How to Build a Better Compensation Strategy: A Step-by-Step Guide

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Compensation Strategies In Hr

Compensation is the chief component of EVP. In fact, its importance has only increased with time, especially after the pandemic upheaval. And so, organizations are now formalizing compensation management as a strategic function to stay ahead of the competition.

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Read on to understand the meaning, importance, types, and steps to create a robust compensation strategy.

Per the 2022 Payscale Compensation Best practices report, 86% of organizations say they have a formal compensation strategy or are working on one, a 16% increase from previous years. Also, 70% of organizations plan to increase their investment in compensation management in 2022.

What are Compensation Strategies?

A compensation strategy is a systematic approach an enterprise takes to determine compensation for its employees in terms of salary and benefits. 

Key components of compensation:

  • Financial Benefits or Salary includes base pay, allowances, bonuses, variable commissions, overtime pay, and employee stock options (ESOPs).
  • Non-Financial Benefits includes retirement compensation and benefits, health and life insurance, paid time off, flexible timings, and wellness programs.
  • Career Advancement includes promotions, skill enhancements, and leadership opportunities.

Compensation strategies determine how your organizations define salary structures, pay bands, and performance payments. It outlines how salaries are determined based on the external market environment, fiscal responsibilities, company culture, and growth outlook. 

It specifies the relative weights of financial and non-financial benefits in the overall compensation structure. It also defines the human resource (HR) business processes, team roles, and responsibilities for ongoing review of the compensation strategy.

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Why is Compensation Strategy Important?

The compensation strategy serves as a chief competitive advantage for high-performing organizations. It determines how you position yourself as an employer of choice for existing employees and potential recruits. It helps in the following ways:

Compensation Strategy Types
How to Build a Better Compensation Strategy: A Step-by-Step Guide 1
  • Compete for top talent – The compensation strategy could be leading the job market, matching or lagging it, based on your growth and talent acquisition goals.
  • Ensure employee satisfaction – Compensation benefits make the employees feel valued and rewarded and ensure financial stability. 
  • Drive employee performance Variable payouts and bonuses based on performance help boost morale and drive productivity.  
  • Comply with wage regulations – Every enterprise must meet laws and regulations determining the minimum pay for employees, working hours, overtime, and more.  
  • Adhere to HR budgets – A compensation strategy ensures that HR expenses stay within the annual budgets allocated for recruitment and performance management.
  • Ensure pay equity – HR teams must ensure fair and transparent compensation systems across roles.

Types of Compensation Strategies

Instead of thinking of compensation strategies as having distinct types, it makes sense to visualize them as a continuous spectrum of design approaches you can imbibe to build a unique and competitive compensation strategy. 

1. Grade Structure

At one end of the spectrum is the traditional grade-based structure for defining compensations. In this approach, the HR team defines levels or designations in the organization structure. Each grade is assigned a narrow salary range. 

It provides clarity for recruiters and managers about the pay they can offer to a candidate or existing employee based on the designation of the job. The number of levels, widths of the pay range, and median salaries in each pay range may vary across organizations. 

2. Pay Bands

This approach lends greater flexibility to the grade structure as it defines the salary range in organisation for specific roles. Thus, each grade has a wide pay band associated with it. Recruiters and managers can stretch the salary offers or increments for top performers without changing the designation of the job when following pay band strategies.

3. Market Pricing

In this approach, managers evaluate employee performance and utilise market or competitor data to assign salaries without shaking overall budgets. It depends on performance of employees, competitor’s offering to their people and pricings that can help in better retention rates.

Most high-performance organizations employ compensation strategies that mix elements of the above three methodologies. 

For example, the HR team may design grades in the organizational structure but assign fixed pay ranges only to a subset of these levels. For selected designations, say the top management, the HR team may set pay based on market pricing models.

The HR team must strike the right balance between structure and flexibility while developing a compensation strategy to maximize employee engagement.

How to Develop Your Compensation Strategy Roadmap?

Per Deloitte’s High-Impact Rewards study, 2018, most business executives are dissatisfied with the HR compensation process. It garnered an abysmal net promoter score of negative 15, the second lowest score for any HR-related practice in any prior study by Deloitte’s research groups.

With the HR landscape undergoing rapid disruption, enterprises must adopt a structured approach to build a sustainable and comprehensive compensation strategy to guide their talent management functions.

Compensation Strategy Roadmap
How to Build a Better Compensation Strategy: A Step-by-Step Guide 2

1. Define a Compensation Philosophy

A compensation philosophy formally documents the reasoning behind each component of the compensation plan. It provides a transparent framework to ensure consistency in pay decisions. It explains the organization’s stance on market competitiveness, pay equity and pay for performance. 

It must be objective and straightforward to understand, so managers can decide on individual salaries easily. A well-drafted compensation philosophy can also be a unique element in your company’s employer branding.

2. Align Compensation with Strategic Goals 

List your strategic goals and make sure your compensation strategy ties into them. For example, if your organization is in the initial growth phase, you could look at prioritizing components like joining bonuses and higher base salaries to attract top candidates. 

If your organization targets profitability with stability, you could prioritize retaining current employees by focusing on health, retirement, and other benefits. If you wish to drive specific behaviors crucial to your organization’s success, say customer service excellence, you can link the variable components of rewards and recognition to employee performance in these aspects.

3. Think Total Rewards for Defining Complete Strategy

Post-pandemic, non-financial benefits, especially those enabling work-life balance, have assumed much greater importance than before. 

Per a Mckinsey Survey of employees who quit jobs during the pandemic and then returned to employment, 40% of respondents cited workplace flexibility as the top reason for accepting the current workplace.

HR teams must analyze the changing expectations of employees and use the ‘total rewards’ package, encompassing the financial, non-financial, and career benefits, to define a wholesome compensation strategy. It can potentially deliver a higher ROI for your compensation investments. 

4. Benchmark Compensation Against Competitors

Use market data from Payscale, LinkedIn, GlassDoor, or other research providers to benchmark your current employee compensation figures. It enables the HR team to understand employee expectations better and eliminate arbitrary decisions. 

While benchmarking, it is prudent to compare data from companies in the same industry vertical for similar roles and employees with comparable qualifications and experience.

5. Gather Feedback From Employees

Per a Mckinsey Survey of employees who quit jobs during the pandemic and then returned to employment, 40% of respondents cited workplace flexibility as the top reason for accepting the current workplace.

Collect feedback from current employees to understand which components of compensation matter the most to them. You may receive varying feedback from different segments of employees. 

For example, freshers may emphasize variable pay components, and managers may cite stock options as more crucial. HR teams must carve out a compensation strategy that caters to a majority of employee expectations. 

Employee surveys help you take an informed approach to compensation management. 

6. Formulate a Salary Structure

A ‘one size fits all’ approach doesn’t work while designing an optimal salary structure. Each technique has its pros and cons. A traditional grade-based salary structure offers clarity to employees about their pay progression. 

However, it lacks the flexibility to facilitate lateral movements of employees within the organization. Broad pay bands enable managers to reward deserving candidates with higher salaries. However, it may lead to a negative perception among peers in the same pay bands who receive lesser pay. 

A market data-based salary structure ensures transparency and facilitates internal mobility. However, in a dynamic market, it is tough to keep pace with salary trends constantly. It requires sizeable resources and can lead to ad-hoc salary decisions. 

Considering these aspects, you must design a salary structure tailored to your organization. Weigh the growth trajectory and manager autonomy levels while developing the salary structure for your organization.

7. Seek Legal and Top Management Approvals

The HR team must present the compensation strategy with complete details like the rationale and expected benefits to the top management. The organization leaders should judge if the suggestions align with the business strategies and employee expectations. They must also consider the fiscal implications of the compensation changes.

Post-approvals, business leaders need to communicate the value of the compensation strategy to employees and be prepared to address public pay data. The compensation strategy document should also abide by labor regulations of the country, state, and territories you operate in. If necessary, seek external legal consultancy to ensure compliance.

8. Leverage Technology and Analytics

Per a 2020 Deloitte report, 57% of organizations still use spreadsheet software for compensation planning.

Many organizations get caught in a rut, reformulating their compensation strategies without revamping their legacy compensation management technology. 

You must explore modern cloud-based HR Management systems (HRMS) that are equipped to handle complex salary and benefit structures and are easily customizable. They also allow for centralized clean enterprise compensation data that enables compensation analytics. 

It can result in insights that feed into your compensation strategy to eliminate bias, ensure equity and enable market outperformance.

9. Continuously Review the Compensation Strategy

Measuring the business outcomes of the compensation strategy enables you to track if it is performing up to the mark. 

The HR team must measure the impact on the business goals prioritized while drafting the compensation plan. It is necessary to conduct these reviews every year or bi-annually. A dedicated compensation sub-function within the HR department lends the resources and credibility to this important exercise.

Final Words

Compensation remains one of the top factors in the selection of the workplace. Most organizations are combating the post-pandemic ‘Great Attrition‘ trend with increased salaries and flexibility benefits.

Per the Great X report, Michel Page, India, 60% of Indian employers are planning for more than a 5% increase in annual salaries.

An equal proportion intends to offer more than 5% of the yearly salary as a bonus. Organizations that continually work on their compensation strategies in alignment with market changes will continue to beat the competition in attracting and retaining the best talent.

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