Compensation Design: Beyond Foundational Needs

US Treasury, Wikimedia Commons, Public Domain

We spend a lot of time thinking about (and writing about) employee motivation,engagement and what it takes to create an awesome work environment with a high performance culture. But, before we can turn our sights to creating that awesome environment, there are some basics that must be addressed.

As Maslow discovered, people are motivated by different things depending on their current state. This means that people’s foundational (physiological) needs must be met before more complex needs even hit their radar. In the context of the workplace, foundational needs typically relate to compensation. Before employees can think about job satisfaction and their level of commitment to the company, they must first earn enough to provide food, shelter and other necessities of life.

Having said that, compensation is not just about the money—it just starts there. Compensation can be defined as all of the rewards earned by employees in return for their labour, including:

  • Direct financial compensation: pay received in the form of wages, salaries, bonuses and commissions provided at regular and consistent intervals.
  • Indirect financial compensation: all other financial rewards not included in direct compensation that form part of the agreement between the employer and employee, such as benefits, leaves, retirement plans, education, and employee services.
  • Non-financial compensation: additional value such as career development and advancement opportunities, recognition, as well as general work environment and conditions.[1]

The combination that makes up each employee’s total compensation depends on a number of factors including; the complexity of the work and level of responsibility; whether the company focuses on internal or external equity; and the individual needs and negotiation skills of the employee.

Designing Employee Compensation

Taking the time to think about your approach to compensation early on will help avoid challenges as your workforce expands. In designing employee compensation, you will typically follow these five steps.  

1. Establish a compensation philosophy

A compensation philosophy will serve as a guide to support all future compensation decisions. Address the following questions when developing your compensation philosophy:

  • Where will the company’s pay rates sit with respect to the market? Will you pay a premium to attract the best talent, or strive to match the market and build attraction in other ways?
  • How important is it to maintain internal equity. Will merit and performance be more influential than internal equity in determining pay rates?
  • How much of the total available envelope will go to benefits and other indirect financial compensation and how much to base pay?
  • What proportion of pay (if any) will be performance based?
  • What additional value will be added through non-financial compensation and what form will that take?

2. Do an external scan

Once you’ve determine where you want your compensation to sit with respect to the market, you need to find out what the market is paying for similar work. If you don’t already have job descriptions in place, you’ll need to create them first so you have a basis for comparison. There are a number of ways to find out what the competition is paying, including:

3. Set base wage/salary/bonus/commission rates

Based on your research and compensation philosophy, you would then set your base salary or wage rate for each defined position, determine commission rates, if applicable, and define a standard bonus structure.

4. Define your indirect and non-financial components

Having set your base pay rates, it’s time to define all other elements of compensation for each defined position. This involves determining and documenting:

  • All indirect and non-financial compensation you will provide.
  • When and how employees become eligible for each component, including any progressive levels of support and/or eligibility.
  • Frequency and format of any indirect and non-financial compensation.
  • Any approval process involved.

5. Define your policy for increases to base pay and other compensation components

Once you’ve established total compensation for each position, you have to consider how raises will be determined. If you have no policy or structure governing raises, your carefully constructed compensation plan will soon deteriorate. Some things to consider at this stage include:

  • Has sufficient HR budget been planned to accommodate raises so that performance can be adequately compensated?
  • Will a cost of living increase be automatically provided for all employees?
  • What range is acceptable for raises based on performance reviews?
  • Will each manager or unit have a maximum budget allocated for raises across the team?
  • Does the final decision on whether someone gets a performance raise belong to the manager, HR or someone else? 

If you do your homework and follow a clear compensation design process, you will create a total compensation package that balances the needs of employees with the objectives of the organization. More importantly, you will elevate your employees past their fundamental physiological and security driven needs to a higher level, where belonging, respect and engagement can flourish.


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Additional References:

Secord, H. (2003). Implementing Best Practices in Human Resources Management. 2nd Edition. CCH

Fung, J. (2011) How to Create and Measure a High Performance Culture.

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