“What is your compensation or reward strategy?”

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If you cannot answer the above question in 120 words or less, you probably do not have one.

So what do we mean by a compensation strategy? Like any other strategy it is a direct statement of how your company plans to pay and reward its employees, both today and into the future. It typically will establish parameters or benchmarks like:

  • Where on a measurable scale your company plans to pay employee salaries versus similar or select jobs or companies within the marketplace—usually stated as a relative position within the market (say 50th percentile*).
  • What amounts (levels) of total annual compensation (salary plus bonus) is the company willing to pay its employees for various levels of achievement or performance—generally also stated as a relative position within in the marketplace.

Let me present an example of a recent client’s statement of compensation strategy. It is written in a way that any company stakeholder (owner, manager, employee or lender) can understand. Its objective is to provide a clear statement of pay objectives and principles. Our example does not include some of the nuances of executive compensation such as long-term incentives. This is often considered, and treated as, an additional leg to the compensation strategy. Our example:

The Specialty Division of ABC Industries, LLC will endeavor to pay all of its employees total annual cash compensation (salary plusannual bonuses) at the median (50th Percentile, or middle) of appropriate national or local market rates of pay for similar jobs in similar companies.

If company or individual performance exceeds expectations and industry standards, higher levels of total annual cash compensation will be awarded. The Division will help fulfill its total annual cash compensation strategy by targeting average salaries for all employees at the median (50th Percentile, or middle) of appropriate national and local market rates of pay for similar jobs in similar companies. However, salaries may be adjusted versus market levels based upon experience, competency and sustained performance. (120 words).

It is also quite possible (and common) that a company may choose to pay a premium to employees or candidates with unique or prized experience or skills. Examples of this are: key executives, IT professionals (more of a legacy than a requirement in today’s markets) or holders of special scientific & technical credentials. For example, I once saw a company pay premium compensation for experienced ceramics engineers. These premiums are, or should be, very select. A company can also make a decision to offer discounted pay to some less-prized skills, but I would not recommend it in terms of a strategy, but rather as a temporary market reaction.

Notice that no mention has been made of employee benefits. I thought of adding a line on employee benefits’ competitiveness in the example but realized how difficult it may soon become to benchmark or measure benefit-plan fairness or competitiveness with the advent of (evolution to) The Patient Protection and Affordable Care Act.

Some would argue that benefits are a key part of employee compensation and should be considered in your reward strategy, I would agree. However, I believe that the long-standing relationships between pay and benefits are now undergoing a major shift (right under our feet), and until a company decides where employee benefits will fit into its future pay structure and calculus, they should endeavor to be “fair” and commit nothing else to writing in 2012. [Refer to our June 2011 edition of the Corner Office Gazette to read our most recent article regarding The Patient Protection and Affordable Care Act.]

A compensation strategy is often much like a company’s overall business strategy when you take a look at its benefits. Let’s examine four.

  • Benchmarks—a compensation strategy provides you with benchmarks against which you can measure success or progress. For example if you want your employees to be paid at the median (or middle) of the market, you can readily determine where you stand versus that benchmark, you can then make appropriate plans to adjust actual pay practices, as required. It is a bit like an annual or periodic audit.
  • Competitiveness (“Keeping up with the Jones”)—if you know (anticipate) that market pay will increase by a certain amount in the coming year you know what you have to do and budget to achieve or maintain your pay strategy and competitiveness. Most of you see market forecasts for the coming-year each spring offered by consulting firms and other research sources. If you do not heed these forecasts, your company could gradually lose its competitive edge in the talent market.
  • Guidance with annual bonus plan design—we always believe that it is important to design bonus plans to pay out a “competitive amount” when the participant meets or exceeds the company’s expectations.  With a strategy statement in place, that “competitive amount” can be clearly defined by your compensation strategy—in dollars and cents. It is then the job of the incentive-plan designer to build a motivating plan that has the characteristics or topography outlined (or required) in your compensation strategy. For example:  “If company or individual performance exceeds expectations and industry standards, higher levels of total annual cash compensation will be awarded.” You could interpret the above statement to mean that 75th percentile instead of 50th percentile total annual cash compensation will be paid to bonus-eligible employees when performance expectations are greatly exceeded–through the use of the company’s annual bonus plans.
  • Ability to quantify pay-for-performance and budget compensation expense—if I were your CFO, I would be very glad to have a company compensation strategy to use as a guide and a tool. Why? It would allow me to simply tell the Board and our lenders how changes in company performance will impact total compensation expense for the company. Further, it provides a budgeting guide that clearly will reveal the costs of adopting (a new) or continuing your (current) compensation strategy—good or bad.

Does your company have a written (or unwritten) compensation strategy? If you do, also think about what you plan to do about employee benefits in the coming 24 months.  Are you receiving the benefits I have described above? They are there–go get them.

If you do not have a compensation strategy and believe it is a good idea, try this. Take the above-stated example and apply it to the current pay practices of your company.

  • Would it (or something like it) make sense for you?
  • What would be the results (in dollars and cents) and impacts if you applied the benchmarks and benefits discussed above to your company and current pay practices?

If you like what you see, take the step of writing and adopting your own company’s pay strategy. I bet you will learn to like the benefits.

Wilkening & Company has helped many clients write and benefit from compensation or reward strategies, and would be glad to discuss methods and benefits in more depth.

* When the writer refers to the 50th percentile salary practices versus the market, it means that you have selected a salary practice at the middle of the market (as represented by reported data)—or median. The 50th percentile is a point where ½ of participants reported data observations higher and ½ reported data observations lower. It is again the middle of the market. Likewise, the 75th percentile is where ¼ of participants reported data observations higher and ¾ reported data observations lower.

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