Editor's note:Philip Watson is the Chief Financial Officer of Payscale, a Seattle-based SaaS company that provides compensation data and software services. The views expressed in this article are solely those of the author.

Many companies lack a comprehensive compensation strategy. A "total compensation strategy" refers to a data-driven, structured approach to designing and managing all forms of employee compensation—including base salary, variable pay, equity, and benefits—and aligning them with business goals, talent philosophy, and financial realities.

As is well known, when the economy absorbed the shock of the COVID-19 pandemic, the early 2020swere a boom period for employee and hiring mobility. Driven by 0% interest rates, companies competed to lock in and retain talent. As companies set aside concerns about labor efficiency, compensation expenses inevitably ballooned. Loose monetary policy gave rise to a labor market bubble, and when interest rates rose, those that over-hired in 2021 found themselves in trouble. Since 2023, stakeholders and shareholders have demanded increasing financial discipline, leading to waves of layoffs and a sharp decline in job openings.

Companies will always be affected by macroeconomic fluctuations. Having (and executing) a comprehensive compensation strategy cannot fully shield you from these natural ups and downs, but it can help you navigate them better. Ultimately, you need to reach a position where you can control what you can control.

Managing your talent pool

A key aspect is ensuring that your top performers are properly recognized and rewarded. These top performers are the cornerstone you rely on regardless of market conditions, especially during economic downturns.

At the same time, it is important to support underperforming employees by setting clear expectations and providing opportunities for improvement. When improvement does not materialize, organizations must make thoughtful decisions aligned with long-term goals.

Allocating compensation resources correctly in both cases is crucial to giving your business the best chance of success in any economic environment. Therefore, effective compensation planning requires a chisel, not a hammer. Organizations that master this can strategically reward talent and precisely cut waste, thereby maintaining their competitive edge across any economic cycle.

Leveraging market uncertainty to your advantage

Regardless of the economy, the competition for top talent is fierce. As the current labor market continues to loosen, savvy organizations will seize the opportunity to attract top performers at potentially discounted rates.

Companies will focus on attracting top talent before or as they enter the market, retaining their own core talent, and optimizing performance evaluation processes to understand their talent pool.

Regardless of the market, budget constraints always exist. But the key is how to maximize the efficiency of your largest expenditure. Hiring freezes and layoffs can be blunt instruments that damage long-term employee morale. A finely tuned compensation plan—paying the right employees the right amounts—is a more precise approach. It is important to continuously think about how your actions fit into a broader compensation strategy in which you are always competing for talent.

The cost of an inefficient compensation strategy

Losing top talent is bad regardless of the market. Some estimates suggest thatthe total cost of replacing an employeeis three to four times their annual salary. When you lose an employee, you not only bear the direct costs of recruiting and hiring, but you also suffer greater financial losses in productivity.

The onboarding period obviously varies by role and level. But one thing is constant: when top performers with rich institutional knowledge, close client relationships, and skills leave, future performance is put at risk. The cost of retaining these employees almost always yields better returns than the immediate savings from reducing headcount.

If budget constraints limit your ability to offer larger raises to top performers, then creativity becomes your competitive advantage. Consider variable pay incentives tied to individual performance, flexible work arrangements, and other meaningful benefits.

Determining the right mix of fixed pay, variable pay, and other incentives is not easy. Many organizations lack the data confidence to do so.

Payscale's Compensation Best Practices Report shows that 60% of organizations are confident in theirpay raises being competitive. Another 63% express confidence in their job pricing to attract and retain talent. This is good news. But we should also pause to think. After all, 40% of companies admit they lack confidence in their market competitiveness.

These data confidence gaps directly translate into inefficient spending. Organizations uncertain about their competitive positioning cannot strategically allocate limited compensation funds, often underinvesting in critical talent attraction and retention. The most successful compensation strategies begin with market intelligence, turning uncertainty into targeted investment, ensuring every dollar goes to the employees who drive results.

Building a resilient compensation strategy

Our current economic environment demands moving beyond reactive responses to market conditions and embracing a mature approach to talent investment. This means developing a comprehensive compensation strategy that flexibly adjusts with the market while closely tracking top talent. It also means leveraging data to make informed investment decisions.

Organizations that can balance rewarding and retaining the right talent with meeting increasingly difficult budget goals will thrive in any market conditions. Seize the current market uncertainty as an opportunity to build a stronger, more resilient compensation strategy, while your competitors continue to struggle with the impact of boom-and-bust compensation tactics.