Ahh, employee compensation. The word that gets employees out of bed in the morning and simultaneously sends HR teams edging towards the door.
With 28% of workers saying their company has redesigned their comp structure in the last year, and a whopping 64% of workers saying their company is planning to do so again sometime in the next three years, that’s a lot of work for HR.
And it’s not getting any easier. 😬
From mounting compression issues to growing employee turnover, the challenges surrounding employee compensation have accumulated fast post-Covid (especially for small businesses struggling with the pandemic’s impact). Today, the need for straightforward compensation strategies that attract great candidates, boost retention and increase employee satisfaction, is higher than ever.
So, how do you create a compensation strategy that works for everyone?
In this ultimate guide to employee compensation, we’ll help you figure out how much you should really be paying employees, including a set of proven pay structure formulas to get you started.
What is employee compensation?
From attracting new hires to retaining great employees, there are many reasons your employee compensation plans matter.
Here are a few examples of the different types of employee compensation:
- Cash compensation, e.g. wages or salaries
- Employer contributions to retirement plans
- Employer-paid health/life insurance
- Paid leave for vacation
- Paid leave for sick days
- Disability insurance
The right comp strategy should be affordable, well-structured and competitive — leaving employees with no doubt about how valuable they are to your company, and leaving your HR teams free to support your growing business in other ways (read: less time stressing about preparing the next update to your comp plan and more time creating an awesome culture).
Employee compensation definition: Ever received a paycheck? A bonus? Vacay pay? Then you’ve received employee compensation. Put simply, employee comp refers to the benefits a worker gets in exchange for their service to an employer.
Employee worth + Employee compensation = The perfect comp strategy
Employee compensation is usually the major expense for businesses, averaging at $39.01 per hour per employee (including salaries and benefits). Needless to say, it literally pays to understand how employees affect your bottom line.
Once you know how much an employee is worth to your company, you have a baseline for figuring out how much comp to pay out.
Here are some quick calculations to help understand those baseline numbers:
Calculate average revenue per employee
Before creating a fair employee compensation plan, you need to know how much your employees contribute to the overall success and value of your company (because sometimes you have to get a little data-heavy to become truly human-first).
This is especially important for small and growing businesses struggling to balance the pandemic’s backlash of empty roles and lost revenue.
Here’s a quick formula to figure out the average revenue per employee:
Net Profit / FTE Employees = Revenue per employee
In real life, this is what it could look like:
Say your Net Profit is $500,000, and you have 20 FTE Employees, your sum would be:
$500,000 / 20 = $25,000 per employee
Note: There’s no getting around the fact that quality hires tend to bring in more revenue than others. This formula is simply to give an idea of the average revenue per employee, so you can create a fair compensation strategy that hits all bases.
Figure out employee salaries that make sense
Once you know your average employee worth, it’s time to work out how much salary each role should be paid.
This is where things can get a little complicated, so here’s a simple way to calculate compensation cost per employee:
- First, you need to understand compa-ratio (CR). Put simply, compa-ratio (or compensation ratio) determines how current salaries compare to the industry average.
- To work out compa-ratio for a role, you need to do a little digging to find out the average industry salary for that role. For example, a receptionist role in the US usually falls somewhere between $33,000 and $42,000.
- Next, you need to take that average and work out the midpoint (MP). In this example, the MP is $37,500.
- Now for the number crunch: Actual salary / Midpoint of pay range x 100 = Compa-ratio
So, let’s say you have three employees working for you, who earn $33K, $37.5K, and $40K respectively. Here’s what your sum would look like in practice:
- Receptionist 1 — 33 / 37.5 x 100 = 88%
- Receptionist 2 — 37.5 / 37.5 x 100 = 100%
- Receptionist 3 — 40 / 37.5 x 100 = 106.6%
So, the Receptionist 1 is below the MP, Receptionist 2 is bang on, and Receptionist 3 is higher than the industry midpoint. In general, most companies will aim for a compa-ratio range of somewhere between 80%-120%, based on these five areas:
- 80-87%: Newbies or unsatisfactorily-performing employees.
- 88-95%: Employees gaining experience but not yet fully competent.
- 96-103%: Fully competent performers.
- 104-111%: Employees consistently performing at a higher level than required.
- 112-120%: Outstanding performers.
For a pay-for-performance compensation strategy, you could compare these five areas with the employee’s performance and how long they’ve been in the role, and then make any necessary changes to employee salary.
Focus on fair employee compensation plans
Remember, it’s important to think extremely carefully before paying employees differently for the same job.
In the interest of fair employment, there are a ton of laws and legislations that support fair pay for female, minority ethnic or disabled workers.
Many states have different legislations, so get to know your local laws when deciding employee compensation. And remember, these formulas should be used to work out the baseline of where your employee comp plans currently sit, so you can then make informed decisions about fair compensation.
Note: We love giving you the latest hiring lowdowns, but remember — we’re not lawyers. If you need any extra legal advice check in with a legal professional to make sure your compensation plans are 100% on the right side of the law.
Work out employee compensation and benefits
Now that the complicated part’s over, it’s time to work out how much average compensation your employees should receive on top of their salary. Obviously, this could change once you factor in things like industry, experience, role level, skill sets and location (unless you opt for a fair one-comp-fits-all strategy).
Here’s a quick recap of some of the different types of employee compensation (excluding salary):
- Employer contributions to retirement plans
- Employer-paid health/life insurance
- Paid leave for vacation
- Paid leave for sick days
- Disability insurance
Now, let’s take a look at what the experts say about extra compensation. According to Joe Hadzima, Senior Lecturer at MIT:
“The costs… (basic salary, employment taxes and benefits) are typically in the 1.25 to 1.4 times base salary range — e.g. the cost range for a $50,000/year employee might be $62,500 to $70,000.”
In other words, once you know your employees’ base salaries, you can multiply them by 1.25-1.4X to find out your employer costs for employee compensation.
This is how it could look in real life for our receptionists:
- Receptionist 1 — $33,000 x 1.25-1.4X salary = $41,250-$46,200
- Receptionist 2 — $37,500 x 1.25-1.4X salary = $46,875-$52,500
- Receptionist 3 — $40,000 x 1.25-1.4X salary = $50,000-$56,000
Retain top talent with a stellar employee compensation plan
Great compensation plans show employees they’re valued — and there ain’t no employee like a satisfied employee. Plus, compensation and benefits are related to employee motivation too, meaning the better your comp plan, the better your overall productivity. 💪🏼
But to beat the competition, you need to be creative.
Here are a few extra perks you could add to your employee compensation plan to really make it shine and attract those A+ candidates:
- Retention bonuses: During lockdown, high employee turnover became the norm for small businesses. To stem the flow, some businesses started to pay retention bonuses in the form of cash or gift cards. In fact around 33% of companies paid out, up from 30% in 2019. The moral of the story? A bonus is often cheaper than the cost of hiring a new employee. 😉
- Flexible scheduling: Flexi-working has been in the spotlight over the past few months, as more people than ever started working remotely (thanks, Covid). Working from home is hard, and returning to work isn’t much easier post-lockdown, so show employees you get it by cutting them some slack with flexible working packages.
- Next level parental perks: In 2020 alone, 64M+ women lost their jobs globally — that’s 5% of women worldwide. To show you really value your employees, it’s time to bring parental perks to the top of the agenda. Think: “No explanation needed” policies for time off to attend family events, staged returns to work for new parents, or in-house peer support groups.
Build your employee compensation plan the right way
Employee compensation has always been a moving target — but with such high turnover for small businesses, getting it right is more important than ever.
Because with the right compensation strategy in place now, you can save yourself a ton of time later. (We all know you have better things to do, right?)
From offering flexible working packages, to focusing on parental perks, there are a lot of ways to build fair compensation plans into your business from day one.
The result? Happy employees and an awesome company culture. And that’s something you just can’t put a price on.
