The Components of Compensation Management

Compensation management is one of the most critical areas where people-driven companies should invest their time and resources. 

In this article, we’ll describe the different components of compensation management to better understand the landscape of compensation solutions. 

What is Compensation Management?

Compensation management is the science (and art) of determining how much to pay your team. Whether you’re a small company with just a few staff on payroll or a huge corporation with over a million employees like Walmart or Amazon – the question of how much to pay your team is an important factor in operating your business efficiently. 

There are several different components that are typically considered in a compensation management system. 

This particular compensation management article will provide a survey of the different components – what they are, how to use them, and how most companies address them in their compensation management system and compensation philosophy. 

What Does Compensation Management Typically Cover

A complete compensation management solution will help you to cover several different components of compensation:

Base Salary

Base salary is the most basic element of compensation. Employees are paid a standard wage – typically either a fixed amount of annual cash or a standard hourly rate (sometimes with an associated overtime rate, as well). This forms the foundation of a company’s compensation structure. 

Setting the right base salary and adjusting it for market conditions and inflation is a critical task for any compensation management solution. Base salary is the first component of compensation that most candidates will consider when determining whether to work at your company and is the most important driving factor for employees’ satisfaction with their current pay. 

Variable Compensation

To help encourage employees to work harder and more creatively, many companies use bonus or commission structures to pay employees more (or less) depending upon their job performance. This type of compensation system helps to motivate and reward high-performing employees while also weeding out low-performers. 

Bonuses and commissions are the most common types of variable compensation:

• Bonuses are paid out based on performance. Bonus amounts can range from a deterministic calculation based upon performance (for example, “Exceeds Most Goals” equates to 120% of your target bonus) to a much more flexible calculation based upon a manager or executive’s discretion, company performance towards financial targets, team achievements, or all of the above.

• Sales commissions are determined by how much of their quota a salesperson managed to hit in a given period, typically a month, quarter, or year. Sales commissions are complex and vary significantly across industries, and are beyond this post’s scope. However, it’s typical for salespeople/account executives to essentially receive a percentage of the business that they’ve brought in

For some jobs, such as commission-based sales or certain sectors of financial services, bonuses and commissions may ultimately constitute the majority of the compensation an employee will receive in a given year. 

Because of the complexities of performance-based variable pay, it’s very common for companies to invest in a compensation management product to automate this component of their team’s compensation. 

Compensation management solutions can help to set up and administer incentive bonus schemes or sales commission plans that help leaders accomplish their efficiency and motivation goals with minimal effort. 

Equity Compensation

For some industries, particularly in technology, equity is one of the most important components of a compensation plan. Many compensation management products are specifically tuned to help organizations navigate equity incentives in a streamlined manner. 

Equity is a particularly important compensation mechanism because it tightly aligns incentives between a company and its employees. If the value of the company increases, so do its employees’ equity stakes. 

Additionally, due to the magnitude of potential company growth and favorable tax treatment of capital gains, employees can see very significant upside from equity compensation (in the tech industry seven-figure payouts are relatively rare but far from unheard of).

Equity is typically granted to employees in several different ways. Some of the most common ways in which companies can provide equity compensation in addition to base salary include:

• Incentive Stock Options give employees an Option to purchase shares in the company at what is often a favorable price. In the best case, ISOs can also have significant favorable tax treatment. ISOs are typically granted by earlier stage startups. 

• Restricted Stock Units grant employees the right to a certain number of shares in the company that vest over time. RSUs are typically granted by public companies or late stage startups that are close to a public offering (IPO). 

• Employee Stock Purchase Plans allow employees to purchase shares in a company at a discounted price, in exchange for paying cash upfront (or specifically, deducting base salary). Companies typically set up an ESPP after they are already public. 

These types of equity structure differ significantly in their administration and the implications for employees’ actual expected compensation. 

As a result, compensation management systems need to consider multiple factors when it comes to handling employee equity: 

• Calculating vesting schedules and total annual compensation
• Modeling equity value at potential likely valuations
• Visualizing the impact of multiple overlapping equity grants

Benefits

Benefits are an essential compensation component and an important consideration for employees and candidates.. 

Employee benefits consist of a wide range of offerings that an employer provides to their team members, ranging from essential services to optional (some might even say luxuries):

• Insurance: Health, dental, vision, life, death & disability. Typically an employer provides several options for insurance and foots the bill for part of the premiums; the degree to which an employer contributes can be viewed as a form of compensation in and of itself
• Retirement benefits such as 401(k) plans, and 401(k) matching programs
• HSAs and FSAs: Health Savings Accounts / Flexible Savings Accounts that enable tax-advantaged healthcare expenses
• Childcare benefits
• Commuter benefits
• Gym memberships

While they sometimes extend beyond pure dollars-and-cents, the monetary value of a given set of benefits can typically be quantified directly. 

As a component of compensation management, a robust system should help companies showcase the value of their benefits in order to retain or attract talent. 

Additional Perks

Many companies also provide additional perks to employees. Examples include:

• In-office meals, snacks, and drinks
• Access to a corporate credit card
• Spot bonuses or “swag” (e.g., company-branded backpacks or apparel)
• Use of company facilities or resources, such as the ability to use a company’s office to host a meetup or non-work gathering, or get a ride home in a company vehicle. While this has largely fallen out of favor in recent years, historically employees of some large corporations could even tag along on flights on their corporate jets!
• Discounts at company retail outlets – for example, many fashion and retail companies provide significant employee or friends & family discounts
• The (in)famous on-site massage services provided at certain large technology companies

Additional perks are one of the components of compensation that vary the most widely, and as a result are typically not factored into a compensation management system. However, these perks can be a significant boon for recruiting and employee retention. 

If your company does offer competitive perks, you should make sure to showcase them when hiring new candidates. Communicating perks as part of the offer process is an important way to maximize the leverage that you get from your company’s unique resources. 

Final Thoughts

Employee compensation has many components, and compensation management systems need to account for many different components as well. Use this article to ensure that your compensation management product can help you to make better decisions faster for all of the components of compensation that your company offers.