The Science of Compensation Benchmarking: Getting Pay Right

Compensation is among the most consequential decisions companies make about people. Pay too little and you lose talent to competitors. Pay too much and you waste resources that could drive growth. Get it wrong systematically and you create inequity that damages culture and creates legal exposure.

Effective compensation benchmarking provides the foundation for getting pay right.

Why Benchmarking Matters

### The Compensation Challenge

Every company faces competing pressures:

- **Candidates expect market rates.** Information asymmetry has collapsed; candidates know what peers earn. - **Retention requires competitiveness.** Underpaid employees are vulnerable to poaching. - **Resources are constrained.** Every compensation dollar has opportunity cost. - **Equity matters.** Unexplained pay disparities create legal risk and cultural damage.

Benchmarking addresses these pressures by grounding decisions in market data rather than gut feel.

### What Good Benchmarking Provides

**External competitiveness:** Understanding where your pay stands relative to market.

**Internal equity:** Framework for consistent pay across similar roles.

**Decision support:** Data to guide offers, adjustments, and promotions.

**Planning input:** Information for compensation budgeting and strategy.

Building the Benchmarking Framework

### Defining the Market

Start by defining your relevant labor market:

**Industry:** Do you compete primarily within your industry or across industries?

**Geography:** Where do you hire? What markets are relevant for each role?

**Company size:** Does stage, revenue, or headcount define your competitive set?

**Funding stage:** For startups, investor funding affects compensation norms.

Different roles may have different relevant markets—engineering talent may compete across tech, while industry-specific roles compete within sector.

### Selecting Data Sources

Multiple data sources exist, each with tradeoffs:

**Compensation surveys (Radford, Mercer, Culpepper):** - Pros: Large sample sizes, rigorous methodology, detailed cuts - Cons: Expensive, lagging indicators, may not reflect your specific market

**Equity compensation data (Carta, Option Impact):** - Pros: Excellent for startup equity benchmarking - Cons: Limited cash compensation data

**Crowdsourced data (Levels.fyi, Glassdoor, Blind):** - Pros: Real-time, detailed, free - Cons: Self-reported accuracy issues, selection bias

**Recruiter intelligence:** - Pros: Current market insight, offer and acceptance data - Cons: Not systematic, potential bias

**Offer data (what you're competing against):** - Pros: Directly relevant, real-time - Cons: Limited sample, may not represent full market

Best practice: Use multiple sources and triangulate.

### Job Matching

Data is only useful if jobs are properly matched:

**Leveling:** Most surveys use standardized job levels. Map your internal titles to these levels.

**Scope:** Ensure responsibility scope matches—a "Director" at a 50-person company differs from one at 5,000.

**Function:** Be specific. "Marketing" is too broad; "Product Marketing Manager" is better.

**Hybrid roles:** Where roles combine functions, consider multiple matches and weight appropriately.

Analyzing Compensation Data

### Key Statistics

**Percentiles:** The most useful metric. 50th percentile (median) represents market midpoint. 75th represents premium pay.

**Mean:** Less useful than percentiles due to skew from outliers.

**Range:** Spread from 25th to 75th percentile indicates market variation.

### Target Positioning

Define where you want to pay relative to market:

**At market (50th percentile):** Competitive for most roles and most companies.

**Above market (60th-75th percentile):** Premium positioning to attract scarce talent.

**Below market (25th-40th percentile):** May be appropriate with strong equity, mission, or other non-compensation value.

Different roles may have different target positioning based on strategic importance and market scarcity.

### Compensation Mix

Total compensation includes multiple components:

**Base salary:** Fixed cash compensation.

**Variable compensation:** Bonuses tied to performance metrics.

**Equity compensation:** Stock options, RSUs, or other equity grants.

**Benefits and perks:** Healthcare, retirement, professional development, etc.

Benchmark each component separately, as mix varies by role, level, and company stage.

Building Compensation Ranges

### Range Construction

For each role/level, define:

**Minimum:** Entry point for new-to-role employees (typically 80-85% of midpoint).

**Midpoint:** Target for fully competent performers (market reference point).

**Maximum:** Cap for exceptional performers (typically 115-120% of midpoint).

**Spread:** Width of range (typically 40-50% from min to max for professional roles).

### Range Penetration

Use range penetration to guide individual pay:

- **New-to-role:** Lower in range (0-40% penetration) - **Competent:** Middle of range (40-60% penetration) - **Expert/exceeding:** Upper range (60-80% penetration) - **Exceptional/at cap:** Top of range (80-100% penetration)

### Geographic Differentials

For companies hiring across locations:

- Define primary market (usually headquarters) - Calculate differentials for other markets - Decide policy: full localization, partial adjustment, or location-agnostic - Apply consistently with clear communication

Maintaining and Using Benchmarks

### Update Frequency

Compensation markets move. Update benchmarks:

- **Annually:** Full re-benchmarking at minimum - **Semi-annually:** For fast-moving markets (tech, etc.) - **Real-time:** Track offer competitiveness ongoing

### Application in Hiring

Use benchmarks to:

- Set initial offer targets - Define negotiation limits - Evaluate competing offers - Ensure new hire equity with existing team

### Application in Retention

Use benchmarks to:

- Identify employees significantly under market - Prioritize market adjustment investments - Evaluate competing offers to current employees - Plan merit and promotion budgets

### Application in Internal Equity

Use benchmarks to:

- Identify unexplained pay disparities - Ensure consistent treatment across managers - Document compensation decisions for legal defensibility - Build transparent, explainable compensation systems

Common Benchmarking Pitfalls

### Overreliance on Single Sources

Any single data source has limitations. Use multiple sources and understand each one's methodology and biases.

### Stale Data

Compensation markets move quickly. Using 18-month-old survey data in a hot market is a recipe for failed offers.

### Poor Job Matching

Garbage in, garbage out. If your Senior Engineer maps to a mid-level survey job, your data is worthless.

### Ignoring Total Compensation

Comparing base salaries alone misses equity and variable comp—especially problematic for startup comparisons.

### Averaging Across Markets

Averaging SF and Des Moines salaries doesn't give you a valid number for either market.

### Set-and-Forget

Markets change, roles evolve, and competitive dynamics shift. Benchmarks need ongoing maintenance.

Building Compensation Philosophy

Benchmarking supports a broader compensation philosophy:

**Market positioning:** Where do we target pay relative to market?

**Transparency:** How much do we share about compensation approach?

**Equity emphasis:** How do we balance cash vs. equity?

**Individual variation:** How much do we differentiate based on performance?

**Consistency commitment:** How do we ensure fair treatment?

A clear philosophy, supported by rigorous benchmarking, creates compensation systems that attract and retain talent while maintaining financial discipline and legal defensibility.

The companies that get compensation right treat it as a strategic capability—one that requires ongoing investment, systematic data, and thoughtful analysis.