Craft a Compensation Philosophy Lay the groundwork for compensation - - PowerPoint PPT Presentation

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Craft a Compensation Philosophy

Lay the groundwork for compensation that is competitive, cost-effective, and brand-aligned.

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A compensation philosophy should be primarily driven by business strategy and objectives.

• A compensation philosophy should include: compensation objectives, current structure, basis of job value, focus of variable

compensation, approach to raises and promotions, competitive intent for each employee segment, and approach to administration.

• These building blocks will help you to create employee segment plans that are legal, culturally-aligned, and designed to

support organizational goals.

Executive Summary

A well-designed compensation philosophy is the foundation of an effective compensation strategy.

• Employee compensation often comprises in excess of 70% of an organization’s ongoing operating expenditure, yet few
• rganizations have plans in place to properly direct and control this expenditure.
• The first step in compensation planning is the development of a compensation philosophy that clearly articulates the
• rganization’s high-level approach to pay for each of its employee segments, including its target competitive position.
• “Competitive compensation” is a vague term that is generally used to indicate that an organization pays at or around the

midpoint of the market (P50) for base pay, total cash compensation (base + variable pay), or both.

• A compensation philosophy needs to be specific in order to effectively direct compensation practices; it needs to specify

the target approach (lag, match, lead) and the target market position it desires for each employee segment.

• Note: The approach and/or the specific percentile target may be invisible to employees. It depends on the desired

degree of pay transparency.

Saying you have “competitive compensation” isn’t enough – articulate your competitive position.

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Understand the Total Rewards model before beginning the compensation design process

This blueprint focuses on the base and variable components of Total Compensation, often referred to as Total Cash Compensation (TCC).

Variable Compensation Benefits

Short-term Incentives Long-term Incentives

Base Pay Performance & Recognition Total Compensation Learning & Development Culture & Work Environment

Total Rewards

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A compensation philosophy is the first building block – every

• ther element of your compensation strategy depends on it

Executive compensation is often considered to be a competitive-positioning document. As a result, details of the target market position is seldom included in the organization-wide Compensation Philosophy and specific plan details are seldom included in the Compensation Policy. If this is the case in your organization, be sure to document these details in the Executive Compensation Plan.

Compensation Policy Compensation Plans by Employee Segment Compensation Philosophy

This set will focus on the development of a Compensation Philosophy based on business strategy, business lifecycle, laws and regulations, culture, industry, and workforce composition and demographics. The Compensation Philosophy will

• utline the organization’s target

market position and its total target compensation (TTC), which will drive the selection of total compensation elements – base, variable, and benefits – for each employee segment.

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What’s in this Section: Sections:

Make the Case

Make the Case Develop a Compensation Philosophy

• Business factors and HR trends that are driving the

need for compensation planning.

• The risks of not implementing a compensation plan.
• Common objections to, and challenges of,

compensation planning.

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Today’s competitive business climate means organizations need to take a strategic approach to compensation planning

Win the war for talent in an improving economy:

• Even during economically challenging times, the right talent can be

hard to come by because of small talent pools, skills scarcity, inter- business competition, and/or remote geographical location.

• Organizations need to effectively use compensation offerings to:

1. Define the employer brand to attract talent and set candidate expectations. 2. Engage and retain their current employees.

Since employee compensation is the biggest expense in nearly every

• rganization, compensation philosophy is a high return HR activity.

Control ongoing costs in a competitive era:

• Compensation is the number one operational cost in any
• rganization, often in excess of 70% of total expenditures.
• In an era of increased global competition, knowing where the

money is going, justifying that spend, and being able to project long-term costs is crucial to the long-term fiscal health of the

• rganization.

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Establish a Compensation Philosophy to guide compensation management and overcome compensation challenges

 Is it challenging to determine compensation level for a new hire?  Is determining compensation level for a promotion difficult?  Is it difficult to explain the reasoning behind relative compensation decisions?  Do employees constantly speculate about how they are paid in comparison to their peers?  Do department managers report that they are hearing staff complaints about compensation?  Does compensation frequently show up as a primary departure driver in exit surveys and/or exit

interviews?

 Is organizational turnover higher than historical norms and/or industry benchmarks and you have

reason to believe that compensation is a contributing factor?

If you are experiencing some or all of these compensation issues, you are not alone.

Setting compensation that is fair, competitive, and cost-effective is tricky and requires careful thought and planning.

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Without clear direction, it’s easy for compensation to go

• ff-course

Compensation issues can easily become organizational issues. Stop them with a clear Compensation Philosophy that guides pay decision-making.

Common organizational issues:

Pay inequity is the basis for most compensation-related discrimination claims. As a result, it is good practice to evaluate the internal equity of your compensation practices on a yearly basis.

Compensation issue:

• Inability to recruit people with needed skill sets
• Inability to engage current employees
• Inability to retain high value employees

Compensation is too low; other organizations in your labor market are offering compensation packages that are more attractive.

• Inability to engage current employees
• Inability to retain high value employees
• Vulnerability to high cost discrimination claims

Compensation is inequitable; employees are paid differently for the same job and there is no apparent rational justification.

• Turnover that is too low, which can lead to stale

ideas and/or the retention of employees with a poor organizational fit Compensation is too high; other organizations in your labor market are offering compensation packages that are much less attractive.

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26% 35% 51% 71% 76%

0% 10% 20% 30% 40% 50% 60% 70% 80%

No philosophy, but plan to create one No philosophy and no plan to create one In the process

• f developing a

philosophy Have an out-of- date philosophy Have an up-to- date philosophy

Organizations with an up-to-date compensation philosophy are 1.9 times more likely to experience compensation success

Compensation strategy success Compensation philosophy: stage of development

Despite its correlation with compensation success, only 26% of

• rganizations have an up-to-date

compensation philosophy. Despite its correlation with compensation success, only 26% of

• rganizations have an up-to-date

compensation philosophy.

Survey Findings:

• Of organizations who currently

have no philosophy, those that intend to create one are experiencing less success (26%) than organizations with no intent to create one (35%). This is likely because compensation-related issues (i.e. low success) have prompted them to invest effort in developing a compensation philosophy.

• Of organizations who have a

philosophy in place, those with an

• ut-of-date philosophy are almost

as likely as those with a current philosophy to experience compensation success. This makes sense if the philosophy is deemed “out of date” because of its age rather than because it is no longer aligned with business strategy or characteristics.

Source: McLean & Company, 2012; N=62

An organization is 96% more likely to experience compensation success if it is in the process of developing a philosophy rather than just planning on it. An organization is 96% more likely to experience compensation success if it is in the process of developing a philosophy rather than just planning on it.

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What’s in this Section: Sections:

Develop a Compensation Philosophy

Make the Case Develop a Compensation Philosophy

• Key internal and external influences on the

compensation planning process.

• How to deliver a compensation philosophy

development brainstorming session.

• Key themes and elements of a strong philosophy.
• A compensation philosophy template.

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A compensation philosophy should be detailed enough to direct compensation planning efforts

Philosophy  Mission Statement

• There is a great deal of variation among compensation

philosophies – both in terms of content and form.

• Some companies have philosophies that are effectively short,

compensation “mission statements” that speak to high-level principles and practices. These philosophies tend to be very vague (e.g. “We offer competitive pay to attract and retain talent”).

• Other companies have detailed philosophies that contain details

that will help during the compensation planning process, such as target market position.

• The compensation philosophy should be sufficiently detailed

as to be useful during the planning process. This will require that key stakeholders consider both internal and external influences during the philosophy development process.

The philosophy should go beyond a compensation “mission statement” to include details that are useful during compensation planning.

Stakeholders

• HR (facilitation, writing)
• Executive (idea contribution, approval)

Stakeholders

• HR (facilitation, writing)
• Executive (idea contribution, approval)

Time and Effort Guidelines

• Two to four hours for stakeholder

discussion and the creation of a philosophy draft.

• Two hours to finalize the draft.
• Additional time (variable) for philosophy

document review and approval.

Time and Effort Guidelines

• Two to four hours for stakeholder

discussion and the creation of a philosophy draft.

• Two hours to finalize the draft.
• Additional time (variable) for philosophy

document review and approval.

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Use a Compensation Philosophy Worksheet to document your approach

The completed template will:

• Act as a reference document for thoughts and

decisions during the working session.

• Inform your initial Compensation Philosophy.
• Reduce the time and effort involved in Philosophy

refreshes; can review for accuracy and update rather rewrite each time.

• Include important information you have chosen to
• mit from the public Compensation Philosophy, such

as market positioning details.

Use this template to document:

• Internal or external influences on the

Compensation Philosophy and their expected impact on the organization’s approach to compensation.

• E.g. Business strategy; Laws and regulations;

Organizational Culture

• Core Compensation Principles (e.g. market

competitive).

• Market positioning strategies and targets by

segment. Remember: the talent you want isn’t always the talent you can afford; be sure to consider cost. If you don’t have current market data to use to calculate the cost of target positioning, take an educated guess based on current compensation. Later, when market data is gathered, perform a cost analysis to ensure that the positioning chosen is still affordable.

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Plan to hold a working session with key stakeholders – you’ll design the organization’s compensation philosophy together

Send a “save the date”

• Schedule the session for the morning

– between three and four hours. It may surprise you how much debate can arise during this process; especially as you discuss the six factors.

• Communicate the goal of the

exercise – e.g. to develop a compensation philosophy that reflects the culture and characteristics of the organization.

• Communicate that no preparation is

required from participants – this is a brainstorming exercise, so the spontaneous flow of thoughts and ideas is encouraged.

Select session attendees

• The executive team and HR are the

crucial participants; they are the

• wners and managers of
• rganizational strategy.
• Some organizations choose to also

invite other members of the management team and/or

• employees. The rationale for this

decision is often these employees can offer insight into the employee base that the executive team and HR personnel may not have.

• Note: This decision is very culture-

dependent; relying on the degree

• f transparency that is considered

desirable in your organization.

Plan your approach

• Select someone with strong

facilitation skills to run the working session; typically, this would be the head of HR or a senior member of the HR department.

• Select someone to act as scribe; they

will take notes in the Compensation Philosophy Worksheet. This person should have strong active listening and writing skills.

• If you will have a large number of

participants (e.g. more than six), consider breaking them into small discussion groups, with each group exploring one of the six factors in depth.

Choose session attendees wisely, save the date, and make decisions around facilitation and organization ahead of time.

If the executive team isn’t present for the entire working session, it may be difficult to get buy-in later. If they aren’t available in a large block of time, consider holding several sessions instead of just one. It may take more time overall, but once they understand the philosophy informs all aspects of compensation, executives will make the time.

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The compensation philosophy is shaped by internal and external influences – review them before engaging stakeholders

Understand the influencing factors before you begin discussions with your stakeholders; they will frame the discussion.

Factor: How it affects the compensation philosophy: Business strategy Culture Business lifecycle Workforce composition and demographics Laws and regulations Industry

The HR strategy and, in turn, compensation plans are derived from the business strategy and must be aligned with it to have any real business value. A culture that does not value employees will offer minimum compensation or adopt a “churn and burn” approach (i.e. pay low and work people hard until they burn out and quit). Know your culture to avoid efforts that won’t gain support. Whether a business is in a state of start-up, growth, maturity, or decline will dramatically affect business needs and objectives, and how compensation is leveraged as a tool to recruit, engage, and retain talent. You will want to tailor your plan to meet specific objectives. For example, an organization wanting to change the mix (i.e. bring in more experience) or appeal to a certain demographic (i.e. Generation Y) will need to tailor the compensation philosophy to attract these target groups. Labor laws regarding compensation (e.g. minimum wage, health insurance) must be complied with – no exceptions. Breaking these rules can bring stiff penalties and damage your brand. If your competitors are having trouble finding core skills and have to offer better total compensation (base pay, benefits, and variable pay) to win talent, you will need to do the same.

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Kick off the working session with a discussion of the first three factors – these will constrain what you can ultimately offer

 What do our values and mission/vision statements say? What keywords or

concepts can we extract from them and focus on?

 How competitive do we want to be/do we need to be?  What roles and skills are going to have the biggest impact on our ability to

execute on our strategy? Which of these skills is the most difficult to acquire?

 How do we want to be viewed by our stakeholders (or shareholders)?

• 1. Business Strategy

Importance of employees and the role/value of compensation Business environment posture Areas of focus and/or investment Responsibility requirements

The answers should reveal:

Use these factor-related questions to uncover important information that will shape your approach to compensation.

 Have we had any compensation-related issues that have, or could have,

escalated to litigation?

 Do employees perceive problems with internal equity?  For hourly paid jobs, do we want to just meet or exceed minimum wage to be

more attractive to applicants?

• 3. Laws and Regulations

Legal compliance Communication/transparency gaps Appetite for exceeding basic legal requirements

 Where are we in our lifecycle: start-up, growth, maturity, or decline? Are we

more about aggressive growth, maintaining stability, or controlling costs?

 Do we want to tie compensation to performance?

Bottom-line reality – fiscal position Importance of performance, and the role of metrics and incentives

• 2. Business Lifecycle

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Next, talk about organizational culture – and be prepared for disagreement

 What’s most important to our employees: base pay, benefits, or variable pay?

What’s most important to the executive team?

 How important are employee engagement and retention to our success?  Are we a people first, product first, or bottom line oriented organization?  Do some earn hourly wages and others salary? Are benefits and variable

compensation different for different employee segments?

 Are hours of work different for one group over another?  Are flex time, lieu time, and overtime options different for one group over

another?

 Do we want to offer greater flexibility in work hours, shifts, and education

support?

 What role do qualifications and academic accreditation play in total

compensation?

It will be hard to gain consensus around culture since it varies from one department to another – be prepared for disagreement.

• 4. Culture

Conflicting priorities and needs Perceived employee value/influence Business priorities and orientation Compensation diversity Nature of work diversity Work flexibility diversity Stratification of jobs and premium pay requirements Importance of work/life balance and benefits

The best compensation plans mirror the culture of the employer.

Source: BLR, 2011

The answers should reveal:

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Pay less than the midpoint in target labor markets; below the fiftieth percentile (<P50). Competitive stance

Now address industry conditions – considering both current conditions and those expected in the next 6-12 months

 What trends are in play in the industry which will affect our human resourcing

• bjectives?

 What skills do we need that are industry-specific? What skills do we need that

are more common/ general?

 Are we competing with others in our industry for scarce skills, or over a small

selection of available talent?

 Do we want to be considered an employer of choice in our industry? How do

we want to distinguish ourselves from others in our industry?

 In general, what is our market position (i.e. do we strive to pay at, above, or

below market)? External threats and opportunities Commodity vs. specialized skills required Skills scarcity or availability Target EVP (employee value proposition)

• 5. Industry Conditions

The answers should reveal: Concept refresh: Market positioning

Pay more than the midpoint in target labor markets; above the fiftieth percentile (>P50).

• 1. Lead the market
• 3. Lag the market

Pay the same as the midpoint in target labor markets; at the fiftieth percentile (=P50).

• 2. Match the market

This factor continues on the next slide.

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Remember to include organizations outside your industry when looking at market data and target positioning

Your competition for some labor may be only within your industry – especially for certain types of tradespeople – and it could be virtually all industries for other labor – like customer service reps. Normally though, you are going to be benchmarking against at least a couple of industries aside from your own for the majority of positions – that more common labor that has transferable skills. – HR Manager, Health & Fitness Industry

Consider the degree of non-industry competition for the job category when setting market positions and selecting data.

Degree of non-industry competition: Sample Positions: None

Positions at any level that require skills or competencies that are only applicable in a particular industry, making it very difficult for those employees to find skilled work

• utside their industry.

Emergency medical technicians, Miners, Engineers with industry-focused specializations, Diagnostic technicians

Moderate

Positions at any level that require skills or competencies that are only applicable in a few industries, making it moderately difficult for those employees to find skilled work

• utside their industry.

Millwrights, Salespeople for complex products (typically requiring specialized knowledge to be effective), Scientists, Actuaries

High

Positions that typically require skills or competencies that are applicable in many industries, making it simple for those employees to find skilled work outside their industry. Client service representatives, Administrative staff, HR, Finance, IT, Marketing, Communications

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• 6. Work Composition and Demographics

Last, address workforce demographics and consider their impact on compensation planning

 Are we going to lose a lot of talent in the years to come due to Baby Boomer

retirement?

 Do we have enough experience on board to ensure operational stability?  Do we have enough junior talent on board to feed our succession plans?  Do we have a sufficiently diverse workforce in terms of demographics?

Future threats to skills availability Internal gaps or threats Internal gaps or threats Attraction and retention of diverse skill sets and experience

Keep an eye out for changes in your demographics. Employee profiles are a prime determinant of effective compensation practices.

The answers should reveal:

Don’t forget to consider geographic differences if you operate in more than one jurisdiction. If you focus exclusively on the headquarters of operation, you are likely to miss regional influencers that can have a dramatic effect on the success of your Compensation Philosophy and, later, your Compensation Plans.

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Use the information you have gathered in your session to uncover your areas

• f focus.

Now that you have discussed the influencing factors, distill information to uncover fundamental compensation principles

Common compensation principles:

• Market competitive / externally equitable
• Internally equitable
• Focus on pay for performance
• Focus on pay for tenure
• Focus on Total Rewards (as opposed to Total Compensation alone)
• Structured, but flexible approach:
• I.e. There is an overarching structure in place to drive compensation decision-

making and support the other aims, but flexibility is allowed where business needs mandate it.

• E.g. If the organization needs people with a specific skill set, but they cannot be

attracted without a compensation package over what would typically be offered.

Areas of focus must reflect compensation practice

Your compensation philosophy must be supported by your actions; a common mistake in compensation philosophy setting is using common areas of focus that don’t map to current or intended practice. So, if you say internal equity is a focus, you shouldn’t use market data alone to set initial salaries. Also, you should commit to regular (e.g. yearly) internal equity assessments. If you don’t practice what you preach, you’ll soon lose credibility and your philosophy won’t be worth the paper it’s written on.

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A compensation philosophy model can help to clearly illustrate areas of focus – consider developing one

Use a graphic illustration to communicate with stakeholders whenever possible. It is both easier to understand and more memorable.

Market Competitive & Internally Equitable Focus on Total Rewards Structured, but Flexible Approach Focus on Pay for Performance

Compensation Philosophy Example:

• You have arrived at five areas of focus that you intend

to support through compensation practice:

• 1. Market competitive/externally equitable as well as
• 2. Internally equitable
• 3. Focus on pay for performance
• 4. Focus on Total Rewards (as opposed to Total Compensation

alone)

• 5. Structured, but flexible approach
• For simplicity, you decide to group the second one and

create a four-bucket model (group 1 and 2 together).

• This model will make communication of your

fundamental compensation principles easy and memorable.

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Refer to your Compensation Philosophy Worksheet during this process to ensure choices are legal and reflect your business strategy, culture, and aims.

Use your driving principles to select market positioning strategies and targets for salaries

Administrative staff Salespeople Professional employees Technical employees Managers Executives

Possible market position for salary: Common segments:

Lag at P25 – Client service is not a competitive differentiator and roles are easy to train. Lead at P60 – High-quality salespeople are crucial to support an aggressive growth strategy. Match (P50) – Quality is important, but top tier talent isn’t required. Lead at P70 – Skills are needed and there is a labor shortage in most/all areas of operation. Match (P50) – Effective leadership is crucial, but there is a labor surplus in most/all areas. Lead at P80 – Aggressive growth strategy requires very strong leadership in the C-suite. Some jobs may be paying in the 90th percentile – well above market – if the business strategy depends on top talent and outperformance in those areas. It might make business sense to pay other jobs at market (50th percentile) or less. – Carroll, Align Pay with Business Priorities

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Benchmarking against total cash compensation (base pay + variable pay) ensures you are competing with your competitors’ EVPs.

If you have decided to benchmark against total cash compensation (TCC) as well, review and modify your targets

Administrative staff Salespeople Professional employees Technical employees Managers Executives

Alternate market position: Common segments:

Lag at P20, but offer up to $5,000 in variable compensation. Match at P50 and offer a high commission rates with a payout target of $30,000. Lead at P60 because no variable pay plan is currently in place. Lead at P60 and offer project bonuses with a payout target of $15,000. Match at P50 and offer a profit-sharing plan with a target payout of $5,000. Lead at P65 and offer stock options with a target value of $100,000. Use the total compensation figures from market surveys to get a clearer idea of the EVP your competition is offering. Base pay targets are great, but they won’t tell you if your total compensation offering is way off the mark. – HR Manager, Health & Fitness Industry

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• 1. The objectives of your compensation approach
• E.g. to support sustained growth through a focus on pay for

performance or to recognize and encourage long-term

• rganizational commitment through a focus on pay for tenure.
• 2. The basis of job value
• I.e. internal equity, external equity/market value, or a

combination.

3.

Competitive intent for each employee segment

• I.e. target market approach (e.g. lead, lag, match); target market

position (e.g. P50); and target pay mix (base to variable).

Document these core elements in your compensation philosophy to make future compensation planning easier

The core components of a compensation philosophy: The core components continue on the next slide.

If market value is being used, take note of whether you have decided to use base pay or total cash compensation (base + variable) to benchmark against.

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The core components of a compensation philosophy: (cont.)

Gauge what to include based on your target degree of transparency

4.

The current structure

• E.g. traditional, broad-based, none

5.

The focus of variable compensation (bonuses and/or incentives)

• I.e. individual-based, team-based, organization-based, or a

combination

• 6. The approach to raises and promotions
• E.g. merit-based or performance-based

7.

Approach to administration

• I.e. authority and responsibility for decision-making

If pay practices in your

• rganization aren’t entirely

transparent, consider

• mitting competitive intent

from your public compensation philosophy. Specific details surrounding intent are typically reserved for “HR eyes only” as these details can be disengaging for employees if adequate information justifying the practices isn’t provided. If you aren’t completely pay transparent, substitute a vague statement in the public- facing philosophy, such as: “We strive to be competitive in

• ur pay practices.” or (if

accurate) “We strive to match the market for all positions.”

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Periodically review your compensation philosophy to ensure it is still aligned with organizational goals and culture.

Refresh for Success

• If there are no changes in the business, schedule a bi-

annual review.

• HR can conduct the review and draft any

recommended changes. The executive team should then be brought in to review the recommendations and approve any changes.

• Try to schedule these reviews at off-peak times for both

HR and the executive team. This will ensure that HR doesn’t push off the task and that the executive team doesn’t resent the disruption.

• Changes to any of the six factors should trigger an

immediate review. This will ensure that the compensation philosophy and resulting compensation practices are legal and fully supporting the business.

• If the change is a small one, such as a change to

minimum wage, take a Case 1 approach: HR conducts the review and drafts recommended changes. Then, the executive team is brought in to review the recommendations and approve any changes.

• If the change is a large one, you will likely need to

rewrite some or all of your compensation philosophy. Start from the beginning of this set.

Case 2: Business change triggers review Case 1: Planned reviews

Recruiters can be your “canary in the coal mine” – their feedback can be grounds for a review. If market positioning is out of alignment with talent targets, recruiters are often the first to know. Be sure to ask for – and investigate – their feedback and modify the compensation philosophy if your findings demand it.

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Summary/Conclusion

Saying you have “competitive compensation” isn’t enough – articulate your competitive position.

• A compensation philosophy needs to be specific in order to effectively direct compensation practices; it needs to specify

the target approach (lag, match, lead) and the target market position it desires for each employee segment.

• Note: The approach and/or the specific percentile target may be invisible to employees. It depends on the desired

degree of pay transparency.

A well-designed compensation philosophy is the foundation of an effective compensation strategy.

• The first step in compensation planning is the development of a compensation philosophy that clearly articulates the
• rganization’s high-level approach to pay for each of its employee segments, including its target competitive position.
• Your Compensation Philosophy has clearly set out your competitive intent, which was developed after careful

consideration of business conditions and objectives. This clarity ensures that pay practice is legal, culturally-aligned, and designed to support organizational goals.

• However, the existence of a Compensation Philosophy also give employees something to point to if practices aren’t

measuring up. So, ensure that there is an ongoing commitment to the core objectives before posting them on the walls.

Follow through on the implicit pay promises articulated in your Compensation Philosophy.