Compensation packages don’t just get created once — when you hire someone. They come into play multiple times during an employee’s tenure with a company.

When you hire them.
When you’re growing or promoting them.
When they are no longer satisfied with their salary.
When a market shift triggers a change to their salary.

How do you develop a system for compensation that gets you the talent you need, is relatively easy to administer, and is equitable across your organization?

How to think about compensation

There are three basic philosophies for compensation.

I’m going to pay what the role is worth to me. You’ve taken the time to establish the return on investment for that particular role within the company.
I’m going to pay based on this individual’s contributions. You’re making your decision subject to the person that’s filling the role.
I’m going to pay what I have to pay. The market has you backed into a corner, and you pay what you must to fill the role.

It probably goes without saying: the best scenario is the former — to pay what the role is worth to your organization. Not what an individual is worth.

Basing payment on individuals rather than roles is a slippery slope. Yes, we invest in people. That’s a management philosophy. It’s not a compensation philosophy.

See: Developing Your Employer Brand: How to Attract and Retain High Performers

Financial components of compensation

Let’s get nitty gritty. What are the elements you can use to design a compensation system?

Base salary

The part everyone’s most familiar with — what is the employee’s guaranteed pay each month? As long as they’re still working for you, this is what they make.

Commissions

Commissions are performance-based compensation. These are mostly tied to roles that bring revenue into an organization or have measurable outcomes (such as customer retention). You’ll consider these for sales jobs, grant writers, fundraisers, etc.

Performance bonuses

A performance bonus could go to anyone in the organization who achieves a named objective. Performance bonuses can be company-wide, department-wide, or just for an individual.

Company-wide bonuses often take the shape of a profit-sharing program where some percentage of the company’s profits are allocated to employees. Bonuses can be flat figures as well — perhaps everyone in a department receives a set bonus if they meet their annual KPIs, and the bonus amount is based on their level within the company.

Ownership interest

Outside of venture-backed, Silicon Valley style tech companies, employees today seem to be less interested in ownership as a meaningful part of their compensation package.

It’s worth looking at how it might work given that there’s a fair amount of folklore and mystique here.

If the company is privately owned, an ownership interest could be a commitment to a piece of any future equity event. That could be formatted as a clause in an employment agreement or a company plan, like a phantom stock program. If and when a sale does occur, everyone who’s present gets rewarded — often based on the level of their role or their tenure with the company.

If the company has stock, the ownership interest could be options or shares. With a true stock option plan, an employee has the right to exercise the options and purchase the shares as they vest, or should they leave the company. Of course, if you’re leaving the job, odds are that you’re not optimistic about the outcome.

(I rarely see anyone exercise options when they leave. The one time I personally did it, the company subsequently went public and took a nosedive, yet I was on the hook for a big tax bill for gains I never saw.)

See: When to Hire Your First Employee (and the One After That)

Benefits as part of compensation

When is a benefit an element of compensation and when is it just a part of your core values and your company culture? After all, if you’re offering it to everyone in the company, is it really compensation?

Some benefits do allow for more flexibility and could come into play during negotiations — things like vacation time, work-from-home stipends, or help with travel costs.

Is it a good idea to negotiate on benefits like that?

The best practice is to create equitable benefits across the organization. People talk. The less equitable you are, the more opportunity there is for conflict and perceptions of preferential treatment or discrimination.

Of course, concessions happen. For instance, at companies that accrue vacation days, candidates will often ask for extra days. So maybe a company has a policy that top management gets four weeks off, vice presidents get three weeks off, and everyone below them gets two weeks off.

Someone comes in at rank and file and says they want three weeks vacation. The company agrees because they really need that candidate’s skill set.

Just remember that every exception encourages other exceptions. And every exception that gets made is another obligation that needs to be tracked.

Plus, every exception creates risk for conflict or the perception of preferential treatment. It almost always gets disclosed. There are no secrets in compensation, despite how private you wish to keep it. There may not be a published list, but there’s always gossip.

What if someone wants something specific and you want to avoid the appearance of discrimination or preferential treatment?

Negotiate it into their base pay. This position is worth $110k to me, but I’ll pay you $120k to cover those costs.

Salary banding

As companies get bigger - say, around 25 people, salary banding can be helpful. Perhaps, for example, Band 3 is $60k to $75k, Band 4 $75k to $90k, Band 5 is $90k to $110k. You can assign a junior engineer to Band 3, a mid-level to Band 4, and a senior to Band 5. Those same bands and salary ranges are used for every position in every department.

By creating bands, you establish fair and equitable value to those roles in your organization. You’re forced to determine exactly what each position is worth to the company, which means you’re paying for a role rather than an individual.

Banding also creates clarity for employees. If someone’s due for a promotion, they know they’re going from one band to the next. If they want to go from a junior engineer to a mid-level engineer, they know what they’re achieving. They have something to work on, and it can be especially valuable in creating a development plan.

Of course, companies sometimes hire outside their own bands. Remember, that’s another exception that needs to get tracked.

See: All Employees Should Have Professional Development Plans. Do Yours?

When compensation needs adjustment

A change in market conditions can require a change to your salaries. Organizations should be doing market surveys annually (at least) to see what people are getting paid across the market and which of your employees’ compensation is out of whack.

You may not be able to bring them into range. Still, it’s important to know the risks and have a plan to address them. Maybe you can move those employees up within their own range even if you can’t bump them to market conditions.

Put them on a “watch list” and look for behaviors that might indicate they’re not happy.

If you are planning to make adjustments, there are generally three options for evaluating a change:

On your company’s anniversary date, you make a company-wide adjustment to all salaries based on company conditions and the market.
On an individual’s anniversary date, you make their specific salary adjustment based on their performance and the market.
You make adjustments on an ad hoc, as-needed basis, when their performance changes or there are company or market factors that have changed abruptly.

Of course, there are pros and cons to each of these philosophies. Whether they’re all available to you depends on how big you are and how effective your human resources team is.

Making everyone’s adjustments at the same time is the best way to be equitable, and it’s a heck of a lot of work. Plus, it can be distracting for the company as a whole because everyone’s talking about it and sitting on pins and needles waiting.

If you make adjustments at the individual level, you may have a harder time keeping general alignment. You’ll be creating much less distraction and disruption to the day-to-day workings of the company, though.

What if an employee comes to you and says they’re worth more?

It obviously happens — especially in this market. It’s a complex issue.

Look for a compromise that might be good enough to keep them and might be still equitable within your policies. Try to use your existing systems as much as possible. If you overpay someone because you’re scared of losing them, their peers will learn about it. And it often multiplies at that point. Keep in mind that 90% of people who quit (or threaten to) and are saved with a compensation bump, end up leaving anyway within six months.

I’m planning to write a more extensive article about just this topic so shoot me an email if you have thoughts.

See: Should You Outsource Your Hiring?

Final thoughts

If I could impart two pieces of wisdom to every company with employees, they would be these:

Document every promise or concession you make.
Assume compensation transparency.

I’ve seen way too many situations where companies made promises in order to hire someone — guaranteeing their first-year bonus is a common one — but didn’t document it. Now someone else has taken over as the new employee’s supervisor, and they don’t know anything about that promise.

That’s a sure-fire way to create conflict and unmet expectations. Don’t make any promises you’re not willing to write down. Document everything.

As for compensation transparency: I’m not suggesting that it should be your policy, but I am saying you should expect that your employees are talking about what they make. You should expect people to notice if one person gets an extra week of vacation or an extra work-from-home day.

We’ve coached clients through figuring out the balance between equity and flexibility in their compensation structures. Contact us to see how we can help you in this tight talent market.