Develop Your Compensation Strategy - dummies

Develop Your Compensation Strategy

By Bob Kelleher

You should diversify your approach to rewards in order to encourage achievement and engagement among your employees, but compensation is still a key part of the equation. Careful compensation is one great way to reward employee engagement.

Unfortunately, some managers use what could be called the “peanut-butter approach” to paying their employees. That is, they simply use “number of employees” as the denominator in their salary or bonus pool and spread everything around evenly, like peanut butter on a piece of bread.

Managers may think this approach will satisfy all their employees equally, or use the “We’re a team!” excuse to justify their distribution strategy. But the sad fact is, this approach is about as effective as a paper parasol in a typhoon. It simply doesn’t work. Why? Because employees are not created equal, nor do they achieve equal results.

If your goal is employee engagement — and it is — then rewards, including pay, must be tied to performance and achievement. If you don’t reward your high performers more than your average and below-average employees, you do not incentivize your high performers to continue with their high-performing ways or your average and below-average employees to improve.

Over time, this will result in a culture of mediocrity. (Not to pick on unions or public-sector compensation structures, but collective bargaining of pay increases, where everyone gets the same percentage raise, do not create a high-performing culture. Instead, it can erode employee engagement, as high-performing employees perceive that their achievements aren’t being recognized.)

To reinforce the importance of high performance, successful firms pay their “stars” — those high-performing people who routinely achieve results, as well as embracing the firm’s values — a disproportionately high amount. Indeed, you should pay your top performers so much that the competition could never afford them. It’s money well spent!

These days, and for as long as most people can remember, merit budgets have been in the 3 percent to 4 percent neighborhood. This has created a challenge for managers: How do you allot such a pool to adequately reward your top performers and maximize engagement?

Here’s how not to allot it: by using the peanut-butter approach. Take great care in determining who gets what. For guidance, look to the compensation matrix in this figure.

You can use this matrix to help you divide up a merit pool or even a bonus pool. Although other factors — such as an employee’s position in her salary grade, the employee’s tenure in the position, market conditions, and so on — may be at play, this tool offers managers a great place to start.


Looking at the figure, if X is the average reward, then

  • Transition employees (the 10 percent to 20 percent of employees who aren’t quite making the grade) should receive no merit increase. Not to be harsh, but they shouldn’t be rewarded for failing to perform. If you’re inclined to give them something, just remember: Your top performers will, in effect, subsidize it.

  • Investment employees (the 10 percent to 20 percent of employees who really matter — who function above and beyond the norm and define the standard for exceptional performance) should earn double the average merit increase or bonus. They should be rewarded extra for their excellence.

  • Performers (the 30 percent to 35 percent of employees who are strong and steady workers, but who don’t yet display their full potential) deserve your average bonus.

  • Potentials (the 30 percent to 35 percent of your talent pool who haven’t yet reached their potential because they haven’t yet had time to develop) deserve your average bonus.

If you want to boost the merit increases and/or bonuses of your performers and potentials a bit, give the edge to potentials. They’re likely to be new or junior staff for whom the slight boost will be more closely tied to specific, recent achievements.

As you assess your employees’ performance, decide which metrics carry the most weight. Some metrics will likely be more important than others, and they should be rewarded for accordingly. For instance, suppose you’re a software firm, and your competitors have recently passed you in new products launched.

In that case, you may decide that in the coming year, special performance metrics will reward new product development. It’s also important to build in both quantitative and qualitative metrics.