Compensation Strategy Creation: The 4 Components that Attract Top Talent
Great business leaders and acclaimed psychologists alike agree: You need to set an informed compensation strategy for your company; the earlier, the better. Despite this advice, organizations and finance leaders across the board find themselves wasting time and making mistakes regarding salaries on the regular.
Most companies are looking to operate fast and make quick, nimble decisions. They are okay with things not working out and needing to be redone as long as they can learn from the mistakes; think of Facebook’s “move fast and break things” approach. However, a tightening global economic climate means scarce capital, which translates to a lower margin for error.
These errors compound over time and lead the company to a place where re-evaluating past decisions becomes almost impossible. Think of how much effort it would take to re-evaluate a set of random employees’ respective pay and benefits without doing a whole salary refresh or rebalancing effort across the company. Not many companies have the finance and HR firepower to make this happen.
So what can companies do?
Write down a framework to make decisions with. The framework for paying employees in the company is referred to typically as a “compensation strategy”, which guides the HR team when making salary decisions for new or existing employees.
I will cover the essential aspects of a compensation strategy, laying the groundwork from which you can layer your own personnel needs to come up with a comp strategy that works for you. I’m here to do the heavy lifting so you can focus on System 2 decision-making, without requiring so much time.
What is a Compensation Strategy?
A compensation strategy illustrates what and how a company is willing to pay employees, relative to their peer group.
It outlines the following:
- Payscale - whether the company is willing to pay at the 75th percentile or the 90th percentile.
- Pay components - split of base pay, variable pay or sales commissions, benefits, and stock options.
Pay bands and components are influenced by the current and forecasted cash flows of the company in conjunction with the quality of talent they anticipate to attract and retain for the long term.
What is Salary Benchmarking?
The Merriam-Webster dictionary defines benchmarking as “a point of reference from which measurements may be made.”
So, by extension, salary benchmarking refers to the process of evaluating your existing and offered compensation plans against market averages, competitive companies, and talent demand.
You can also look internally, benchmarking the salaries of top talent from various parts of your business against others; for example, if your top-performing salesperson is earning 5x your top-performing customer experience and retention agent, you may want to re-evaluate your compensation strategy, unless you want to lose your lower-paid staff and departments and create a company culture of sales-above-all.
Why is Benchmarking Important?
Benchmarking provides awareness that lays the groundwork to implement a compensation strategy. Without the output from a salary benchmarking exercise, you shouldn’t implement your compensation strategy. Without collecting available information on the topic, you may realize you’re about to try to wildly over- or under-pay all new employees.
Pay too little and you’re going to lose out on top talent; pay too much and you may be unnecessarily decreasing your margins.
The biggest benefit of a sound compensation strategy is the ability to explain the rationale upon which a particular compensation decision has been made (or will be made in the future) to current and prospective employees. If you have a solid, data-driven strategy you can point to and set expectations from, you’ll find that employees are much happier.
The next time an employee asks, “What is the basis of the raise you’re offering me?” You have an answer.
The best response is always a clear one. For example: “We aim to be in the mid quartile when it comes to cash compensation but the top decile for stock options because we want our employees to participate in the upside of our company.” Obviously, this exact strategy can change to suit your business goals but you get the gist of it.
Often, the compensation offered to a highly skilled individual also changes based on the demand and supply for that particular skill set. If a position is at risk of automation through AI or outsourcing, you’ll likely want to adjust your compensation philosophy to account for it; conversely, if competitors are looking to poach your talent, adding some additional benefits wouldn’t be a bad idea.
Regardless of your exact circumstances, benchmarking should give you more information to work with.
Best Tools for Compensation Benchmarking
To undertake any form of benchmarking, it is important to have access to good market data. Benchmarks vary based on region and role, so for any software tools that are identified for compensation benchmarking, ensure to do some additional research on the number of companies included in the analysis, how often this data is refreshed, and whether the companies included in the benchmarking process are in a similar valuation range to your own.
The gold standard in compensation benchmarking is a product called Carta Total Compensation. Carta is a world leader in cap-table management and related tools for Finance and HR teams. Carta is great for the North American market and they refresh their benchmarks at least twice a year.
Alternatively, check out Pave if you are looking for a free tool before you shift to something that is paid like Carta. Pave does have paid tiers for add-on features but their freemium tier is a great place to start.
Compensation Structure: 4 Main Components
There are 4 main types of compensation typically offered by companies. These are:
- Fixed pay, which is the minimum fixed salary paid out to an employee on a monthly/bi-weekly basis. If your organization operates across different regions, this is likely to be different for each one.
- Performance-based pay is dependent on the performance of the individual as well as the company they work for. In most cases, there’s a weightage defined upfront between the company's performance and the employee’s performance.
- Stock Options, where employees receive ownership rights in the company and get to participate in the upside in the case of an M&A transaction or the company going public.
- Benefits are the most underrated employee retention tool in an organization. Benefits are added perks beyond normal wages and salaries.
Fixed (Base) Salary
The fixed vs. performance pay in the overall cash compensation varies based on the role being hired for, the stage of the company, and the experience of the employee. It may seem obvious, yet an inordinate number of people end up making the following mistake: Don’t establish a fixed salary in isolation; consider the other factors in your compensation strategy before landing on a base salary figure.
Performance-Based Pay
This pay component’s importance scales linearly with the percentage of the overall cash compensation it contributes to. These are some of the most important things to consider:
- What the “performance” is and how it’s measured. If they aren’t in control of it, they’re going to push back.
- What the typical bonus payout percentage has been, in case it is dependent only on organizational performance. If you set too lofty of targets and your staff never gets bonuses… once again, they’ll be annoyed.
- The frequency of the payout - monthly, quarterly, bi-annually, annually, etc.
- Milestones that need to be reached and course correction strategies when milestones change. If the organization-wide goals change - which they have every right to - you need to know and be able to communicate how pay will be affected.
The ratio of performance-based pay vs. stock options can vary highly, depending on the job role. For sales roles, performance-based pay can be as high as 100 of the fixed-pay component and paid out either monthly or quarterly based on the quota/target attainment.
For roles like sales (including Account Executives, Customer Success, Sales Development Reps, or Business Development Reps), performance-based pay can be measured against outcomes such as:
- # of leads,
- # of qualification meetings conducted or set,
- # of demos scheduled/conducted,
- revenue generated,
- renewals, and more
In such revenue-focused roles, performance-based pay is strongly geared toward motivating the individual to maximize the revenue for the organization and thereby maximize their own income.
However, for other roles like Engineering, Design, or Product Development where outcomes are less measurable, the performance-based pay could be linked to company performance or achievement of pre-agreed milestones like on-time or bug-free product releases, product uptime/reliability, security certifications, etc.
Stock Options and Benefits
Stock Options
Everyone wants stock options but they matter the most in early-stage start-ups. Legend has it that a graphic design student, Carolyn Davidson, got paid $35 for the iconic Nike swoosh when she designed the logo in 1971… but that’s not all.
She also got 500 shares, worth a total of approximately $125, the day Nike was listed on the NYSE in 1980. The stock price today is around $100 per share, and it has split seven times. Two to the seventh times $100 a share, times her 500 shares, is worth $6.4 million today.
Most employees dream of this kind of wealth from the start-ups they work for (and rightfully so). The uncertainty, long hours, and inclusion in an intense work environment might not be for everyone; most people need to be adequately compensated for that effort, not only in terms of cash but also by having upside potential in the future based on the company’s success.
Just as performance-based pay is contingent on employee positions, the quantum of stock options given to individuals varies by role.
In addition to being a compensation component, stock options are also a great retention tool by setting them up to (typically) vest monthly, over a 4-year period, with a 1-year cliff. The cliff refers to the minimum amount of time the employee needs to work in the company for their options to be eligible for exercise and, at this time, the employee typically gets a small pool of options unlocked. After the 1 year period is up, 1/48th of the overall option grant would vest for the rest of the 3-year term in the above example.
Performance vs. Time Based Vesting
Stock options work as a great retention tool since the employees are required to stay employed in an organization for their options to vest over the duration of the option grant. This is most commonly the case.
However, in case there are clear milestones or goals to be hit, options can also be used as an effective incentive mechanism to accelerate progress toward these milestones, allowing a set number of options to vest upon the achievement of the milestones. Vesting in this case is referred to as performance-based vesting.
Joining Grants and Refresh Grants
Stock options are typically offered at the time of the employee joining the company. In addition, refresh grants could also be offered to employees as part of their review cycle or alongside promotions.
Benefits
Employee benefits are non-monetary compensation provided to employees in addition to their base salary, bonuses, and stock compensation. A well-thought-out benefits package can, at times, offer outsized returns for companies that are unable to provide generous monetary compensation; as benefits are charged on a per-usage basis, many companies can provide numerous benefits without forking the cash out directly.
Be wary of this though, as higher-than-expected utilization ratios from your employees could result in insurance premiums rising dramatically for your company.
Examples of benefits include:
- Health insurance
- Dental insurance
- Life Insurance
- 401(k) Matching
- Flexible Work Schedules
- Extensive or Unlimited Paid Time Off (PTO)
- Educational Assistance
- Childcare Support
- Mental Health and Wellness
- Gym Memberships
- Free Meals
- Remote / Hybrid Work
- International / Domestic Travel
The benefits program would need to be tied back to the demographics of the employees in the organization and what they would perceive as most beneficial and, of course, work for the company itself. Have a company full of young salespeople? They’ll likely care less about extended healthcare and parental leave, favoring things like free meals and hybrid work.
Establishing a Compensation Strategy
In this section, I’ll break down each of the 3 components once again, based on which compensation quartile you want to be at. Don't take my examples as law, though, as this is where there’s the most scope for innovation and creativity.
The easy way out would be to just pay all employees above market base salaries to get them hired; however, that obviously isn’t feasible for most companies. Plus, while pay could get people through the door, it’s the performance-based pay, stock options, and benefits that make them stay.
The compensation strategy of an organization depends on the following:
- Access to capital (current and future)
- Employment location
- Current and potential employee demographics (most critically, geographic information)
- Presence of competitors
- Stage of employees being hired
- Education level required of employees
Where the employers want to be versus the overall market rate is measured on a percentile basis. The percentile provides a comparison between a particular company and the average of the rest of their peers, with regards to a specific compensation aspect.
| Comp. Strategy | Fixed Pay (%) | Performance Pay (%) | Stock Options (%) | Benefits |
|---|---|---|---|---|
| Aggressive | 75+ | 75+ | 75+ | High |
| Balanced | 50+ | 50+ | 50+ | Moderate |
| Non-Competitive | 25+ | 25+ | 25+ | Low |
| Results-Based | 50+ | 75+ | 75+ | Moderate |
Some sample business strategies and percentiles are provided above for reference; here are some cases in which they could apply:
- Aggressive - Company has high access to capital in a tight labor market, where employers need to work hard to differentiate themselves to attract and retain talent.
- Balanced - Company strives to provide market pay and benefits and has access to the talent pool that it needs.
- Non-Competitive - Company is offering below-market pay and benefits. This could be in a case where talent is abundant and/or the company is the sole employment provider in a region’s job market or type of employment.
- Results-Based - Company provides a low base salary and wants to incentivize outcomes, putting an outsized component in the form of performance-based pay and stock options.
Cashing Out
Like every other part of the business, there is no single most effective compensation strategy. The best compensation package is one that helps you achieve your objectives and flex your competencies, while being mindful and predictive of the constraints of the business.
The easy part about any strategy is writing it down; the hard part is the implementation. As a finance leader, you may easily be able to implement the value in your strategy, however, you need the buy-in of Human Resources and the rest of management before the plan is put into action.
Spend some time thinking about why a particular decision has been or not been made, as it’s quite likely that the same question is also in the mind of the employees for whom these policies might have a material impact.
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