Compensation Philosophy: What is It Worth?

Recently, there has been a lot more discussion of compensation philosophy.  Almost every human resource conference, publication, or discussion group has at least one session or article addressing what is your compensation philosophy.  However, as I work with human capital professionals around the country, I find that the level of understanding and application of compensation philosophy varies considerably.  Compensation philosophy can refer to the method utilized to increase pay, relative market positioning, or overall compensation approach.  The common element across most organizations is that the philosophy dictates how and at what level pay will be increased in the future.  Although organizational strategy and objectives should guide the philosophy, most organizations focus more on availability of resources, projections of future resources, relative market position, market competition, and turnover when defining its strategy.

There are three guiding elements that should be serve as the basis for creating any compensation philosophy:

  • Strategic
  • Organizational
  • Individual

Strategic

The strategic elements of your philosophy pertain to what your organization wants to accomplish in the future and how it is going to get there.  Degree of change, level of performance, and complexity of objectives all play a role in dictating what type of strategy your organization might have.  Some organizations are like a slow freight train that does well on the flat ground and struggles on the hills.  The strategy for this train is very different from a high speed bullet train or even a mountain train.  In any case, the compensation philosophy should match the strategy which should correlate with the desired outcome.   The competitiveness, degree of customization, and flexibility of the compensation philosophy are critical components to meeting the strategic needs of the organization.

Organizational

Just as the strategy and desired outcomes influence the overall structure of the philosophy, the organizational needs focus on internal culture and require customization as well.  Each organization possesses a unique culture and structure that influence the type of employees present and their attitudes and attributes.  The philosophy needs to be consistent with the culture or it will fail to support the strategic needs of the organization.

Individual

The individual element relates to how the philosophy motivates or de-motivates individual employees on a consistent basis.  Since each employee possesses specific and in some cases even unique needs, the philosophy should be broad and flexible enough to account for the major need clusters present in the organization.  It is inevitable that an employee will look to the philosophy to assess how the organization sets his or her value.  Engagement, satisfaction, and performance are tied to success of the compensation philosophy and rarely can their full potential be realized without a strong and accepted philosophy.

Obviously, a strong philosophy development process is more detailed than just saying “we want to pay well.”  Given the required work, what is the benefit? The benefit of a compensation philosophy is that it provides predictability for employees and managers, encourages high performance levels, guides resource allocation, and supports alignment to strategic goals of the organization.  Another big component is the messaging that accompanies the philosophy.  Your philosophy sends a message to internal and external recipients:

  • Internal – the philosophy notifies employees of the value of their abilities and contribution based on the current compensation and relative market positioning of the organization.
  • External – the philosophy communicates to the marketplace (especially potential job candidates) where your organization wishes to position itself vis-à-vis its relevant market peers, what its performance expectations are, and the type of employees it prefers.

While current employees consider a number of factors in remaining with an employer (relationships, satisfaction with work, and supervisor quality), potential candidates are very influenced by perceived market positioning.  If we assume rationality in the marketplace, potential candidates compare their perceived value to what an organization typically offers and determines if it is a place where he or she might want to work.

So, what does a strong compensation philosophy include?

  • Linkage to the organization’s strategic goals;
  • Alignment with the desired level of performance;
  • Definition of where the organization wants to be in the marketplace; and
  • General enough language that allows for pay policy adjustments when necessary.

How do I develop one?

  • Assemble major stakeholders and share information on the strategic goals, availability of resources, projections of future resources, relative market position, market competition, and turnover;
  • Reach consensus on market positioning;
  • Determine how positioning, movement, and rewards will be utilized in the organization; and
  • Develop a compensation policy.
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