How To Create a Compensation Plan

How to develop and implement a compensation plan
  1. Create an outline. …
  2. Appoint a compensation manager. …
  3. Create a compensation philosophy. …
  4. Rank jobs and place them within a matrix. …
  5. Develop grades for seniority within each job classification. …
  6. Settle on salaries and hourly rates of pay. …
  7. Complete necessary policies.

Organizational leadership and human resources professionals are constantly faced with challenges when developing a base compensation plan. In addition to remaining competitive, you want to be able to draw in, keep, and reward employees. However, you also want to make sure that pay is distributed fairly for the work done, that each position and employee are valued, and that managers are aware of and supportive of the compensation plan.

The committee members will need to comprehend that they are committing to constructing or improving the current compensation plan over the long term. They must be prepared to collaborate in order to reach potentially difficult but just decisions, and they must be able to take the organization as a whole into account at all times. Being able to separate people from their positions is essential.

You will be helped in defining the pay groups throughout the compensation structure by using the midpoint average of positions with comparable salaries. Typically, you start at the top and build subsequent ranges based on positions with similar values. There are typically 10% advancements between midpoints, but there may be larger advancements between executive and upper management positions and smaller advancements between mid-management and staff positions.

All positions are included in the salary structure after the ranges are established. The structure should be reviewed to ensure it makes sense. On the basis of the relative value of the positions, the results of the internal equity analysis can be used to make any necessary final adjustments to the compensation structure. If the position’s value differs from the external market value or if external market data is unavailable due to the position’s uniqueness, internal equity considerations are especially brought to the forefront.

Your business can use a comparative ratio analysis (also known as an employee impact analysis) to determine how current pay rates compare to the midpoints of the recently established compensation structure. The organization can assess pay practices generally using the comparative ratio analysis to see if they adhere to the organization’s compensation philosophy.

The analysis also identifies those who might receive salaries that are below or above market. It is a very efficient tool that the company uses to manage compensation. This tool can also be used to include other administrative factors, like performance. Additionally, it can help the company identify any potential issues with pay equity for protected classes.

HR Basics: Building a Compensation Plan

What are the types of compensation plans?

Salary, hourly, and commission-based compensation plans are the most prevalent types of compensation plans:


No matter how many hours an employee works, their salary is paid at a fixed rate. A salaried worker receives a regular paycheck as well as additional perks like paid time off, bonuses, health insurance, retirement benefits, and the right to minimum wage. Some businesses also reimburse salaried employees for overtime work.


A pre-determined rate is paid to an employee on an hourly basis for each hour worked. Additionally, they are paid overtime for hours worked past 40 in a week. Hourly workers must use timecards or an automated tracking system to record their working hours. Hourly employees, also known as non-exempt workers, are paid less than the minimum hourly wage. Additionally, they are not entitled to the benefits that salaried workers receive.


Employees who work on a commission basis are paid in accordance with the amount of sales and revenue they make during a given pay period, such as a month or a quarter. Additionally, some businesses guarantee a base salary for commission employees regardless of their performance. Some employees may receive bonuses in addition to base pay and commissions as compensation for exceptional performance.

What is a compensation plan?

A formal document called a compensation plan outlines an organization’s philosophy regarding employee compensation and benefits. Depending on an organization’s compensation philosophy and the state of the market, different compensation plans are offered. A company lacks a framework for employee compensation in the absence of a compensation plan. Ad hoc compensation methods are likely to result in high employee turnover. A compensation plan, in the end, harmonizes business practices and company guidelines that direct the development and distribution of rewards to employees.

How to create a compensation plan

Making an equitable, competitive compensation plan that motivates staff to deliver outstanding performances is one of management’s most fundamental duties. However, there isn’t a single strategy that works for all businesses, so learning how to create one is crucial for your enterprise. Here are the key steps in creating a compensation plan:

1. Develop a compensation philosophy

Establishing your organization’s desired reward philosophy and strategy is the first step in developing a compensation plan. The fundamental idea supporting the compensation plan is called a compensation philosophy. A sound compensation philosophy strengthens competitive advantage, benefits business operations, and advances the strategic goals of the organization. The philosophy serves as the foundation for all decisions regarding employee compensation, incentives, and benefits. A well-grounded philosophy addresses the following:

Instead of relying on an ad hoc approach, the responses to the above checklist assist in determining the basis of compensation. Most businesses today tie their compensation policies to employee performance, rewarding top performers with higher benefits and vice versa. This strategy aids businesses in maximizing the return on investment made in employee compensation.

2. Gather relevant data from multiple sources

It is essential to gather enough data when creating a compensation plan in order to determine current market trends and position your organization effectively. The type and quantity of information will vary depending on the size of the company, the project’s timeline, and whether you are revising an existing plan or creating a new one. Some of the information to be gathered includes:

Information should ideally be gathered from a variety of reliable sources in order to increase the data’s reliability because this enables triangulation and the filling of data gaps. Unreliable data could compromise the validity of findings and result in expensive, poor decisions. You could use the following reliable sources of information for a salary survey:

3. Benchmarking external to internal positions

Once market data has been obtained, the next step is to analyze the data to determine the benchmarking jobs that will be charged based on the market externalities. It is recommended to benchmark between 50 and 65 percent of positions using market rates to account for at least 70 percent of all workers. It’s crucial to keep in mind the following advice when conducting the benchmarking exercise:

Review current pay rates in comparison to market data at the conclusion of the benchmarking process. This makes it possible for you to develop appropriate pay structures that complement the organizational compensation philosophy and take into account current market conditions.

4. Create a job description for each position

Create a detailed outline of the obligations and responsibilities of each position. Consider the job descriptions for comparable positions on the market, as well as the associated pay You might choose to combine positions if they are performing essentially the same duties. Give each position the appropriate job title in accordance with the current market conditions and organizational internal rules.

5. Develop the pay structure

Creating pay structures involves creating job grades, a market pay line, and pay ranges. A job grade is a collection of various but comparable jobs. By establishing job grades, it is possible to treat similarly remunerated jobs fairly. Additionally, they offer guidelines for promotions from one grade to another. You can convert market data into information for internal use by using a market pay line.

You can compensate employees according to their experience, level of education, and performance by establishing pay ranges within job grades. Determine your benefits as well as how they will fit into the company’s budget. Make sure you adhere to all applicable federal and state employment laws when creating a pay structure.

6. Establish the cost of the pay structure

The pay system directly affects the financial health of an organization. It is crucial for a business leader to determine the compensation plan’s financial impact and sustainability. You should take into account the plan’s future costs in addition to the pay structure’s current costs. While maintaining the organization’s ability to recruit and retain talent, a sustainable compensation plan should strike a balance between present and future organizational needs.

7. Document the compensation plan

It takes a lot of time, consultation, correspondence, and paperwork to create a compensation plan. Therefore, it is crucial to properly document the process’s final product for future use.

8. Implement and evaluate the plan

Implement the compensation plan developed. To increase transparency throughout the entire compensation policy, it is also appropriate to share the specifics with managers and employees. Consistency in decision-making is made possible by understanding how the compensation system operates. However, due to the sensitivity of the issues, some organizations may decide to restrict access to the compensation plan.

Make sure you review the compensation plan during the compensation plans implementation period to account for changing market dynamics. For instance, you might need to review the pay scale for highly sought-after skilled workers. Additionally, you must update your compensation strategy to reflect changes in legislation and policy.

Frequently asked questions about compensation plans

Here are some answers to common questions about compensation plans:

How frequently should compensation plans be reviewed?

Compensation plans should be reviewed every two years. But some things, like falling behind on benchmarking or having to compete for talent, might make you need to review the compensation plan more frequently.

What do you do with an employee who feels their pay is unfair?

Employees frequently question whether their pay is fair in comparison to that of their coworkers or counterparts in other organizations. Make sure the compensation philosophy is transparent to ensure there aren’t many complaints about the compensation plan. Display to staff how their pay compares to going market rates.

What should you consider in evaluating compensation data?

There are several factors to consider when evaluating compensation data. These include:


What is an example of a compensation plan?

Additionally, compensation can be given as a reward for excellent work. Bonuses, commissions, stock, profit sharing, and gain sharing are some examples of such plans.

How do you create a good compensation plan?

How to create a compensation plan
  1. Develop a compensation philosophy. …
  2. Gather relevant data from multiple sources. …
  3. Benchmarking external to internal positions. …
  4. Create a job description for each position. …
  5. Develop the pay structure. …
  6. Establish the cost of the pay structure. …
  7. Document the compensation plan.

What are the five steps in compensation planning?

With this in mind, here are five (5) easy steps for setting compensation.
  1. Define the job. …
  2. Price the job. …
  3. Determine the job’s value to your organization. …
  4. Review where a job fits within a grade/range. …
  5. Consider organizational factors, including budget.

What are the 3 compensation plans?

Here are the three most popular types of compensation packages and a few notes on who might be most attracted to them.
  1. Straight salary compensation. …
  2. Salary plus commission compensation. …
  3. Straight hourly compensation.

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