How to Write a Compensation Plan

Psst… check out this post to create a compensation plan that is competitive enough to retain top talent.

Compensation plans help companies get clear about how they want to spend their compensation dollars. So let’s discuss why compensation plans are so important, and how to write one, today, that will keep us in business for the long run. One that will encourage employee retention, maintain morale, limit employee turnover and keep us HR types on the CEO’s “nice” list.

Start with These Three Keys for Successful Compensation Plans

1. Retain our critical employees – when has retention been more critical?
2. Don’t overpay a dime, if possible – what company has profits to burn needlessly?
3. Pay everyone fairly (enough) so that they can focus fully on their work

I know what you’re thinking, “How do I develop a compensation plan that meets all of these objectives?” The most critical are the last two points: pay enough, but without overpaying. And to accomplish that we can be grateful for the solid pay data Payscale provides. But there’s still much more for us to do to develop a sound compensation plan.

Compensation Tip: Make sure you #pay enough but don't overpay.

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Working Examples of Compensation Plans to Retain Critical Employees

Top employee retention seems to be a frequent missing logic step in designing compensation plans. Here are two examples of how to recognize if you have a critical employee on your hands.

Compensation Plan Example #1: What do you pay your star retail salesperson?

Probably high, as in above market median, but you can’t open the vault for this employee. Even if they’re brilliant, a salesperson’s success is dependent on many other employees’ tasks being done well. The buyer has to buy the right goods at the right price. The inventory person has to ensure the appropriate stock is in the right store. The floor designer has to display the merchandise to its best advantage. Many, many tasks are required for success.

So in retail, ultimately, the entire system is more likely to be critical to company success than any one employee in the system, no matter how well they do their job. Overpaying a star salesperson isn’t likely to give you much of a return on that investment, so don’t overdo it.

Compensation Plan Example #2: What do you pay Sid Meier?

Sid Meier is the video game designer responsible (well, I also played a role) for really irritating my family a few years back. That was after our son taught me how to play Sid’s computer game, Civilization II. The dog – I got addicted.

“Where’s Dad?”
“On the computer.”

The point is that rarely, in certain jobs and companies, one person really can have a big impact on the success of the entire company. The costs of employee turnover for one person might threaten a company’s future. Steve Jobs seems to have had this impact on Apple. You can think of your own examples. Here’s a case where you might want to open the vault! Like hiring the “hot” movie star, you could get a great ROI on off-the-charts pay for a top talent.

Sid, I hope it worked out for you; it’s really an entertaining game!

The Cost of Overpaying in Employee Compensation Plans

Rigor, such as the compensation data from Payscale.com makes possible, is more than a nicety. It may be a key to survival. Let’s do the math. Say your company has 1,000 employees. Revenues are $100 million a year, profits will be $1 million next year, and the Board is pretty happy – after all, $1 million in profits is nothing to sneeze at. So you give all of your employees a raise on January 1 and, because you’re nice, you end up overpaying everyone by only $1,000. On an average salary of, say, $50,000, that’s nothing. But then, we do the math. Uh-oh. $1,000 x 1,000 employees is (yikes) your entire profit. Get your compensation data from a reliable source, like Payscale.com, and make your profit target for the year instead of gobbling it up. It’s much nicer than layoffs in the long run.

The Cost of Underpaying in an Employee Compensation Plan

Older news here: Jac Fitz Enz showed the cost of employee turnover was 6-24 months of salary. For a key employee making $100,000 per year that cost might be $200,000 – or more, if his name is Sid. It’s worth keeping this cost in mind. Retention pays. It could pay a lot, and that’s just dollars we’re talking about, not sense. Retaining people matters for morale, hitting goal targets, and being an employer of choices in a competitive time.

The Art of Designing Compensation Plans

We’ll talk more about this on another day, but here’s the simple core reality of employee compensation plans: to design a compensation system that pays someone competently – not too much, not too little – you only need to do three things:

1. Determine the market compensation rate
2. Compare an employee’s work to the market
3. Align employees’ compensation with their work, relative to the market.

It is simple, in concept. At raise time, it can be this simple:

High pay +  poor results = no raise
Low pay  + great results = big raise

Your Goal: People Forget About Pay, So They Can Focus Fully on Work

Frederick Herzberg made this point, and I’m not sure it’s ever been improved upon: compensation does not act as a “satisfier”, or motivator. But it sure can act as a dissatisfier if someone believes they’re underpaid. W. Edwards Deming fully agreed. And he was one consultant who got consistently brilliant results. Can you name anyone with half his record of turning organizations into profit machines? Deming’s “prescription”:  pay people well, so they forget about pay.

Any ideas triggered for you by what I’ve mentioned above? As always, I’m curious.

Regards,

Stuart Jennings, M.S.

For further reading:

• Get our 50 page, step-by-step eBook and learn how to create a compensation plan that sizzles!
• Learn tips for customizing your compensation plan for your organization.

What are you waiting for?