6.2 Developing a Compensation Package

There are a few basic aspects of compensation packages we should discuss before moving into the specific aspects of compensation. These foundations can assist in the development of a compensation strategy that meets the goals of your organization and is in line with your strategic plan.

Before beginning work on your compensation packages, some analysis should be done to determine your organization’s philosophy in regard to compensation. Before development of your compensation philosophies, there are some basic questions to address on your current compensation packages.

1. From the employee’s perspective, what is a fair wage?
2. Are wages too high to achieve financial health in your organization?
3. Do managers and employees know and buy-into your compensation philosophy?
4. Does the pay scale reflect the importance of various job titles within the organization?
5. Is your compensation good enough to retain employees?
6. Are state and federal laws being met with your compensation package?
7. Is your compensation philosophy keeping in line with labor market changes, industry changes, and organizational changes?

Once these basic questions are addressed, we can see where we might have “holes” in our compensation package and begin to develop new philosophies in line with our strategic plan, which benefits the organization. Some possible compensation policies might include the following:

1. Are salaries higher or lower depending on the location of the business? For example, nurses are paid higher in the California ($133,340) than in Pennsylvania ($80,630), according to the U.S. Bureau of Labor Statistics of May 2022^[1]. Reasons could include cost of living in the area and fewer qualified people in a given area, giving them leverage to ask for a higher salary.
2. Are salaries lower or higher than the average in your region or area? If the salary is lower, what other benefits will the employee receive to make up for this difference? For example, wages might not be as high, but offering flextime or free day care might offset the lower salary.
3. Should there be a specific pay scale for each position in the organization, or should salaries be negotiated on an individual basis? If there is no set pay scale, how can you ensure individual salary offers are fair and nondiscriminatory?
4. What balance of salary and other rewards, such as bonuses, should be part of your compensation package? For example, some organizations prefer to offer a lower salary, but through bonuses and profit sharing, the employee has the potential to earn more.
5. When giving raises, will the employee’s tenure be a factor, or will pay increases be merit based only, or a combination of both?

Let’s discuss some internal and external factors in determining compensation in more detail.

Internal and External Pay Factors

One major internal factor is the compensation strategy the company has decided to use. Benefits cost the average US worker 31%, but cost the organization 38% to provide benefits to the employees. This percentage could be more if the sector is state or government work^[2].

Some organizations choose a matching the market, market leader, market lag, and lead-lag pay policy.

A matching the market is to pay in the middle of the market for a like position. In other words, 50 percentile of organizations that utilize the matching the market will pay above the market rate. The other 50 percent will pay below the market rate.

A market leader is to pay above the market rate. Organizations will pay in the 75 percentile to ensure that their employees are receiving the highest rate in the market. It is also possible to provide a lesser compensation or benefit package, and allow for the pay rate to ensure that the pay stays in the Market Leader position.

A market lag is to pay below the market rate. Organizations will pay in the 25 percentile and take the market lag position.  If an organization is more apt to provide a wealthier compensation and benefit package, they will be more likely to be in the market lag poison.

A lead-lag is to pay the first half of the fiscal year in the top 50 percentile, and to pay in the lower 50 percentile in the second half of the fiscal year.

There are many reasons why an organization would choose one philosophy over another. A lead-lag pay philosophy may tie into the company’s core values, or it may be because the types of jobs require an unskilled workforce that may be easier and less expensive to replace. A company may use a market lead pay philosophy because the industry’s cutting-edge nature requires the best and the brightest.

Other internal pay factors might include the employer’s ability to pay, the type of industry, and the value of the employee and the particular job to the organization. In addition, the presence of a union can lead to mandated pay scales. Unions are discussed in Chapter 12 “Working with Labor Unions”.

External pay factors can include the current economic state. For example, in December, 2023 the US unemployment rate was 3.2 percent. As a result of surplus workers, compensation may be reduced within organizations because of oversupply of workers. Inflation and cost of living in a given area can also determine compensation in a given market.

Once an organization has looked at the internal and external forces affecting pay, it can begin to develop a pay system within the organization. We discuss how to develop a pay system in Section 6.3 “Types of Pay Systems”.