How to Create a Compensation Plan for Your Business

A well-designed compensation plan is crucial for attracting and retaining top talent at your company. The right plan motivates employees, keeps pay fair and equitable, and helps control costs. But creating a plan from scratch can be daunting, especially for first-time entrepreneurs.

Follow this step-by-step guide to develop a strategic compensation structure tailored to your organization’s needs and budget. With the right framework in place, you can ensure pay aligns with your business goals and culture.

Set Your Compensation Philosophy

The first step is deciding the overarching principles that will guide your approach to pay. Outline the core values driving your compensation strategy. Common philosophies include:

• Pay for performance – Compensation directly ties to productivity and results achieved. High performers earn substantially more than average.

• Internal equity – Pay is standardized across roles with similar levels of responsibility. Emphasis is on fairness.

• External competitiveness – Offering compensation comparable to industry peers is priority Keeps pay competitive.

• Employee ownership – Compensation promotes employee investment via vehicles like stock options. Fosters an “owner” mindset.

• Work-life balance – Generous vacation time flexible schedules and other perks take priority over maximizing pay.

Determine which philosophies best align with your culture and business goals. This guides decisions as you build out pay structures and policies

Create a Total Rewards Outline

With your compensation philosophy set, map out a total rewards framework encompassing:

• Base pay – Salaries, hourly wages, commissions and other guaranteed pay

• Short-term incentives – Performance bonuses, profit sharing and other variable pay linked to individual or company goals

• Long-term incentives – Employee stock options, phantom stock and other equity-based pay

• Benefits – Health/dental insurance, retirement savings plans, paid time off and other indirect pay

• Growth opportunities – Training, mentoring and other programs for professional development

• Work experience – Culture, career path options, workplace flexibility and other strategic advantages to attract talent

Blending the right mix of monetary and non-monetary rewards allows you to maximize appeal within your budget. This outline provides the blueprint.

Conduct a Job Analysis

Now it’s time to delve into specifics. Start by compiling detailed descriptions of each role, including:

• Primary duties and responsibilities

• Required knowledge, skills and abilities

• Typical education and experience qualifications

• Level of problem-solving and critical thinking involved

• Amount of supervision required

• Scope of decision-making authority

• Interactions with internal and external stakeholders

• Any unique working conditions or physical demands

This analysis evaluates the relative worth of disparate jobs using consistent criteria, enabling fair pay-setting.

Categorize Jobs and Develop a Pay Structure

Next, group jobs with similar characteristics into job grades or bands. Common methods include:

Traditional job grading – Rank individual jobs from highest to lowest importance. Assign corresponding grade levels, often using point factor evaluation.

Market-based job grading – Group jobs based on pay for comparable roles in your industry and region. Useful for startups without historic internal pay data.

Broadbanding – Divide jobs into broad skill-based bands instead of narrow grades. Simpler but allows wider pay variation within bands.

Role-based classification – Cluster jobs performing similar functions versus focusing on qualifications or hierarchy. Fits flat organizations.

Determine salaries or hourly wage ranges for each job grade aligned with your compensation philosophy. Ensure consistency and equity between grades.

Develop Pay Structures Within Grades

With job grades set, build pay structures within each:

• Pay ranges – Establish a minimum, midpoint and maximum salary or wage for each grade. Employees progress toward max with growth in skills and experience.

• Pay scales – Create incremental steps between salary minimums and maximums based on seniority. Employees receive “step raises” at set intervals.

• Open ranges – Pay is individualized based on performance and ability versus tenure. Maximums still define upper end.

• Salary bands – Assign broad percentage bands for base pay increases based on performance ratings. Allows flexibility.

• Market pricing – Set pay targets at a specific percentile of market rate for that role. Used to align pay with industry benchmarks.

Mix and match elements to craft a pay structure aligning with your compensation philosophy.

Finalize Pay Setting Policies and Guidelines

To administer pay fairly going forward:

• Document policy for starting salaries – typical % of range minimums or bands

• Standardize annual review process used to determine raise amounts

• Select performance metrics used to determine any variable pay eligibility

• Outline bonus opportunity ranges and weights by job grade

• Develop employee scorecards to track goals and manage incentives

• Create merit matrix used to allocate raises based on performance rating

• Formalize promotion guidelines including typical pay increases

With these program details defined, you can apply pay structures consistently when hiring and developing staff.

Control Program Costs

Once your compensation framework is established, focus on cost control tactics:

• Utilize salary bands over narrow grades to contain costs

• Emphasize bonus and equity pay for high performers over large base raises

• Add eligibility requirements such as tenure before maxing salaries

• Phase in larger pay structure changes versus immediately adjusting all salaries

• Limit guaranteed wage increases to only cover cost of living

• Suspend annual merit raises when finances are tight

A proactive approach prevents pay creep from escalating expenses as your company scales.

Compensation Planning Best Practices

When developing and implementing your custom compensation plan:

• Involve key stakeholders – Finance, HR, executives – to align on philosophy and strategy

• Benchmark pay against comparable roles in your geographic location and industry

• Make pay grades and structures transparent to employees to build trust

• Audit pay equity across genders, ethnicities and other groups and address gaps

• Review pay competitiveness and structure annually based on market trends

• Crunch the numbers on total cost implications of pay changes before finalizing

• Communicate pay structure updates and details of annual merit planning cycles clearly

• Train managers on equitably allocating merit raises and bonuses within guidelines

With careful planning guided by your business objectives, you can design smart compensation that attracts top talent, rewards high performance and fosters growth. Employees who feel valued through fair pay deliver their best in return.

Employee Compensation FAQs

Crafting compensation plans involves many complex considerations. Here are answers to some frequently asked questions:

How often should we review our compensation structure?

Annually is best practice to keep pay competitive as markets change. Budget at least biannual benchmarking.

What percentage of revenue should be spent on total rewards?

Industry averages range from 15-35% of revenue, depending on business model. Set targets based on margins and growth plans.

Should all employees be eligible for bonuses?

Tying incentives to specific measurable goals is best. Support roles can have upside for helping achieve team and company objectives.

How much of compensation should be base pay versus variable?

Base pay guarantees future stability for employees while incentives drive short-term performance. Aim for 70% base, 30% variable for most roles.

Should we share our compensation philosophy with staff?

Transparency builds trust that pay is equitable. Share core principles and general structures while keeping specific details confidential.

When an employee is promoted, how much of a raise is typical?

Bumping pay 10-20% upon promotion to a higher grade is common. Budget additional market alignment increases if needed.

How often should we adjust pay structures?

Annually reviewing ranges, grades and bands against market data ensures they keep pace with changes.

Conclusion

A strategic compensation plan that motivates employees and aligns with financial goals is foundational to organizational success. While developing a plan requires time and expertise, the long-term benefits for your culture and bottom line make it well worth the investment.

With clearly defined pay grades and structures, transparent policies, regular auditing and market benchmarking, your business can offer rewards that attract top performers, engage employees and fuel growth for years to come.