What is a compensation philosophy and how to set it up?
When it comes to compensation, every company is different. And you probably have a decent idea of your organisation’s general approach to compensation — even if it’s never been formalised.
But there are some major advantages to putting your compensation philosophy down on paper — like improved employee attraction, retention and morale, to name a few.
In this article, we’ll take you through everything you need to know about compensation philosophies, including what they are, why you need one and how you can go about creating one for your company.
Psst! Scroll to the end for a free template to help you create your own compensation philosophy, plus some examples from real companies!
What is a compensation philosophy?
A compensation philosophy is a formal statement that documents a company’s approach to compensation. It’s a lot like your company mission, vision or values statement, except that it specifically relates to compensation.
The aim of a compensation philosophy is to answer two questions:
- What are your goals in terms of compensation?
- Why do you believe in those goals?
Your compensation philosophy should detail your beliefs and expectations concerning pay, benefits, rewards and recognition. It should be underscored by your company culture and reflect your organisational values.
Ultimately, your compensation philosophy should be the foundation of all of your internal policies and processes when it comes to compensation.
Compensation philosophy vs. compensation strategy
Your compensation strategy is different from your compensation philosophy. While your compensation philosophy is a statement of your core beliefs about compensation, your compensation strategy is how you put those beliefs into action.
Essentially, a compensation strategy is a plan for how you’ll use compensation to achieve your company’s strategic objectives, guided by your compensation philosophy. It covers things like how you balance fixed vs. variable pay, your desired market positioning and how you communicate about compensation, among other things.
Compensation philosophy vs. compensation policy
A compensation policy is a concrete application of your compensation philosophy and strategy. It should be a comprehensive document that outlines your policies on things like salary ranges, bonus structures, benefits, equity, performance evaluation criteria — and everything else related to compensation.
Your compensation policy should be guided by your compensation strategy, and everything should be underpinned by the core values set out in your compensation philosophy.
Also, it’s important to remember that your compensation policy will likely change over time. A standard iteration is once a year, but in the very intense market we’re in today, you might want to reassess at least some parts of your compensation policy every six months.
Your compensation philosophy, on the other hand, is a high-level statement of your overall approach to compensation. While the details might change, this is likely to stay the same as it’s a key part of who you are as a business.
Do you really need a compensation philosophy?
If you’re thinking that creating a compensation philosophy sounds like a lot of work, you’re not wrong. It’s a long process that involves several different stakeholders, including your leadership, finance and HR teams (we’ll get to that in a moment).
So, why is it so important to have a compensation philosophy? Here are two main reasons:
1. Positions your organisation as a competitive employer
Having a clear compensation philosophy gives potential hires an understanding of your culture and values, and how you put them into action. It shows them that you care about paying your employees fairly and competitively.
Also, talking about money is uncomfortable for a lot of people, which means some employees might be less likely to bring up concerns related to compensation. Having a compensation philosophy reassures them that you’re committed to fighting pay inequity and have a detailed and well-thought-out pay infrastructure in place.
2. Makes life easier for your managers and people team
Your compensation philosophy should act as a guide for people/HR teams and managers as they carry out processes related to compensation, like hiring, promoting and rewarding talent.
It also makes it easier for your organisation to react to market changes or shifts in the way you operate. When these things happen, you may need to adapt your compensation strategy and policies — but they should still be underpinned by your compensation philosophy.
Having a documented compensation philosophy means it’s much easier for managers, people teams and leaders to make the necessary changes since they don’t have to start at square one and rethink everything.
When should you write a compensation philosophy?
Simple answer: right now! It’s never too early to define your compensation philosophy — and it’s never too late either.
Because here’s the thing: even if you don’t yet have a formal compensation philosophy, you still have a certain approach to pay and total rewards. Just like an organisational culture, all companies have a compensation philosophy, whether or not they officially document it.
Taking the time to define your compensation philosophy (whatever stage your business is at) forces you to take a step back and formalise the things you want to promote and why you care about them. On the other hand, if you don’t put thought into your compensation philosophy, it could be sending the wrong message to your employees — or even perpetuating historical inequity and unfairness.
The key components of your compensation philosophy
In most organisations, compensation is made up of a combination of different components that all come together to form each employee's total rewards package. There are lots of different elements that can be included, but here are four of the main ones:
- Financial compensation: This is all monetary compensation, including fixed salaries, individual performance bonuses or commissions and team bonuses.
- Equity: This includes things like stock options, stock appreciation plans and restricted stock units (RSUs). These give employees a stake in the company and incentivise them to work towards its long-term success.
- Benefits: This covers things that are non-monetary, but still form part of an employee’s compensation. Examples include health insurance, additional time off and flexible work arrangements.
- Perks: Perks are extra benefits that can help employees to perform their jobs better, like company cars, gym memberships, free lunches or employee retreats. While benefits tend to be ‘need-to-haves’, perks are more like ‘nice-to-have’ extras. Perks are also less likely to appear in an employee’s contract and might be things that the employee wouldn’t necessarily pay for themselves.
Putting your compensation philosophy together: 3 questions to ask
Ready to start putting your compensation philosophy together? Here are three questions to ask yourself to kickstart the process:
1. Who should be involved?
Before you can start creating your compensation philosophy, you need to get buy-in from a few different parties. The number of people involved in the process depends on the size of your company — but it should be led by your company leaders. After all, your compensation philosophy is a key part of your company’s culture and values — which means it needs to be championed from the top down.
Your people team also has a key role to play in facilitating the process and providing key insights into your employees and the wider market. And you’ll also need to align with your entire leadership team (the C-Suite), as their input will be invaluable. Lastly, your finance team will be able to provide information about the company’s long-term financial position, which could influence your compensation philosophy.
2. Do you already have resources to refer to?
As we’ve said, every company has a compensation philosophy, even if they haven’t actively thought about it. That means you may have some initial ideas written down that you can refer to when you’re putting your philosophy together.
It’s also a good idea to get some inspiration from other companies, within and outside of your industry. We’ve put together a list of resources that helped us to define our own compensation philosophy, to help you get started.
3. What’s your overall vision when it comes to compensation?
Lastly (and most importantly), you need to think about your core beliefs when it comes to compensation. That means thinking about your company’s values and mission, and how they translate into your approach to compensation.
For example, let's say one of your core values is transparency. If being open and honest with your employees is an important part of your company culture, you probably want to include transparency about pay in your compensation philosophy.
You should also think about what differentiates you from other companies. For example, you might not be the employer with the highest salaries on the market, but you likely have other great things to offer, like social responsibility, top-level benefits or something else.
Real-world compensation philosophy examples
Need some inspiration? We’ve scoured the web for some real-world examples of companies’ compensation philosophies and how they put these into action. Here are a few examples:
French health insurance company Alan believes strongly in transparency when it comes to compensation. That means that they share extensive information about their compensation philosophy and policies on their website.
Crucially, Alan doesn’t believe in defining levels through job titles. Instead, levels are defined through technical exercises carried out during the hiring process. The company also provides equity to all employees, because they want employees to ‘act like shareholders within a culture of collective achievement’.
US-based software development company Gorgias believes that compensation should be based on three key principles:
- Compensation should be based on data
- Compensation should reflect everyone’s ownership (meaning everyone should have equity)
- Compensation should be transparent
To put these principles into practice, Gorgias has created a compensation calculator that takes into account criteria like an employee’s position, level, location and strategic orientation to determine their salary with a fair, consistent formula.
Social media scheduling tool Buffer has come up with four key principles that guide all of their decisions about compensation: transparency, simplicity, fairness and generosity.
To this end, they have created a salary calculator that lets anyone find out what they would be paid at Buffer. They are also one of the few companies to publicly share all of their employees’ salaries from the CEO down — truly embodying the principle of transparency.
Banking company Shine believes that a company has a high social responsibility. That’s why supporting employees with children or dependents by factoring them into salary calculations is an important part of the company’s compensation philosophy.
French real estate agency Zefir decided to create a flexible formula to calculate salaries rather than a traditional salary grid. Because the company values transparency and simplicity, its compensation model is public — anyone can use their online salary calculator to see what their salary would be at Zefir.
Communicating your compensation philosophy to your employees
Once you’ve created a compensation philosophy, you need to decide how transparent you want to be about it. At the very least, you’ll need to make sure your compensation philosophy is clear and accessible to the people who need to use it to back up decisions about pay — like managers and team leaders.
At Figures, we believe strongly that your compensation philosophy should be part of your company’s common knowledge. Once again, it’s part of your company culture — and goes to the very core of who you are as an employer. So, it makes sense to share it with your employees.
That said, it doesn’t have to be all or nothing. Some companies opt for full transparency about their compensation philosophy, and some keep it completely confidential. But many others land somewhere in the middle, offering some level of transparency even if they don’t share everything.
Pros and cons of a transparency compensation policy
A transparent compensation philosophy can:
- Create trust with employees and managers
- Increase employee retention
- Promote equal and fair compensation
- Reinforce company culture
- Limit myths and rumours around compensation
- Help to attract top-quality talent
- Increase accountability for decision-makers
And there are also some downsides. For example, full transparency could:
- Lead to difficult conversations about pay
- Imply internal changes that have not yet been made transparent
- Create frustration for some employees
On balance, we believe that the advantages of a transparent compensation philosophy far outweigh the potential disadvantages. And, particularly with the implementation of the EU pay transparency directive just around the corner, any transparency you can introduce into your compensation structure is a good thing.
How to put your compensation philosophy together (free template)
Creating a compensation philosophy for the first time can be overwhelming — even knowing where to start can be a challenge. That’s something we realised first-hand when we were putting our own philosophy together.
To make things easier, we’ve created a free template that you can fill in and adapt to your own needs — here it is! This template lays out the core questions you’ll need to answer to create your compensation philosophy — no matter the size of your company or the industry you’re operating in.
Want to learn more about key compensation principles? Check out these articles: