How to Set Up a Compensation Structure in These Easy Steps

Compensation structure looks intimidating, especially for those new to the process. The complexities of balancing internal equity, market competitiveness, and budget limitations can make it seem overwhelming.

However, by following some easy steps and understanding everything about pay structure, as we will discuss later, setting up a salary structure can be a manageable and rewarding task.

This article explains what a compensation structure is, why it's important to organizations, the types of structures, examples, and easy steps to set it up for your organization.

What is compensation structure?

A compensation structure, also called a salary structure or pay structure, is a system that a company uses to determine how its employees are paid. It organizes grades, bands, or levels of employees' wages, essentially outlining the elements of an employee's total compensation and how they are rewarded.

Why do organizations develop a compensation structure?

A compensation structure in an organization aims to attract, retain, and motivate talent, align individual performance with business goals, and ensure fair and transparent pay within the workplace. It establishes clear pay ranges based on job value, experience, and performance, which provides competitive salaries and incentives to attract top talent and enhance organizational success.

Compensation structure benefits

A well-designed pay structure can be a major asset to any organization, bringing various benefits for both employees and the company itself. Here are some key advantages:

• Attracting and retaining high-caliber talent

• Increasing employee motivation and engagement

• Ensuring performance is aligned with organizational objectives

• Creating a culture of fairness and transparency

• Building a strong employer brand and reputation

• Lowering employee turnover rates

• Improving overall financial performance

Factors that determine compensation structures

Compensation structures are determined by many different factors. Here are the major factors that influence pay structures in an organization:

• Job characteristics. The skills and responsibilities required for a job can affect how much it pays. Jobs needing specialized skills or more effort often pay more.

• Employee characteristics. Factors like experience, education, performance, and tenure affect pay. Employers use these to decide raises and bonuses.

• Company policies and values. An organization's beliefs about pay and its policies shape how it pays employees. Some focus on competitive salaries to attract top talent, while others prioritize fairness among employees.

• Market trends and data. Employers check market trends to make sure their pay is competitive. They compare salaries with similar jobs in other companies and industries.

• Government regulations. Laws about minimum wage, overtime, and other compensation rules affect how organizations set pay.

• Economic conditions. Economic conditions affect pay decisions. During periods of economic growth, employers may offer more pay and bonuses to keep employees. In bad times, they may be more careful with pay.

• Supply and demand of labor. If there aren't many qualified candidates for a job, employers may raise salaries to attract them, especially in industries or regions where certain skills are in high demand.

Types of compensation structure

There are many ways organizations can pay employees, but the best one depends on factors, such as the organization's size, industry, employee types, and compensation philosophy. Here are some common structures:

Traditional

In a traditional pay structure, employees are grouped into job levels based on job complexity, responsibilities, and skills. Each level has a salary range with minimum, midpoint, and maximum values. Pay increases are typically based on tenure or performance within the level. This structure offers clear career progression but can be inflexible in rewarding high performers.

Broadband

Broadbanding combines multiple pay grades into broader bands. For example, instead of separate grades for different levels, a broadband structure might have one band for professional roles and another for managerial positions. This offers flexibility in setting salaries and career paths, allowing lateral movement within bands as employees gain experience.

Market-based

This structure determines pay based on market rates for similar jobs in the industry and location. Organizations use surveys and data to set competitive pay ranges, aiming to attract and keep talent. While it ensures competitiveness, it may not always match the organization's budget or internal equity needs.

Step-based

In a step-based compensation structure, employees get set pay raises based on things like how long they've been working, how well they perform, or when they reach certain goals. For instance, they might get a raise every year or after a set number of years on the job. This system gives clear rules for pay increases, which can motivate employees to stay. However, it might not always match market changes or individual performance.

Commission

Commission-based pay is often used in sales-related roles, where employees get a percentage of the sales they make. This system motivates employees to perform well because they earn more when they sell more. But it can create competition among employees and may not work well for jobs where sales depend on factors beyond an individual's control.

Skills-based

In a skills-based pay structure, pay is linked to the skills and competencies employees have, not just their job title. This encourages employees to improve their skills, making the workforce more skilled and adaptable. However, it can be hard to measure the value of each skill, so it requires a thorough skills assessment and management process.

Hybrid

A hybrid structure mixes different pay methods to fit the organization's needs. For example, it might use market-based pay to stay competitive and skills-based pay to reward skill growth. This lets organizations benefit from different pay strategies while managing their drawbacks. This structure needs careful planning to work well and be fair.

Compensation structure examples

To give you a full understanding of compensation structure, here are two scenarios:

Scenario 1: Traditional pay structure

Let's say ABC Corp has five job levels for software engineers, from Junior Engineer (Level 1) to Senior Engineer (Level 5), with a salary range for each level.

• Level 1: $50,000 - $70,000

• Level 2: $60,000 - $80,000

• Level 3: $70,000 - $90,000

• Level 4: $80,000 - $100,000

• Level 5: $90,000 - $120,000

Within each level, employees can get pay raises based on their time with the company and how well they perform. For instance, a Junior Engineer (Level 1) might start at $50,000 and get a 5% raise each year if they meet expectations. After a few years, they might move up to Level 2, starting at $60,000, and continue to move up the salary range based on their performance and time with the company.

Scenario 2: Broadband pay structure

Let's consider a fictional company, Tech Corp, that has implemented a broadband salary structure for its engineering team.

In this example, Tech groups its engineers into three categories: Entry-Level, Mid-Level, and Senior, instead of using separate pay grades for each level of Software Engineer.

• Junior band: Entry-level positions, paying $40,000 - $50,000 per year.

• Mid-level band: Positions with more experience, paying $50,000 - $70,000 per year.

• Senior band: Top-level positions, paying $70,000 - $90,000 per year.

Broadbanding works well in diverse organizations with fluid career paths, but it needs careful planning and ongoing management to meet both the organization's and employees' needs.

How to set up a compensation structure

Setting up a salary structure involves a few important steps to ensure it aligns with your company's goals, is competitive in the market, and is communicated effectively. Here's how to do it with the help of Salary.com's Compensation Software.

1. Step 1: Analyze your workforce

   Analyze your workforce, including job roles, skills, experience, and performance. This analysis will help you set appropriate pay ranges and structures for different roles in your organization.

   Compensation Software's Pay Equity Reporting Toolkit helps you analyze internal pay differences by employee group. It lets you set up automated reports and compare pay for protected classes like age, ethnicity, and gender.

2. Step 2: Research the market

   Research market rates for similar roles in your industry and location. This process helps you compare your pay structure to market standards and stay competitive.

   The Market Pricing feature helps you match and price your company's jobs accurately. It recommends job matches, automates scopes, and allows for fine-tuning adjustments. You can create pay markets for different industries, locations, and company sizes globally.

   Also, you can easily match your organization's job titles and descriptions with market data by using the software.

3. Step 3: Choose a competitive compensation structure

   Choose a salary structure that fits your company's goals and culture. Common options are traditional, broadband, and market-based structures, each with its own pros and cons.

4. Step 4: Set up your compensation structure

   Set pay ranges, salary bands, or grades for different roles based on workforce analysis and market research. Ensure flexibility for factors like experience, performance, and market changes.

   Improve your pay structure with Compensation Software's Merit Modelling. Easily calculate costs and create merit matrices based on performance and market data. Gain insights with analytics that link employee performance, range position, and market competitiveness.

5. Step 5: Implement and review the structure

   Implement the pay structure organization-wide and track its effectiveness. Regularly review and adjust it to stay competitive and aligned with your goals.

6. Step 6: Communicate compensation structure to shareholders

   Transparent communication is important for your pay structure's success. Clearly communicate the structure, pay ranges, and performance expectations to employees, managers, and shareholders. Address any questions or concerns to build trust and ensure support.

With Compensation Software, you can analyze and share compensation reports easily. Use the universal search to find templates and data quickly. Export presentation-ready reports directly to stakeholders.

Setting up a compensation structure doesn't need to be complicated. By following the easy steps mentioned above and leveraging tools like Salary.com's Compensation Software, the process can be simplified. Always remember that several factors determine compensation structures, and each type of salary structure has its advantages and disadvantages. Choose carefully the right pay structure for your organization.