The Definitive Guide to Building a Winning Compensation Philosophy (With an Example!)

Table of Contents

1. What is a Compensation Philosophy and 3 Reasons Why it Matters
2. 4 Quick Tips
3. Compensation Philosophy: What to Include
4. Key Considerations
5. Compensation Philosophy Example

“If you don’t know where you are going, you’ll end up someplace else.”  —Yogi Berra

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Within the HR world, “Compensation Philosophy” (sometimes “Compensation Strategy” or “Pay Strategy”) gets thrown around a lot as a core component of your compensation program. But the online resources on compensation philosophies can be really… obtuse. It’s hard to know what it really is, what information should be included in it, or even how you should be using it within your organization.

This is a shame, since building a great compensation philosophy can be an amazing tool for strategic HR leaders to drive alignment across their organizations around their compensation programs.

In this post, we’ll address in simple terms what a compensation philosophy is, and why you should care about building a great one. Then, we’ll go over concrete topics that should be addressed by the content of your compensation philosophy, followed by a compensation philosophy example you can use as a starting point to begin drafting your own. Finally, we’ll close with some key considerations for operationalizing your new compensation philosophy at your organization. By the end of this post, you should not only be able to draft a best-in-class compensation philosophy, you should know how to actually use it as a strategic tool to drive better compensation decisions - decisions that help you attract and retain talent, build trust with your employees and managers, and ensure true pay equity. That’s what it’s all about, right?

What is a Compensation Philosophy and 3 Reasons Why it Matters

💡Tip: Follow along with our compensation philosophy template

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Let’s get started with a basic definition of what a compensation philosophy really is. A compensation philosophy is the formal, single source of truth for your organization’s approach to compensating employees. 

Building your compensation philosophy is the highest-level and most strategic aspect of an organization’s compensation program. Typically crafted in conjunction with company leadership, it ties the organization’s overall business goals, constraints, and core values to your company’s approach to compensation. 

There are three big reasons why strategic HR leaders should care about building a great compensation philosophy at their organization:

1. It is a crucial way to align leadership and get buy-in on their compensation program

The compensation philosophy is the component of your compensation practice where you make explicit the connection between an organization’s overall goals and how they manifest in compensation. It’s the ultimate “Why should I care?” document for strategic leadership, and a great communications framework for HR leaders to position their function to other C-suite executives in a way that contextualizes the impact of compensation in terms of broader company strategy.

At Assemble, we recommend that HR leaders use the compensation philosophy as a tool to align the highest levels of the organization around a set of core objectives and principles for the organization’s compensation program. Once a compensation philosophy is in place, it becomes easy for HR leaders to frame conversations about compensation with leadership in terms of mutual goals that bubble up to core business strategy, promoting cross-functional collaboration and reducing confusion.

2. You can (and should) build everything else based on it

At Assemble, we consider the compensation philosophy the first place to start when building out a compensation program, because everything else about your program should flow directly from your core philosophy. Let your compensation philosophy be the shared framework that drives your compensation decisions.

Once your leadership has aligned on your compensation philosophy, you can begin to assemble the building blocks that make that philosophy a reality in your day to day pay practices. For example: Does your organization consider location an important factor in compensation decisions? If so, how? If you do consider location a factor in compensation, you'll need a framework for location-based compensation decisions. If commitment to transparency is an important component, you’ll need a strategy for enabling managers, recruiters, and employees with the tools they need to achieve accurate and consistent messaging. And so on.

3. Starting with a philosophy is the best way to measure your compensation program’s effectiveness

At Assemble, one of our five quality tests for any compensation program is consistency - the idea that your compensation practices should be consistent with your organization’s core policies and beliefs. These core policies and beliefs should be clearly outlined in your compensation philosophy, which in turn, should become the blueprint for how you measure your compensation program’s overall performance. For example, if your compensation philosophy says that you aim to pay at 60th percentile of the market, you can measure the extent to which your actual compensation practices are consistent with this policy by looking at the total compensation of employees to see how many are above or below 60th percentile of market for their position and location (if applicable).

4 Quick Tips for Building Your Compensation Philosophy

1. Make it visible.

Greater visibility will help ensure adoption. Share with your full organization or, at a minimum, with all leadership.

2. Be intentional.

Ensure your compensation philosophy supports your mission and business objectives. Use it to guide compensation strategy and decisions.

3. Be clear and specific.

If your compensation philosophy is too general or ambiguous, it will fail to give sufficient guidance. Avoid room for misinterpretation.

4. Review it periodically.

Your compensation philosophy is a breathing document. Review and update it anytime one of your practices or policies change; at a minimum once a year, ideally before merit cycles or during the annual planning process.

Compensation Philosophy: What to Include

Compensation Program Purpose

Clearly describe the purpose of your compensation practice within the context of your broader organizational goals and mission. A few things to consider as you think about your the purpose of your compensation practice:

Goals & Mission

What are your organization’s high-level goals? How does compensation help achieve them?

Values

What are your company’s values, and how should they manifest in how you compensate your employees?

Constraints

What are some of your organization's constraints and limitations when it comes to compensation? Are there any factors of your business that limit its resources with respect to compensation? (e.g., due to location, industry, market environment, business model, etc.) 

These statements can be general or specific, but commonly include some variations of the following:

• To attract, motivate, and retain talent; or
• To support the organization’s mission and business objectives

At Assemble, we recommend considering our five pillars as you build this out:

1. Fair across departments, ladders, and positions
2. Equitable among employees — (i.e., avoid unwanted biases; equal pay for equal work)
3. Competitive against your desired market
4. Consistent with your policies and beliefs
5. Explainable (e.g., transparent, easily justified) to your people

Incorporating these principles in your compensation philosophy will help you make better compensation decisions that empower your people, and can build trust and buy-in across your organization.

Market Competitiveness

Include a statement on your target competitiveness against the market, and use this to guide decisions around your compensation bands and pay decisions. Your philosophy’s stance on competitiveness should be achievable for your business - i.e., don’t say that you would pay at 90th percentile of the market if your budget will not allow you to make that intention a reality.

Specificity on competitiveness tends to vary wildly company by company, from general statements like "at or above market," to specific commitments such as "50th percentile on cash for sales roles." We recommend being as specific as you can. Statements that are too general or ambiguous fail to give sufficient guidance and leave room for misinterpretation.

Some organizations also explain what they consider to be their "market" (e.g., organizations with similar funding raised, valuation, employee count, and/or revenue), and the process to determine market competitiveness (e.g., selecting market dataset(s), matching internal positions against market positions). We recommend doing this as well.

Location

With the rise of distributed work, many organizations now have employees across multiple locations, and are hiring in even more locations. For such cases, it is important for your organization to have a view on how location will impact compensation decisions — if at all. 

We generally see two main approaches to location-based compensation:

1. Cost of market (aka cost of labor). This requires local pay rates for each position at your organization. While preferable, this is more difficult to achieve, as data is sometimes unavailable.
2. Cost of living adjustments. This requires adjustment rates for each location, using cost of living indexes found in websites like Numbeo.com or Expatistan.com.

For organizations with many locations, we recommend creating "zones," "regions," or “tiers” that group similar locales, rather build different compensation frameworks for every city you hire. This can reduce variability and administrative burden, and give your organization control and consistency over decisions, without overloading your team with too much work.

Compensation Types

List out the compensation types that your organization uses. For many, compensation is more than just base salary. Does it include benefits, variable pay (aka incentive pay), equity, or other allowances (e.g., stipends or reimbursements)? We recommend being specific and transparent about which compensation types your organization uses, and if applicable, the departments eligible for each type (e.g., a statement such as “Only Sales and Customer Success are eligible for incentive-based pay”).

At Assemble, we categorize compensation types into the following:

Salary

Salary typically gets paid out every two weeks or twice monthly depending on company policy.

Variable Cash or Incentive Pay

For example: Commissions for quota-bearing positions), and Recurring Bonuses (aka MBOs) for certain positions, such as management.

Benefits

For example: Healthcare (e.g., medical, dental, vision), Financial (e.g., 401(k) with or without matching), Other (e.g., commuter benefits).

Equity

‍Participation in the organization's long-term value creation. For example: for corporations - Stock Options and RSUs (for more mature organizations); for partnerships - Shared Profit Interests or Capital Interests.

Allowances and Perks

Stipends or reimbursements. For example: cell phone, gym, lunch, or WFH setup stipends.

Equity Compensation

If your organization has equity-based compensation and you plan to share your compensation philosophy with employees, we advise incorporating an overview for your employees, since not all will be familiar with equity.

Some items to consider including in your compensation philosophy:

Equity compensation overview

‍Make sure to include what specific types of equity is awarded to employees at your organization, as well as why you include equity as part of compensation.

Equity compensation programs

‍Consider including the programs and policies for new hires and existing employees to be awarded equity (e.g., refresh grants, promotion grants, liquidity programs).

Process Overview for Compensation Decisions

How are compensation decisions made and when do they take place at your organization? For many, forming this for the first time can be daunting. Having views on the following categories could help reduce that complexity:

Hiring

‍How is new hire compensation determined? We recommend tying new hire compensation decisions to your official compensation bands for the specific position to which the candidate is applying.

Market Adjustments

‍These are compensation changes tied to changes in the market rates for roles, such as inflation. We recommend reviewing your compensation for market adjustments twice annually.

Performance Adjustments‍

These are compensation changes tied to strong performance, but not associated with a change in level or position. We recommend clearly stating how performance affects compensation, how and when merit increases take place, and who is eligible for each increase cycle.

Promotions‍

These are compensation changes associated with a change in position within a ladder (e.g., L3 → L4), or a change in tracks (e.g., from IC to Manager). We recommend clearly stating how promotions are handled at your organization, and if applicable, who is eligible.

Transfers and Relocations‍

These are compensation changes associated with a change in position across ladders (e.g., Account Executive → Marketing Manager), or change in the employee's Location (e.g., San Francisco → Denver). We recommend having views or guidelines on how these changes will affect compensation. Pay close attention to how you may deal with instances where an employee is transferring to a position with lower pay or relocation to a lower cost location.

Optional Additions

You may choose to add additional topics of consideration to your compensation philosophy depending on specifics related to your unique organization, or depending on the types of roles within your company that you plan to make your philosophy public to. Some additional topics you may include:

1. An explanation of equity, if you choose to share your philosophy with more junior employees
2. Information about compensating in different currencies and accepted currency exchange rates, if you have international employees
3. Tips for contextualizing compensation packages in order to attract top talent, especially if you are resource constrained or your compensation is below-market (e.g., if you run a nonprofit and your resources are limited, you may want to emphasize a sense of mission over a pay package, or a flexible work schedule, etc.)

Key Considerations

Making it Public

Consider making your compensation philosophy visible to all employees — or at least to all stakeholders involved in compensation decision-making, such as hiring managers and recruiters. Visibility will help ensure that your organization makes better compensation decisions by ensuring that everyone is aligned around a common set of program objectives. Do this in Assemble or a shared drive (like your wiki).

Continuous Review

Remember that your compensation philosophy should be a living, breathing document that is a true reflection of your organization’s compensation practices and goals. Make a plan to review it on a regular basis with the appropriate stakeholders. We recommend engaging leadership to review your compensation philosophy at least annually, ideally during the annual planning process or in advance of performance reviews and adjustment cycles.

Compensation Philosophy Example

Now that you understand the core pieces of a compensation philosophy, you can begin the drafting process for one that is unique to your organization. To make it easy, we’ve put together a simple example for you to use as a reference as you write your first draft. 

One quick note: this template is an example compensation philosophy, intended to illustrate what a complete statement might look like. What you choose to include may be more or less detail than what is included here.

For further help up-leveling your compensation philosophy, please schedule a call-- we will be happy to help! :)‍

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Kick-start your Compensation Philosophy

Use our Compensation Philosophy Template

Conclusion

Compensation is not just a number; it reflects how you value your employees as people, and as important contributors to your organization's success. Your compensation philosophy is an opportunity for you to show your employees how you value them, and to clearly communicate the impact of compensation programming to leadership.