- The four primary direct forms of compensation are salary, hourly pay, commissions and bonus pay.
- Indirect compensation, including benefits and equity-based programs, is just as crucial as direct compensation.
- When you’re developing and implementing a desirable compensation package, research its elements, do what’s right for your team and ensure it’s legally compliant.
- This article is for small business owners and HR managers who want to learn about competitive compensation programs.
A robust compensation plan is crucial for attracting and keeping a quality team. A successful compensation strategy incorporates multiple elements beyond salary, including flexibility, employee benefits, paid time off (PTO) and much more.
We’ll detail compensation plan elements and explain how to develop and implement a competitive compensation plan that can boost recruitment and retention efforts while ensuring equity and fairness.
What is a compensation plan?
A compensation plan, also called a “total compensation plan,” encompasses all of the compensatory components of a company’s strategy: employees’ wages, salaries, benefits and total payment terms. Employee compensation plans also include raise schedules, fringe benefits, union perks and employer-provided vendor discounts.
A strategically designed compensation philosophy that is kept current, relevant and compliant supports critical components of your business, including the following:
- Strategic plans
- Budgeting and business goals
- Industry-competitive challenges
- Operating needs
- Total reward strategies that support retention of the company’s top talent
When your business maintains a robust compensation program, you’ll enjoy the following benefits:
- A compensation plan can support your business strategy. A desirable compensation plan describes how your organization’s pay and compensation philosophies support your business strategy, industry competitiveness, operating objectives and staff needs.
- A compensation plan can help with recruitment. A desirable compensation plan helps your business attract and retain top talent with the in-demand career skills that can take your business to the next level.
- A compensation plan can boost employee motivation. A desirable compensation plan motivates employees to perform at high levels and exceed goals.
- A compensation plan can keep your business competitive. A desirable compensation plan helps keep your business competitive in the marketplace in terms of base pay, incentives, total compensation and benefits opportunities.
When you’re writing a job offer letter, detail the position’s salary, commissions and pay schedule, and provide an overview of the benefits package and perks the employee will receive.
Why do companies need a compensation plan?
Companies need a thoughtful compensation program to stay competitive in their industry and attract and retain top talent. Employers that determine salaries and benefits without regard for industry data will slowly lose the talent game to competitors. Additionally, managing a workforce without a predetermined business budget is risky. Compensation programs allow for consistent and predictable budgeting and planning.
According to Payscale’s 2023 Compensation Best Practices Report, job seekers have the upper hand in today’s job market. To attract and retain the best workers, more organizations are focusing on building compensation packages that will help recruit employees in a tough labor market and keep them engaged and motivated.
What is direct and indirect compensation?
There are two types of foundational compensation:
- Direct compensation: Direct compensation includes salary, hourly pay, commissions and bonus pay.
- Indirect compensation: Indirect compensation includes various benefits.
We’ll take a closer look at direct and indirect compensation.
4 types of direct compensation
Most employers choose one type of direct compensation and stick to it. However, you can use various methods to compensate employees for their work. The exception is bonus pay, which is meant to be an addition to regular pay based on employee or company performance.
- Salary: The most traditional form of salary is a monetary amount scheduled over one year. How often salaried employees are paid is another part of the compensation strategy. However, businesses typically pay their employees every two weeks. Salary is the most common method of direct compensation for exempt employees. An exempt employee is not eligible for overtime pay. They receive a base salary for their work instead of being paid an hourly rate; employers pay exempt employees for their job instead of the number of hours they work.
- Hourly pay: Nonexempt employees are typically paid an hourly rate and are eligible for overtime pay; they’re guaranteed at least minimum wage. When an employee works over 40 hours in a workweek, their employer must pay them overtime. The hourly pay rate is typically a predetermined dollar amount per work hour. Hourly employees generally keep a timecard or clock in and out to begin and end their work shifts. During times of slow or reduced work or budget changes, nonexempt employees might not work as many hours as they did in previous weeks. Thus, a routine number of hours worked per pay period is not guaranteed.
- Commission: Commission is when compensation is based on volume, production or a predefined performance level. This compensation type is also known as “piecework” or “piecemeal.” Paid commissions are usually based on the volume of services performed or products made, or are structured around sales volume. For example, a real estate agent who sells a house will receive compensation from that sale. It doesn’t matter how long or what work activities were necessary to sell the house, only that it was sold.
- Bonus pay: Bonuses are used to motivate employees or increase their overall performance. Bonuses are a variable compensation method that’s commonly associated with sales professionals, who tend to be salaried or exempt personnel. For example, if a sales professional exceeds their quarterly target by a specific dollar amount based on a predetermined matrix, they will receive a commensurate bonus. Bonuses can also be paid for company performance or when hard-to-fill positions are filled with employees with unique or highly sought-after skills or experience. Holiday bonuses are another popular type of bonus.
When you’re deciding whether to pay employees a salary or an hourly wage, consider the type of work they’ll perform, applicable state laws and job market trends.
Types of indirect compensation
Indirect compensation can be any fringe benefit employers offer. Most commonly, it refers to the various insurance types employers offer in their employee benefits plans. For example, the employer may offer health insurance, dental insurance, life insurance, short- and long-term disability insurance and vision insurance. Employee retirement plans, like 401(k) plans, are another common form of indirect compensation.
Equity-based programs are another compensation offering. However, these aren’t typically offered within the small business realm. Equity-based compensation is generally some sort of share or stock in the company.
Other examples of indirect compensation include the following:
How to develop and implement a compensation plan
There’s no one-size-fits-all strategy for developing a compensation plan. Rather, it’s best to approach it in terms of what’s right for your team. Here are some suggestions to guide you along the way.
- Create a compensation plan outline. Set an objective for your program and specific targets. Begin with job descriptions for each position on the team, and set a generalized budget for your personnel.
- Appoint a compensation manager. This position, usually filled by someone in human resources, aligns the program and researches what each position pays within the industry, how job classifications will be determined and how direct compensation will be selected.
- Craft a compensation philosophy. Determine how competitive you’ll be in your industry’s job market. Will you lead the market in direct compensation or offer modest pay with great benefits?
- Rank jobs and place them within a matrix. Outline what, if any, pay tiers should exist in pay structures for executives and sales employees, for example. You also should determine potential tiers within each job classification.
- Develop seniority grades within each job classification. It’s essential to develop opportunities for career advancement. For example, create levels or senior- and entry-level roles that may affect the compensation matrix but offer advancement for employees.
- Settle on salaries and hourly pay rates. After you outline your compensation platform, assign pay rates and salary ranges for each position and job classification. This is when you’ll fine-tune your organizational budget.
- Complete necessary policies. A compensation plan may affect policies related to payroll, fringe benefits and other pay-related matters. For example, companies often have policies for paid holidays, healthcare benefits, payroll administration and company-issued pay advances that must factor into — or at least align with — the company’s compensation policy. Ensure that all policies are updated and included in your employee handbook.
- Get approval or buy-in from your company’s other leaders. Once everything is in place, ensure that your company’s leadership team fully supports your compensation packages.
- Develop a communication plan. All of your employees should learn about the compensation program at the same time. Use several communication methods to share the plan (e.g., email, group gatherings, social media, flyers in common areas). Issue this messaging in multiple languages if not all of your employees speak English as a first language. You should also expect many questions. The complexities of total compensation are not easy to understand, and it’s essential for every employee to understand their compensation package.
- Monitor your compensation plan. Be prepared to keep tabs on and change employee compensation. Over time, adjustments will be necessary for you to remain legally compliant and competitive.
Commissions and bonuses are considered variable pay for sales employees. An employee’s base salary and variable pay are called the employee’s “pay mix.”
How can you ensure equity, fairness, legality and competitiveness?
Part of developing a compensation plan is ensuring it’s fair for all employees. This pertains to gender, culture, race and ethnicity, as well as to the skill sets and experience new team members bring to your company.
Before you unveil your compensation plan, address the following questions:
- Are the programs in your compensation policy legally compliant? Be mindful of labor laws, including state laws (which may include PTO or vacation regulations) and federal laws (such as the Affordable Care Act).
- Is the overall program fair to all employees?
- Do employees perceive the overall program as fair? In this case, perception is reality.
- Is the overall program fiscally sound? Can you maintain the benefit offerings even if profits dip for a quarter or two?
- Can your organization effectively communicate the overall program to employees?
- Are the programs fair, competitive and in line with your overall compensation policies?
- Is the compensation policy competitive? Will it help your organization attract and retain top talent in your industry?
It’s crucial to keep your compensation plan active and relevant by adjusting it as necessary to stay compliant and continue attracting and retaining excellent employees.
Tracking commissions, bonuses and other compensation types can be daunting, but the best payroll services can streamline calculations, determine taxes and minimize errors.
Resources for creating compensation plans
Consider the following compensation planning and design companies that can guide you toward a fair, desirable compensation plan:
- Culpepper and Associates: Culpepper and Associates offers compensation surveys and other services.
- PeopleFluent: PeopleFluent provides talent management services.
- Unit4: Unit4 offers comprehensive HR and financial software, including employee compensation management software.
- Flex HR: Flex HR provides full-service consulting.
- emPerform: emPerform offers all-inclusive employee performance management.
Performance management software can help with compensation management as well as succession planning and employee reviews.
Good compensation plans make good teams
A solid compensation plan should be a key component of any company’s strategy for attracting and retaining the best team members possible. There are many ways to offer a good compensation program to your employees based on your business needs and budget. Take the time necessary to develop a comprehensive program that works for your organization, and then communicate the plan effectively to everyone on your team. Do it right, and your employee morale and retention will increase substantially.
Natalie Hamingson contributed to this article.