the US in the
year 1998. This concept involves a process of collecting information about a person’s behaviour
from the people around him his boss(es), colleagues, fellow members in the team, suppliers, as well
as customers. The basic assumption underlying this approach is that a person who works closely
with an employee sees his or her behaviour in various settings and circumstances that a supervisor
might not be able to see. Thus, the term 360° implies that everyone around is involved in evaluating
the performance. Unlike traditional methods, only supervisors do not evaluate the subordinate rather
literally everyone around gives the feedback. It tries to eliminate the subjectivity in evaluation, as
many people rate an employee on a fairly extensive list of attributes. Companies prefer this method
as they receive a broader and more accurate perception on their employees from multiple sources.
This performance appraisal method is a very effective method as it provides an individual an
opportunity to learn about others perception of him. It provides a more open culture and an
opportunity to resort to self-development for employees. It increases the overall communication
networks in the organisation. The 360° feedback is widely accepted as an effective performance tool,
 but if it is not managed properly then it does more harm than benefit. As so many people are going
to appraise an employee’s performance, all of them might not be closely familiar with him and might
not be able to give an accurate judgement or opinion about him. So in order to use this method
effectively every organisation must develop an effective system and an appropriate procedure for
generating enthusiasm amongst key decision makers and participants, ensuring that all of them have
the skills to support the process. This might call for providing an orientation benefiting participants
in one-to-one meeting and providing organisational summary data.
8. Potential Appraisal:
This is done to predict whether an employee is capable of taking on more demanding work,
and the speed at which he or she is capable of advancing. This appraisal method tries to judge the
potential of employees for being promoted to higher positions. In this method it is necessary to
inform employees of their future prospects and give them an opportunity to perform to the best of
their capacity. The organisation also might have to modify and update training and development
programs and advice employees of what they must do to enhance their career prospects. In the
potential appraisal process, attempt is made to match the employee’s abilities and aspirations with
the organisation’s forecast of requirements for higher-level managerial staff. This aspect of
employee appraisal is considered as a highly positive and motivating because this tries to give an
employee an incentive to work hard as they can look forward to growing up in their career path. The
potential appraisal is concerned with forecasting the direction in which subordinates career can and
should go and the rate at which he or she is expected to develop. The assessment of potential
requires an analysis of the existing skills, qualities, and how they can be developed to the mutual
advantage of the company and the employee. There is also an important counseling aspect to the
review of potential which consists of discussions with the individual about his or her aspirations and
how these can best be matched to the future foreseen for him or her. They can also provide
employees with additional motivation and encouragement which they need to remain with the
company. Finally, once the employee’s performance has been evaluated with the help of any of the
methods listed above, the results should be reviewed in a meeting with the manager.