One of the most significant concerns that face startups and SMEs is how to pay employees. In nearly all cases the two options are hourly pay and salary. Hourly employees are paid a set amount for each hour of work, and are typically eligible for overtime pay. Salary employees receive a set amount per year regardless of the number of hours worked. You may sense that the two types of positions just feel different, but making pay decisions based on such intuition can lead to financial, productivity, and legal troubles. Similarly, considering only the company bottom line may lead to decreases in morale and overall output. To help clarify the decision, we’ve put together five critical considerations for setting employee compensation schemes.
Exempt or nonexempt
First, let’s look at the law. The Fair Labor Standards Act (FLSA) classifies employees as either exempt or nonexempt. Essentially, employees classified as exempt do not receive overtime pay for work beyond 40 hours per week; nonexempt employees do. In terms of salary vs. hourly pay, salaried employees are typically exempt (ie. exempt from overtime pay rules), and hourly employees are nonexempt.
It’s important to note that employees must be paid at least $23,600 per year ($455 per week) to be considered exempt. There are also certain job duties that qualify an employee for exempt status (see below).
Primary job duties
The FLSA outlines three categories of exempt job duties: executive, professional, and administrative. Greater discussion of these job duties can be found at the FLSA website, but in a nutshell exempt employees must typically involve one or more of the following:
- Supervision at least two employees.
- Managerial responsibilities (hiring, firing, etc.)
- A high level of education or professional training.
- Regular exercise of independent judgement and discretion about matters significant to the business.
There is, of course, nuance to these categories. But in general an employee cannot be exempt from overtime pay unless he or she meets exempt job duty criteria. Paying a nonexempt employee salary is a risky financial move, as the company will be liable for potentially higher rates of overtime pay (or legal trouble) if the employee works more than 40 hours in a week. Time tracking systems and software are handy for monitoring work hours and keeping nonexempt employees from going into overtime. It’s also wise to consult time tracking data to determine which positions are most likely to involve working past 40 hours a week.
Stability of staffing levels
Seasonal work is a good candidate for hourly pay, as is any other position in which demand for work hours fluctuates throughout the year. Idle salary workers are deadweight for the company bottom line. The ability to reduce payroll by cutting hours is another advantage of an hourly wage in industries with peak and slow seasons. But be careful, as cutting hours can have a negative impact on employee satisfaction and turnover.
Incentives to productivity
Remember that compensation is about driving productivity. Take some time to reflect on the job responsibilities, ambitions, and non-monetary needs of your employees. If quantity of work is a larger concern than quality of work (both may be important, but consider which matters most to the business), hourly wages allow companies to get what they pay for – more work for more money. Especially when employee motivation is largely tied to financial compensation.
On the other hand, if employees tend to have more intrinsic motivation about the work – say in roles that require more creativity, initiative, or education – the sense of investment and growth potential that comes with a salary can be highly motivating. Salaried positions tend to be associated with increased stability, higher status, and greater opportunity for advancement.
Finally, consider how important loyalty is in your employees. On a subtle level, offering salary shows interest in working with someone for at least a year, whereas hourly employment signals nothing more than moment-to-moment commitment. Such loyalty goes both ways, and if retaining employees is a priority, salary pay schemes can promote employee loyalty and longevity with a company. Salary packages are also easier to supplement with benefits such as health insurance, bonuses, or paid leave. Perks and benefits can go a long way toward increasing employee satisfaction and reducing turnover.