What Is a Compensation Strategy? (And How to Build One)
Every company wants to attract and retain talent. And your ability to do that ultimately comes down to one thing: compensation.
Because here’s the thing: you can have all the pool tables, beer fridges, pizza nights and casual Fridays you want. But if you’re not paying your employees fairly and competitively, they won’t stick around for long.
If you haven’t yet given your compensation strategy much thought, don’t worry — we’re here to help. In this article, we’ll take you through everything you need to know to set up a robust, scalable compensation strategy that works for your organisation.
What is a compensation strategy?
A compensation strategy is a comprehensive plan for how you handle compensation within your organisation. It should be built on your compensation philosophy and your company’s mission and values. Ultimately, the point is to use compensation strategically to help your business achieve its goals.
Your compensation strategy includes things like your desired market positioning, the principles you use to make pay decisions and the benefits you offer to your employees. We’ll go through all of these elements (and more) in detail below.
Compensation strategy vs. compensation philosophy
Your compensation strategy is different from your compensation philosophy. A compensation philosophy is a formal statement of your company’s approach to compensation. It’s a bit like your company’s mission statement, but specifically relating to pay and benefits. It should be based on your company’s core values.
Your compensation strategy is how you put your compensation philosophy into action. Every part of your strategy should be aligned with the core principles outlined in your compensation philosophy. And your compensation philosophy should guide you as you put your compensation strategy together.
If you don’t already have a compensation philosophy, we’d advise building one before you go any further.
The importance of a solid compensation strategy
A well-thought-out compensation strategy can have a huge impact on your employer brand and your position in the market. Specifically, it can help you to:
- Attract top talent: A competitive compensation strategy can help you stand out to potential employees, making it easier to land top-quality candidates.
- Boost employee engagement: A fair compensation strategy should leave all of your employees feeling valued and appreciated — a big driver of employee engagement, morale and satisfaction.
- Increase productivity: Paying employees fairly and competitively helps to motivate them to improve their performance — and that’s only possible with a solid compensation strategy.
- Retain people for longer: A great compensation strategy ensures everyone is paid fairly and competitively, keeping employees happy and convincing them to stick around for longer.
6 things to consider when you’re putting your compensation strategy together
There’s no one perfect compensation strategy that works for every organisation. Every business is different — and the whole point is to build a strategy that’s in service of your goals and priorities. Below, we’ve listed six of the most important factors you’ll need to consider when you’re building your compensation strategy.
In many ways, your budget is the most important consideration to have in mind when you’re building your compensation strategy. After all, there’s no point in aiming to pay everyone at the 90th percentile if you simply can’t afford to.
However, having a limited budget doesn’t mean you shouldn’t give thought to your compensation strategy. If anything, it means it’s even more important to be creative with your strategy to ensure you’re still giving employees what they deserve.
For example, this might mean upping the balance of variable pay in your compensation, or dialling up your benefits to make sure your offer is still valuable (we’ll get to both of those in a minute).
The important thing is that you can’t develop a meaningful compensation strategy if you’re unclear about your budget — so make sure you get clarity on this before you go any further.
2. Fixed vs. variable pay
Another important element to consider is how much weight you want to give to fixed vs variable compensation in the way you pay your employees.
Fixed pay is the set salary or wage that you give each employee. It’s agreed on in their contract, and it stays the same unless you give them a pay rise.
Variable pay changes from one pay period to the next, and includes things like bonuses, overtime pay, commissions and profit-sharing. Variable compensation is usually linked to performance — either of the individual or of the organisation as a whole.
Most companies use a combination of fixed and variable pay in their compensation strategy. But you’ll need to decide on how you’ll balance these two elements.
There are arguments for both sides, and it largely comes down to your company culture and what you want to reward. For example, companies that want to emphasise the importance of individual performance might offer smaller base salaries, with the opportunity to earn big commissions and bonuses.
3. Direct vs. indirect compensation
You’ll also have to decide on the balance between direct and indirect compensation that you’ll offer to your employees.
Direct compensation includes all monetary payments that your employees receive, including base salary, commissions, bonuses and overtime pay. Indirect pay is any type of compensation that you offer employees other than money. This might include equity in the company, such as stock options and profit sharing.
Your employee benefits are also an important part of your employees’ indirect compensation. While they may not be hard cash, they still have a monetary value. Benefits might include things like:
- Private healthcare
- Life insurance
- Retirement plans
- Mental health services
- Childcare and family benefits
Any paid time off work that you offer your employees above the statutory minimum in your country is also a form of indirect compensation. For example, if you offer your employees an extra five days of paid holiday every year, you’re essentially giving them five days’ extra salary.
Dialling up benefits like these can be a great way of increasing the value you can offer employees, even if you’re working with a tight budget.
4. Market positioning
A key part of setting up your compensation strategy is deciding where in the market you want your salaries to sit. Every job has an external value, and how well you pay compared to the market average can make a big difference to your employee value proposition (EVP).
When you’re determining your desired market positioning, there are three basic options to choose from:
- Lead-the-market: This means setting salaries above the market rate. This is an aggressive strategy that can position you as an employer of choice and help you to attract top talent. However, it’s (obviously) more expensive than lagging or meeting the market.
- Lag-the-market: This is when you set salaries below the market rate. Although this can save you money, it also makes it harder to attract and retain talent. If you go for this option, you might need to offer very competitive benefits to make up for your lower salaries.
- Meet-the-market: This is when companies pay the market rate for each role. It means employees are paid fairly — but you may still lose experienced people to employers who are willing to pay more. Enhancing your benefits offering or providing other incentives can help to sweeten the deal for employees.
You can also talk about your desired market positioning in terms of percentiles. For example, if you aim to pay at the 50th percentile, that means you’re paying in the middle of the range for each role (i.e. meeting the market). A company operating a lead-the-market strategy might aim to pay at the 70th, 80th or 90th percentile (for example).
5. Salary increase criteria
Compensation is not a one-and-done thing. If you want to stay competitive (and fair), you’ll need to regularly review the salaries you’re paying. We recommend doing this at least once a year, although we’ve recently seen some companies opting for even more regular reviews.
Whatever schedule you choose, you’ll need to decide what factors you’ll take into account when you make decisions about salary increases. Here are a few options to think about:
- General increase: Some companies give all employees a fixed or percentage-based increase each year. This ensures everyone gets a raise, but it could be seen as unfair as it rewards people who are just doing the bare minimum the same as top performers.
- Inflation increase: This involves giving employees a percentage-based increase based on the rate of inflation where they live. This helps them to meet the rising cost of living and ensures their salary is still worth the same as it was a year ago.
- Performance-based increase: This is when companies give raises to certain employees based on them (or their team) meeting set performance criteria.
- Increases for tenure: Some organisations give employees a pay increase based on the number of years they’ve worked for the business. This rewards long tenure and encourages employees to stick around.
- Market adjustment: This means adjusting everyone’s salaries to bring them back in line with the market (at your desired positioning). Since market rates change over time, this ensures that employees are still paid what they’re worth.
There’s no one right way to handle salary increases — it largely comes down to your company culture and your compensation philosophy. The important thing is to decide on your criteria in advance, and then stick to them. This ensures that salary increases are consistent and fair across your organisation.
6. Communication about pay
How (and how much) you communicate about pay is also a vital part of your compensation strategy. Each company has its own way of doing things, but in our opinion, the best advice is to be as transparent as possible.
After all, if you’re not transparent with your employees, they might end up thinking they’re being paid unfairly, even if they’re not. This can lead to discontentment and problems with retention and engagement down the line.
Here are a few tips on how to effectively communicate with your employees about pay:
- Emphasise your total rewards package so employees understand every aspect of their compensation, both direct and indirect.
- Decide in advance who will be the person to communicate compensation decisions with employees — this might be their manager or someone in HR.
- Share your compensation philosophy so employees understand the guiding principles behind pay decisions.
- Have important conversations about compensation one-on-one and face-to-face. These are important discussions for your employees, so give them the respect they deserve.
The key to a fair and competitive compensation strategy
Want to know the secret behind an equitable, competitive and well-structured compensation strategy? Salary bands.
Stay with us: building a robust and scalable salary band structure can help you turn your compensation strategy from a mess of ad hoc decisions to a well-planned, well-oiled system that keeps everyone happy.
Salary bands provide a clear framework for progression, so employees can understand where they sit in the company hierarchy (and how to move up). They ensure every pay decision is based on a logical, data-driven process.
And they even make communication about compensation easier: managers don’t have to spend time justifying pay decisions, because they have a credible, tried-and-tested framework to back them up.
Easily create your compensation strategy with Figures
The best part? Thanks to Figures, it’s never been easier to build a customisable, flexible salary grid based on real-time market data.
Using our platform, you can set your desired positioning, and play around with salary band width, overlap and more until you’ve found the perfect setup for your organisation. Want to learn more? Sign up for a free demo to see our salary bands tool in action.