Compensation Strategy

Compensation Strategy | vcfo

The Role of Compensation Strategy in Attracting and Retaining Employees

The U.S. Bureau of Labor Statistics reported that job openings in the United States reached an all-time high of 11.5 million in March. This translates to roughly two job openings for every unemployed citizen and an environment where employees are leaving their employers more than ever to pursue higher pay and better working conditions. Inflation is adding a new variable to the mix for the first time in 40 years as well. As a result, businesses are taking a long, hard look at their compensation strategies to build and sustain the workforce they need to succeed.

Compensation strategy is an articulation of how an organization will approach compensating its employees for their work. The process is generally led by the HR Executive with leadership team collaboration. An effective compensation strategy results in a framework that promotes clarity and consistency for employees and is informed by several factors, including competitor approaches, employee needs, and the organization’s broader business model and strategy.

Here, we examine key aspects of compensation and what employers need to consider when it comes to attracting new employees and retaining top talent.

Establishing Base and Incentive Compensation

Wages and salaries comprise approximately 70% of an employee’s compensation. In an extremely tight labor market like that of the present, employers who are not competitive in base compensation are highly likely to experience turnover issues and incur significant net additional costs when trying to find and hire new employees as replacements.

Historically, examining compensation strategy and conducting compensation benchmarks has largely been an annual or, in some cases, even less frequent endeavor. Today, because of both short supply and inflation, evaluating compensation structure and equity needs to occur at greater frequencies to minimize employee flight and ensure opportunities are competitive to candidates.

This does not mean that base compensation must stay continually fluid, but employers must monitor the conditions and climate to determine when adjustments need to be made to remain fair and competitive with their practices. Employers don’t have a bottomless pit of dollars to increase compensation, and should also remain mindful of the importance of evaluating pricing strategies in a period of inflation. Everything must adjust for an employer to remain profitable and viable.

A Word on the Impact of Inflation

Costs generally increase every year, as do salaries. National compensation firms have used a 3% factor for many years, but this year, in response to inflation, have moved to a 4% factor when they “age” the data they periodically gather through extensive surveys. Employers have been lulled into forgetting how significant the cost price increase can be in setting compensation because it has been relatively low for decades. As an example, if an employee receives a 3% raise in January in a year of 7% inflation, they may have lost ground depending on how an overall inflation rate is impacting them personally. It is important to consider that stated inflation does not impact everyone the same way. Taxes and fixed rate expenditures for debt are examples of expenses that are not directly subject to the annual inflation rate. As an example, an employee with 40% of their compensation directed to the payment of taxes and fixed cost debt payments may be experiencing 7% but only on 60% of their expenses. That would translate to a 4.2% personal impact of inflation (60% * 7%). That still exceeds the raise they received at 3% in this example. All this needs to be considered in setting the right compensation plan in a year of inflationary pressure.

Control and timing are also key elements of compensation practices. When an employee communicates to their manager that they feel an increase in their compensation is warranted, a manager needs to be prepared with a clear explanation of the viability of meeting that request and what a timeline would look like. Managers should be able to communicate clear steps that the employee can take to reach a higher compensation level, and what the expected timing would be. This might entail taking on more training or working toward a higher level of responsibility. Conversely, sometimes the answer is, “it is not achievable,” and if so, that is important and fair to communicate as well. Having a prompt, genuine conversation that provides clarity ensures the employee feels heard and encourages actions that will benefit everyone.

Performance-based compensation can also serve as a supplement to base compensation approaches for some positions by rewarding employees for reaching defined milestones, or when the company collectively reaches certain milestones or performance thresholds. These rewards can vary widely in type but, like goals, should generally be constructed and communicated in a SMART (specific, measurable, achievable, relevant, and time-bound) manner.

Benefits: Part of a Total Rewards Strategy

An employee’s total benefits package comprises, on average, the other 30% of an employee’s total compensation. This includes areas such as paid time off (PTO), 401Ks, health insurance, tuition assistance, and more. While these areas represent a relatively smaller slice of the total compensation pie, employers should not view them as less important to current and prospective employees. Demonstrating flexibility and customization is becoming increasingly important for organizations as they look beyond base compensation for ways to attract and keep employees.

Read our post on Rethinking Employee Benefits for more on this topic.

Flexibility is demonstrated when employers make accommodations that meet the unique life needs of different employees. For example, if an employee needs every Thursday off to attend to a family member, can the organization adjust from its normal preference of a Monday-Friday schedule? Organizations that can make such accommodations foster increased loyalty and other positive outcomes. Conversely, inflexibility in accommodating the life needs of employees translates to negative impacts on recruiting and retention.

Employees do not view compensation only in terms of monetary rewards. When it comes to what else employees want from their employer besides fair pay, that’s where customization and creativity come in. Customization may come in the form of unique and tailored development opportunities that allow employees to shape their career path, temporary assignments that give them more responsibility and new skill sets, or control over their workspace, location, and/or schedule. Seemingly small details like these can matter mightily to employees and job candidates.

Make Sure Employees Know They Are Valued

An effective compensation strategy needs to result in employees feeling like they are equitably compensated and genuinely valued by their employer. For employers, achieving this aim requires open and ongoing engagement with employees about what each needs and how well the business is doing in terms of supporting those needs. It also requires a proactive and continual approach to assessing their compensation strategy and practices.

Now more than ever, establishing and executing a proactive and competitive compensation strategy is a necessity for businesses to maximize their long-term success.


Request a free consultation from a vcfo HR consultant who can redesign or tune up your company’s compensation practices. We have worked with more than 5,000 business teams in our 25+ years, would love to hear your story and concerns, and share how our experience and collective wisdom can help.