What is a Compensation Strategy?

A compensation strategy is a framework that defines how a business will compensate its employees, encompassing salaries, wages, bonuses, and benefits. This approach aims to align with the company’s broader objectives, market standards, and legal obligations and to effectively motivate and retain staff.

Why Do You Need a Compensation Strategy?

A well-planned compensation strategy:

• Attracts and retains talent. A competitive compensation strategy is essential to setting your organization apart from competitors and reducing the risk of employees leaving to work for a competitor. 
• Helps you execute your business strategy. Your strategy complements and supports the objectives of your business strategy. It should also align with your compensation philosophy and company culture. 
• Is essential for budgeting. Compensation is a significant expense for an organization. A clear compensation strategy allows you to budget for it and ensures you can compensate employees as promised. 
• Ensures pay equity. Pay equity is a legal requirement in many situations. Beyond this, a transparent pay strategy reassures employees that pay is determined fairly and objectively, improving employee happiness and performance. 

Types of Compensation Strategies

Compensation strategies are often guided by an organization’s decision to meet, lead, or lag the market.

• Meeting the market: With this strategy, a businesss offers the same compensation as its competitors. While this is generally a competitive strategy, there is a risk employees may leave the organization for higher-paying roles.
• Leading the market: If an organization intends to lead the market, they offer higher compensation than the market does for similar positions in the same industry. Suitable for competitive labor markets and attracting top talent, an organization must have the necessary financial resources to fund this approach.
• Lagging the market: Some organizations choose to lag behind the market and pay less than their competitors, typically due to financial constraints. While this approach saves the employer money, it can make it difficult to attract and retain talent. To counteract this, organizations often offer other non-financial rewards to their employees.

What to Include in a Compensation Strategy

Base pay

Your compensation strategy should address employees’ base pay, explaining how it’s calculated. Some organizations classify positions and set pay bands according to job classification. Others set a fixed base pay rate for individual positions that increases with years of service. 

Additional pay

Your strategy should also address any additional or performance-based compensation. This includes how bonuses or commissions are structured and who is entitled to them. For example, bonuses may be given to all employees when the organization achieves a certain level of profit, calculated as a percentage of an employee’s base pay. 

Benefits

Finally, your compensation strategy should set out any additional benefits you offer employees and their eligibility criteria. This may include health insurance, stock options, equity packages, and PTO. For example, employees may be entitled to two weeks of paid vacation leave after working with the organization for six months. 

How to Design a Compensation Strategy

Here are several factors to consider when designing or updating your business’ compensation strategy:

1. Align it with your compensation philosophy, business strategy, and organizational goals. Consider how your compensation strategy can support objectives such as pay equality, attracting top talent, or increasing profitability. 
2. Assess existing roles and descriptions. Look at the current salary ranges in your organization, as well as the total salary budget. Ensure the job descriptions accurately reflect the roles. This provides a framework for adjusting your compensation strategy. 
3. Collect employee input. Your compensation strategy directly affects your employees. Seeking their feedback on your current strategy and how it can be improved can help you to tailor it to ensure your employees feel valued.  
4. Review the market. Determine what the market rates are based on market data, such as salary surveys, and what your competitors are offering. You can then decide how to position your compensation strategy against the market. For example, if your goal is to attract the best quality candidates in a highly competitive job market, you may seek to lead the market with a generous compensation package and extensive benefits. 
5. Align job descriptions with the market and salary grades. The roles in your organization may not mirror exactly the job titles in your market review. But by comparing the roles and their responsibilities, you should be able to identify matches. This helps you then confirm the market salary range for a role. 
6. Confirm your compensation budget. Understanding your financial position guides your compensation strategy. For example, if a company’s annual compensation budget is $500,000 and they spend $400,000 on salaries, it then has $100,000 to use towards a benefits package. 
7. Set a pay system. Determine the pay scales for the various roles in your organization, for example, based on job classification and pay bands or by skills or competencies. As well as being transparent, this shows employees a pathway for salary growth. You should also detail any additional pay and benefits for each role. 
8. Check that your compensation strategy is legal. Your pay strategy must be legally compliant. Review any applicable legislation, like the Fair Labor Standards Act (FLSA), and seek legal advice, if needed.
9. Sign off on the strategy. Given its impact on an organization’s budget, executive management is typically involved in the development of a compensation strategy, including the final sign-off.  
10. Communicate your compensation strategy. For your compensation strategy to be effective, employees need to know what they’re entitled to. Make sure you communicate it to them, during the hiring process and during their employment. Especially if you’re adjusting an existing compensation strategy, ensure employees can ask any questions they have.