The Ultimate Guide To Compensation Benchmarking

Compensation Benchmarking 101

Before we get into details, let’s get clear on what compensation benchmarking means.

Compensation benchmarking is the process of comparing your company’s roles to similar roles at other companies within the industry and the broader marketplace.

This definition can make compensation benchmarking seem straightforward, but it’s actually very nuanced.

Compensation benchmarking is challenging because it involves mapping employee data to survey data. And while different organizations can have the same job titles, the roles and responsibilities for those job titles can vary. For instance, a startup employee often juggles responsibilities typically handled by multiple individuals at larger companies.

When compensation benchmarking comes into play

Compensation benchmarking is the first step in a four-step process for designing a compensation program:

STEP 1 – Market analysis & benchmarking. Using fresh and relevant data from a reputable source, learn how you’re paying compared to similar companies in your industry.

STEP 2 – Compensation philosophy. Create a statement that formalizes how you plan to pay and reward your employees. This is based on information gathered in your market analysis, your company values, and financials.

STEP 3 – Pay structure creation. Guided by your compensation philosophy, construct your pay structures.

STEP 4 – Program design. Bring it all together to build your compensation program – everything from offer letters, to compensation packages, merit, cycles, burn analysis, and diversity, equity, and inclusion (DE&I).

This practice helps human resources professionals make smarter compensation-related decisions and streamlines the compensation process.

Common Mistakes & Misconceptions

Now that you know what compensation benchmarking is, let’s talk about what it is not.

𝗫 Asking your board and/or peers for advice
This can help you get a sense of what’s happening in your immediate circle, but this information often lacks context, such as: What stage of growth is the company in? Why is that person paid in that specific salary range? What is the company’s compensation philosophy?

𝗫 Basing compensation on previous salary
By basing your offer on previous salary – instead of doing the work to figure out what’s fair – you risk building on the mistakes of previous employers and continuing pay inequities, especially for women and minorities.

For women, unfair pay practices create a wage gap that could mean up to $2 million in lost wages over a lifetime.

𝗫 Googling numbers
The internet is ripe with unverified salary information that, like peer advice, lacks context and is often plain wrong. Plus, you don’t know how old that data is. For competitive compensation benchmarking, you want the freshest data you can find.

𝗫 Asking candidates for their salary expectations
Job candidates rarely have access to the market data that you do and base their expectations on anecdotal and unverified information. It’s not the candidate’s responsibility to ensure they’re paid fairly, it’s yours.

𝗫 Guessing to see what sticks
Random pay is a surefire way to lose trust with candidates and employees who will eventually sniff out your lack of strategy.

𝗫 Throwing out your highest number just to stay competitive
Offering an employee the highest salary possible could set you up for sustainability and pay equity problems down the line. Stay true to your benchmarks and compensation philosophy, emphasizing your company’s value proposition and the value of equity to win over candidates.

Consequences of Getting Compensation Benchmarking Wrong

Compensation benchmarking is the foundation for everything related to comp: budgeting, hiring, employee development, retention, and promotions. By building all of those things off bad benchmark data, you risk:

• Wasting time and resources – Trying to win candidates with noncompetitive offers is a waste of everybody’s time, and could quickly ruin your budding reputation. And if your compensation practices cause retention issues, the cost of turnover is extremely high: it’s estimated that losing an employee can cost 1.5 to 2 times the employee’s salary.
  
  
• Over- or underpaying for talent – If you overpay to win a candidate, you’ll need to make up for that elsewhere in the budget. Meanwhile, underpaying could lead to turnover. Offering too much equity can over-dilute the option pool, while non-competitive grants can be expensive to correct later on.
  
  
• Creating internal equity issues – When you pay really competitively for new hires, you can cause pay compression. This means your current employees are paid less than the new hires with similar roles. In addition to impacting morale and culture, this kind of inequity can also create issues with responsibilities, promotions, and seniority.

Steps To Get Compensation Benchmarking Right

With the right benchmarks, companies strengthen hiring, retention and revenue, and reduce over-dilution. According to OpenComp data, they also:

• Increase offer acceptance by 17%
• Reduce gender pay disparity by 75%
• Gain 34% more funding per round

Just as important as those benefits, accurate compensation benchmarking data helps you explain to candidates why you’re making the offer you’ve presented, establishing a relationship of trust and transparency from the beginning.

The following steps will help you approach compensation as a science instead of an art. In the following pages, we’ll dive into each step of the compensation benchmarking process.

Step 1: Select a competitive data set that’s relevant to your business
Step 2: Make sure your benchmarks compare apples to apples
Step 3: Identify the point in the market you can securely afford

Step 1: Select a competitive data set that’s relevant to your business

Good data is:

✔ Verifiable
Don’t know the source? Don’t trust the data. It’s imperative that you trust the expertise of the folks who are collecting and cleaning your compensation benchmarking data.

✔ Employer-reported
This data comes with complete context and is free of errors and bias that often come with employee-reported data.

✔ Less than 6 months old
The market is changing rapidly, and shows no sign of slowing down. Fresh data helps ensure you’re keeping pace with the market.

✔ Relevant to industry
Different industries have different trends, data, and benchmarks. Use data exclusive to your industry or as close to it as possible.

✔ Relevant to funding stage
Similar to industry, companies of different funding stages will have different budgets to work with, and therefore different compensation strategies.

Good data helps you make defensible decisions. And objective data means that compensation isn’t influenced by demographics like race or gender.

Step 2: Make sure your benchmarks compare apples to apples

Choosing data from companies in the same industry, and funding stage helps you make an apples-to-apples comparison of your roles. A startup can’t compare itself to a public company and a Series A company can’t compare itself to a Series D.

Using data from similar companies reduces the risk that you’ll make the wrong assumptions about what’s competitive (and underpaying and overpaying for talent) or that you’ll place employees in the wrong pay range, aka salary band or pay band.

Keep in mind that the responsibilities tied to a job title can vary greatly between companies. For instance, a manager at a seed stage startup is going to have a very different set of responsibilities compared to a manager at a Fortune 100 company. Beware: most survey providers don’t properly cleanse their data to account for these nuances.

Step 3: Identify the point in the market you can securely afford

Once you’ve decided how you want to pay relative to the market, you need to determine whether you can actually afford it. While you might want to pay everyone in the 90th percentile, your budget might say otherwise.

Scenario modeling will help you see the potential impact of specific decisions. For example: What will it cost to pay everyone in a particular role at the 90th percentile? 60th percentile?

Look 9 to 12 months ahead and consider the implications of possible changes to the market and your industry.

The final touch is to create a compensation philosophy based on data, scenario modeling, and your goals. A compensation philosophy is a formal statement that explains how your company plans to pay and reward its employees.

Here’s an example: We plan to pay everyone in the 70th percentile based on San Francisco benchmarks, regardless of their location.

Compensation Benchmarking Best Practices

Here are steps you can take to ensure that you’re making the most of your data and creating a compensation program that supports your company:

Create a healthy collaboration between finance and HR

Finance isn’t always versed in HR and HR doesn’t always understand the financial implications of comp. Sharing insight between these departments will help your company make holistic pay decisions.

Place employees in job levels

Jobs levels (e.g. engineer, sr. engineer, lead engineer) help you to place people in roles based on their competencies. They also show employees what they need to work on to get to the next level. For accurate job leveling, involve managers who have deep insight into a role’s required skills.

Use data to build pay ranges

Pay ranges, aka salary bands or pay bands, set the boundaries for salaries for roles or groups of roles. Guided by your compensation philosophy, pay ranges will help tell the story of how your employees will progress through each pay range to the next level for a role.

Conduct regular pay audits

Don’t wait until you get complaints or lose people. Conduct pay audits regularly to spot gaps and problems while you can still fix them. And make room in your budget to make necessary adjustments.

Remember compensation benchmarking is not a one-time process

You have to keep pace with changes in the market and your organization. While it’s easy to focus on getting to the next milestone or fund raise, proper and regular compensation benchmarking will not only help you reach those goals, it’ll keep your company healthy for the road beyond.

Pillars of Effective Communication Around Compensation

These compensation benchmarking best practices also empower you to have a more successful dialogue about compensation with candidates & employees.

Conversations about pay are core to a culture of trust. Here are the pillars of meaningful compensation conversations.

• Consistency. This is key in compensation. Make sure everyone receives the same message and understands how compensation is handled across the board. Compensation benchmarking data and your compensation philosophy will help you tell the story.
  
  
• Transparency and education. These two pillars go hand-in-hand, because information without context is meaningless. Don’t just share compensation information, help people understand how you made your decisions and what it means for them.
  
  
• Open door policy. Extend pay conversations beyond the hiring process and annual reviews. Executives, managers, and employees should feel comfortable and empowered to talk to each other about compensation whenever a need or question comes up.