What Is a Compensation Structure? (With Guide and How-to)

Updated November 11, 2022

A compensation structure helps employers to determine how they can pay their employees. While the specifics of most organizations' compensation vary, the frameworks themselves are typically identical. Learning the different compensation structures and how they work can help you make more informed career decisions. In this article, we define what is a compensation structure, the different types of structures, the factors that determine the structure, and how to create a compensation plan.

What is a compensation structure?

A compensation structure refers to the pay-based framework that businesses utilize to ensure that all employees get fair and equal compensation. It also establishes explicit criteria for establishing starting pay rates, managing increments, and allocating incentives within an organization. A compensation system that's efficient aims to eliminate inequitable pay practices, such as previous salary history and ineffective negotiation, and also inherent prejudices such as gender or race.

Types of pay structures

Pay structures can take on a variety of forms, depending on the organization's goals. Some popular compensation models include:

Broadband structure

A broadband structure is a more traditional kind of remuneration that is still used by some businesses. The business establishes pay bands in a broadband structure, which may also vary significantly from entry-level to top-level compensation. Numerous businesses use the broadband structure to accommodate employees who may remain with the organization for the entirety of their careers, frequently in the same role.

Related: What Are Salary Pay Scales?

Structure in steps

The step pay structure is a tenure-based framework that emphasizes an employee's length of service with the organization. Step structures are very successful in some professions and positions where there is little potential for upward mobility, such as teaching or firefighting. Employees receive rewards for their loyalty to the company and continuous commitment to the industry through the payment steps.

Grade and range structure

The grade and range structure are some of the most frequently used compensation systems in a modern company. It's similar to the broadband structure in that each grade has a salary range, but the range is frequently significantly narrower and the system gives more options for growth and advancement. Typically, when transferring personnel between grades, a grade and range structure can consider both tenure and performance.

Benchmarking structure

The benchmarking pay structure focuses on market research and data to determine what salaries are competitive for various positions. Unlike some other systems, where personnel and their compensation follow a defined upward trajectory, a benchmarking structure is heavily data-driven and may change from year to year. A benchmarking framework is especially beneficial for companies or positions that are extremely competitive or challenging to fill.

Factors that determine a pay structure

Many factors may affect the pay structure that a business adopts. Several of the most often considered factors by companies when developing their pay structure are:

Unions and collective bargaining rights

Collective bargaining is the process through which employees, through their unions, negotiate contracts with their employers to establish their employment conditions, which may include compensation, benefits, hours, leave, occupational health and safety standards, and strategies for having a healthy work-life balance. One issue that can affect the pay structures of some organizations is whether employees have union and collective bargaining rights. Certain businesses consider the contract they agree upon during collective bargaining sessions when determining their overall pay structure and the stages, ranges, or grades that comprise it.

Perceptions of employees

Employee perceptions can affect the overall pay structure chosen by a business. The majority of employees like to work for a business that's open about how they reward their employees and how the company sets those salaries. Often, it's in the company's best interest to create a pay structure that employees perceive to be fair and equal.

Cost of living

The cost of living is another element to consider when developing a salary structure. Certain areas, particularly large cities, may experience greater increases in the cost of living than suburban or rural areas of the country. Also, you may consider the impact of annual non-performance or tenure-based increases on the company's overall pay structure when developing an effective pay structure.

Government legislation

The minimum wage premise is to provide a uniform baseline for the lowest amount a company may lawfully pay an employee. Depending on where you live, your province may have unique pay and salary restrictions that may affect how an organization arranges its remuneration. Certain provinces increase the minimum wage regularly, which can cause every pay band, step, or grade in a company's structure to go upward.

Growth potential

The overall development potential of the business may also influence how they organize its organizational compensation. For businesses that expect significant development and expansion, it's critical to factor that possibility into the remuneration structure. These businesses may prefer a step or grade system that is readily expandable to handle more levels, or for a broadband or benchmarking system that is easier to alter for single role changes or additions.

Job competition

Demand for a particular position can also influence the kind of pay structure used by a business. For instance, if a hospital requires a lot of highly educated and experienced surgeons, they may employ a benchmarking system to ensure they're paying sufficiently to attract the specific type of doctor they want. Alternatively, if a corporation largely employs administrative staff who don't require a lot of specialized training, they may prefer a step or grade structure.

Industry

Certain sectors have a consistent remuneration structure, whereas others vary from company to company. It's common in the public sector to employ a step or grade pay scheme. For instance, the military grades all active-duty personnel uniformly, giving them the same salary regardless of job type. Numerous private sector firms utilize independent mechanisms to examine their total pay structure. Certain businesses, such as those with long-standing staff, may rely on the broadband system, while others may utilize a benchmarking system, such as younger businesses.

How to create a compensation plan

Here are the key steps in creating a compensation plan:

1. Create a compensation philosophy

The first step in developing a compensation plan is determining the reward philosophy and approach that you want the organization to follow. A compensation philosophy is the central principle of a compensation plan. A sound compensation philosophy benefits company operations, increases competitive advantage, and contributes to the achievement of the organization's strategic goals. Try to ensure that your philosophy is well-rounded and takes the following into account:

who can be compensated
which type of compensation plan is most suited to the employees' needs
justifications for compensating staff
the compensation plan's legality
the compensation plan's budgetary sensitivity, fairness, equity, and defensibility

2. Compile relevant data from a variety of sources

It's critical to collect sufficient data when developing a compensation plan to assess current market trends and help position an organization effectively. The type and quantity of information required can differ according to the size of the company, the duration of the project, and whether you are modifying an existing plan or creating a new one. You may collect the following information:

currently available job descriptions for various roles
pay structure in effect
a recent pay structure survey
employee perceptions of the present pay structure
how geographical location influences employee compensation

To increase the dependability of the data, it's best to gather it from many reputable sources since this enables direct correlation and the filling of data gaps. Having reliable data can help organizations reach accurate conclusions and avoid costly errors.

3. Benchmarking external to internal positions

After collecting market data, it's necessary to undertake data analysis to build benchmarking tasks you can price using market externalities. It's recommended to benchmark 50%–65% of occupations using market pricing to cover at least 70% of all employees. The following areas are critical to consider during the benchmarking exercise:

Compare job descriptions regularly when determining if you can match an external role with an internal position.
Choose benchmark jobs that reflect the organization's primary functions.
Take note of outliers and determine whether to include or eliminate them.
Make required modifications to elements, such as location, to lessen annual variability.
Create a market composite for each benchmark position.

Review current pay rates against market data after the benchmarking process. This helps you to develop appropriate pay structures that are consistent with the organization's compensation philosophy and market conditions.

4. Create a pay structure

You can establish pay structures by generating job grades, setting a market pay line, and establishing pay ranges. A job grade is a collection of distinct but comparable occupations. Establishing work grades enables comparable occupations to be compensated similarly. They can also define the criteria for advancement from one grade to the next. A market pay line can help you convert market data into internal useable information. Paying employees according to their experience, education, and performance is possible by establishing pay ranges within job grades.

Related: Biweekly vs Bimonthly Pay

This article is based on information available at the time of writing, which may change at any time. Indeed does not guarantee that this information is always up-to-date. Please seek out a local resource for the latest on this topic.

What Is a Compensation Structure? (With Guide and How-to)