We all know that navigating compensation is something of a rollercoaster nowadays. Between base salaries, bonus/commission programs, stock options or RSUs, and all the other kinds of benefits, it can get quite complicated!
One of the key parts of any P&C professional’s job is to be able to clearly communicate your own compensation philosophy to potential, current, and future employees.
Every organization’s compensation philosophy should reflect, and be strongly tied to, its values, employee value proposition, and market standing.
This is why it’s important for all P&C professionals and managers to thoroughly understand what a compensation philosophy is and how to craft one.
This step-by-step guide is meant for P&C professionals crafting their first-ever compensation philosophy, or those wanting to update/solidify their current one.
- What is a compensation philosophy
- Benefits of a compensation philosophy
- Compensation strategies
- Steps to creating a compensation philosophy
- Examples of compensation philosophies
What Is A Compensation Philosophy?
Compensation philosophy refers to the organization's approach and standing on how they reward their employees for work and how work should be done. Having a clear and documented philosophy will help you define and strategize for talent at any stage of the employee life cycle.
Your compensation philosophy should be unique to your organization and tied to your values. Given that companies grow and change over time, you should build in the practice of regularly revisiting your compensation philosophy to make sure you’re still aligned with those.
Employees are looking at an increasing number of factors when joining organizations: competitive salaries, non-traditional benefits (flexibility, hybrid workplace), opportunities for professional development, and culture (inclusivity, community, mission).
Defining and documenting your compensation philosophy (or total rewards package) will help attract, retain, and develop the talent you need in order to continue to grow in this competitive market.
How can a compensation philosophy benefit your organization?
Having a defined compensation philosophy has a waterfall effect: ambiguity and lack of transparency decrease, employees' morale increases, and productivity and trust will get a boost.
Let’s dive deeper and explore two distinct areas of the employee life cycle and how those are affected by having a defined compensation philosophy.
1. Attracting Talent
Now more than ever, employees are seeking transparency from organizations. One detail people are increasingly caring about is listing the pay band in job descriptions. Job listings that state salary receive on average 10% more applicants.
This number might seem small but, in reality, it’s a huge time saver for organizations. Not only will it increase the number of applicants for your roles, but you’re also more likely to close a candidate that is already in agreement with your salary range.
Citing the pay range from the beginning creates a sense of trust. Additionally, this will benefit your internal equity and help keep it controlled.
Compensation is part of your employer value proposition (EVP). When your compensation philosophy is shared with prospective employees, they make an informed decision on their alignment with the company and their future with it.
Sharing this information during the recruitment process increases your chances of hiring people that are aligned with your organization and increases the quality of your hires
2. Retaining Talent
An important part of retaining talent is ensuring there is pay equity across the organization. Pay equity means you’re ensuring equal pay across your organization i.e. paying employees the same when their responsibilities are identical.
Research suggests that Gen Z/millennials are more likely to talk to their peers about compensation. Get ahead of the curve and create an environment where people feel comfortable with their salary grade and why they’re getting that pay.
It’s gradually becoming more common for people across all age categories to disclose their salaries. When there is a pay difference, negative feelings towards employers and amongst employees arise. If employees even perceive a pay inequity it will most likely affect their tenure or performance.
A compensation philosophy will help you avoid biases during pay rises and promotions. In order to avoid this, and other biases like certain groups not getting raises at an equal speed to others, it's better you develop the practice of checking for pay equity as part of your compensation philosophy.
Being transparent about your compensation philosophy helps create a better relationship between employees and management as both parties know what they need to do to get to the next level or make a career switch.
Lastly, in some countries this is becoming a law mandate (in Norway it already is), so you might as well get ahead of the curve.
Types of compensation strategies
Depending on where you are, and the industry you’re part of, there are many different types of compensation strategies.
Here I’ll highlight the three easiest, most common, and most accurate to us: lag, match, and lead.
You can use one for the whole organization or a mix! This will depend on the organization’s philosophy and market (in simple economic terms: demand and supply for the talent you are recruiting and retaining for).
One term that we will refer to throughout this section is ‘percentile’. Most of the time, you will find salary data arranged by percentiles (25th, 50th, and 75th).
For example, using the 25th percentile means that 25% of the reported salaries in your data set are lower than the figure given. So, if the 25th percentile for a job is $40,000, that means that 25% of people in that same role are making less than $40,000 per year.
This means you will be paying lower than the market median. A lag-the-market strategy is located below the 50th percentile threshold and is usually a strategy taken on by non-for-profits, companies that are struggling, organizations with little competition, organizations that have a large supply of potential employees, or organizations with other amazing perks (think about government work).
The main advantages of this strategy are that you will attract employees that are undoubtedly aligned with your values, lower overhead costs, and it allows you to invest in your total rewards package.
A match-the-market strategy means you will pay the median of what the marketplace is, which includes the lowest, highest, and everything in between salaries. This means you will be paying the market median (50th percentile).
The strategy is usually used by employers who don’t lack talent attraction and organizations that are in an employer-driven market. This strategy usually benefits lower-paying positions and slows down the increases for higher-paying positions.
The main advantages of this strategy are that employees are being fairly paid, it enables organizations to keep up with inflation, and ensures companies do not fall behind with salaries.
This means you will be paying above the market median (75th percentile). A lead-the-market strategy means you are one of the top payers for talent in your marketplace.
The strategy is usually used by organizations that are in an employee-driven market, have high competition, or are in an industry where salaries are constantly increasing.
Companies that use this strategy typically expect high performance, above-average results, and top-quality work. The benefits of this strategy are a surplus of talent, a decrease in turnover, and increased productivity as employees want to stay with the company.
Steps to creating a compensation philosophy
Now that we have covered the benefits of compensation philosophy, and compensation strategies, I’ll take you through the process for developing one in your organization.
Step 1: Dive into your values and align your compensation philosophy to them
Start by getting the decision-makers together in a room to form your compensation committee. Normally it’s human resources/P&C, a finance executive, and the CEO.
You will want to allocate at least ⅓ of the meeting to go over the purpose of the meeting, a brief on compensation philosophy, and answer any questions they might have.
It should be very clear who the owners of each action are and what the expectations of the new tasks are. Some of the questions you should answer are:
- Are all my salary bands created using the same salary percentile?
- Are each of my jobs defined and tied to a data set (role matching)? Ex. For the software developers in my organization, we are using the data set ‘software engineers’. You want the role from your data set to match the role in your organization at least 60%.*
- What is our cadence for checking external salary data?
- Who will be refreshing our salary bands and when?
- Who will be responsible for keeping a pulse on pay equity?
Step 2: Define what your ‘marketplace’ is
The next step is determining what ‘marketplace’ means to your organization.
As an example, a food manufacturing company in Vancouver looking for tech workers (so their core product isn’t software) might want to define their ‘marketplace’ as ‘all companies in Vancouver’ so that their tech employees are paid similarly to other industries in Vancouver.
On the contrary, a software or engineering company might want to define their ‘marketplace’ as only software/engineering companies so that they are directly competing with similar organizations. You can define your marketplace by geographic location, industry, revenue size, number of employees, or a combination of them.
After researching the data, decide if you’ll be lagging, matching, or leading the market.
Step 3: Create your pay bands
Now you’ve identified your market and model, it’s time to create your pay bands for each role. One of the models I’ve used in the past is depicted below.
In the example, you will find three important items: our philosophy (three compensation zones and three different levels per role), our chosen percentile (50th), and the salary data (80-120%).
Let’s assume that you’ve agreed to use the 50th percentile for salary data and your role matching suggests that L1 is $80,000. If you fill in the blanks your pay band will look like this:
Now you can repeat this stage for all your roles and “Hooray!” your pay bands are ready.
Step 4: Create a total rewards package that compliments and strengthens your salary compensation
Compensation goes beyond salary and nowadays it is more important than ever that we understand our current and future workforce and offer the best package.
Total compensation refers to monetary and non-monetary benefits an employee receives.
- Total compensation. This is the monetary portion of the equation (‘take home $’) and is usually made of base salary, commission, bonus, awards, and equity.
- Total rewards. This is the non-monetary (although costly to employers) portion. It can include benefits (extended healthcare, vision, dental), PTO, remote-friendly, flexible work schedules, learning stipends, wellness programs, etc.
Before putting any programs in place we suggest you do focus groups, keep an eye on our employee surveys for comments, and understand how your workforce is transforming (e.g. is there a wave of ‘new parents’?) to put together the best package for your current and future workforce.
Step 5: Review
After all this hard work you should aim to do at least three types of reviews to keep your compensation philosophy and total rewards package accurate and relevant.
Compensation philosophy review
Revisiting your philosophy and making sure it is still aligned with your values. This exercise can be done once a year, or every time an impactful change has happened like a merger, acquisition, rapid growth, or change in values.
Salary band reviews
The last couple of years and world events (covid, political changes, inflation) has shown us that salaries are as volatile as everything else. It is best practice to revisit your salary data with updated information 3-4x per year.
I’m not suggesting you change your pay bands that often as peaks usually even out after the dust has settled. Think about, when Covid-19 first started, how salaries plummeted because we were all afraid of the unknown and 4 months later, once life stabilized, salaries skyrocketed again.
You don’t want to be stuck on either side of the graph changing your salary bands when we are at rock bottom or when we are sky high because nobody wants to take a pay cut.
It’s normal that your organization will grow and change over time and thus people will too.
Through your eNPS, employee feedback/comments, industry trends, or even how extended benefits are being used, you can get a good idea of what’s most important for your organization now or what they will care about in the future.
Since this tends to be a slower change, we like revisiting it 1x per year usually in alignment with our renewal for extended benefits contract.
Compensation philosophy examples
- Government of Canada. They are known for paying below the market median but offering perks that are unheard of elsewhere in Canada. Some of these are double or more paid vacation time and PTO, generous pension plans, reduced work hours, average performance expectation, and unionized environments.
- Financial institutions (with the exception of investment banking). They are known for paying median salaries, have decent total rewards packages, and regular expectation for performance.
- Tech giants. They are known for being one of the top payers for their HQ employees in Canada with above-median salaries, generous sign-on bonuses, and high-yielding RSUs. The downside is that they expect top performance, more than average work hours, and unpaid on-call for certain roles.
This article has mostly focused on different compensation approaches and salary bands, but it’s important to note that salaries are just one part of the puzzle. A well-rounded compensation philosophy must include; total compensation, salary structure, and raise/promotion models.
Compensation philosophy has been a hot topic in the last few years as people become more interested in closing the pay gap, pay equity, and salary transparency.
In my experience, having a defined and documented compensation philosophy has an enormous impact on organizations and the performance and well-being of their employees.
By dedicating time to this organizations will see positive changes in culture, reduced costs, and overall increased performance.
Some further resources surrounding compensation:
- 6 Tips For Effective Employee Compensation Discussions
- 10 Best Employee Compensation Management Software In 2023
- 13 Best Compensation Courses For HR, Business Owners And Managers 2023
- 20 Types Of Employee Benefits You Should Know
- 10 Best Benefits Administration Software For Employees (2023)
- Why Pay Transparency Is A Good Business Practice And How To Ensure It
* Usually, salary data will be shown like this:
- ‘Software Developer'
- 25th $60k, 50th $90k, 75th $125k
- 2+ years in web app development
- 2+ years experience in agile development environment
- 1+ years in architecture design
Your job might look like this:
- 'Software engineer'
- Salary - TBC
- 2+ yrs experience developing using ruby on rails
- experience in agile and/or kanban environments
- knowledge in system design, scaling systems
- ability to pair program and convey technical information simply
So, in this case, you can see there is a 60%+ overlap between the responsibilities of the two roles. This means you can use that 'software developer' salary data for your 'software engineer' position (job matching).