How to Design a Fair Compensation System for Agile Companies

Rating

How to Design a Fair Compensation System for Agile Companies

In his book Management 3.0, Jurgen Appelo argues that in agile (innovative) companies, people should not be paid according to the time they spend in work or only the results of their work. Rather they should be compensated based on two types of effort they put in work:
1. The effort of pursuing new things that add value through experimentation (innovation), and
2. The effort of following good practices that are already known (deliberate practices)
In order to measure these efforts, we must rely more than before on peer pressure since coworkers are fine observers of each other's behavior.

A compensation plan should have two parts: a salary formula and a merit/bonus system. Salaries are predictable stable monthly income, while merits money is unpredictable in line with the varying business environment.

1. Part one—Design a Salary Formula:
   
   • Step one: Group people into broad categories (C). Categories are defined by the strategic value the group adds to the business model and allocated with different weights accordingly (e.g. in a software development company, developers should be grouped into one separate category that has the highest weight). Each person is identified into only one category based on his main responsibility/contribution.
   • Step two: Subcategorize people of the same category into "tags" (T), based on their secondary or tertiary responsibilities. Each person can have from zero to multiple tags. Like categories, tags also need to be assigned with different weights in line with the amount of value they add to the company.
   • Step three: Within each category and tag, rank each employee into several levels (L) based on his seniority, maturity, or competence (e.g. junior, medior, and senior levels). Similar to job categories and tags, job levels are used only as weights in the salary formula to distinguish different employees with different values, and not meant to create any hierarchy.
   • Step four: Add more optional variables into your salary formula, such as the employee's age (A), the years of relevant work experience he has (W), his total years of education (E), and the stock options he selected as part of his monthly salary (O), etc. You can even add extras for the person's outstanding and unique qualities and accomplishments, such as winning a Nobel Prize, publishing an excellent management book (N)…
   • Step five: Construct your salary formula with all the variables, taking into consideration the geographical area (G) in which your employees live to reflect the different cost of living in different areas. The formula would look similar to: S = (C x T x L + A + W + E) x G + O + N…
   Important points to keep in mind:
   
   • Transparency is key. Your formula must be well communicated to and understood by everyone. Pay secrecy damages a company's culture and results in low morale, bad performance and high turnover.
   • Never include in the formula any individual performance metric (such as a quarterly or monthly sales target), nor any physical or mental attribute, e.g. race, gender, IQ test result, etc.
   • There's no best salary formula. It depends on a lot of factors, such as your business model, the resources you have, the qualities and desires of your employees, etc. All factors can change, so you must keep your formula easily adaptable.
2. Part two—Design a Merit/Bonus System:
   
   • Step one: Select a virtual currency representing merit points (e.g. hugs, credits, stars, etc.) and distribute it equally to everyone.
   • Step two: Let everyone give the merit out to others (peers) in the organization based on their performance and the value they created.
   • Step three: Periodically, convert the merit points into money or other forms of reward, such as vacation days.
   The key is to use the wisdom of the crowd to decide who deserves what, based on peer workers' observation, and keep the policy as simple and transparent as possible, so as to limit gaming-the-system behavior and encourage good performance and collaboration.

Obviously, the earnings for each employee can then be derived as follows: Earnings = Salaries + Merits-based money
Source:
Appelo, J. (2014). Management 3.0: Leading Agile Developers, Developing Agile Leaders Rotterdam, the Netherlands: Happy Melly Express.