How To Create A Compensation Plan

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Compensating your employees fairly can be more complicated than it sounds – you have to balance your company’s budget while at the same time offering salaries and benefits that are competitive with the rest of the market. Taking the time to create a good compensation plan can help you meet both of these goals.

In this article, we’ll explain what a compensation plan is, how to create one, and the reasons why you should take the time to make a compensation plan for your organization.

Key Takeaways:

• Compensation plans are more than just salaries: They also include health coverage, raises, and other perks and benefits.

• Creating a good compensation plan starts with researching how other companies in your industry and region are compensating their employees so you can remain competitive.

• A good compensation plan can help you attract top talent and lower your employee turnover rate.

What Is a Compensation Plan?

A compensation plan is a structure a company uses to pay its employees. Compensation plans typically include:

• Base pay (salary or hourly wages)

• Benefits

• Bonus schedule and structure

• Raise schedules

• Commissions

• Other perks and benefits

How to Create a Compensation Plan

Every company has slightly different methods of creating compensation plans, but these are the general steps you should follow to create yours.

1. Determine your compensation philosophy. As an organization, you can choose how you want to approach compensation plans. Do you want to lead the industry and pay more than your competitors? Or do you want to match the going rate?

   You can technically also pay less than the industry average, and some companies can be successful with this if they provide outstanding benefits.

   To determine your compensation philosophy, you’ll need to do a lot of research on how much companies are paying their employees and what benefits they’re providing. As you conduct this research, look at:

   • Companies that have employees with similar roles and responsibilities.

   • Companies in the same or similar industries as yours.

   • Companies that hire in your region.

   As you perform your research, don’t just look at how much companies are paying their employees, pay attention to how their compensation plans are structured as well. Try to answer the following questions:

   • Do they pay salaries or hourly wages?

   • Is everyone on the same pay structure?

   • What role do commissions or bonuses play in their compensation?

   • How often do they give their workers raises?

   • How happy are their employees?

2. Make sure your compensation plan is both legal and fair. There are laws you’ll need to follow when designing a compensation plan, so run your ideas past a lawyer before you implement them.

   Not only do you need to make sure your plan is legal, but you also need to look at your plan critically to make sure you are treating employees equitably.

   That doesn’t mean you need to pay them all the same amount, but it does mean you need to make sure that there aren’t any groups being given preferential treatment or being blocked from making as much as their peers.

3. Research the market for individual positions. This step builds on your first round of overall market research by diving a little deeper into the individual positions you will be creating compensation plans for.

   If you want to attract top talent – or even average talent – you need to offer competitive pay. This means making sure your salary ranges for every position are similar to those of your competitors. It also means making sure they’re reasonable for the areas where your employees are going to be living.

   Each type of position’s overall compensation plan also needs to be comparable to your competitors. In other words, if you don’t want to pay your salespeople commissions, but your main competitors do, you’ll have a hard time attracting good employees unless you pay them significantly higher salaries to offset the difference.

4. Decide how you want to pay your employees. Now that you’ve performed all of your research, you’re going to need to decide how you’re going to compensate your employees.

   Start with base pay: Are you going to pay salaries or hourly wages? Then, decide how you are going to handle commissions, bonuses, and benefits.

   You can choose to create a different structure for each position, but most of the time, companies create different criteria for employees to meet for each compensation plan.

   For example, you may have five different categories of employees across the company:

   • Assistant

   • Specialist

   • Coordinator

   • Director

   • Executive

   Each employee, no matter what department they work in, would fit into one of these categories. Each category then would have its own compensation plan and pay range depending on the employees’ education, work experience, and tenure.

   In addition, rather than using titles like this, many companies use pay-grade systems. This operates on a similar premise: Employees with similar backgrounds and levels of responsibility are paid similarly, no matter what department they work in. Rather than this differentiation being in their title, though, they’re assigned a number like P3 or M5.

   Larger companies often choose to use this type of pay scale because it gives them more freedom to move employees up and down the scale without having to change their job titles.

5. Establish pay ranges for each position. Once you’ve established a pay structure for each level of employee, you need to assign pay ranges to each one. Use your market research to do this, and remember to keep what you’re going to be paying them in benefits in mind as well.

   If you’re going to give employees bonuses or commissions, establish how you’re going to determine those amounts too.

6. Choose what indirect compensation you want to offer. This step goes hand in hand with the previous one, but it’s important to mention it. Research your benefits options to see which ones you want to offer, and consider what perks and bonuses you want to provide.

   This is an important step in making a compensation plan that is comparable to your competitors.

7. Revisit and revamp your plan. While you don’t need to (and shouldn’t) revamp your whole compensation plan regularly, you shouldn’t just set it and forget it, either.

   Make a plan to continue your research, which includes keeping tabs on the cost of living in your area, what your other competitors are paying, and how happy your employees are with your compensation plan.

   Then, revisit your plan to make sure it still makes sense with your research findings. Companies that don’t do this run the risk of frustrating their employees to the point of leaving and not being able to attract high-quality employees.

Why It’s Important to Have a Good Compensation Plan

It’s important to have a good compensation plan because it helps attract talent, lower employee turnover, and balance the budget.

1. Good compensation plans attract top talent. If you want candidates who bring top-tier skills, industry experience, and educational backgrounds to apply to work at your organization, you’re going to have to offer them competitive pay.

   This doesn’t have to be in the form of a six-figure salary, but the combination of your benefits and base pay needs to give them a reason to work for you rather than one of your competitors. At the least, it needs to not be so low that it gives them a reason to turn down your job offer.

2. Good compensation plans lower employee turnover. If employees feel like they’re being paid fairly and have plenty of opportunities to earn even more, they’re going to be much more loyal to you than they would be if they weren’t making enough.

   Not only will your employees be less susceptible to headhunters from other companies when they’re compensated well, but they’ll also feel more valued by their employer, which increases engagement and lowers burnout. All of this, in turn, lowers turnover rates.

3. Good compensation plans help you manage your budget. When you have a clear compensation plan in place, you can allocate your resources more effectively.

   If you don’t have a plan in place, you run the risk of losing track of where your money is going and spending too much as a result, as well as spending too little on your employees because you aren’t sure how much you have.

   A well-made compensation plan helps you make the most of your resources, allowing you to ensure you’re paying everyone fairly while sticking to your budget.

Direct vs. Indirect Compensation

There are two commonly recognized types of compensation: direct and indirect.

1. Direct Compensation

   Direct compensation is the money that employees pay their employees directly. In other words, it’s the money that ends up in employees’ bank accounts.

   Here are the types of compensation that fall under the direct compensation umbrella:

   • Salary

   • Hourly wages

   • Commissions

   • Bonuses

2. Indirect Compensation

   Indirect compensation is any compensation that companies give their employees that isn’t in the form of cash. This compensation may still have monetary value, but it doesn’t end up in employees’ bank accounts.

   The most common types of indirect compensation include:

   • Health and dental insurance

   • Contributions to a 401(k) retirement plan

   • Life insurance

   • Stock options

   • Profit-sharing opportunities

   • Relocation benefits

   • Tuition reimbursement

   • Employee discounts

   Some people also include these benefits under the umbrella of indirect compensation, while others consider them a separate category called non-monetary compensation:

   • Flexible working hours

   • Paid time off/vacation time

   • Sick leave

   • Company car

   • Company equipment

   • Training opportunities

Compensation Plan FAQ

1. What is the simplest compensation plan?

   The simplest compensation plan is a straight salary. This means you pay your employee the same amount every pay period. You can add benefits, raises, and bonuses on top of that to make it more complicated, but even then, it’s still simpler than hourly pay or commissions.

2. What is the difference between salary and compensation?

   The difference between salary and compensation is that salary is a part of compensation. Salary is the base pay level an employee earns. This is just one part of overall compensation, which also includes bonuses, benefits, and other perks.

3. What are the two types of compensation?

   The two types of compensation are direct and indirect compensation. Direct compensation is money paid directly to the employee in the form of a salary, bonus, or commission. Indirect compensation includes non-cash benefits and perks such as health coverage and life insurance.

4. What is a fair compensation package?

   A fair compensation package pays employees based on their skills, experience, performance, and job responsibilities. This is much fairer than paying all employees the same amount.

References

1. U.S. Office of Personnel Management – Federal Employee Compensation Package

2. University of Minnesota Libraries – Human Resource Management: 6.1 Goals of a Compensation Plan

Author

Caitlin Mazur

Caitlin Mazur is a freelance writer at Zippia where she has written 140+ articles that have reached over 1 mil viewers as of June 2023. Caitlin is passionate about helping Zippia’s readers land the jobs of their dreams by offering content that discusses job-seeking advice based on experience and extensive research.