How to Build a Compensation Strategy that Pays Off

April 08, 2024

Master the art of compensation to transform payday into a powerhouse of engagement and retention.

Fair pay isn't just a nice to have. It's the bedrock of your business, shaping the caliber of talent you attract and keep. Plus, it's a hefty slice of your budget, so making a savvy compensation strategy is pivotal for success.

How's your business's pay strategy shaping up?

This guide is here to illuminate the path to creating a dynamic pay strategy, zeroing in on the essential elements and tactics that should define your approach.

What is a Compensation Strategy?

A compensation strategy is a comprehensive plan that outlines how an organization manages and allocates financial rewards to its employees. It's more than just salaries — it also includes bonuses, health benefits, retirement contributions, and any other form of financial reward that employees receive in exchange for their work. 

Your compensation strategy isn’t static. It evolves in response to changes in the market, industry standards, and internal growth. It acts as a reflection of the organization's values, highlighting its commitment to employee well-being and recognition. 

Key Components of a Compensation Strategy

It helps to break down your compensation strategy into smaller components. Generally it’ll include:

  1. Base Pay: The fundamental salary or hourly wage that an employee earns. It's determined by factors such as the role's importance, the skills required, the employee's experience, and market pay rates.
  2. Variable Pay: Incentives or bonuses tied to performance, company profitability, or other metrics. This can include merit-based bonuses, commissions for sales roles, or annual performance bonuses. 
  3. Benefits: Beyond salaries and bonuses, benefits are a major part of compensation. Offerings like health insurance, retirement plans, paid time off, and other perks contribute to an employee's well-being and job satisfaction.

Learn More: The 14 Best Employee Benefits to Dazzle Your Talent

Key Takeaways

  • A compensation strategy is how an organization allocates financial rewards to its employees, including salaries, bonuses, and benefits.
  • A well-crafted compensation strategy can boost employee engagement, reduce turnover, and attract high-caliber staff. 
  • To stay competitive and compliant, it's vital to adjust your strategy periodically to account for market and organizational changes.

Why Is a Compensation Strategy Important?

Compensation is more than just trading cash for work. It’s an invaluable tool for keeping your workforce engaged and onboard.  

So, why should you think about pay strategically?

1. Reduces Staff Turnover  

It shouldn’t come as a surprise that employees who feel compensated fairly are more likely to stay (and those who don’t are more likely to leave).

A Gallup survey found that 20% of employees who left their jobs in 2022 indicated pay was the primary motivator. Pay your employees fairly, and they’re more likely to stick around. 

Learn More: What is Employee Turnover? A Comprehensive Guide

2. Attracts High-Caliber Staff

In addition to keeping your employees happy, compensation is a major player in attracting new talent. Another no-brainer: 59% of job seekers consider pay to be a major factor when evaluating a new opportunity. 

And it doesn’t just help attract talent, but high-quality talent. 

When you align your compensation package with market standards and the expectations of top-tier candidates, you can draw in individuals who seek environments where excellence is recognized and rewarded.

Should You Highlight Wages in Your Job Posting?

Listing a salary or hourly rate in a job description comes with its own set of pros and cons. 

On the upside, showcasing competitive pay can attract a higher volume of applicants, especially top-tier candidates. But it also broadcasts part of your compensation strategy to your market competitors, who may use the knowledge to siphon talent away. 

That said, your hands may be tied depending on where you hire. Many states have laws mandating wage disclosures upfront.

Your decision depends on your organization’s unique circumstances — check out our article Pay Transparency: What HR Needs to Know Today for Tomorrow for more information.

3. Boosts Employee Engagement 

Employee engagement is multifaceted, influenced by a wide range of factors from company culture, work-life balance, managerial styles, and personal circumstances.  

Yet, compensation is a significant variable in the engagement equation. According to a PayScale report, 75% of employees who felt they were compensated fairly were also satisfied with their job. 

Again, this makes sense. Compensation is a tangible way an employer can communicate how much it values its staff. Appreciation naturally boosts employees' engagement, driving them to invest more deeply in their roles.

What Are Different Types of Compensation Strategies?

Let's explore the diverse landscape of compensation strategies and how they uniquely support various organizational needs and goals. 

  • Market-Based: This approach sets pay scales based on market research and benchmarks against what other companies in the industry are paying for similar roles. It ensures competitiveness and fairness in pay, helping attract and retain talent by offering compensation that matches or exceeds industry standards.
  • Merit-Based: Here, pay increases are tied directly to performance metrics. Employees who perform at or above certain thresholds receive higher pay increases, bonuses, or promotions. This strategy incentivizes performance and rewards employees based on their contributions to the organization’s success. 
  • Pay-for-Skills: In this strategy, compensation is linked to the skills and knowledge an employee possesses, rather than their job title or seniority. As employees acquire new skills or certifications, their pay increases, encouraging continuous learning and adaptation.
  • Profit-Sharing: This approach ties a portion of an employee's compensation to the company's profitability. Employees receive bonuses or additional pay based on the organization's financial performance, aligning their interests with the company's success. 
  • Equity-Based: Often used in startups and high-growth companies, this strategy offers employees stock options or equity stakes as part of their compensation package. It's a way to attract and retain employees by giving them a direct interest in the company's future success.
  • Total Rewards: This comprehensive approach considers all aspects of compensation, including salary, benefits, work-life balance, recognition, and development opportunities. It aims to provide a holistic package that addresses various employee needs and motivates them across different aspects of their lives. 

Choosing the right compensation strategy depends on your organization's objectives, the nature of your industry, and your workforce's characteristics. 

But these strategies are mutually exclusive. You'll probably use a combination of tactics to craft a compelling compensation package. 

How to Create a Compensation Strategy 

Crafting a compensation strategy is all about aligning with your company's big picture. Let’s break down the steps to building a plan that attracts and retains top talent while supporting your business objectives.

1. Define Your Goals

This foundational step ensures that your compensation strategy supports specific business objectives, such as growth targets, market positioning, and company culture. Consider what you aim to achieve in the short and long term, and how attracting, retaining, and motivating the right talent plays into those goals.

For example, if your goal is to be a leader in innovation within your industry, your compensation strategy might include significant investment in R&D roles, competitive salaries for creative positions, and incentives for groundbreaking work.

This step requires collaboration among leadership to ensure consensus and commitment to the compensation strategy as a tool for achieving organizational success.

2. Conduct a Job Analysis 

Identify the responsibilities, skills, effort, and working conditions for each role at your organization. This information is invaluable for creating job levels, descriptions, determining necessary qualifications, and setting appropriate compensation levels. 

Ultimately, you’ll use this data to ensure that pay scales reflect the job's value to the organization and the market's demand.

To help you get started, ask yourself these questions about each role:

  • What are the essential functions and qualifications?
  • What are the physical and mental demands? 
  • What level of decision-making and autonomy does the job have?
  • How does the role fit into the larger organizational structure?  
  • Is this a managerial or supervisory role?
  • What is the work environment like? 
  • What are the performance expectations?

After conducting the job analysis, use this data to categorize positions into job families or groups based on similar responsibilities, skills, or contributions to the company. 

3. Benchmark Against the Market 

Don't go making compensation decisions in the dark. Leverage market data to ensure your offerings are truly competitive. 

This involves gathering data on salary ranges, benefits, and other compensation elements for similar roles in your industry and region. Use reputable salary surveys, industry reports, and possibly consulting with firms specializing in compensation. 

Benchmarking should be an ongoing process, as market conditions and industry standards can change. Regular updates ensure your compensation strategy remains relevant and competitive. 

It's also important to consider the total compensation package, not just base salary. Benefits, work-life balance initiatives, and career development opportunities can differentiate your company in the eyes of potential employees. 

Benchmarking these aspects can provide a more comprehensive view of how your organization compares to talent competitors.

Caption: Paylocity’s Market Pay tool automatically imports local, regional, and national compensation data for easier salary benchmarking. 

4. Determine Pay Structures

With the insights gained from job analysis and market benchmarking, you can now establish pay structures and grades. 

This step involves deciding on a range for each role (minimum, midpoint, and maximum) and determining how you'll differentiate pay within those ranges. Consider factors such as the role's importance to the organization, the scarcity of the skill set, and internal equity among employees. 

Here’s a simple example salary scale to illustrate:















Senior Associate









Senior Manager









Pay structures should be transparent and understandable, allowing employees to see the path for growth and income progression within the organization. This clarity helps in managing expectations and promoting fairness and equity.

Pay structures also facilitate administrative efficiency and budget planning while ensuring compliance with legal requirements regarding pay equity. They enable HR and management to make informed decisions about starting salaries, raises, and promotions. 

5. Define Variable Pay and Incentives 

How will you use compensation to reward employees for achieving specific performance targets or contributing to the company's profitability? 

Incentive programs can include individual or team performance bonuses, sales commissions, profit-sharing plans, or equity-based incentives. The right mix of incentives can drive performance and align employee efforts with the company's strategic objectives.

For example, if your sales team exceeds their revenue targets by 10%, they'll receive a bonus equating to 15% of their base salary.

When defining variable pay and incentives, it's essential to ensure transparency and fairness in how rewards are allocated. Employees should understand how their actions contribute to the criteria for incentives and see a clear link between their performance and rewards. 

6. Consider Benefits and Perks 

When determining benefits, consider the needs and preferences of your workforce, which can include health insurance, retirement savings plans, paid time off, parental leave, and flexible working arrangements. Supplement this with any market research about what your talent competitors are offering. 

Perks might include gym memberships, free meals, transportation subsidies, or other employee wellness benefits. The goal is to offer a package that not only meets basic needs but also enhances the quality of work-life for employees.

Regularly assess the effectiveness and usage of offered benefits and perks, ensuring they continue to meet employees' needs and remain competitive in the market. Use employee surveys to gather feedback about what benefits are most appreciated and where there might be gaps. 

7. Ensure Compliance and Equity

This isn't the Wild West — compensation and pay equity are regulated by laws, which can differ based on your employees' work locations. 

Federal legislation like the Fair Labor Standards Act (FLSA) defines minimum wage rates, overtime pay policies, and exemption statuses. Many states also have their own minimum wage rates and labor statutes. To avoid any legal ramifications, ensure your offerings comply with any local, state, and federal regulations. 

There's also pay equity legislation, like the Equal Pay Act, that protects employees from wage discrimination based on gender, age, race, or religion. Conducting regular pay equity audits can help identify any disparities in compensation that might exist within the organization, allowing for adjustments to ensure fairness across different demographic groups. 

A commitment to equity and compliance not only mitigates legal risks but also promotes a culture of fairness and respect.

8. Integrate Into Your Performance Evaluation Processes 

A fair performance management strategy is a key partner in executing your compensation strategy. You need a way to identify which employees should receive promotions, raises, and bonuses.

Establish clear, measurable performance metrics aligned with organizational goals and directly link them to compensation. This ensures transparency and motivates employees by making it clear how their efforts contribute to the business and their own financial rewards. 

You can tie compensation outcomes to a performance rating or core competency framework. For instance, at a healthcare facility, nurses who consistently demonstrate exceptional patient care and teamwork might be eligible for a higher percentage increase in their annual performance bonus.

Regular, constructive feedback and performance reviews are essential to this integration, providing employees with ongoing insights into their progress and areas for improvement. Compensation adjustments based on both individual and team performances encourage a culture of accountability and collaboration.

9. Continually Reassess

Don’t just set it and forget it!

In today’s fast-evolving labor landscape, you must regularly reassess your compensation strategy to remain competitive and compliant.

Changes in market conditions can significantly impact the attractiveness of your compensation packages, necessitating adjustments to stay ahead of competitors. And as your organization evolves, your offerings must adapt to new roles, structures, and business objectives.

In particular, keep an eye out for pay compression, which occurs when there's little difference in pay between employees regardless of their experience or skill level. This often results from rapid market changes or internal promotions without corresponding adjustments in pay scales. 

Take a proactive approach when it comes to compensation. Regularly reviewing your compensation strategy can help mitigate these issues and maintain fair and competitive pay across your workforce.

How Often Should You Review Your Compensation Strategy?

Review your compensation offerings at least annually to ensure they remain competitive, fair, and aligned with your organization's strategic goals. 

However, more frequent reviews may be necessary in response to significant changes in the market, regulatory updates, or shifts in your business objectives. Payroll software with integrated real-time market data makes it easier to monitor industry changes.

Make Compensation Management Easy With Paylocity

Crafting a strategic compensation plan is more than a financial exercise — it's a critical component of your organization's success in the competitive talent landscape.

It's no small feat to craft an enticing compensation package. The process demands time, internal resources, extensive data analysis, and external insights. Fortunately, HR technology is on hand to streamline the process and lighten the load.

Paylocity’s compensation management solution helps simplify compensation decisions, ensure budget alignment, and drive equity across employees — while staying within budget. 

  • Make Data-Driven Decisions: Use dashboards to see performance and compensation history, and market pay data.
  • Manage Your Budget: Configure population and eligibility requirements, proration rules, and automated approval process for plans.  
  • Showcase Your Investment: Easily create and distribute a view of total compensation — including salary, benefits, gym memberships, etc. — to provide employees a view into their pay and additional benefits.

Want to learn more? Request a demo today!


Guarantee Fair Pay, Bonuses, and More

In today's labor market, employees expect fair, competitive wages. Our Compensation Management tool can make it happen. Dig into compensation analytics and insights to inform salaries, merit increases, bonuses, and more. With continual data collection, feel confident you're always paying your employees accurately and fairly, while staying in alignment with your company's budget goals.

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