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compensation plan

In theory, a compensation plan is a formal written statement that reveals the company’s stance on employee pay and rewards. A compensation plan can vary from company to company. However, they often involve addressing the “what,” “why,” “how,” “how much” and “how often” of employee rewards in a manner that aligns with the company’s mission, vision and strategic objectives. Ultimately, the result is a synchronized set of practices and policies that guide decision-making when it comes to creating and distributing compensation.

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A Compensation Plan is More than Just a Document

In practice, a compensation plan is more than a formal document. It is also a product of the company’s culture, as the structure of the plan is indicative of how employees can expect to be treated in terms of rewards.

Without a compensation plan or policy, the organization has no frame of reference for rewarding its employees, resulting in an ad hoc approach, where there’s no consistency or theoretical or practical basis from which to work.

Conversely, a well-designed compensation plan focuses on attracting, retaining and motivating employees through base pay and salary structures, cash or noncash incentive pay such as bonuses and stocks, and benefits such as health insurance and retirement savings. Though consistency is imperative, the compensation plan also needs some level of flexibility in order to reflect changing market conditions and the business’s position at a given moment.

How to Build a Compensation Plan

A compensation plan is usually drafted jointly by company executives and the human resources team. A number of factors should be taken into consideration during the development phase of the compensation plan , including the company’s size, financial position, industry and objectives. Also important are market salary data and the level of complexity involved in finding the right talent.

Step 1: the who, what and why

First and foremost, before working out what you will award employees in your compensation plan, you need to work out the basics.

A good compensation plan typically addresses:

Who (which employees will be compensated)

You need to be strategic in deciding who should be awarded compensation what in your compensation plan as you can’t be seen to favoritize anyone in particular, it must be based purely on performance. So, for example, make the decision that team X will be awarded for outstanding results and not Mr Y because he is a close buddy of yours.

What (types of compensation)

Next, decide the types of compensation to be included in your compensation plan. Will you offer bonuses? Gifts? Healthcare coverage? You need to choose incentives that your employees will actually want to receive.

Why (reasons for the compensation)

Did someone achieve results that were above and beyond their targets? Did someone bring in a huge deal that will make your company a lot of money? Has a manager consistently increased his or her team’s performance year-over-year? Set these types of rules in your compensation plan.

Step 2: how much and how often

Once you have decided on your basic compensation plan, you need to look at more specific details. Like how much you will award employees and how often. Giving away too much and too often can end up being detrimental for your company and could leave you at a loss. Make sure you set out the minimum and maximum you are willing to award, and if the compensation is based on a percentage of a new deal or if it is a fixed amount for a certain result. Also to be included in your compensation plan is if the amount depends on the employee’s salary, i.e. a manager will receive a certain percentage more than someone lower down the rank.

Deciding how often you award pay raises in your compensation plan means that the compensation plan has a structure and you are not giving benefits away too often.

Step 3: represent all functions in the company

Bonuses and benefits are not just for managers and heads of departments. In theory, employees at every level, from high to low, work hard for your company and try their hardest to achieve their goals. Think of your company as a machine with many different components all working differently and in different areas to make the machine run smoothly. If only some of these components, or employees, are rewarded, it is sending out the message to the others that their contribution is not important or worthy of recognition despite the hard work they have put in. This lack of appreciation will only result in a decrease in motivation and work output by those who do not receive recognition for their effort.

Step 4: find out how much your competition pays

You want to at least maintain, and with any luck increase, your employee engagement and loyalty. This is one of – if not the main – reason to create a compensation plan. After all, if your competition offers more to its employees, yours might start looking to leave your company for a better offer elsewhere.

Interesting compensation can really boost a person’s salary and a person might look at the deal offered by a potential new company as a whole (including compensation) rather than just the salary alone.

To find out about what your competitors pay, try talking to other people in the industry and ask them outright what their company pays, not forgetting to give the responsiblities of the positions you are enquiring about so the person in question can give a ballpark figure depending on each role. You could also look at online salary surveys. 

Once you know what other companies pay, adjust your compensation plan accordingly to be just that little bit better than them, budget permitting.

Step 5: review it regularly

Make sure you review your compensation plan now and again to ensure it echoes current market conditions affecting your business. For example, when there’s a shortage of skilled workers, you may need to pay a higher salary in order to secure the right fit. You would also need to update your compensation plan so that it supports this need.

Furthermore, the compensation plan should promote compensation policies that are equitable, transparent and perceived as fair by employees. These policies must comply with applicable federal, state and local employment laws. As laws change, so will your policies so keep abreast of latest developments in your state. Also, you’ll need an effective strategy for communicating the plan and related policies to employees. As communication methods and technology change with the times, so might your means of communication. Adapt your compensation plan accordingly.

Step 6: make sure goals are achievable

How frustrating is it for employees if you dangle a carrot in front of their eyes that they can never quite reach? Unattainable goals are demotivating, especially if employees try their hardest to achieve them, sometimes wracking up dozens of hours of overtime and giving themselves a burnout in the process. You want your employees to work hard but if they are promised rewards and never receive them, you will see a drop in employee engagement not to mention a frustrated and fed-up workforce, and even a significant turnover of staff. Your compensation plan should set the bar high in terms of goals but make sure the goals are not impossible to reach either.

Step 7: invest in job analysis

Be specific about what every position in your company entails as this will be the foundation for your compensation plan. Job analysis entails three steps:

Research: identify every role in your company and detail the responsibilities, daily tasks and skills required for each one. 

Job description: specify the major requirements of each role in your company (place of work, salary range, working hours and conditions etc.)

Job specification: describe the minimum qualities needed to succeed in every role (education level, years of experience, skills, abilities, personality traits etc.)

Once you have worked out this information, you can use it not just for your compensation plan but in job postings as well.

In conclusion, it’s critical for businesses to have a well-stated compensation plan as a part of their payroll management, as it not only helps foster a culture of transparency and trust but also enables the creation of a rewards strategy that aligns with business goals.

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