Building an effective base compensation plan

When it comes to building a base compensation plan, organization leadership and human resources professionals are constantly being challenged. You want to be able to attract, retain and reward employees, as well as stay competitive. But you also want to administer pay equitably for the work performed, recognize the value of each position and employee, and have managers understand and support the compensation plan. 

There are seven steps to developing an effective base compensation plan: 

1. Create a compensation committee

The first step is to create a compensation committee made up of senior management and at least one HR professional. Try to keep it to an odd number, with three or five members who represent a cross-section of the organization’s leadership.

The committee members will need to understand that they’re making a long-term commitment to building or enhancing the current compensation plan. They must be willing to work together to make potentially tough but fair decisions, and be able to consider the full organization throughout the process. Being able to separate people from their positions is essential. 

2. Develop or update job descriptions

A well-designed compensation system begins with clear documentation of job accountabilities, responsibilities and qualifications. Make sure to include:

• Job title
• Exemption status (don’t forget about FLSA considerations)
• Reporting relationships
• Position summary
• Primary accountabilities and responsibilities
• Secondary responsibilities
• Education, experience and other requirements
• Working conditions
• Employee acknowledgement/disclaimer 
• Competencies (as desired)

Competencies are defined as a blend of the knowledge, skills and abilities needed to achieve success. Knowledge is what you know, skills are what you can do and abilities are what we know and can do together (e.g., link customer needs to organization products).

3. Conduct an internal equity analysis

An internal equity analysis determines the relative value of each position within your organization to every other position based on certain factors. 

Common factors include:

• Skills: education and experience 
• Responsibilities: complexity, contacts, impact of errors, confidential information access, and safety and supervision of others
• Effort: physical demands and mental or visual demands
• Job conditions: working conditions and unavoidable hazards

Points are assigned to the factors and levels. Positions are assigned the appropriate point value based on the factors and levels. Note that the compensation committee should consider the job requirements only, not the people currently filling the role.

If an organization elects to conduct an internal equity analysis (and not all do), we recommend it be conducted before the external market analysis.

4. Conduct an external market analysis

An external market analysis determines the market value of each position by comparing it to published compensation data and/or to customized survey results. A reputable survey will have an adequate sample size and sound compensation survey methodology practices. 

Each job description is matched to the survey job descriptions to ensure an accurate match of each position’s roles and responsibilities. Because roles and responsibilities may vary, do not rely solely on the job title.

An appropriate external data analysis includes:

• Survey name
• Survey job
• Demographics of data used
• Number of organizations
• An aging factor
• Weighting
• Median (or average where median not available) 
• Bonus/incentive (if doing total cash compensation)

5. Design a salary structure

After completing the internal and external equity analyses, the compensation committee designs the compensation structure. The external market analysis is used to develop the compensation structure.  

The midpoint average of similarly valued positions will assist you in defining the pay groups throughout the compensation structure. You typically begin with the top position; subsequent ranges are developed on the basis of similarly valued positions. Normally, there are approximately 10% progressions between midpoints; however, there may be larger progressions between executive and upper management positions and lower progressions between mid-management and staff positions.

Once the ranges are established, all positions are incorporated into the salary structure. The structure should be reviewed to ensure it makes sense. The internal equity analysis results can be used to make any final adjustments to the compensation structure on the basis of the relative value of the positions. Internal equity considerations are especially brought into focus if the value of the position internally differs from the external market, or if external market data is unavailable given the uniqueness of the position. 

6. Conduct a comparative ratio analysis

A comparative ratio analysis (or employee impact analysis) allows your organization to determine where current rates of pay fall in relationship to the newly established compensation structure midpoints. The comparative ratio analysis enables the organization to evaluate pay practices on an aggregate level to determine if pay practices align with the organization’s compensation philosophy.  

The analysis also identifies individuals who may be paid below or above market. It is a highly effective tool that enables the organization to administer compensation. This tool can also be used to incorporate other factors used to administration, such as performance. Further, it can assist the organization in identifying if there are any potential concerns with pay inequity for protected classes. 

7. Develop administration policies

A formal, written compensation philosophy serves as an excellent guidepost when making compensation decisions. It specifies the purpose and desired market position (i.e., strategy) of each component of an employee’s total compensation mix. Total compensation mix includes base salary, short-term incentives, long-term incentives and benefits.

Effective plan administration policies should (and this is not an all-inclusive list):

• Outline the plan’s objectives
• Identify who is responsible for the plan
• Describe the importance and proper use of job documentation
• Describe how the internal and external equity analysis process occurs
• Describe how the salary structure will be administered
• Outline how pay adjustments will be handled
• Summarize the tools you utilized 

It’s important to maintain the compensation plan developed to ensure it remains competitive until it’s time to conduct a full analysis on all or a subset of positions. The organization should develop a plan to ensure the following areas, at a minimum, are addressed on a regular and ongoing basis:

• Update job descriptions annually
• Review compensation structure annually and adjust to reflect market structure movement
• Conduct a full review at least every three years
• Manage employees falling outside the established compensation structure ranges 

Final considerations for your base compensation plan