Salaries 101: Creating Your Company’s Compensation Plan
Learn how to create an effective and fair compensation plan for your company by following these 8 essential steps.
The business of employment is ever-changing. The labor market is constantly shifting, workplace laws are always evolving, and business needs are always in a state of flux. Still, some things have remained constant, such as the value of compensation. Compensation plays a significant role in securing qualified candidates, keeping top-performers on board, and helping employers remain competitive in the talent marketplace. However, to achieve these outcomes, you need a well-built compensation plan. In this article, we show you how to develop one.
We cover the following:
- What is a compensation plan?
- The 2 types of compensation
- 8 Steps to building your compensation plan
- Specialized compensation plans
- What if you don’t have enough money?
What is a compensation plan?
A compensation plan is a formal (written) document describing the company’s position on total rewards provided to employees for services rendered. The plan addresses:
- Who (i.e., which employees) is compensated
- What types of compensation are supplied (e.g., salaries, benefits, bonuses)
- Why the compensation is offered (e.g., standard pay package, employee incentive)
- How much (i.e., the amount of compensation)
- How often (i.e., the frequency of the compensation)
A strong compensation plan helps you retain and attract qualified talent, ultimately allowing you to achieve your business goals.
As explained by the Society for Human Resource Management (SHRM), a strong compensation plan:
- Supports your business strategy and your operational and workforce needs
- Keeps you competitive within your industry
- Attracts qualified talent
- Motivates employees to perform at their best
- Retains high-performing employees
- Helps define your competitive market position in terms of pay, incentives, and benefits
- Helps you establish a total rewards plan based on your ability to pay, competition, and business conditions
Before you start developing your compensation plan, make sure you understand the different types of compensation. There are 2 types: direct and indirect.
Direct compensation refers to salaries/wages paid by employers to employees for work performed. It is monetary — such as base pay, variable pay, and differential pay.
This is the employee’s hourly rate or an annual salary, without additional pay like overtime or incentives. It’s the foundational amount that you offer new hires. Generally, this amount increases or decreases over time, based on the employee’s performance.
According to SHRM, base pay is a solid indicator of your company’s value on an employee’s role and contributions. Moreover, “For base pay rates to be effective, both the organization and employees must view them as being internally equitable, externally competitive, affordable and cost-effective, legal and defensible, understandable, and appropriate for the organization and for the workforce.”
Per SHRM, more and more organizations are offering variable pay based on performance or results achieved. Variable pay is incentive-driven. It can take the form of short-term incentives, such as:
- Commission plans
- Profit-sharing plans
- Cash recognition awards
Or it can take the form of long-term incentives, such as stock-based plans. Some jobs are a mixture of base and variable pay, such as salespeople who receive salary plus commissions.
Also called “premium pay,” differential pay is extra wages paid to employees for working undesirable shifts (e.g., nights or weekends) or for working under adverse conditions (such as unusually cold weather). Differential pay is typical in the manufacturing industry.
Indirect compensation refers to the benefits an employer offers its employees, whether voluntarily or mandatorily, and includes:
- Health insurance
- Retirement plan
- Paid time off
- Paid holidays
- Flexible spending accounts
- Health savings account
- Educational assistance
- Disability insurance
- Life insurance
- Supplemental insurance
- Discount programs
- Learning and development programs
- Employer assistance program
- Wellness benefits
- Company-provided equipment or vehicle
Now that you have an idea of what constitutes “compensation,” let’s move on to creating your compensation plan.
8 steps to building your compensation plan
1. Define your underlying compensation philosophy
A compensation philosophy is a formal statement that explains your moral position on pay and benefits and provides a framework for consistency. It helps guide your principles about how you dole money out and what compensation stands for at your company.
Compensation shouldn’t be based on age, gender, race, or religion — it should be based on merit, tenure, skillset, and geographic area.
Your compensation philosophy will be unique to your company. That said, best practice dictates adopting a Fair Pay philosophy. Fair Pay believes one’s pay should match their merits, tenure, and skillsets. It remains unbiased by age, gender, race, religion, or other protected categories and stays competitive with other similar roles in similar geographic areas.
In other words, it’s about paying people the appropriate rate for the work that they’re doing and the experience they bring. Studies show employees feel happiest in their roles when they are paid equitably. Fair pay also ensures compliance with equal pay laws.
2. Know what you want to achieve
This helps you figure out what type of skills you need to have on staff and how to prioritize various hires. It also helps inform incentive strategies to drive intended outcomes among current employees.
For example, if you need to plug talent gaps, you may take the following steps:
- Write down your business goals.
- Rank the goals based on priority. What objectives must you achieve vs. those you’d like to achieve?
- Define what’s/who’s needed to achieve those goals. Who are the people, and what skills and experience levels are required to achieve the goals?
- Document your “people gaps.” Wherever you’re missing talent, record the gap — you must write out where your business is missing key hires. This demonstrates your ability to anticipate human capital needs, plus buffers the People Ops team from finger-pointing when key business goals are missed.
- Devise a compensation strategy for each gap. You can utilize compensation benchmarking tools to inform your talent costs. Also, you may want to offer higher rates for more urgent roles.
- Share your results with your leadership team. Once you’ve defined your talent gaps and estimated the costs to fill them, the final step is to make strategic recommendations on filling the roles. This could be a change to roles and responsibilities internally or a plan to attract, recruit, and hire new people.
3. Conduct a job analysis for all positions in your company
A job analysis gives you the knowledge you need to set appropriate pay ranges for each position. The analysis involves carefully observing the role to determine:
- Its duties and responsibilities
- Its importance compared to other positions
- The qualifications needed to execute the role
- The working conditions for performing the job
4. Obtain pay rates for all positions, and develop pay ranges
You’ll need to understand going rates for all roles, including open positions. You can try reaching out to your personal network: friends, colleagues, mentors, etc. What have they been seeing as going rates for specific roles? What can their experience share? This may be the quickest way to get ballpark numbers. But, it may also be subject to bias. And while you can get free salary information from the U.S. Bureau of Labor Statistics, you will need to dig further for more meaningful data.
A more reliable solution is to leverage compensation benchmarking tools like Indeed, Glassdoor, Salary.com, LinkedIn Salary, or Zenefits. Salary benchmarking tools offer actual — and real-time — salary data for specific jobs in specific geographic regions. In addition, they can provide median wages and salary ranges based on quartile, and they can estimate salary changes that project whether demand for the role will increase or decrease.
5. Decide which benefits to offer
This decision of which benefits to provide as part of your compensation plan is driven by several variables, including:
- Full-time or part-time employment
- Exempt versus non-exempt employees
- What benefits your competitors are offering
- Which benefits you’re legally required to offer
- The benefit needs of your workforce
- What benefits you can afford to provide
An excellent place to start is The Zenefits 2021 Benefits Benchmark Report.
6. Do not overlook the power of incentives as part of your compensation plan
Incentives are the perks (typically monetary, but not always) used to motivate existing employees — such as bonuses, company stocks, paid holidays, and gifts or vouchers. They should tie as close to performance as possible. Note that employers who leverage strong incentives see an increase in:
Poor incentives fail to motivate staff and put your company at risk of turnover.
A soundly-constructed incentive plan covers:
- The target employees (for incentivization)
- The requirements for earning an incentive
- The rewards employees should expect
- The timing for such rewards
Your incentive plan should:
- Support efforts that move the business closer to its goals
- Be clear and achievable by all, and NOT favor any particular subgroup
- Make sense fiscally and infrastructurally
7. Stay in tune with your budget
Your budget gives you a sense of how many people and what level of experience you can afford to hire. It also helps inform current employees’ raises, promotions, and compensation adjustments.
Your budget helps define:
- The total number of people you can afford to put on your payroll
- The extent of and types of incentive strategies you can use
- Salary ranges for various positions
- The mix of total compensation (salary, benefits, and perks) you can provide to each worker
- The combination of worker types that are best to keep (contract, full time, part-time, etc.)
8. Take applicable laws into account
Consider the federal, state, and local laws relevant to your business when drafting your compensation plan. Some of the most common compensation-related laws include the following:
- Title VII of the Civil Rights Act
- Americans with Disabilities Act (ADA)
- Age Discrimination in Employment Act (ADEA)
- Fair Labor Standards Act (FLSA)
- Equal Pay Act (EPA)
- Affordable Care Act (ACA)
- Employee Retirement Income Security Act (ERISA)
- Family and Medical Leave Act (FMLA)
- State and local wage and benefits laws
Specialized compensation plans
Depending on how your business is structured, you may need to create specialized compensation plans, such as for executives and salespeople.
Considerations for executive compensation plans:
- The organization’s long-term and short-term goals
- What your direct compensation will be, typically based on industry, organization size, and sales revenue
- Annual incentives and bonuses, typically based on executive performance and a percentage of profits
- Long-term incentives typically offered to select leaders who directly influence organizational performance and success
- Incentive stock options and restricted stock grants
- Special benefits and perks, such as supplemental health and welfare benefits, nonqualified retirement plan, and company-provided vehicle
Considerations for sales compensation plans:
- Salary and commission, or only commission — what will you offer?
- Will the plan consist of salary and incentive, or only salary?
- Will incentive earnings be allocated as a dollar amount or a percentage of base pay or sales generated?
- Does the plan meet your entire organizational needs and your budget?
- Does the plan facilitate ongoing corporate growth and increased profits?
What if you don’t have enough money for your compensation plan?
Don’t panic if you can’t afford top dollar (or even median rates) for critical positions. This doesn’t necessarily mean you won’t be able to hire top talent or keep star employees. It just means you need to get more creative.
For example, although smaller businesses usually don’t have big pockets, they have the strategic advantage of being more agile than large corporations. They can be more flexible in the ways they incentivize work from both monetary and non-monetary standpoints. Financial perks (like performance-based bonuses, profit sharing, or earning equity in the company) and non-monetary perks (like flexible work hours or career opportunities) can be value-adds for employees.
Lean into that flexibility and develop a total compensation package that delivers real value to your ideal workers. To define its value, you can even allocate a dollar amount to each non-monetary perk.
See Zenefits’ People Operations’ Guide to Compensation for further insight into constructing your compensation plan.