Developing Your Own Compensation Strategy

Nobody grows up longing for the opportunity to decide what salary other people are going to make, except maybe a sociopath. The rest of us just want to do the right thing and still end up with a friend or two.

I've come to believe that aiming for perfect compensation decisions is a fool's errand. The best we can do is to develop a smart compensation strategy, and then apply that framework carefully each time.

There's too much emotion and too many variables to hope for anything except "close enough" and having a strategy is a methodical way to make as few errors as possible. So that's what I'm going to describe to you. It's essentially a decision-making matrix to keep you as objective as possible. Here are the assumptions I think you should make, in order.

1. Pay yourself first. Some of you are paying a very hefty price to ensure that you never have another boss, and it's unnecessary. Whether you split this between fixed compensation and ownership distributions, I don't care, but the principal of any firm of five people or more should not be making less than USD $170,000. When you have dozens of people, your regular comp should be in the $300,000-400,000 range. (Multiple partners will lower this a fair bit.) I publish tables for this and integrate them into my valuation work, but that'll get you started. If that number seems high to you, then use the liberating formula of never paying yourself less than 130% of what the highest non-partner makes.
2. Set a scientific salary cap. Decide how much of your gross profit (fee after cost of goods sold is taken out) you can afford to pay on unburdened comp (no taxes, benefits, or bonuses), including yourself. The industry standard is 45%. If you elect to pay more, that has to come from net profit, occupancy costs, or innovation. This is your "salary cap"—it's what you have to work with, and it is a zero-sum game. Overpay one person and you'll have to underpay someone else. This rule is universal: it doesn't matter where your HQ is, where your clients or, or where your team works.
3. Embrace employee turnover as healthy for your firm. If it's for the right reasons, a steady stream of new team members is valuable. Even though it's third, it may be the most challenging mental change for you to make. Most of your bad compensation decisions have sprung from a desire to keep someone around, and since the primary way to make more money in our world is to change jobs, you try to provide that benefit without them having to go somewhere else. More specifically, here are the four groups of people that you will tend to overpay: they have been with you a long time, they know what other team members make, they sell themselves well, or they have taken over something that freed you up substantially from something you don't want to start doing again. Recognize these particular temptations, and then of employee turnover as your chance to draft well rather than having to sign expensive free agents. One of those big name hires can equal two or three rising employees.
4. Minimize the pain of employee turnover. The most important component is to take recruiting seriously. I think it's harder to find great people than great clients, and because of that it's more important to have a marketing plan for people than for clients. In that pursuit, your positioning is your culture. The second is to have great orientation procedures in place. The third is to make training something that you reward in people: everybody seems to talk about "curiosity" in their values but they seldom talk about mentorship. Your shop needs to get the reputation where people go learn from the very best, but there's the tension. If your ecosystem doesn't allow for and in fact encourage mentorship (versus always being "billable"), it will be difficult. Identify the natural teachers on staff and honor them. These are the people who are all about process, patience, systems, and prompt check-ins. The people who would otherwise drive you crazy, but whose role is indispensable.
5. Compensation determinations are an integral part of management. If a person's manager isn't making decisions around compensation, hiring, firing, and reviewing, they really aren't managing but suggesting. Give a manager a budget to spend, adjusted quarterly, and push these decisions lower. You can build their management muscle by giving them a compensation strategy. Every compensation change that you institute or avoid is a value judgment.
6. Compensation reflects your actual values and not necessarily your stated ones. One disconnect I'd like to see our industry do better by biulding the values espoused on the website into the employee review process. At the moment they feel more like a positioning tool rather than a management tool, and I wish they weren't as superficial as some of them are. What signal does it send when you pay a handsome amount to that talented, demanding jerk? Or the control freak account manager who has an unhealthy relationship with your biggest client? If you value curiosity and teamwork, build those metrics into your review process.
7. Compensation increases should reflect additional contribution and not the passage of time. Cost of Living Adjustments (COLAs) have not been meaningful in our recent past, so stop it. If you raise someone's pay it's because they are responsible for creating more value. But let me make an important note: some people are better than others at selling themselves and making the case for you. Reward people for doing and being and not just for convincing.
8. Many important factors are not easily measurable and require a judgment call. Whoever said that you can't improve anything you can't measure was in love with philosophical bumper stickers. The team member who spends non-billable time bringing team members up to speed and improving collaboration is just as valuable as the sales closer.
9. Frequent, smaller decisions are always better than infrequent, bigger ones. Not only does this take the pressure off (in case you get it wrong), but you'll be adjusting compensation closer to the accomplishment you are trying to reward and instill in the team. Making a yearly adjustment makes as much sense as keeping track of when your dog pees in the right place and settling up once a year at Christmas. On a related note, scheduling all salary reviews at the same time may make it more convenient, but it's not employee-centric like it should be. Any new compensation plan should be published as "provisional through [date]" so that you can adjust it based on what you learn without appearing to change your mind all the time. Then leave it in place at least three years or the team is going to experience some whiplash.
10. Equity is easy; fairness is hard. Where you fall on this spectrum will have something to do with your philosophical outlook, of course. But some principals choose equity because it's less messy than distinguishing decisions. You aren't doing your job unless you are making judgment calls, but before you announce any such call, explain your reasoning and humbly look to see where you missed something. In the end, though, you'll have to live with some healthy tension. Attempting to resolve tension is how you ended up here in the first place.

There we go, but there's one thing that comes up a lot. "Should I match a higher offer that a key employee gets?" The answer is a firm "no" unless you are correcting an imbalance that you should have fixed long ago, and the ideal is to not let that happen in the first place.

If you've run the numbers and are paying way more than you should as a percentage of the whole, but don't feel like people are necessarily overpaid, the near certain issue is the money you are leaving on the table. Read more here. Overpaid employees are rare—firms who leave too much money on the table and thus struggle to pay those people are common.

*I had a tech meltdown when doing a webinar on this topic, so I've just decided to turn this into an article. You can download the original deck I was using, though I kind of wandered off on my own for the recasting of the content.