Compensation Benchmarking

March 3, 2020 | Article

By Lauri Dahlberg

While benefits, career paths, cultural fit, time off and work-life balance still matter, salary remains one of the most important factors in recruitment and retention. In fact, two-thirds of the respondents in Workforce 2020, an Oxford Economics and SAP SE study, said compensation matters most.

Each position in an organization has its own set of responsibilities necessary to meet the overall goals set forth in the organization’s strategic plan. The skill set, experience and qualifications of the person filling a position can determine how successfully that plan is carried out. Identifying pay ranges for a position can aid management with determining if they are paying appropriately for the job responsibilities being performed, while taking in to account factors such as the industry, size and geographic location of the organization.

Compensation is just one item to consider in a successful recruitment strategy.

VARIATION IN PAY RANGES
Variation in pay ranges may be based on years of experience, professional credentials or longevity in the same role. To be effective, for the position listed, pay ranges should show both base and total compensation for the 25th, 50th and 75th percentiles with total compensation being inclusive of what is considered “bonus comp.” 

There are a variety of reasons why an employer would consider paying above the 50th percentile. They include:

  • A pay philosophy that supports paying employees at the top of the range to be more competitive.
  • Responding to pay pressure due to geographic location and difficulty with finding qualified individuals in the area.
  • Responding to pay pressure due to other industries in a business boom, driving up pay ranges for all positions in the market.
  • An employee with substantial experience or years of service.
  • An employee with an exceptional skill set that is difficult to find and/or retain.

Conversely, there are a variety of reasons why an employer would consider paying below the 50th percentile. They include:

  • An organization’s offering of benefits at little-to-no cost to the employee.
  • An organization’s focus on work/life balance and flexible work schedules where employees work fewer hours than those of a competitor’s employee.
  • An organization’s culture that is positive with processes, practices, equipment and other employment-related perks that make it an “employer of choice,” offering an environment beyond those found at similar companies.
  • High rates of unemployment resulting in a surplus of potentially qualified individuals for hire.
  • An employee with fewer years of experience or expertise.
  • An employee with a skill set that is below the position requirements.

BONUS COMP AND INCENTIVE PLANS
Key employees in an organization (those whose position can substantially affect performance outcomes) often receive a large portion of their compensation from incentive plans. Incentive plans are formula-driven awards based on the employee’s contributions to the organization’s performance, which can be set up as either short or long-term programs.

Short-Term Incentive Plans
Short-term incentives tend to cover a period of up to one year and hold individuals accountable for outcomes which they have the ability to impact or control. The at-risk nature of the short-term incentive provides motivation for the employee to perform well or lose out.  

Examples of why an organization may use short-term incentives include:

  • Revenue/profit.
  • Net promoter score.
  • Employee retention.

Long-Term Incentive Plans
Long-term incentives are inducements to influence longer-term results (those greater than 1 year). This practice is common in private companies that use cash to incentivize employees to perform their best to achieve longer-term results. 

Examples of why an organization may use long-term incentives include:

  • Market share growth.
  • Innovation.
  • Financial strength.

Executive Benefits
Executive benefits are established specifically for key producers (executives) in an organization. It is a means of building and protecting wealth for the individual, and it helps the organization secure a competitive advantage in attracting and retaining premier talent.

Examples of executive benefits include:

  • Deferral Plan: Provides a means for highly compensated employees to defer pre-tax income for retirement at an amount greater than that allowed for 401(k) contributions. The amount can be as much as 50% of compensation.
  • Deferred Compensation: Provides a defined contribution, supplemental retirement plan for key individuals funded by the organization. A portion of the executive’s income is paid out at a later date after which the income was earned.
  • Strategic Deferred Compensation: Provides an incentive-based deferred compensation plan tied to the fulfillment of performance standards. Better results lead to higher contributions to the executive’s account and allocations may then be self-directed. Plan accounts are typically subject to vesting schedules.
  • Supplemental Executive Retirement (SERP): Provide a defined benefit executive retirement plan for highly compensated, key employees. The plan is a deferred compensation agreement between the organization and the key executive in which the organization agrees to provide supplemental retirement income to the executive and his/her family if certain pre-agreed eligibility and vesting conditions are met by the executive.
  • Hybrid Plans: Provide a plan for key, highly compensated employees that is funded by both participant and organization contributions.
  • Executive Life Insurance Plans: Provide an organization or shared funded supplemental life insurance program to key employees. The organization provides the key executive with a bonus that is taxable as income to the recipient. The bonus is used to buy a whole life or universal life insurance policy that builds cash value that grows tax deferred.
  • Executive Disability Plans: Provide an income replacement plan for key people in the event of a sustained disability that requires an extended or permanent absence from work.

Incentive Pay Generalities
A strong executive compensation package will include a mix of base compensation, short-term incentive pay and long-term incentive pay. When establishing incentive pay, it is important to identify performance levels and the amount of compensation tied to the performance level as follows:

  • Threshold: the minimum level of performance that must be achieved before an incentive can be earned. The most prevalent threshold is 50% of target.
  • Target: the expected and/or planned level of achievement or a realistic goal that is achievable and meaningful.
  • Maximum: the total incentive opportunity that may be earned for superior performance, sometimes referred to as a cap. The most common maximum payout levels are 150% and 200% of target.

Incentive pay is directly linked to the individual performance of the executive as well as the financial and strategic performance of the organization. For this reason, executive pay is meant to fluctuate from year-to-year. The incentive portion of total compensation is structured as a leveraged vehicle with the ability to zero out if organization or individual performance is below threshold levels or pay out significantly in a banner year.

THE IMPORTANCE OF REVIEWING YOUR COMPENSATION PLAN
Many compensation plans fall short of their impact potential because they are introduced then forgotten. To be effective, a compensation plan needs to be reviewed and modified as necessary to meet current organizational needs.

Need help with compensation plans?

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