The Ultimate Annual Compensation Review Process Guide

November 15, 2023
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The ultimate annual compensation review process guide

We know you were looking for best practices for this year's annual compensation review. Which is why we hosted a live workshop and put together a guide for you! Whereas a manual process could prove complex, an automated compensation system will be more fair and efficient while giving credibility to individual outcomes. Let's get into it...

What is a compensation review process?

A compensation reviews process also known as a "salary review process" is one of the concrete applications of your Compensation philosophy and policy.

There are lots of different ways to perform your compensation review, but eventually, the exercise can be summarized as follows: A review of the company compensation structure to evaluate whether employees are paid fairly based on your internal guidelines and equity, and market alignment

Doing this review regularly will mitigate potential inequities, whether they are based on gender, performance, or compared to the market.

We recommend running your salary review at least once a year. Lately, more companies have been switching to reviews every six months to be sure to evolve as quickly as the employment market.

Now that you’re convinced you should run regular compensation reviews, let’s see the main steps and tools for success.


1. Budget planning for your annual compensation review process

First, you need to know your salary increase budget to start running it. Depending on your organization, there can be different owners and ways to define it:


Ownership

Salary increase budget definition can be owned by Finance, People, CEO; it will depend on your organization's size and model.

No matter who’s the owner, make sure to involve those different functions, as they’ll all have different views to bring to the table:

  • CEO will bring a strategic direction and vision about compensation 
  • Finance will bring a comprehensive view of the financial capabilities of the company
  • People will bring knowledge of the market and Internal employees’ situation


Budget structure

Your budget can include lots of variables, but if you want to focus on the most common ones, this will be:

  • General increase: some companies allocate a general increase to all employees or part of their population (fixed amount or, more generally, set % of basic salary). Lately, we’ve seen an increasing number of companies using this general increase budget to cope with inflation rates, most of them to a portion of their population (the lowest paid employees, often).
  • Market adjustment increase: This will help close the gap between your employees’ salaries and your market positioning target. Let’s say you aim at the 50th percentile of the market for each role, but given market changes, some are (way) below this target → you will close the gap to bring them back on track. 
  • Merit increase: if you want to reward individual performance, you can use performance ratings to define individual salary increases, differentiating the increase of an outstanding performer from someone who is “just” meeting expectations.

At this stage, you can also take a combination of performance and market positioning to define the merit increase, to be sure that once again you close the gap to internal inequities putting employees with the same performance at the same level of salary, even though they were not starting with the same salary.

2. Best tools for your annual compensation review process

Regardless of the Compensation management software or HRIS you’re using; it’s likely that your salary review is eventually going to happen in a spreadsheet!

As we want to make your life easier, we’ve built a template that you can copy and customize as you see fit. Here it is, just for you!

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The most important things you’ll find out are:

  • A global budget tab to access a summary of your budget simulation - automatically calculated based on what’s done on your Master file tab
  • A parameters tab for you to fine-tune the master information you want to apply afterward: your merit increase matrix, inflation rates per countries, exchange rates, etc. (check the following section to guide you on these parameters set up)
  • The Master file tab to view individual simulations for each employee and process potential individual adjustmentIf you’re using Figures, you can pull out lots of this tab’s information from the Budget Calculator, though you’ll still have to manually add some more information, such as the employee’s track record, if you want to
  • A calibration tab to be used during your calibration meeting to finish your process

3. How to define the annual compensation review process parameters

Inflation rates

You may decide to compensate your team for current inflation, which will drive a flat % increase based on the employee’s location.

You can find updated inflation rates from many different sources (one of them here) and then decide country by country the associated salary increase from completely aligned to inflation to no compensation at all.

→ Make sure to list all countries where you have employees and the associated inflation rate in the parameters tab.

Exchange rates

You want to process your compensation review with a common currency all over the board for consistency issues; this parameter is relatively easy to set up.

→ List all currencies other than your reference one (€ in our template) and the exchange rate you want to apply.

Merit matrix

As explained earlier, you can conceive merit increase in two different ways shown in the sample charts below:

1. Considering only performance ratings - 1 rating = 1 increase %

With this methodology, two individuals in the same role with the same performance will receive the same % of increase, which sounds fair (and is more appropriate than a pure discretionary increase).
   
If you look one step further, however, if their initial salaries were not the same for some reason, is it fair that they get a similar increase while one of them is better compensated than the other? We don’t think so. This is why we encourage you to…


   
2. Take performance ratings + market positioning into account to determine fair individual salary increases


This time, you make sure to take into account potential inequities you had in the past and correct them moving forward. You will reduce, if not delete, any salary gaps between two individuals with the same job, same level, and same level of performance.
   

Both ways work just fine, though we strongly advocate the second one, which ultimately tends to more fair compensation of your team, taking away possible entry biases (this person negotiated better than the other at offer time, this person had a higher salary before joining, etc.).

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4. Collaborating with people managers and calibration for your salary review process

Managers review

Once you’ve set up general parameters and applied them to each individual, you’ll have a first version to be reviewed with people managers.

1️. Split your master file into sub-files or tabs to be shared with the manager, so they only have access to their team and sub budget.

You can use tools such as Split Sheet to build your sub-files more easily.

2️. Depending on the size of your team and the level of autonomy, you can either:

→ Plan a compensation review meeting with each manager to go over each employee and review step by step their:

  • Inflation increase
  • Market adjustment increase
  • Merit increase

→ Or share managers’ files directly with them with a detailed explanation of how it works (we recommend sending them a Loom or Claap that could look like this!) and let them do the review work independently.

It will be time for managers to overwrite the increase proposition if they want to. The overwrite could go both ways (higher or lower increase); in any case, we recommend limiting the number of manual adjustments so that, eventually, the fair system you build doesn’t lose credibility.

In any case, might it be with you or on their own, make sure managers are giving factual and clear explanations for their overwrites; you need to be able to justify objectively any deviation from the standard process!

3️. Ensure your master file is updated once all managers’ reviews are done.

This way, you can keep track of the following:

  • Budget post managers’ adjustmentAre you still on track? Are some teams being way more generous than others? Is it always legitimate?
  • How many manual adjustments have been made?As mentioned, the fewer manual adjustments you make, the more credible and robust your automated system will be. A good practice would be to set a limit of up to 15% for manual adjustments and stick to it as much as possible.

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Calibration

Calibration meetings are designed to discuss salary increases proposed by managers as a group, looking at sub-groups when needed: teams, levels, gender, etc.

Eventually, the goal is to ensure fairness all over the board and avoid potential biases: a manager being more generous/harsh than others, some team members being overly rewarded vs. others being limited for some subjective reasons, any discrimination, etc. This helps drive greater consistency in the compensation review process.

Methodology

There are lots of different ways to organize your calibration meeting, though here are some options that can make sense:

1️. In larger teams (at least 100 employees), you can run your review team by team; there will be enough employees at the same level for comparison to make sense. For smaller teams, you might want to start at step 2.

2️. Order employees per level + performance rating

3️. Check the proposed final salary and look for discrepancies (same level / same performance level should land on a similar salary)

4️. Check manager overwrites to explain, challenge, and validate them

Using the budget dashboard is also a way for you to understand how you should organize your calibration meeting: Do you notice a gender gap in terms of average increase? Are increases per level consistent enough? Does any team stand out compared to others?

Timing

Depending on how many people you have to review, plan enough time and be a ruthless timekeeper! Compensation discussion can easily drag on longer than needed, designate a timekeeper, and be sure they’ll do their job. You shouldn’t spend time on every employee but more on exceptions and overwrite extremes. An average of 3 minutes per employee should be enough time.


Accountability

Some managers may come out of the calibration meeting disappointed as they won’t always get what they expected for their team members; though make sure they are accountable for the outcome and make it clear they will have to disagree and commit. You don’t want a manager communicating afterward to the employee saying: “I wanted to give you more, but the calibration committee decided otherwise…”.

Ownership

Before starting the meeting, be sure everybody knows who will be the final decision maker. It can be the department head of each team member, moderator, or people team. No matter who it is, be sure it’s clear to everyone; it will save you some time afterward.

Confidentiality

It may sound obvious to you, but it’s always worth mentioning it; everything discussed in the calibration meeting remains within the calibration meeting. And outcomes should only be communicated once the People team has given their green light for communication.

5. Communicating your compensation review process with employees

Compensation is an emotional topic for most people; it’s then critical that communication of the compensation review process and outcomes are well managed and controlled.

Communicate before the end of what’s about to happen

Most of the time, this part of the communication will be handled by the People team
  • Compensation philosophy and policy: take this occasion to remind them about the fundamentals of your compensation approach.
  • Timeline: when are you running the review, and when will the outcomes be individually announced
  • Ownership: who is involved in the process, and who is the final decision maker? Who will then get back to them for the individual announcement
  • Parameters: depending on your transparency level, you can consider communicating about the overall budget, split between inflation/market/merit budgets, merit matrix, etc. The more you share with them in advance, the more accountable you are and the more reliable your system will be.
  • Exceptions: except if you decide that there will be no exceptions, you should still remind everyone that some manual adjustments can be made, but for instance, you can commit to the fact that there will not be more than 10% of these.

If your communication process and systems are well-oiled, they will be your best ally.

Prepare your communication!

Managers usually handle this one
  • Disagree and commit! It’s possible that the person announcing the increase (most likely the manager) is not aligned with the decision that the calibration committee has taken. Though, they should still disagree and commit and show a united front to the employee. Getting into the meeting saying, “I wanted more for you. It’s their fault”, won’t help anyone moving forward. So make sure you can explain the decision the most factually and objectively possible.
  • Even in the case of good news, it’s an important piece of information you’re about to deliver! No matter what, prefer 1-to-1 conversation face-to-face (virtually or in-real-life) rather than written communication
  • In most cases, there is a clear link between performance reviews and compensation, though these should be two separate discussions!
  • When talking about performance reviews, you want them to focus on the core message solely: are they meeting expectations or not? Why? How can they improve? What are the next steps/action plan?
  • Compensation should only come during a second phase once the essence of your message has been assimilated.
  • Detail the increase structure - If you’ve built a system considering several variables (inflation, market, merit), you want your team members to understand which part of their increase is coming from which variable. If your parameters and the breakdown are clear, there should be a tiny room for negotiation, if any!

Properly follow up…

  • Make sure to have a written follow-up to the announcement, might it be with an email, a formal information letter, or even a contract addendum
  • If the discussion was heated, you might want to check in the following day to make sure the information has been understood and accepted‍

So with all these tips and resources, we hope that you go forward and conduct your most efficient, fair and successful compensation review ever!

FAQ: Creating your compensation review process

Why are salary reviews important?

Salary reviews are crucial for several reasons.

  • They help ensure fair and competitive compensation for employees, which is essential for attracting and retaining top talent.
  • Regular salary reviews demonstrate an organization's commitment to rewarding employees' contributions and maintaining internal equity.
  • It also helps address any disparities and align salaries with market trends, promoting employee satisfaction and engagement.

How do salary reviews affect company culture?

Salary reviews can significantly impact company culture.

When conducted fairly and transparently, they foster a sense of trust, fairness, and recognition among employees. It demonstrates that the organization values its workforce and acknowledges their efforts. This, in turn, can enhance employee morale, motivation, and loyalty.

Conversely, if salary reviews are inconsistent or perceived as biased, it can lead to dissatisfaction, low morale, and a negative impact on the company culture.

How can you prepare for a salary review?

To prepare for a salary review, consider the following steps:

  • Gather relevant data: Collect market research, salary surveys, and industry benchmarks to understand the current compensation trends.
  • Review employee performance: Evaluate individual performance, considering factors such as goals achieved, skills acquired, and overall contributions.
  • Assess internal equity: Analyze salary ranges within the organization to ensure consistency and fairness.
  • Determine budgetary constraints: Consider the financial resources available for salary adjustments.
  • Plan communication: Prepare a clear and transparent communication strategy to convey the salary review process, timeline, and expectations to employees.

What is the compensation cycle review?

Compensation cycle review refers to the systematic evaluation and adjustment of employee compensation within an organization.

It typically involves assessing and updating salary structures, conducting salary reviews, and implementing changes based on various factors such as market conditions, employee performance, and budget considerations. The compensation cycle review ensures that salaries remain competitive, equitable, and aligned with the organization's strategic goals.

How to evaluate your salary review process?

To evaluate your salary review process, consider the following aspects:

  • Clear criteria: Assess whether the criteria used to determine salary adjustments are well-defined, transparent, and consistently applied.
  • Equity and fairness: Evaluate if the process ensures fairness and internal equity by considering factors such as performance, experience, and market value.
  • Employee feedback: Gather feedback from employees to gauge their satisfaction with the process and perceived fairness of the outcomes.
  • Market competitiveness: Compare your organization's salary levels with industry benchmarks to ensure competitive compensation.
  • Retention and engagement: Monitor employee retention rates and engagement levels to gauge the effectiveness of the salary review process in motivating and retaining talent.

Regularly reviewing and refining your salary review process is essential to ensure its effectiveness and alignment with the organization's goals and values.

Looking for more resources, tools and content?

That's why we created Figures, you don't need to be a compensation expert, we are. With our an all-in-one compensation platform updated in real-time, expert HR and People insights, we want to make your job more efficient and power more fair decisions. 

  • Follow us on LinkedIn to never miss an update
  • Learn more about compensation philosophy, the gender pay gap, and best practices on our blog
  • Check out our other product tutorials on YouTube

And of course, if you want to get access to our full range of tools, ask for your demo of Figures today!

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