Does compensation even matter?

The topic of compensation is one of the most discussed aspects of the employee lifecycle—it gets attention from both employees and managers and is often the largest expense for any company.

Yet ironically the research is clear that rarely, if ever, do we see it act as a driver of employee engagement, retention, or performance. And increasingly, we hear that compensation matters less for employees than factors like learning, flexibility, company culture, and the ability to make a meaningful impact in the organization and for its customers.

Why then do most companies spend so much of their resources on this one very expensive area of People Systems?

In order to fully understand compensation and build an actionable compensation plan for your company, we will guide you through:

1. Getting compensation right
2. Retaining employees
3. Preventing productivity loss
4. Establishing a fair system
5. 5 compensation models
6. Resources we love
7. Takeaways & next steps

Are we all wasting our time and money trying to get compensation right?

The answer, of course, is yes and no. Compensation, even on its face, clearly is an important reason why employees join and leave jobs. But a more useful framework to understand the impact of compensation is Frederick Herzberg’s Two-Factor theory of motivation. Herzberg recognized that:

Compensation alone rarely increases job satisfaction

But, if compensation is too low or perceived as unfair, it can easily decrease satisfaction

And compensation rarely increases motivation for sustained periods of time

Herzberg called compensation a “hygiene factor” rather than a “motivator.”

What that means is that within a certain level of having one’s needs met, compensation doesn’t move the needle much on retention, satisfaction, or performance. But at the extremes, it can make a big difference, especially when an employee feels wildly undercompensated.As an analogy, consider that taking care of your physical hygiene will rarely get you lots of praise and positive attention, but failing to take care of your hygiene will get you lots of negative attention. Compensation typically works in the same way.

3 compensation pitfalls

Given the “hygiene” nature of compensation, let’s begin by focusing on how to prevent your compensation strategy from having a negative impact. In many ways getting compensation right is all about avoiding the most common compensation pitfalls. The following three factors are the most common compensation culprits:

1. Difficulty hiring and retaining employees
2. Productivity loss
3. Feelings of injustice

Compensation is never just about the quantitative value of the money. It’s just as much (maybe more so!) about the emotional aspect of feeling fairly remunerated. Compensation consists of all monetary and non-monetary rewards that employees receive in exchange for their work. This includes salary, bonuses, equity, and benefits (both physical and emotional).

The most foundational way to get compensation wrong is to offer a comp package that can’t compete with the marketplace. To make sure you don’t fall into this camp, here are four strategies to keep in mind:

1. Define your UEP

Just as companies must have a USP (Unique Selling Proposition) to differentiate themselves from their competitors, employers need to have a differentiation strategy on the value they offer their employees--their UEP (Unique Employment Proposition). Very few companies can or should compete in all areas (e.g., salary, equity, benefits, perks, diversity, mission, geography, flexibility, learning culture). See the exercise below to narrow your UEP and set your compensation strategy.

2. Research market pay

Once you are clear(ish) on your UEP, you’ll want to determine what average compensation looks like for industries, company sizes, and geographies you compete with for talent.

Tools: There are robust tools for this like PayScale, free tools like Glassdoor Salary, and input from your advisors and investors. More advanced data-based tools like Radford or Advanced-HR are great and highly recommended.

Asking candidates: You can also ask candidates to share their compensation requirements for research purposes—just keep in mind that it’s illegal to ask about compensation history because it exacerbates any pre-existing inequities in their salary. It often may be helpful to have a conversation with candidates about compensation expectations early on in the process to set expectations.

Please keep in mind that there is a risk of introducing harmful bias into your hiring process if you anchor offers to where candidates were in the past. It’s a much better strategy to identify a narrow salary range of up front and share that transparently.

‍Using UEP: With your UEP in mind, determine where you want your compensation to land relative to market averages.Note: Not every company has to—or should—pay at above or equal to market ranges. By definition, about half the companies must be below the median, and especially for early-stage companies, it’s much more likely that a higher percentage of compensation will come in the form of equity than cash.Given our increasingly virtual and distributed hiring pool, we recommend equal pay for equal work—with pay tied to roles versus locations. The only exception we believe it makes sense to consider is location-based pay bumps in hard-to-hire, expensive markets or pay bumps for roles that require in-person responsibilities. If someone moves from one of those pricier markets, we do not recommend cutting pay (since this is almost always highly demotivating), but we suggest simply freezing all pay increases until the employee reaches their new pay level.

3. Stay current with the market

You’ll want to reassess your compensation levels every one to two years or whenever you notice an increase in departures or difficulty hiring. Especially in heated job markets, benchmarks rise rapidly, almost certainly faster than is reflected in external data sets. This is another reason why it’s helpful to have your recruiting team gauge candidate expectations so that you can keep current on where the market is moving.

Remember that employees today have access to a wide array of data on what others are getting for their roles. Inside companies, it’s common for people to share what they’re making (and we believe it’s a good thing because it fosters transparency and creates positive pressure towards fairness). Plus, in a strong job market, it’s likely your best employees are getting calls from recruiters telling them exactly what they can earn at other places.

When doing compensation reviews of your current team, adjusting to the market is often equally important as adjusting for increases in job impact and role responsibility.

Keep in mind that:

There may be lots of historical reasons why an employee is undercompensated relative to their peers—perhaps they were a very early employee or others negotiated better when they were hired (this is a big reason why we discourage companies from negotiating offers).

Either way, employees will be increasingly resentful if they feel underpaid.

While it may seem unusual to offer an underpaid team member a significant increase, consider how much it will cost you to replace that employee. In almost all cases, it’s far less expensive to retain existing employees than hire new ones. You will likely be paying that new employee market rate at the same premium “increase” you would have given to a known quantity.

4. Expand your hiring pool

Another way to make your compensation strategy work with your hiring needs is to constantly seek ways to expand your hiring pool.

Ask yourself:

• Can you hire in cities where cost of living is lower or job opportunities are more rare?
• Can you reduce unnecessary barriers to entry (like years of experience or specific education requirements) and search for potential over experience?
• Can you invest more in employee onboarding and training so that employees don’t have to come in fully-loaded with all the skills and knowledge you need?

Cash is often not the most important component of overall compensation, and it’s certainly not the biggest driver of retention. If you are an early-stage company, it’s very likely that you don’t have a significant amount of cash on your balance sheet. But you do probably have meaningful equity to offer, perhaps with considerable upside.

Leverage that when selling your offer—especially for candidates who believe in the long-term vision of your company. It can be a huge competitive advantage.

We’re big fans of using equity as a key aspect of compensation. It’s much more closely tied to retention and, more importantly, it aligns all employees around common, shared goals for company performance. Startups are often a marathon, not a sprint. You want to orient your compensation around long-term objectives and ensuring all employees have a real stake in the company’s success.

Just as businesses need to differentiate themselves from their competitors to attract and retain customers, they need to differentiate themselves from other employers to attract and retain talent.

To define your company’s Unique Employment Proposition (UEP), try this team exercise from LifeLabs Learning:

Template: Unique Employment Proposition Exercise

Based on the insights you glean from the discussion, narrow your UEP to 2-5 factors you believe can allow your company to compete for the types of employees you most need. Use this UEP as your guide to decide on your compensation philosophy and strategy.Keep in mind that non-financial benefits are becoming a more impactful way to differentiate your company. For example, strong benefits around physical, mental, and financial wellness are increasingly important and compelling.

Another easy way to miss the mark with compensation is to pay people so little that they can’t afford to be fully focused on and invested in their work. To avoid this situation, consider the following tactics:

‍Pay a living wage: Ensure that you’re paying enough for your employee to maintain a normal standard of living. Here is a helpful database to check your wages.

‍Have sufficient benefits: Aside from salary, make sure your health benefits make it possible for employees to take care of themselves and their families to the extent your company can afford it.

To get the most value from your benefits, do an annual survey to learn which benefits matter most to your team.

‍Offer financial education: Increasingly, we’re seeing companies go beyond physical and mental health support and also provide financial support, like 401(k)s, and education, like workshops or advising on paying down debt and saving for retirement.

Companies like Northstar offer a powerful benefit to employees to help make sure they can focus on financial wellness and security.

‍Provide enough sick/wellness days: Don’t reinforce working while sick, which can harm productivity, engagement, and—as 2020 has taught us—spread illness to others.

A simple solution here is to offer as many sick/wellness days as your company can reasonably afford.

While paying too little is the far more common scenario, paying too much also has its downsides. Overfocusing on extrinsic motivators can “crowd out” intrinsic motivation, making employees less engaged by their work and more dependent on earning larger and larger amounts of money to stay motivated.

The single easiest way to upset your employees with compensation is to create the reality and/or perception of injustice.

It’s important to remember for many people compensation is as much an emotional experience as it is a rational one—the feeling of being paid fairly is often more important than objective valuation. To counteract this possibility and create a truly fair system, consider instituting the following norms:

Share your comp philosophy

It’s easy for people to make assumptions about why some people are paid more than others or receive a different amount of equity, inviting resentment to seep in. Prevent it before it starts by being forthright with your compensation philosophy (see the exercise below).

Explain how you think about salary, benefits, equity, and any other aspects of your compensation and why you compensate your team the way you do.

To see part of our internal compensation training at LifeLabs Learning, check out this video.‍

Distribute decision-making power

If a judgment call ever has to be made about someone’s compensation (e.g., assessing someone’s skill level), reduce the impact of bias by having at least two decision-makers and a third tie-breaker.

Use a transparent formula

Even if you’re not publishing each person’s salary transparently, make your formula for calculating compensation transparent.

For example: Buffer’s formula is job type X seniority X experience + location.

At LifeLabs Learning, we use the formula role band X skill level X tenure + location (if in a hard-to-hire city).

Do not negotiate

Decide on your compensation offer with your decision-making crew before making an offer (whether you’re hiring a new employee or hiring an existing employee into a new role). Explain to candidates and employees up front that you do not negotiate as part of your commitment to reduce compensation gaps and inequities.

Avoid “pay-for-performance”

A common but highly outdated salary model in the U.S. called pay-for-performance is at the heart of a lot of pay inequity and conflict. We strongly advise against it.

This model assumes that it’s desirable (and possible) to pay people who are doing the same work differently based on their performance. In practice, there is no evidence that this model drives performance among knowledge workers and it is almost impossible to identify meaningful differences in individual performance. Instead, the impact is competition, frustration, pay gaps, and unfairness.

Especially in early-stage startups where goals are constantly changing to a quickly moving marketplace, it’s difficult to apply fair and bias-free measurement of performance against others on a regular basis.

Instead, hold the bar high for performance and impact and assume anyone in the role is at that level. Drive accountability and coach and develop to improve performance wherever you can. Rather than assuming you will pay employees differentially, ask the hard questions about why you’re tolerating sustained levels of lower performance to begin with.We recommend and favor:

Salary models focused on market-based pay for role responsibilities—with all individuals who have the same role and objectives (or same role band) being compensated equally within relatively narrow bands.

Team-based bonuses over individual ones for most roles; especially in early-stage companies where you want to incentivize collaboration over competition, and the goals by which performance might be measured are often changing month to month.

To come up with your company’s compensation philosophy, you can start by assessing your principles around compensation:

Compensation Philosophy Exercise

After completing this team exercise, you’re ready to craft your startup’s compensation philosophy statement. For example:At our company, we believe that compensation should be .So here is the formula/system we use to determine how compensation works for each role/person: .If you have any questions or feedback, please contact us.

Want to consider different models for how you pay your team? Here are some less-common but increasingly popular models to explore (or mix and match):

Tenure-based

Compensation increases with time (as long as employees are meeting all their role requirements and success metrics).

Comp stack

Different components of someone's role earn different amounts and employees can

Self-set

Compensation is set by employees themselves, following consultation from a group of peers (if their peers do not believe the pay is justified relative to their contributions, they can choose to fire the employee).

Marketplace

Employees can apply (or be recruited) for various projects and are paid on a per-project basis.

Equal pay

All employees are paid the same exact amount regardless of their role.

Many resources and tools are readily available—and economical—to help you and your team manage an agile product development process. For starters, take a look at these recommended reads and technologies.

Must-reads

Creating the Lean Startup [Inc.com]

I’m a true fan of articles that share real-world learnings which have evolved into market norms that we practice every day in the workplace. In 2011, Eric Ries wrote a book that transformed the way in which people thought about product development. “The Lean Startup” introduced the modern—and now best in practice—approach toward product development, inspired by the ability to iterate and evolve at hyper speed in the online services economy.

Prior to the release of this book, however, Eric was a successful CTO, having built IMVU, a disruptive messaging app founded in 2004 that boasted millions of users and over $50 million in revenue in 2011. This Inc. Magazine article, which was written following the release of Eric’s industry-changing book, recounts the product challenges and experiences he faced that allowed him to develop the lean methodology. The article demonstrates the moment of realization of how things could be done better—and sets the field for modern product practices.

A Quick 5-Step Guide to Lean Product Development [Dozuki]

There’s nothing like a step-by-step guide to business excellence; I’m a big fan of lean methodology in the process of building products and taking them to market. However, there is often confusion related to two main questions around this approach:

1. Is this for software/services only, or can it be applied to a wider set of product offerings?
2. How is this different from a traditional approach, and how do I know which one I am executing?

Dozuki provides enterprise-level workflow software to drive more efficiency in teams. This blog article is a great encapsulation of lean methodology that is not industry-specific and clearly illustrates the different choices being made between lean and traditional methods.

As true evangelists of the lean approach, Dozuki provides a great guide on the decision criteria and processes to be undertaken to optimize the product development process in this easy-to-follow summary.

‍How Superhuman Built an Engine to Find Product-Market Fit [First Round Review]

‍I always really enjoy reading stories by entrepreneurs about their growth and learnings as they face challenges and introduce unique approaches in their areas of expertise.

Rahul Vohra is CEO and founder of Superhuman, an email management platform that has established a tremendous following even while in stealth mode. Even though they’ve been onboarding tens of thousands of users already, they boast a waitlist of over 250,000 applications to use their service. Superhuman is a true example of product-market fit and a poster child for lean product development and mastery.

Superhuman faced a meaningful challenge in trying to practice agile development while limiting their access to public market feedback. They mastered the art of solving for product-market fit by asking their limited number of test users one simple question:How would you feel if you could no longer use Superhuman?‍

‍A) Very disappointedB) Somewhat disappointedC) Not disappointed

‍The theories behind metrics they collected and what those meant are detailed and well-defined in this article. I believe this is a very repeatable practice for other firms in their early stages of product development.

Process management tools

• Clubhouse.io is the issue-tracking tool M13 recommends first for smaller teams and startups. Like its competitor tool JIRA, it accommodates defect tracking and agile project management. As your team ramps up in size, JIRA may provide a more robust solution for your evolving needs. SamePage, WorkOtter, and ProjectManager are also good issue-tracking tools for early-stage startups.
• Basecamp is a web-based project management tool that offers to-do lists, milestone management, forum-like messaging, file sharing, and time tracking. It’s perfect for deliverable management and archiving— especially creative deliverables. Interested in a couple of alternatives? Check out Trello, Asana, or Monday.

Communication tools

Keep remote product teams connected and collaborating seamlessly with these communication tools: Slack, Zoom, Chanty, or RocketChat.

Moving toward product-market fit takes an agile methodology, a commitment to customers, and a willingness to test and learn nonstop.

An effective pricing strategy will lead to a strong go-to-market hypothesis, but it must also be responsive to insights that you learn from being in market. There are three steps to creating a pricing strategy:

1. Understand your stakeholders, including their problems and motivations and their options for addressing each
2. Define your model by using all of the parameters to create rules that scale prices in proportion to your customers’ willingness to pay
3. Measure and optimize your model by defining your target metric and implementing a measurement strategy

Optimizing your pricing model provides a significant competitive advantage by allowing startups to capture more of the value that they create as revenue so that it can be reinvested into growth—but founders have to consider a dizzying number of inputs to craft a good model. There are many important factors on the customer side (including value vs. baseline, competitor alternatives) and the business side (costs to serve, growth loops).This guide can help founders organize their research and the most pertinent factors. Each business has unique considerations—some of which can’t be accounted for in a streamlined template—but we’re always available to help you apply insights from other companies to your unique challenges.

Resources we love

Growth at All Costs is Perilous — This is How to Scale Sales Sustainably learn more about how acquisition efficiency is measured and used to improve acquisition efficiency for Sales-led acquisition models.

Outcome Based Value Metrics Reduce Churn, Increase Revenue review the data that Profitwell collected on the efficacy of the three types of value metrics.

Whether you need help selecting partners for your financial tech stack or polishing the messaging in a press release for your new pricing, you can reach out to your investment lead or the Propulsion team.