How to build a meaningful compensation scheme for employees

When it comes to workforce compensation, the definition of fair is not so easy!

Ok! The first level should be easy: your compensation strategy has to ensure there is no discrimination (gender, ethnicity, age,…).

How to build a meaningful compensation scheme for employees

The second level is trickier, because this is when fairness does not mean equality. I am talking here about criteria such as performance results, cost of living, market rates, country benefits, job drudgery, financial results per business unit and sales incentives. Here, you need to find a good formula.

The third level is out of today’s discussion. This concerns compensation exceptions where unfairness is needed for business-critical reasons: retention of key talent or an increased offer to a top-notch candidate.

Modern compensation solutions allow you to organize, run and administer your compensation strategy end-to-end. They come with multiple features to automate calculations, enforce your rules, control user input, raise exceptions and many others…

So what can possibly go wrong?

Here are three important elements to take into consideration:

The human factor

The most obvious element that is difficult to control is the human factor. How can you ensure the responsible person to distribute compensation is unbiased?

One possibility is to remove this factor from the process! Some organizations automate the entire compensation distribution process. This can be about giving a bonus to only a subset of the company and based the department’s financial results. Or about managing compensation through salary grids/matrices and automatic adjustments.

This is just a minority because most organizations want to be able to consider the employee’s performance. A more common process tries to eliminate the human factor from the compensation process only. This means the employee compensation is automatically calculated based on formulas that can include some individual goal achievements or overall performance results, but there is a clear separation between talking performance and talking money. I guess this worth a future article on how to insure a fair performance evaluation!

Finally, the last approach is to give the manager the possibility to manage their budget. This is the best solution for me because:

  • You expect engagement from your managers, they expect in return that you trust them
  • Even with the best formula, you will miss some context that only the manager is aware of
  • It brings flexibility into the process

Modern compensation solutions help to secure data entered for managers and compensation administrators. Here are three examples:

Boundaries – while giving some flexibility to managers on how they want to distribute their budgets within their team, you can fix some lower or upper limits as a percentage value or as an absolute amount. These limits can be dependent on the current salary or mixed with other criteria such as performance or compa-ratio for instance.

Alerts – modern solutions are changing the way you work. The objective is to help you directly focus on the most important items. Alerts are used this way so that you will first look at exceptions and questionable compensation proposals instead of going line by line through the entire worksheet. It is possible to set up any kind of alert e.g. an employee who would be granted a more than x% salary increase while their performance is poor.

Justifications – In addition to having all history kept in the solution (who, when, how much), you may ask for justifications on certain conditions. That way, the manager who wants to give an extra increase or generally giving low salary increases to a specific person would have to explain this. This will be tracked in the system and requires an approval process including an audit.

The missing parameter

You define your compensation strategy the same way a star chef prepares their menu. Using multiple ingredients and great expertise, the objective is to make all customers satisfied and ensure they will not regret their choice even when glimpsing at their friends’ plate.

A dish can be ruined because you may have forgotten one ingredient. A compensation strategy can be unfair because you forgot one parameter when designing it.

Some parameters should simply be forgotten! This is the level one rule. Elements like gender, ethnicity, disability or age should not be taken into consideration for any eligibility rule, formula or filter.

 Source: Statista
Source: Statista

However, do not underestimate side effects. For instance, let’s say you want a bonus being prorated based on the duration the employee has been working in the department or business unit. I see sometimes this duration be prorated based on number of days in different assignments. Depending on the system you are using and the way it is set up, it may be that you are excluding paternity/maternity leave from the calculation. Most probably this is not on purpose but, doing so, you just created a difference between women and men as part of your calculation.

There is no one magic formula and this is the reason why you need a compensation solution that

  • Is flexible, allowing for multiple plans with specific eligibility and rules definition.
  • Allows you to do simulations to validate and rework your rules
  • Is integrated with your HR system (admin and talent) to be able to build rules based on any parameter

 The country budget bias

Another side effect I discovered and discussed with two international companies recently was linked to the country budget.

The compensation mechanism was based on three principles:

  • A team can be international
  • Manager is given a budget they can distribute with some flexibility within their team
  • The manager has to ensure that they are distributing according to the country budget

Here is an example:

Let’s say the UK decides on a 2% bonus (of the total wage bill) and Germany for a 3% bonus. A manager with a mix of employees from the UK and Germany will have a budget defined the following way:  Budget = UKbudget + GERbudget (where UKbudget=2% of total salaries of employees from UK and GERbudget=3% of total salaries of employees from Germany).

Then, to be in line with the third principle, this manager has to ensure that the overall bonus is distributed to his UK employees will not go over the UKbudget and same for his German employees.

It does not seem too bad! We can all understand that an international company may have different compensation strategies per country and, for legal reasons, have to ensure country budgets are given to employees from the same country. Also this could work if the amount was forced to the exact number (2% for UK employees, 3% for German employees).

But remember second principle was for the manager to have some flexibility. Let’s take an extreme example, the manager has 10 employees on the German payroll and 1 employee on the UK payroll!

The manager can distribute different bonuses to their German employees. They can give 5% or more to the best achiever as long as he does not go overall above the 3%. What about the UK employees? Here there is no more flexibility. He/She can simply not go above the 2% even if he/she might be the valued resource on the team!

Fair compensation requires some thinking, lots of testing and a modern compensation tool to ensure you reflect your company’s values, your business requirements and your industry specifics.

About the Author:

With a strong background in supporting, developing, maintaining, implementing and demonstrating HR oriented solutions, Nicolas Bouché understands the impacts of HR transformation projects. You can find more information on LinkedIn. Views are his own.