Defining the Purpose of a Pay Plan

It is not unusual for our firm to get a phone call from a potential client that goes something like this: "I'm looking to set up a long-term incentive plan and maybe redo our bonus plan." The request is specific and narrow. In an attempt to "flesh out" what the business leader is hoping to achieve with these additions and changes in their pay plans, we'll often respond by saying: "That sounds like somethng we can help you with. Tell me, though, what are you hoping to achieve through the development and re-engineering of those programs." Too often, the response to that question is as vague and imprecise as the request is clear and exact. In other words, people making decisions about compensation often seem to know what they want but not why they want it. It's a problem.

Every pay plan should have a clearly defined purpose.This phenomenon exists primarily because of how a compensation strategy evolves in an organization.  When businesses first start out, their focus is on hiring employees, negotiating salaries and meeting payroll. With growth comes more employees, the addition of a simple benefits plan and maybe an ad hoc year-end bonus. At this point, the business leader is trying to figure out a "fair" arrangement that will keep his business going and growing. If the company succeeds, things get more complicated. Finding employees becomes more "competitive," employee expectations increase, the range of plans needed to "satisfy" the workforce expands, HR people are hired, compliance issues are in the mix and doing the "right" thing for the employees becomes harder to achieve.

Somewhere around this time, our phone rings. The organization is looking for help and thinks it has a handle on what kind of assistance it needs. However, probing of the type described at the outset reveals that there is a gap in understanding what compensation can help a company achieve and how each plan should be engineered as a result. 

People responsible for compensation in a business should be able to justify the existence of every plan they institute. They should be able to answer the following questions about each:

  • What will improve as a result of this plan? (Greater focus on KPIs, improved ability to recruit premier talent, improved level of stewardship for shareholder goals)
  • What group of people or roles will be impacted by the plan? (All employees, executive level, a department or team)
  • What results are being targeted by introducing this plan? (Improved margins, increased profits, growth in revenue)
  • What part of our compensation philosophy does this plan fulfill? (Long-term value sharing, competitive salaries, alignment with business model)
  • What is the standard of measurement for this plan? (Percentage of salary, share of profits, market pay data)
  • How will the ROI on this plan be measured? (Improved ROTRI, increased productivity profit)

Other questions could be asked but hopefully this list will get you started.

The important issue here is that without a clear purpose, a pay plan will likely eventually turn into an entitlement. Bonus payments, for example, become just an expected part of pay.  Key people start asking if they can get equity in the company. Shareholders begin wondering what they're getting for what they're paying out.  Resentment sets with both owners and employees.  When that occurs, the culture is infected and it becomes difficult to cure.

Thinking through the purpose of each of your plans is made easier if you build a Total Compensation Structure and evaluate each program in the context of a comprehensive strategy and not just a series of unrelated, individual plans.  The combined purposes of the various plans should work together to create greater clarity about what's important to the organization and what the priorities are.  Such a tapestry of clarity will also give employees a picture of the kind of financial partnership shareholders want with them.

The purpose of a pay plan is a critical issue to resolve so you should take time to think through each one. It will pay dividends and make your organizational life much easier and your compensation strategies significantly more effective.  


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