How to Use Compensation Plans to Drive Company Culture

How to Use Compensation Plans to Drive Company Culture

Your compensation philosophy--written, unwritten, or unknown—drives your organizational culture. It doesn’t matter if you pay for performance, loyalty, or effort—it defines how you value employees and what they do. You get what you pay for.

The latest annual Payscale reported a chasm between perceptions of employees and management. Only 20% of employees think their pay is fair, but 44% of employers do. What causes us to pause is wondering what the 56% of companies who say compensation isn’t fair are doing about it. Do they publish a compensation philosophy and strategy? Are they reviewing their compensation plans?

A WorldatWork survey reported that over 90% of companies have a compensation philosophy, but only 53% of their employees understand it. Only 63% have their philosophy in writing. As McCloud would say, “There ya go.” For decades, we have been reading reports that employees don’t trust their leaders. That makes sense to us. If they don’t understand their pay, they won’t believe managers who say it is fair.

Build a Culture of Trust

If you want to create a culture of trust, compensation is an excellent place to start, and the place to begin is a clear, concise, and transparent compensation philosophy.

There is no “right” way to define your philosophy, strategy, and policies. Every organization will be different. The following are a few general guidelines to help you get started.

Know Your People

Before you begin a compensation review, use feedback tools and your people analytics team to understand what motivates your people. Benchmark surveys are useful food for thought, but they won’t tell you what your people want and what your business needs.

Start with Understanding

A compensation philosophy explains one or two short paragraphs how your organization views employee compensation. It explains why the philosophy is what it is and explains how the business strives to achieve consistency and fairness. It explains the competitive market position and how the company balances competitive position, talent needs, and ability to pay.

The philosophy should reflect the organization’s purpose and mission. Express it in general terms, so it does not need major revision when you need to change a strategy.

Employees will see through an evasive message. A philosophy that doesn’t reflect current practices will require a statement about addressing the disconnect.

If you can’t pay market rates, as often happens in non-profits, explain why.

Define the Strategy

Philosophy is the mission and purpose; strategy is the execution. Plans may change frequently, and a change may trigger a compensation review.

  • Define each pay strategy and what it intends to achieve.
  • Determine the structure or each pay plan and what market benchmarks you will use. Most organization use several, and will often use specialty market surveys for in-demand skills.
  • Explain each component of total compensation in simple language.
  • Show how you will measure the results and ask for feedback.

Write the Policy

Create the compensation policy in the same manner as other directives. This is the document that puts the philosophy into play. It provides the framework for the compensation strategy and pay plans.

  • Include the compensation philosophy and strategy.
  • Explain the process used to determine internal equity. If the policy includes specific initiatives, such as gender equity, cite them here.
  • Define compensation management responsibilities.
  • Include payroll policies and schedules.

Transparency Matters

It won’t matter how well you construct your plan if employees think you are concealing information. We know few organizations have achieved the level of trust where they can publish every person’s job, grade, and salary, but you can explain how decision are made.

Write your communications and directives in plain language that anyone can understand. If you need to, get help from your Marketing writers or hire a professional. The language should be no higher than an 8th grade level on the Flesch-Kincaid readability scale. Many managers have difficulty communicating compensation decisions to their employees. Make yours so easy to understand they don’t need explanation.

We recommend you implement an instant feedback tool if you haven’t already. There are many options available, and you can embed them in the tools your employees use every day. Encourage every executive leader to take part in answering questions. That conversation will open lines of communication you never thought possible.

7 Tips for Building a Compensation Framework that Supports Your Culture

7 Tips for Building a Compensation Framework that Supports Your Culture_IA

Your organization’s management style and values drive pay ranges. Hierarchical organizations use many narrow grades while a team-based flat organization may have very broad bands.

If you don’t align your compensation programs with your pay philosophy and strategy, your workforce will not be aligned to your company.

In a previous article, we wrote about how compensation philosophy, policy, and strategy drive organizational culture. Our main point was that transparency and open communication will drive a culture of trust.

Executing the strategy requires the same transparency and openness. People want to know about the mechanisms you use to value their jobs and reward performance. If they don’t have the answers, they will make assumptions based on how much they trust management.

Putting the compensation strategy in place requires a framework to define how your organization benchmarks 7 Tips for Building a Compensation Framework that Supports Your Culture_IB.png
market rates, aligns pay ranges to the market, establishes the value of jobs, and manages equity across the organization.

Market Rates

Most organizations benchmark pay against market rates using compensation surveys, BLS statistics, and online companies that collect data from employees. These studies enable you to evaluate market trends and labor availability based on two assumptions:

  • Market rates rise and fall based on the scarcity of talent.   
  • Local rates reflect the local economy and demand for skills.

Using these data sources enables you to compare your current pay with market rates to help pinpoint areas where pay rates may make it difficult to attract the right talent. Or, you might overpay for skills that are no longer scarce. These data also enable your compensation team and business leaders to make better decisions about resource allocations and your competitive position.

7 Tips for Building a Compensation Framework that Supports Your Culture_IC.png

Tips for Success

  • Using surveys requires the expertise of a seasoned compensation analyst to fill in missing data. Companies structure and evaluate jobs differently, and the scope of duties varies. Some jobs don't seem to fit into any group. Any comp pro will tell you it is as much art as science.
  • By using two or more sources, you can fill in missing information and can resolve differences and outliers. But beyond a small handful of sources, you will reach the point of diminishing returns.
  • For most jobs, an annual benchmark may be sufficient, but critical skills and “hot” jobs require more attention. If a critical skill is in demand, salary rates can change so rapidly you will need to review the market at least monthly, or whenever you hire a new employee into the job.

Pay Structure

Pay structures give you a way to match compensation to market rates, manage costs, and handle the complexity of compensation planning.

Ranges enable you to decide how you will lag, match, or lead the market. For example, your philosophy might be that to be a competitive leader, your company will lead the market by 15%. This means that the midpoint of the pay range will be market + 15%, and that a performing, seasoned employee should be at or above the midpoint.

Tips for Success

  • How you approach designing salary structures depends on your organization, but it must be consistent with your culture and your compensation philosophy. If you say will to lead the market, your salary structures must reflect that, or you risk alienating your people. If your philosophy is to lag the market, be prepared to say why.
  • Transparency and communication are essential to organizational success. Communicate the why and how of the design.

Job Structures

Job structure or job leveling is the process of evaluating positions to determine their value to the organization, and it is the primary tool for determining job equity.

Creating a common language and comparisons across the organization make internal movement easier. For global organizations, a consistent structure across the organization makes career mobility easier, where companies can institute career paths that cross boundaries.

  • Ranking or job comparison uses subjective analysis by an “expert” committee to assign a ranking or a position on a scale. Some organizations use nominal group technique or paired comparisons.
  • Most government agencies use grading or grade/step systems. The organization assigns many narrow pay grades and experts place the jobs into the correct pay grade. Step increases compensate for length of service.
  • Most private sector organization use point factor systems where they group jobs by factors and assign weights and values to each factor. The number of points determines the grade.
  • Factor comparison uses a set of benchmark jobs and compares the using common factors such as physical effort, mental effort, the scope of responsibility, working conditions, and the education and experience required to attain proficiency.

Most organizations use several of these methods for different employee groups such as executives, and different methods for union and non-union employees.

Tips for Success

  • Organizations with narrow grades and rigid policies manage employee concerns by implementing a formal process for individuals to dispute compensation decisions. That could be useful in any organization where open communication is lacking.
  • Explain how and why you make decisions and communicate it in language everyone can understand. Make it so easy you need not explain it, then prepare to explain it. Some people need more reassurance.

Consistency, transparency, and communication are the main components of a successful compensation program. When it comes pay, conversation matters more than cash.

7 Steps to Effective Merit Compensation Planning

7 Steps to Effective Merit Compensation Plans_IA

Thinking logically, using merit pay to reward high performers and encouraging low performers to leave or improve should work. But after decades of using merit pay to improve employee performance, the industry consensus seems to be that merit plans don’t improve employee engagement.?

In spite of all the recent noise about the ineffectiveness of merit pay plans, we see a different problem. The fundamental issue, as we see it, is when the real purpose of a pay increase is disguised as merit pay.

Why Merit Pay Plans Fail

As in most human endeavors, the original principles of merit pay get lost during the implementation, or over time as routine procedures lose their purpose.

  • When companies fail to fund their programs, it sends the message that pay for performance is not important.
  • If everyone gets a merit increase and high performers get just a bit more, the annual pay increase becomes an entitlement. Employees see through the ruse when their employer calls pay increases “pay for performance” when the employer is only responding to market changes or inducing people to stay.
  • Supervisors often cannot explain the reasons for a salary change. If they can’t give an increase, they sometimes blame it on HR or management instead of explaining the real circumstances.
  • Almost all of us think we are “better than average.”[1] Many people have a difficult time with being labeled average, especially when it affects income. Try explaining your “averageness” to your spouse.
  • Most people have an innate need to feel their earning power is increasing. When it doesn’t, they become dissatisfied and look for other avenues of growth.
  • The metrics and evaluations used to differentiate among employees are often lacking or deeply flawed.

Recommendations for an Effective Merit Pay Plan

None of these issues negate the principle of merit pay, and with careful planning and diligence, you can overcome each one of them. But for most organizations, a little tweak here or there won’t solve the issues. It requires a fundamental, strategic, organization-wide approach.

  • First, make a commitment to truth and transparency. Provide clear and consistent policies and communicate them well. Identify your employee groups and tailor your communications to each audience. Make sure every individual knows the factors that affect pay and how you calculate increases.
  • Second, agree on the strategic compensation plan and the purpose of each of its components. Understand that you should base merit pay on sustained performance of regular job duties, not on projects or events. You are not rewarding past achievements—you are paying for expected future performance.
  • Do not lump merit pay with other compensation increases. If you are providing a general increase for everyone, say so. If you are adjusting for market changes, don’t call it pay for performance. If your past practices have made an annual “merit” increase automatic, consider designing an organizational change to a different mindset.
  • Define what you mean by performance and devise accurate, credible ways to measure it. Use multiple information sources. If teamwork is a component, get feedback from the team. For customer service, include customer-centric behaviors, not just customer feedback metrics. For sales, consider the difficulty of making the sale, not just the sales numbers, and consider sales assists in the calculations.
  • Train managers and supervisors on how to discuss compensation and hold them accountable for doing it well.
  • Measure results. Get feedback from employees. Talk with those who are leaving to understand If the program was a factor. Include the merit plan in your pulse surveys and publish the results and the action you will take.
  • Implement the right technology. The minimum requirement is a robust compensation tool integrated with talent management and business analytics. Managers should have every detail they need to consider at their fingertips when they are deciding on compensation. Ease their administrative burden as much as possible so they can focus on making the right decision.

Communication is the Key to Effective Compensation Planning

Finding the right mix of incentives to drive performance and retain talented employees requires an open dialogue. Consider your communications carefully to develop the kind of trust that fosters effective two-way communication.

If you find any of our suggestions controversial, or you would like to start a conversation, please share this article with your comments.


1. Scicurious. "The Superiority Illusion: where everyone is above average." Scientific American. August 06, 2013.