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Compensation Plan

How to Create a Compensation Plan that Motivates Employees

Employers that want to succeed in this increasingly competitive environment must have a well-designed compensation plan that motivates employees, controls compensation costs, and ensures equity. The best compensation plans mirror the culture of the employer. Therefore, employers should establish a compensation philosophy. Benefits programs should also be part of an employer’s compensation strategy.

Employers have myriad options when it comes to designing a compensation plan, and they must consider and how it will fit into their overall strategy for recruiting and retaining employees. Many employers base their decisions on the market—that is, they look at salary surveys to see what other employers are paying (external equity). Once they access the market data, they set their wages and salaries at some point above, below, or equal to the market data depending on the circumstances.  For example, some employers decide that they will set wages for certain positions at well above the market rate to attract and retain highly valuable employees.

However, employers should also consider internal equity—that is, whether their compensation plan reflects how much they value positions in relation to other positions within the organization.

To ensure both internal and external equity, employers must establish an effective compensation administration program. To do this, employers must conduct:

  • Job analysis (thoroughly analyze and describe each job within the organization)
  • Job evaluation  (determine what jobs are worth on an absolute basis and relative to other jobs in the organization, such as giving jobs that are of greater value to the organization a higher labor grade)
  • Job pricing (establish rate ranges; that is, minimum, midpoint, and maximum dollar values for each labor grade)

A growing number of employers are incorporating performance-based compensation plans to boost productivity and maximize their return on investment in compensation. These types of plans are designed to reward employees who produce. Some experts argue that traditional salary increases aren’t as connected to performance as they should be. By contrast, a well thought out performance-based bonus plan can be tied directly to the results the company sees as valuable. However, developing a performance-based compensation plan isn’t easy. One mistake employers often make is setting performance targets too low. Another common mistake is for employers to use the wrong metrics in determining an employee’s performance.

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