How Employee Compensation Works

Setting Up Your Compensation Structure

Although money isn't everything, it certainly is one of the top issues potential employees look at when interviewing new companies. (Yes, face it, they are interviewing YOU.) Whether you're offering a straight basic salary structure or an incentive-based pay structure may make or break you in the eyes of top job candidates. Let's look at how each system works.

A standard base pay program offers fixed salary ranges for each position type for employees performing the standard duties of their jobs. Set up minimum and maximum levels within those pay ranges to account for variations in experience and skill levels. When setting the base pay structure, determine where your company falls within your own industry as well as competing industries that may also offer job opportunities for your employees. Set up your pay levels to be competitive, or else you risk losing employees. You can use the Internet to find industry-standard salary levels for specific jobs in specific geographical areas. Click here to search for Web sites with free-access databases of salary information.

Once your base pay structure is in place, most companies then set up a merit pay program that will take the employee through the salary range for their position at a performance-driven speed. This comes into play when the employee's managers do annual employee performance reviews. The downside of this is that employees may begin to see it as a given that they will get a salary increase after each evaluation, and it ceases to be a motivation to perform better in their jobs. For this reason, more companies are moving toward more of a reward-based compensation style, also called Incentive Compensation.

Incentive-based compensation is becoming much more common because of the increased emphasis on performance and competition for talent. This type of compensation structure significantly helps motivate employees to perform well. Hiring bonuses are also frequently used now, even for new college graduates. However, you might want to tie in a specific time period prior to the employee collecting this bonus -- for example, one-half after six months and the remainder after one year of employment. Otherwise, you could run the risk of the employee departing after that first check, which would defeat your purpose. So does that mean incentive compensation is the way to go? Maybe so, if your business is in an industry where you really have to compete to get good employees.

Setting up an incentive-based compensation program requires the same research into your industry as the base pay program. You'll still establish base pay levels, but it may be slightly lower and you will build into that base the annual or quarterly (or any other interval) bonuses, commissions, or other types of shared cash compensation.

In the next section we'll talk about other forms of compensation, including bonuses, commissions, and vacations.