Beyond 'Competitive Compensation': What Separates Pay Practices from Compensation Philosophy

Why 'Competitive' Isn’t a Compensation Philosophy

Ask most executives about their compensation philosophy -- whether at startups, private, or public companies -- and you'll hear some variation of "we pay competitively” and/or “we pay for performance." Press for specifics—competitive means which percentile? Performance measured how? What happens when market rates and performance signals conflict?—and the answers often reveal that what passes for philosophy is really just an accumulation of pay practices that evolved over time.

This matters more than most founders and many investors and boards realize. A compensation philosophy doesn't describe what you do; it explains why* you do it and provides a framework for making difficult tradeoffs.

Without it, every compensation decision becomes a negotiation rather than an application of principle. Recruiters drive the conversation instead of following guidelines because no coherent guidelines exist. Your offers become internally inconsistent. And your long-term cost structure becomes unpredictable or untenable.

Effective compensation programs rest on four foundational principles. Most organizations violate at least two without realizing it, then wonder why their compensation spend doesn't translate into the business outcomes they expected.

(*See Simon Sinek’s 2009 Book, Start With Why)

Principle 1: Strategy Aligned

Compensation strategy must be directed by business strategy and support strategic initiatives (see my previous article, the HR Strategy Pyramid). This sounds obvious until you examine the details.

Consider a technology company that identifies growth as its primary strategic aim—specifically growth in number of customers, ACV, and ARR. Sounds right on track, doesn’t it? Yet when you examine their variable compensation plan design, the metrics don't take into consideration cost structure or margins. With no consideration of customer acquisition costs, market share or penetration rates, customer retention, or successful launches into new categories—this business is potentially bleeding cash without a path to break even.

Or think about the organization that claims to value cross-functional collaboration and knowledge sharing, yet structures variable pay around individual performance goals with no teamwork or organizational alignment incentives.

Here are a few examples of critical questions to ask:

If growth is your strategic priority, how do you ensure employees are genuinely incentivized to sustainably and repeatedly create this growth? How is innovation rewarded? What happens when an initiative succeeds strategically but fails financially in its first year?

What behaviors do you need to see more of? If you need people taking calculated risks on new products or initiatives, your compensation approach should not penalize short-term failures in the service of long-term learning and ultimate success. If you need radical improvements in operational efficiency, your metrics should reflect process and quality improvements, not just cost reduction (which can also be achieved by cutting headcount).

Most scaling companies come to discover their current compensation programs are artifacts of prior business strategies. The metrics, incentives, and desired behaviors that may have made sense two or three years ago may no longer work for next year or the next 3-5 years (the organizational equivalent of Marshall Goldsmith’s book "What Got You Here Won't Get You There").

Without explicit strategic alignment—reviewed and iterated on—your compensation philosophy can fossilize while your business evolves.

Principle 2: Behavior Reinforcing

Compensation tied solely to revenue production creates short-term thinking and potentially destructive behavior, both internally and externally. Alternatively, compensation tied solely to tenure, seniority, and culture is destructive to meritocracy and typically at odds with achievement of performance objectives. Neither extreme serves an organization well, yet many companies trend toward one or the other without recognizing the consequences.

The principle here is deceptively simple: compensation systems shape and reinforce behavior, and you must be explicit about which behaviors you're reinforcing. There is no replacement for active and thoughtful management of performance -- and your compensation approach either supports or undermines that management.

Consider what happens when you structure sales compensation purely on revenue without constraints on discounting, contract terms, or customer quality. You get revenue—but you may also get unprofitable or unreliable customers, unsustainable contract terms, and a sales culture that optimizes for closing deals and selling "vaporware" rather than building lasting client relationships and partnering with the product team.

Or think about organizations where there is little differentiation in total compensation within levels in the same function. High performers receive roughly the same compensation as adequate performers. The message, however unintentional, is clear: exceptional contribution and adequate performance are valued similarly. Over time, this creates what economists call a "sorting effect"—high performers leave for organizations that differentiate rewards, while low performers stay because they're unlikely to find better compensation for their contribution level elsewhere. In this case, your compensation philosophy is selecting for mediocrity.

The solution here isn't simply to swing to the opposite extreme. Pure pay-for-performance systems can create problematic behaviors of their own: excessive risk-taking, short-term optimization at the expense of long-term value creation, internal competition that destroys collaboration, and gaming of metrics.

Effective behavior reinforcement requires thinking through second-order effects. What behaviors will this compensation approach encourage? What will it discourage? What will people optimize for? Are those the behaviors and optimizations we actually want?

This is where your performance management process and your compensation philosophy must align. A performance framework should articulate the values, competencies, and behaviors you expect. Your compensation approach should reinforce those expectations. If your values emphasize collaboration but your compensation is purely individualistic, expect the values to be ignored.

Principle 3: Affordable

Compensation expense has historically accounted for 70-80% of a company's operating costs. Today, AI development and workflow automation can reduce that cost, through lower headcount requirements, and in some cases partially shifting that cost from OpEx to CapEx. Understanding the P&L at a high level is critical.

So, "affordable" requires further definition based on context.

Is affordability based on a percentage of total expenses? On benchmarking ranges and market pricing of jobs? On revenue per employee? On how much "performance" an employee or team can deliver? Can you quantify the value of employee loyalty or the cost of employee turnover?

These aren't rhetorical questions. They require specific answers that reflect your business model, stage of development, and competitive position. A growth-stage "startup" burning through venture funding to capture market dominance has different considerations than a profitable, bootstrapped business optimizing for sustainable growth.

The companies that manage compensation most effectively model multiple scenarios before establishing programs. What does this compensation structure cost at 50 employees? At 200? At 500? What if we achieve 80% of our growth targets? 120%? What does our option pool and equity overhang look like after this funding round? After the next one?

Unfortunately, many executives make pronouncements like "we'll pay at the 75th percentile" or "we want merit increases in the 4-5% range," thinking of these as proxies for a management philosophy without understanding the long-term implications for both compensation structures and equity dilution. This is essentially creating a financial plan without understanding how these effects compound over time. When budgets tighten, they don't know which levers to pull. They make reactive decisions or reduce programs or headcount in ways that anger employees, confuse managers, and undermine the compensation philosophy and employment brand they claimed to champion.

What affordability actually requires: Understanding your constraints before making commitments. Building compensation guidelines that flex when appropriate. Using incentives (both monetary and non-monetary) strategically rather than reflexively inflating base salaries. Resisting recruiter pressure to throw signing bonuses at every negotiation instead of maintaining sustainable cash and equity cost structures.

Principle 4: In Harmony With Expectations

A compensation program should be externally competitive and internally fair. It should be simple and straightforward, not promote gaming or manipulation, and should recognize and value different skills and competencies. This is where philosophy meets practice, and where most companies struggle.

External competitiveness requires quality market data and the discipline to use it correctly. That means understanding which labor markets you're competing in (geography, industry, company stage and size), using statistically valid data sources rather than anecdotal or publicly sourced information, correctly matching and leveling your positions, and making conscious decisions about where in the data you target (median? 75th percentile? varies by function?) and why.

The companies that manage this well understand comprehensive total rewards—not just base salary, total cash, or relying on forward-looking equity value statements. They know which components matter most for different roles and levels, and what type of employee they are trying to attract.

Internal fairness is harder and often more important for retention. Employees usually don't know what the market pays for their role with precision. But they are likely to know what their colleagues earn. They definitely know whether compensation decisions feel arbitrary, political, or principled.

Internal fairness requires clear job leveling, consistent application of market data, and structured decision-making about exceptions.

When two seemingly similar people earn different amounts, the explanation should be based on objective factors like scope of responsibility, years of relevant experience, performance history, or market demand for skills.

This is where many rapidly scaling companies fail. They negotiate individually with each new hire (or each retention risk), leading to salary compression between managers and direct reports, or creating situations where recently hired employees earn more than tenured high performer. This can also result in inconsistencies in pay practices across teams.

The principle of harmony with expectations means that employees can and should understand how compensation decisions get made, and have trust that those decisions will be made fairly. Be transparent about your philosophy—what you optimize for, what tradeoffs you make, what factors influence decisions. This is not the same as pay transparency.

Building a Philosophy That Actually Guides Decisions

A compensation philosophy isn't a document you write once and file away. It's a framework you return to every time you face a difficult compensation decision:

"We have two strong candidates—one wants $150K base with minimal equity, the other will take $120K with significant equity. But which offer is consistent with our philosophy?"

"Our top engineer got an offer from a competitor at a 30% increase. Do we match it? Counter it? Let them go? What does our philosophy tell us about how to respond?"

"We missed our revenue targets but exceeded our strategic milestones. Do variable pay plans pay out?"

Companies without a coherent philosophy make these decisions reactively, often setting problematic precedents. Companies with strong philosophies use these situations to stress-test and refine their frameworks.

The development process matters as much as the output. A compensation philosophy should reflect input from leadership, board members, finance, and people managers. It should address the specific tradeoffs your company faces—not generic platitudes that could apply to any organization.

Most importantly, it should be revisited regularly. A compensation philosophy at 50 employees will probably not serve you well at 500. Your philosophy as a private, venture-backed company will need revision as you approach an IPO. A philosophy optimized for rapid growth may need adjustment as you shift toward profitability.

Every compensation decision reveals philosophy through practice. The question to answer is whether that philosophy is serving your strategic objectives, reinforcing the behaviors you need, remaining affordable given your constraints, and is in harmony with the expectations of the talent you need to attract and retain.

If you can't answer these questions, then you don't have a philosophy. You have a collection of practices that evolved by accident. And you're likely spending far more time, money, and equity than necessary while getting far less performance and cohesion from your team than you could.

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The four principles of compensation philosophy noted here were initially presented to me by my first independent advisory client; I thought they were perfectly synthesized and have re-crafted the examples and descriptions to meet the needs of my evolving client and portfolio base over the last 15 years.