Yes, you do need a compensation strategy

If you think you don’t have a compensation strategy, we have bad news. You do have one. It’s doing a terrible job. It makes your company less competitive. The message it sends to employees is: this doesn’t matter. It says that in your organization, their compensation is not a first-class concern.

The good news is, you can start fixing this today. As a startup founder or CFO, you don’t take an ad-hoc approach to engineering or sales. The care and thought you put into these processes becomes part of your company’s competitive advantage. Compensation strategy just means being as thoughtful about employee compensation as you are about the rest of your business.

There’s no one right way to pay. What and how you pay is your company culture, just like what you make and who you sell to. But there is a compensation strategy that matches your company’s values. Choose from the following options:

Three compensation strategy approaches

Broadly speaking, there are three basic pay strategies:

• Lead the market. You can offer a total compensation package that’s larger than any competitor can offer. The assumption here is that the highest package attracts the best talent. This strategy requires you to have deep pockets, even during hard times, but it can burnish your company’s reputation and attract stars.
• Match the market. You can offer employee compensation that’s around the same as your competitors. This gives you more flexibility to be generous with bonuses when business is good. But you might not be able to attract star talent or even retain your own rising stars.
• Lag the market. You can pay below expected compensation. Obviously, this lowers your costs and frees up money for bonuses. It does make it harder to attract and retain employees, but depending on the nature of your business, you might have a high tolerance for churn. Some companies do very well lagging the market because they're hiring mission-driven people in certain jobs.

Of course, you can also mix it up. You might have lower wages for hourly workers in a low cost-of-living geography, but you might need to pay up for salaried employees who are otherwise unwilling to leave urban centers. You might have to pay more for specific technical skills that are in short supply, but choose to match the market in business and administrative roles.

The point is to connect these choices with company values. You don’t want to unwittingly punish employees for not negotiating, or overpay poor performers. It’s not just bad business. It’s against the law.

Four features of a compensation strategy

1. It’s written down. A pay strategy is a communication tool. A document shapes managers’ thinking and gives them concrete guidelines to refer to as they make decisions. In case of arguments, referring to a written compensation plan can help resolve disputes.
2. It uses salary bands. Job grades and salary bands are the basic building blocks of a modern compensation plan. They make it possible to compare salaries of employees doing similar jobs, both within a given company and against job market benchmarks. Salary bands highlight employees who are being over- or under-compensated compared to their contributions, as well as managers who may be making compensation decisions that don’t conform to company values or the law .
3. Salaries get reviewed. Just knowing who’s getting paid what compared with whom only gets you part of the way there. Markets change, benchmarks change, people change, responsibilities change. Compensation needs to be reviewed on a regular cycle, to make sure that employee incentives are correctly aligned with company goals, especially around retaining your best talent. Shared incentives have been shown, time and time again, to improve employee engagement and productivity.
4. It complies with the law. In the USA, compensation is regulated by the Fair Labor Standards Act and subject to other Federal and State legislation. A compensation plan reduces your company’s legal liability by helping managers understand and follow the relevant laws.

A compensation plan can be more and do more, but getting started isn't so hard.

Five benefits of a compensation strategy

Even this basic a compensation plan has some great benefits for your company!

1. Communication. As we alluded to above, communication about what to offer or whether to give somebody a raise can get pretty hairy. A good manager wants their people to be treated fairly and well, and should advocate for their people, which is tough if they don’t know what the overall plan is. Arguments about pay can be two people talking past each other, and having a framework can help the argument move from “We need to offer at least this much!” and  “That’s too much!” to the real concerns like “This candidate is a senior engineer” and “Oh I didn’t realize they were that senior, are you talking E4 or E5?”
2. Forecasting. Your board probably asks how much you’re going to be spending. Reduce the guesswork and inaccuracies by knowing how many senior and junior people you’re going to hire into different job types, and use salary bands to make good estimates for those roles.
3.  Costs. Know when not to pay too much. Know when to say “It’s OK if this engineer does not take our offer, we know it’s a good offer and fair.” Know when somebody’s already making enough and you should ask them about stepping up to the next level before they get the raise they’re asking for.
4.  Retention. Retaining people definitely helps keep costs down, especially when you factor recruiting and interviewing time as well as dollar costs, and lost productivity and ramp-up time as opportunity costs  But retaining the people you want to retain is also great for morale and culture. Everybody in a team is happier if the individuals in it feel like they belong, like they want to stay, and have a commitment to do great work at a company that is doing well by them.
5.  Scaling. If you’re small, you’re going to have to scale your processes. Constant one-off decisions and emergency competitive salary research projects don’t scale. Offer amounts and raise discussions should be handled efficiently and routinely with a well-established and well-communicated framework.