Compensation Philosophy: Lead, Match, or Lag?

When developing a new organization and/or corporate infrastructure, two of the most important considerations include the internal compensation philosophy and methodology.

While there are many specific details that lie within the numerous strategies, there are only three generalized categories for an employer or firm to select; those being matching the market, leading the market, or lagging the market in compensation. Perhaps the most common choice for the majority of employers lies within the first mentioned.

By setting pay levels relative to competing companies in an existing market, an organization guarantees a fair, competitive structure that improves its overall capability to attract and keep the most skilled works in its particular industry.

Despite the fact that it also allows employers to have better management over labor fees, it, unfortunately, comes coupled with the potential of placing the company’s wallet in a position of having to catch up to tighter labor markets. However, a far more daring approach to the matter of compensation lies within establishing a strategy that is in direct excess of the prevailing market’s pay rates.

This strategy has the potential to increase overall candidate numbers, increase qualified applicant selection rates, lower turnover for employees, boost productivity and morale, and possible prevention of worker efforts to unionize.

Prior to the implementation of such a strategy, a company is advised to carefully consider the necessary benefits that it expects to achieve; all with the understanding that this particular structure possesses “the greatest propensity of increasing overall labor costs”. This strategy and philosophy may be a critical step to take for those companies located in extremely competitive labor markets that desire to equate their pay rates as much as possible to competitors.

Despite this, the employers that take steps to adopt this strategy must continue to weigh the benefits over the increased fees associated with labor. Conversely, an employer may make the decision to establish an internal compensation structure that deliberately pays lower rates than their respective marketplace.

Of all strategies, this is both the least popular and least recommended by corporate advisors. The organizations that find themselves selecting such a strategy to choose to do so because many simply do not possess the financial means to pay workers the necessary rates set by the market. Moreover, these employers may attempt to supplement the lower wages by rewarding employees in ways unrelated to money to minimize the turnover.

For the organizations that select this dangerous path, they find themselves far more susceptible to labor market fluctuations, risk themselves enduring far more difficulty in regards to attracting and retaining the highest qualified candidates, and typically experience the highest rates of dissatisfaction amongst employees which inevitably results in feeble performance and rates of turnover.

Given the three strategies/philosophies and the typical companies which take each specific one on, other organizations outside normal jurisdiction often find themselves selecting a combination of the three. One example includes the instance of an employer attempting to lead the market in compensation in a time where the labor is tight and competitive.

Like each individual strategy, combinations require intensely close and regulatory monitoring, with pay rates requiring adjustment on a quarterly basis. Regardless of which method or strategy a given organization decides to adopt, the compensation will pave the organization’s internal pay rate philosophy in a manner that is relative to the rates set by the marketplace. While there is no one-trick pony in compensation strategy, the one selected should directly reflect the mission and vision of the respective corporation to positively influence overall business.

For example, the field of information technology (IT) represents an industry where salaries nearing or above six figures per year are commonplace, selecting the lagging compensation strategy is destined for failure. In the below demonstration, we will create an illustration using the company name X.

Despite the fact that most of the previous generation still in the workforce rarely discusses their salary, millennials have an infamous reputation of being very public with the numbers and therefore any new or existing employees would immediately be informed that competing corporations are rewarding their own workers with more cash.

Under the lagging strategy, this would create an incentive for such a company’s employees to leave or at the very least underperform and reduce company productivity. Conversely for similar reasons, leading the market would make employees very happy yet cause disaster to the company budget given the already high standards of salary for employees in this industry.

It is therefore in IT corporation X’s best interest to simplify and adapt the safest compensation philosophy that includes matching the median base salary within its local area.

However, despite the fact this is a safe strategy and does not necessarily scare away or serve to disinterest new potential employees, it is recommended that other beneficial components be included to improve company image. For exceptional performance in labor, we will also be awarding annual bonuses; determined based solely on results generated from our semi-annual formal reviews.

For any employees that work for IT company X for more than a set period of time (e.g. 5 years), there will be a special one-time added bonus provided for them.

Moreover, the company will continue to add these bonuses in accordance with how long the company exists for. With regards to paid time off (PTO), IT company X will guarantee its employees up to 12 holidays every year. The full-time, permanent employees will receive anywhere between 3 to 5 weeks of leave that is annual and comprehensive; all relative to company tenure.

Every employee of IT company X will possess the eligibility to join the 401k plan right after being hired. After a single calendar year of employment, they can reason close to a 10% match. Our schedule for matching is specifically targeted towards rewarding employees than cannot invest a large contribution. However, those that do contribute as much as 1 to 3 percent of their base salary will receive a 200 percent match between 2 to 6 percent.

In doing so, this will encourage all members of the staff to seek enrollment into our program. After working for the company for only a year, any employees of full-time attendance will be automatically qualified for a plan of severance that will provide and guarantee up to 2 weeks' worth of pay in the event of employee termination. Employees that have been with the company longer than 2 years may see eligibility for even larger amounts of severance.

Despite the fact that IT company X will guarantee salaries that at the very least meet the median range of our local area, progression into higher ranges of pay will occur as a result of performance, and the acquisition/application of higher figures will result from technology-based certification. This process of achieving more difficult work for a higher salary can result even without the typical formality in advance. Any ability to perform higher levels of work can be shown through coordination of productions, taking positions of leadership in times of need, etc.

Advancement to a more difficult and higher level of competency-based job resulting in an increase in salary will not always necessarily occur as a direct catalyst of any significant/permanent alteration in job function, any additional responsibilities, or team leadership roles.

In order to maintain the integrity of the philosophy and program, any changes in position or salary will require the same amount of time dedicated for review and approval.