Few business leaders are immune to the anxiety and discomfort that go along with discussions of compensation. What we hear:
- “They think the bonus is a guaranteed part of their pay. It’s entitlement!”
- “They expect to be gifted equity for time served.”
- “They brought me an internet search that indicated they were 50% underpaid. That can’t be right.”
- “I hate it when they ask for more money.”
- “I’ve got people who’ve been around for a long time that are probably overpaid, and some new energetic hires that should be making more, but I can’t afford it.”
It’s no wonder business leaders become defensive when the topic turns to compensation. But it doesn’t have to be this hard.
Research by Payscale found that only 20% of people fully understand how their employer decides their pay. This statistic doesn’t surprise us as we’ve seen enough leaders that give increases only when asked, pay family members higher salaries for lower performance, or hand out bonuses on a whim. Even with the best of intentions, these “perks” can create a lot of blow back from those that didn’t receive them…even when they were well deserved by the recipients.
What we’ve found is that people work to make money. Not all the money, but enough to meet their standard of living and keep them feeling safe. The pay philosophy “you get what you get and you don’t get upset” may have worked in the past (maybe) but the access to information today makes it a dangerous one.
Strong compensation plans are perceived as fair by the employees when looked at from two perspectives:
- Are they being paid fairly relative to similar positions outside your firm (external competitiveness)?
- Are they being paid fairly relative to similar positions within the company (internal alignment)?
Reduce the anxiety of all parties around compensation and improve employee satisfaction by taking these six steps to building a formal compensation plan for your organization.
Six Steps to Building a Formal Compensation Plan
Step 1: Develop a Pay Philosophy
A pay philosophy outlines the guidelines a company has decided to follow on compensation. The philosophy explains what they’re willing to pay for and why they’ve made these decisions.
Some helpful questions to consider when developing a pay philosophy are:
- How do we define value creation? In other words, what value is being created by the people that work in the business rather than just the shareholder capital already at work?
- Will we pay below, at, or above market levels?
- Do we want to pay more with fewer benefits or less with greater benefits?
- How much compensation should be fixed and how much variable?
- What combination of company vs. individual performance should make up the variable component?
- How can people make more money? In other words, how much is based on an individual with superior performance earning a larger slice vs. team performance to grow the entire pie?
- How will we address merit vs. cost of living increases?
- Will owners / leaders / family adhere to the same compensation plan as employees?
Step 2: Evaluate the Market
It is often external competitiveness that leads to misalignment internally. The organization is competing for talent in the open market. Other organizations are competing for people with similar knowledge, skills, and abilities across multiple industries. It’s important to understand who the company’s competitors for talent are (not just within the industry) and how they are compensating their staff.
A detailed job description with the qualifications, duties (things the employee does), and performance metrics (results those duties will produce) allows a company to search for true comparables. The simplest way to then gather the competitive compensation information is by asking business leaders in your network how they are compensating similar roles. Some companies will give the same title to vastly different jobs so refer to the job descriptions to make sure you are talking about the same types of positions. In some industries, competitive salary benchmarks can be bought. In other circumstances, using indeed.ca’s salary calculator or just a Google search on salary surveys for your industry can work. Keep in mind that these competitive benchmarks are often not apples-to-apples comparisons.
Also note that the leaders in most companies think of their companies as performing in the top 25% of their competitors and therefore conclude that they should position their compensation above industry average. Of course, only 25% of companies are actually performing in the top quartile. Make sure to use objective criteria such as market share or profit when figuring out the company’s positioning in the market, rather than simply a sense of corporate pride.
Step 3: Draft a Compensation Plan
With this information in mind, draft out a reasonable salary or hourly pay band for each level of authority on the organization chart. Companies will typically have about a 150% spread within the bands. For example, a Supervisory band might have a range of $30/hr – $45/hr or $60,000 to $90,000 per year.
Often there will also be a variable part to the compensation package – a bonus structure that outlines more compensation when certain goals are reached. This can further align the employee with the company’s goals; however, research has proven that these kinds of incentives can actually have the opposite of their intended effect. This is particularly true in the case of knowledge workers where job duties can be nebulous and where creativity is an important part of the role. For these types of roles, learning and development opportunities as well as demonstrated career progression can have a more motivating effect. For more information on variable compensation see our upcoming article on Incentive Plans.
Step 4: Internal Alignment
In terms of internal alignment – when first implementing a compensation structure you need to discover whether similar contributors are compensated at similar rates. In small business, without a regular and formal system of review, compensation can become misaligned. For example, in a time of market expansion, the need for talent may see managers offering high compensation to candidates to entice them into a job where longer standing employees (particularly those that haven’t asked for raises) are being paid at a lower rate. In times of contraction or recession, the opposite may also be true.
Step 5: Implementation and Feedback
Compensation is ideally reviewed for everyone at the same time, two or three months after the close of the fiscal year. Once the philosophy and structure have been set this annual review compared to the company’s budget and the market should be sufficient to maintain internal alignment.
While compensation reviews should be decoupled from performance evaluation, within the pay band, the annual compensation review should see the top performers earning at the higher end of the band, and lower performers at the lower end. A 0-5% annual raise is typical for most companies, and employees rarely get more than a 10% raise in one year.
Step 6: Final check
Following these steps should develop a comprehensive compensation strategy. As a final check, ensure your plan meets the following criteria:
- Simple and easy to understand.
- Aligns employee, client, and owner interests.
- Will be perceived as fair by the employees (they will eventually learn what comparable positions earn both inside and outside of your company if you haven’t already told them)
One goal may be to achieve radical transparency when it comes to compensation – allowing all employees to understand both the job descriptions and compensation bands for all positions. If they have all the information the rumour mill is destroyed and energy can be redirected toward more important initiatives.
This article tackles the topic of compensation – the cash money in your pocket, typically made up of base pay and bonus. Total compensation includes benefits, such as insurance benefits or a company vehicle. These two factors together keep employees from being dissatisfied with their job, but it is the learning and development opportunities, flexibility, and general culture of an organization that actually motivate. Total reward is therefore a more helpful term when considering how companies motivate their employees. Compensation gets the employees in the door and keeps them. Total reward allows them to thrive. This article focuses only on the compensation side of the equation.
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