Hey you! In part 1 of this blog series, the case study talked about the benchmarking exercise we did first with the client. However we need to recognise that Part 1 talks about benchmarking and this in itself cannot make up your total comp strategy. This blog will talk about how we use a top down and bottom-up approach to create our compensation philosophy and what it must include.
The impact of ‘climate change’ on comp
Given the current climate, the best start-ups are becoming more granular with the details required to base decisions on. In better times, some companies enjoyed a more blanket approach to rewards and equity allocations, and this may not be a good idea anymore.
The reality is People Leaders must work closely with Finance to scenario model everything to align and stress test whether a desired comp philosophy will be smart for the business before any go-live.
Comp strategies must consider the industry and market conditions. In these climates start-ups are now doubling down on performance and making difficult decisions on individuals, and what comes with that is a focus on identifying top performers and bonuses/comp budgets being biassed towards that.
Aligning bottom up and top-down means bringing together your employee sentiment on comp and benefits, your salary benchmarking results, with your top-down business needs and objectives.
Now you have the bottom-up insight, you can start creating scenarios against the ideal comp philosophy. This way you can work out the financial forecast. You can then tweak the comp philosophy and formulas accordingly until you have something that works for you.
How to create the ideal comp philosophy
We need to understand what the purpose of a comp philosophy is. This is useful not only for the business to keep on track, but rolling out the philosophy is an opportunity to educate employees that comp is an important part of business strategy, and the business needs to become profitable one day. As such, the purpose of the philosophy is to explain (a) what the business is trying to achieve, (b) why, and (c) how comp decisions are made.
We need to know what the company objectives are, the principles, and priorities. Do we need to be more transparent? Are we being more competitive? Do we want to reward and retain high performers? Do we need to address roles that are hard to fill? It may be a mix of all of these. You can then start defining what key principles you want to drive decisions around comp. For example, ‘be transparent’, ‘bias to top performers’, ‘be competitive’, ‘benchmark to market’ and so forth.
Additionally, given the climate, companies need to think about whether the need is to optimise just for the short term or consider the long term. We’re only now coming out of turbulent lay-off times and most people are still figuring out how to get through this year alone. This year may have to be focused on performance or attracting some key execs/hires to come in to transform, or simply requiring weathering the storm. These factors will affect how comp philosophy prioritises things and it can evolve overtime.
The impact of comp on culture
And then there’s culture. How do we want our compensation approach to affect culture? Because whatever you decide will affect it, so we should be intentional about it.
In addition to aligning with company values, there are wider repercussions to consider. For example, if you’re leveraging equity over base pay this is going to motivate and attract a particular type of hire and mindset. Additionally, you’ll need to ensure people truly understand the value of equity if you’re optimising here.
Segmenting your survey results by demographic may also prove/disprove if a less experienced/early career hire cares about base pay over equity and if you’re hiring more junior talent then the approach needs to be attractive. Equity driven cultures can put pressure on consistent growth on fair market value. If the strike price becomes stagnant, or there’s repricing, it could be difficult to retain people. A compelling long-term vision combined with truly mission driven hires makes this approach work.
How transparent you are regarding pay also reflects the culture. Transparency doesn’t necessarily mean people need to agree with it. But being open about the ‘how’ and ‘why’ creates trust and respect. With the new laws in the US and the EU Directive on salary transparency there’s a greater expectation of this in the west. Transparency could be a competitive lever for companies to exploit. It may be such that closed cultures that are not transparent might struggle to attract the best talent down the line.
‘Pay for performance’ approaches will need to be competitive and motivating to employees. Launching this approach needs to be done in parallel to a competency framework and aligned goal setting so that employees buy into this and know how they can get a better increase next year.
If you’re tackling pay equity and fairness, then you may decide your position on negotiations. If a ‘no-negotiations’ approach is the case, leadership will need to commit to a no-nonsense stance on this. Salary bands, as we found in Part 1, did support gender parity and help improve forecast modelling.
Aligning common sense and comp
Then there’s the formulas and logistics to address. You’ll need to determine your offer structure and rationale behind this.
Explaining base pay is likely to look at the job family (grouping jobs together based on knowledge, responsibilities, and skill), role, and level. Your location pay may vary based on whether your stance is to pay in narrow geographies or have a more regional approach. This stance is likely to be swayed on whether you want people in an office or not, the rate you scale in different countries, or whether you want an equal pay approach to location.
You may decide on certain cost adjustment multipliers (particularly where benchmark tools can’t cover your geographies), but candidates might argue this does not truly reflect the difference in cost of living/labour so you’ll need to do your own research on this. For those leveraging equity, the best FDs I’ve worked with have also spent time creating projection and scenario calculators for offered candidates to play around with (these are estimates only however). You’ll need to determine whether equity will align to role and level in the same way base pay might.
You might also have an additional formula around performance outcomes (e.g. bonuses, pay rises, commission. Also known as ‘raise models’) to explain how pay might vary between team members. This could be based on company, team, and/or individual performance. More mature start-ups will have designed a reward/merit matrix. You’ll need stage fit appropriate milestones to direct people, and how you’ll reward based on a material difference in the valuation you’re striving towards will need to be thought through.
A good comp philosophy also spells out the benefits granted to team members. This is a good opportunity to design them based on employee feedback while uniquely reflecting your culture and values which is often overlooked.
When comp is reviewed needs to be decided. Pay reviews can become a logistical nightmare if you’re not careful. Some of the more organised start-ups create a transparent comp calendar consequently. For example, you might decide a mid-year cycle is suitable for equity refreshers, promotions, and market adjustments. Annual cycles would then be used for performance-related pay outcomes.
The pros to having a mid-year cycle is that it creates continuous dialogue around comp and performance, and you may be more proactive with equity refreshers before they lapse.
The cons of introducing additional cycles can mean accelerating spending and creating an expectation around more regular pay variation which might not be viable to your company right now.
Mercer’s latest study says 80% of companies only have an annual pay review cycle. Figureshr study on start-ups found 67% host annual pay reviews and 30% every 6 months. Either way, spelling out to everyone when to expect comp adjustments and/or review is an important part of the philosophy.
There are some wider questions around comp that’s also worth answering. Inserting FAQs might be useful for this. For example, explaining how you approach offers for interim/consultants adds another layer of transparency to team members and is often lacking in philosophies. If someone ends up working out of scope and to what extent, what happens? Will you give them any recognition award? Will their role change to recognise this? How will you align a role expansion to a job family would need to be understood.
Dealing with inflation is another area to tackle in the philosophy. We’ve found that founder consensus seems to be this is lower priority when their original base pay percentile strategy is high. However, since people’s lives are usually built around base pay, depending on the roles you have and geography, for some this might be a question that needs attention.
Once the scenario(s) against the philosophy is modelled and signed off, you’ll need a plan to communicate and transition against new philosophy decisions. The most common issues are when the new benchmarking exercise reveals that you’ve overpaid new hires in comparison to existing employees (this happens a lot without salary bands). In this case performance cycles are the windows of opportunity to close the gaps.
And finally, when changing your stance on hybrid vs remote or location pay then it’s best to either give extended notice for any business change (e.g. 6 months) or leave the existing pay as it is but lower the increments overtime so it eventually evens out. Same also goes for levelling reviews. If someone is over-leveled it’s best to create a high accountability plan for them, as opposed to changing their level (and subsequent pay) down.
If you need further advice or an extra pair of hands to deliver this for you, let’s chat.