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5 Key Elements of a Solid Compensation Philosophy

What is a compensation philosophy?

A compensation philosophy is the foundation on which companies build their compensation programs and strategies. At its core, it reflects beliefs and principles about how employees should be rewarded. A well-defined compensation philosophy ensures remuneration isn’t just about dollars and cents, but about fostering a culture of recognition, fairness, and motivation driving both individual and organizational success.

A compensation philosophy is necessary no matter what stage your company is in. Our partner Remote explains, “Global compensation refers to how companies manage direct and indirect compensation for a globally distributed workforce. While direct compensation accounts for salaries and bonuses, indirect compensation includes all the extra benefits offered by the employer with the aim of attracting the best talent and boosting employee retention.”

A compensation philosophy can help both early-stage and established companies alike to prevent wage inequality, boost employee retention and morale, and to serve as an extension of the company’s values.

Why is a compensation philosophy important?

Tim Low, senior vice president at PayScale, explained the significance of having a compensation philosophy, “It’s not just what a company pays, it’s how they pay and how they communicate about it that has a major impact on culture, attitude and morale, engagement and performance.”

Echoing this sentiment, Remote shares, “Offering a fair and equitable compensation policy is a necessary part of building a happy, diverse, and productive workforce.”

Despite layoffs and economic instability, Payscale’s 2023 Compensation Best Practices report emphasizes that attracting and retaining talent will still be a top challenge for companies. Employees have greater bargaining power and expect more from employers — from work-life balance to transparency and fair pay. In fact, according to Pew Research Center, most workers leave their jobs due to low pay.

Issues around employee compensation can have a real impact on the bottom line. Filling open roles takes time and money. No matter how good your talent pipeline might be, if you have a leaky bucket, you’re likely wasting resources in the wrong place. Ultimately, it’s much more cost-effective to pay all of your employees fairly than to look for “bargains” that will inevitably come to light, causing resentment and turnover.

So if you’re considering creating a compensation philosophy from scratch or revamping your existing one to meet current business needs, read on for five steps to set you on the right track.

1. Benchmark salaries with market data

Data is an absolutely critical element of any compensation philosophy. Companies like PayScale, SalaryExpert, and Salary.com all offer great tools to help you benchmark all your current and future roles so you can understand the market rate for a given position.

Hired.com Tech Salary Calculator

2. Determine where you pay relative to the market rate

Probably the most critical part of a compensation philosophy is making a determination about where you are going to pay relative to the market rate. Whether it’s 50th percentile or 90th, you must apply this standard consistently across every individual and role.

Remote ran an extensive pay and equality analysis to understand how to benchmark compensation for each role and the compensation benchmark is based on:

Cost of living/rent index (geo pay)
Alignment to industry benchmarks
Level of experience and alignment to the position
65th percentile positioning within the overall market
Benchmarking across teams and departments to ensure internal equity and fairness

3. Take a holistic view of compensation

Salary should be just one part of your overall compensation philosophy. Things like equity, benefits, vacation allowances, flexible work policies, and perks like catered lunches and dog-friendly offices should all be components of a total rewards package. And indeed, for smaller companies that aren’t able to compete with the big guys on salary, these other elements can be especially important in attracting the right talent and keeping existing employees happy.

Specifically linking performance and compensation is a powerful motivator. A part of your compensation philosophy should detail how you reward exceptional performance. This might involve bonus schemes, profit sharing, or stock options. It encourages employees to contribute their best efforts toward the organization’s success.

Pavania Naidu, Senior Total Rewards Analyst at Remote says, “When employees feel that they are compensated fairly for their work — in relation to their skills and in comparison to the remuneration received by their colleagues — they tend to be happier and more motivated. Equitable compensation is really one of the cornerstones when it comes to retention in any organization. An equitable compensation philosophy instills trust and confidence in employees, who in turn feel incentivized to perform better and remain with a company.”

4. Be transparent

Once you’ve created a compensation philosophy, it’s important to be as transparent as possible about it. This means making it part of your hiring process and running through it with all current employees, both in company-wide settings and as part of your performance and review process. It’s also important to share your strategy for ensuring that employee pay lives up to the philosophy you’ve outlined and how you’ll deal with cases of individuals who are being under-compensated.

5. Review employee compensation periodically

Do regular reviews of employee compensation to make sure you are staying within the market range you’ve committed to. Just as you track profit and revenue, make employee compensation a mission-critical metric you keep up with just as fervently.

Be sure to align your philosophy with legal requirements too. This includes compliance with laws related to minimum wage, overtime pay, equal pay, and anti-discrimination.

Build a strong compensation philosophy

Being thoughtful, transparent, and consistent with your compensation philosophy is one of the keys to employee happiness and retention. Few things are as demoralizing for employees as feeling they are underpaid, or worse, that they are being paid unfairly relative to their coworkers.

Internal equity means employees in similar roles, with similar skills and performance levels, are paid fairly and equitably. This fairness fosters a positive work environment, reduces the risk of discrimination claims, and enhances employee satisfaction and morale.

Given the move toward more salary transparency and the abundance of resources to help workers understand what they should be making, the days when companies could get a “good deal” on in-demand talent are rapidly coming to an end. While on the surface this may seem like something only larger companies have the luxury of time and resources to think about, it should absolutely be on smaller companies’ radar. It is never too early to start.