In my consulting practice I get asked frequently about what factors go into determining someone’s compensation. As one client put it “what are the ingredients that go into the compensation plan?”
Similar to when you’re preparing a new recipe for the first time – following the directions to the letter, doing the steps in order, and adding all of the ingredients – the same can be said for creating any recipe for success, including compensation plans.
Here is my recipe for creating a successful compensation plan:
Step 1: Determine the Firm’s Compensation Philosophy
Before determining salary ranges and creating a compensation structure, first determine your approach or philosophy to compensation. Ask yourself this question; what is the mindset that drives my pay decisions? Defining your compensation philosophy requires an in-depth look at your beliefs regarding compensation. The key is to create a solid philosophy and be consistent to its application regarding pay practices.
A firm can choose from three general compensation philosophies: to lead, match, or lag the market when compensating its employees. Being a market leader means you pay more for talent than your competitors. Typically, this compensation strategy is to gain an advantage or attract talent away from others. If you decide to match the market, it means you pay roughly the same as your competitors. If an employer lags the market; it is paying less than market rates. Generally, an employer rarely chooses to lag the market as a conscious pay strategy. It is often either discovered after market research reveals the practice, or it may be the result of a limited compensation budget. A company’s attitude toward compensation will drive its decisions through the rest of this process.
An effective compensation philosophy should pass the following quality test:
- Is the plan equitable?
- Is the plan defensible and perceived by employees as fair?
- Is the plan fiscally sustainable over time?
- Is the compensation philosophy and policy legally compliant?
- Can the organization effectively communicate the philosophy, policy and overall programs to employees?
- Are the programs the organization offers fair, competitive, and in line with the compensation philosophy and policies?
Once the firm’s compensation philosophy has passed the quality test, you should have some goals in mind to turn the philosophy into policy. Here are some goals that a firm’s compensation philosophy may strive to achieve:
- Provide market driven competitive compensation.
- Ensure that compensation levels are economically affordable and equitable.
- Reward individual performance, behavior, and key contributions to the firm.
- Reinforce teamwork and cohesiveness by having everyone participate in the plan and share in the financial success of the firm.
- Tie an individual’s compensation to the expectations of the role and position.
- Align the individual’s compensation with the goals and key initiatives of the firm.
- Promote and encourage the values of the firm, including:
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- Client first
- Creating full transparency
- Providing prudent financial advice
- Developing long-term relationships
- Respecting others
Step 2: Rank the Positions in the Firm
The concept with ranking the positions in the firm is to determine the value or worth of each job in comparison to other jobs in the organization – placing jobs in a hierarchy of their value and contribution to the company. The general rule I give here is, the roles that have more impact to the end client should have a higher compensation opportunity. For example, advisory roles that have direct interaction with and influence on clients (and have the highest earning potential) should have the highest compensation. Now, what about your support staff roles? With roles such as client service administrators, operations and portfolio analysts, operations managers, etc., focus on how critical their job function is to servicing and retaining your existing clients. The value of these positions can also be determined by reviewing compensation benchmark data in the next step of my recipe.
Step 3: Establish Market Ranges
Establishing market rates for core positions within your organization based upon benchmark data is important for a variety of reasons. First and foremost, it guides your decision making for pay decisions including hiring, promotions, internal equity and salary adjustments, and general compensation budget planning. Because labor costs are the largest expense to any organization, a solid understanding of the external value of each position allows you to develop an approach for setting overall compensation. Compensation benchmarking provides the information needed to define the costs associated with salaries, bonuses/incentives, and total cash compensation. So, by matching up your job descriptions with compensation data, you can get a clear comparison between your staffing expense and the market rate for similar roles in the advisory industry. Here is some advice to follow:
- Start with the industry benchmark reports; always compare job descriptions—never titles alone—when deciding whether a survey job is a good match to your roles. Titles vary widely from firm to firm in terms of scope, size and responsibility.
- Read through the report findings for the latest compensation trends. The Investment News 2017 Adviser Compensation and Staffing Study found that the largest growth in compensation has been in the advisory ranks; support advisors have seen an average increase of 13% in compensation, service advisers have seen a 14% increase, and lead advisors have enjoyed a 23% increase. Understanding the recent compensation data and trends can help you make the right investments with your compensation dollars.
Step 4: Decide on Individual Compensation Levels
Once you have salary survey data for each role in your firm established the following guidelines will help to determine where your employees should be paid within your compensation structure:
- The lower 25% is where an inexperienced person just starting out new in a role would be positioned in the salary range.
- The median represents the pay range for a more seasoned and experienced incumbent in the role, and who is meeting or exceeding performance expectations.
- 75% and above is the range is for the most experienced incumbent who is seen as an expert. Within this range, increased pay opportunities should only come in the form of incentive pay unless, market conditions and competition for talent forces increasing bases above the 75% range.
In referencing years of experience of new hires or incumbents, remember this is experience relative to the employee’s current role. This should not include prior professional experience that is not directly related to the role. For example, if you hire a junior level advisor who previously worked selling medical equipment you would not count the years working in the medical field as related experience.
There are some grey areas, or as I like to say, “Setting compensation levels is more of an art than science.” In this example, you have candidate “A” who has some related work experience that makes them more attractive than candidate “B” without any work history. Bringing in candidate “A” would mean paying them within the median range to compensate for the amount of applicable work experience they bring. Bringing in candidate “B” would mean paying them in the bottom 25% to compensate for their lack of work experience. It would be up to you to decide if work experience is of more value than saving on your bottom line.
Step 5: The Special Ingredients
So what are the special ingredients that go into finalizing your recipe for pay ranges and overall compensation levels? Most of the salary survey data that is available is of national average statistics, meaning the pay that someone living in an average US demographic would receive. Some geographical locations will be above the national average (San Francisco, New York City, Chicago, etc.) and others may fall below (Colombia SC, Albuquerque, NM, Nashville, TN, etc.,) so adjusting for the cost of labor is an important step in determining whether or not your current pay practices are competitive. If your firm falls within a demographic that is at or below the national average, consider whether there is an additional premium that you need to pay to recruit and retain talent in certain positions. For some firms that may be a 10% premium or even higher. The point is that if you know there is competition for talent you may want to apply a premium. It’s important to keep in mind that this premium is applied to not only the new hires to the firm, but also to incumbents who have proven their performance level over time.
Recipe Note: Beware of Internal Equity Issues
Bringing in new hires to the firm during talent shortages – when the price for talent may be at a higher rate – may create inequity with longer tenured employees. If your current salary increase practices haven’t kept up with market pay rates, making pay adjusts for long tenure, outperforming employees is an important step to solidifying internal pay equity.
A Final Recipe Note
Despite the public debate about equal pay for equal work, research indicates that a very small proportion of the gender wage gap is attributable to paying women less than men for doing the same work. This is true, unfortunately, because scholarly research indicates that the gender wage gap occurs because women tend to work in lower-paying jobs, whereas men tend to work in higher-paying jobs. In my consulting experience within the RIA industry this research seems to be correct. The majority of the higher paying roles are filled with male incumbents. I highly recommend making sure you are offering developmental and career progression programs and tracks for all employees in your firm and aligning compensation accordingly. It goes without saying that your firm’s pay practices should pay fairly for experience, knowledge and credentials, notwithstanding, gender, race, color, religion, or national origin.
Kelli Cruz is a Financial Planning columnist and the founder of Cruz Consulting Group in San Francisco. Email her at kelli@cruzconsultinggroup.com or follow her on Twitter at @KelliCruzSF
