Understanding Everything That Constitutes Employee Compensation
There's a lot more to compensation than just paying employees for their work. We look at the variables to consider when creating a strong employee compensation plan.
Published on April 11, 2022
What’s included in a typical employee compensation plan?There are different variables that make an employee compensation plan solid. Broadly speaking, employee compensation can be split into the following three types — direct compensation, indirect compensation, and variable compensation.
Direct compensationDirect compensation is the most basic form of compensation. Think of it as the bare minimum required to legally hire employees and leverage their services to keep your business up and running.There are two types of direct compensation:
- Salary: A fixed amount paid to an employee at long intervals — typically on a bi-monthly or monthly basis — in exchange for the work they do. A salary indicates a long-term and more permanent relationship between an employee and an employer. The employee gets the same amount of salary no matter how much they work.
- Wages: A partial amount paid to employees usually on shorter intervals, which can be either hourly, bi-weekly, or weekly. Wages are usually used as a compensation tool for hourly jobs such as construction, customer support, and retail. The total amount that an employee ends up earning with wages isn’t fixed, as it depends on the number of hours they clock in.
Variable compensationAs the name suggests, variable compensation isn’t fixed. This type of compensation includes certain performance-based incentives given to employees besides their salaries and wages. The main types of variable compensation include:
- Commissions: Monetary rewards given to salespeople for closing sales. Commissions are calculated by multiplying a fixed rate by the total sales revenue. For example, if the rate is 4% and an employee closes a sale worth $2,000, they earn $80 in commission.
- Bonuses: Awarded to employees when they hit a certain threshold, such as achieving a sales quota or finishing a certain number of projects. Bonuses can be fixed or based on a percentage of the employee’s salary.
Indirect compensationIndirect compensation includes benefits and perks offered on top of base pay and performance-based incentives to retain employees. Some common examples include:
- Retirement plans: Employer-sponsored retirement, including a 401K or pension. 401Ks are offered in the US and require employees to designate a certain percentage of their paychecks toward retirement, which is sometimes matched by the employer. Pension plans guarantee a fixed contribution from the employer toward the retirement of their employees.
- Insurance: Includes health, life, and/or disability insurance plans. Both the employees and the employer can contribute to the insurance premiums, depending on the carrier and the state (if in the US).
- Paid time off: A pool of personal, vacation, holidays, and sick/medical leaves that employees can use throughout the year whenever they want.
The 3 Cs of employee compensationA great employee compensation plan is not just highly rewarding but is also sustainable and compliant with the local labor laws. In other words, compensation should be compliant, competitive, and calculated. These qualities will ensure a healthy talent pool while keeping your business afloat and clear of any legal hiccups. Here’s what they mean:
CompliantEvery country and state has its own employment laws to ensure that its citizens are treated fairly by their employers. Failing to comply will potentially lead to penalties and/or lawsuits that will cost your company up to millions of dollars. As far as compensation goes, you must consider the following:
- Minimum wage: Employers are legally required to pay their employees minimum remuneration determined by the country, state, city, or even the county. For example, the federal minimum wage in the US is $7.25 per hour, and most states have their own rates. The UK has minimum wage bands based on age groups. Employees who are 23 years old or above must be paid at least £9.50 per hour.
- Mandatory benefits: These include benefits that companies are legally obligated to provide to their employees. Mandatory benefits also vary from country to country. For example, labor laws in Portugal entitle employees to at least 22 days of paid vacation per year if certain conditions are met.
CompetitiveWith 48.1% of US employees considering looking for new jobs, employers need to step up their game and offer a lot more than the bare minimum. About 63% of Americans quit their jobs in 2021 due to low pay, according to a survey by the Pew Research Center. Employees feel valued when they get compensated substantially and are therefore less likely to quit.Try compensating your employees more than what’s currently offered for their positions in the market. Take everything into account, including salaries/wages, commissions, and bonuses, along with other incentives and benefits.Websites like Payscale, Glassdoor, and Indeed can give you a rough idea of average salaries and common benefits offered for certain positions. Platforms like Radford and Option Impact allow you to dig deep into salary levels and location-specific information for more structured compensation planning. If the average salary is $60,000, consider offering a higher package if you have the budget for it.Also, consider incentives and benefits in addition to base salary to see if you can create a more competitive package. For instance, if the law in the country you’re hiring does not impose childcare or healthcare benefits, offer them anyway to remain competitive.Finally, keep in mind that the perception of what’s considered “competitive” will change from time to time due to economic factors. Keep your finger on the pulse of the market averages for the different job titles in your company to ensure you’re keeping up. In addition, run internal surveys to see if your employees are happy and content with what they’re getting.
CalculatedFinally, compensation has to be carefully calculated to ensure that your business can sustainably continue to offer the salaries and the benefits in the long run. It’s tempting to go all out and offer the most competitive salaries, along with highly attractive benefits and perks, to cultivate an amazing employer brand. But if you’re not careful, the handsome compensation packages will drain your company’s budget.What’s more, if you remove some of the employee benefits later on to cut overhead costs, you’ll risk losing your employees to your competitors.Therefore, compensation planning should be considered an innate part of headcount planning. Allocate a budget to compensate your workforce. Ideally, there needs to be a substantial margin to achieve your business goals. If not, think about what you can take out from your employee compensation plan before committing to anything.
How to negotiate compensation with candidates and employeesCandidates and existing employees who are confident in their professional abilities may try to negotiate better packages. Finding a balance between what you’re offering and what they’re demanding is key. Your goal as the employer isn’t to convince them to agree to lower compensation. While that may seem ideal, you instead want to make sure that everyone walks away happy.
- Fix a salary range: Determine how much budget, if any, you can spare to meet the demands of the candidate or employee. That way, you’ll be able to make on-the-spot decisions if they give you an ultimatum.
- Prepare data: From above-market rates to better benefits, look at anything that helps you create a strong argument for why your employee compensation package is reasonable.
- Consider the impact of the position: Some roles are harder to fill than others due to the shortage of skills or the nature of the job. Be more flexible when negotiating if that’s the case.
The information contained in this site is provided for informational purposes only, and should not be construed as legal advice on any subject matter.
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