written by: N. Plowman
• edited by: Michele McDonough
• updated: 5/18/2011
Understanding and developing compensation plans can be extremely difficult for non-HR employees. However, by following only five simple steps, anyone – even project managers – can develop an effective compensation plan that is fair and consistent, while still rewarding individual contributions.
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The Importance of a Well-Planned Compensation Strategy
Understanding the many facets of compensation can be difficult, even for a person educated and experienced in compensation analysis. Although it is difficult, with the right tools, anyone is capable of developing an effective, equitable, and motivating compensation plan for project teams.
Compensation decisions cannot be arbitrary – they must be made with careful consideration and strategic planning to ensure employees are compensated equitably with respect to experience, tenure, responsibilities, and others in similar positions inside and outside of the organization and/or project. Therefore, to develop a fair and motivating compensation plan, project managers and company leaders need to develop a strategy that best instills a strong pay-for-performance mindset without inhibiting employee satisfaction, motivation, and productivity.
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How to Develop an Effective Compensation Plan
1. Understand the purpose of a compensation plan.
First and foremost, a project team’s compensation plan must align with the project’s goals in terms of profitability margins, process versus results orientation, deadline adherence, and interdependence expectations. A compensation plan is also another type of job description – how employees are compensated determines where they will invest time to ensure the greatest return on their investment. Finally, a compensation plan reinforces behaviors. Ideally, a compensation plan is a positive reinforcement for productive behaviors as identified in a performance evaluation; however, a poorly planned and executed compensation strategy can act as a demotivator and an instigator of negative competition and hostile working conditions.
2. Determine what percentage of compensation will be team-based and what portion will be based on individual contributions.
The benefits of a team-based compensation plan include: increased teamwork and cooperation, improved processes and implementation results, increased flexibility to change, and encouragement of information sharing and communication.
The benefits of an individual-based compensation plan include: promotion of healthy competition among team members, increased innovation and creativity, increased personal satisfaction for achievement of individual results, and increased motivation to exceed expectations.
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3. Determine what percentage of compensation will be fixed and what portion will be variable.
Fixed compensation, also called base pay, is the amount of compensation that employees earn for working, regardless of performance and productivity. A fixed amount helps ensure a minimum compensation level, which is beneficial to reduce anxiety and unhealthy competition. Although fixed pay is set at employment or project onset, it does not mean that every team member’s base pay is the same. Instead, an effective fixed compensation strategy accounts for variations in job responsibilities, experience, and skill competencies.
It is recommended that a base pay range be developed for each job description (not job title) to ensure equal payment for equal work because not all similarly named jobs are equal indicators of responsibilities, tasks, difficulty level, and expectations. After developing a pay range by researching market and industry standards, the following pay scale is recommended.
Entry-Level: 0-35% through pay range; defined as little to no prior experience or skills
Professional: 35-65% through pay range; defined as mid- to advanced-level experience or skills
Managerial: 65-100% through pay range; defined as professional-level worker with supervisorial responsibilities
Variable compensation, also called incentive pay, is the amount of compensation that employees earn in excess of fixed compensation for reaching a certain productivity or performance goals. Variable pay increases motivation, encourages healthy competition, and provides an opportunity for project leaders to reward employees and teams for exceeding expectations. The following variable pay guidelines ensure incentives are effective.
Incentive ceilings should never be set (or at least communicated to employees) because it only limits the productivity of employees. Once a limit is reached, an employee’s motivation to exceed that production goal diminishes.
Incentives should be meaningful to employees, while being practical for the company.
Incentives should be varied in amount, type, and frequency, so employees don’t begin to associate variable pay as a form of entitlement or expectation.
4. Specify the percentage makeup of project team compensation.
Use the example on the left as guidance to specify the details of a project team’s compensation plan.
In the example, the project manager decided that compensation should be based equally on individual contributions (50%) and team results (50%). Furthermore, 70% of an individual’s compensation will be fixed, while 30% will be variable.
Of the individual’s fixed pay, 35% will be based on individual skills, experiences, and tasks. The remainder 35% will be based on available project funds equally dispersed among team members. Of the individual’s variable pay, 15% will be based on individual achievements, and 15% will be calculated on team achievements.
5. Document and communicate the compensation plan.
Prior to implementing a compensation plan, the plan’s details must be recorded clearly and concisely in writing. After the plan is documented, project managers must communicate the changes to employees verbally as well as providing a written copy of the plan’s specifications.