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Direct vs. indirect compensation

Types of direct compensation

How to determine direct compensation

What is direct compensation

Direct compensation refers to the payment an employee receives in exchange for their work or services rendered to an organization.

This payment can include the employee’s base salary, bonuses, commission, overtime pay, and any other type of payment directly related to the employee’s job performance or productivity.

Direct compensation is a key component of an employee’s overall compensation package and is often used to attract and retain top talent. It’s typically outlined in an employment contract or offer letter and can be structured in various ways, such as hourly wages, annual salaries, or performance-based pay. 

Direct vs. indirect compensation

Direct compensation is just one component of a complete compensation package. Direct compensation includes monetary payments based on an employee’s performance and experience. It is applied in addition to indirect compensation, employee benefits packages, and other perks. 

Indirect compensation completes the total compensation package. Also known as non-cash compensation, indirect compensation refers to rewards over and above base salary, such as health insurance, contributions to retirement plans, paid time off/paid leave, pension plans, memberships, and employee discounts. 

Indirect compensation offers monetary value that is not included in the employee’s regular pay, and it is not based on performance or experience. Non-financial compensation is also a type of indirect compensation that holds no inherent monetary value, such as developmental opportunities and flexible work schedules.

Types of direct compensation

There are various types of direct compensation that an employer can offer to employees, each with a unique structure and purpose.

Salary and wages

Salary and hourly wages are a fixed amount of money employees earn for their work, typically paid on a regular pay schedule (such as weekly, bi-weekly, or monthly).

Overtime pay

Overtime pay is additional reimbursement that an employee receives for working more than the standard number of hours in a workweek, usually at a higher hourly rate.


Bonuses are one-time payments that an employee receives for achieving specific performance goals or for exceptional achievements.


Commission pay is a type of performance-based pay that is typically used in sales roles, where an employee earns a percentage of the sales they generate.

Car allowance

Employers may provide employees with a company car, fuel allowance, and/or cover the expenses associated with parking, public transportation, or taxi fares.

Profit sharing

Profit sharing is a form of compensation where employees receive a share of the company’s profits in addition to their regular pay.

Stock options and equity grants

Stock options allow employees to purchase company stock at a predetermined price, while equity grants offer employees shares of company stock as part of their compensation package.

Relocation packages

Relocation packages cover expenses related to an employee’s relocation to a new region for work. This may include moving company costs, travel expenses, real estate agent fees, and visa expenses.

How to determine direct compensation

Determining direct compensation for an employee typically involves several factors, including the employee’s job responsibilities, industry standards, experience level, and geographic location. 

Take the following steps to determine an employee’s direct compensation.

Conduct a job analysis

A job analysis involves the evaluation of the position’s duties and responsibilities to determine the appropriate level of compensation. Employers may consider factors such as the required education and experience, the complexity of the job, and the level of responsibility.

Research industry standards

Employers must research industry compensation benchmarks to determine the average pay for similar positions within the same industry and geographic location. The process ensures the compensation offered is competitive and attractive to potential candidates. When working with a remote team, this research should consider the global market.

Consider employee’s experience and performance

The employee’s experience level, education, and performance play a role when determining compensation. Employees with more experience or who perform exceptionally well may be eligible for higher compensation.

Review budgets and resources

The human resource management and finance team must work together to optimize compensation management. The process includes reviewing the company’s budget and available resources to ensure the compensation offered is within their financial means.

Offer a comprehensive compensation package

Employers should also consider additional forms of compensation included in direct compensation packages, such as bonuses, commissions, or equity grants, to incentivize employees. Including indirect compensation can improve employee retention, boost employee engagement, and help workers feel valued. 

Each of these factors should be carefully considered when compiling an employee compensation plan to ensure fair, competitive, and attractive compensation for attracting and retaining employees.

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