Types of Compensation: How to Build Fair Pay Structures(2026)

How is your compensation determined? What structures have you put in place? And how often do you actually follow them?

Pay structures are frameworks made up of grades, levels, or bands that connect related roles and provide a system for implementing reward strategies and managing pay progression. At the same time, pay transparency is increasingly becoming a source of competitive advantage.

Meanwhile, wage growth adds another layer of complexity. Data from the U.S. Bureau of Labor Statistics shows that compensation costs for private-industry workers rose by 3.5% year over year in mid-2025.

In Nigeria, the picture looks different, as the Nigeria Tax Act 2025, which took effect in January 2026, changed how employment income and benefits are taxed. As a result, payroll teams across the country have had to rethink how compensation is calculated.

Across the wider African market, types of compensation practices vary significantly from one region to another. This means the rules governing how compensation is designed and applied are constantly evolving and differ in ways that a generic compensation checklist simply cannot capture.

So, how do we bring these moving parts together into a pay structure that is fair to employees, financially sustainable for the business, and transparent enough to manage effectively?

The Architecture of Compensation

Compensation works more like an architectural blueprint. Every component influences another. Compensation architecture is the framework that determines how pay decisions are designed, managed, communicated, and reviewed across an organization.

A promotion cannot be implemented fairly without understanding:

• The employee’s current pay band.
• The target pay band.
• Market compensation benchmarks.
• The organization’s progression policies.

A well-designed compensation architecture typically includes the following elements:

Component	Purpose
Job architecture	Defines roles, responsibilities, and job levels
Pay structure	Establishes salary ranges and compensation bands
Pay progression	Defines how employees move through compensation ranges
Incentive systems	Connects rewards to performance and business outcomes
Compensation governance	Creates policies for reviews, approvals, and adjustments

Compensation architecture, therefore, acts as the foundation upon which every salary decision is built.

Pay Structures and Pay Progression: Definitions, Their Strategic Role in Compensation Management

What Is a Pay Structure? 

A pay structure is a formal compensation framework that organizes jobs into predefined grades, levels, bands, or job families and establishes the salary ranges attached to each role within an organization.

From a strategic perspective, a pay structure does much more than determine salary ranges. It serves as the organization’s compensation governance system by creating standardized rules for:

• Job evaluation
• Salary administration
• Career advancement
• Performance rewards
• Internal equity
• Market competitiveness
• Budget control

Without a defined pay structure, compensation decisions often become decentralized and inconsistent. Individual negotiations begin to replace objective compensation policies, increasing the risk of salary compression, pay inequities, and employee dissatisfaction.

For leaders, a pay structure creates a balance between these competing priorities:

• Paying employees competitively enough to attract and retain talent.
• Maintaining financial discipline and controlling labor costs.
• Aligning compensation with business objectives
• Supporting legal and regulatory compliance
• Internal equity

 67% of employers use a formal pay structure, with adoption rates being highest among large organizations and public-sector employers.

What Is Pay Progression?

Pay progression is the process through which employees move to higher levels of compensation within an established pay structure.

A salary increase is not pay progression. Pay progression reflects professional growth, increasing contribution, greater capability, or improved performance.

Organizations use pay progression to achieve three primary goals:

• Encourage desired employee behaviors.
• Maintain competitive compensation.
• Create a transparent process for salary growth.

Pay progression is determined by the following 

• Performance: Employee measurable contributions(productivity, project delivery, revenue generation)
• Skills: Developing new capabilities(cross-functional skills, specialized expertise)
• Labor-market conditions.

The Key Difference Between  Pay Progression & Pay Structures

Imagine a compensation structure as a ladder. The ladder itself represents the pay structure. Climbing the ladder represents pay progression. The differences are below;

Factor	Pay Structure	Pay Progression
Primary purpose	Organizes compensation	Determines compensation growth
Focus	Salary ranges	Employee movement
Key question	What should this role pay?	How should pay increase?
Influenced by	Market data and job evaluation	Performance, skills, tenure, and promotion
Review cycle	Periodic	Continuous

Types of Pay Progression

A well-designed pay progression framework should answer four questions:

• What determines salary increases?
• How do employees advance?
• How often is compensation reviewed?
• Which behaviors and outcomes are being rewarded?

Organizations typically use five types of pay progression.

1. Seniority-Based Progression

Compensation increases are tied to an employee’s length of service. This model offers consistency and predictability, but it may not accurately reflect performance, productivity, or skill development.

2. Performance-Based Progression

Salary growth is linked to measurable results. Employees who consistently exceed expectations typically progress more quickly. This model works best when organizations have clear performance metrics and standardized evaluation processes.

3. Competency-Based Progression

Compensation increases are based on the development of new skills, certifications, qualifications, or technical expertise.This model is commonly used in knowledge-based industries where continuous learning directly affects organizational performance.

4. Promotion-Based Progression

Employees receive compensation increases after moving into positions with greater responsibilities.This approach follows a traditional career path and remains one of the most widely used progression models.

5. Hybrid Progression

Many organizations combine multiple progression models rather than relying on a single approach. A hybrid system may include:

• Merit increases
• Performance incentives
• Promotion-related increases
• Skill-based adjustments
• Market-based salary reviews

Progression Type	Primary Driver
Seniority-based	Length of service
Performance-based	Individual performance
Competency-based	Skills and expertise
Promotion-based	Career advancement
Hybrid	Multiple factors

No single progression model is suitable for every organization. The most effective frameworks balance employee development, business performance, market competitiveness, and long-term financial sustainability.

What are the main types of compensation?

Before building a fair structure, it helps to separate the major forms of compensation.

1. Base pay

Base pay is the fixed amount an employee receives for performing their role. It may be expressed as an annual salary, hourly wage or another agreed rate. Base pay normally reflects factors such as:

• The responsibilities of the role
• Required skills and qualifications
• Job level
• Market rates
• Location
• Relevant experience
• Internal relationships between roles

Base pay should provide the foundation of the compensation structure. Variable incentives should not be used to compensate for an unnecessarily weak base salary.

2. Variable compensation

Variable compensation changes according to predefined conditions. Common examples include:

• Performance bonuses
• Sales commissions
• Profit-sharing
• Production incentives
• Team bonuses
• Individual achievement awards

Variable pay can be useful when the organization wants compensation to reflect measurable outcomes. But it needs careful design. If employees are rewarded for a metric that conflicts with the company’s broader objectives, they may optimize the metric rather than the outcome.

3. Benefits and indirect compensation

Types of compensation are not limited to money appearing in an employee’s bank account. Benefits can include health insurance, retirement contributions, paid leave, disability coverage, allowances, and other employer-provided benefits.

In March 2026, wages and salaries represented 69.9% of private-industry employer compensation costs, while benefits represented 30.1%. Benefits included areas such as paid leave, insurance, retirement, and legally required benefits.

4. Equity and ownership-based compensation

Some organizations use shares, stock options, restricted stock or other ownership-related arrangements as part of compensation, particularly for executives, senior employees and employees in high-growth companies.

Equity can connect an employee’s potential financial upside to the long-term performance of the organization. However, it should be explained carefully because its value, taxation, and legal treatment vary considerably by country and plan design.

5. Non-cash rewards and incentives

Not every reward needs to be added to payroll. Companies may use experiences, gifts, additional development opportunities, public recognition or other rewards to reinforce particular achievements.

The five building blocks of a fair pay structure

Once you understand the different types of compensation, the next step is creating the structure that determines how they are applied.

1. Start with job architecture: 

Group roles into logical job families and levels.

For example:

Job family	Level	Typical scope
Sales	Entry	Supports pipeline and customer acquisition
Sales	Mid-level	Owns accounts or a defined revenue target
Sales	Senior	Handles strategic accounts or larger targets
Sales	Manager	Leads a sales team and owns team performance
Sales	Director	Owns a major revenue function or region

A better starting point is:

“What is this role worth within our organization and market?”

This creates a framework for evaluating jobs before individual circumstances influence the decision.

2. Establish salary ranges

Once jobs are grouped into levels, create salary ranges. A basic range might contain:

Minimum → Midpoint → Maximum

The midpoint represents the reference point for a role or level. Employees can sit at different points in the range depending on factors such as experience, capability, sustained performance, and relevant market considerations.

The exact range should come from your organization’s compensation philosophy and reliable market data rather than an arbitrary percentage.

3. Define objective criteria for progression

A pay structure becomes much less useful if nobody understands how employees move through it. Clearly define what progression means. That could include:

• Increased role scope
• Greater decision-making responsibility
• Demonstrated capabilities
• Consistent performance
• Promotion to another level
• Changes in market conditions
• Acquisition of critical skills

Be more careful with the phrase “performance-based pay.” Performance should not become a vague explanation for every pay decision. If performance affects compensation, define what performance means and how it will be assessed. Why?

The phrase “works hard” is difficult to evaluate consistently. But this: “Maintains 95% compliance while meeting quality standards” is considerably easier to assess.

4. Separate market value from individual performance

Market value answers:

“What does this type of role typically cost in the labor market?”

Performance answers:

“How effectively is this employee performing within the role?”

They are related, but they are not the same thing.

Suppose a company discovers that its engineers are paid 15% below the market median. Giving a high-performing engineer a larger performance bonus does not necessarily solve the underlying problem.

The base types of compensation structure may need adjustment.

Likewise, paying an employee above market simply because they have performed well does not automatically mean the person should remain in that position forever.

A useful compensation structure therefore separates at least three decisions:

• Role value + market position + individual contribution

That makes compensation conversations much easier to manage.

5. Review the structure:

Fair pay is not something you establish once and then forget. Organizations change. Markets change. Roles change. New employees are hired. Promotions happen. Acquisitions occur. Business priorities shift.

A useful review should look for issues such as:

• Employees outside their intended salary ranges
• Large unexplained differences between similar roles
• Salary compression
• Rapidly changing market rates
• Inconsistent promotion increases
• Differences in variable-pay opportunities
• Pay disparities across demographic groups
• Roles whose responsibilities have materially changed

The goal is not to eliminate every difference. The goal is to identify differences that the organization cannot reasonably explain. Fair pay requires visibility. If leaders cannot see how compensation, performance, and rewards are being applied across teams, inconsistencies can remain hidden until they become expensive problems.

PerkFlow helps organizations connect performance signals, incentives, and execution so leaders can see what is being reinforced and where performance is drifting.

A fair compensation structure is a management system

Gallup estimates that replacing leaders and managers can cost organizations up to 200% of an employee’s salary, while replacing employees in technical roles can cost approximately 80% of annual compensation. 

Turnover is expensive, and compensation strategy plays a measurable role in reducing that risk.This is why compensation should not be managed as a collection of independent decisions.

Instead, it should function as an integrated system in which every component supports the next:

Job Architecture → Pay Ranges → Individual Positioning → Pay Progression → Performance → Incentives → Review → Adjustment

This framework creates consistency across the employee lifecycle while helping organizations align compensation with broader business objectives.

A fair compensation structure is therefore not defined by identical salaries or annual pay reviews. It is defined by an organization’s ability to explain how compensation decisions are made, apply those decisions consistently, and adapt them as workforce needs change.

Frequently asked questions 

What are the types of compensation?

The main types of compensation are base pay, variable compensation, benefits, equity-based compensation, and non-cash rewards. Most organizations combine several compensation types to create a balanced compensation strategy.

Compensation vs. salary: What’s the difference?

Salary is a fixed form of compensation. Compensation is broader and includes wages, bonuses, commissions, benefits, equity, and other financial or non-financial rewards.

Does fair pay mean equal pay?

No. Employees in similar roles may receive different compensation because of differences in experience, skills, responsibilities, performance, or market conditions. Fair pay depends on consistent and objective criteria.

How often should compensation structures be reviewed?

Organizations should review compensation structures regularly and whenever significant changes occur in market conditions, business priorities, organizational structures, or job responsibilities.

Should all employees receive performance-based pay?

No. Performance-based compensation should be used only when performance can be measured objectively and employees can directly influence the outcomes being evaluated.

Is equity direct or indirect compensation?

Equity is generally considered direct compensation because it has a measurable financial value, even if employees do not receive it as immediate cash.

KEYNOTE:

A good compensation structures therefore answer four questions:

• What is this role worth?
• How does this employee progress?
• Why is one employee’s compensation different from another’s?
• Are we rewarding the behaviors and outcomes the business actually needs?

These questions should be answered clearly. 

However, every element covered in this article — pay grades, pay structure, pay progression, market benchmarking, incentive design, transparency- eventually comes down to one question: 

‘Can you clearly connect what someone is paid to what they were actually asked to do?’ 

At PerkFlow can help organizations connect performance and execution so rewards are tied to clearly defined actions, milestones and outcomes. Explore PerkFlow to see how organizations can close execution gaps, consistently and measurably.