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What Is Compensation Management?

Compensation is key

Employee compensation is one of the most significant areas of investment for many companies. From tech firms to marketing agencies to banks, deciding how to pay employees is one of the most important sets of strategic decisions that many companies need to make. 

If you’re a company like Starbucks, management of your supply chain is crucial: where you’ll source the right coffee beans, or how you’ll make tradeoffs to guarantee that you’re paying the right amount for the millions of muffins and espressos that you’ll sell every day. If you’re a technology company or other people-driven enterprise this dependence upon your supply chain is no different – except that your supply chain consists almost entirely of the people who help make your business successful. 

As a result, compensation management is a crucial part of operating many people-driven businesses. Let’s discuss the different components of compensation management, why they’re valuable, and how to get started no matter what size your organization is today. 

What exactly is compensation management? 

Compensation management is the science (and art) of determining how much to pay your team. Since compensation decisions are made on an ongoing basis throughout the life of an organization, there’s a wide range of activities that constitute compensation management:

Taken together, these activities constitute the main requirements of a compensation management strategy.  

What’s the goal of compensation management? 

Compensation management has two primary goals: 

  • To motivate and retain your team, 
  • While also hitting your strategic business goals and ensuring that your company’s cost structure fits your desired financial objectives 

Compensation is a primary driver of any productive team. No matter how mission-driven your company might be, at the end of the day your team needs to be able to put food on the table and feel inspired to go above and beyond with respect to their job performance. Compensation is one of the best ways to align incentives to grow, retain, and motivate your team, ultimately leading to higher employee engagement and retention. 

At the same time, you need to make sure that you are compensating your team fairly, but not excessively. After all, if you triple your employees’ compensation you’ll likely retain everybody, but won’t be able to hire a complete team that can actually get necessary work done. It’s important that your compensation management strategy gives you the tools to budget  effectively so that you can run your business responsibly. Balancing these two priorities is the key goal of compensation management. 

What are the benefits of compensation management? 

When done well, compensation management allows you to make high-quality compensation decisions faster

Compensation is an opaque field in which it’s easy to make poor decisions. Many companies fall into a common set of traps, such as paying inexperienced new hires more than veteran employees when the market shifts, eventually causing employee retention problems among their most valuable team members. An effective compensation strategy helps company management to make better pay decisions. 

At the same time, compensation management can be time-consuming and inefficient. A great compensation management strategy, typically supported by high quality software tools, will allow your team to make these high quality decisions faster than they otherwise could, saving time while also improving the quality of your operations. 

One of the most important ways in which compensation management helps you to save time is by improving the scalability of your pay decisions. At a small firm, the CEO might be able to make all compensation decisions; at a large company, ranks of middle managers need to be able to make equitable compensation calls in a way that’s consistent with company policy and one another. 

Types of compensation management

The most common type of compensation management is the simplest – ad hoc decision-making by executives, often the CEO. 

As an organization scales up, it’s common to see a combination of regimented processes (say, annual merit compensation or promotion cycles) and ad hoc tools such as spreadsheets for adjusting bands or sharing compensation data. This combination of tools and processes constitutes a barebones comp management system that may result in good decisions, but is often inefficient or error-prone. It’s also common for edge cases to be missed in these nascent compensation management systems – for example, base salaries might be set effectively while equity compensation is all over the map.  

At large companies, compensation management is typically run via software systems and governance to ensure that comp decisions are fair and consistent across groups. These tools and processes typically ensure that high quality decisions are made, but are expensive to set up and can still be inefficient to run. Additionally, they typically won’t take advantage of modern product features such as automatic data analysis or detection of pay inequity. 

Who is responsible for compensation management? 

One of the trickiest parts of compensation management is that it requires several stakeholder teams to be successful:

  • People Operations teams are typically responsible for setting up compensation bands, administering compensation cycles, and laying out the framework for how compensation management will be run at the organization. 
  • Finance teams should be stakeholders in compensation management, particularly at businesses where headcount expense is a major business factor. Finance teams often set budgets for the compensation management process – determining how much cash or equity can be allocated to increases in headcount expenses in the form of new hires or comp increases. 
  • Departmental leads (head of engineering; head of sales) are key decision-makers in crafting offers or running compensation adjustments as part of regular cycles. Managers and department leads may be responsible for virtually all decisions, may have limited leeway to make decisions within a framework crafted by a People Operations team, or anything in between. 

No matter what your company’s operational framework is, you’ll need all of these stakeholders at the table. If they’re not involved, watch out! 

What is the process of compensation management?

Implementing a scalable compensation management system can be done in stages, and the most important steps to take depend heavily upon the stage and size of your business:

  • If you’re a very small company – say, less than 20 employees – you may be able to get away with virtually no compensation management strategy to speak of. 
  • If you’re a small organization of a few dozen people, you’ll want to get the basics in place first: setting up basic job levels and compensation bands, and regularly assessing the comp market that you’re operating in. 
  • As you scale up to over a hundred employees, you’ll need to establish regularly recurring comp-related processes such as compensation and promotion cycles. 
  • As you grow to hundreds of employees, it’s increasingly important to establish efficient compensation management systems. This includes setting up repeatable processes such as standard offers for all job roles or optimizing compensation cycles for efficiency and to ensure compliance with company policies. 
  • As an organization with thousands of employees, you’ll want to handle all of the above and also ensure that you have ways of ensuring compliance and quality – ensuring pay equity, analyzing headcount expense versus regrettable employee retention, and optimizing recruiting efforts. 

At the earliest stages your toolkit might just consist of a few spreadsheets and manual processes, but eventually you’ll need to scale up to a purpose-built system. Many large companies build these sorts of products in-house – if you’re looking to bring more efficiency to your compensation management processes, we provide a total compensation management software offering that you can learn more about here. 

Final Thoughts

Setting up a compensation management system may seem daunting at first, but is essential to help you and your team make high quality decisions about how to pay your team faster and more efficiently. 

Peter McKee

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