Incentive Compensation

How to Build Effective Compensation Plans

Siva Subramanian
min read
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"What is your compensation plan?"

This is a key question that has to be answered in detail if you want to attract top talent who can help your company grow. 

A compensation plan details out how you want to pay your employees, which includes the base pay, wages, commissions, benefits, stock options and other perks. To remain competitive in your market, it’s important that your compensation plan is well defined. 

A lot of factors are taken into consideration when designing compensation plans. From determining your overall objective to your company size, location, your market, every factor plays a crucial role in getting your compensation plan right. As you address each vital component in your plan, you avoid the problems you may face because of it in the future. In this blogpost, let's look at the key steps involved in the creation of compensation plans.

Define Your Compensation Philosophy

Firstly, all the key decision-makers in your organizations should be on the same page before finalizing the compensation strategy. What are your company’s goals? How do you want the pay structures to be? Will you offer bonus incentives for employees? Be sure to be as specific as possible as you figure these out.  

After you’ve done the initial research and arrived at a policy, you would fall under one of the below three categories:

  • ‘Leading the market’, which means your compensation is higher than your competitors
  • When your compensation is the same as the competitors, it is called ‘Matching the market'.
  • ‘Lagging the market’ means that you offer lower compensation than your competitors. 

You should adjust your compensation plan if your compensation is on the lower side, for you’d find it difficult to get talents in such cases.

Research and Analyze the Job Market

You cannot arrive at the right compensation package without conducting thorough research of the market you operate in. List down each and every role in your company, the job description, and the skills required. Also consider the location, the educational requirements if needed. Get to know about all these, and make sure you don’t miss any key factors that would impact the compensation plan. 

Categorize Jobs Based on Pay Grades

The next step is to create pay grades and define the salary range so that you can categorize the job positions accordingly. By doing this, you establish a framework of compensation that your organization can depend on. 

Decide on the Salaries and Hourly Wages

Depending on how you want to compensate your employees, you can either choose to implement salary or hourly wages. What you want to choose depends on your goals, your industry, and various other factors like the size of your company, the revenue you make, what position you are looking for, etc. 

While you can determine the pay grades to define the employee salaries, you can also do this by determining the salary bands as well. Here, the pay grades are divided into salary bands, and the amount is higher in each band than they are in pay grades. When you choose this type of compensation structure, the emphasis for employees will be on career development rather than a job promotion. 

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* You have to understand your economics, and you have to understand what drives people. Then you have to test your way into what makes the most sense, because the human element/reaction can't be modeled.

* You need to use a data-driven vs gut instinct approach. Have a deep understanding of the competitive environment and create a plan that folks would choose if provided a choice.

Choose the Benefits

A well-defined compensation plan should consist of benefits that can further motivate your employees. General benefits include health insurance, dental care, pay rises, paid holidays, PTO, etc. Determine what all benefits you want to have in your compensation plan, and make sure it is competitive enough to bring in the talents you are looking for.

Set Achievable Goals

Nothing demotivates an employee like an unattainable goal. Make sure that the goals you set in the compensation plan help them raise the bar, yet isn’t something that can never be reached. Setting goals that are impossible to achieve would result in less employee engagement, and leave them frustrated, which would eventually affect your business growth.  

Appoint a Compensation Manager

In general, a human resource person is appointed in this position, who does the industry research, decides on the direct compensation, classifies the job, etc.

Put Down the Required Policies

Compensation policy helps set the expectations clear for your employees, and a well-thought-out one is needed for your company as well. You may have policies for health benefits, paid holidays, and other forms of incentives, and all these should be in sync with the compensation plan. 

Get Approval from Your Leaders

Once you’ve finalized the plan, get approval from the leadership team, so that they fully support the compensation plan, and you don’t want to make changes to it later, which may lead to chaos. 

Develop a Communication Plan

All your employees should understand the compensation plan clearly. You can distribute in different methods that seem fit for you, like email, or group gatherings. What's important is, you’ve to ensure every query from the employees is addressed. Compensation plans may be a little complex for some to understand, and it’s your responsibility to make sure your employees understand it.

Monitor Your Compensation Plan

Analyze the plan you’ve created regularly, and update it so that it remains in sync with the current market conditions. You’ll also get a fair idea of whether you overpay or underpay, and can bring the necessary adjustments to the plan. That’s not all, reviewing also helps you meet the legal requirements, and ensures you comply with the federal, state, and local laws. 

Measure the Performance

Measuring employee performance should also be done in a transparent manner, and you can fix the criteria based on your business objectives. For example, a sales organization may need to review the performance of sales reps periodically, and the criteria can be, the volume of sales done, the number of new deals closed, the level of customer satisfaction, etc.

Track if Candidates Reject Your Compensation Plan

You should find out if people reject your job offers due to your compensation plan. Also, understand the reason why your employees leave your job. If it is because of low compensations and benefits, then it’s time to make significant changes to the plan. 

Final thoughts

To start with, make sure your compensation plan is well defined. Be open to feedback from your employees, and alter the plan as and when needed. You aren’t going to stick to the compensation plan you created once forever. What’s important is to ensure that the plan attracts top talents and helps your business grow. 

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