The Complete Guide to Managing Compensation Cycles

Lars Lofgren Avatar
Disclosure: Our content is reader-supported, which means we earn commissions from links on HR Advice. Commissions do not affect our editorial evaluations or opinions.

A compensation cycle is a period when a company reviews employee compensation to ensure that it meets market standards and reflects company values. In many companies, a compensation cycle lasts for one year, allowing the company to reevaluate and keep compensation updated annually for each employee. 

However, organizations can choose the length of their compensation cycles. While some might review compensation every two years, others might do so quarterly.

One thing is clear: Running regular compensation cycles is a must for businesses. With irregular compensation cycles can come irregular pay practices, unfair rates, and pay compression.  

What Is a Compensation Cycle?

A compensation cycle is a set amount of time during which an organization reviews the wages, salaries, and other forms of pay for its employees. If a company has a one-year compensation cycle, then the company reviews its compensation amounts and practices each year for each employee. 

The term is interchangeable with compensation review cycle. However, it’s not the same as a pay cycle or pay frequency, which refers to the period during which an employee earns their pay for the next paycheck. For example, many companies use a biweekly pay cycle, meaning that their employees earn pay during a two-week period and are paid what they earn every two weeks.

During a compensation cycle, an organization reviews wages or salaries, bonuses, overtime pay, commission and tip structures, and anything else that results in monetary compensation. Meanwhile, non-monetary benefits, like retirement plans or paid vacation or sick time, are not usually included in this review.

Although there are no set rules when it comes to the frequency of a compensation cycle, aligning a business with a set compensation cycle comes with several benefits:

  • Identifying problems quickly: Going years between compensation reviews isn’t going to help companies identify issues that could become significant problems. However, regular compensation cycles keep the process of compensation reviewing in motion to pick up on inconsistencies that could affect employee satisfaction.
  • Fair pay: Compensation cycles encourage companies to benchmark the salaries and bonuses they pay against market value, ensuring that employees receive fair pay for their work based on industry standards.
  • Reduced pay compression: Without consistent compensation reviews, employees may experience pay compression, which causes new hires to have similar salaries as long-term employees. Regular compensation cycles can thwart the issue.
  • Better recruitment efforts: Companies that pay fairly and competitively may find it easier to recruit top talent for open positions. Regular compensation cycles may also help companies retain their best talent.
  • Builds consistency: When a company develops practices that work and continues to participate in them, those practices can become second nature. Pay practices can absolutely benefit from becoming routine to create a solid foundation for fair, transparent pay.

Tying Compensation Cycles to Start Dates

One question business owners should ask themselves regarding compensation cycles: When is the best time to start a compensation cycle?

Sure, you could mark a date on the calendar to renew compensation cycles each year. The problem with that is that not everyone starts working with a company at the same time. Therefore, people who were just hired in the last month may get a quick compensation review, but they may have to wait even longer to get the raise they can only qualify for after one year of employment. 

Additionally, aligning everyone’s compensation cycles can overwhelm the HR team and individual managers responsible for performance reviews. This can lead to checking boxes during a cycle rather than investing the right amount of time into each employee’s compensation cycle. 

At Stone Press, we run compensation cycles once per year, beginning on the day an employee starts with us. If they get a promotion out of cycle, the promotion date acts as their new start date. 

Personally, I believe this process has created a fair cycle for us. Management and HR have between one and three employees to review compensation cycles for each quarter, on average, with clear dates to prepare for. Plus, each employee gets the same one-year cycle that’s easy for them to keep track of if they remember their start date. 

What’s the Best Compensation Cycle Frequency?

I advocate for running a compensation cycle at least once a year. This seems to work well for most companies, as it doesn’t leave too much time in between reviews, yet still gives management ample time to monitor and evaluate employee performances.

With that said, more frequent compensation cycles aren’t necessarily a bad thing. Take a bi-annual compensation cycle, for instance. This could help alleviate the following problems that an annual compensation cycle might not catch as quickly:

  • Accounting for rapid increases and declines in inflation 
  • Identifying pay compression
  • Having more frequent reviews of raise and bonus eligibility

Of course, bi-annual compensation reviews do place more work on managers and HR teams, so you’ll need to decide if its potential benefits outweigh the drawbacks. 

What you don’t want to do is run comp cycles less frequently than once per year. Doing so could push you out of the running as a competitive company in terms of pay and benefits, reduce employee satisfaction, and cause unnecessary rifts in your compensation management process.

How to Manage the Compensation Cycle

Compensation cycle management should come as second nature to a company as creating a payroll budget. Still, only about 55% of businesses have a compensation strategy, according to PayScale data. 

Defining a compensation cycle and its management strategy is a must for organizations of any size. Here’s a basic framework to make it happen:

Step 1: Create a Compensation Team

Small companies might have just one person overseeing compensation and compensation cycles. But even having just one or two more people join can help reduce bottlenecks in compensation cycle management. Plus, additional people bring more viewpoints to the table, evening the compensation playing field.

Organizations with multiple departments should include HR, payroll, and finance departments in compensation cycle management. IT teams can also come in handy to manage the digital aspect of compensation cycles.

Step 2: Determine Your Compensation Goals and Budget

Next, the compensation cycle team and executives should determine the company’s compensation budget. Having a maximum number in place can help the team break down how much the company can put toward salaries, leaving the rest available for bonuses, benefits, and other incentives.

This is also a good time for the company to evaluate how it wants to compare to the market in terms of compensation. Does it want to be ultra-competitive in how it pays employees? Or is it okay aligning with median market pay? Organizations interested in pulling in the best talent may decide that opening up more space in the budget can help them pay more competitively. 

Step 3: Define Each Role

Each role in an organization should be clearly defined to make it easier to define its compensation structure. This is a good time to review position descriptions to ensure that each role’s pay structure accurately reflects its responsibilities. These roles and descriptions should be reviewed during each compensation cycle to ensure accuracy.

Step 4: Create an Action Plan

Finally, it’s time to create a plan for compensation cycle management. This is when a company decides the length of its compensation cycle and when cycles should begin for employees. Organizations should also detail the rules for reviewing compensation, analyzing new compensation data, and updating compensation structures. 

A compensation cycle can keep your payment processes and policies on track to ensure compliance and fairness when paying workers. Once you set your plan for compensation cycle management in motion, it should become easier and more efficient to oversee.

Build and Grow right from your Inbox

Scroll to Top