How to Create a Compensation Strategy

An empty office.

Inadequate compensation was cited as the main reason employees quit, according to a survey conducted by the Pew Foundation. Poor pay shared the top spot with a lack of opportunities for advancement. But given the other factors that prompted employees to resign, such as dissatisfaction with benefits, it’s a good bet that improving your total compensation strategy can help you avoid the high costs of employee churn, retain top performers, increase productivity, and grow sales.

The Four Components of Compensation

Compensation is often conflated with salary, but there’s more to employee earnings than wages. A successful employee recruitment and retention policy includes the following forms of remuneration:

  • Direct guaranteed: This category includes payroll allocations such as salary or hourly wages, as well as shift differentials and other negotiated expenses and allowances that the employer is obligated to provide to employees and cannot legally curtail without prior notice.
  • Direct variable: These monetary rewards are tied to how well either the individual or the company performs and include sales incentives and annual bonuses.
  • Indirect: Indirect compensation includes employee benefits and perks, ranging from health insurance to free meals, expense accounts, or use of a company car.
  • Equity: These include stock options or other ownership stakes.

Why Do You Need a Compensation Strategy?

If you’re running a small business or startup, it may be tempting to assume you can simply tailor salary offers and raises to the qualifications and performance of each employee. But without a strategy to guide compensation, it can be difficult to scale your business to meet the demands presented by periods of rapid growth.

A well-developed compensation strategy can improve the effectiveness of the following HR and management functions:

  • Talent acquisition: The less you share about your compensation policy during the hiring process the more likely it can seem that you have something to hide. Some states now require employers to share salary ranges in job descriptions, which benefits job seekers and hiring managers, since it promotes pay equity and allows candidates who are seeking a higher starting salary to take themselves out of the running early on.
  • Retention: Fair, easily understood remuneration, aligned with your company and your employees’ values, can augment employee engagement, increase employee tenure, and boost your employer brand. It can also increase the possibility that your employees will talk up your company as a great place to work to their friends and former colleagues.
  • Budgeting: Knowing how much to budget for payroll and benefits from year to year, can help you create effective recruitment and retention plans.

Compensation Best Practices

The best way to attract and retain top talent is to make sure that you offer a competitive compensation package that is appropriate to your industry and geographic area, and to each employee’s position, expertise, and value.

There are a variety of ways to determine your wages and benefits. Regardless of which you choose, to be effective they should embody the following core attributes:

  • Simplicity: Your employee incentive plan should be easily understood by all your employees. An overly complicated strategy is likely to be perceived as overly technical, or even as a cover for an arbitrary system.
  • Clarity: Make the details of your system easily available to employees across a variety of platforms and make it clear that questions about compensation are welcome.
  • Transparency: Millennial and Gen Z workers are more likely than previous generations to share salary information, and more likely to take offense when they learn of significant discrepancies. If they believe your compensation strategy is unfair or arbitrary it could prompt them to start dusting off their resumes.
  • Consistency: Once you’ve established your policy, resist tweaking it too frequently, especially in ways that might reward newer employees in ways that seem unfair to valued long-time employees who may be closing in on significant milestones.

Legal Considerations

Laws affecting wages and benefits are changing fast. As you craft a strategy, check federal, state, and local mandates and consider conferring with an attorney to answer any questions you may have, such as:

  • Do I need to list salary ranges in job postings?
  • Am I prohibited from asking candidates what they made at their last position?
  • Can I prohibit employees from discussing their salaries?

Aligning Compensation With Values

Establishing or revising an organizational compensation strategy requires fact-gathering and reflection to determine whether the benefits, wages, and rewards you provide to your employees align with your:

  • Company culture and employer brand: You can’t claim to be passionate about equity in your mission statement and branding if your pay structure proves otherwise, for example.
  • Organizational strategy: Compensation is an integral part of your company strategy. Make sure any changes you make are in service of recruiting and retaining the talent you need for your business to be successful.
  • Industry norms: Conduct stay and exit interviews and ask about counter-offers to determine what your competitors are offering. You can also use a salary tool to determine median incomes according to job title and location.

Types of Compensation Strategies

Now that you’ve done the preliminary work of considering your company values and researching your sector, it’s time to select the strategy that aligns best with your brand and long-term goals.

Ranked Compensation

In this strategy, employers award raises based on ranked appraisals that require managers to identify top performers, adequate performers, and struggling employees. A small percentage of top performers earn significant raises, those in the middle earn modest rewards, and poor performers receive no raise or are even counseled to leave the organization.

This is an outdated model that today’s workers are not likely to tolerate for long, nor does it encourage workplace values that data shows improve performance, such as teamwork, trust in management, or diversity, equity, and inclusion (DEI). Younger workers are especially unlikely to remain in an environment that deemphasizes collaboration and encourages this level of intense competition among coworkers.

Formulaic vs. Discretionary

The era of the discretionary—or subjective—compensation strategy may be at an end. Because millennial and especially Gen Z workers are far more likely than older cohorts to compare salaries, and they are more likely to complain or quit if they learn they are making less than their coworkers for the same job. It’s beneficial to use a formula that takes position, location, and tenure into consideration.

Leading, Meeting, or Lagging

Once you’ve researched salary and benefits trends in your industry, you can use this knowledge to decide whether you want to undercut, match, or lead your sector in compensation.

Matching or leading will tend to help you attract and keep top talent. If you decide to offer lagging compensation packages, you can try to make up for it with cost-effective perks, but you may also want to attract talent through other means, such as offering a remote or hybrid schedule or unlimited paid time off (PTO).

If you opt for a matching or lagging strategy you can strengthen employee engagement by providing smaller but more frequent raises and tying them to the market performance that you share frequently and in detail across the organization.

Paying for the Person, Position, or Performance

Sometimes referred to as the 3Ps, this strategy requires managers to consider their needs and set their compensation priorities accordingly.

  • Paying for the Person: This is most likely to occur at the C-suite level, where an individual with a well-known reputation can signal a change in direction or investment in excellence.
  • Paying for the Position: You might need to reward employees based on position in industries where workers with certain expertise are at a premium. For example, a healthcare organization in desperate need of nurses may need to offer a comparatively high salary for anyone who meets your minimum job requirements to maintain safe staffing levels.
  • Pay for performance: This structure is more likely to be used to reward and incentivize top performers who are already on your payroll. Performance-focused compensation tends to lean more heavily on incentives and bonuses, which can be based on productivity, sales, innovation, or the completion of a large project. On an organizational level, this might mean tying raises to company performance.

Learn How to Make Your Newly Developed Compensation Strategy Pay Off

Now that you know how to craft an effective compensation strategy, learn about more management best practices with Monster’s latest hiring news and expert how-tos.

Legal disclaimer: None of the information provided herein constitutes legal advice on behalf of Monster.