Compensation Philosophy: What Is It & Why Is It Important?

Almost 50% of the organizations agree to the fact that employee turnover is on an all-time high, thanks to the strong job market.

One of the main reasons which influence this employee turnover rate is the inadequacy of the companies’ compensation policies which lack transparency and commitment, has less or no non-monetary rewards, no performance pay, unfair basic pay and a lot more.

In the 21^st century, where the market competition has become fierce, losing a key player can cost your company a lot. Finding a new applicant who can handle the position adequately can take a lot of your time and effort. And this new employee will also need some time to adjust to the work-place environment.

This builds up the reasons for a company to plan a well-designed compensation philosophy to retain and attract skilled employees.

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What Is Compensation Philosophy?

A compensation philosophy is a formal written statement about the compensation program and reward strategies of a company in regards to its employees. It answers the reasons behind the compensation provided to the employee.

Both the human resource team and executives are responsible for developing the well-designed pay philosophy of a company that aligns with both the company’s as well as the employees’ goals. A well-balanced pay philosophy reflects transparency and commitment that helps builds a trust bond which is beneficial for achieving the company’s goals.

There are four basic types of compensation philosophies:

Market pay: Compensation is determined by the difficulty level of the job and the experience and qualifications necessary for the position.
Equal pay: Wages are equal for every employee irrespective of their position and complexity of the job. This pay philosophy is usually seen in a family business.
Flexible pay: Determined by the board of directors or senior managers. This method combines the company’s culture metrics along with market study information to determine the salary.
Tailored pay: Wages are determined by the market condition. They also receive payment for achieving personal goals and the overall performance of the company.

Factors Influencing Compensation Philosophy

Some of the key factors that should be taken into account while drafting a compensation philosophy are:

Company’s financial condition
Size of the company
Type of industry
Company’s goal
Salary given by competitors
Level of talent required for success

Why Is Compensation Philosophy Important?

The importance of compensation philosophy lies in the fact that monetary benefits stand first in ‘attracting’, ‘retaining’ and ‘motivating’ the employees.

Attract skilled applicants: According to SMART Recruit Online, a company can attract almost 30% more job applicants if they mention wages in their job advertisements. Another survey by Jobsite found that the applicant’s number drop by 25%-30% if they don’t include salary. Thus, by sharing and publishing pay philosophy, the company can attract more talented and skilled job applicants who are more appropriate for the job position.
Retain employees: Employee turnover is inversely related to employee satisfaction; the more they are satisfied in the organisation, the less chances are for them to leave. A comprehensive compensation philosophy plays a great role in increasing employee satisfaction. According to a PayScale survey, how employees feel about the compensation process is 4 times more important than how much they are paid. Thus, the fairness and transparency of your compensation philosophy can increase retainment rates of employees.
Motivate employees: A survey by APA found that only one in five employees who accept being valued within the organisation intend to look for a new job the next year. Moreover, almost 93% of those valued employees agreed that they feel motivated to do their best at work.

How To Write A Compensation Philosophy?

The compensation philosophy can be written in four different ways:

Percentile-based: A percentile-based salary tells what amount certain percentage of the total population in an area or within certain industry earns. Say for a job of $25k, the wage was 25^th percentile annually. It means 25% of the mentioned population earns $25k annually, while the remaining percentage of people earn more than $25k.
Compensation package: A compensation package is the combination of the monetary pay (bonus, salary, allowances) along with some non-monetary benefits (life insurance, pension plan, vacations, etc.). In a good compensation package, both the monetary and non-monetary benefits are properly balanced.

Fixed numbers: In this method, the exact amount of salary of each employee is included in the compensation philosophy. The fixed salary with regular increment after a certain time period helps to attract talented applicants. For example, a new employee gets a salary of $20,000. Due to his good performance, his salary is increased to $22,000 in the following year.
Non-specific: This philosophy is concerned with the guiding principles that focus on the payroll process rather than a compensation package or fixed salary or percentile salary.

Bottom-Line?

Compensation philosophy helps you can attract and retain the right talents for the right position. But just developing a compensation philosophy is not enough. Understanding the company’s requirements and framing the philosophy in a way to get maximum talented and satisfied employees is the main goal.