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How to design a compensation strategy and plan

By Higginbotham on February 10 , 2021

Compensation plan

Compensation plans, also referred to as total compensation plans or compensation programs, encompass all of the compensatory components of a company's strategy. In addition to salary, compensation can include health benefits, retirement benefits, tuition reimbursement, bonuses or any other non-salary benefit that is considered part of a total compensation package.

The Two Types of Compensation

There are two types of compensation: direct and indirect. Direct compensation pertains to monetary benefits, such as salary (for exempt employees), an hourly wage (for non-exempt employees), commission and bonus pay.

Indirect compensation is considered the “benefits” of a compensation plan. Indirect compensation includes medical, dental, vision and/or life insurance, short- and long-term disability and employee retirement programs like 401(k) plans.

Other examples of indirect compensation can include paid time off, education benefits, flexible work hours, company car, career development, referral bonuses, additional retirement benefits and more.

Direct compensation is earned in return for work performed. Indirect compensation is the added benefits that contribute to your organization’s company culture and enable you to attract and retain qualified candidates and loyal, productive employees. A good compensation plan encompasses a blend of direct and indirect compensation.

What is a compensation strategy?

According to the Society for Human Resources Management (SHRM), a well-designed compensation plan supports the organization's strategic plan and initiatives, business goals, competitive outlook, operating objectives and compensation and total reward strategies. This is also known as a compensation philosophy. As such, most compensation plans are designed to follow basic tenets:

  • To identify the organization's pay programs and total reward strategies
  • To identify how the pay programs and strategies support the organization's business strategy, competitive outlook, operating objectives and human capital needs
  • To attract people to join the organization
  • To motivate employees to perform at the best of their competencies, abilities and skill sets
  • To retain key talent and reward high-performing employees
  • To define the competitive market position of the organization in relation to base pay, incentive compensation and benefits opportunities
  • To define how the organization plans to pay and reward competitively, based on business conditions, competition and ability to pay

Why do companies need a strategic approach to their compensation program?

Compensation programs are the catalyst for attracting and retaining employees. According to PayScale’s 2020 Compensation Best Practices Report, more organizations are working toward building "an employer brand, which includes a more strategic approach to compensation and career pathing as well as better benefits and more varied and incentivizing ways to reward performance."

What are the steps to creating a compensation strategy?

Look at Your Company’s Goals

The first step in creating a compensation strategy is to look at your own company’s mission, values and vision. What is most important to your company? Are you looking for immediate profitability, or are you wanting to focus on the future and start building a strong employee base to grow ever time? Are you actively recruiting to attract and retain the best talent? This could determine how you position benefits, such as pay incentives and retirement plans.

Knowing your company’s goals is also important when creating employee incentive plans or bonus plans. Do you want to tie incentives to new business acquired, such as a sales commission? Or do you want incentives to reflect the company’s growth, like a yearly bonus based on profitability?

Do Research – Externally

SHRM suggests purchasing a salary survey from a survey organization or commissioning a customized salary survey through a reputable consulting company or trade organization. You can also use data from the Bureau of Labor Statistics. Reviewing data from salary surveys will give you a good benchmark as you work to create your own company strategy.

Check Out Your Competitors

Find out what companies in similar industries, structure and number of employees offer. Other than purchasing data, you can research sites like Glassdoor and LinkedIn for general information. These are also good resources to gauge employee expectations and employee engagement based on employee reviews.

Perform Salary Audits

Markets change; therefore, it is important to perform routine salary audits to ensure salary ranges reflect current compensation trends in a particular industry.

When performing an audit, the goal is to determine how competitive those particular jobs are and what the external market is demanding.

Review the Laws

It’s important to ensure your compensation plans are in compliance with state, federal and employment laws as well as the Equal Employment Opportunity Commission (EEOC). In addition, ensure that it is in line with company policies and fair to employees across the board.

Do Research – Internally

Once you’ve researched the market to determine a benchmark, now it’s time to look inward at how your company currently looks and what’s offered.

Take a Look at Job Positions and Job Descriptions

Are they in line with other titles and responsibilities within your industry as far as titles, job responsibilities and qualifications? How often are they updated? Do employees have a voice in the job descriptions?

Review Your Current Compensation Package

Has your compensation program been structured the same for years? What are some of the pros and cons of your current program? Have you ever solicited employee input via surveys or other feedback to determine what’s important to them in a compensation plan? Is your current plan effective to attract and retain employees?

Determine the Budget

How does the cost of your compensation package align with the overall company budget? If your company has a tendency to experience regular down times, an overly ambitious compensation package may come back to bite you. Start within your means; you can always add a benefit later.

Develop Pay Structures

Pay structures include determining job grades as well as salary ranges. Job grades allow employers the flexibility and a framework to ensure equivalent jobs are paid equally. They also show employees a pathway to advancement.

Pay ranges are just that – the range minimums and maximums for each job. Pay ranges give employers the flexibility to support experience, performance and career growth.

Explore Total Rewards

Many organizations are turning to positioning their compensation packages as total rewards. Total rewards encompass not only base pay, but benefits such as stock options, health insurance, dental and vision benefits, retirement contributions, life insurance, paid time off, etc. They can also include perks like performance bonuses, company-sponsored training, employee wellness programs, workplace flexibility options, identity theft protection plans, employee discount programs – things not usually included in compensation or benefits discussions.

Total rewards programs have been proven to be an attractive recruitment tool in addition to going a long way toward attracting and retaining employees. In addition, total rewards have been linked to an increase in overall employee performance and satisfaction.

Ensure You Have Management Buy-In

Once you develop the compensation plan, make sure you have acceptance from leadership. According to PayScale’s Compensation Best Practices Report, it’s important to convey to them how your plan ties closely to your business priorities, how increases (or decreases) to payroll will affect the bottom line and the costs of not having a compensation plan in place.

Important Factors to Remember

Make Sure the Compensation Plan Unifies Rather Than Divides Employees

If your compensation program isn’t fair and equitable, you’ll find yourself with disgruntled employees who will either cast a negative tone within your organization or ultimately leave. While you’ll always have employees who disagree, ensuring your compensation plan meets, if not exceeds, industry standards will go a long way toward employee satisfaction, better performance and reduced turnover.

Communicate It Properly and Keep Employees In the Loop

Employees should be kept informed about changes or updates to your company compensation plan – and transparency is key. Use multiple methods to communicate the program to employees, including organizational charts, internal emails, intranet, in-person discussions or webinars with the human resources department, posted information throughout the company, etc. Also consider keeping a running list of FAQs that you can add to over time.

Ensure employees have a point of contact or method of asking questions, whether that is about the overall package or a specific question related to them. Conduct periodic surveys to gain feedback from employees for future modifications to the compensation plan. Finally, be sure to have detailed materials available for recruiting and onboarding.

Designing a compensation strategy and subsequent plan can be a long process. It's important to employ human resources professionals who have experience in compensation planning and ensure they have the time, budget and resources to gather the information necessary to construct an employee compensation plan that will enable you to be a competitive organization in your industry and attract and retain the best talent. Contact our HR Services team for more information.

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