The Ultimate Guide to Building Compensation Models That Work

May 14, 2022
Daily digest

Designing an effective compensation model is no easy feat. It’s one of the most complex series of decisions any company, especially the ones that are starting out, will face.

It involves carefully selecting right components–like base pay, variable pay, incentives, and pay levels–that create a win-win situation for both employees and the organization. The employees need to be remunerated fairly and appropriately for their contribution without affecting the company’s bottom-line greatly.

A good compensation model starts with the organizational objectives. Answering questions like:

  • How do I attract the best talent?
  • How can I scale operations?
  • What kind of talent do we need?

will help you zero in on a compensation model that can be fruitful.

The different elements of compensation

Good compensation management is important for any business as it keeps employees happy and the business thriving. Adjusting the different components to varying levels to create an effective model is paramount to success. The different types of compensation include:

  • Salary
  • Overtime pay
  • Commission
  • Bonuses
  • Long-term incentives, equity awards
  • Several allowances
  • Health and life insurance
  • Vacation time
  • Retirement savings

Benefits are pretty much going to be determined by government laws and compliance regulations but you can modify your perks to create an attractive compensation package. Some place emphasis on the base pay while others focus more on the performance-based components.

How to create a solid compensation model

Before you build a compensation model, you need a thorough understanding of your business and its objectives. Think about the expanse of your business, how many people you’d need to run operations, and which ones are essential to your future goals.

Gather the background information

The first step to a successful compensation model is to understand why it is being built in the first place, what needs to be executed, and what the desired end result is. You need buy-in from the management and other key decision-makers. That way, your compensation model is aligned with business objectives and company culture.

Building a pay structure from scratch means you need to develop a compensation philosophy, do the market research, clarify concepts that define your organization’s fundamental beliefs, and then develop it.

You need the following basic information to get started:

  • Jobs roles and designations
  • Pros and cons of current models
  • Internal and external surveys
  • Geographical locations
  • Industry standards

Write job descriptions

Once you have the titles for each role, come up with unique job descriptions for each of those positions. Research your competitors but more importantly, make it unique to your company. Think along the lines of what responsibilities you want each of those individuals to hold and make sure they are reflected in the job descriptions.

You also need to develop job grades to enable flexibility and fair compensation. You’ll have a reference framework which ensures equivalent jobs have pay equity.

Determine an appropriate amount

You’d have already researched your competitors by now. Make sure you note down how much they are paying on average for a specific role and what the industry average is.This should give you a rough idea about what you need to spend to attract the best talent in town.

Identify benefits and incentives

When doing your compensation research, keep tabs on what benefits they offer and what incentives are common in your market. Benefits like dental insurance, vacation days, child care facilities, and gym memberships are increasingly common. Understand what you’ll be able to offer and what’s the best form that can be lucrative. It’s important to remember the best benefits are not always the most expensive ones. Understand what your potential employees care about and offer them that.

When it comes to incentives, you need to know what motivates them to go above and beyond. We wrote an entire article about designing sales compensation plans and incentives. Check it out here.

Benchmark positions against market data

Salary benchmarking is a technique to identify the market rate for each role by matching internal job descriptions to external jobs with similar responsibilities.

You need to perform market assessments and salary comparisons before you create a new position complete with job responsibilities and a corresponding salary. Things like location, company size, and education level factor into the final salary, and all must be considered before filling the position.

Using all these data points, you should now be able to arrive at a pay range for each of your job roles. These ranges allow hiring managers to be flexible in factoring experience and additional qualifications.

Evaluate and implement the model

Review your model and build rules to make sure your pay structure stays current and up to date.

  • How often will you update the model?
  • When will the new model be effective from?
  • What are the procedures for updating the model?
  • Who has access to the model and who can make changes?

Now your compensation model is ready to be deployed after getting approval from key stakeholders. Send out organization-wide communication so everyone understands the pay structure clearly.

What makes a good compensation model?

Though there’s no one-size-fits-all model, you need to ensure that your pay structure passes the following checks:

  • Is the compensation equitable across gender, race, religion, age, and more?
  • Do employees perceive the model as fair?
  • Is it financially sensitive to the organization’s strategy?
  • Does it adhere to your organizational philosophy?
  • Are the policies legally compliant?
  • Is it current and in line with what is offered in the broader market?

Closing thoughts

To be successful in attracting and retaining talent in today’s competitive marketplace, you need to develop a model that suits your objectives and unique requirements. A well-designed compensation model bolsters the organization’s strategic plan, business goals, and competitiveness.

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