Best Practices in HR

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G&A Partners
  July 20, 2016

Developing A Compensation Strategy

While many employers keep the focus of their recruiting conversations on their company’s culture, at the end of the day a lot of employment decisions (on both the employer and candidate sides) are driven by compensation.

That’s why having a compensation strategy is essential for employers looking to recruit top talent. This is especially true for companies who are looking to fill positions that require a high level of expertise, or those recruiting for brand-new positions within their organizations. Defining a compensation strategy allows employers to assess whether the compensation package their company offers for given positions is on-par with the “going rate” for similar positions, and to understand when/if adjustments to their compensation strategy are in order.

What is compensation?

Before delving into the different types of compensation strategies, it’s important to know exactly what “compensation” means. While many people think compensation just refers to the hourly rate or salary an employee earns (i.e. what an employee “makes”), it actually encompasses much more than that. An employee’s total compensation is essentially everything an employer provides to an employee in exchange for their work, above and beyond their base salary.

Included in the calculation of an employee’s total compensation is:

  • Base salary (either paid at an hourly wage rate plus overtime for non-exempt employees, or as an annual salary for exempt employees)
  • Employee health benefits
  • Raises, bonuses and other forms of variable pay
  • 401(k) contributions and other retirement plan contributions
  • Employee perks (gym membership reimbursements, on-site childcare, etc.)

Compiling and calculating the value of these elements to create a compelling compensation package is a challenging undertaking best reserved for HR professionals who find actuary tables and calculus formulas fascinating. Business owners and managers need not be compensation experts, but they should understand the various pay components and be aware of the most recent trends in the area of compensation.

Related reading: Exempt vs. non-exempt employees: What’s the difference?

Types of compensation strategies

Generally speaking, a company’s compensation strategy or policy can be defined as either leading, lagging, or meeting the market. Employers with more aggressive recruiting strategies might choose to have a leading compensation policy that offers above the “going rate” for a given position. Alternatively, employers might find that their pay levels are slightly below the industry or position-level average, and would be categorized as a lagging pay strategy. Employers who stick to offering compensation that is on par with the going rate for positions are those whose compensation strategies are focused on meeting the market.

Compensation strategies do not necessarily have to be the same across all levels or departments of an organization. An employer may decide that it wants to lead the market in compensation for one category of jobs/positions in order to be more competitive or recruit top talent, but decide that a pay policy that meets the market for a different job family is appropriate. Employers should be wary about having significant disparities in compensation between like positions however, as that could lead to claims of compensation discrimination.

Related reading: What is compensation discrimination?

Evaluating compensation

When it comes to determining the appropriate compensation for a given position, employers should start by analyzing the duties of the position and the qualifications necessary to perform the job.

(All of this information should be found within the job description for the position. If there isn’t currently a job description available for the position, employers should stop this process and create the job description.)

It’s then helpful to understand what the average compensation is for employees in similar positions at companies in the same industry and geographic market as the employer looking to fill the open position. Employers can find this out by conducting a salary survey, which gathers compensation data from external sources and gives employers a better understanding of how the compensation their company offers stacks up against the compensation offered by other companies.

But knowing the local industry average for a given position isn’t necessarily enough to determine appropriate compensation. Many employers are choosing to determine compensation on a “person-based” methodology, taking into account things like an employee’s knowledge, skills and competencies. This strategy certainly has its appeal, as it lends itself to rewarding and promoting continuous employee development and individual performance. It also provides employers with a bit of flexibility when making decisions on compensation, but may not work for all employers.

The use of variable pay as a differentiator

Variable compensation programs, which often include things like performance bonuses, company-paid trips, stock options, raises, and other perks, provide companies a powerful and adaptable means to recognize employees for their contributions to an organization’s goals.  Variable pay also often offers employers a way to differentiate themselves from other employers during the recruiting process. Variable pay is usually linked to some sort of metric – company performance is a popular metric used to determine variable pay, but really any metric that is important to the company and its stakeholders, such as individual performance or productivity, team productivity or client retention, could be used here.

Employers have a lot of flexibility in creating variable pay strategies and plans, including individual-based variable pay plans (i.e. merit pay increases); team-based variable pay plans (i.e. cash bonuses at the conclusion of a project); and company-side variable pay plans (i.e. profit sharing).