How to develop a winning compensation strategy
An expertly crafted compensation strategy is essential in attracting, retaining, and motivating top talent within your organisation.
In this blog, we'll guide you through the fundamental components of a successful plan and share best practices to help you develop an approach that truly stands out.
Understanding the Fundamentals
Before diving in headfirst, we need to understand the core, underpinning principles. Gaining a solid understanding of these fundamentals will provide us with a strong foundation upon which to build your compensation strategy.
Compensation philosophy and objectives
Before you begin designing your compensation strategy, it's essential to define your organisation's compensation philosophy. This philosophy should outline the principles and values that guide your compensation decisions and practices, serving as a roadmap for your approach to employee rewards.
Your compensation objectives should align with your overall business goals and values. These objectives may include attracting top talent, driving employee performance, motivating high-performers, and retaining key personnel. By establishing clear compensation objectives, you'll ensure that your compensation strategy is purpose-driven and supports your organisation's mission.
Market positioning and competitiveness
Determining your organisation's position in the market is crucial for developing a competitive compensation strategy. You’ll need to research and analyse market data, industry trends, and competitor practices to understand how your compensation package compares to those offered by similar organisations.
Striking the right balance between internal and external competitiveness ensures that your compensation management remains attractive to potential candidates while also maintaining a fair and consistent pay structure for your existing employees.
Internal and external equity
Ensuring pay equality within your organisation is a critical aspect of your compensation strategy. This involves establishing and maintaining equitable compensation management practices that promote fairness and consistency across job roles, experience levels, and employee demographics.
By focusing on both internal and external pay equity, you'll create a compensation strategy that fosters a positive work environment, reduces the risk of pay-related disputes, and upholds your organisation's reputation as an equitable employer.
Key Components
The next step is to explore key components that form a comprehensive and competitive compensation strategy. By understanding and implementing these elements effectively, you'll be well on your way to creating a winning compensation plan.
Base pay structure
A solid base pay structure is the bedrock of your compensation strategy. It involves crafting a systematic approach to valuing the array of jobs within your organisation, ensuring that every role has a fair and consistent pay rate.
To create this framework, you can employ various job evaluation techniques. You might choose a job ranking method to create a hierarchy of roles, where each position is ranked relative to others based on its importance and value to the organisation.
Alternatively, you could opt for point-factor systems that break down jobs into key components or factors, such as skill level, responsibility, and complexity. Each factor is then assigned a weight or points, and the total score for each job determines its place within the pay structure.
For a more market-driven approach, you could use market pricing, where you gather salary data from comparable companies within your industry and use it as a benchmark for setting your own pay structure. This helps ensure your organisation remains competitive in the talent marketplace.
Once you've completed your job evaluation and determined worth, you can create pay grades and salary ranges that align with your findings. This structure helps maintain internal consistency and external competitiveness, ensuring that people feel valued for their contributions and your organisation attracts and retains the best talent it can.
Mixing it up: Fixed or variable compensation?
To truly engage your employees, you'll need to strike the right balance between fixed salaries and variable rewards.
The perfect blend depends on factors such as:
Company size
Industry
Company culture
Senior leadership’s risk appetite
For example, smaller organisations might allocate a higher percentage of variable compensation to incentivise growth and agility. Meanwhile, larger companies may lean more heavily on fixed salaries to ensure stability and predictability.
Industry dynamics also play a significant role in determining the right balance. Tech-savvy firms often shift the balance towards variable compensation, fostering a culture of innovation and rewarding employees for their creativity and problem-solving abilities.
On the other hand, financial services, utilities, and other heavily regulated industries generally prefer a more stable approach, with a substantial portion of fixed compensation. This approach ensures that people have a secure income while still providing a degree of incentive for performance.
The incentive tightrope: Short-term vs. long-term rewards
Walking the tightrope between short-term and long-term incentives can be a tricky task.
Short-term incentives, such as annual bonuses, are usually cash-based and tied to specific yearly objectives. On the other hand, long-term incentives like stock options or restricted stock units keep employees' eyes on the horizon by rewarding sustained performance over multiple years. So, which do you favour? It really depends on what you’re aiming for.
It’s common to see venture capital backed start-ups boasting significant short-term incentives to drive quick results. Though if they’re cash strapped, they may try to tempt and retain top talent with equity compensation instead.
Companies that prefer slower, more stable growth may alternatively focus on long-term incentives for lasting performance and strategic harmony. But this doesn’t mean they should ignore the ability cash has to grant immediate satisfaction and meet people’s short-term needs.
Benefits and perks
In addition to monetary compensation, offering a tailored range of benefits and perks can significantly enhance your strategy's attractiveness, even with budget constraints or when catering to specific types of workers.
By understanding the needs and preferences of your employees, you can design a benefits package that provides value while staying within your budget.
Health and welfare benefits
Providing basic health coverage or partnering with local wellness providers for discounted services can support your employees' well-being without breaking the bank. Explore cost-effective wellness initiatives, such as virtual fitness classes or mental health support.
Retirement plans
Encourage long-term financial security by offering simple, low-cost retirement savings options, such as a pension scheme with employer-matching contributions or a group Registered Retirement Savings Plan (RRSP) for employees to contribute to voluntarily.
Work-life balance programmes
Demonstrating your organisation's commitment to employee satisfaction doesn't have to be expensive. Consider offering flexible working arrangements, like remote work options or adjustable hours, and implementing reasonable leave policies that cater to your employees' needs.
Professional development opportunities
Boost employee engagement and retention by providing affordable professional development resources. Leverage internal expertise to create mentorship programmes, offer access to online courses, or organise skill-sharing sessions among employees.
Source: 2022 Bionic survey of 1000 UK employees (bionic.co.uk)
Best practices and application
Okay, so we have the foundations and key factors for compensation, but how do we actually apply them? After all, your organisation has unique needs and objectives which might not be met by a one-size-fits-all approach.
Conduct market research and benchmarking
Benchmarking salaries is crucial to attracting top talent and retaining employees. If salaries are not competitive, people can become unsatisfied and start looking elsewhere for better pay.
To effectively benchmark salaries, you need a collection of salary data for the roles you're researching. This information is often available in industry annual reports, like the ones created by our sister company Paydata.
Third-party services are also common for streamlining the process. Crowdsourced tools, such as Glassdoor, Indeed, and Reed, can provide average salaries for specific roles, industries, or skills.
For more in-depth knowledge on salary benchmarking and its benefits, resources such as the Chartered Institute of Personnel and Development (CIPD) offer comprehensive guides on job evaluation and market pricing.
Consider your company culture
Compensation goes beyond pay checks; it's a vital tool for aligning employees' interests with the company's success.
The reality is that compensation affects the entire employee journey. It shapes everything, starting from the moment someone steps into an interview right through to their eventual exit from the company.
As a result, a thoughtful approach to compensation can skyrocket an employer’s brand. One such example is allowing employees to retain vested shares upon departure (except in cases of misconduct or contract breaches), demonstrating appreciation for all past contributions to company goals.
A company-wide commitment to a comprehensive compensation strategy nurtures a positive company culture and allows finance and HR teams to focus on higher-value strategic projects.
By integrating compensation into every aspect of the business, companies can build a healthy, people-centric culture.
Don’t overcomplicate things
You shouldn’t need to whip up a spreadsheet just to calculate your potential earnings.
Remember, people will generally try to modify their behaviour in ways which result in the largest rewards. However, a compensation plan with too many factors can obscure the actions that lead to the best outcomes.
The result? It confuses people, and they ignore the plan.
Instead, they’ll revert to autopilot and stick to their familiar work habits. All your hard work will be undone. With that, the chance to encourage the desired behaviour through your compensation strategy is squandered.
“Perfection is achieved, not when there is nothing more to add, but when there is nothing left to take away.”
— Antoine de Saint-Exupéry
Tailor your strategy to accommodate generational differences
Don't forget to consider the diverse needs and preferences of different generations within your workforce.
Older generations nearing retirement will have different priorities than those at the beginning of their career. The former may value stability enhancing benefits such as reduced schedules, healthcare cover, and pension matching. The latter may instead favour flexibility/autonomy, access to the latest tech, and a workplace that gives them meaning.
So, you need to craft a compensation strategy that caters to the unique requirements of each age group, blending traditional monetary rewards with flexible work arrangements, professional development opportunities, and non-monetary benefits.
By recognising and addressing these differences, you'll create a more inclusive compensation package that resonates with a diverse audience. This will also help build a stable and sustainable workforce in the long term.
Ensure legal compliance and adherence to regulations
It can be easy to get carried away devising the perfect compensation strategy. But remember, it needs to comply with applicable employment laws, regulations, and industry standards.
Companies operating in multiple countries must also be aware of varied local labour laws and regulations, such as minimum wage requirements, overtime rules, and pay equity legislation.
Regularly reviewing and updating your policies allows you to quickly address any changes in the legal landscape and ensure ongoing compliance.
Communicate effectively with employees
Promote understanding, fairness, and consistency in your compensation strategy by being transparent about your pay structure and policies. The worst thing you can do is hide your pay decisions behind a veil of complicated business logic.
Don’t believe us? Just consider these statistics:
Image source: https://officevibe.com/blog/secret-to-discussing-pay-with-employees
All of these problems come down to one issue: poor communication.
Clearly communicating the rationale behind pay decisions allows people to understand how you determine their compensation. So, engaging in open conversations will ensure that employees approach pay discussions with greater understanding and practical expectations.
If you want to read more about how to communicate pay to employees, you can read our full blog on the subject.
Regularly review and update compensation policies
Continuously assess the effectiveness of your compensation strategy and make adjustments as needed. Regularly review and update your policies to reflect changes in your organisation's goals, market conditions, and employee needs.
Measuring Success
All of this planning is not something to just set-and-forget. After all, it’s made up of many changeable parts, and a shift in any of these can affect the dynamics of your strategy.
That’s why it’s essential that you constantly measure and evaluate all these factors to ensure that they remain relevant and effective.
These key performance indications (KPIs) can be split up into two categories: financial and process-based:
Financial KPIs relate directly to the money being spent
Process-based KPIs are more about how strategy is affecting different business processes
“The goal is to turn data into information, and information into insight”
— Previous CEO of Hewlett-Packard, Carly Fiorini
Financial KPIs
Workforce Total Cost
This is made up of all expenses associated with staffing and related costs. Calculations should encompass pay, benefits, HR operating costs, and expenses associated with outsourcing, gig workers, and temporary staff.
Pay Range
Pay range encompasses the minimum and maximum pay for a specific position. This includes the midpoint, which is the average of the two. Understanding the pay range guides you in setting salaries for new hires and considering raises for existing employees, ensuring a systematic approach to compensation.
Compa-Ratio
This ratio compares an employee's salary to the midpoint or the average market rate.
By understanding this metric, you can determine whether your compensation strategy is competitive enough to attract and retain top talent. Another useful metric is salary range penetration, which measures an employee's salary within the total pay range for their position.
Internal Equity
Internal equity measures the pay of individuals in the same role compared to employees in similar positions across the company. By calculating internal equity, you can ensure pay equity, eliminate discriminatory pay practices, and demonstrate fair pay practices within your organisation.
Cost of Employee Turnover
It’s important to track the costs associated with employee turnover, such as recruiting, hiring, and training expenses (as well as lost productivity). High turnover costs may suggest issues with your strategy. From ones that contribute to employee dissatisfaction and departure to others that make it harder to recruit.
Process-Based KPI
Employee Retention Rate
This metric is essential. A high retention rate indicates that people are satisfied with their compensation packages and are likely to stay with the company. Compare your company's retention rate to industry benchmarks to understand how effectively your strategy retains talent.
Employee Satisfaction
As you might have guessed, this measures people’s satisfaction with their compensation package. The standard method gathers data through regular surveys and feedback sessions.
Time to Fill Open Positions
This tracks the average time it takes to fill open positions in your organisation. A shorter time to fill could indicate that your compensation strategy is competitive and appealing to potential candidates, making it easier for your company to hire top talent quickly.
Conclusion
Developing a winning compensation strategy is crucial for the success of any organisation.
A well-crafted and carefully executed strategy helps attract, retain, and motivate top talent, ultimately leading to improved performance and growth for the company.
As you have seen, there are a lot of factors to consider. But, by being mindful of these many faces, you can create a compensation strategy that benefits everyone involved.
Check out our blog for more insights into improving compensation strategy, bonus calculations, and performance review.