HR-Glossar
Compensation & Benefits (pay system design)
How a German pay system is built, which four legal frames bound it and why added benefits rarely set an employer apart for long.
1. What is Compensation & Benefits (pay system design)?
Compensation & Benefits describes the design of the whole pay system – from base pay through variable components to added benefits and occupational pensions.
The structure orders itself around three questions. Base pay: how are roles evaluated and placed in a structure? Variable components: what is paid on top, and what does it depend on? Added benefits: what is granted alongside money – company car, pension, mobility, health benefits?
The scope for design is bounded by three frames to be tested in turn: collective agreement coverage or a reference to one, the employment law equal treatment principle for collective arrangements, and the AGG with its prohibition of indirect discrimination. On top of this comes co-determination under Section 87 BetrVG on pay principles. Three of these four have no counterpart in most other systems, which is why a globally designed programme regularly has to be reworked before it can be applied to a German subsidiary.
2. Origin and development
Pay systems grew historically out of collective agreements which evaluated roles and placed them in groups. Their purpose was equal treatment: equal work should be paid equally, regardless of negotiating skill.
As collective agreement coverage has declined, many businesses have built systems of their own – and have frequently done without any system at all. The result is pay structures that have simply grown, in which differences reflect the course of negotiations rather than the value of the role.
Two developments have put that under pressure. The first is pay transparency: on defined conditions, employees can request information about comparative pay. The second is the increased attention to indirect discrimination – criteria such as an unbroken employment history or full-time availability operate systematically differently on particular groups.
Both lead to the same requirement: pay differences must be capable of justification. A structure that has merely grown is not.
3. Core principles and how it works
Evaluate the role, not the person
Base pay places roles. Personal characteristics belong in the performance component, not in base pay.
Differences must be capable of justification
That holds against the equal treatment principle, against the AGG and against requests for information on pay transparency.
Test for indirect discrimination
Criteria such as length of service, full-time working or an unbroken employment history operate differently on different groups without that being intended.
Co-determination on pay principles
Section 87 BetrVG covers the principles of remuneration and the introduction of performance-related pay – not the amount in the individual case.
Added benefits are easily copied
They work in the short term and rarely set an employer apart for long. What really distinguishes are working conditions and paths for development.
Think through the tax and contribution effect
A euro as a benefit in kind, as a subsidy or as a pay rise works very differently in net terms – and on wage replacement benefits as well.
Transparency creates pressure to justify
An employer that discloses its system must be able to explain it. That is the real effort – and at the same time the reason many systems fail at this point.
4. Who is Compensation & Benefits (pay system design) relevant for?
- Businesses not bound by a collective agreement – they have to create the system themselves.
- HR – they design the structure, the bands and the rules.
- Managers – they hold pay conversations and must be able to explain the system.
- Payroll – tax and contribution effects come together with them.
- Works councils – pay principles are subject to co-determination.
5. How it differs from related terms
- Compensation & Benefits and pay benchmarking – benchmarking supplies market data, the system places it. - Base pay and variable pay – one remunerates the role, the other a result. Mixing them makes both unclear. - Added benefits and optimising net pay – optimisation is a tax exercise, the benefit is the substance. - C&B and pay transparency – transparency is a legal frame, the system the object it makes reviewable. - C&B and collective agreements – where an agreement applies, the scope is narrow; it then concerns components above the agreed rates.
6. Variants and adaptations
Common building blocks:
- Role evaluation with pay bands – roles are evaluated and assigned to bands, with scope for experience and performance. The most systematic route. - Collectively agreed grading – prescribed where an agreement applies; design then concerns supplements above the agreed rates. - Variable pay – bonuses, profit sharing or awards; with the familiar distorting effects of target systems. - Occupational pensions – effective over the long term and frequently underrated in how they are perceived. - Mobility and health benefits – public transport passes, company bicycles, preventive health offers; often tax-privileged. - Choice models – employees assemble a package from a catalogue. Raises the perceived effect, but also raises administration considerably.
7. Advantages and challenges
Advantages
- A systematic structure makes pay differences explicable and defensible
- It lowers the risk of indirect discrimination
- Tax-privileged building blocks work harder, net, than an equally costly rise
- Clear bands relieve managers in pay conversations
- An explicable system does more for perceived fairness than its level does
Challenges
- Structures that have merely grown are hard to order retrospectively without making someone worse off
- Added benefits are easily copied and rarely set an employer apart for long
- Choice models raise administration considerably
- Variable components bring the familiar distorting effects of target systems
- Privileged components do not feed into sick pay, parental allowance or unemployment benefit
- Transparency creates pressure to justify that a disordered system cannot withstand
8. Best practices for implementation
The system first, the level second
Without role evaluation and bands every pay decision remains an individual negotiation – and over the years the structure becomes inexplicable.
Test the system for indirect discrimination
Criteria such as length of service or full-time availability operate differently on different groups. That test belongs in the design, not in the justification.
Compare building blocks by their net effect
A euro as a tax-free subsidy, as a benefit in kind or as a pay rise works very differently. The comparison belongs on a gross and a net basis.
Explain the knock-on effects
Contribution-free components build no pension entitlement and raise neither sick pay nor parental allowance. That needs saying – otherwise disappointment follows later.
Enable managers to explain the system
A system only HR can explain does not work. Other people hold the pay conversations.
9. Tips for employers and employees
For employers
- **System before level** – without evaluation any structure becomes inexplicable
- **Test for indirect discrimination** – neutral criteria can operate unequally
- **Co-determination on pay principles** – Section 87 BetrVG
- **Added benefits rarely distinguish** – working conditions do
For employees
- **Ask about the system** – how is your role placed, and why?
- **Information on comparative pay is possible on conditions** – Pay Transparency Act
- **Compare net, not gross** – privileged building blocks work differently
- **Consider the knock-on effects** – contribution-free components do not raise sick pay or parental allowance
10. Conclusion
A pay system consists of three levels – base pay, variable components, added benefits – and the scope for design is bounded by four frames: collective agreement coverage, the employment law equal treatment principle, the AGG and co-determination under Section 87 BetrVG.
The requirement that follows from pay transparency and the AGG together is this: pay differences must be capable of justification. A structure that has merely grown, in which differences reflect negotiating histories rather than the value of the role, is not – and can hardly be ordered retrospectively without making someone worse off. That is why the system comes before the level.
Two practical points are regularly underestimated. Added benefits rarely distinguish an employer for long – they are easily copied; what really distinguishes are working conditions and paths for development. And privileged components have knock-on effects: what stays free of contributions builds no pension entitlement and raises neither sick pay nor parental allowance. That belongs said before it is noticed.
Sources
- Section 87 BetrVG – Co-determination rights in social matters (official English version) (opens in a new tab)
- Section 10 EntgTranspG – Individual right to information (official English version, as at 5 July 2021; the German text governs) (opens in a new tab)
- Section 7 AGG – Prohibition of discrimination (official English version) (opens in a new tab)
- Federal Statistical Office – earnings and earnings differences (English pages) (opens in a new tab)
Related terms
Our promise
Software supports. People take responsibility.
Let us talk about your payroll – no strings attached, specific, and with a dedicated contact from day one.