- Blog post
Principles for an Effective Compensation Program
Keys to Making A Compensation Program Work
The first principle to an effective compensation program is to operate with as few people as possible. There’s a reason these days why when there is a downturn in business companies reach for the layoff button. It’s the quickest way to reduce expenses and ensure profits. Revenue minus expenses equals profits. So, cut expenses and generally that means cutting people. You can have higher profits. So, operate with as few people as possible.
However, provide the ones that you do keep better than average pay opportunity. With regards to pay opportunity, it means that they have the ability to make higher than average pay. Most of the research indicates that a truly exceptional individual, an employee can actually do the work of two people, two average people.
You may have to pay 30% higher in wages than an average person but here you get the ability for somebody to essentially produce two times what an average person can do. That’s pretty good return on your investment.
If you can even get good people, you probably will be able to increase productivity by one and a half times what an average person can do and you probably have to pay something around 15% above market in order to do that. So, provide your people with above average pay opportunity.
Put as much of the total compensation program as you possibly can in variable expense and that’s opposed to fixed expense, or base salary.
Base salaries never go down. Regardless of how well the company does, base salaries will remain the same or actually go up. Assuming you want to still maintain competitiveness in the market. The market goes up approximately 3% per year. Operate with as little fixed cost as you possibly can which means don’t raise salaries too high. And put as much of the total compensation package into variable expense. And by variable expense, we’re really talking about things like bonus or commission programs or stock programs.
A compensation program that pays out based on how well the company does. So, if company does go south, then you’re not liable to pay out large sums of money.
There are some limits in each of these areas. For example, although you want to operate with as few people as possible, if you’re a growing business, you need to add people. There are some limits on how far you can take salaries down. You can’t pay at the 25th percentile and attract the same, the right caliber of people to may be do the jobs that you’re asking them to do. But if you follow these principles, generally overall, you’ll have a lot better chance for success in your compensation program.
Edited Remarks from “The Seven Deadly Sins of Employee Compensation Plans (and How to Fix Them)” by Rick Olivieri