What is a compensation strategy, and why is it important?

By Caitlin Allen, Apr 26, 2022 8:37:41 AM

When managing a high-growth or recently funded organization, deciding how to pay your people can sometimes feel like navigating uncharted waters. Although you have the benefit of experience, you have been growing so fast that you may not have had the chance to establish a consistent approach to compensation.


Without clarity around how you pay relative to the market and decide on compensation, you might make costly mistakes, making it harder to find and keep great people. Conversely, when you take the time to develop a strong compensation strategy for your organization, you have the potential to attract and retain the talent you need for growth.

 

What Is Compensation Strategy?

Compensation strategy consists of the goals and framework you use to pay your employees. It guides your future actions when setting pay, making salary adjustments, and determining variable compensation.

The importance of compensation strategy is evident not only in your recruiting activities but also in the pay decisions you make for existing employees. Without a solid strategy, it can feel like you’re reinventing the wheel every time you make a hire or promote an employee.

 

Compensation strategy typically covers:

  • Base salaries.
  • Cash incentives, such as bonuses, overtime, and commissions.
  • Non-cash incentives, including stock options and common stock.

Although not classified as pay, elements such as benefits and time off can also be part of your compensation strategy. Taken together, all these elements play a critical role in motivating, engaging, and retaining your workforce.

 

Considerations for Selecting the Right Compensation Strategy

Your compensation strategy can vary according to several factors, including your growth stage, funding stage, geographic location, and the types of talent in your organization. It’s why a seed-stage services company in the Midwest will often have a different compensation strategy than a Series-C-funded tech company in New York City.

Furthermore, the strategy you choose should reflect how aggressively you want to use compensation to attract and retain talent. For instance, if you have the finances and a need to compete even harder for scarce talent, you may choose to follow a strategy based on paying at the top of the market.

More often than not, for the sake of achieving a healthy burn rate, it is usually more sensible to follow a strategy based on paying at the median of the market (i.e., the 50th percentile). Not only does this strategy allow you to pay competitively, but it also affords the option of supplementing compensation with non-compensation benefits, such as training and work flexibility.

Like other critical business strategies, your compensation strategy can change as your organization grows. A 2020 Deloitte survey found that most companies (79 percent) were either in the middle of a compensation strategy redesign or had changed their compensation strategy within the last three years. So no matter where you are in your organization’s growth, now may be the perfect time to create or revise your compensation strategy.

 

How Compensation Strategy Attracts and Retains Talent

Your compensation strategy goes hand in hand with your compensation philosophy to guide a range of critical employee pay decisions, including:

  • The mix of cash versus non-cash compensation you pay.
  • The structure of employee pay ranges.
  • How often you make compensation adjustments.
  • The actions you take to limit bias in pay practices.

Because your compensation strategy can determine everything from the structure of new hire pay packages to the size of annual salary increases and bonuses, it impacts how candidates and employees view your organization. As a result, you should develop a strategy that reflects your culture, values, and goals.

An employee pay strategy can make a measurable difference in how well you attract and retain talent, allowing you to:

 

Manage your compensation budget efficiently.
According to CB Insights research, running out of cash is the number one reason pre-IPO businesses fail. However, it’s possible to sidestep such an outcome by developing a strategy that limits waste and uses each compensation dollar wisely. With more control over your compensation budget, you can maintain a modest burn rate and make adjustments where needed.

Keep employee pay competitive.
When you set a compensation strategy to pay employees at the market median, your pay practices will flow from that strategy, helping you stay on target and limit exceptions. By relying on your strategy to keep pay competitive, you can position your organization as an employer of choice and avoid losing people due to uncompetitive pay.

Create more thoughtful offers.
In a competitive market in which great candidates often have multiple options, you can’t afford to make an offer based on guesswork and experiences with other companies. With a solid pay strategy that guides the parameters of new hire offers, you don’t have to. You can be more deliberate and thoughtful when drafting offers and make it easier for your recruitment team to land top candidates.

Pay employees equitably.
Instead of reacting to a complaint or rumors in the workplace, you can use your compensation strategy to take a proactive approach to pay equity. Your strategy can guide you in setting goals and monitoring pay equity across genders, ethnicities, position types, and locations. As a result, you will be better positioned to avoid the consequences of pay inequity, including low employee engagement, high turnover, and discrimination claims.

Build consistency and transparency in employee pay.
In a Glassdoor survey, 70 percent of employees said they believed salary transparency was good for employee satisfaction, and 72 percent said it was good for business. By applying your compensation strategy consistently, you demonstrate that your pay practices are not based on favorites, special deals, or exceptions. And if you remain consistent over time, employees will know what to expect and trust your compensation program.

 

Build a Winning Compensation Strategy

Human resources compensation strategies set the tone for employee pay and help you meet your goals for prudent spending, transparency, and fairness. Beyond understanding compensation strategy definitions and benefits, you also need to know how to leverage your pay strategy to attract and retain talent.

Once you have a compensation strategy in place, you will find it easier to achieve consistent pay practices that tie back to your organizational goals and values. From there, you’ll be able to utilize compensation data more effectively, communicate your compensation philosophy to your workforce, and build a more effective compensation program. To learn more, read our guide, Compensation Philosophy 101.

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Caitlin Allen is VP Marketing at OpenComp and has served in similar roles at Happy Returns, Lyft, and Andreessen Horowitz. She also writes about topics including marketing, sales compensation, and happiness. Connect with her on LinkedIn here.