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Which is Better--Higher Salaries or Bigger Incentives?

August 30, 2018 • By Ken Gibson

That is a question every business struggles to answer.  Some company leaders reason that paying salaries at the higher end of the market will attract the best people and therefore the company will perform better.  Others are determined to tie compensation to results and so want a high percentage of employee compensation to be “at risk.”  So is one right and the other wrong?

You’d be surprised if I chose sides, right?  Well, I do actually believe one is the better approach, but I need to lay some groundwork before I tell you which it is.  So let’s begin with a few foundational issues.

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The reason most companies have a hard time with this issue is because it requires them to identify two things:

  1. What kind of talent they want to attract.
  2. What their philosophy is about compensation.

The two issues really can’t be separated from each other. A company’s pay philosophy has to align with the people it hopes to draw to the business. This is because what the company believes about compensation will be reflected in the pay package it offers to recruits.  That package is an important part of the overall employee value proposition the company serves up.  Without the right value offer, a company will never attract the people it needs.

The other reason the two are related is that your pay philosophy becomes a means of screening the recruits you are pursuing.  For example, if you are trying to hire a chief revenue officer with an expectation of doubling revenue over the next two years, and you then find out the person you are speaking with would prefer a large salary with modest incentives, then you probably have the wrong person.  It’s your pay philosophy that told you that.

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3 Principles

So, with that background in mind, let’s talk about three principles that can guide you in deciding whether high salaries or high incentives are a better strategy for your compensation approach

Principle #1—Have a clear value creation definition. 

Before you can decide on a how your pay approach should be structured, you have to know the threshold at which you consider profits to be attributable to the performance of your people as opposed to other assets at work in the business.  This can be determined by doing a ROTRI™ calculation and identifying the productivity profit being driven by your employees.  You can learn about ROTRI and productivity profit by clicking here.

If you know how value creation is defined in your business, it is easier to envision the best way to share that value with those who help produce it.  Pay structures that favor high salaries and low incentives do not reflect a wealth multiplier philosophy which essentially says that all stake holders should have their earnings tied to their ability to help the company grow.  Paying high salaries and low incentives is antithetical to a philosophy that wants to encourage value creation.

Principle #2—Understand what kind pay arrangement the talent wants that you are trying to attract.

For example, if you have an environment where you are trying to fill a lot of tech engineering positions, there is a good chance a high salary approach is going to be better suited to what you’re trying to accomplish.  Engineers are typically looking for stability rather than a chance at a high upside through some kind of value-sharing plan. 

However, be careful in your assumptions.  If you are trying to attract people that are coming from public companies that gave their employees stock or options, those recruits may be expecting a similar opportunity with your organization.  In this context, they don’t look at participation in such a plan as being a performance driver.  Instead, they look at it simply as “fair."  The feeling is that if people contribute to the growth of a company, they should participate in the value they helped create.

Principle #3—Be realistic about the stage of development your business is in right now.

If you are a startup company, it is not likely that you can “afford” to pay high salaries right now—even if you think it is the best approach.  By default, you have to be more creative and place emphasis on long-term earnings opportunities based on company growth.

However, even if you are operating a mature company, if high growth is a priority, it probably doesn’t make sense to lock in high salaries.  If you want growth, then you need employees to be growth partners.  That means a good portion of their earnings opportunity should be “at risk” just as yours is.  In other words, you should want employees who want a compensation arrangement that ties their earnings to their performance.  Those people will be hungry to achieve results and more aligned with ownership when it comes to focusing on outcomes.

If you are following the logic being laid out here, you are probably beginning to conclude that the only organizations that might gravitate to “higher salaries, lower incentives” are non-profits and those who are essentially “riding the wave” of previous success and just trying to maintain rather than grow.  Frankly, I don’t know that any company falls in that latter category anymore.  Companies are either growing or going away.  There’s not a lot in between.  As a result, pretty much everyone should want a high degree of their compensation offering to be variable and not guaranteed.

So as you look at your situation, consider these three principles.  Perhaps you will arrive at a kind of middle ground rather than at either extreme.  And you may determine that you want more compensation at risk for some employees (top tier executives, for example) than others (clerical or “staff” roles).    Just be careful about making too many assumptions until you have formulated a clear pay philosophy.  And don’t assume because others in your industry are doing it a certain way that it makes sense for you to follow suit.

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Ken Gibson

Ken is Senior Vice-President of The VisionLink Advisory Group. He is a frequent speaker and author on rewards strategies and has advised companies for over 30 years regarding executive compensation and benefit issues.