Total Cost to Company – Benefits and pitfalls

Total Cost to Company – Benefits and pitfalls

Business, Human Resources, Legislation, Payroll / eTorQue, Tax

Moving to a cost to company arrangement is beneficial for both the employer (much clearer employment costs) and employee (more flexibility to choose what they prefer). Feel free to contact us for advice on how to set this up and manage the internal communication process.

Editor: The cost to company remuneration basis is a great methodology to get the right balance between employer and employee decisions in managing remuneration. It makes employees far more aware about the components of their remuneration and the impact it has on their take home pay.

The ‘total cost to company’ basis of remuneration (otherwise known as CTC), whilst not a new concept, is taking hold in South Africa. Initially only bigger companies used this approach to remunerate staff but over the past 5 years I have noticed that its use had spread to most companies who operate recognised payroll systems. The question that is often asked is ‘why is the approach being used and what benefits does it create for both employer and employee?’

In my experience companies invariably convert to this basis of remuneration to gain control of the costs of employment.

  1. In the past employers negotiated salaries with employees and only concentrated on the actual cash benefits payable to employees. Benefits such as medical aid and retirement fund contributions were not considered. If you analyse the cost of these benefits you would notice that they make up a significant portion of employees’ total cost of employment. Benefits therefore must be considered on an equal footing with the cash salary paid to employees. The ‘total cost of employment’ concept is therefore the logical answer to this remuneration issue.
  2. Legislative changes can result in increased costs for employers. These changes however are seldom accompanied by a decrease in the increases expected by employees annually. A cost to company approach allows employers to better manage overall employment cost increases.

Another common question asked by employers is “how do I determine what an employee’s total cost of employment is?” The answer is very simple. Add the employee’s cash salary (basic pay plus allowances) to the company’s contributions to the employee’s benefit funds.

Let’s look at an example:

Employee A receives a monthly basic salary of R 15 000, a travel allowance of R 5 000 and the company contributes 7% of the employee’s basic salary to a provident fund and R 1 000 per month to a medical aid. The employee’s total cost to company is therefore:

Basic pay: R 15 000
Travel allowance: R 5 000
Provident fund: R 1 050 (R 15 000 x 7%)
Medical aid: R 1 000
Total cost to company: R 22 050

Using this approach, employers will always know what an employee is costing them. The advantages to the employer is that they now have a basis on which to work from when allocating employees annual increases and bonuses.

Employees on the other hand often fail to see the fact that benefits paid by employers are also salary costs. They are also suspicious of changes to their pay structures, thinking that their employer is trying to rob them. It is important that these concerns are addressed before there is unnecessary industrial action. For the more informed employees though the CTC approach offers flexibility when negotiating salary increases. The employee is able to choose the salary components that best suit their immediate needs. Salary increases can be channeled, subject to the company’s policies, into components that they choose. This flexibility has however been significantly reduced by the amendment of employee tax legislation over the past few years.

As an incentive to look at the possible conversion to a CTC approach it may be a good idea to look at a topical example which many employers are currently faced with, the high annual medical aid premium increases.

Employers who have traditionally paid contributions on behalf of employees have been hard hit by these cost increases. In many cases employers have had to absorb at least a 16% increase in medical aid premiums as well as granting employees inflation linked annual increases. The only way of controlling these costs is to use the CTC approach to remuneration. At the time of granting annual increases the employer agrees a total cost to company figure with their employees. When medical aid increases are announced the employee would be faced with a problem. As the CTC cannot change the employee would have to take a cut in cash salary to absorb the medical aid increase. This forces most employees to take a good hard look at their medical aid requirements. Many employees have downgraded their medical aid schemes to better suit their needs whilst at the same time maintaining an adequate cash salary. There is still however a belief that some companies have adopted the CTC approach in order to pull the wool over employees eyes and have changed conditions of service without adequately explaining the total cost concept to the employees.

The use of the ‘cost to company’ concept is gaining momentum. This fact is clearly evident if you page through the ’employment’ section of your local newspaper. Employers want to know what employees are costing them and also seek solace in comparing the salaries that they pay with those reflected in newspapers. The concept is here to stay and I believe that more employers will begin to use this method of remuneration in an attempt to gain consistency in terms of pay structures in the market place. It is imperative though that there is extensive consultation with all employees before implementing the CTC concept as a remuneration practice. This consultation must allow the employees to ask questions and work through examples. It is therefore important that the correct process is followed and that an experienced legislative compliance specialist is used.