Mar 3, 2008

Why have a compensation philosophy

When a firm becomes large it needs to rationalise its salary structures. It no longer pays salaries on an ad hoc basis. People at a certain parity as far as responsibilities and authority go need to be paid similar salaries.

Salaries also need to be maintained with external competition.

So when an organization looks at salary levels there are two reasons - for maintaining internal equity and for external equity. Setting a salary level also means consciously looking at two things- financial budgets and corporate strategy and taking a decision on where to peg one's organization in relation to the market.

Salaries are usually reported by compensation consultants in percentiles. So if one draws a graph of the 1st percentile to the 100th percentile at any time for a particular role one gets a graph of how the salary changes across organizations. Averages are not used to track salaries across organizations or industries, as any outlier in the data can skew the whole data. Outliers are much better tracked on a percentile graph.

Typically organizations look at certain key numbers for deciding their salary philosophy.
What is the median of the distribution?
What is the budget for salaries as a percentage of turnover?

Typically an organization that starts off in an industry to attract talented people pays a very high percentile, in the range of 85-99 percentile. They define the higher levels of the distribution. Typically these organizations are cash rich or have investments from VCs who earmark a proportionately large part of the budget for attracting talent.

At the lower end are organizations for whom the role is not core to the business. Typically the support functions roles are pegged at lower percentiles like the median or even lower.

The organization therefore has to look at how it will peg itself against the market and therefore what are the trade-offs it has to make. For example, if an organization pegs itself at the 65th or 75th percentile in comparison to the industry it is effectively ruling out the candidates in the higher 35 to 25 percentile range. While this seems a good trade-off the thinking is usually jettisoned when business pressures force organizations to overshoot their pay ranges and offer higher salaries than the norm internally.

While throwing money seems to be the only option when candidates are not willing to join, organizations need to keep in mind that there is an option. Building a great employment brand using learning opportunities and other benefits like organizational culture and nature of work as an attraction basis rather then just numbers.