What Are Compensation Strategies and Why Are They Important?

Updated November 21, 2022

Compensation refers to all remuneration packages employees receive, including salaries, benefits, and paid time off. An effective strategy that outlines how to determine compensation can help a company manage costs and improve employee quality. If you attract, hire, or retain top talent for a company, understanding how to set compensation strategies can help your offering remain competitive. In this article, we answer the question "What are compensation strategies?" and explain why they're important and how to develop appealing strategies for your organization.

What are compensation strategies?

Compensation strategies are plans that describe how a company determines employee benefits and pay. These plans include information on the company's goals for providing compensation and remuneration ranges for roles within the company. It also outlines how the company evaluates employees when determining compensation. Implementing an effective compensation strategy can provide a company with a competitive advantage. It can also encourage employee loyalty.

You can include the following types of compensation in your strategy:

  • Base pay: This is the initial salary an employee receives without benefits, bonuses, or raises.

  • Bonus: A bonus is the amount added to an employee's pay as a reward for excellent performance.

  • Commission: This is the amount an employee receives for completing a task, which typically involves selling products or services.

  • Overtime pay: Overtime is the amount employees receive for working extra hours.

  • Paid time off (PTO): PTO is the money employees receive while away from work.

  • Flexible schedules: This enables employees to work at a more convenient period other than regular nine-to-five hours.

Read more: Importance and Common Types of Compensation

Why are compensation strategies important?

Compensation strategies help to formalize staff remuneration. Here are common reasons to develop and implement a compensation strategy where you work:

Ensure company goals

Developing a compensation strategy can encourage employees to work toward reaching the company's objectives. By structuring compensation to reward performance that aligns with the company's objectives, you can motivate new hires and tenured employees. This can also lead to improved productivity and a more positive work environment.

Related: What Are Reward Systems? (Including Benefits and Examples)

Improve the recruitment process

A company's compensation strategy can also impact recruitment and encourage employees to continue in their positions. For example, if the company where you work has competitive compensation strategies, candidates may prefer this company over its competition. Having an attractive compensation strategy can also help you target employees that can provide the best results in a company.

Read more: Guide to the Process of Recruitment (With Tips)

Ensure budget management

Following a compensation strategy can help a company operate within its budget. For example, with a compensation strategy that states $400,000 is available for promotion bonuses, you can plan promotions to ensure you stay within this amount. Similarly, if a company's strategy is to offer $500,000 to $600,000 in raises every year, you can estimate how many employees to offer a raise.

Ensure equity in the company

Having an effective compensation strategy can ensure pay equity, which is equal pay for equal value of work. As a strategy outlines the compensation packages and how employees earn them, companies that implement a plan can be more transparent about compensation. Creating and following a compensation strategy where top performers receive the highest compensation can also encourage others to perform at higher productivity levels.

How to develop effective compensation strategies

Developing a company's compensation structure is easy if you know the steps. If the company where you work needs a compensation strategy, follow these steps to create one:

1. Assess the company's goals

Start by evaluating the company's goals and what it wants to achieve using a compensation strategy. For example, a company may require a compensation strategy to reduce employee turnover or attract quality candidates. As a compensation strategy is part of a company's overall strategy, it's important for your plan to align with company goals.

2. Identify the company's competitive advantage and current strategy

Next, recognize what makes the company unique. By determining the company's current advantage over its competition, you can understand whether to use it to plan for compensation. For example, suppose a marketing agency offers discounts on client products to employees who meet a performance target on a particular campaign. Identifying this advantage can help them plan to update their strategy by including invectives or other employee benefits, such as management training.

3. Seek employee input

When developing a compensation strategy, consider employee satisfaction and morale. You can inform employees of the plan to create an effective compensation strategy, as it directly affects them. By discussing current compensation packages and requesting employee feedback, you can also determine how to make compensation more attractive. For example, employees may provide ideas on how to update the compensation strategy and ensure pay equity.

4. Research compensation data and evaluate the talent market

Next, analyze the talent market and your competitors' strategies. Doing this provides insights into what strategy to create. For example, researching compensation data can help you discover more diverse compensation strategies than what others may offer. Consider the duties and qualifications of employees when comparing compensation strategies with other companies.

5. Determine your priority for competition

As companies may have several goals for implementing compensation strategies, consider prioritizing the company's most important need. For example, you may develop a strategy that focuses on hiring quality talent over addressing employees who currently receive appealing benefits. Alternatively, you may focus on creating a strategy that targets employees more than potential candidates to ensure high retention rates. Determining your priority also involves considering the budget for your compensation strategy.

6. Select compensation packages

Next, identify what rewards to offer employees. For example, you may offer a vacation package to entry-level hires and retirement packages to senior employees. Depending on the company's needs and budget, you may also offer the same compensation packages across departments or have different rewards for different departments. Assess various ways of using the compensation budget by referring to your research and the feedback employees provided.

7. Create compensation ranges

After determining packages for employees, consider creating compensation ranges instead of set values. For example, you may provide two to four weeks of paid vacation to employees who meet a performance target. Doing this enables you to adjust your offers based on employee performance, experience, and qualifications.

8. Check compensation strategy for legal compliance

After developing a compensation strategy, ensure you confirm it aligns with all federal and provincial or territorial laws. For example, suppose your compensation strategy is to offer four per cent to six per cent of earnings to eligible employees for two weeks of vacation. Check that this strategy aligns with laws on annual vacation and vacation pay by the Canada Labour Code. You can collaborate with a legal professional to ensure the company can legally implement your compensation strategy.

9. Seek upper management approval

Next, present your compensation strategy to the management team for approval. When meeting with upper management, prepare a report that outlines competitor strategies, compensation data, and employee feedback. You also want to show your proposal's benefits to improve the likelihood of getting a favourable response. Depending on your strategy, the management team may adopt your proposal or request updates that align with the company's goals.

10. Write the compensation strategy

After receiving approval, write a document explaining the parameters concerning the compensation strategy. You may collaborate with human resources professionals to include the strategy in the company's employee handbook. Writing the compensation strategy is important for future reference.

11. Monitor and review the compensation strategy

Finally, implement the compensation strategy and track the results relating to the company's goals. Doing this can help you determine the plan's impact. For example, if employee retention increases by 40 per cent because of your compensation strategy, the compensation plan you developed is successful. Regardless of the goals reached by implementing a compensation plan, review and update it regularly. You may have annual or biannual reviews to achieve this.

Tips for developing an effective compensation strategy

Follow these practices when creating a compensation strategy to make it as effective for employees and management as possible:

Be specific

Ensure you have clear goals and objectives for creating a compensation strategy. You can create SMART goals, which are specific, measurable, achievable, relevant, and time-bound. You also want to develop an action plan for reaching the goals you set.

Read more: SMART Goals: Objectives for Your Career

Be accurate

Perform accurate research and present informed data. For example, you can benefit from finding research compensation data from reliable sources. Stay current with the competition's strategy and remember to monitor the talent market's trends and fluctuations. Using accurate data to develop your strategy can address company, employee, and prospective candidate needs effectively.

Be clear and direct

Ensure your strategy addresses all questions employees might have about compensation. For example, suppose you're offering education reimbursement to new hires. Ensure you describe the amount they can expect to receive, which schools the package applies to, and what degrees it covers. Being transparent and communicating effectively can positively impact how the strategy reaches its goals.

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