Your small business is growing. You’ve hired good people. But are you paying them correctly? If you’re like most small and mid-sized business owners, you might be making compensation decisions on the fly, negotiating individually with each employee, or simply matching what you think competitors are paying.
This approach is risky. According to Gallup, organizations that effectively manage compensation see 31% lower turnover than those that don’t. Your compensation practices affect everything from recruitment to retention to your company’s financial health.
It’s time to stop winging it and develop a real compensation strategy and plan.
Why Your Business Needs a Compensation Strategy
Many small and mid-sized businesses operate without a formal compensation strategy or plan. They make pay decisions reactively, responding to immediate needs rather than following a structured approach.
The Problems with “Making It Up As You Go”
Without a compensation strategy, you’re likely facing:
- Pay inequity: Similar roles receive vastly different compensation based on negotiation skills rather than value.
- Legal risks: Unstructured pay practices can lead to discrimination claims or wage and hour violations.
- Employee distrust: According to SHRM, 54% of employees believe they’re underpaid because they don’t understand how their compensation was determined.
When employees perceive pay practices as arbitrary, they lose trust. This often leads to the “squeaky wheel” syndrome, where the loudest employees get the biggest raises, regardless of performance.
Having a compensation strategy isn’t about bureaucracy, it’s about fairness, clarity, transparency, and trust.
~ Carolyn Ross, Founder, Ross Insight Solutions
The Benefits of a Clear Compensation Philosophy
A strong compensation philosophy establishes:
- How you’ll position your pay relative to the market
- What behaviors and results you’ll reward
- How transparent you’ll be about pay decisions
- How you’ll ensure pay equity
With a well-defined comp philosophy, you create consistency in decision-making and build trust with employees.
Creating Your Compensation Strategy
Your compensation strategy starts with a clear philosophy that guides all your pay-related decisions.
Establishing Your Comp Philosophy
The first decision is how your pay will compare to market rates. You have three main options:
- Lead the market: Pay above-market rates to attract top talent and reduce turnover. This approach costs more but can provide a competitive advantage in tight labor markets.
- Match the market: Pay at market rates to remain competitive while controlling costs. Most SMBs choose this balanced approach.
- Lag the market: Pay below-market rates but compensate with other benefits like flexibility, learning opportunities, or equity. This approach works best when cash flow is limited, or your company offers unique non-monetary benefits.
A small company we worked with had one team of employees who were accustomed to negotiating for larger and larger pay increases each time they were granted a raise at their annual review. Their pay was “all over the map” and they were still feeling things were unclear and unfair. Now that they have a compensation structure in place, it is easier and clearer for management to deny pay increases just because someone has asked. They can assure each employee that they are being paid at the appropriate level for their role and can ensure equity among staff within that role. While the specific pay rates are not made known (those must be kept confidential), employees know it is all being done fairly and they are being paid “to market.”
Remember: Management cannot legally prohibit employees from discussing their pay with each other. That would be a violation of the National Labor Relations Act.
Developing a Compensation Plan
Once you’ve established your compensation philosophy, you need a structured plan to implement it.
Building Your Comp Structure
A good compensation structure includes:
1. Defined Roles and Job Descriptions
Start by clearly defining each role in your organization:
- Core responsibilities
- Required skills and experience
- Performance expectations
- Reporting relationships
2. Market Data Analysis
Research current market rates for each position based on:
- Industry standards
- Geographic location
- Company size
- Required skills and experience
According to PayScale, 82% of employees who understand how their pay compares to market rates are satisfied with their compensation, regardless of whether they’re paid above or below market.
3. Creating Pay Ranges
Establish salary ranges for each position with:
- Minimum (for new or less experienced employees)
- Midpoint (for fully proficient employees)
- Maximum (for highly experienced top performers)
4. Slotting Jobs into Ranges
Place existing positions within your established ranges based on:
- Market data
- Internal equity
- Individual skills and performance
5. Variable Compensation Components
Consider adding variable pay elements to your structure:
- Performance bonuses tied to individual, team, or company results
- Commission structures for sales roles
- Profit-sharing plans that align employee and company success
- Spot bonuses for exceptional contributions
When implementing variable compensation, create clear qualification criteria and payment schedules to avoid confusion.
6. Reviewing for Pay Equity
Analyze your compensation data to identify potential inequities based on gender, race, or other protected characteristics. A BLS study from 2023 found that companies with formal pay equity processes reduced unexplained pay gaps by 29%.
Annual Compensation Review Process
Your compensation plan should include an annual review process to:
- Adjust salary ranges based on market changes
- Review individual employee positioning within ranges
- Address any emerging pay equity issues
- Align compensation with company performance and financial constraints
The Risks of Not Having a Plan
Organizations without structured compensation plans face:
Legal and Financial Risks
- Discrimination claims from employees in similar roles receiving different pay
- Wage and hour violations from inconsistent classification practices
- Budget overruns from unplanned or reactionary salary increases
Employee Morale and Retention Problems
Pay inequity undermines trust and leads to resentment. According to Gallup’s 2023 workplace study, employees who believe their pay is unfair are 2.4 times more likely to be actively searching for new jobs.
Recruitment Challenges
Without clear compensation structures:
- You may struggle to attract qualified candidates if your offers seem arbitrary
- You risk overpaying new hires without accurate market comparisons
- New employees may receive higher compensation than veterans, creating internal equity issues
Getting Started with Compensation Planning
Ready to develop your compensation strategy? Here’s how to begin:
- Audit your current pay practices to identify inconsistencies and potential inequities
- Create a simple compensation philosophy statement that reflects your company values and market position
- Gather relevant market data from reliable sources for benchmark positions
- Define job families and career paths to show progression opportunities
- Establish pay ranges for key positions
- Review for internal equity across similar roles and responsibilities
For many SMBs, the process seems overwhelming. Consider working with an HR consultant to develop a right-sized approach that works for your business.
Conclusion
A thoughtful compensation strategy helps you make consistent, fair decisions about one of your largest business expenses. By establishing a comp philosophy and creating a structured plan, you’ll reduce risks, build trust with employees, and position your company for sustainable growth.
Remember that your compensation strategy should evolve as your business grows. Review it annually to ensure it continues to serve your company’s needs and remains competitive in your market.
The investment in developing a proper compensation structure pays dividends through improved recruitment, retention, and business performance—making it one of the smartest moves a growing company can make.
Worried about getting all of this done on your own? We can help.
Ross Insight Solutions can help with any or all of this: a review or current pay practices; audit of current pay rates; creating comp philosophy and structure; market data research; review of equity factors, or anything else you’d need. Reach out today!
