Designing High ROI Pay Plans

Use returns, not just market competitiveness, to maximize pay-plan impact

• Compensation executives are often asked to make changes to pay plans, and they are “forced” to make these changes because of the inability to demonstrate the lack of benefit of doing so. As a result, companies are likely spending millions of dollars that may have little or no impact.
• To maximize the impact of pay plans, organizations must determine what changes to make based on their effect on attraction, intent to stay, and effort, relative to cost, rather than based purely on market competitiveness of pay.
• Organizations that do this can increase attraction, intent to stay, and effort by more than 20% without increasing compensation costs, and over time, they can reduce their costs by as much as 7% without negatively affecting employee outcomes.

Making Design Decisions with Little Information

Compensation functions receive daily requests from business leaders to make exceptions to their pay plans and frequent requests from senior leadership to change plans that are perceived as ineffective.

With few exceptions, compensation executives are frustrated with their inability to determine the benefits—or lack thereof—of making these changes and exceptions.

As a result of this challenge, companies often make pay changes that have little impact but are perceived to be a solution to a talent issue, costing them millions of dollars for little or no return.

ROI Rather Than (Purely) Market Competitiveness

While it has an impact on employee attraction, intent to stay, and effort, market competitiveness only accounts for at most 30% of the impact of plan design. Organizations need to take into account a much larger set of pay elements while making plan design decisions.

To ensure pay plans are achieving employee outcomes, compensation executives must look at the value employees perceive from a pay element and the cost to the organization of providing it.

Based on this analysis, the Roundtable has found that some pay elements provide 20 times the impact per dollar than others.

Apply the ROI Approach to Increase Outcomes

By applying the ROI approach to pay plan design and making design changes that reallocate what they are currently spending on pay, organizations can increase employee outcomes by an average of 20% without incurring additional costs. Over time, by increasing pay expenses less than they otherwise would, organizations can reduce compensation costs by as much as 7% without negatively affecting employee outcomes.

High-return plan design changes include the following:

• Focus on time—not pay—to promotion: Time to promotion is more important to those earlier in their career than the pay increase that comes with the promotion. Organizations should therefore maintain promotional increases of 5–10%, while reducing time to promotion to roughly three years.
• Increase differentiation: Employees—even those who know they are average performers—want more differentiation than most companies currently have. On average, organizations can achieve the highest impact by setting the merit increase payout ratio to 0-1-3 (for low, average, and high performers respectively).
• Determine mix based on objective: The return on an STI target that is 25% of base pay is the same as the return on an LTI target of the same size. The decision on which type of incentive to use should therefore be based on the organization’s objective for it; STI will drive performance, while LTI will drive retention.