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compensation management

What is compensation management?

Compensation management is the discipline and process for determining employees' appropriate pay and benefits. A critical element in talent management and employee retention, it uses financial and nonmonetary benefits to attract recruits, reduce turnover, spur performance and boost employee engagement.

Human resources (HR) professionals typically carry out compensation management strategies. They're responsible for ensuring that salaries and bonuses remain competitive, and benefits change with the needs of the workforce. The HR leaders in this role must gather and analyze internal and external salary figures, demographic and economic statistics and other relevant information. They are also keen to understand the complexities of benefits administration.

List of elements of compensation management
Specialized software is used to carry out compensation management processes.

Breaking down the main types of compensation

An employee's total compensation includes two different types: direct compensation and indirect compensation.

Direct compensation

Direct compensation refers to monetary earnings tied to an employee's work and value to an organization. The following four are the main types of direct compensation:

  • Salary. Full-time employees typically get an annual salary that's paid out weekly, bi-weekly or monthly. These employees tend to be skilled workers or managers. They're usually people that an organization has an interest in investing in a long-term relationship. Most professional and specialist roles are salaried positions, such as teachers and healthcare professionals.
  • Hourly. Unskilled, semiskilled, part-time and contract workers are often paid on an hourly basis. Hourly wages are also associated with temporary and gig jobs. These employees are often eligible for overtime pay when they work beyond a contracted number of hours. They can also be subject to minimum wage requirements. Service, food and hospitality workers are often compensated hourly.
  • Bonuses. A bonus can be given to employees for a particular reason, such as good work on a specific project. They can also be given out universally across an organization when it has good end-of-the-year results, for example. Bonuses are sometimes paid based on the number of years a person is employed at an organization or as merit pay for meeting a specific goal. Bonuses aren't specific to any type of role, though they are often part of compensation packages for upper-level managers and executives.
  • Commission. People employed in sales roles are often paid on a straight commission basis or a salary plus commission. Commissions are usually tied to meeting a certain target or quota amount of revenue or profit.

Indirect compensation.

Indirect compensation refers to ancillary compensation that has financial value. This type of compensation is often divided into monetary or non-monetary categories, such as the following:

  • Monetary. Monetary forms of indirect compensation include benefits such as health, dental, vision, life and disability insurance. Employee stock options, 401Ks and pensions are also examples of indirect monetary compensation.
  • Nonmonetary. This type of indirect compensation includes paid time off, sick leave, parental leave, child care, training, upskilling, as well as company-provided cars, phones, laptops and meals.
List of ways to increase employee retention and its benefits
Promoting both monetary and nonmonetary compensation will increase employee retention and its accompanying benefits.

Why is compensation management important?

Several factors make compensation management an essential practice in many organizations:

  • Salaries are typically a business's biggest expense. Executives need good data to prepare and monitor budgets, plan their compensation strategy and make consistent compensation decisions.
  • Employers face new pay equity laws that require them to report employee wages along with data on gender, race, ethnicity and occupational role. U.S. states that have adopted these laws, notably California in 2021, use this data to identify wage patterns that suggest discrimination. On the federal level, the U.S. Securities and Exchange Commission in late 2020 began requiring companies to report human capital metrics, including pay equity.
  • Employers are giving pay equity issues more attention as part of their diversity, equity and inclusion (DEI) efforts.
  • Remote work is prompting some organizations to change compensation strategies. Employees who move from high-wage regions, such as Silicon Valley, to Midwestern cities might see their pay reduced to local prevailing wages. Ensuring competitive compensation packages in an era of flexible and hybrid work is becoming more complicated.

How to implement a compensation management strategy

Compensation philosophies and compensation management strategies vary from company to company, but the steps to implement them apply to organizations across the board. They include the following:

  • Policies with vision. Organizational leaders should craft policies that tie compensation to the scope and vision of the various roles they're hiring for.
  • Broad input. Looking at ways to improve existing compensation plans, as well as looking to other sources and organizations for insights, is a good way to shape a comprehensive compensation plan.
  • Compliance. Laws concerning compensation and benefits, whether local, state or federal, must be taken into consideration when fleshing out the details of the plan.
  • Finalizing the plan. Once all these factors are carefully considered, business leaders must finalize plan details.
  • Communication. The full plan must be explained to all employees and stakeholders.
  • Reassessing and improving. Once put into effect, business leaders should assess how well the plan works for their employees and improve it based on feedback.

Compensation management software

Compensation management software is a standard component in human capital management (HCM) and talent management suites. Its primary purpose is to give executives, hiring managers, recruiters and HR teams information about the budget for employee salaries and industrywide compensation rates for similar positions.

This type of software also acts as a centralized system for managing every type of compensation. This includes monetary compensation such as bonuses and performance incentives, as well as nonmonetary compensation such as extra time off, flexible work hours, public recognition and wellness programs.

Compensation management software also provides tools for calculating and communicating the total rewards provided to each employee. This is a personalized statement of the value of each compensation package, including employee benefits like health insurance and retirement accounts.

Like other HR applications, compensation management software increasingly relies on machine learning to spot disparities in data and ensure salary rates are competitive. Platform vendors have also been adding data analytics tools and access to cloud-based anonymized data to make it easier for employers to benchmark pay rates against other firms in their industry.

Compensation managers can use the software to gather salary data by industry, company size, job role and geography. Other sources of wage information include government data, information from publicly available sites that collect user-reported salary data and data purchased from third-party firms that conduct ongoing salary and benefit surveys.

Another trend affecting compensation management software is the adoption of on-demand pay, also known as earned-wage access. It gives employees the option to receive pay for hours as they're worked instead of waiting for a check every week or two. Numerous niche vendors specialize in software as a service for managing earned-wage access.

Nevertheless, compensation management systems have limits. For one thing, they're not good at connecting pay to employee potential. Patty McCord, a former chief talent officer at Netflix, said in a 2018 Harvard Business Review essay, "How to hire," that the compensation analysis is usually based on an employee's historical value, that is, what they've produced in the past, rather than on their potential to add future value.

Compensation management software market and vendors

The major HCM suite vendors include compensation management software in their platforms. These platforms help streamline compensation management processes to assist managers and HR professionals. MarketsandMarkets lists some of the large and better-known HCM companies with these offerings, including ADP, Cegid, Ceridian, Cornerstone, EmployWise, IBM, Infor, Kronos, Microsoft, Oracle, PeopleStrategy, SAP, Sum Total, Ultimate Software and Workday.

There are also lesser-known niche vendors that specialize in compensation management. Gartner has compiled a list of small vendors in this space, including Aeqium, Barley, Beqom, CaptivateIQ, Complete, Complogix, Compport, Dartican, Decusoft, HRSoft, MroganHR, Pave, Payscale,

What to look for in compensation management software

While compensation software platforms are meant to add value and efficiency to HR departments, organizations must examine which features and components are included in each platform. The following are features to consider:

  • A configurable, drag-and-drop dashboard to help executives understand compensation trends and costs.
  • Automated, customizable reporting.
  • Data visualization tools for creating charts and graphs that will also look good in Microsoft PowerPoint presentations.
  • Analytical tools that give human resources management the ability to analyze compensation data easily.
  • The ability to run comparisons of wages by industry and geography.
  • Support for third-party add-on tools.

Benefits of compensation management

Compensation management will bring various benefits to an organization when done effectively. These include the following:

List of five benefits of compensation management
Good compensation management practices bring benefits to organizations.
  • Competitive monetary compensation. Ensuring salaries are competitive is the main benefit of compensation management. Up-to-date market data gives hiring managers critical information they need when making offers to top talent. The same applies to raises and bonuses for employees, who have ways to find out about their peers' salaries and benefits. An effective compensation management system is alert to changes in the market, which can help with attracting and retaining the best talent.
  • Employee morale. Compensation management tools can help motivate employees, boost retention and reduce turnover. Those impacts, in turn, save money on operational expenditures, such as recruitment and training costs.
  • Productivity and performance. More broadly, the right mix of compensation can improve employee performance, productivity and creativity.
  • Increasing profit. These improvements, in turn, can boost the organization's revenue and profitability.

Challenges of compensation management

Despite the benefits of effective compensation management, there are also obstacles involved with these efforts, including the following:

  • Budget constraints. Compensation packages can quickly eat up a company's budget, impeding business leaders from offering everything they want to employees.
  • Knowing what to include in plans. Knowing what to include in compensation plans can be a challenge. In some cases, industrywide data is available to benchmark data. However, this information can be hard to obtain, and business leaders might have to use their own best judgment.
  • Communication. Organizations must explain all plans and packages to employees and other stakeholders, especially new hires. This can take time and effort.
  • Comprehensiveness. Organizations must ensure their compensation policies are fair to all employees and accommodate special needs. This, too, takes more time and effort.
  • Continuous monitoring of success. Continuously assessing how compensation plans are faring over time using various metrics can be time-consuming and arduous. This task is often outsourced to third-party service providers.

Compensation management specialist role: Salary and career info

In small firms, HR managers often double as compensation managers. Generally, however, compensation management is a distinct government-recognized occupation. Compensation and benefits managers earned a median annual wage of $131,280 in 2022, according to the U.S. Bureau of Labor Statistics. The lowest 10% of these managers earned less than $77,230, while the highest 10% earned more than $217,650.

The Bureau of Labor Statistics estimated that there were about 17,500 compensation managers in the U.S. in 2022. The number of people employed in this role is expected to grow by about 2% from 2022 to 2032.

The future of compensation management and benefits

Compensation management is having to adjust to rapidly changing workforce priorities. HR departments are increasing their use of analytical software to meet their DEI goals. They're analyzing compensation management data for wage disparities by gender and race, from entry-level positions to senior management.

Before the COVID-19 pandemic, wellness incentive programs had a significant impact on employee compensation packages, and this role has only grown. Financial support for the home office setups of remote and hybrid workers is also becoming part of compensation management. Remote work has also increased compliance issues as employees are increasingly located in multiple states and internationally.

Benefits are an important part of a business's compensation program; compensation management software needs the flexibility to handle new types of benefits and changes to existing ones. For example, some corporate wellness technology programs offer activity-tracking smartwatches, such as the Apple Watch, to employees at no charge if they meet fitness goals. The watch's data, such as the number of steps taken per day, is collected. If an employee doesn't meet the goal, they might have to pay the full cost of the watch.

There are also benefit packages that offer employer-subsidized DNA testing, as well as flexible work options, phased return to work for new parents and reimbursement for adoption and eldercare expenses.

New integrated platforms are combining HR and payroll processes. Learn about the benefits of these integrated platforms.

This was last updated in March 2024

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