The pay bill is usually the largest investment an organisation makes, yet most organisations believe they can manage compensation (base pay and variable pay) better than how they do it currently. Organisations typically claim to have a reasonable view of what they pay people, and why, but admit to having a hazier idea of what they should be paying them. As a result, most organisations both overpay (to the tune of around €1200 per person per year) and underpay their employees. The first is a straightforward waste of money; the second exposes them to the risk that people will be demotivated and/or leave, with the considerable knock-on costs of poor performance and/or having to recruit and train replacements. 

Most organisations believe they can increase both the efficiency and the effectiveness of their pay strategies by doing things a little differently. A common mantra followed by many is: ”We target salaries around the median and reward upper-quartile performance with upper-quartile incentive levels.“ But unless these organisations take a much more targeted approach to the way they apportion the pay budget, and improve their guidance to line managers on how these budgets should be distributed, there is no guarantee that they will get the best value for money from their investments.

To target pay effectively, organisations need to understand the value that different employee segments bring to the business. They could segment their employees according to a range of factors, including:

After critically assessing such factors, an organisation can decide how to position itself against the market and how to balance the different compensation components to best effect. Getting better value for money out of the compensation spend is always important, but it has become critical during a recession, when budgets have shrunk in most organisations. Even if pay reviews have been put on hold this year, now is an ideal time for organisations to think carefully about the way they manage and communicate about compensation, so that when the upturn comes they will be in a better position to take advantage of it.

The governance of and communication about compensation are inextricably linked. In other areas of reward, such as pensions and long-term incentives, small numbers of people typically make big decisions periodically. But in compensation, large numbers of people (including line managers) are making regular, multiple, but smaller decisions. In the absence of strong guidance, this usually leads to inconsistency, both between line managers and between line managers and the company's overall approach.

Using Mercer's Compensation Management Index, we recently conducted research among companies in Europe to find out what aspects of compensation management they believed were most important and how they ranked their own performance in those critical areas. Overall, companies' own performance lagged their aspirations in all six areas – strategy, organisation, design, process, technology and communication – but the discrepancy was by far the biggest in compensation communication. Organisations believed communication was the most important aspect of compensation management but ranked their performance lower in this area than in any other.

Poor communication lies at the heart of inconsistent compensation management practices. Line managers tend to shy away from tough performance decisions and are given little guidance in how to make them. These managers, therefore, tend to rank everyone “above average” and aim to award them “above average” compensation. This approach creates the very divisiveness that they are so keen to avoid, because it discriminates against the genuine above-average performers who the organisation wants to encourage. Employees in receipt of such mixed messages rely on the grapevine for information, leading to a decline in trust.

Organisations must develop and communicate to line managers the guiding principles for determining compensation. They also need to communicate directly with employees and encourage consistent communication from line managers. The value is clear: employees who understand the basis on which compensation decisions are made are five times more satisfied with their pay than employees who don’t understand what drives their compensation. This has a knock-on effect on job satisfaction and commitment to the organisation in general, and on attraction and retention.

But trying to communicate about ineffective compensation strategies is clearly pointless. Only when you have more robust structures that encourage more consistent decision making can you can be more transparent about pay.

So how can you improve compensation management? Look at the six components previously listed and try to get a better alignment between what you think is important and what you actually do. It might sound obvious, but if something is really important, you should do it really well – and if you don’t think it is very important, you should stop wasting time on it.

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