Compensation Management 101: A Simple Guide to HR’s Biggest Priority
Planning, analyzing, and managing compensation is one of the most complex, time-consuming, and high priority things that HR does.
HR and compensation pros will often tell you that managing compensation is a mix of science and art.
It’s important to get the numbers right, but it’s just as important to use that data thoughtfully to make better decisions about pay.
The science involves things like planning merit increase budgets, calculating metrics like compa-ratio, or even calculating the width of your salary bands.
The art comes in when you have to use your judgment to figure out the “what”, “why”, and “how” behind compensation. This can include things like designing a thoughtful total rewards program, setting your compensation philosophy, or deciding what job to benchmark against.
With so much to balance, compensation management can seem overwhelming. But it doesn’t need to be.
In this post, we are going to break down the key components, goals, and impact of a good compensation management process.
So, what is compensation management?
First, the basics.
Compensation management is the process of planning and distributing pay and benefits to a company’s employees.
It can also include managing other types of incentives, like stock options, retirement/pension plans, paid time-off, flexible work arrangements, and more.
It has always been a crucial HR function that impacts everyone at the company and the bottom line.
Over the years, the priorities of compensation management have shifted to become more proactive and strategic.
This means that companies are now actively looking to their compensation programs to address important business challenges, like:
- Attracting new people to join your team with a comp package that is competitive and compelling
- Engaging and rewarding your existing employees for their work
- Motivating the right employee behaviors with pay incentives that align with your business goals
- Maintaining pay equity, while avoiding opportunity gaps and salary compression
- Adjusting pay for a team that might now be working remotely across the country (or the world)
- Figuring out the level of pay transparency that is right for you
- And doing it all while managing your budget!
Why do you need compensation management?
Compensation management is more than making sure that everyone is paid on time or gets their yearly bonus.
The goal of compensation management is to ensure that a company’s total compensation package is attractive, equitable, and within budget.
At the end of the day, compensation is a key factor in whether someone chooses to join your company. It also plays a large role on whether someone decides to stay or look for a new job. It is at the heart of the employer-employee relationship.
You can think about good compensation management as one way to consistently nurture that relationship so that your company and your employees can thrive.
What are the types of compensation?
These days, compensation usually refers to more than a paycheck.
Many companies use a blend of different types of comp to build a total rewards or total compensation package.
Let’s break down the components that you can leverage to create a compensation program that fits your business needs.
The salary or hourly wages that an employee is paid.
When setting base pay, a good place to start is creating a compensation philosophy to guide you.
Sometimes referred to as incentive pay, this is typically any compensation that is based on performance, such as a bonus, commission, or profit-sharing.
This is where the concept of on-target earnings (OTE) comes into play. OTE refers to the total amount of money that an employee can earn if they hit 100% of their quota or performance goals. OTE is the sum of both base pay and (on-target) variable pay.
The ratio of base pay to variable pay that makes up your OTE is called pay mix.
Changing your pay mix is one way that you can adjust your compensation strategy to motivate the actions that you want.
Most roles tend to have a pay mix that leans predominately on base pay. You may see an annual or quarterly bonus plan that reflects something like an 80% base pay to 20% variable pay mix.
In software sales, it’s quite common to see a relatively strong lean on commission (to motivate salespeople to close more deals) with a pay mix of 50% base pay and 50% variable pay.
This is considered a long-term incentive that gives employees a direct or indirect ownership stake in a company. This can be in the form of stock options, restricted stock units (RSUs), or performance shares.
You will likely see early stage startups lean on equity compensation (in the form of stock options) as part of the total compensation package. In the past, equity in a startup was in lieu of a lower base salary. However, expectations are changing and stock options have become the "icing on the cake" to motivate employees to grow with the company and be rewarded with a (potentially) large payout in the long-term.
Benefits can include health and dental insurance, paid time off, retirement plans, short-term and long-term disability, parental leave, relocation reimbursement, and more.
These benefits support employees inside and outside the workplace, but they can also help your company stand out against the competition by bringing something unique to the table. For example, if you’re looking to recruit and retain more women and employees with growing families, a good parental leave program can be a deciding factor.
Many companies get creative here with great perks like catered meals, fitness programs, daycare benefits, and paid time off for volunteering. These perks speak to your company’s culture and values.
They can also be a great way to remove friction from your employees’ lives, which supports productivity. Think of tech campuses that have an on-site gym or big law firms that pay for transportation home if you’re working late.
Designing a compensation management program with the right mix of pay, equity, benefits, and perks is one of the most high-impact things that HR and total rewards teams can do.
How does compensation management impact employee performance?
Good compensation management can improve your company’s ability to hire the right people, keep employees engaged, and increase productivity.
Recruit the people you need to grow
When someone is looking for a new job, salary is an important criteria, but not the only one.
The total compensation package that you offer a candidate tells a much bigger story than base salary alone.
For example, some candidates might value having robust health and wellness benefits (like a flexible spending account) or retirement/pension plan matching programs. Other candidates might be swayed by nearer term incentives like a sign-on bonus or relocation allowance.
Once you have designed a compensation plan that will be attractive to the kind of people you want to hire, you then need to communicate it fully during your entire candidate journey. This starts with your careers page, your job postings, the interview experience, as well as your offer process. Many companies talk about salaries, but neglect to fully explain all the other aspects of their total rewards package.
Retain your people for the long-term
When employees feel that they are being paid well and fairly, they are more engaged, more productive, and more likely to remain in their jobs and want to move up within your company.
In this way, compensation management is the foundation of a stable organization with low turnover.
Employees also want benefits that match their needs and values. During the pandemic, many companies began offering mental health programs, access to telemedicine, flexible work schedules, and other types of indirect compensation.
These benefits can have a bigger positive impact on an employee’s life than a modest pay increase.
Good compensation management has the power to make your employees feel like your company understands what they really want and care about.
Help your people perform better
A strong compensation management process will help employees understand the relationship between their pay and their performance.
Without a strategy in place and strong communication to bolster it, an employee might feel that they have no idea how or why their salary is determined. They don’t know what to do to get their next raise or promotion. And worst of all, they might be left feeling like the quality of their work has no meaningful impact on their pay. This is a recipe for disengagement and disaster.
On the flip side, a good compensation management process emphasizes understanding and ownership. Employees feel like they understand all the aspects of their compensation. They can have clear conversations with their managers about what they need to do to hit their goals, increase their pay, and get that next promotion. They are less likely to be dissatisfied and constantly looking for their next job opportunity.
When it comes to performance, compensation management can help motivate and engage employees, because they feel confident that excellent work will be recognized and rewarded by a system that makes sense.
What does compensation management software do?
Most companies start out by managing their compensation in spreadsheets. You might duplicate this information in your payroll or HRIS system. Over time, you might supplement these spreadsheets with a document or slide deck that explains some of your pay policies.
As your number of employees grows, these spreadsheets get bigger and messier, with complicated formulas and tables. They also tend to multiply, with different copies for different managers and leaders. They can be difficult for others to understand and even more difficult to share.
At around the 100 employee mark, you might notice that you’re starting to outgrow your spreadsheets and start looking for a software solution that can handle more complexity and scale with you.
A good compensation management software serves as the source of truth for compensation at your company. It centralizes all your data into one secure system, so that you never have to worry about where your data lives and who can access it.
It should help you design and structure a compensation strategy that can be implemented across your organization and set you up for consistency and success with each new employee that onboards.
Once you’re ready to run a merit or salary review cycle, compensation management software lets you calculate, review, approve, and communicate salary increases and promotions. It gives you visibility into your budget and helps you plan for the future.
Compensation is one of HR’s most important priorities. It impacts every single person at your company. Using data as the basis for creating a thoughtful compensation program is the key to attracting, keeping, and growing great employees for the long-term health and success of your business. Compensation management software gives you all the tools to plan and execute this strategy - efficiently and consistently across your organization. It is an investment in your most important asset: your people.