The 5 Components of Compensation
Knowing how to compensate employees well and right is not always easy. Whilst we want to make sure our team members feel taken care of by their employer, monetary compensation alone will not ensure they are intrinsically motivated to fulfil their full potential. A stimulating work environment, opportunities to develop personally and professionally as well as great people management can make all the difference. Nevertheless, fair compensation is a core requirement for any of the extra efforts to bear any fruits. It is a hygiene factor so to say; a component of the overall work experience that needs to be done right before any of the other factors can have their intended effect. In total there are five most common components of compensation that you need to be aware of:
Base Salary
Bonuses
Equity
Benefits
Perks
Whilst bonuses, equity, benefits and perks are a significant component of any compensation package, the most important will likely always remain the base salary. That is because it is the most direct, cash component that enables everyone to pay their rent, bills and provide for their families as well as have a fun and comfortable life. It has a significant impact on people’s lives as anyone who has ever run payroll will know. Any slight mistake will be noticed and brought to attention; rightly so. It is the most basic, direct, historically persistent and recurring recognition and compensation an employee will receive from their employer for their contribution to the company. Getting it right is therefore crucial. And getting it right from the start, meaning not underpaying people and paying them fairly across departments, but also not overpaying people, will not only help employees feel appreciated but also make your Finance Officer happy. Keep in mind, about 80% of a company’s costs go to paying their employees’ salaries! The impact can be immense. The best way to exercise control over this huge cost factor on your balance sheet, is to get two things right: Your Salary Ranges and Salary Reviews.
Knowing how much to pay people can be easy and tricky at the same time. Whilst most of us, especially those who have been in the game for a while, would say they got a pretty good grasp of how much people within their industry are being paid by their employers, most of us actually don’t. What we are actually good at is knowing the pay for the jobs we as individuals have held or researched when deciding on next career moves. So having tools at hand that guide your compensation strategies and ensure they are fair and equitable to all stakeholders involved is highly beneficial. The best way to do that are salary ranges.
Salary ranges are essentially a minimum, average and maximum salary you would want to pay an employee for their specific role, at their specific job level in their specific office location. Those are the main components determining someone’s pay in our job market. A Backend Engineer in Madrid would likely earn a different salary than a Backend Engineer in Berlin on the same seniority level and two Backend Engineers in Berlin that have different seniority levels are also likely not going to be compensated the same. Makes sense, doesn’t it? As you might already notice, one of the main components that needs to be in place for salary ranges to work are job levels. Without them building a solid compensation framework will be tricky as you want some frame of reference on which you are able to compare people.
Step 1 Define Your Job Levels
As most startups prefer flat hierarchies this often translates into roughly 7 job levels from
Level 1: Interns or working students
Level 2: Junior
Level 3: Mid-level
Level 4: Senior
Level 5: Director
Level 6: Vice President
Level 7: C-Level
Step 2 Build Your Salary Ranges
Once you have defined your levels and assigned each employee their respective level, you can start building salary ranges for each role and employee at your company. And you might be thinking that I am saying, once the company has grown to the size of 20 employees or more. You are mistaken. Have them ready from day one. And here is why: The sooner you have them at hand, the better you will be able to determine fair salaries for new hires avoiding having to correct them tediously one by one in the future. It can also be a tool to avoid unconscious biases that may lead to gender or age pay gaps. Things that are not well regarded in the forward-thinking industries that we operate in.
Salary ranges live in a simple matrix where each type of job you have in your company is a column and every job level you have is represented as a row. Each cell holds the average salary a person in that type of job at that level would earn in your particular city. Add a column to the left and to the right of that cell. Have the left one calculate 80% of that average salary in the middle and the right column 120% of it, and click click you have your first salary range. Check out the examples for a Backend Engineer in the attachment below.
You can, of course, decide to make your range wider or slimmer by choosing a 75% to 125% range or a 90% to 110% range. It is also advisable to increase the range breadth as levels increase. Check out the attachment below for a Sales Account Manager example. This accommodates for the greater variance you see in positions on higher levels.
Deciding on the average salary for any position can be tricky. You can consult external market research like Payscale, Redford, Mercer but the cheapest and most effective way often is to ask the experts you already know, which are your managers and recruiters. They will usually have the best understanding of what salaries are currently being offered to candidates in various positions. Benchmarked market data on the other hand is usually at least 6 months old and might not reflect your type of industry or company size well.
Step 3 Apply Your Salary Ranges
Once you have built salary ranges for all types of jobs at your company, use them . . .
When making offers to new hires
When promoting people and adjusting their salaries
When offering salary increases to people
When hiring new employees, use the salary range as a starting point to decide what offer to make them. Find the right job type in the salary range matrix, find the right level their role would be placed at and what the associated salary range is. Typically, for new hires, offers are made closer to the bottom of the range around the 80% mark for example. This ensures there is still enough room for their salary to develop upwards over the next few months and years. The same applies to promotions. What you absolutely want to avoid is paying people below their salary range, even if that is the salary they requested. Your salary ranges are there for a reason, you should stick to them and not underpay people. The best rule of thumb to follow with any kind of salary decision is: If the whole company knew everyone else's salaries, would you be able to justify each one of them and be comfortable with it? If not, don’t do it. It is especially because salaries are the main tool of recognition and respect a company offers their employees that you do not underpay people simply because they did not know what your internal salary ranges were and they did not ask for more.
What you might also notice about the way salary ranges are set up is that sometimes the upper end of the range overlaps with the lower end of the salary range on the job level above. Don’t worry, that is just how the numbers turn out sometimes. Use your common sense in deciding what salaries to pay people. Sometimes it can be worth creeping into the bottom of the salary range of the job level above the tone that the employee currently holds but make sure to explain that to them and manage their expectations that should they get promoted the salary increase might not turn out to be quite as high as expected. But they should recognise that more cash in their pocket now is a good turnout for them.
Last but not least, it is important to mention who owns salary ranges in the company. Typically, the People team is responsible for creating and maintaining them. Access to them is restricted on a need-to-know basis which usually excludes employees - they typically receive indications on where on the salary range they are at but not concrete numbers - and managers will be able to view them for their area of responsibility only.
It is tempting to think that once you have set up your salary ranges you won’t have to touch them for the foreseeable future. That is only partially true. Whilst salaries typically do not change from one day to the next, most of us do operate in a fast-moving environment where one year Software Engineers are getting paid more than Product Managers and the opposite is the case the next. Also recruiters have seen a significant increase in their salaries over the past few years, rightly so; they build the foundation for what the company is going to become. You better pay them well.
Step 4 Maintain Your Salary Ranges
At least once a year, review and update the salary ranges for all roles in your company with recruiters and the respective people managers. Also consult up to date external market data if available. This will ensure that whatever you are comparing your employees’ salaries to has a solid foundation. Otherwise, you might as well leave it all together.
Once updated, you will of course need to review the salaries you are paying your employees as well. The salary you offered your Accountant last year might be outdated now for example. You don’t want them to be poached by competitors who are offering them a better, more competitive salary. It is therefore in your own interest to run salary reviews at least once a year.
Step 5 Run Salary Review Cycles
In this exercise, review every employee's salary, their seniority in terms of their skills and aptitude to live up to the potential of their roles at least once every year, ideally right after you have updated your salary ranges to ensure they are as up to date as possible. Get their people manager involved in this exercise as they would know best how well the person is performing. This is why salary reviews usually take place right after a performance review cycle as you have their latest performance evaluation right at hand.
You will now compare their current salary against the salary range respective to his job level and job type and see where they land on the range. Are they earning less than 80% of the average salary, then increase it to make sure no one is getting underpaid. Better even, try to understand how this could be the case. Were they hired on a salary that was too low? Were they promoted and their salary was not corrected upwards as well? Are they close to the end of the range? Then maybe they are already operating on the next job level and might be ready for a promotion? Or has their expertise level not grown much from the last review and they are fine right where they are on the salary range right now. The rule of thumb for deciding on how much of a salary increase to give people is of course to try to stay within the salary range, that a salary increase below 3% is not significant enough and might be better left out altogether and that promotions usually come with a salary increase of 10-20%. Exceptions should be avoided but might be needed sometimes. Whatever you decide, always remember that you will need to be able to justify your decision no matter what.
The 7 Keys to Successful Employee Compensation
Set salary ranges from the start
Never let your salary ranges get old
Proactively run salary reviews at least once a year
Pay people what they are worth
To not deviate from the salary ranges, unless there is a valid reason to
Pay people fairly across the company and demographics
Always ask yourself ‘Would I be able to justify the salary decision to the rest of the company if they were to know about it and still feel good about it?’
You now have the basics to give your employee compensation program and strategy the foundation it needs to thrive. All the best on your journey. In case of any questions, get in touch.