Compensation Planning Based On Performance

Compensation is something you absolutely need to get right. Otherwise, what’s the point of putting all those resources into attracting top talent if you struggle to keep them engaged? That makes compensation planning—everything that goes into your strategy for rewarding people—such a high-stakes game. Most organizations know performance should have some influence on compensation, but aren’t clear on how much or how.

Some roles—like sales—are so naturally suited to performance-based compensation that it’s a no-brainer. But what about other roles? Does tying compensation with performance motivate them or artificially block their progress? Let’s find out.

Key takeaways:

• Compensation planning is how you figure out the best way to compensate employees for their work.
• When compensation has such a massive impact on retention, hiring, and engagement, getting it right becomes essential.
• Compensation planning involves a number of key stakeholders, from CEOs to the legal team.
• Any change in compensation has to be communicated organization-wide as clearly as possible.

Curious about how your performance management platform can help you implement performance-based compensation? Check out 15Five Compensation!

What is compensation planning?

Essentially, compensation planning is everything that goes into figuring out and building your company’s compensation plan. That includes creating salary bands (or pay scales), setting the actual numbers for salaries, defining benefit packages, and designing all the non-monetary components of employee compensation.

The responsibility for compensation planning sits squarely with HR, and they lead efforts to build, adjust, or completely revamp an organization’s compensation strategy. By putting effort into devising a well-structured compensation plan, HR teams (and the companies they work for) can get some serious benefits:

• Talent acquisition: If you want top talent, you’ll have to pay top dollar. Building a strategy covering exactly how you’ll make your compensation competitive is the first step to doing that.
• Employee retention: Organizations that pay below-market or market rates are vulnerable to poaching from companies that pay higher salaries or offer better benefits. To keep that top talent, you’ll need a robust compensation plan.
• Employee engagement: While a high salary is great for attracting and retaining talent, a more holistic compensation plan with flexible benefits and perks is essential for keeping people engaged.
• Greater institutional knowledge: Institutional knowledge refers to all the accumulated information about your industry, your product, and your company across all your employees. The longer the average tenure at your organization, the more institutional knowledge you can build up. A strong compensation plan is essential for this.

With that covered, let’s explore how performance can tie into compensation.

Understanding performance-based compensation

Many organizations tie performance into their compensation plan in one way or another. In some plans, this is done by having promotions tied explicitly to performance goals covered in performance reviews. In others, incentives like commissions and bonuses make up a large part of an employee’s overall compensation.

When analyzing the influence of an employee’s performance on their compensation, you’ll find three essential categories:

• Fixed pay: Employees receive a fixed yearly salary no matter how well they perform. They may get quarterly or yearly bonuses on top of their salary, but this isn’t a guarantee. A software developer who makes a $150,000-a-year salary is receiving fixed pay.
• Variable pay: While part of an employee’s income is fixed, a significant portion is made up of an amount that varies in one way or another. This variance can be tied to the employee’s own performance or other factors. A team lead who makes a $200,000-a-year salary and receives a portion of the company’s profits in stocks receives variable pay.
• Performance incentives: Employees of all stripes may receive performance-based incentives, from commissions to bonuses. A salesperson, for example, may get a fixed salary of $40,000 a year plus a 20% commission on anything they sell as a performance incentive.

While performance-based compensation is often limited to roles like sales and marketing or specific performance incentives, this isn’t always the case. Many companies make performance a core part of their compensation plan, determining where an employee ends up on the pay scale, when they get promoted, and even what perks they have access to.

Implemented correctly, performance-based compensation can create a fairer pay structure and help to undo historical inequities. To do this, you need to track the right performance metrics so your compensation plan can be as objective as possible. Examples of these metrics include:

• Goal attainment rate
• Demonstration of values
• Demonstration of competencies
• Number of vacation days used (to ensure work-life balance) 

Want to learn how to make performance part of your compensation planning? Check out 15Five’s Compensation Playbook.

Developing an effective compensation strategy

Whether you’re building a compensation plan from scratch, making adjustments year to year, or rolling out a fix for a major problem (like making your compensation fairer overall), you’ll follow these steps:

1. Assess the current state of compensation
2. Get input and feedback from key stakeholders
3. Draft updated compensation strategy
4. Share your draft with key stakeholders
5. Finalize updated compensation plan
6. (Optional) Define performance management process
7. Evaluate tools needed to execute
8. Define owners for compensation decisions

Let’s cover each one in detail.

Step 1: Assess the current state of compensation

Before making any big change, you need to know where you’re at. When it comes to your compensation plan, that means getting the answers to some crucial questions, like:

• How is your current compensation plan documented? Can this be improved?
• What is your current compensation philosophy?
• Are you offering market rates for all roles? Below? Above?
• Are there any legal implications to the compensation planning work you’re about to do?

While you might think you already know the answers to some of these questions, not digging into them could lead to you getting blindsided later in the process.

Step 2: Get input and feedback from key stakeholders

Making any changes to your organization’s compensation plan can have a huge impact throughout the organization, so you’ll have to get buy-in and input from several stakeholders before you start, including:

• The CEO
• The CFO
• The executive team
• Your board
• The legal team

Not only do you need buy-in from these stakeholders to start your work, but their perspectives can actually highlight potential issues before they become roadblocks that delay your entire efforts.

Sending simple surveys to each key stakeholder is usually the easiest way to get that feedback in a way you reference later.

Step 3: Draft an updated compensation strategy

From the input you’ve received, it’s now time to work on the updates to your compensation plan. You’ll want to start by breaking down your plan into individual components and identifying the ones that need the most work. Here are just a few examples to get you started:

• Benefits
• Correlation between pay and performance
• Merit cycle structure and scope
• Base salaries
• Total rewards
• Long-term incentives

How do you draft changes to these elements? You start by looking to the market to see what similar organizations are offering or look into trends in your industry. From there, make small changes to a section of your plan, give it some space to think it over, then move to the next one.

Working on this with a team is ideal; you’ll want more perspectives to craft the best plan you can. 

Step 4: Share your draft with key stakeholders

When you’ve finished the first draft of your company’s new compensation plan, it’s time to go back to relevant stakeholders to show them what you’ve come up with. Pointing out portions where you used their input to make specific changes can be especially powerful for engaging them and getting them more involved in the process.

Don’t be surprised if you get a significant amount of feedback at this stage. It can be tough for stakeholders to verbalize the changes they want to see when working with the old compensation plan, but these ideas will usually crystalize when they see your changes. Trust the process!

Step 5: Finalize the updated compensation plan

After receiving feedback from stakeholders, it’s time to roll it all out to work on a finalized draft. Expect to go back and forth a few times and keep track of any changes you made throughout the process.

You’ll also want to compare your finalized draft to any past documentation for your compensation plan. Are there improvements you can make beyond the compensation itself? For example, adding an FAQ (frequently asked questions) section is a great way to lighten the load on your HR team when people inevitably have questions about the new compensation plan.

Step 6: (Optional) Define the performance management process

If you decide to make performance goals a significant part of your new compensation plan, you’ll either need to define a new performance management process or refine an existing one.

The more important performance is for determining compensation, the more robust your process has to be. You might want to consider using dedicated tools for this, which automatically introduce checks and balances, calibrations, and data in your process.

Step 7: Evaluate tools needed to execute

Does your compensation plan begin and end on a spreadsheet? That might mean it’s the perfect time for an upgrade. Here’s a quick list of tools you might want to look into as you work on your compensation plan:

• Salary survey tool
• Compensation planning software
• HRIS or payroll system
• Performance management platform

Step 8: Define owners for compensation decisions

Finally, once you’ve built out your compensation plan, there’s one critical step left: clearly outline who makes decisions on compensation.

Say you have a top performer who’s looking to move up in your organization while also nurturing an offer from a competitor. Who decides if you’ll try and counter? How far is the company willing to go to retain this person?

These decisions are high-stakes, stressful, and high-impact. That doesn’t always mean they should be made by an executive, but the process for making that call should be crystal clear.

Want a checklist you can bring to your next HR meeting? Get 15Five’s Compensation Strategy Checklist.

How to leverage compensation planning software

Building a fair and rewarding compensation plan isn’t easy. There are lots of decisions to make, data to parse through, and places where things can go wrong. If the tools you’re using aren’t cutting it, they’re not just going to slow you down; they can get in the way.

Compensation planning software can guide teams through the 101 decisions involved in building a better plan. Not only that, but they can even make up for skill gaps in your team. Here’s what you can expect from these platforms, like 15Five Compensation:

• Compensation reviews with built-in performance data.
• Centralized storage, editing, and sharing of pay bands or pay scales.
• Real-time benchmarking with robust data.
• Employee-facing total rewards dashboard.

Compensation planning software shouldn’t just make it easier to build your plan. It should answer just about any question about compensation you or your employees might have.

Want to see what compensation planning software can do for you? Get a demo here.

Communicating the plan to your employees

Almost as important as how you adjust your compensation plan is how you communicate those changes to employees. Here are just a few best practices to get this right:

• Sequence communication at different stages of the company so leaders are prepared to answer questions before their teams get the info.
• Define (and share) a clear timeline for when changes will take place.
• Communicate changes in as many public channels as possible so no one’s left out of the loop.
• Book extra availability for the HR team so they can take questions.

Monitoring and adjusting the compensation plan

Your compensation plan isn’t a one-and-done sort of thing, and applying a one to two-percent salary increase across the board isn’t really going to cut it, either. HR teams and leaders have to regularly get together to evaluate the effect of the company’s compensation plan on employee engagement, turnover, and talent acquisition. That means evaluating the broader market, addressing feedback on compensation from employees, and making the right adjustments.

Employee feedback might come to you organically, but that’s usually only the case when your plan is particularly lacking. Usually, organizations have to be proactive about gathering feedback—usually through surveys—to gauge their compensation’s effectiveness.

Once you have that feedback in hand, you’ll want to remember the following as you make adjustments:

• Compensation isn’t one-size-fits-all: Some employees are nearly exclusively motivated by their salary, while others prefer other perks. Keep your plan flexible to reward everyone as equally as you can.
• Not all organizations can pay above-market rates: While every HR team might wish they could, it just doesn’t make sense for everyone. In some cases, giving stronger non-monetary benefits can make up the difference.
• Small changes, big impacts: Big sweeping changes shouldn’t be too frequent since employees need to feel like there’s some level of consistency in how they’re compensated. Instead, start with small changes that can have an outsized impact.
• Get the legal team involved: No matter how small a change might seem, you can bet there’s some obscure legislation somewhere that dictates whether it can actually be done or not. Consult the experts.

Plan ahead

Compensation planning based on performance might not be the most important part of the job for everyone, but it’s still up there. Building a robust compensation plan allows your company to stay competitive when attracting talent, improves employee engagement across the board, and helps retain top performers. That makes getting it right absolutely essential.