A compensation plan is a set of guidelines by which employers reward employees beyond their salaries. It's a form of employee benefits that includes bonus payments, retirement investments, health insurance, and other financial incentives.
A compensation strategy is very attractive to both the employer and employee because not only do they provide financial rewards but also align employees with company values and goals.
Key takeaways:
- The main goal of a competitive compensation plan is employee retention.
- The total compensation package can be direct compensation (e.g. base pay only), indirect compensation (e.g. special perks), or a mix between the two.
- An effective compensation program includes both potential and existing employees.
- It forms a crucial part of your business strategy to attract and retain talent.
- The future of compensation plans leans toward more transparency about compensation plan payouts and the utilization of AI management software tools.
Why You Need a Compensation Plan for Your Employees
As mentioned, a compensation plan is a structured strategy that outlines how employees are rewarded for their contributions to your company, beyond their salaries. It involves various financial elements such as bonuses, benefits, commissions, and incentives designed to attract, motivate, and retain top talent.
There are two types of compensation options:
- Direct compensation strategy - in the form of employee salary, bonuses, and equity.
- Indirect compensation strategy - such as health insurance, education incentives, paid time off, or housing and car allowances.
Implementing a comprehensive compensation plan forms an important part of your business strategy for several reasons:
Attracting Top Talent
- A Lever study shows that 46% of workers say their salary or bonus is the biggest motivator for staying at their current company.
- However, a well-crafted compensation strategy isn't just about paying employees well; it's also a magnet to attract top-tier talent.
- Offering a competitive compensation plan that goes beyond base pay is key if you want to attract and retain talent. Things like health insurance, commission pay, or retirement annuities are attractive benefits for employee compensation considerations.
Retain High Performers
- According to The Conference Board, 62.3% of American workers were satisfied with their jobs in 2022. Competitive employee salaries, perks, and a strong workplace culture were the key driving forces.
- With this being said, reducing employee turnover is crucial, especially when hiring fees become costly. A strong compensation plan can prevent this.
- When employees feel valued through fair pay and recognition, they are more likely to stay for the long haul.
Ensuring Fairness and Equality
- According to Pew Research studies, women aged between 25 and 34 received $0.92 for every $1 men earned in 2022.
- Transparency in your compensation plan can help rectify pay inequalities.
- When employees perceive fair compensation, their job satisfaction and loyalty to the company improve.
- A compensation plan essentially shows how an organization values its workers and gives them a glimpse into the corporate culture they strive for.
Aligning Employee Goals with Business Objectives
- A compensation plan, especially those involving profit sharing or stock awards, aligns employees' interests with the company's goal.
- This is a win-win situation, whereby employees are rewarded for their hard work and contributions, and the employer benefits from improved productivity, operational success, and profit growth.
- These plans foster a collaborative workplace where employees feel motivated and incentivized to earn their contributions.
Compensation Plan Statistics
- According to the U.S. Bureau Of Labor Statistics, the total employer compensation costs for private company workers averaged $41.53 per hour. Wages and salaries accounted for 70.6% of employer costs with salaried employees averaging at $29.34 per hour.
- According to a Payscale survey, only 55% of current businesses have a compensation plan program in place, which is a 7% increase from pre-pandemic days.
- Harvard University said that every $1 per hour pay increase results in a 2.8% employee retain rate; whereas every $1 per hour loss can result in a 28% turnover increase.
- Studies show that for every $1 employers spend on employee wellness benefits generates a return of $3.
- According to a 2019 CNBC report, 25% of Americans do not feel they are paid well enough for their job. While the majority of workers receiving over $150,000 per year reported to be satisfied in their employment.
Designing a Compensation Plan that Attracts and Retains Top Talent
Effective planning is crucial for attracting and retaining top-tier employees. Your compensation strategy needs to encompass your company values and business goals while also fostering an inclusive workplace culture that drives results.
The compensation philosophy is simple: Create attractive compensation packages that are hard for employees to resist.
Here's a step-by-step guide on how you can do it:
Conduct Market Research
- Identify key players in your industry of similar size.
- Look for businesses within the same geographical area - especially if your employees are location-based.
- Compare the salary ranges, job roles and employment descriptions, and job satisfaction of these companies to get an idea of what employees expect.
- Make use of salary surveys and other benchmark tools to help make your full analysis.
Define Company Compensation Philosophy
- Set clear objectives and benchmark standards that are aligned with your company culture and values.
- Explain performance-based incentives, like profit sharing or gainsharing programs, in a clear and understandable language to avoid any misunderstandings.
- Discuss how company culture impacts the compensation program and how it should reflect the company's values, mission, and objectives at all times.
- Ensure employees understand the different types of compensation programs, such as direct and indirect compensation packages.
Develop Salary Structures
- Create salary ranges or salary bands for different positions, considering geographic differences (e.g. remote vs in-office working), experience, and education.
- These bands should allow for ample growth within the company but be structured to maintain internal equity.
- Ensure employees' salaries are aligned with current industry standards and are given room for qualification rewards.
Incorporate Variable Compensation
Discuss how to design performance-based incentives, allowing for employee input.
- For instance, profit sharing rewards could form part of your total compensation program. This is when employees are given a fraction of overall business profits after a certain timeframe - and when business objectives have been met. This form of compensation plan fosters long-term employee commitment and loyalty.
- For more info about this type of compensation plan, see our profit sharing template.
- Gainsharing is another employee compensation strategy to consider. This is when employees are rewarded for improved operations and reduction in running costs and wastage. These "gains" are compared against benchmark standards and the positive improvements are split amongst employees - often used for short-term wins.
- Stock or equity compensation is ideal for larger companies, where profits are consistent and companies can give away percentages of their market share.
Add Benefits and Perks
- As briefly mentioned earlier, benefits and perks would fall into the indirect compensation category. They are "additional compensation" benefits over and above base pay.
- These types of employee compensation programs include financial benefits such as:
- Health insurance
- Disability insurance
- Dental and vision cover
- Wellness benefits (e.g. mental health days, gym memberships)
- Retirement plans
- Businesses can also include special perks that align with their company culture, such as flexible work hours or childcare benefits.
Legal Compliance
- Business owners must understand that employee compensation programs are like any other legal document. They serve as an addition to employment contracts and promise employees certain benefits or payments based on performance goals.
- When crafting your compensation plan, ensure it aligns with employment laws, such as salary pay, anti-discrimination laws, and other relevant industry regulations.
- Regularly review compensation packages to ensure they are relevant and compliant.
Implementation Planning
- When drafting total compensation packages, ensure employees are kept up to date with any changes and the timeline for rolling out plans.
- Discuss financial implications and budgeting for the new plan with all involved employees. Ensure they understand compensation calculations, payout timeframes, and any repercussions of falling short of company expectations.
Communication of the Plan to Employees
- Once you are satisfied with your compensation plan, it's time to explain all the details to your employees.
- Clear, open communication is key to fostering an inclusive and informative team discussion, where all employees understand their duties and incentive payouts.
- Suggest ways to incorporate employee feedback into the final plan. This makes employees feel included and their input is valued.
- Ongoing communication, in the form of board meetings, webinars, or brochures, is recommended regularly. This keeps employees (and managers) up to date with any compensation changes and business expectations.
Types Of Compensation You Can Use
We've briefly mentioned the difference between direct compensation (e.g. base pay) and indirect compensation (e.g. special perks), but a compensation package doesn't end there. Let's take a look at the different types of compensation available for you and your business:
Monetary Compensation
This is quite straightforward as employee compensation is in the form of money, such as:
- Base pay: This is the core component of compensation and is usually in the form of a 'set' amount paid monthly. It does not include bonuses or other financial perks.
- Hourly wages: Typically paid for part-time, contract, or hourly employees.
- Overtime pay: This employee compensation is when employees work over and above their usual employment hours as stipulated in their employment contract. This is often needed from time to time. For instance, when production deadlines must be met over busy holiday periods - overtime pay is x1.5 of employers' usual wage rate.
Short-Term Incentives
- Bonus pay: These are additional compensation payouts given to employees for achieving specific performance targets or for exceptional work. Bonuses can be structured in several ways, such as annual, project-based, or based on the employer's discretion.
- Commission: This is commonly used in sales positions where employees are given a portion of their sales as employee compensation. It's used to motivate employees to increase their sales performance.
- Profit sharing: As mentioned, this is an employee compensation plan that gives employees a portion of overall business profits. It's often used to motivate employees to work toward a common business goal.
Long-Term Incentives
- Equity compensation: This is commonly used in startup businesses where employees are given stock shares at a reduced cost. This essentially makes them "part-owners" or equity holders of the company, boosting their motivation and drive to succeed.
- Restricted stock units (RSUs): This is when businesses incentivize employees by giving away stock shares or equity based on performance metrics and operational success. It's a type of variable pay plan. It's used to foster long-term employee commitment and loyalty and is usually paid out after a certain vesting timeframe (e.g. 5 years). RSUs are taxable incomes.
- Performance shares: Similar to RSUs, these are another type of equity compensation. However, performance shares are tied to specific performance metrics, hence the name. The vesting of performance shares is based on meeting predetermined benchmark standards and is paid out after a certain timeframe.
- For example, if a company's goal is to reduce wastage they would implement a performance share compensation plan. Similar to gainsharing, employees are rewarded for performance improvements. If they manage to reduce waste by $10,000 per month over six months, the total compensation of $60,000 is divided amongst employees.
Non-Monetary Compensation
- Health insurance is a common employee compensation benefit. The employer can structure this in different ways, such as full or partial compensation of the health care plan. There can also be limitations tied to this type of compensation, whereby employees must use the employer-designated healthcare provider.
- Retirement plans are another attractive compensation package addition. Employers pay a portion toward the employees' retirement plan which they are entitled to when reaching retirement age. This is a type of deferred compensation, usually seen as retirement or profit sharing 401 (k) plans.
- Paid time off, like paid vacation days, sick leave, or family responsibility days, forms part of this kind of employee compensation.
Compensation Plan Examples
An attractive compensation package may include some of the following:
- While paid vacations are not legal requirements in the US, oftentimes employers reward employees with paid time off. An employee's total compensation package could include 10 paid days off, which can be an attractive benefit for many workers.
- Severance pay is a way to reward employees after they have left their employment. It does not apply to employees who terminate their contracts but rather is used in the instance of retrenchment. Employees are paid a certain amount of money per year they have remained at the company - as a "thank you" of sorts.
- Employers could factor in disability insurance for their employees, should they become disabled from a work-related injury. Employers can pay toward a separate insurance cover or implement their own internal disability compensation cover.
- Another employee compensation package could include wellness benefits in the form of gym memberships, mental health consulting, dental and vision coverage, or discounts on spa treatments.
- For senior-level employees, employers could provide car or housing benefits over and above base salary pay. For instance, let's say an engineering manager receives $160,000 per year as base pay; employers could provide an additional $15,000 per year toward monthly car repayments.
Whichever employee benefits you opt for, ensure they are aligned with your company's values, goals, and business strategy objectives. Budget is another important element to consider to ensure the company can maintain employee compensation payments.
For employers looking to implement a successful compensation plan in the form of profit sharing, ShareWillow offers services to streamline the process for you. We've simplified the complexities of traditional methods to bring you a more automated and efficient compensation management solution!
The Basics of Compensation Planning: Your Questions Answered
What is a Compensation Plan?
A compensation plan is a structured strategy that outlines how a company rewards its employees beyond base pay. It includes bonuses, incentives, and other forms of benefits to attract and retain talent and boost employee motivation.
Why are Compensation Plans Important?
A compensation plan is designed to attract and retain current and prospective employees. It's an attractive business strategy tool that many companies use.
What is the Role of HR in Compensation Planning?
HR plays a pivotal role in constructing and implementing a company's compensation plan. HR professionals are responsible for calculating performance-based payouts and pay equity - often using compensation management software - and keeping employees aligned with company objectives.
HR professionals also collaborate with finance and management teams to set fair compensation plan budgets and control costs.
If you're unsure how to calculate profit sharing bonuses for your employees, read our article to learn more.
What to Avoid when Designing a Compensation Plan?
When designing your compensation plan, whether it be indirect or direct compensation, there are a few crucial things to avoid such as:
- Lack of market competitiveness
- Lack of transparent and clear communication
- Ignoring internal equity (fairness across similar roles)
- Neglecting legal compliance
- A "one-size-fits-all" approach
- Not linking the compensation plan to business goals
- Improper budgeting and financial planning
What is the Future of Compensation Plans?
The future of compensation plans transcends several key trends, such as
- Increased transparency about payment structures
- Tailoring compensation packages to individual employee preferences and needs (e.g. allowing flexible work hours)
- Focusing on non-financial compensation like skills development
- Technology integration using AI data analysis and advanced compensation management software
- Shifting from traditional annual compensation plan reviews to a more continuous feedback system
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