Modern HR in the Cloud Blog

The Advantages of Differentiated Compensation

February 25, 2014 By: Anke Mogannam

Originally featured in Talent Management Excellence Essentials

Today's compensation and talent management professionals are looking strategically at the role of performance-driven rewards as a key lever for engaging and retaining top performers. There are numerous strategies for creating a high-performance culture, and today's technological advances have created major opportunities for looking at compensation structures differently than in the past.

Historically, companies had fairly narrow boundaries for compensation plans. The major levers were the merit increase for base pay and bonuses for achievement of goals. While these are still primary, compensation departments are looking more broadly at other variable pay mechanisms that take into account business performance in addition to employee performance.

The most basic example of this type of reward mechanism is to tie a portion of an employee's compensation to the company's financial performance measures, such as sales or revenue at company, division, or even departmental levels. This is an easily available metric that all employees understand. The issue is that the linkage of employee work to this particular measure might not be clear-cut.

Variable reward programs can be part of risk management and thought of as profit insurance. When a company has lower than expected profits, variable compensation budgets are reduced to mitigate any shareholder impact. This is not punitive, as the shareholders have based their investment on the performance of the company and employee actions are directly linked to this performance. On the flip side, when the company's profits exceed targets, the bonus pool is deepened and employees reap the benefits of the linkage between their performance and the exceptional results.

Other business success metrics being linked to employee compensation include customer satisfaction, customer retention, and customer support. These get a bit trickier to map to individual levels, yet they are critical to a company's success.

Savvy businesses are also looking at other incentives to retain top performers. Grants of stock options and full value shares, education and other development activities, and spot bonuses are also being factored into differentiated compensation plans. Interestingly, top talent rarely leaves a company for compensation reasons alone.

The more tightly aligned the high-performance culture, the more complex the compensation scenarios. Compensation professionals must look at multiple types of measures for various roles in the company. This is further complicated when factoring in commensurate incentives across geographic and regulatory boundaries.

This complexity makes it hard?if not impossible?to keep up with all the potential incentive and regulatory parameters with manual processes and spreadsheets. In large organizations, the process is so complex it is common to find ?leakage? in compensation. For example, by the time some businesses get their compensation budgets approved, the compensation pools do not reflect the reality of the staff currently in place.

In order to mitigate the risk of these complexities, the entire performance and compensation process should have a strong technology underpinning. Without a strong talent technology platform, companies end up with static goals and performance documents that are not modified based on changing business conditions and are not reviewed until the next performance cycle.

In addition, the talent calibration process relies on a single view of organization talent. Without a strong technology solution, talent reviews become a lengthy and costly manual process. The solution is also critical to move the calibrated performance assessment data into the compensation technology process.

Given the extraordinary complexity of global compensation plans, flexible and highly configurable technology is essential to manage the process in a way that enables focus on top performers. The technology should take the ?heavy lifting? off of the compensation team with regards to compensation rule definition and editing, employee eligibility, and transparency into process and practice in any organization across the globe.

Considerations for the technology platform should include a review of how compensation rules and calculations are created, edited, and implemented. This will be absolutely critical in order to administer a complex compensation landscape. Additionally, the system should be capable of dynamically calculating employee eligibility. Since employees might be eligible for multiple plans - and it is certain that employees will transfer between departments and geographies - eligibility can change along with these transitions.

To use metrics from the finance and customer support systems, consideration should be given to whether the compensation system can use the input system to calculate variable pay. For example, if employees are compensated based on financial results for their division, the compensation engine must calculate the proper compensation based on the data passed from the finance system.

Finally, the company might consider whether the system can accommodate a single consolidated view of compensation budgets. This is a radical departure from the manual spreadsheetdriven process that requires the compensation team to compile multiple disparate spreadsheets. As employees transfer within the organization, leave the company, or get hired, manual processes make it difficult to react and change the budgets accordingly.

Because the budgets are a challenge to keep updated, there is a high likelihood of budget leakage, where monies are not controlled tightly and are then not available to use on the top talent. Many existing systems are limited in that they require companies to standardize their compensation plans, which force the plans to conform to existing rules. An effective compensation management technology should be designed to handle the increasing level of complexity of all the different existing and emerging compensation plans (variable pay and pay for performance) and tools (such as options, restricted stock units, phantom stock, and short- and long-term incentive plans).

By leveraging the right technologies, companies can ensure they take advantage of the best talent insurance available. Companies then can focus executive-level time and attention on compensation philosophy and strategy, acquire reliable market pay data, hire a top-notch compensation team, and train managers to execute on the compensation rules. Creative cash and noncash incentives and disproportionately distributing them to your highest performers and highest-potential employees is not only good talent management, it is good business.

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