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A compensation philosophy is a statement summarizing your organization’s approach to compensating your employees. It expresses your organization’s values and expectations around compensation to ensure consistency across decision-making around pay.
When it comes to compensation, a philosophy answers why—compared to a strategy that answers how.
A compensation philosophy should complement your organization’s vision and mission. It needs to account for factors such as the organization’s size, industry, financial resources, market, and organizational goals. Developed by HR alongside executive management, your philosophy should also be reviewed and updated to reflect changes in external factors or organizational priorities.
Why Do You Need a Compensation Philosophy?
A compensation philosophy can:
- Ensure employees are compensated fairly
- Reinforce pay equity across the organization
- Help attract and retain talent
- Increase an organization’s transparency around pay practices
- Identify the goals of an organization’s approach to compensation
Types of Compensation Philosophies
Market pay
Under a market pay approach, positions in an organization are graded for pay purposes based on the difficulty of the job and the skills, experience, and qualifications required. Salary ranges are then guided by external market data—usually in the form of a salary survey—and how an organization wants to position itself in the market to be competitive.
While this approach is impartial and rational, it’s also rigid, leaving little room to recognize individual contributions to an organization.
Equal pay
Often seen in family businesses, equal pay means everyone is paid the same regardless of the specifics of their role or market factors. In a family-owned business, this approach removes internal competition and gives the organization full control over employee pay free from external constraints.
However, it can lead to employee dissatisfaction as it fails to acknowledge the different levels of work or responsibilities between roles.
Flexible pay
This approach allows an organization to take a combination of factors, objective and subjective, into account when making compensation decisions. This includes both market factors, such as the data from a salary survey, and company culture, such as a pay philosophy that ties bonuses to team—rather than individual—performance.
While the flexibility this philosophy offers is often attractive to organizational leadership, there’s a risk that employees may perceive decisions made under a flexible pay philosophy as biased, unfair, or discriminatory.
Tailored pay
A tailored pay philosophy takes into account market conditions as well as individual and organizational performance. In practice, this often involves setting base pay rates with additional compensation, such as bonuses or promotions, for achieving certain targets.
This philosophy allows an organization to offer competitive pay both according to the market and internally.
What To Include in a Compensation Philosophy
An organization’s compensation philosophy needs to be clear and fair and should justify an organization’s compensation strategy. To do this, it typically includes one or a combination of the below:
- Values. Values can guide an organization’s approach to compensation. For example, human rights charity Reprieve’s compensation philosophy promises that the “highest paid member of staff will be paid no more than double the lowest-paid member of staff”.
- Summary of compensation strategy, explaining how employees are compensated. Detailing how you determine salary ranges and benefits increases your organization’s transparency around pay.
- Commitments. For example, an organization may commit to paying every employee an end-of-year bonus.
- Types of compensation. Some philosophies detail the types of compensation the organization offers employees such as salary, bonuses or commissions, and benefits including health insurance, remote work, and child care.
- Differentiate your organization from its competitors. Highlighting the unique features of your compensation philosophy helps you to stand out and attract top talent in a competitive market.
How To Choose a Compensation Philosophy
Here are some tips for selecting your organization’s compensation philosophy.
- Align your compensation policy with organizational goals and business strategy. Your compensation philosophy should support your organization’s priority goals, such as lowering the attrition rate or attracting top talent.
- Understand your employee’s needs. If you’re trying to hire and retain the best talent, it’s essential you understand how compensation motivates these employees. What are their priorities when it comes to compensation? Are benefits more important than a market-leading salary? Taking these factors into account will help shape your compensation philosophy.
- Competitor research. You and your competitors are drawing from the same pool of candidates, so it’s important to understand what your competition is offering. Especially if you’re using a market-based philosophy, knowing your competitors’ position is crucial.
- Communicate your philosophy to your employees. Do so clearly, so that potential and current employees understand where you stand. Your philosophy should be put in writing, adding to your organization’s overall transparency around compensation.
Conclusion
A compensation philosophy summarizes your organization’s values, expectations, and approach to compensating employees. It ensures your compensation process remains fair, transparent, and equitable across the organization.
Crafting an overall compensation philosophy that aligns with your business strategy and takes into account your employee’s needs and competitors’ offerings provides a framework for consistent and predictable decision-making around compensation.
