As Figure 10.1 shows, an employee’s total compensation has three components. The relative proportion of each (known as the pay mix) varies extensively by firm.1 In most firms the first and largest element of total compensation is base compensation , the fixed pay an employee receives on a regular basis, either in the form of a salary (for example, a weekly or monthly paycheck) or as an hourly wage. The second component of total compensation is pay incentives , programs designed to reward employees for good performance. These incentives come in many forms (including bonuses and profit sharing) and are the focus of Chapter 11 . The last component of total compensation is benefits, sometimes called indirect compensation. Benefits encompass a wide variety of programs (for example, health insurance, vacations, and unemployment compensation), the costs of which approach 42 percent of workers’ compensation packages.2 A special category of benefits called perquisites, or perks, is available only to employees with some special status in the organization, usually upper-level managers. Chapter 12 discusses benefit programs in detail.

Compensation is the single most important cost in most firms. In 2014, private-industry employers spent an average of $29.67 per hour in employee compensation. For the same period, total compensation for state and local government workers averaged $41.73 per hour.3 Personnel costs are as high as 60 percent of total costs in certain types of manufacturing environments and even higher in some service organizations. This means that the effectiveness with which compensation is allocated can make a significant difference in gaining or losing a competitive edge. Thus, how much is paid and who gets paid what are crucial strategic issues for the firm.4

Research shows that employees severely undervalue their employer’s contributions to indirect compensation or benefits (which is estimated at close to $21,500 per employee, on average, in 2014),5 and as a result they often take their employer-funded benefits for granted.6 This situation may be changing as a growing number of companies—including General Motors, IBM, Boeing, Lucent Technologies, and others—are transferring a significant portion of these costs to employees.7 Firms are also becoming savvier in explaining to employees how much these benefits cost, and that this leaves them with less money for raises.8 According to a recent survey of 350 large firms, 85 percent are increasing employee communication about the real cost of benefits.9 This means that employees are more likely to become acutely aware that base compensation, pay incentives, and indirect compensation/benefits are all part of the same pie and that companies cannot increase one piece without reducing the size of the others.