As an HR leader for your organization, you know that employee compensation is not just something you determine when you hire a new team member and then forget. In fact, how you compensate a team member should reflect their performance and change throughout their journey with your organization.
Whether you’re conducting performance reviews or moving an individual from one position to another, redefining how an employee is compensated is critical, especially if you want to increase employee loyalty and retention. After all, without fair and enticing compensation, people may start to leave. This is currently a big concern for employers as the trend of employees quitting in droves (known as “The Great Resignation”) continues. According to SHRM, November 2021 alone saw 4.5 million workers quit their jobs.
Since 1999, we at Astron Solutions have helped growing organizations, including businesses and nonprofits alike, streamline their HR strategies and better manage employees through ups and downs like the societal shift we’re currently experiencing. We’ve written this guide on employee compensation to help leaders like you do all you can for your own team members and avoid missing any essential gaps during these unprecedented times. Here’s what we’ll be going over:
- What is Employee Compensation?
- How to Measure Employee Compensation
- Best Practices for a Successful Employee Compensation and Benefits Strategy
- How Can an Employee Compensation Consultant Help?
It’s crucial that your organization’s compensation plan both motivates employees and sets the foundation for their own individual advancement. Without your hardworking staff members, your organization would not be where it is now. If your organization is struggling to create an effective strategy, consider investing in compensation consulting services. Let’s jump right in!
What is Employee Compensation?
Employee compensation involves all the ways your organization gives back to team members for their hard work. The obvious form of compensation is pay, whether it’s salaried, hourly, or sales-based. It’s important to financially compensate employees fairly, especially in terms of balancing the job role and your organization’s budget.
Employee compensation has many components, giving your HR team additional variables to consider. In this section, we’ll review exactly why creating a dedicated employee compensation strategy is so important, as well as the different forms it might take.
Why is Employee Compensation important?
It’s critical that you develop a strong and clear strategy for how employees are compensated for their work with your organization. However, there’s more to it than just ensuring that everyone is fairly compensated.
A fleshed-out and comprehensive compensation strategy should give employees insight into why their contributions are valued and how they align with their job roles. With a clear understanding of what their jobs are, why they’re important, and how much value they bring, employees are further motivated to continue working hard.
The best compensation strategy will also create a structure for how employees can grow in their roles and do more for your organization. When those times come, make sure you have a plan in place for how you will reevaluate each employee’s, as well as your overall organization’s, compensation strategy.
In summary, not only does your employee compensation plan provide a concrete and tangible representation of your organization and values, but it also establishes the foundation for overall growth and an improved employee experience.
The Different Types of Employee Compensation
Coming up with the best way to compensate your employees isn’t just about the numbers. The types of employee compensation are often broken down into the following:
- Direct compensation. This involves the financial ways that an employer gives back to team members. This comes in the forms of salary, hourly pay, incentive pay and/or bonuses, or overtime pay. For instance, some jobs are commission based, incentivizing staff to do more in order to receive higher pay. Allowances for travel, food, and relocation can also be included.
- Indirect compensation. This includes all the ways an organization can give back to an employee without paying them directly. For instance, this can include health insurance; paid time off; a retirement plan; diversity, equity, and inclusion plans; performance management styles; recognition of achievements and contributions; internal culture; and more!
While how you directly compensate team members is certainly important, it’s often found that indirect forms of compensation are the driving factors behind employee engagement, satisfaction, and overall retention.
In fact, it’s highly recommended that your own organization and HR team take a total rewards approach to employee compensation. This approach allows you to incorporate both direct and indirect forms of compensation into a larger strategy designed to both compensate your employees and demonstrate how much you value them. The diagram below shows how both indirect and direct compensation methods can come together in one holistic approach.
The challenge now comes from how to actually measure employee compensation.
How to Measure Employee Compensation
As you already know, how you compensate an employee will often change over time. This is especially true with your direct compensation, as each job and role will likely have different pay. Whether you’re advancing an employee or simply moving them to a new role, rethinking their compensation is a necessary process.
It’s easy to think that the best and fairest way to approach direct compensation is to look at the employee’s current performance. However, taking into consideration an employee’s performance rating alone often does not reveal their true market value.
By contrast, taking performance rating in tandem with an employee’s compa-ratio will reveal a fuller picture.
What is Compa-ratio?
Sometimes referred to as “compensation” or “comparison” ratio, the “compa-ratio” is the percentage obtained by dividing the actual salary (AS) paid to an employee by the midpoint (MP) of their position’s salary range. To find the MP, you might need to do additional research on the job role within the larger industry and calculate the middle of the salary range.
CR (Compa-ratio) = [AS (actual salary) / MP (midpoint of pay range)] X 100
This is a very simple but powerful formula when it comes to deciding how large of a pay raise an employee needs at a given time. This allows an organization to understand how an individual’s pay relates to the organization’s pay ranges and the market. So, if the individual’s compa-ratio comes out to 100%, then the individual is already being paid what a competent performer should be.
How to use Compa-ratio
To better understand this, let’s walk through an example. Let’s say the market pay range for the average receptionist position is between $35,000 and $52,500 per year, with the midpoint being $43,750 per year.
If there are five actual receptionists who earn (respectively) $37K, $39K, $43K, $45K, and $50K/per year, then the compa-ratios would be as follows:
- Receptionist A – 37,000/43,750 = .845 x 100 = 84.5%
- Receptionist B – 39,000/43,750 = .891 x 100 = 89.1%
- Receptionist C – 43,000/43,750 = .982 x 100 = 98.2%
- Receptionist D – 45,000/43,750 = 1.028 x 100 = 102.8%
- Receptionist E – 50,000/43,750 = 1.142 x 100 = 114.2%
Here are five clear percentages. The first two compa-ratios are below what a fully competent solid performer should be paid, the middle figure is nearly at midpoint, and the latter two are above the midpoint for the given position.
So how does one use compa-ratios to determine compensation? While pay scales always have a defined range, so too do compa-ratios. As outlined by Australia’s National Remuneration Centre, there are usually five zones of compa-ratio, each associated with a pre-defined level of performance. A commonly accepted range for compa-ratios is 80% to 120%, which divided into 5 zones are:
- 80-87% – new, inexperienced, or unsatisfactorily-performing incumbents.
- 88-95% – those gaining experience but not yet fully competent in the job.
- 96-103% – fully competent performers fulfilling the job as defined.
- 104-111% – those consistently performing the job at a level higher than what the job definition requires.
- 112-120% – those universally recognized as outstanding performers, both inside and outside the organization.
Each one of these zones is associated with a pre-defined level of performance, with 100% representing fully competent performance in the job. If we use these zones to compare the salaries of the aforementioned five receptionists, Receptionist A would be making a salary comparable to that of an unsatisfactorily-performing employee; B, that of an employee gaining experience; C and D, a fully-competent performer; and E, an excellent performer.
Time spent in a position and pay compression should also be recognized when setting hiring rates or implementing a new or revised pay system. For example, even though Receptionist A’s compa-ratio is low, if they are brand new in the job while Receptionist E has been in the role for 15 years, the pay difference makes sense.
However, if the organization has a true pay-for-performance focus, then compa-ratio is often used to determine the % adjustment, assuming the goal is to move to the midpoint. This would mean that an employee with low compa-ratio and outstanding performance should have their pay accelerated towards the midpoint.
Comparing these five percentages with the actual performance of each receptionist along with the time they’ve been in the role will indicate necessary changes to the individual’s pay. Ideally, an employee’s performance should match the compa-ratio range into which their salary falls.
Best Practices for a Successful Employee Compensation and Benefits Strategy
How you approach your own employee compensation and benefits plan will likely depend on your unique situation and organization. You have to take into account the type of job roles your organization has, your current budget, how your business is doing right now, as well as a number of other factors.
Nonetheless, there are some best practices that any HR leader can learn from. Consider the following as you design the best compensation strategy for your organization:
- Take a total rewards approach. As you know, it’s often the indirect forms of compensation that truly retain employees and provide a meaningful and valuable experience. Especially when budgets are tight, a total rewards approach to compensation provides ways other than direct financial pay and bonuses to help your organization attract and retain its talent.
- Consistently review employee compensation, including executive compensation. It’s easy to only look at employee compensation during the end of the year or during an employee performance review. However, it’s beneficial to review compensation practices at least once a quarter, giving your HR team time to make any necessary adjustments. If you’re wondering when a good time to review your current compensation plan is, consider asking yourself these questions:
- How would you estimate your organization’s current retention rate?
- How many paid employees currently work at your organization?
- What has been your historical employee turnover rate?
- How difficult was it for your team to adapt the last time you lost a member?
- Conduct audits on a regular basis. HR should audit compensation on a regular basis. There are many potential factors that could impact salaries and the need to make adjustments for employees.
- Research the compensation strategies of organizations comparable to your own. If you’re unsure of how to fairly compensate your team members, take a look at your competitors. Try to examine staff size, average yearly revenue, and missions or value propositions of similar organizations. You can research employer reviews on websites like Glassdoor for additional anecdotal insights.
- Conduct surveys of your employees’ feelings on their direct and indirect compensation. Getting feedback straight from your employees can also clue you into how to improve your current compensation strategy. Consider outlining surveys on what team members think of your indirect benefits. This not only provides an overview of how your employees feel, but can reveal if team members are at risk of turnover.
- Draft total compensation statements. Outlining the direct and indirect forms of compensation that each employee receives can not only help current team members understand their roles and value within the organization, but also be a key tool for recruitment. This way, prospective employees know exactly how they will benefit by being a part of your team.
- Foster a transparent culture. Try taking steps to create a transparent culture within your organization. Provide employees with ample chances to give feedback on their current compensation plan and continue to communicate compensation information as changes come.
As you begin to re-evaluate your employee compensation plan, you need to come up with ways to create a reliable process, not just a one-time fix. This means not only improving your current employee compensation strategy, but also determining how you’ll continue to review and improve it. Only with a long-term strategy in place can your organization start to truly grow and meaningfully engage employees.
How Can an Employee Compensation Consultant Help?
Your employee compensation plan is not something you can just come up with on the spot. It takes careful research of your larger industry/field, an in-depth look at your employees and their roles, and consideration of your current organizational standing and budget. That’s where an employee compensation consultant can help.
Dedicated HR consulting firms often help organizations by providing a third-party perspective on their current processes and how to improve them. There are specific compensation consultants with different specialties, so make sure to find one that fits your organization. For instance, nonprofits should seek compensation consultants who understand the unique circumstances and laws associated with nonprofits.
In general, a dedicated compensation consultant should be able to do the following:
- Total rewards consulting for your base compensation strategy.
- Custom survey design to help you learn what compensation you should offer for specific roles.
- Specialized strategy development for executive and sales-based compensation.
- Incentive and variable compensation program development to address particular goals.
- Policy development guidance to help HR departments effectively administer their new compensation programs.
If you have questions about compensation consulting services or are even unsure whether consulting is the right move for your organization, reach out to us at Astron Solutions. We’ll be happy to answer any question about this critical but often overlooked strategic element for growing organizations.
Employee compensation is a vital component of the HR strategy of businesses and nonprofits of every size. Make sure you not only develop a strategy that accurately reflects how you appreciate and value your employees’ work, but also grows and evolves as your organization’s goals and priorities do.
Take the time to flesh out your own strategy and even partner with a dedicated compensation consultant to really highlight areas for improvement and then, take action.
To continue your research on how to best compensate and manage employees, we recommend exploring these additional resources:
- Nonprofit Employee Compensation: Understanding the Essentials. If you work in a nonprofit organization, you understand that there are special considerations in your field. Learn more about it in this guide!
- Executive Compensation: Taking Charge of Your Org’s Approach. Ironing out your organization’s approach to executive compensation comes with unique challenges. Check out this guide to learn everything you need to know.
- HR Consulting Firms: 20+ Top Providers for Small Businesses. Working with an HR consultant can help your small business hone its approach to employee compensation. Explore this list of providers!
Wesley Tyulu says
I’m the Head of my department and new in the role. Some my subordinates have reached their mid-point and their monetary salaries exceed my starting salary. How fair is it that those I am responsible for earn more than me. I need help, please.
Jennifer Loftus says
Thanks for sharing your question with us!
The situation you’re describing can be an example of pay compression. Pay compression can be a source of frustration to managers when their employees’ salaries exceed their own.
As a rule of thumb, a manager’s pay rate should be at least 10% higher than the highest paid subordinate. However, in some instances, it might be OK that the employee is paid more than the manager. For example, if the employee has considerably more years of experience, higher degrees / certifications / licenses, works a different shift, and / or works in a higher wage area than the manager, the employee’s higher pay rate could make sense.
At this time, I recommend having a meeting with your HR team. Present the facts regarding salary levels, any bonuses, and any differences in the benefits package between you and your employees. Ask the HR team for more information regarding your organization’s total rewards philosophy, how the pay ranges are built, and how fresh those ranges are. Then, explore possible approaches to addressing this pay compression situation.
Good luck! And thanks again for reading our posts and reaching out.