Why is an intelligent compensation strategy so important?

While it seems like a no-brainer that an intelligent compensation strategy is important, many companies don’t know exactly how much of an impact the right (or wrong) compensation strategy can have on overall budget and performance.

Compensation is not only one of the highest costs a company will face, but it’s also one of the most important influencers in maximizing company performance.

The ultimate goal is to find a strategic compensation plan that will maximize employee performance and satisfaction while controlling costs.

Start with a fair and strategic salary base

Regardless of whether you’re paying hourly, salary, or base + commission, it’s important to have an understanding of the average market pay for each of your employees.

While there are multiple online salary resources that can give you general information about market salaries, the most up-to-date and accurate information will come from an expert who has experience with local companies of all sizes and industries.

Decide where within market salary you want to pay your employees, then do your best to stay consistent with that percentile among all employees. Pay satisfaction has little to do with actual salary dollar amount. Instead, satisfaction depends on the comparison of salary to market average, comparison of salary fairness in relation to other employees’ pay within the company, and overall confidence in the organization paying fairly.

Transparency vs. Secrecy

Should you be open and honest about sharing employee salaries within a company? Or should you keep salaries private? There are arguments that support both methods.

On one hand, visibility into company pay structures—if fair and consistent—can increase company trust and overall salary satisfaction. On the other hand, it can also increase competition among employees or highlight shortcomings if your strategy is inconsistent across different departments.

What is the best compensation strategy for your company?

There are many different compensation theories, each with its own benefits and detriments. Below we’ll discuss some of the most common theories and the circumstances under which they are most effective.

STICK & CARROT

Rewards and financial compensation will encourage good behavior while punishment will discourage bad behavior.

The pay-per-performance—a.k.a. stick and carrot approach—theory of salary is an economic standard when it comes to compensation strategies. The reason this has become such a popular method of pay structuring is because of the concept that “In a perfect world of perfect information and low transaction costs, the parties will bargain to a wealth-maximizing result.”

Or basically that people will perform actions based on their calculation of highest financial reward.

While this pay structure largely includes the base pay + commission pay structure, the theory also encompasses yearly or quarterly bonuses, raises as incentives, and other financial or extrinsic rewards to be used as motivation.

When does Stick & Carrot compensation work?

Even though this is one of the most widely used compensation strategies, it’s also typically only effective for motivating up to 30% of employees. In the remaining 70%, this compensation structure has been proven to significantly diminish performance and overall job and pay satisfaction.

Studies completed by economists, psychologists, and sociologists alike have repeatedly shown that in most cases extrinsic rewards actually diminish employee performance, creativity, and overall job satisfaction. The reason for this is that the presence of external rewards squashes any intrinsic motivation or enjoyment of a job and creates a tunnel vision that severely affects creativity and innovative thought.

However, incentivizing performance works well in algorithmic jobs where there the duty is a single path to a single outcome (as opposed to heuristic jobs, which require a person to experiment with possibilities to devise a novel solution). That is because these jobs are typically unchallenging, unrewarding and non-creative, so extrinsic rewards help motivate workers while not diminishing the overall creativity of work (since there is no creativity).

TOTAL REWARDS

Combining monetary and nonmonetary rewards can create overall job satisfaction and thereby yield positive business results.

If you are part of an HR team or if you have a Human Resources team who helps organize your compensation structure, then you’re probably familiar with Total Rewards. The idea is that if employees are overall satisfied with their job and compensation, that they will perform at optimal levels.

Consider the following:

Plan, Communicate, and Maintain.

One of the shortcomings of Total Rewards is that it takes considerable planning, communication, and upkeep to maintain its effectiveness. Without an HR professional maintaining these benefits, this compensation strategy can be difficult to maintain which means it quickly loses its effectiveness and value.

What do your employees value?

The biggest mistake with Total Rewards is not recognizing what the employees want most out of the plan. Total Rewards compensation strategies are effective when employees feel like the plan is built around their desires and values, but quickly lose effectiveness when employees feel like the plan was not designed with their considerations in mind.

Understand the value

Total Rewards also loses its effectiveness when the value of the program isn’t communicated well to employees. Without understanding what the plan is worth to them, employees will not recognize it as a factor of satisfaction within the company.

Plan for now and for later

There can be a difficult balance in making sure employees are satisfied and that the plan is maintainable long-term. However, as John Brement, managing director of talent and rewards at The Americas, Towers Watson, it’s also important to think about total rewards as a way to attract the talent you want.

OWNERSHIP

Why do you get up in the morning? While salary compensates employees for contribution, ownership gives them actual control over their—and the company’s—success.

There are multiple reasons an ownership plan may be a good addition to your strategic compensation plan.

It aligns employee objectives with long-term goals

When employees have ownership within the company, believe in the company, and are fully aware of how the company succeeding means they will succeed along with it, their goals within the company begin aligning with the organization’s long-term goals.

It provides feelings of ownership

People crave knowing their work matters and that they are contributing to a larger whole. Nobody wants to be a button pusher—they want to become bigger and better contributors in work they believe in. Giving them ownership of a company helps them to feel more ownership in their work since they can better connect the work they do with the outcomes of success.

It fosters unity within the company

Robert B. Reich, former U.S. Labor Secretary, gauges the health of an organization based on what he calls a “pronoun test.” When people are talking about the company they work for, are they describing it in terms of “they” or in terms of “we”? If an individual is feeling alienated from a company, they’re likely referring to the company as a separate entity from themselves. An ownership plan helps take away the “big guys vs. little guys” feelings within the company since there is more of a feeling that everyone is in it together.

Things to consider with ownership plans:

Transparency: If employees don’t believe in the company’s future by understanding the company’s growth, successes, and struggles, they won’t believe that their ownership in the company has any actual value.

Dilution: Make intelligent financial decisions regarding offering ownership to your employees. Use ownership options judiciously so you don’t dilute existing equity.

Rules for a successful compensation strategy

1 – Track, Measure, and Analyze

When you’re developing, launching, and maintaining a compensation strategy, it’s important to have the tools in place to make sure the plan is fiscally supported and that the strategy is fulfilling your strategic goals.

2 – Budget and forecast

Make sure your plan can be supported financially in the short- and long-term.

3 – Set clear goals

Know what you’re trying to accomplish with your compensation strategy—improved performance KPIs, lower compensation costs, higher employee satisfaction scores, lower turnover, lower employee acquisition costs, etc.

4 – Track key metrics

Having goals isn’t enough. Track your company’s progress scrupulously to ensure your compensation plan is achieving what you’d like it to achieve.

5 – Empower yourself (and others) with information

Just as goals are useless without tracking, so too is tracking useless without using it to empower yourself and your team members with information. Don’t keep your metrics secret. Involve your teams in developing goals and keep them regularly apprised on the progress of these goals.

6 – Review cost-effectiveness

Compensation plans should not be set and forgotten. It’s wise to regularly review the pieces of your compensation plan to make sure it’s in line with your budgeting and forecasting, as well as to ensure the benefits of the plan is in line with actual cost.

7 – Analyze overall plan effectiveness

Quantify and review your goals, metrics, tracking, and team member collaboration and regularly review the plan effectiveness. There’s no way a team of any size can perfectly predict the effectiveness of a plan before it’s ever put to the test with your team members, so understand that you can—and should—fine-tune your plan based on its performance.Save

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Where to begin

It can be overwhelming to design and execute a strategic compensation plan, but with the right planning, forecasting, and analysis, the right plan can successfully decrease your compensation costs while skyrocketing employee performance.

Begin with understanding what it is your employees actually value and what will most motivate them toward success. After this, careful budgeting and planning can help direct what your company can strategically accomplish without breaking the bank. Finally, remember that compensation is a huge part of your budget, so it is important to always set specific goals, track, and analyze to make sure you’re maintaining an intelligent and effective compensation strategy.

For more information about compensation strategies, talk to one of our expert CFO consultants.

About the Author

Jerry Vance

Founder & Managing Partner

Jerry Vance is the founder and managing partner of Preferred CFO. With over 13 years of experience providing CFO consulting services to over 300 organizations, and 26 years in the financial industry, Jerry is Utah’s most experienced outsourced CFO.

References:

Dr. Trent Kaufman, D. Joshua Christensen, Andrew Newton, National Research by the Cicero Group, Drivers of Great Work, 2015
Daniel H. Pink, Drive: The Surprising Truth About What Motivates Us, Riverhead Books, 2009
John Boitnott, Why Ownership is now a Favorite Employee Benefit, Entrepreneur.com, March 17, 2015
https://hbr.org/2015/04/the-right-way-to-use-compensation-2
https://en.wikipedia.org/wiki/Overjustification_effect
http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2731358/
http://www.timothy-judge.com/Judge,%20Piccolo,%20Podsakoff,%20et%20al.%20(JVB%202010).pdf
http://www.pnas.org/content/107/38/16489.abstract
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