Inside and outside - what factors to consider when designing compensation strategy

It was a chilly Friday in April, I was sitting cozily on the train home waiting to depart from the station, and that was when I got the fateful phone call from a friend. She is an entrepreneur who started a successful Cybersecurity consulting firm years ago but has recently encountered retention issues. I was half listening to her complain about the difficulties of attracting and retaining top talent, until she asked me if compensation is an issue.

“Compensation is always an issue my dear, paying the highest definitely helps, but its not always about that” and then I proceeded to talk about the technicalities of designing compensation. Looking back on this conversation, I realized the information I shared probably wasn’t too interesting or helpful to my friend, sharing some high-level considerations would have probably help guide her in this process. So, this is me trying to redeem myself.

The general association with compensation is wages and salaries, but it certainly goes beyond a number on a paycheck, it reflects how much an organization values its employees and how much they contribute to its success. Compensation, including its perks and benefits, can help shape employee motivation, engagement, loyalty, as well as their satisfaction with their work and their employer. It can also affect the reputation and image of an organization in the eyes of potential candidates, customers, and partners. For the employee, compensation is the main determinant of their standard of living, an often measure of their worth in society. Safe for us to assume compensation is a strategic tool that can help organizations achieve their goals and objectives by aligning them with the expectations and needs of current employees and potential colleagues.

So how do we go about structuring compensation? Well, it depends on how sophisticated you want to be. It all starts with performing a job evaluation to determine relative value of each job in the organization, you can keep it simple by using a ranking method or go all technical with a point-factor method. Once complete, you would then be assigning dollar figures based on ranking or points. The steps are described in numerous articles and tutorials, so I won’t go into depth here.

One thing I will say, compensation structure becomes exponentially more difficult to change as the organization grows. This applies to companies, but in different ways depending on the stage you are in. For a startup, the challenge is having a purposeful compensation structure with defined objectives. You might get by with providing market rates at the beginning, but this becomes challenging as you scale up because you are susceptible to market fluctuations, pay inequity, and worse of all, burning through too much cash on payroll because of mismanagement.

It’s the opposite challenge for a large company where there is already an established structure, but its too rigid. For a company with hundreds or thousands of employees, changing compensation structure may lead (perhaps a lot of) short term pain including higher turnover, poor recruitment, and lower productivity.

I’m not here to prescribe the “right way” of structuring compensation, I personally believe there is no silver bullet method, rather it must be designed based on your organization to be effective. Here are a few things to consider when deciding compensation structure for your people.

Leadership philosophy

Leaders in any organizations generally determine the culture and strategy of the team or organization, in turn, it influences how employees are being perceived and valued. If people are viewed as value generating assets, then your compensation structure would go to great length to attract and retain these assets. On other extreme, if employees are perceived as cogs in a machine, then cost minimization would be the goal of your compensation structure. As a leader, really think about where you place between these two extremes, and it will help you determine how far you will go for your people.

Competitors and market

The market and your competitors play a big role in shaping your compensation structure. Let’s first talk about competitors. You can be a trend follower, doing the same thing your competitors are doing (maybe a little more/less in different areas), or you can be a trend setter by doing something different (adapting a compensation structure from another industry) that makes you unique in your industry. Both have benefits and drawbacks of course. With being a trend setter, you are sticking with what’s already working. Companies using the same structure are profitable while able to attract and retain talent, and it’s familiar to current and potential employees. The downside is that you are effectively entering a bidding war with your competitors for talent, where both will try to one-up another to attract and retain talent. On the other hand, being a trend setter means you don’t play the same game, components of your compensation are different so that current and potential talent cannot directly compare your compensation package to your competitors, things like introducing variable pay for positions that don’t normally have this it or having interesting perks and benefits. This is an edge if it offers distinct value, it goes south if it doesn’t align with your target market. Which leads to talk about the market. Your market consists of both potential employees and your current employees. The key is to understand your market, what’s important to them and why. You must consider what keeps your employees that also attract new ones to your organization, and this is where employee testimonial can help bring it to life.

Financial constraints

This is a no-brainer, every company faces financial constraints when designing compensation packages, but I like to believe that every challenge creates an opportunity to be innovative, for compensation structure, this means using perks and benefits as way to differentiate. Higher salary certainly makes your compensation package attractive, but it is easy for your competition to imitate as well. Perks and benefits (often called indirect compensation) helps to demonstrate your company culture and how you choose take care of your people.

Internal equity

This concept applies mostly to large organizations, but it is starting to take hold in startups and smaller organizations as well. This sometimes becomes a shackle when trying build a competitive offer to attract new employees, or in attempt to retain a current employee with another offer. Any employer should consider how your current employees place on the pay scale before you revamp your compensation structure, or you might create inequity amongst new and old employees. I’m not a fan of talking about compensation with colleagues, but there are people that do talk. While you don’t have to pay everyone the same, it is advisable have justifications on perceived pay differences.

In this current economy, I believe every employer, big and small, are facing this issue in one way or another. While this is not a tutorial on the process of designing compensation, I hope it gives you, the reader, some strategic guidance when considering the design. As for my friend, I couldn’t help at the time, but she did eventually find a creative way to retain talent. I did still get a bottle of wine from her for Christmas though.