We talked a bit about how to come up with a salary range for an individual employee in our article on how to write a job description. In today’s article we are going to continue our series on how to hire and manage with a deeper dive into pay and how to come up with a comprehensive plan for how to pay employees.
Before we dive into the details on this topic, we also suggest you check out Gusto, our recommended payroll provider. Gusto will manage all payroll taxes on your behalf, issue payments via direct deposit, generate year-end W-2s and 1099s, help you find workers comp insurance and more. Visit Gusto to learn more.
Pay is only one component.
In 1959 Frederick Herzberg published “The Motivation To Work”, which changed the way we think about compensation. In his studies conducted for the book Herzberg found that there were numerous factors, which affect job performance. His research showed that while a competitive salary and benefits are necessary to keep employees from being unhappy with a position, they are not a factor in motivating employees to do better work.
His work also suggested that a different set of factors actually motivated people to do a better job. These are things such as:
- Opportunity to learn and grow within the organization
- Increased Responsibility.
With this in mind you should embrace a “total compensation philosophy” which focuses on designing a full package comprised of:
- Dollar Amount of pay.
- The motivating factors listed above.
In today’s article we will cover how to come up with the total dollar amount you pay your employees. In future articles we will cover benefits and the motivating factors.
Where should you post a job? Try Indeed.
Step 1: Establish a pay philosophy
The first step in designing an employee compensation plan is deciding what your pay philosophy will be. In this step you should ask yourself questions such as:
- Do I want to pay more or less than those companies that compete with me for talent? Keep in mind here that just because someone does not compete with you in the marketplace, does not mean that they do not compete with you for talent.
- Do I want to give a lot of other benefits besides pay, or less benefits so I can pay more.
- How do I want to incentivize performance?
- Will owners adhere to the same compensation plan as employees?
Throughout each stage of developing your total compensation plan; you should test yourself by asking if the plan meets the needs of all three of the primary stakeholders in the company which are:
When thinking about the fairness of their compensation, employees are going to focus their attention in two areas. The first is how much they are being paid in relation to similar positions at other firms. The second is how much they are being paid relative to other positions with in your firm. With this in mind the next step is:
Step 2: Find out how much the competition is paying.
If you have not done so already, you will need to put together a job description for each of the positions in your company so you can compare what you are paying with the competition. When putting together your job description think about:
- What is the scope and major responsibilities of the job.
- How complex is it and what is its impact on the company.
- What are the knowledge, skills and competencies required to perform the job.
- What are the education levels and experience required
Once you have an outline of the duties and responsibility level of each position then you can go out and find out what others that compete for the same talent are paying. There are three primary ways to do this:
- Talk to people within your industry and ask them what they are paying. Make sure you describe the duties and responsibilities of the position so you can compare apples to apples.
- Use indeed.com’s salary calculator and the advanced search feature at Careerbuilder.com.
- Look for salary surveys online by searching “Your Industry + Salary Survey” on Google.
Once you have your data set, write down a range compensation levels that are being paid for those positions.
Step 3: Set the salary level or per hour rate
As we discussed in step 1, competitive compensation is necessary for an employee to not be unhappy, but it is not a motivator for higher performance. With this in mind we generally recommend paying salaries that are in line with the competition.
Exceptions to this rule would be if you feel a role is particularly valuable to your firm and warrants paying above the competition, or that it is not that important and therefore you can pay less.
You must also keep in mind how this salary will be viewed internally. It needs to be fair in the context of the responsibilities and experience required to do this job versus others.
Step 4: Set your pay for performance components.
Much of the management literature out there will advise adding a pay for performance component to all types of jobs. The thinking goes that paying a bonus when particular goal or set of goals are reached is a great way to align workers interests with that of the companies.
I would caution you to be careful with this approach however, as research has shown over and over again that performance based pay often has the opposite of its intended effect. This has shown to be especially true with “knowledge” workers, who are not performing a pre-defined set of tasks, and where creativity is a large part of their jobs. For these types of workers providing them with autonomy, mastery (learning opportunities), and purpose have proved much superior motivators to performance based pay.
Dan Pink has recently written a very popular book called Drive, which summarizes this research, and you can see an overview of the topic in a Ted talk he gave in the video below.
For those that would still like to implement a performance based pay program it is important to consider all the factors that come into play. For example if you pay for the acquisition of new client’s without a customer service component to the performance benchmark, then client retention will likely suffer. Here are examples of the types of things you may want to benchmark against:
- Improving processes and/or results
- Enhancing customer satisfaction
- Formulating and implementing new products or protocols
- Providing innovation and cost-savings to operational methods
- Performing at a significantly higher level of complexity for a specified period of time due to workload demand or similar circumstance.
Step 5: Raises
Once you have your base levels of compensation set for each level of employee, you want to budget for raises to reward your top performers and make sure that your salaries keep pace with inflation.
The first thing you want to do when budgeting for raises is make sure that your job descriptions and salary ranges for each job are up to date. (See steps 1 and 2 for this.) If your salary ranges have become outdated then you may need to factor in an across the board raise to get your employees back in line with the competition.
Once you have made sure that your pay is fair in the context of how much those that compete for your same pool of talent are paying, you want to make sure that pay is fair internally as well. To do this, rank the employees who fall under each job category from best to worst performer, and make sure no one is being paid unfairly in relation to their peers.
Once your pay practices are in line from both an external and internal standpoint, you can look at rewarding top performers with raises. It is important to give raises at the same time that performance reviews are given. This makes it so employees understand that there is a well throughout process behind the raise, and that they are not just being given on a whim. Keep in mind that it is about percentages and not total dollar amount. Anywhere from 0 to 5% is the norm for most companies, and companies rarely raise someone more than 10% in any one year.
For an in depth overview of how to handle raises, see this article from bizfilings.com.
Step 6: Choose Your Payroll Software
Once you have your compensation strategy set, it’s time to make sure you have the systems in place to successfully implement that strategy. For that see our buyer’s guide on how to choose the best payroll software for your business.
Who do we recommend? We recommend Gusto (formerly ZenPayroll). Their solution is easy to use, inexpensive, and they provide the first two months free.
The Bottom Line
The 6 steps above are designed to give you a step by step process that any company can follow to design the pay portion of their compensation package. Once you have your package designed, give it one final check over to make sure it meets the following points:
- Is simple and easy for everyone to understand.
- Aligns employee, client, and owner interests.
- Will be seen as fair by the employee when comparing similar jobs both internally and externally.
Do you have questions about paying employees that we have not addressed in this article? What positive or negative experiences have you had with paying employees? I would love to hear from you via email at firstname.lastname@example.org or in the comments section below. Also be sure to stay read the next article in this series where we explain Obamacare for small business.
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