The Dos and Don’ts of Employee Compensation

It’s at this time of year, when many of our companies perform their annual compensation reviews, that I’m reminded of my cardinal rules for employee compensation.

Don’t: Make compensation decisions emotionally. I love all our team members and I would pay them all $1 million a year if we could. However, injecting emotion into compensation decisions will ultimately erode an otherwise sustainable business model.

Do: Use market compensation rates for each position to guide your decisions. Through company acquisitions and other consulting work, I see dozens of payrolls each year. While I would never use a specific company’s data for my own benefit — considering a preponderance of compensation models provides a solid understanding of what good organizations are paying good people.

Do: Leverage discussions with other business leaders through trade associations and other member organizations to keep tabs on market compensation.

Do: Reference online job boards for open positions in your area to gauge market compensation for roles similar to those in your organization.

Don’t: Give up when these tactics for understanding market compensation fall short. There are plenty of compensation strategy companies that, for a reasonable fee, can study each position in your company and offer feedback and formal reports on market rates of compensation by position.

Don’t: Determine compensation based on the roles your team members might otherwise fill in yours or other organizations. In other words, if an individual might be qualified to fill the role of director of operations in another company but fills the role of shift supervisor in yours, pay them as a shift supervisor, albeit perhaps at the higher end of the shift supervisor range, assuming they’re performing at a high level.

Do: Pay slightly above-market rates. I find that being 10% above market enables me to recruit the best performers and that the impact on company performance of having premium quality teammates far outweighs the added expense.

Don’t: Think compensation is the most or only important factor in whether yours is a great place to work. Team members often place company culture, work flexibility, independence, mission and sustainability as factors more important than the amount of their paycheck.

Don’t: Base compensation decisions on what a team member might think or how they might react to your decision. To reiterate, use the market as your guide, not a person’s feelings. When we base compensation on how someone might react to our decisions, we literally reward the complainers at the expense of the rest of the team.

Do: Expect some employees to be disappointed at salary review time even when you thought you were being fair. Compensation is a delicate issue which every employee views differently and all kinds of factors, reasonable and unreasonable, can come into play. My personal favorite was a design engineer who objected to his compensation model because he thought he was smarter than his brother who worked in a totally different job at another company and his brother made more money than he did. I had no words for him.

Don’t: Use percentage increases as your guide to compare team members. Say, for instance, that market increases in a given year range from 3% to 3.5%. Some companies might provide 2% increases to their underperformers and 6% increases to their high performers. Over time, this practice compounds and leads to significant wage inflation for the high performers. In one case with which I’m familiar, over time this practice led to a person being compensated, in dollars, at a rate about 30% higher than market. When the economy turned south and the company had to shed expenses guess who was the first to go? The company had literally performance increased the poor guy out of his job. Here again, use market compensation rates, in dollars, as your guide.

Do: Use annual bonuses to reward team members for strong company performance or goal accomplishment.

Do: Use an objective set of goals or targets to determine annual bonuses.

Don’t: Provide what I call “discretionary breakaway bonuses.” When a team member has a year where they go above and beyond the call of duty, there’s a temptation to reward them with an outsized annual bonus. I admit I have fallen victim to this practice. Here’s what happens. Year 1: Good performance = good bonus. For the sake of example, let’s say $2,000 and the employee is pleased. Year 2: Amazing performance = amazing bonus, say $5,000, and the employee is ecstatic. Year 3: Good performance = good bonus, say $2,500, and the employee is disappointed even though the reward for good performance is 25% higher than it was 2 years before. Human nature being what it is It’s hard to blame the employee for being disappointed, but in the pursuit of rewarding an employee for amazing work in year 2 the company has now discouraged the employee in year 3. Instead, base bonuses on an objective set of criteria, determined in advance, that both employee and employer understand.

Don’t: Adjust compensation on employee anniversary dates and instead perform compensation reviews for all employees at the same time of year. Too many times I’ve seen companies provide paltry increases to individuals following a few months of poor overall business performance and generous ones when times are good. This practice literally punishes certain employees based on when they joined the company. Perform all reviews during the same month of the year regardless of anniversary date, which has the added benefit to the employer of only having to review market compensation once annually.

A disciplined process for reviewing market compensation and adjusting it in an objective and fair manner will save significant time and distraction, and optimizes employee satisfaction and retention. At a time when manufacturing talent is the most important factor that sets great companies apart from average ones, a logical approach to compensation is an imperative.