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Compensation 101: The Building Blocks for Designing a Strong Performance Compensation Plan

Written By: Sherry Fox
Published On: November 16 2010

Employees: The backbone of every organization.
Motivation: Often the driving factor behind an employee’s performance.
Compensation: The motivation.

What I’m trying to say (if you couldn’t read between the lines) is that rewarding your people can ultimately lead to an increase in your bottom line. This can be achieved through the creation of a strong performance compensation plan.

Employee Demographics
Before I dive into how and where to begin, let’s take a look at today’s workforce. Who are we? Employee demography is the study of the composition of a social entity in terms of its members’ attributes, and includes such factors as gender, age, ethnicity, occupation, seniority, salary levels, and marital and family status.

The last decade has brought about significant change to the global workforce: employees are changing in their values and expectations, their demographic diversity, their education, and their willingness to accept change. Some are looking to make more money, while others may be more concerned with vacation time. Some are expecting certain packages based on the level of education they have achieved, while others are just happy to be employed, given the context of such a fiercely competitive job market. Employers must respond to this diversity by designing a strong compensation strategy that ensures that all types of employees are considered in the overall plan.

Strategic Planning
When confronted with the need for rapid—and often constant—change, human resource managers, like their counterparts in marketing and finance, often adopt strategies that enable them to manage their work forces more effectively. Developing a compensation plan, however, requires defining the workforce performance goals needed to support the organization's overall business strategy as well as the human resource implications of these goals.

Not all compensation decisions are strategic, however. Only decisions that are critical to the success of the business are strategic—such as those that affect labor costs and performance. Strategic planning must be carried out in a manner that accommodates a link between performance and rewards.

Building Blocks
Before your organization jumps into designing its “perfect performance compensation plan,” you must first understand the overall objectives of your company (which can often change over time).

Is your company looking to focus strictly on maintaining its current position in the market, or is it more concerned with improving and growing its operations? If the latter, you might be interested to know that studies have shown that companies looking for growth are more willing to pursue the development of compensation programs than those looking to simply maintain their current position.

In order to develop a solid compensation plan, organizations should start with these five key steps, which will build the foundation for success:

1. Analyzing the implications that compensation brings to the organization’s business strategy, external environment, and internal human resources (employees).
2. Establishing objectives consistent with both the overall corporate and human resource positioning/strategies.
3. Comparing actual conditions with objectives and then identifying any gaps.
4. Developing actions to close gaps by turning the strategy into practice.
5. Following through (e.g., tracking progress).

Because compensation is both visible and important to employees, a compensation program designed to communicate and reward strategic goals increases the probability that employees will not only understand what those goals are, but achieve them. The plan should clearly spell out its purpose; eligibility requirements; performance targets for individuals, departments, and the organization; and awards and how they will be paid.

Ultimately, the elements of the compensation plan should achieve the organization's objectives while supporting its values, culture, and business strategy.

The Payout
Decisions regarding how to administer pay must also be strategic. A total compensation plan is typically comprised of five main components:

1. Base salary: the dollar amount to which an employee is entitled, before deductions, and exclusive of additional compensation.
2. Annual incentive plans: distribution of monetary reward based on the completion of previously identified goals/objectives (e.g., bonuses, merchandise prizes).
3. Long-term incentive plans (LTIPs): A reward system designed to improve an employees' long-term performance by providing monetary rewards that are not necessarily tied to the company's share price.
4. Perquisites (perks): These are benefits that typically include company car access, stock options, etc.
5. Benefits: These typically include extended medical and dental plans, short- and long- term disability, life insurance, flexible benefits, and more.

The Payoff
Creating a compensation plan that works for your organization (and your people) can have enormous payoffs in the end. Some of these include:

  • greater employee loyalty

  • less absenteeism

  • increased motivation

  • increased revenues

  • and more…


The benefits are endless (no pun intended).

Don’t be afraid to embark on the creation or enhancement of a compensation plan. You’ll be surprised at the results it will bring. But remember one thing: change is often met with resistance.  As such, it’s important to keep your team leaders/department heads involved throughout the planning process. Doing so will help win both their loyalty and their enthusiasm for the new or improved plan. Nothing spells disaster like releasing a compensation plan before you’ve gotten the buy-in from your management/leaders.
 
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