3 Types of Compensation: Choose the Best One for Your Team

In 2021, 63% of workers who left their jobs reported low pay as one of the reasons. Fair and competitive compensation is rated by both Millennials and Gen Z, the largest portion of today’s workforce, as a major factor influencing their decision to even apply for a job. If you want to build a global team and attract and retain the world’s top talent, you should take choosing the right compensation type seriously.

This guide takes you through the different types of compensation to help you determine the best route for your team.

What is employee compensation?

Employee compensation encompasses salary, benefits, bonuses, and any additional perks payable to an employee in return for the services they provide.

Also called remuneration in different English-speaking regions (in the UK, for instance), employee compensation typically includes several types of employee benefits that employees receive in addition to their base salary, including statutory employee benefits (social security, health insurance, unemployment insurance) and other monetary and non-monetary perks (bonuses, stipends, stock options).

Employee compensation can have a direct impact on your workforce’s productivity, engagement, satisfaction, and retention.

3 types of compensation

There are several categories of employee compensation based on whether they’re paid directly to the employee and whether they take a monetary form. The three major pay types are:

• Direct compensation
• Indirect compensation
• Non-monetary compensation

Types of direct compensation

• Base pay (salary and wages) and
• Variable pay (bonuses and commission).

Base pay

Base pay is the amount of money an employee receives each pay period (for example, monthly or bi-weekly). Compensation for salaried employees is typically fixed, determined on an annual level and is stated in the employee’s contract as such.

Full-time employees, employees at management positions, and skilled employees typically receive this type of salary. Teachers, accountants, and doctors are usually salaried.

Employees can also be paid an hourly rate based on how many hours they’ve worked within a pay period. Hourly wages are typically assigned to part-time workers, new employees or entry-level workers who have yet to prove their skills. Small businesses are more likely to hire part-time workers paid hourly rather than those on an annual salary, to increase cash-flow flexibility.

Employees who earn an hourly wage are eligible for overtime pay whenever they work more hours than their contract stipulates. This type of compensation is common in hospitality and retail.

Most countries around the world have set a minimum wage that an employer needs to pay to their workers to comply with the Fair Labor Standards Act (FLSA) and avoid legal issues.

Variable pay

Bonuses and commissions are types of variable pay and employees may receive different sums of money each pay period, based on different criteria.

For example, a company may offer an end-of-year bonus or merit pay to top contributors or employees who successfully complete projects and surpass their goals. The non-discretionary performance bonus, for example, have clear eligiblity criteria and employees know what goals they need to achieve to get this bonus, unlike discretionary, which is often kept secret until it's time for an employee to receive it.

Many companies offer their employees a profit-sharing scheme. It means workers get a bonus based on the company’s annual or quarterly profits. This can serve as great motivation for employees to put maximum effort into their work. It’s advisable to create a policy with guidelines on how an employee can withdraw this money.

Commission is a common way to pay sales teams. Sales reps receive a certain percentage of the sales they make, which can increase if they exceed their quota. There are several types of commission:

• Salary plus commission
• Graduated commission (commission goes up along with sales)
• Straight commission (no fixed income, commission only)
• Tiered commission (commission increases after a revenue goal is achieved)
• Residual commission (ongoing commission as long as an account generates revenue)
• Territory volume commission (commission based on a region assigned to a sales rep)
• Variable commission (a combination of different commission types)

Types of indirect compensation

Indirect compensation is a type of financial compensation, where the employer doesn’t make a monetary contribution. Instead, these are typically paid as benefits and can involve the following:

Statutory benefits (depending on the country you hire from):

• Health insurance
• Social security
• Disability insurance
• Unemployment insurance
• Medical leave
• Retirement plans

Non-mandatory benefits:

• Stock options
• Life insurance
• Tuition reimbursement
• Paid time off

Types of non-monetary compensation

Non-monetary compensation typically involves rewarding high-performing employees with a benefit that can’t always be measured by dollar amount:

• Travel vouchers
• Shopping coupons
• Career development opportunities (courses, seminars, stipends)
• Tuition assistance

Other non-financial benefits can be offered to all employees:

• Flexible work schedule
• Remote work options
• Coworking space usage
• Company-provided equipment 
• Fringe benefits, like catered lunch or company car
• Business phone with VoIP facility (for international teams)
• Gym memberships and similar wellness services
• Childcare

What is total compensation?

Total employee compensation can encompass all of the above.

For example, a junior sales representative can have a total compensation made of base salary + mandatory benefits + commissions + non-monetary compensation (remote work options and company-provided equipment). When they receive a promotion and become a sales manager, more benefits may be added to their total compensation.

The total compensation statement is a useful document to provide to your workers, as it contributes to company transparency and helps the employee understand their compensation better. It’s a breakdown of all compensation items, so the employee can reach out to HR or their manager if they have any questions.

How to determine what types of compensation work for your company

Determining the best type of compensation for your employees is a complex and challenging question. Your human resources department may come up with suggestions based on thorough research that involves looking at other businesses in your industry, the availablity of the talent you're looking for, and location since taxes may vary by state.

Other factors that may affect your decision are:

1. Your budget and company goals

Budget will have a significant impact on how you structure employee compensation. For example, startup or small business owners with limited budgets sometimes opt for offering an enhanced benefits package to compensate for a lower base salary.

High-level company goals can also influence your compensation strategy. The goals will determine what activities and positions you’ll prioritize. For example, if you want to grow your sales team, you will have to budget for commissions and bonuses if you want to match the market’s standard.

Don’t forget that there’s a difference between an employee’s gross pay and what they actually take home (net pay). Take your time to calculate what part of your overall funds can be directed to employees’ compensation.

2. The worker's job title, experience, and previous wages

You may want to make a difference between entry-level workers and seniors, staff and managers. For example, new employees may not be entitled to paid days off immediately, but need to spend some time working before they can take a paid day off. The hourly wage for juniors may also be lower and then increase over time.

How much your employees worked for before they started at your company is also relevant. They may be looking for higher pay, or at least the same-level salary that your offer should match.

3. Employee performance

Top-performing employees will deserve merit pay, bonuses, and commissions more often. You can set different forms of compensation depending on employee engagement and the results they achieve, but also need to ensure you have enough room in your budget for these bonuses.

Before you create a compensation system, make sure you can afford all the benefits you’d like to offer to stay competitive and attractive to new hires.

Many companies don’t mention salary in their job posts. If you post a job description, you should include a couple of benefits and at least a salary range your prospective employees can expect.

Note that both full-time employees and contract workers can receive some kind of additional pay as bonuses, as long as you pay them compliantly.

4. Employee location

Many companies opt for global hiring to expand their team’s expertise, and gain some fresh, international insights and a competitive edge, but also to cut hiring costs. Hiring employees in countries where the cost of living is average or below average can make a significant difference to your budget.

The compensation you offer still needs to be fair and competitive if you want to incentivize global talent to work for you. There’s no universal solution for the best compensation plan for remote workers, but these four strategies typically work well:

• Compensation package based on local employee rates, which you can determine by researching local rates for each country you hire from, using job boards like Indeed, Glassdoor, or LinkedIn
• Compensation based on your head office location, based on the market rate for their role in the company’s region
• Global compensation rates, where total compensation is not impacted by the employee’s or company’s location or the employee’s performance, but all employees with the same role and experience level have equal compensation.
• Benchmark rates plus cost of living (COL) adjustments, where you find the global or national benchmark rate for a role to determine an employee’s salary and make adjustments based on the employee’s cost of living.

Create an ideal compensation plan for your business

Creating a compensation plan becomes a more complex task when you start building a global workforce. There are multiple ways to compensate your employees for the work they do: through base salary and benefits, bonuses, non-financial incentives, and more. At the same time, there are multiple compensation strategies to choose from, each with its own benefits and shortcomings.

Thorough market research will help you take the pulse of what talent needs and setting goals and priorities will help you determine which strategy will be most effective to grow your business.

To learn more about compensation strategies usually giving the best results in remote teams, download our Guide to Employee Compensation Strategies.