Compensation philosophy — your ultimate guide to setting an awesome pay strategy

A compensation philosophy is an organisation’s approach to compensation as a whole. It’s a big topic, so we’ve broken it down for you…

What is a compensation philosophy?

In short, a compensation philosophy is a policy explaining a company’s reasoning and logic behind why their employees are paid what they’re paid. It is developed by the people team and senior executives, and works as your organisation’s strategic blueprint for making compensation decisions.

A compensation philosophy is made up of many parts. It should cover total rewards like base pay, bonuses, benefits (health insurance, perks, wellbeing allowances etc), paid leave, and flexible working policy. The way these are decided is based on things like the company’s size, the industry, financial position, company values, and overall business objectives.

Why does my organisation need a compensation philosophy?

Whether you have a written document outlining it or not, if you pay your team, then you have a compensation philosophy.

That said, outlining it can be a great way to communicate to your team what your company values are and guides your organisation in creating a fair and transparent culture.

Here’s why you might want to think about drawing up a compensation philosophy…

Attract talent

Having a clearly defined pay philosophy helps you to attract the right people to your team. If your compensation approach clearly reflects your company values and is fair, then your hiring process will become more streamlined and you can be sure to attract people who share those values.

Retain talent

It’s all well and good getting people to sign the dotted line to join your team, but keeping them is a whole other ball game.

A great compensation philosophy that is reviewed regularly and is transparent, can make the world of difference when it comes to employee retention. Employees will feel more secure in their role and their career trajectory if there is a clear path and guidelines for how they’re compensated.

Achieve pay equity

The gender pay gap is a major challenge for modern organisations, but having a clearly defined, fair and transparent compensation philosophy can help address this inequality and close the gap. You can also conduct regular pay equity audits as part of your pay philosophy.

Improve employee experience

A clearly communicated compensation philosophy can improve employee experience as it gives a clear structure, programme and explanation for why they’re offered what they are for their time & commitment. Compensation philosophies have the power to create a fair company culture through encouraging transparency, honesty & self-evaluation. This in turn can improve employee experience and satisfaction!

Types of compensation philosophy

There are a few types of compensation philosophies. These can involve only financial compensation, or can include total compensation and rewards.

Market pay

This is the most common type of compensation strategy. Market pay is when you pay your employees a competitive market salary for their work. These are usually calculated by percentiles. For example, if a company decides to pay in the 75th percentile, each employee will get paid within the top quarter for their role in their industry. This is usually based on frequent industry benchmarking.

Jobs are grouped together and then evaluated on the following criteria:

• Complexity of the role
• Qualifications needed
• Size of the talent pool

Market pay is viewed by many as the most fair compensation philosophy. Yet, it can be challenging for smaller businesses, who are more restricted by financial constraints, to compete with larger players in the market. Smaller businesses often turn to other forms of compensation (e.g., equity, flexible working) to close this gap.

Equal Pay

Equal pay philosophies are when every employee gets paid the exact same amount, no matter what their role is. This type of approach to compensation is well suited to family run and small businesses where there is less competition for talent compared with other industries. Equal pay philosophies are rare as they can lead to employees not feeling recognised for their work.

Flexible pay

Flexible pay is when companies combine market pay with their organisational culture. This could mean that they pay employees roughly market rate, but the goal posts are moveable and can be shifted depending on subjective reasons from within the company.

Performance-based pay

This strategy is determined by market conditions, employee performance and organisational performance. This is a great way to motivate employees to hit business goals and targets as they can increase their individual pay. Performance-based pay can take the form of bonuses, promotions and increases and is a popular pay philosophy in sales and recruitment teams that are highly motivated by goals.

It’s entirely possible for companies to use a mixture of different pay philosophies across different teams depending on their needs. For example sales might be best suited to a performance-based approach, whereas a tech team may require market pay to attract talent.

What makes a good compensation philosophy?

A good compensation philosophy should be:

Fair

• Is your compensation philosophy unbiased and impartial?
• You can ensure your comp philosophy is fair by having a predetermined structure for how compensation is measured. You can also strive to be transparent with your pay to hold your company accountable for maintaining fairness.
• Something to keep in mind is if your compensation is viewed as fair by your employees.

Legally compliant

It’s important to consider the law when drawing up your compensation philosophy. Laws can vary depending on the country, and even state that your business operates. For example, in Norway, there have been laws requiring pay transparency for many years.

Effectively communicated

A great compensation philosophy is one that all of your employees understand! Ask yourself:

• Do they understand why and how their pay is calculated?
• Are they aware of all of their benefits?
• Do they feel comfortable talking about them at work?
• Is your compensation policy easily accessible by all employees?

Competitive

A clearly defined compensation strategy should at the very least match the competitors in your industry. A highly competitive compensation philosophy will put you above your peers when it comes to attracting and retaining talent.

How often should I review my compensation philosophy?

We recommend that you review your compensation philosophy at least annually, but ideally more often than this. This means that you can account for changing market conditions, catch any irregularities in pay early, and ensure your team is happy & understand the reasoning behind their compensation plan.

In some situations you may have to review your policy in response to market conditions. Take this year (2022), for example, very few companies will have factored in the steep rise in inflation and the subsequent cost of living crisis, but will have to respond accordingly.

Can my compensation philosophy help close the gender pay gap?

In the UK, the nation-wide gender pay gap sits at 15.4%. Here are the facts: When employees are treated equally, you increase their workplace trust.

So how can your compensation philosophy address this?

A compensation philosophy can target gender inequality through:

• Pay transparency — making salaries public, especially on job adverts.
• Not asking salary history.
• Offering generous paid parental leave to both parents regardless of gender.
• Conduct regular pay equity audits (PEA) to identify any pay differences.

Why have a transparent compensation philosophy?

Transparency helps you stay accountable to maintaining fair practices as the criteria is the same for everyone. Similarly, it allows for people to be paid differently because it outlines the processes for deciding how individuals are compensated.

How to create a compensation philosophy

So you’ve decided to create a compensation philosophy. Now what?

We’ve created a compensation philosophy template for you to use as a guide! Download our free template here.