Compensation plans

During difficult economic times, employers might wonder if they can attract and retain talent without offering competitive compensation packages. The hard truth is that investing in people is always necessary to sustain growth. What’s more, employees today aren’t concerned solely with their hourly wage or salary. They also want their employers to support their life and long-term careers. A well-rounded compensation plan is necessary to meet this need and create lasting relations with employees.

What is a compensation plan?

A compensation plan, or compensation strategy, is how employers determine the right mix of pay and benefits that will attract and retain talent without putting their business at risk. This process has the following primary objectives:

• Ensure fair and consistent pay practices
• Comply with applicable federal, state and local laws and regulations
• Operate within budgetary constraints or financial resource limitations
• Ensure administrative efficiency
• Offer competitive salaries relative to the labor markets

What are the different types of compensation?

Comprehensive plans cover five types of employee compensation:

• Salaries
• Hourly wages
• Bonuses
• Incentives
• Non-financial rewards

Salaries and hourly wages

Competitive salaries are often based on industry benchmark data, location, role and employee experience. However, market conditions can shift rapidly in competitive industries, so it’s important to revisit benchmarks regularly. Employers must also consider internal pay equity, business profitability and long-term financial stability when determining salaries and wages.

Bonuses and incentives

Bonuses and incentives, such as stock options, appeal to high-performing employees because they link individual success to the organization's success. When designed effectively, these rewards can foster a strong connection and commitment between employers and employees.

Non-financial rewards

Many employees today seek holistic compensation plans that include non-financial benefits, like retirement plans, tuition reimbursement, child-care assistance and wellness programs. In addition, flexible and remote work opportunities have increased the demand for mental health services and work-life balance initiatives. Employers should assess which benefits matter most to their workforce and personalize the offerings accordingly.

The importance of a compensation strategy

A well-designed compensation plan is essential for attracting, retaining and motivating talent in competitive job markets. Conversely, an ineffective compensation strategy can cause disengaged employees and high turnover. Employers can also face legal and reputational risks if employees raise concerns about pay transparency or fair pay.

How to create a compensation plan

Creating a compensation plan requires thoughtful planning and flexibility to ensure it aligns with employee needs and business objectives. The process typically involves these steps:

1. Define compensation goals
2. Create a project plan
3. Analyze jobs
4. Update job descriptions
5. Conduct salary surveys
6. Build pay structures
7. Draft compensation policies
8. Communicate compensation policies

Defining compensation goals

Compensation policies commonly have the following objectives:

• Recruitment – Although many factors may influence an individual's decision to join an organization, finances are usually a primary motivator.
• Retention – Employees who believe their pay is fair may be more inclined to stay with an organization.
• Motivation – Compensation tied to specific goals can incentivize employees to perform at higher levels.

Creating a project plan

These preparatory measures can help ensure a compensation strategy meets the intended goals:

• Determine the effective date for the new salary structure or pay changes.
• Construct a timeline for implementing and monitoring the compensation plan.
• Estimate a budget for the proposed salary changes, bonuses, benefits, etc.
• Identify the key stakeholders who will be assigned tasks within the project plan.

Analyzing jobs

Job analysis is the process of determining the tasks that comprise a particular job and the skills, knowledge, technology, working conditions, interactions and communications needed to perform it. The information collected is used to:

• Determine each job's relative internal worth to the organization.
• Ensure that the organization's pay rates are competitive with pay rates for similar jobs in the labor market.
• Set standards for merit pay so employees are rewarded based upon job requirements and performance.

In some large organizations, a committee of managers from major departments or divisions conducts the job evaluations. The committee members typically have direct knowledge of the positions under review.

Updating job descriptions

Job descriptions should contain compensable information that HR practitioners can use to conduct market pay surveys and job evaluations. Examples include:

• The skills required to perform the job
• The duties and responsibilities of the job
• The mental and physical effort needed to perform the job
• The working conditions that people in the job encounter

Conducting salary surveys

Salary surveys, which reflect labor demand, help employers assess if their compensation levels can sufficiently retain employees and attract new candidates. They’re also useful in determining if job evaluation methods are accurate and equitable. However, before relying on survey data to set salaries, employers should consider the reputation of the survey provider and the accuracy of the information obtained.

Building the pay structure

Pay structures are a series of pay ranges or grades, each with a minimum and maximum pay rate. Compensation specialists create them using information gathered during job evaluations and market surveys. The process is as follows – jobs are assigned a grade based on their internal and external worth, and employees are paid a rate that falls within their job’s range. Constant fine-tuning of pay structures is usually necessary to support pay equity.

Drafting a compensation policy

Compensation policies generally consist of four parts:

• Philosophy – A broad statement of the company's attitude toward employee compensation
• Objectives – Specific descriptions of what the compensation program will accomplish
• Program components – A list of compensation programs, such as job analysis, performance appraisal, incentive pay programs, etc.
• Procedures – Explanations of how the program components will be administered

Communicating the policy

To be effective, compensation policies must be thoroughly understood by all supervisors and employees. Employers can educate them with formal communications that cover the following points:

• Salary ranges by job title
• How pay structures were developed
• The minimum, median and maximum for each pay grade
• How pay increases are determined and how often they are provided

How can compensation planning software help?

Automating compensation management using software can help employers reduce regulatory compliance risk and control costs. It can also support equitable pay practices, sustaining a competitive position in the market and attracting and retaining talent.

Depending on their software provider, employers may be able to perform the following:

• Analyze and compare compensation within their company or against similar positions in other companies
• Make informed decisions with customizable and robust reporting of key compensation data
• Secure sensitive data with role-based permissions that limit the information managers can access about employees
• Identify issues and trends related to overtime, turnover and compensation

Frequently asked questions about the compensation planning process

What is an employee total compensation package?

Total compensation is an employer’s entire investment in an employee. In addition to a yearly salary or hourly wage, it may include bonuses, health insurance, retirement savings plans and other benefits.

How do you structure a total employee compensation package?

There isn’t a singular approach to compensation design. However, employers generally structure their compensation packages to resonate with their employees’ needs and align with their organization’s long-term goals.

How do you calculate the cost of a total employee compensation package?

To calculate the cost of an employee’s total compensation, employers first determine the sum of the individual’s monetary rewards by adding the base salary to any bonuses or commissions received. They then estimate the cash value of non-financial incentives, such as health benefits, and add it to the monetary total.

What are total compensation and total reward statements?

Total rewards statements are documents given to employees that show the full value of their compensation, including salary and benefits. Employers usually distribute these statements annually during performance reviews.

What factors are considered when designing an employee compensation plan?

Designing a compensation plan requires careful consideration of market trends, employee expectations and the company's financial health. Employers must also ensure their plan aligns with industry best practices and complies with applicable equal pay laws.

Are compensation plans only for executive-level employees?

Understanding how compensation will help attract, retain and motivate employees of all levels is pivotal to ensuring engagement and productivity. As such, compensation plans are usually designed with the entire workforce in mind.

How does a compensation plan motivate employees?

Base compensation encourages employees to perform at an acceptable level. Employers who want their people to exceed expectations may need to update their compensation plans with bonuses and payments tied to specific performance metrics. Doing so may not only motivate employees to go the extra mile, but also may help the business achieve its goals.

Can a compensation plan be adjusted over time?

Market conditions can shift rapidly, especially in competitive industries. To maintain balance between internal and external pay equity, employers should regularly repeat compensation analyses. This schedule can be adjusted based on the organization’s age, forces affecting its industry and its financial success.

This guide is intended to be used as a starting point in analyzing compensation plan formats and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax guidance or other professional services. Please consult with your legal counsel.