Reduction of Payroll Costs: Rewards


Background information

Organizations, both private and public are faced with the challenge of accelerated changes within operation areas (Nadler, 2008). There is a relentless pressure on managers to expedite operations and minimize operational costs. To beat this challenge, private and public entities are beginning to explore the best approaches to adopt in management of its workforce. Primarily, the employees are challenged to meet staff demands and in turn demand that staff meet their demands (Bratten & Gold, 2009: 76). Unfortunately, most organizations still lack the appropriate expertise and strategic tools to optimize their work force productivity without having to incur unnecessary payroll costs. Management organizational workforce must go along with three key organizational factors, that is, productivity, efficiency, and profitability (Kumar, 2006; Tellis, Prabhu, Chandy, 2009). Management of workforce is a high valued decision and many organizations acknowledge that reducing labor management processes and payroll costs are just but a step. The real challenges lie in doing the same and remain competitive and responsive to needs of its target clientele. Ability to pro-actively manage and maximize workforce output is therefore a necessity (Wilson, 2006).

Theoretical problems associated with payroll reduction

When times get rough, employers as well as employees grapple with the possibility of losing valued employees and losing employment respectively. Recent trends have made it no unique news for people to lose their jobs as a corporations cost reduction initiative (Lyons, Chatman, & Joyce, 2007: 189). Such occurrences are highlighted in news everyday. What is highlighted to a lesser extent is the extent to which the management has to grapple with the possibility of losing out employees it might need when economic fortunes turn good (Laursen, 2002). Staffs are a critical contributing factor to any organizations functional and operational succeeds. Having to reduce payroll expense is a painful and cumbersome process, although, at one time, when times demand it has to be undertaken. A number of ways have been suggested to reduce payroll costs within an organization. However, each comes with its own cup of challenges. None is as perfect as ideal situation would demand and hence employees have to critically evaluate which options would best suit its case. In doing so, the employer may have to answer some fundamental questions, some of which are under-listed below (Deeprose, 2006; DeCenzo, & Robbins, 2007).

  1. Is there a more viable alternative?
  2. How will such a move affect productivity levels?
  3. How will the staff react (DeCenzo & Robbins, 2007: 56)?
  4. What key areas will result into minimum impact to the corporation?
  5. What are the weaknesses of the current employee payroll structure?
  6. Are some employee’s redundant (DeCenzo & Robbins, 2007: 56)?

These are just but some of the many questions that an employer would need to answer before deciding the approach to adopt in reducing payroll costs. For instance, it would be preposterous to reduce the number of employees knowing quite well that the existing workforce is already strained and overburdened with work. Similarly, it would be non-logical to maintain a large workforce with low production and hence nothing to do much of the time. Often though, employers realize that production decline is seasonal and the employees will still be needed when production rates return to normal levels (Van de Ven, 2007: 599). The employers would want to keep its expert employees regardless of their unproductively levels at the moment. Generally, while payroll cost reduction is at times a necessity, the challenges it presents offer a critical test to the management’s ability to handle change.

Literature review

Most organizations are faced with the challenge of reducing costs. Gradually the effect is being felt in payroll management as other possible cost reduction areas are fully exploited (Price, 2007: 326). However, it cannot be ignored that it constitutes a significant percentage of many organizations variable costs. In some instances, successful payroll reductions have been attained without compromising quality of service and overall organizational turnover. In other cases though, clear cut trade offs exist between cost reduction and service quality (Price, 2007: 327). Commonly adopted methods in payroll cost reduction across many organizations include reduction in paid working hours, increased use of agents, and reduction of new hire base salaries, reduced the number of staff, relocation of business operations to areas of low labor costs, and reduced benefit offerings to employees.

According to Poškienė Audronė (2006), a renowned scholar in human resource studies, there exists distinct ways of cutting down on payroll costs. These include centralization of operations, whereby corporations achieve savings by bringing together tasks that had previously been done separately and hence reducing staff requirements. This measure according to Poškienė, ensures efficient and adequate utilization of staff. He also mentions that standardization of payroll procedure greatly lowers the payroll costs. “The more ways that pay is calculated and benefits are provided in a company causes the cost to produce the payroll to increase almost exponentially (Myerson & Hamilton, 2005: 10).” Many corporations have lowered reward and compensation complexities through elimination of divergent pay and benefit policies across its employee divide (Kerr & Slocum, 2006).

Employee reward systems define how staff are rewarded base don their performance in value creation to an organization. Rewards are either non-financial or financial (Kerr & Slocum, 2006). However, each way there is always an additional cost that the organization has to incur. It is a widely adopted measure by various organizations which intend to motivate its employees to put more effort into their efforts and hence increase productivity. Value attached to employees potentially impacts on organizational effectiveness and hence it’s central to employer-employee relationship (Kerr & Slocum, 2006). Basically, reward systems aim to attract, retain and motivate employees to commit to achievement of the organizations goals and objectives. A typical reward system is illustrated by the diagram below;

Personnel and development professionals will be involved frequently in reward issues, whether they are generalists or specialize in people resourcing, learning and development or employee relations (Lyons, Chatman, & Joyce, 2007: 188).

Various reward models have been proposed. Of interest is the equity model which works on the assumption that people get fairly rewarded for their individual job contribution (Jassowalla & Soshittal, 2002: 48). The model additionally holds assumptions that employer’s exchanges acts as referents upon which employees compare their exchanges, and that if an employee believes his treatment is inequitable, compared to others; he or she will be motivated to do something about it in seeking justice (Nadler, 2008). Three cases arises from this model, in the first case, there is a perception that pay allocation is fair and hence motivation is sustained, in case 2, there is a claim of Inequity (Underpayment) and as such, the employee is motivated to seek justice leading to a disruption of Work motivation. In the last case, Inequity (Overpayment) results into inefficiency and in some cultures, loss face by employees (Price, 2007; Van de Ven, 2007). Employees undertake measures to combat inequity through a number of ways, which may include reduction of effort input, raise complains and grievances with the management to correct the inequity, attempt to influence the input of other employees, and engage in emotional withdrawal which results into absenteeism, tardiness and quitting of employment (Poškienė, 2006). Such reactions are crucial and could see a corporation lose employees it would have otherwise wanted to retain. Additionally, production may be further strained and the adopted measure rendered meaningless in terms of achieving organizational goals (Jassowalla & Soshittal, 2002: 50).

Tension in internal and external pay equity can be quelled by letting employees now their reward referents within the employment structure. Additionally, pay competitors and internal reward comparators should be established. This is well done within the tournament theory (Jassowalla & Soshittal, 2002: 51). The theory involves competition amongst peer employees in seeking promotion to higher levels which comes with increased pay perks. It more or less represents a situation of “winner takes it all.” Often, the prospects of higher position with the prospect of greater pays, attracts more employees to engage in such competitions. Generally though, reward systems adopted not only affect the costs that an organization incurs but also directly impacts on employee performance (Van de Ven, 2007). Eliminating such systems may in deed lower the payroll costs in an organization but it may not guarantee overall profitability of the organization. The perception of the employees’ with regard to such a measure is fundamental in determining its success of failure. If perceived as a negative move, the employers are likely to initiate a retaliatory measure. However, a positive perception by employees is likely to see continued effort to put the company back on track and regain the benefits. The management therefore has a crucial role in ensuring that changes in reward system aimed at reducing payroll costs are well accepted by the staff (Tushman & Nadler, 2003: 87). This can only be achieved through adequate consultation and dialogue to make the staff understand the reason behind such measures.

Theoretical constructs of reward systems

Employee reward and motivation is a key constituent in satisfaction of employees and hence motivation. Monetary reward and other forms of motivation is core to any individual’s employment satisfaction (Lau & Ngo, 2004). Beyond rewards, employees have an obligation to fully understand their obligations and expectations required of them. Goal setting is key to formulation of any employee motivation system. Goals shape calculation and issuance of rewards to employee. Comparative ratios are often employed in evaluation of how well an organization is rewarding its staff. It evaluates how high or low the employees are rewarded for their contribution to an organization (Lau & Ngo, 2004). It therefore helps the management to know when it exceeded the advisable compensation limits and hence causing strain on its payroll costs. Generally the following equation is used in its calculation.

Three types of ratios are often adopted. These include individual comparison ratio, group comparative ratio, and average comparative ratio (Bratten & Gold, 2009). Individual comparative ratio defines the relationship between company reward practices and the policy reference point within the organization on basis of an individual. It’s useful in reposition of individuals pay as appropriate and practicable within the organization. Group comparative ratios on the other hand, quantifies the link between the companies reward practices and the overall organization policy or a given functional group like a department, or a job family. It determines pay policy implementation and any possible loopholes within the policy that compromise organizational effectiveness. Average comparative ratio is the summation of individual comparative ratios divided by number of employees in an organization (Bratten & Gold, 2009).

Reward management focuses on formation and implementation of policies to ensure that employees are fairly, equitably, and consistently rewarded in line with their value contribution to the organization (Laursen, 2002). It covers reward processes, practices and procedures in order t help an organization attain its short and long-term goals. Reward is special payments for special work.

Reward encompasses all both financial as well as tangible service benefits accrued by employees as a result of their efforts towards organization’s success (Laursen, 2002). Fairness is important in reward allocation process and to retain good employees in the organization manager must be concerned about fairness and appropriately reward those who deserve it Organizations are interested in reward management for two important reasons. First, the absolute cost of payments bearing on cost effectiveness depends on organizations to organizations. Second affect, on employees work attitude and behavior, employee work effectively, to undertake training and accept additional responsibility (Bratton & Gold, 1999: 191-192).

Many human resource specialists agree that in a scenario, to influence employees to work more, with greater productivity as well as to reduce cost with effectiveness, reward system is necessary (Kerr & Slocum, 2006). Reward can change the behavior of employees, if an employee rewards, he is likely to experience some level of satisfaction which would impact on his behaviors towards work and other staff. His loyalty will increase and he will also feel appreciated. Lack of reward systems would work to the reverse.

Most corporations adopt various approaches to rewarding their employees depending on the cost implications on its payroll costs. The criterion used is fundamental in creation of a strong base with non-ambiguous policies. Reward management criteria provides a fair idea of an organization’s internal culture, philosophy of organization, defines its mission, vision, values as well as its overall road to success (Price, 2007). Generally employed measures of rewards within organizations are measured based on the following aspects.

  • Client satisfaction
  • Quality of performance
  • Problem solving ability
  • Quantity of work done.
  • Objectives achievement and surpassing.
  • Work processes enhancement.
  • Work attendance.
  • New skills acquisition (Deeprose, 2006: 36).

Coca-Cola is one of leading global corporations which pride in an excellent employee rewarding system. Coca cola rewards employees on basis of their contribution to the overall objective of the corporation (Coca Cola Corporation, 2011). This is a measure aimed at enhancing the organization’s overall efficiency. It mainly adopts a number of approaches in its regards management including Maslow’s hierarchy of needs, ERG theory and Hurtz Berg theory. Main reward measurement variables include factors of inflation, potential of operating market, and personal occupation growth. These factors ensure that the rewarding systems are accordingly adjusted depending on time demands. Reward systems at coca cola range from monthly rewards to yearly rewards. These include Employee salary raises, Grade Jump, changes in employment designation, annual incentive plan, and monthly allowance for extra-ordinary performance, among others (Gallini, 2001: 59).

Like Coca cola, Nokia rewards its employees competitively across the globe for exemplary contribution to the success of the organization. Compensation levels are dependant on local markets to ensure that they are proportional to the prevailing situations within the market. Employees are offered incentives in form of bonuses, to recognize their contribution (Gallini, 2001: 69). However, employees at the corporation at one point raised issues with the bonus system. To resolve the issue, all stakeholders were brought on board and a review conducted (Tushman & Nadler, 2003). This is meant to ensure that an intended motivation does not turn out to be a source of de-motivation (Amabile, Schatzel, Moneta, & Kramer, 2004). Generally, employee rewards systems must be structured in line with prevailing conditions to ensure that payroll costs match the prevailing market conditions. Organizational rewards are either intrinsically or extrinsically aligned. While intrinsic rewards deal with individual personality achievements, extrinsic rewards are directly controlled and distributed by the organization and are more tangible than intrinsic rewards it includes formal recognition, incentives benefits, pay promotion social relationship and work environment (Byars & Rue, 2000: 272).


While employee reward systems are fundamental to every organization, they must be keenly architecture to ensure minimal employee dissatisfaction with regard to appraisal systems, salaries, bonuses, as well as other fringe benefits. This is a necessary condition if the move is to yield improvement in their work performance, improve quality of production, and reduce the level of occupational stress that arises from feeling of inequality on reward. Likewise, it must reduce perceptional gap on reward management system and develop a culture of high performance. However, the reward systems must reflect the prevailing market conditions if the company is to remain afloat within tough times. There should be a proper check and balance system between goals and performance of the organization in relation to payroll expenses arising from employee rewards. A consultation path should be designated between the management and the employees in understanding an analysis of employees’ career path.

There are three main objectives characteristic of reward systems. These include attraction and retention of competent employees as well as improvement of quality of production within the organization. Basically organizational rewards are either intrinsic or extrinsic. As far as literature is concerned, organizations mostly used two types of rewards which are either monetary or non-monetary. Both play a vital role to motivate employees optimistically to increase efficiency and effectiveness. Reward systems are primarily based on the assumption that reward is dependent on employee performance. This phenomenon is desirable not only at organizational or corporate levels but also at individual employee levels. The underlying theory is that employees will be motivated when they believe such motivation will lead to desired rewards. Unfortunately, many formal rewards provided by organizations can not be connected to performance. Rewards in this category, including paid vacations, insurance plans, and paid holidays, are almost always determined by organizational membership and seniority rather than by performance. Other rewards, such as promotion can and should be related to performance. The primary organizational variable used to reward employees and reinforce performance is pay.

It is therefore evident that pay/compensation is an important tool in managing employee morale which ultimately translates into administration of reward systems. While most scholars mention that reward systems aim to retain, attract and encourage employee morale, perhaps the single-most prime reason for such is to increase corporation performance through enhance employee performance. It is important to mention that the individual efforts of each employee are what translate into the overall performance of the organization. Every employee contribution is important. However, maximum employee contribution is only attainable if the employees themselves are satisfied and identify with the corporation success rather than view themselves as a tool to some means. Rewards systems offer a tangible approach to management of employee morale in addition to making employees feel as part of the organization’s performance. Every management should therefore strive to ensure that employees are appropriately rewarded for the works they do or engage in.


As companies grapple with the reality of changing times and increased competitive markets, the reality of cost management cannot be underestimated. Companies have to reduce their costs maximally if they are to maintain sustainable profitability levels. However, in a bid to reduce costs, they must recognize and appreciate the role of rewards in employee satisfaction. This must not be interpreted to mean irrational rewards. Rather corporation should evaluate reward systems against market conditions in order to come up with feasible reward policies which act to the benefit of both the corporations and its employees. Corporations must therefore adopt best practices in regarding of its employees without compromising performance.

The recommendation based on this report is summarized below:

  • Effective and efficient merit systems should be put in place to encourage employee retention and attraction. Additionally, these laws should ensure consciousness in performance of legal duties, and also provide incentives..
  • Internal salary systems should be modified to allow attainment of equity.
  • Performance-based merit system incorporates various peer review components where need be. Additionally, such systems should engender the kind, amount and performance quality which would facilitate organization’s achievement of its goals and objectives.
  • A clear connection between employee’s performance and the reward system should be put in place.
  • The appraisal process should be designed to allow employees to constructively comment in a manner that enhances their professional growth.
  • The system’s architecture must stay away from system trivialization as a result of thin spread and minimization of incentives impacts.

In general, each reward systems should cater for the needs of the entire employee’s. The manner and approach to implementation of such systems may or may not put to question the impact of the reward systems adopted by the organization. It is therefore important that policyholders, formulators and implementers all critically evaluate existing literature on the same before drawing conclusions.


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