The best way to create a compensation plan to motivate 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 how it will fit into their overall strategy for recruiting and retaining employees. Many employers base their decisions on the market—they look at salary surveys to see what other employers are paying (external equity). Once they access the market data, they set wages and salaries above, below, or equal to the market data depending on the circumstances.  For example, some employers decide to set salaries for specific positions well above the market rate to attract and retain valuable talent.

However, employers should also consider internal equity— whether their compensation plan reflects how much they value positions within the organization.

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

• Job analysis: This involves thoroughly examining and describing each job within the organization. It helps identify job duties, responsibilities, required skills, qualifications, and working conditions. The goal is to ensure that all jobs are clearly defined and understood, which serves as the foundation for job evaluation and pricing.
• Job evaluation: This process determines the relative worth of jobs within the organization. Employers assess the value of each position in comparison to others, considering factors like skill requirements, responsibilities, and impact on the organization. The aim is to establish a consistent and equitable hierarchy of jobs, which informs compensation structures and helps maintain internal equity.
• Job pricing: This step involves setting compensation rates for each job based on its evaluation and external market data. It includes establishing a salary range with a minimum, midpoint, and maximum for each labor grade or job category. Job pricing ensures that compensation is competitive with the external market (external equity) while aligning with the organization’s internal hierarchy.

These three components work together to ensure that compensation is both fair and competitive, attracting and retaining talent while avoiding pay disparities within the organization.

An increasing number of employers are adopting performance-based compensation plans to enhance productivity and optimize their return on investment in compensation. These programs are designed to reward employees based on their contributions and outcomes. Many experts argue that traditional salary increases are often insufficiently linked to actual performance. In contrast, a well-structured performance-based bonus plan can directly align compensation with the specific results a company values. However, creating an effective performance-based compensation plan is challenging. Common pitfalls include setting performance targets too low or using inappropriate metrics to assess employee performance. To succeed, employers must ensure that targets are ambitious yet achievable and that performance metrics are clearly aligned with organizational goals.