How to Design a Compensation Strategy That Is Fair and Affordable

Every offer, raise and bonus your company gives says something about what it values. When those decisions are made one at a time, by different managers, under deadline, the result is a pay structure nobody designed: similar jobs paid differently, ranges that drift, and a budget that grows faster than the business. A compensation strategy is the set of written decisions that stops that happening.

This guide explains what a compensation strategy covers and walks through designing one in order, from the business plan to job levels, salary ranges, incentives, benefits and a pay equity check. It also covers the legal rules a US employer's pay structure has to work within, including the pay transparency laws that put pay in job postings in several US states and the EU directive that gives job applicants a right to see the starting pay or its range.

DisclosureJake Jorgovan co-founded Alpha Apex Group, which is mentioned in this article.

What a compensation strategy is

A compensation strategy is a company's plan for how it pays people: how much, in what form, and on what basis. It answers a small number of questions that every pay decision depends on:

• Where do we aim to pay against the market, and does that differ by role?
• How are jobs grouped and leveled, and what range of pay goes with each level?
• How much of pay is fixed, and how much depends on individual, team or company results?
• Which benefits do we offer, and why those?
• How do we review pay, check it is fair, and explain it to employees?

The written answers are usually called a pay philosophy, or compensation philosophy. The ranges, incentive plans and benefits are how it is carried out. Executive pay raises questions of its own; for advisers who specialize in it, see the guide to executive compensation consulting firms.

It helps to think in terms of total compensation. Direct pay is salary, wages, commissions and bonuses. Indirect pay is benefits such as health coverage, retirement contributions and paid leave. Non-monetary rewards, such as development, flexibility and recognition, do not show up in the payroll but do shape whether people stay. Benefits are a large share of the cost: in June 2026, according to the Bureau of Labor Statistics (opens in a new tab), wages and salaries made up 70.0% of private employers' compensation costs and benefits the other 30.0%. BLS counts paid leave, supplemental pay such as overtime and nonproduction bonuses, insurance, retirement and savings, and legally required benefits such as Social Security, Medicare and unemployment insurance in that 30.0%. Use the same categories when you compare costs, and calculate the share for your own workforce.

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Among U.S. workers dissatisfied with their pay in October 2024, eight in ten cited its failure to keep pace with living costs. The chart describes this dissatisfied subgroup, not all workers.pewresearch.org (opens in a new tab)

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BLS June 2026 private-industry totals: benefits were 30% of total employer compensation, equivalent to about 42.9% of wages and salaries. The latter is calculated as 30 ÷ 70.

The six principles a pay structure has to balance

A good structure holds several goals at once, and they pull against each other. Paying at the top of the market helps hiring and strains the budget; rewarding individual performance can work against internal fairness. Naming the six principles makes the trade-offs visible.

You will not maximize all six. The strategy is the record of how you chose to balance them, and why.

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The approach described in this article, shown as a visual guide.

How to design a compensation strategy, step by step

The steps below run in the order the decisions depend on each other. A company reviewing an existing structure can use the same sequence as a checklist.

1. 1

   Start from the business plan and the budget

   Begin with what the company has to achieve over the next few years and what it can afford to spend on people. A company expanding into a new market needs to win scarce hires there; a company protecting margin needs pay that rises with results. Agree with finance on the total compensation budget and how it should move with revenue, so pay commitments stay affordable through a weaker year.

2. 2

   Write the pay philosophy

   Decide where you aim to pay against the market, and say so for each kind of role. You might match the market for most jobs and lead it for the few that drive the business. Where you pay below the market, decide what you offer instead, such as training, more paid time off or flexibility, and say so. Decide the mix of fixed and variable pay, what earns a raise or a promotion, and who approves exceptions. Keep it to a page or two that a manager can apply.

   As a team grows, a leader can't make every decision, so I'd write the philosophy for the managers who will use it: rules for offers, raises and exceptions clear enough that different managers reach the same decision without escalating each one.

3. 3

   Group and level the jobs by their content

   Sort roles into job families (sales, engineering, finance) and levels within each, based on the scope, skill, effort and responsibility the work requires. The EEOC's guidance on the Equal Pay Act (opens in a new tab) says job content, not job titles, determines whether jobs are substantially equal, and the Department of Labor's exemption fact sheet says job titles do not determine whether an employee is exempt from overtime.

4. 4

   Price the jobs against the market

   Choose the market you compete in for each job family: the industries, company sizes and locations you hire from. Then compare a set of benchmark roles against salary survey data for that market, looking at total compensation as well as base pay. Use more than one survey where the role is critical, and record which survey and date each figure came from.

5. 5

   Build salary ranges for the job families and levels

   Set a minimum, a midpoint and a maximum for each job family and level, with the midpoint at the market position your philosophy chose. Decide whether locations need separate ranges. Ranges let managers place new hires and give raises without renegotiating the structure each time. In several places, ranges must also be published in job postings. Washington State's guidance (opens in a new tab) says an employer without a wage scale or salary range for a position should create one before publishing a job posting. The range should reflect what the employer genuinely expects to pay. Before you roll new ranges out, map existing employees to them, price the adjustments, and decide how to handle anyone paid below the minimum, above the maximum or close to what a new hire would get.

6. 6

   Design variable pay around results people can influence

   Tie bonuses and incentives to a small number of measures the employee or team can actually move, defined before the period starts. Write down how payouts are calculated, share it with the people in the plan and apply the same rules to all of them. Give people regular feedback against the measures during the incentive period.

7. 7

   Choose benefits on purpose

   Budget benefits alongside salary and incentives from the start. Ask employees which benefits they value and use, since needs differ by life stage, and check the compliance obligations that come with each plan (covered below). Time off can set a package apart. A Dolby job posting from September 2026 (opens in a new tab) for a San Francisco engineering role offers every other Friday off alongside compensation and benefits.

8. 8

   Check pay equity before you roll it out

   Compare pay for people in comparable roles across sex, race and the other characteristics the law protects, and look for gaps that legitimate job-related factors, such as location or experience, do not explain. Record the reason for each difference you keep, ideally with employment counsel. Close unexplained gaps by raising pay: the Equal Pay Act does not allow an employer to reduce the pay of either sex to equalize pay. Repeat the check each year, and include bonuses and equity awards as well as salary.

9. 9

   Explain how pay is set

   Tell employees how ranges are built, where they sit, what moves them through the range, and how promotion changes their pay. Under the EU pay transparency directive, as each country brings it into law, employers must make the criteria used to set pay, pay levels and pay progression easily accessible to their workers (Member States may exempt employers with fewer than 50 workers from the pay progression part).

10. 10

    Review it on a regular cycle

    Review ranges and the budget at least once a year, or more often if your market is moving quickly, against market data, inflation and the company's own results, and involve managers and finance so adjustments reflect what is happening in the teams. For a sense of scale, in the Employment Cost Index (opens in a new tab) for the 12 months ending June 2026, private industry wages and salaries rose 3.1%, benefit costs rose 3.8%, and inflation-adjusted wages fell 0.4%.

Two published pay philosophies

Two large companies publish the principles behind their pay, and each answers a different design question.

Netflix's culture page (opens in a new tab) says "we pay personal top of market for the role and location", defined as a judgment about what the person could earn in a similar role elsewhere and what Netflix would pay to keep or replace them. The same page says its teams are driven by performance, and asks managers to apply a "keeper test" to each person. Paying at the top of each person's market is expensive; Netflix pairs it with an equally explicit standard for performance.

Salesforce describes its equal pay process (opens in a new tab) on a page updated in March 2026. It says it began evaluating and addressing pay gaps across its global workforce in 2015 and runs an equal pay analysis each year, grouping employees into comparable roles and accounting for job-related factors such as work location and experience. In 2021 it extended the review to equity grants in its annual stock refresh. The approach is a useful model for the equity step above: a fixed annual cycle, defined comparison groups and a review that goes beyond salary to bonuses and stock.

The two examples answer different questions, and a company needs both answers: a market position, and a check that pay is fair within it. A company that pays above the market still needs an annual equity review.

The rules your pay structure has to work within

A compensation strategy is designed inside federal, state and local law, and the rules differ by location and company size. The summary below covers the main US federal requirements and the pay transparency rules that most change how ranges are designed. It is a starting point, not legal advice; confirm the rules for each location with employment counsel.

Minimum wage and overtime

The federal minimum wage (opens in a new tab) is $7.25 an hour, and employers must also meet any higher state or local rate. Some states go further than the federal rules in other ways. The Department of Labor's table of state laws (opens in a new tab) lists California's minimum at $16.90 an hour in October 2026. For covered non-exempt workers, California generally also requires time and a half after eight hours in a day as well as after 40 in a week, and double time after 12 hours in a day; alternative workweeks and other exceptions apply.

Under the Fair Labor Standards Act, non-exempt employees must be paid overtime (opens in a new tab) at not less than time and a half their regular rate for hours worked over 40 in a workweek. To be exempt, an employee generally has to meet a duties test and be paid a salary of at least $684 a week, according to the Department of Labor's Fact Sheet #17A (opens in a new tab). The same fact sheet says nondiscretionary bonuses and commissions paid at least annually can count toward up to 10% of that salary level, and sets a separate test for employees in office or non-manual work paid at least $107,432 a year, including at least $684 a week in salary or fees, who regularly perform at least one exempt duty. These are minimum standards: the same fact sheet says employers must also comply with any state or local law that sets a higher one. Check each state's rules before you set the bottom of an exempt range. A salaried job wrongly treated as exempt can leave the employer owing overtime as back pay. Across all its enforcement, the Department's Wage and Hour Division recovered more than $259 million in back wages (opens in a new tab) for 176,957 workers in fiscal year 2025.

Equal pay and anti-discrimination

The Equal Pay Act requires that men and women in the same workplace receive equal pay for equal work. The jobs need not be identical, only substantially equal, and the law covers all forms of pay, including bonuses, stock options, profit sharing and benefits. Title VII, the Age Discrimination in Employment Act and the Americans with Disabilities Act separately prohibit pay discrimination on the basis of race, color, religion, sex, national origin, age or disability, and do not require the jobs to be substantially equal. The EEOC's page lists the coverage: the Equal Pay Act applies to virtually all employers, Title VII and the ADA to employers with 15 or more employees, and the ADEA to those with 20 or more.

Taxes and benefits

Employers must withhold, report and pay federal employment taxes (opens in a new tab). Federal income tax and the employee's Social Security and Medicare taxes are withheld from pay. The employer also pays its own share of Social Security and Medicare, and pays federal unemployment tax alone. ERISA (opens in a new tab) sets minimum standards for most voluntarily established retirement and health plans in private industry, including plan information for participants, fiduciary duties and an appeals process. Under the Affordable Care Act, an employer that averaged at least 50 full-time employees, including full-time equivalents, in the preceding calendar year is an applicable large employer (opens in a new tab) and must offer affordable, minimum-value coverage to its full-time employees, and offer coverage to their dependents, or may owe a payment.

Pay transparency: your ranges will be seen

Several US states require employers to put pay information, such as a range, in job postings, which means the ranges you design will be read by applicants and by your own employees. Four examples, from the agencies' own pages:

• California: employers with 15 or more employees, at least one of them in California, must include the pay scale in any job posting, and the Labor Commissioner reads this to cover any position that may be filled in California, in person or remotely. Employees can ask for the pay scale for their own position, and employers generally may not ask applicants for their salary history (California Labor Commissioner (opens in a new tab)).
• Colorado: covered employers must disclose compensation, including benefits, in job postings and notices, both internal and public, and must explain career progressions where they use them (Colorado Department of Labor and Employment (opens in a new tab)).
• New York State: businesses with four or more employees must list compensation ranges for covered advertised jobs, promotions and transfers, and say whether a role is commission-based (New York State Department of Labor (opens in a new tab)).
• Washington State: employers with 15 or more employees must include a wage scale or salary range (or the fixed amount, where that is all that is offered) and a general description of benefits and other compensation in job postings (Washington State Department of Labor and Industries (opens in a new tab)).

The European Union's framework is broader. Directive (EU) 2023/970 (opens in a new tab) gives job applicants the right to information about the starting pay or its range, bars employers from asking about pay history, and requires employers to make pay-setting criteria accessible to workers (Member States may exempt employers with fewer than 50 workers from the pay progression part). Member States had to bring it into national law by June 7, 2026. Employers' obligations come through each country's own law, so check the national rules and dates where you employ people. Gender pay gap reporting follows by size. Employers with 250 or more workers report by June 7, 2027 and every year after that, and employers with 150 to 249 workers by the same date and every three years. Employers with 100 to 149 workers report by June 7, 2031 and every three years. A reporting employer whose figures show a gap of at least 5% in average pay between women and men in any category of workers must justify it on objective, gender-neutral criteria or remedy it within six months of submitting its pay report. Otherwise it must carry out a joint pay assessment with workers' representatives.

For design, the lesson is the same. Settle the pay you genuinely expect to offer before you recruit, and check what each jurisdiction requires you to disclose and when. Be ready to explain why two people doing comparable work are paid differently.

Frequently asked questions

What are the three types of compensation?

Direct compensation is the pay employees receive as money: salary, hourly wages, commissions and bonuses. Indirect compensation is benefits, such as health insurance, retirement plans and paid time off. Non-monetary compensation covers rewards without a cash value on the payslip, such as career development, flexibility and recognition. A strategy should decide the mix of all three.

What are the 3 P's of compensation?

The 3 P's separate three reasons for paying someone. Pay for the position reflects the responsibilities of the job, through its level and range. Pay for the person reflects the skills and experience the individual brings, through where they sit within the range. Pay for performance rewards the results they deliver, through raises and variable pay. Keeping the three apart makes it easier to explain why two people in the same job are paid differently.

What is a competitive compensation strategy?

It is one that sets a deliberate position against the market for each kind of role: lead (pay above the market), match (pay at the market) or lag (pay below it and compensate with other rewards, such as equity, flexibility or development). Competitive means knowing the market rate, choosing your position on purpose and being able to hire and keep the people the business needs at that position.

What is an example of a compensation strategy?

Netflix's published approach is a clear example of a lead position: it says it pays each person at the top of their personal market for the role and location. Salesforce's published approach is an example built around internal equity, with an equal pay analysis that it says it began in 2015 and now runs each year. Within one company, a sales team may be paid differently from everyone else, for example a base salary plus commission, because its results can be measured individually.