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In a competitive market, effective compensation management is key for employee retention and attracting top talent.

In this comprehensive guide, we’ll explore what compensation management actually entails and how to create an effective compensation strategy for your organization.

What Is Compensation Management?

Compensation management is the process of determining employees' monetary and non-monetary remuneration to support hiring and retention in according with business strategy.

Compensation methods include:

  • Base pay
  • Bonuses
  • Employee benefits
  • Annual raises
  • Raise/promotion models
  • Incentives.

Why Is Compensation Management Important?

Compensation management is an important aspect of your overall talent management strategy because of the role it plays in retaining and hiring the best talent.

Although not the be-all and end-all, compensation is a significant factor in employee retention why people choose a particular role over another.

An effective compensation management system will result in:

  • Better hiring—you’re more likely to attract and retain the kind of talent you want
  • Greater pay equity across the organization
  • Consistent and predictable budgeting and planning
  • Helps keep a pulse on the evolution of roles and assists in overall talent management.

It’s such an important process that some HR professionals choose to niche down, and there are a number of compensation courses for those wishing to do so.

Who’s Responsible For Compensation Management?

Depending on the size of an organization, compensation management will be a joint effort between human resources (maybe a separate compensation and benefits department), finance, and the COO/CEO.

In larger organizations, there may be a dedicated team of compensation specialists dedicated to developing and maintaining the organization’s strategy for compensation.

Broadly speaking, compensation specialists are responsible for:

  • Analyzing the market and reviewing internal data, such as feedback from surveys and benefits usage, to determine the effectiveness of their organization’s compensation package and how it compares with that of other organizations in a particular industry and region.
  • Conducting job analyses to determine the skills, knowledge, and abilities required for each position, ensuring that compensation practices are compliant with all applicable laws and regulations, and advising managers on compensation-related matters, such as pay equity, salary negotiations, and job classifications.
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What Are The 4 Main Types Of Compensation?

Compensation is more than just employee salaries. There are four main types of compensation split into monetary and non-monetary.

Total compensation, sometimes called direct compensation, is monetary and includes: 

  • Base Pay: This is the basic salary or hourly wage paid to an employee.
  • Bonuses and incentives: These are additional forms of compensation designed to reward performance or specific achievements.
  • Equity compensation: Typically offered in startup or high-tech companies, this includes options like stock options or shares in the company.

Total rewards, sometimes called indirect compensation, is non-monetary and covers:

  • Benefits packages: Non-wage compensations such as health insurance, retirement plans, childcare, and paid time off.

Additional compensation types: 

  • Profit sharing: Distribution of a portion of the company's profits to employees.
  • Commission: Earnings based on sales or performance targets.
  • Overtime pay: Additional compensation for hours worked beyond the standard workweek.
  • Hazard pay: Additional pay for performing hazardous or risky work.
  • Relocation assistance: Financial support for moving expenses when a job requires relocation.
  • Stock options: The option for employees to purchase company stock at a discounted rate.
  • Education reimbursement: Compensation for educational expenses, such as tuition and books.
  • Travel allowances: Compensation for travel expenses related to work, such as lodging, meals, and transportation.

How To Create An Effective Compensation Management Strategy 

A lot of effort goes into creating a compensation strategy and the work is never done.

The task itself can be loosely split into these 4 phases:

Phase 1: Planning and strategy development

The basis of compensation management in an organization is the compensation philosophy

This is a written document that codifies how an organization will approach compensation management. You’ll want to determine:

  • Your values when it comes to compensation
  • Who’s responsible for what
  • Salaries vs the market average
  • How often the compensation package will be reviewed.

Phase 2: Designing compensation structures

Once you’ve established your compensation philosophy you can build a consistent pay structure.

This involves:

  • Conducting a job-leveling exercise to determine roles based on their relative value in your organization.
  • Creating detailed job descriptions to serve as a foundation for comparing jobs internally and externally.
  • Market research and salary benchmarking to understand how competitive your compensation is vs peers.
  • Establishing pay grades and ranges using the data from job analysis and market research.

Phase 3: Implementation and administration

Once you’ve developed your new compensation plan it’s time to roll it out across your organization.

Our advice is to be open and transparent about any changes you make and why you’ve decided on your employee compensation packages.

This is especially important if you’re implementing performance-based compensation practices.

Phase 4: Monitoring and evaluation

Markets change and so does business strategy. 

Regularly review your compensation strategy for effectiveness and adjust based on market factors and the relative importance of roles in your organization.

You can also gather feedback from employees using methods such as employee surveys and stay interviews.

Questions to ask when determining the strategy

Here are some key questions to ask when making compensation decisions.

  • What are our organizational goals and how can compensation support these goals?
  • What is our compensation philosophy and how does it align with our company culture and values?
  • What mix of base pay, bonuses, benefits, and other incentives will be most effective for our workforce?
  • How will we manage and adjust the compensation plan over time in response to market changes and organizational growth?
  • What legal and regulatory requirements must we comply with in our compensation practices?
  • How transparent will we be about our compensation structures and decisions?

Compensation management software considerations

Compensation management software helps streamline the compensation management process, especially when dealing with international workforces.

Here’s what to look out for:

  • Integration with existing systems. Ensuring the software integrates smoothly with HRIS, performance management, payroll software, and other existing systems.
  • Scalability: The software should be able to accommodate organizational growth and changes.
  • Compliance features: It should help in adhering to legal and regulatory compensation requirements.
  • Data security and privacy: Ensuring sensitive compensation data is securely handled.
  • Analytical capabilities: The ability to analyze compensation data for insights and informed decision-making.

Compensation Management Best Practices

1. Decide on a compensation philosophy that’s unique to your organization and tied to your values, culture, and business goals. For example, perhaps you want to offer median salaries but then generous bonuses depending on performance.

2. Review regularly. It’s recommended that salary bands are reviewed 3-4x per year, total rewards once per year, and your compensation philosophy once a year.

3. Be transparent. When it comes to compensation, it pays to be transparent. While this might not mean disclosing everything about your compensation philosophy, being transparent about pay practices can further help with recruitment and pay equity and help build trust internally.

Key Takeaways

  • Compensation management is rooted in the organization’s strategic goals and values as well as size and industry.
  • It’s wise to regularly reevaluate your compensation strategy, normally once per year or as needed.
  • Compensation is more than just salary and other monetary rewards. Non-monetary rewards such as perks and benefits can be equally important.

Join the People Managing People Community

You can find more expert tips and advice over in the People Managing People Community, a supportive community of HR and business leaders sharing knowledge and expertise to help you grow in your career and make greater impact in your org.

By Finn Bartram

Finn is an editor at People Managing People. He's passionate about growing organizations where people are empowered to continuously improve and genuinely enjoy coming to work. If not at his desk, you can find him playing sports or enjoying the great outdoors.