Compensation Philosophy

What a compensation philosophy is

A compensation philosophy (فلسفة الأجور) is a written statement in which an establishment declares the principles that govern its decisions on pay and benefits. It says what the establishment pays for, where it stands against the market, how it balances fixed pay against variable pay and internal fairness against external fairness, who decides exceptions, and how often the statement is reviewed. It is neither a salary table nor a detailed policy. It is the framework from which tables and policies are drawn, and to which people turn when a decision is disputed.

The concept belongs to pay design in management. What follows is an explanation of the concept, and it does not fix the pay of any particular employee.

How a compensation philosophy differs from a policy and a tool

Several documents in an establishment deal with pay, and they are confused because each speaks about money. They differ in the question that each answers:

• The philosophy. Why do we pay this way? It is one sentence or a few that fix a principle, for example an establishment stating that it links part of pay to team performance.
• The policy. What are the rules? Examples are the date of a pay review cycle, the amount allotted to it and the rule for distributing it. The review cycle is described in salary review.
• The tool. How is it carried out? Examples are a salary structure table and approval forms.

An establishment that has a table without a philosophy may pay figures that are consistent with one another and still be unable to say why those figures were chosen. An establishment that has a philosophy without a table cannot turn it into a concrete offer to a candidate.

The decisions a compensation philosophy settles

Each decision in the list below is detailed in a separate glossary term, which the list links. The compensation philosophy does not repeat that detail. It declares the choice that the establishment makes in each:

• What is paid for. The role, performance, mastery or length of service. Where mastery is chosen, pay moves with a described level of mastery. For more on that choice, see competency based pay.
• The position against the market. An establishment can match the market reference, stand above it or stand below it, and each position has a price. These positions are set out in external pay equity. The compensation philosophy declares which position the establishment takes and for which jobs.
• The internal ranking. Job evaluation is the tool that creates the reference for comparing jobs within an establishment, as internal pay equity explains. The compensation philosophy declares whether pay is ranked by the value of the job or by something else.
• Fixed and variable pay. Pay mix shows how the ratio between the two is set and what happens when a target is only partly reached. The compensation philosophy declares what the establishment wants from each part.
• The package beyond cash. Pay can be presented together with benefits as one package, as in total rewards. The compensation philosophy says whether the establishment competes in cash or in other ways.
• Disclosure. This covers what an employee is told about the employee’s own range and about the pay of others, as discussed in pay transparency.

Two further decisions belong in a compensation philosophy and are not settled by any of the terms above: who approves an exception to it and on what basis, and when it is due for review.

How a compensation philosophy is written so that it gets used

The practical test of any compensation philosophy is that two managers who read it reach the same decision in the same case. These are conditions we propose to achieve that:

• It declares a choice and not a wish. “We reward outstanding people” decides nothing that could be breached. “We stand at the market midpoint in reference jobs and slightly below it in support jobs” is a choice that can be breached.
• It states the price. An establishment that chooses to stand below the reference should say what compensates for that.
• It orders the principles where they conflict. If internal fairness conflicts with responding to an outside offer, who decides, and with what priority?
• It leaves figures to the policy. Percentages and amounts change every cycle, and the compensation philosophy is meant to last for years. If a figure appears in it, the figure should be a limit that a single cycle does not change.
• It is short. It runs to one page that a manager reads in minutes. If it grows so long that it is not read, it is not used.
• It names its owner and its review date. A compensation philosophy without an owner is not updated, and one without a date goes out of date.

A hypothetical example: a compensation philosophy that settles an exception

Take a hypothetical establishment whose compensation philosophy reads: “At hiring we offer between the minimum of the range and its midpoint, and we go above the midpoint only with written approval from the finance director.” The job range runs from SAR 7,000 to SAR 9,000, so the midpoint is SAR 8,000. Four employees hold the job, at SAR 7,800, SAR 8,000, SAR 8,200 and SAR 8,400.

A candidate asks for SAR 9,000, the top of the range, which is 9,000 ÷ 8,000 = 112.5% of the midpoint. The request cannot be accepted as an ordinary offer, and under the compensation philosophy it goes to the finance director, who is given the numbers for the decision. The offer costs 9,000 × 12 = SAR 108,000 a year, and an offer at the midpoint costs 8,000 × 12 = SAR 96,000. The difference is 108,000 minus 96,000 = SAR 12,000 a year.

The requested pay exceeds the highest pay among the current employees by 9,000 minus 8,400 = SAR 600. That raises the question whether the current holders of the job will accept this difference of SAR 600 without a reason being given to them.

The compensation philosophy did not decide whether to accept or refuse the request. It fixed who decides and which numbers are put to that person. The figures are all hypothetical and set to illustrate. They do not represent an establishment or a market, and the example does not mean that a range this wide or a compensation philosophy worded this way is correct.

Who takes part in writing a compensation philosophy, and where it sits in the employee value proposition

Three kinds of knowledge meet in writing a compensation philosophy: knowledge of the budget, of the market and of the jobs. They are held by senior management, the finance officer and human resources. We suggest putting the draft to team managers before it is adopted, because they apply it in recruitment offers and in raises. If they cannot apply it, that appears before adoption and not after.

A compensation philosophy is part of a wider picture that the establishment presents to current employees and to candidates. The employee value proposition sets out what the establishment offers its employees in return for what it asks of them, and pay is one of its elements. If the proposition says that the establishment competes on development and stability, the compensation philosophy should not claim that it competes on the highest pay in the market.

Questions to put to a compensation philosophy before it is adopted

• Can an actual decision breach it? If it cannot be breached, it chooses nothing.
• Can a manager who has not seen it explain why two employees in one job differ in pay?
• Can the establishment fund what it declares in a year when revenue is weak?
• Does it match what employees with long service say about how past raises were actually decided?
• Does it name who owns exceptions, and can approved exceptions be reviewed after a cycle?

These are test questions that we propose. A yes to them does not mean that the compensation philosophy is right. It means that the establishment has looked at the likely points of weakness before adopting it.

When a compensation philosophy is reviewed

We do not propose a fixed number of years, because what calls for review is events and not a calendar. The events that call for review include:

• A change in the establishment’s business model, such as a move from a local service to branches in several cities.
• Repeated failure to fill particular jobs at the advertised range.
• A large number of approved exceptions in a single job.
• A change in what the establishment can afford to fund.

At each review the question is whether the principle has changed, or whether the policy and the tool beneath it have changed. The tool alone may need amending while the principle stays. The date of each review, who approved it and what changed are recorded, so that a reader years later knows whether the compensation philosophy in hand is still in force.

What spoils a compensation philosophy

• Contradicting practice. The compensation philosophy says that pay follows performance while raises are paid by length of service. Employees learn from practice and not from the words.
• Being copied from another establishment. The choice of where to stand against the market belongs to each establishment, according to its financial capacity and the talent market in which it competes.
• Promising amounts. A compensation philosophy that promises amounts, or that describes a grant or bonus in a particular way, may be judged by what the establishment has done in practice and not by what the document says about the grant or bonus.
• Piling up exceptions. If exceptions become the rule, the establishment is working to an unwritten philosophy.
• Being written once and left. Jobs, the market and the budget change while the compensation philosophy stays as it was.

Compensation philosophy and the definition of wage in the Labor Law

Article 2 of the Saudi Labor Law (نظام العمل) defines “wage” as the actual wage (الأجر الفعلي). The actual wage is the basic wage plus all the other due increases that are established for the worker in return for effort spent in the work, for risks faced in performing it, or under the employment contract or the work regulation. Among the items listed are commission, allowances, the grant or bonus and in kind benefits.

Article 2 of the Labor Law makes the grant or bonus part of the wage if it is stipulated in the employment contract or in the establishment’s work regulation, or if it has customarily been granted until workers came to regard it as part of the wage and not as a gratuity. The elements that Article 2 of the Labor Law lists are set out in detail in actual wage.

A compensation philosophy that calls a bonus discretionary does not decide whether the bonus counts as part of the wage. Article 2 of the Labor Law looks to the contract, to the establishment’s regulation and, for a grant or bonus, to the custom that has been followed.

For that reason we suggest writing a compensation philosophy as principles and not as a promise of amounts, and checking the description of each pay element in it against the text of Article 2 of the Labor Law and against the employment contract. This is an organisational suggestion and not a condition in Article 2 of the Labor Law.

What the concept leaves to the establishment

A compensation philosophy does not fix an acceptable position against the market, a recommended ratio of fixed to variable pay, or the number or span of grades. We did not find a provision in the Labor Law requiring an establishment to write a compensation philosophy, and we draw no ruling on any other matter from that. Each of these matters is a decision that the establishment declares according to its capacity and the talent market in which it competes.

A compensation philosophy remains a way of making pay decisions explainable and not a guarantee that they are fair. It gives the establishment a principle against which its decisions can be checked, and what is decided in each case rests on the compensation philosophy and on the figures of the case.

This is an explanation of the concept and of the statutory provisions cited, not legal advice.