It seems like it should be simple, right? Determining how much to pay someone, that is. But in an environment where the compensation offer you make can determine whether or not you secure the talent you want, it’s not easy. And as the talent war intensifies, so does the difficulty of finding the right pay levels. If you underpay, you risk losing a key person to a competitor. If you overpay, you unnecessarily dilute profits. So, what do you do? How do you determine the “sweet spot” in the amount of pay you offer?
Well, the first thing you do is get rid of the idea that there is such a thing as a “sweet spot” or “silver bullet” when it comes to determining the right amount of compensation. There is no universal answer or formula. However, there are universal principles that can help you determine the pay levels that are best for your organization. Here, I organize those principles into four categories or keys, if you will, that can help you determine how much the people in your company should be paid.
The 4 Keys
The value of these keys is in their widespread relevance. They apply regardless of the industry you are in or the number of employees you have. Stated another way, no matter how successful your business is, it will achieve less than its full potential if you don’t apply each one of these principles. So here they are.
1. Define Your Pay Philosophy
I am always surprised by how few companies have taken the time to think through their philosophy about compensation. To me, it should be intuitive. Given the scale of financial commitment made to paying employees, I would think more organizations would take time to define what they expect from that investment and how they will measure the success of their rewards strategy.
A pay philosophy must be in place before you can determine how much you should be paying your employees. In it, you should articulate how value creation is defined in your business. You should then determine how much of that value should be shared and what form it should take. What balance do you want to strike between guaranteed and variable compensation? On the variable side, how much should focus on rewarding short-term value creation and how much for long-term?
Value creation should be the core determinant of the compensation levels you set. And employee earnings should be tied performance that drives revenue, profits, business value or all three, as defined by your pay philosophy.
2. Identify Your Audience
A critical factor in determining both the amount you should pay someone and what form it should take is the kind of talent you are trying attract and retain. Most companies are looking for highly skilled, experienced, educated talent. Many of those individuals are capable of starting their own enterprises—and if they don’t find something they like in the “marketplace,” they will do just that. As a result, both the level of pay and the type of programs you offer should reflect this reality.
Those who can significantly impact the trajectory of your business will expect a pay structure that is heavily weighted towards value-sharing. They would prefer a salary that is in the 40 to 45th percentile of market pay with unlimited upside potential tied to their performance over a high salary and modest annual bonus plan. That said, some organizations may have different needs and so their pay philosophy and compensation levels will be driven by different factors. That’s why it is critical to know your audience in determining pay levels.
3. Look at Market Pay Data, but…
Don’t rely on it solely. Too many companies look at market pay surveys as if they were the final word on what they should pay—or to defend the compensation level of an employee when challenged. Data is important but it is also only a tool. It is likewise imperfect—particularly when trying to apply it in a private company arena.
What market studies do offer are parameters that can guide decision-making when it comes to deciding pay levels. The starting point is incorporating them into your pay philosophy. There you state where you want to be relative to the “market” when it comes to salaries and total compensation. The other place it is helpful is in gauging whether you are possibly underpaying or overpaying for a position. Beyond that, data should not be viewed as some kind of authoritative source for determining what you are going to pay someone.
Ultimately, what should guide the amount of pay you offer is your compensation philosophy coupled with the relative value of a certain role or position within your company. Your philosophy may say (indeed, probably should say) that you believe key producers should have unlimited earnings potential through value-sharing. As a result, your salary offers might be much less than those of your competitors. Similarly, you may determine that the VP of Marketing position (for example) in your company is the most critical role in your entire organization. As a result, you are willing to pay at the higher end of the market for that role—and you designate salaries and total compensation for other positions based on their value relative to that position. Because of that kind of internal equity analysis, the pay levels you set for positions throughout your company may differ greatly from what the “data” says. We call this “scoring the impact of the position.”
4. Adopt a Balanced Approach
I don’t think a company can survive in today’s talent market with an approach that over relies on salary levels. Business dynamics are so fluid that your compensation approach must be agile and adaptable. This inevitably means you must adopt a balanced approach in your pay offering. The balance must allow for high (even unlimited) upside potential for value creators. You must continually search for the right ratio between salaries and value-sharing and between rewarding short versus long-term performance.
Trying to find a kind of compensation equilibrium that reflects the right mix for your organization is what makes pay design as much an art form as a financial exercise. There are no “correct” pay levels for a given position—at least for key producers. Instead, if you construct compensation properly, you should be happy to pay out unlimited rewards; because if you are, it means value creation is meriting those compensation levels. Your rewards are essentially “self-financed” because they paid out of the productivity profit your people have produced.
Certainly, this is all much easier said than done. But what isn’t in today’s business environment? Compensation is a strategic tool that can transform your people from employees into growth partners. As a result, to have success you will need to abandon old standards and practices when it comes to determining the pay levels of your people. The issue today is less about how much you should pay and more about how (in what form) you should pay them.