How to Build a Compensation Model? Proven Steps & Examples

A compensation model is like a blueprint for how your business rewards employees. It aims to attract and retain talent while ensuring competitive and equitable compensation. Without a solid model, you're essentially guessing, which can lead to issues like underpaying or overpaying employees. You need a clear plan to guide you, and that's what a pay model provides.

In this guide, we'll walk you through everything you need to know to develop a winning pay model for your organization. We'll discuss the compensation model meaning and then explore different model types and tips for you to consider.

What is a compensation model?

A compensation model is a plan that organizations use to decide employees' pay. It includes elements such as base salary, bonuses, benefits, and stock options, and sets out how these components are calculated and distributed. Each pay model can differ based on the industry, company size, and employee role. Some focus on being competitive in the market, others on rewarding performance, and some use a mix of approaches.

The main goal of a pay model is to attract, keep, and inspire employees, while also being fair, following laws and regulations, matching the organization's strategic goals, and promoting job satisfaction.

What are the three building blocks of compensation model?

A compensation model includes three main parts: job structures that match pay to a job's value within the organization, a pay structure that's competitive in the market to attract and keep talent, and structures that reward employees for their job performance and contributions, promoting employee satisfaction. These building blocks work together to create a strong comp model.

How important is it to choose the right pay model?

Choosing the right pay model for your organization is important as this can lead you to success and can impact several key areas of a business, including:

• To attract and retain employees: Competitive compensation package is critical for attracting top talent. A comprehensive compensation benefits package, incentives, and growth opportunities improve your company's appeal to potential employees.

• Motivating employees: A pay model that rewards good performance keeps employees engaged and striving for excellence. This can involve bonuses, commissions, or recognition programs that acknowledge their contributions.

• Aligning with business strategy: Your company’s compensation plan should match your business goals and compensation philosophy. For example, rewarding innovation can encourage new ideas.

• Managing budgets: A well-structured pay model helps you manage costs by defining pay scales, benefits, and performance rewards. This allows for better financial planning and prevents unexpected costs.

To fully benefit, seek consulting from Salary.com's HR Analytics and Benchmarking. They'll analyze your turnover, vacancies, time to fill open positions, productivity, offers accepted/declined, etc., and compare your performance to the market, identifying any gaps.

Types of compensation model

There are various types of comp models, each with their pros and cons. The best choice depends on the company’s strategy, culture, and workforce. Here are some common ones:

Localized compensation

This pay model adjusts an employee’s pay based on the cost of living and labor market conditions in their area. It’s often used by companies with employees in various locations to ensure fair and competitive pay.

Pay for performance

Also known as merit pay, this comp model links an employee’s pay to their performance. Employees who meet or surpass their performance goals get a pay raise, bonus, or other reward.

Location-agnostic pay

This is one of the pay models that pay employees a consistent amount regardless of their location. It's commonly used by remote-first companies with employees in various regions or countries. The focus is on paying for the role and skills, not the location.

Job based compensation model

This traditional model sets pay based on the job role. It considers factors like job complexity, level of responsibility, required skills, and market rate for similar jobs. It's common in organizations with well-defined job responsibilities and roles.

Types of compensation to include in a compensation model

When creating a competitive compensation model, it's critical to think about different types of pay to keep and motivate employees. Here are some of them:

Direct compensation

• Base pay: A set amount paid regularly (weekly, bi-weekly, monthly).

• Hourly wages: Payment for each hour worked, common for non-exempt employees.

• Commissions: Pay based on performance. This is common for sales employees.

• Bonuses: One-time payments based on performance or company goals.

• Overtime pay: Extra pay for hourly workers who exceed a set number of hours.

Indirect compensation

• Health insurance: Covers medical and hospital bills.

• Dental and vision insurance: Covers dental and vision care.

• Paid time off (PTO): Includes vacation, sick, and personal days.

• Retirement plans: Include 401(k) matching and pensions.

• Life insurance: Provides financial benefit to beneficiaries.

• Disability insurance: Provides income if employee is disabled.

• Tuition reimbursement: Helps pay for educational expenses.

Non-financial compensation

• Flexible work arrangements: Remote work, compressed workweeks.

• Training and development opportunities: Help employees grow professionally.

• Employee wellness programs: Promote physical and mental health.

• Stock options: Provide ownership stake in the company.

• Free food or snacks: Enhance office environment.

• On-site gym or fitness benefits: Encourage healthy habits.

• Access to company equipment: Laptops or mobile devices that can improve work efficiency and flexibility.

Create a strong pay model with Compensation and Benefits Program Design, focusing on total compensation. Develop and implement programs that fit your goals and business needs, improving your pay strategy and designing employee benefits for a competitive edge.

How do you create a compensation model?

A good comp model should be flexible and regularly reviewed to stay competitive and match the organization’s goals. It must also be fair and equal for all employees. Here's how to build one, with the assistance of Salary.com's Consulting services.

1. Step 1: Define your organization's goals and budget

   To create a compensation model, start with identifying your organization's immediate and future objectives, along with its financial limits. This understanding will guide your compensation philosophy, ensuring alignment with the organization's goals, budget, and company values. Consider factors such as market position, growth intentions, and the desired reputation as an employer.

2. Step 2: Design your job architecture

   Create a clear system for organizing jobs in your organization. Define job families, levels, and hierarchies based on skills, responsibilities, and reporting. A good job structure brings clarity and fairness to pay practices.

   Designing job architecture is easier with Salary.com's Consulting service. Consultants help streamline your job design process, evaluate compensation structure, and make recommendations for better company performance, pay transparency, and employee engagement.

3. Step 3: Conduct a thorough market research

   Research the market to understand current compensation practices in your industry and area. This helps you compare your compensation with competitors and make sure you offer competitive packages to attract and keep top employees. Market research also shows new trends and best practices in compensation.

4. Step 4: Sep up a performance management system

   Set up a strong system for managing performance to tie employee performance to pay. Define clear performance standards that match your organization's goals. A good system gives employees clear goals and chances to improve and ensures fair and open pay decisions.

   Use the Variable Pay Program Design feature to create incentive programs that reward employees fairly, motivate them to achieve goals, and deliver results. Salary.com's experts understand business objectives and design long- and short-term incentive programs.

5. Step 5: Choose the right compensation components

   Choose the best combination of direct compensation, such as salary, bonuses, benefits, and extras, including medical insurance dental. Think about what employees want, what others in your industry offer, and how much you can spend. This mix can meet different needs, like motivating the sales team with bonuses tied to a sales target.

6. Step 6: Finalize your salary structure

   After you've organized your jobs, researched the market, and set up performance reviews, finish planning your pay system. Set salaries, decide pay levels, and plan how to pay. Make sure your employee compensation plan can change with the market and your organization.

7. Step 7: Review and maintain the compensation model

   Keep reviewing and updating your compensation plans to ensure they are effective, competitive, and maintain internal equity. Do surveys, check how well your pay packages work, and ask employees for their thoughts. By doing this, you can ensure the pay plan helps your organization and appeals to great employees.

To stay competitive in the job market and achieve pay equity, use Competitive Pay Assessment to understand your current position in your target pay markets. Salary.com's consultants will assess the market competitiveness of your compensation program and recommend adjustments based on your recruiting and retention efforts.

Building a well designed compensation model is vital for any organization's success, and effective compensation planning is key. Just like a sturdy foundation supports a building, a well-thought-out compensation strategy supports your workforce and business growth. With Salary.com's Consulting services, you can build your company's comp model with confidence, from salary structures to comprehensive benefits packages.