How to Create an Employee Compensation Plan that is Effective


Do you have a hard time getting and keeping good employees? Your employee compensation plan may be to blame.

If your compensation program doesn't include anything special, people may quit. They can find another company with higher pay or more indirect compensation.

Read on to learn how you can use the best total reward strategies in the industry.

Make It Unique

One of the most important parts of creating an employee compensation program is to make the plan unique to your business. While you can copy your biggest competitors, that won't give employees at those companies a reason to work for you.

Consider your company's strategy for business growth and for hiring employees. Look at job postings from the eyes of an applicant. Think about what would make you want to apply to work for your company.

Maybe you have a specific business growth strategy, or you do a lot to retain talent. Perhaps you can offer weekly lunches or other non-financial rewards. Or you might have a gym that your employees can use.

You should also review your operating objectives. Then, you can use that information to create a unique compensation plan that will attract the best employees in your particular industry. And you can keep your current employees from leaving your company.

Of course, you can take inspiration from other compensation plans. But you should do what you can to make yours different. That way, people will want to work for your business, even when other parts of the compensation plan are similar.


Also read: The Most Effective Employee Retention Strategies for Keeping Your Best Talent

Outline a Compensation Strategy

Next, you should create a compensation strategy for your business. Think about the different compensation plans to offer to hourly and salaried employees. Consider how those plans will differ between exempt employees and non exempt employees.

For example, you don't have to offer overtime pay to an exempt employee. To save money, you might want to make more people exempt. Or you might want to offer overtime to more of your employees to encourage them to work for you.

Be sure to think about the job descriptions of different roles in the company. While you should develop an overall compensation strategy and a structured compensation plan, those plans could differ between roles.

Think about the hourly wages you'll pay to employees not on a salary. Make sure those wages make the description of the job and the experience you require. That way, you will make taking the job more worth it to applicants.

You might also want to consider how the compensation plan will play out over time. That way, you can prepare to offer raises to high-performing employees to retain your best workers.


Develop a Compensation Philosophy

As you consider how to create your compensation plan, you should figure out your compensation philosophy. Having a compensation philosophy can help you be more competitive when searching for new employees.

You can create a statement that outlines why you compensate employees the way you do. That can help you attract and motivate top talent. Over time, your philosophy may change as your business changes or the market changes.

The philosophy should be in line with employment laws and your company's mission. You might want to consider how your compensation philosophy can offer career growth, referral bonuses, or flexible work hours.

Those things can help you stand out from other businesses in your industry. While they aren't part of your philosophy for compensation, they can play a role in your overall compensation plan.

Make sure you develop a compensation plan and philosophy that you can stick to. If you ever can't stick to it, consider how to adapt. That way, you'll be able to keep up with the changing elements of running a business.


Also read: What Are 8 Ways To Increase Employee Loyalty?

Research the Market

To make sure you offer a competitive compensation plan, you should research the market for jobs in your industry. Look at other compensation packages from your competitors to see what you can do differently.

Consider employees wages at those businesses along with other benefits. Review the job postings from your biggest competitors and look at the compensation they offer. Maybe they pay super well, but they don't have great insurance benefits.

If you can't offer high pay, you might want to compete with offering better insurance. Then, you can attract and retain people who want those benefits outside of cash compensation.

You should also look at labour statistics for your industry. If there aren't a ton of unemployed workers, you may need to get more creative to attract people. That way, you can fill your empty roles even when there aren't a ton of people ready to apply.

While you should research similar companies in the area, don't be afraid to look at other cities. That way, you can get the best idea of how to attract employees from other businesses. And you can attract applicants from outside of your local area.

Start With Direct Compensation

Now that you have an idea of other compensation programs, you can start to develop the compensation plan for your business. Direct compensation is the easiest place to start because it focuses on the cash you will give to your employees.

Make sure your hourly rate for hourly employees is at least minimum wage. That can give you a base pay for some of your lower-level employees. However, you'll need to increase your compensation for higher pay grades.

You might also choose to offer bonus pay to a sales professional who exceeds their quota. If that's the case, make sure you have a structure for offering those bonuses, such as by a percentage of the employee's sales.

If you have employees on a salary, make sure the annual salary is worth it. When you have non exempt workers, you'll need to follow labour laws regarding the salary and their direct compensation so that you pay them enough.

Be sure to calculate the different types of direct compensation. That way, you can pay employees enough.


Define Salary Ranges

When it comes to employees on salary, you can choose one number to pay for the entire year. However, you'll need to define the salary ranges for different job grades. For example, employees in lower job grades won't make as much as those in higher job positions.

You should also think about salary ranges. That way, you can negotiate with current and new employees to make sure you attract top workers. And you'll have a plan that accounts for more than just the base pay rate you offer when someone starts the job.

Once someone earns raises and reaches the top of their pay grade, they will need to get a new position to make more. This can keep you from having to pay too much for lower-level employees.

Make sure your pay grades reflect the amount of work employees will do as well. Then, you can think about how the salary affects an employee's total compensation package. That way, you'll remain competitive.

Over time, the ranges for different pay grades may change, and that's okay. However, you should create some ranges so that you can pay employees the amount they deserve for their hard work and loyalty.

Define Hourly Rates

Depending on your business goals, offering hourly pay may work better than salaries. A compensation plan with hourly wages can be much more flexible for you and your employees.

You can offer workers flexible work hours, and you don't have to pay for more than the time they spend working.

If you choose to offer hourly rates in your plan, you'll need to make sure you pay enough for the different pay levels, just like with salaries. However, instead of calculating annual pay, you'll calculate the pay per hour.

Ideally, you will be able to offer competitive hourly rates to help attract employees. Your compensation plan should account for the number of hours employees will work. Because with hourly employees, you'll need to pay more when they work more.

You can put a cap on the number of hours someone works. But there may be times when employees have a big project, and they have to work overtime. If you expect that to happen often, you'll also need to plan for paying people for that extra work.

Hourly wages aren't the best if you want following through on your compensation plan to be more predictable. But they can be a good option for some of your employees who aren't full-time or who won't work overtime that much.


Consider Raises

You might know how much you want to offer to new employees now. However, your compensation plan should also include room to give raises to your employees. After each year or so, you should reward the employees who stick with your company.

To keep it simple, you can offer a raise based on a particular percentage. But if you want to retain talent who are helping your company, consider giving them a bigger raise. They'll get the money they deserve, and you can ensure they won't quit and leave your business in a lurch.

However, it can help to offer raises to all of your employees, even if they only perform at an average level. As long as they do their job and are on time for work, you should reward them with a slight pay increase.

The raise doesn't have to be huge, but it can encourage people to keep working. If you don't want to offer much of a raise, at least offer enough to cover inflation. That way, your employees won't be as tempted to look for a job at another company.

And you won't have to spend the money to recruit and hire new employees. When your compensation plan supports current workers, you can save a lot of money and time that you can reinvest into your business and your team.


Add Indirect Compensation

While direct compensation can be an excellent way to attract and retain great employees, you should also think about indirect compensation. This includes compensation outside of cash that you give to your team.

Offering other benefits can be a great addition to your compensation strategy. Plus, it can help you stand out from other companies who may pay the same rates. Here are a few options to consider when offering indirect employee compensation:

  • Employee retirement programs
  • Tuition reimbursement
  • Company car
  • Health insurance
  • Paid holidays
  • Paid time off


Not all companies will reimburse tuition, for example. So offering that will not only help you stand out, but it may encourage your employees to go back to school. And when that happens, they can use their new skills and knowledge to help your business.

You can get really creative with indirect forms of compensation. If you can't think of ideas, ask your current employees what they like that you offer. And ask them what they think about potential new perks.

That way, you can use those responses to help attract new employees. You won't have to spend money or time on something that employees won't use or want.

Determine Employee Benefits

As you think about indirect compensation, you should think about what to offer and how much of it to offer. For example, if you want to help employees with retirement, you might create a retirement account for employees. But you might also choose to match employee contributions up to a certain amount.

Be sure to consider the salary range and bonus pay for employees. Then, you can choose a percentage to use when matching retirement contributions.

Perhaps you want to offer a few insurance plans for employees to choose from. And you might decide to offer more time off for each year the employee works for you. Think about your overall compensation strategy to help choose the benefits to offer.

You should also consider who will be eligible for the benefits. In most cases, you have to offer benefits to your full-time employees. But some businesses will also offer a few things to part-time employees who work a certain number of hours per year.

These benefits can be an essential part of your total reward strategies. Make sure the benefits you offer will help your employees and that they'll use them so that you don't waste money on this part of your compensation program.

hands in

Offer Bonuses and Rewards

Another great way to be unique and stay competitive is to offer company incentives and other rewards. For example, maybe you have an employee of the month program, and you give the winner a gift card to a local restaurant.

Or maybe you host a pizza party for the highest-performing employees on your team. These things can help motivate employees to do their jobs well. And you can use the programs to attract and retain people who are willing to work hard for your business.

You can also offer bonuses and rewards for an employee's career growth. Whenever someone gets a promotion and moves between pay grades, you might throw them a small party or give them a gift as part of your compensation plan.

When employees see others earning rewards, it can make those other employees want to work harder. Sometimes, that can be enough to make someone want to be more productive.

Rewarding employees is also an easy way to show your appreciation. When employees know you appreciate them, they may be more willing to stay at your business and not quit for a different job.

hand shake

Provide More Benefits

As part of your employee compensation strategy, you might want to offer other benefits. These things don't have to come up when an employee does super well. But the right benefits can make people want to keep working for you.

Maybe you decide to offer weekly lunches for free to everyone in your office. Or perhaps you set up a partnership with a local gym, so employees can go there for free or at a discount.

Not all of the benefits you offer have to be huge. Even a small benefit can help set you apart from other businesses, which can make your company the better one to work for.

Whenever you have the money or time, offer something fun to your employees. If you made a ton of profit last quarter, maybe you use some of it to pay for everyone to watch a movie at the end of the day.

Ask your employees what benefits they'd like to see. That way, you'll make sure you don't waste the money on smaller rewards. Instead, you will be able to make your employees happy and motivate them to keep working for you.

around a laptop

Compare Different Jobs

You may need to create a couple of different compensation plans for various jobs. For example, you might create salary ranges for salaried roles. But you might simply start with a base rate for hourly workers.

Be sure to consider the different job grades and the job descriptions at each level. Conducting a job analysis can also be useful when creating compensation plans.

You'll be able to pay employees the right amount based on their job. While you might have some wiggle room to negotiate, you should keep the pay pretty similar for two people with the same job and experience.

As someone works on career development and gets better at their job, you might offer a raise to retain talent in your organization. On the other hand, if someone does the bare minimum, you might not offer them as big of a pay raise.

Use the job grades to come up with hourly and salary ranges for your various roles. That way, you won't have to come up with a salary or hourly rate from scratch. Instead, you can view your pay schedule, and you can give that to employees so that they know how much money to expect.


Make It Fair

As you compare different jobs, consider how you can make the compensation packages fair for your employees. When choosing a starting rate, offer that rate to everyone who starts to do the same job.

Over time, you can choose to reward employee performance with a bigger raise. Perhaps you develop pay structures based on average and above-average performance. Then, you will know how much to compensate employees at different levels.

Another thing to consider is if you want to have a collective bargaining agreement. This can be an easy way to develop your compensation plan for all employees. It may include the pay rate for different jobs and years of service.

Employees will know how much they will be able to make each year. Having that transparency can also take the stress off of you and other managers. You won't have to figure out how much to compensate individual employees.

Consider your employer brand and what types of compensation you want to provide. Then, you can make sure your plan meets the needs of your employees and is in line with your company goals.

Consider Seniority

A fantastic way to motivate employees to work for you long-term is to use seniority in your compensation plan. After a certain number of years at your company, employees receive a raise or other special benefits.

Of course, you can also reward performance. But rewarding loyalty can be excellent for increasing employee satisfaction. When employees are loyal, it can help your business grow, and when your business grows, you can give back to the employees.

Using seniority can also help you create pay equity within your pay structures. Qualified candidates will be able to start working for you and stay on a path toward seniority. They won't have any questions about how to reach a certain level.

That can take a lot of stress off you and others high up in your company. When you have a compensation plan that uses seniority, you can reduce confusion. You and your employees will know what it takes to reach a certain pay grade.

talking to people

Inform Other Leaders

Once you finish creating your compensation plan, you should run it by other leaders in your business. Small business owners may only need to consult themselves. However, if you have shareholders or investors, you should talk to them.

You can all discuss your compensation package and how they relate to your business goals. If the package helps you reach goals without compromising your operating objectives, you can go through with the plan.

On the other hand, you might need to adjust things, like the salary range or retirement benefits. You might also decide to decrease bonus pay. If you can't afford to offer a compensation plan, you will need to adjust it before you tell employees about it.

While you want to compensate employees well, you don't want to do that at the expense of your business. So make sure you can afford the total compensation before moving forward.

Inform Hourly and Salaried Employees

The next step in creating your compensation plan is to tell your current employees. You might choose to have a meeting, or you might send the information in an email.

Either way, be sure to explain your basic compensation plan. Talk about hourly pay, retirement benefits, and other types of compensation. If you create a few plans, be sure to send the plans to the team members those plans apply to.

For example, you might choose to create a bonus system for rewarding employees on your sales teams. Or you might offer a salaried employee one compensation plan and an hourly employee a different plan.

If you have a meeting, be sure to watch for employee engagement. Let them know they can ask questions about the new compensation program.

people talking

Implement the Compensation Plan

After you create a compensation plan that works, you can implement it. Make sure that each salaried employee gets their correct salary. Pay the right hourly wages to your hourly workers as well.

If you're offering more paid time off, make sure you account for that. Create a system for employees to request their time off. The easier you can make for employees to understand and enjoy the compensation plan and benefits, the better.

You'll make it less stressful for yourself and your employees. While small business owners may not have a complex compensation plan, they should still work with employees. Give everyone a chance to ask questions about the plan.

It may take some time before everyone gets used to the plan, especially if you changed a lot. So be patient with everyone. You want to make sure employees are happy with the compensation plans so that you can attract and retain your best workers.

Finally, you may need to adjust your compensation package over time. Perhaps you come up with new reward strategies, or your competitors offer better benefits. Either way, don't be afraid to make changes so that you can stay competitive.

Make Your Compensation Plan a Success

Creating a compensation plan for your employees can be difficult. You have to consider everything from cash compensation to benefits. Compensation programs from other businesses can also be important to know so that you can stand out.

No matter what your compensation plan includes, it needs to make sense for your business. That way, you'll be able to maintain it and keep your best employees on your team.

Employees value compensation plans very highly, as they are receiving something in return for their loyalty and hard work. As well as compensation plans its also important you don't neglect the day-to-day operations of your business. Such as payroll for example.

Using our paystub generator software you are making sure that you are not neglecting such an important business process, while trying to improve other sides of the business.

Frequently Asked Questions

Research industry standards for similar positions and benchmark your compensation plan against them, adjusting as needed to stay competitive. Regularly review and update your plan according to the market.

Regularly solicit feedback from employees through surveys, focus groups, and one-on-one conversations. Use this feedback to identify areas of improvement and make necessary adjustments to the plan to better meet employee needs and expectations.

Develop a clear job grading system based on skills, responsibilities, and experience. Be transparent about how compensation is determined, and ensure that all employees are treated fairly and without discrimination.

Track key performance indicators such as employee turnover, job satisfaction, productivity, and the quality of new hires. Analyze this data to determine the overall effectiveness of your plan and make adjustments as needed to achieve your desired outcomes.

Establish measurable performance metrics that align with your organization's goals. Use these metrics to determine bonuses, merit increases, and other performance-based rewards, incentivizing employees to contribute more effectively to the company's success.

Clearly explain the components of the compensation plan during onboarding, and provide regular updates and reminders through company-wide communications and individual performance reviews. Transparency is key to maintaining trust and satisfaction.

It's a good practice to review your compensation plan annually to ensure it remains competitive and aligned with your organization's goals. However, more frequent reviews may be needed in fast-changing industries or during significant organizational changes.

Key components include base salary, variable pay (such as bonuses and commissions), benefits (healthcare, retirement, etc.), and non-monetary rewards like flexible work hours, professional development opportunities, and recognition programs.

An employee compensation plan is a structured system outlining the financial and non-financial rewards provided to employees in exchange for their time, efforts, and job performance.

An effective compensation plan is crucial in attracting new talent, retaining existing employees, maintaining employee satisfaction, and fostering a productive and motivated workforce.
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How to Create an Employee Compensation Plan that is Effective
James Wilson

After graduating from McCombs School of Business in Texas, James joined ThePayStubs as a CPA to make sure the numbers we provide our clients are correct. Read More

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