Ch 8 Compensation

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Chapter 8
Designing Pay Levels, Mix,
and Pay Structures
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Major Decisions
There are major decisions in setting externally competitive pay and
designing the corresponding pay structures.
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Specify Competitive Pay Policy
Translating any external pay policy into practice requires information on
the external market.
• Surveys provide the data for translating that policy into pay levels, pay
mix, and structures.
• A survey is the systematic process of collecting and making
judgments about the compensation paid by other employers.
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The Purpose of a Survey
An employer conducts or participates in a survey for a number of reasons.
• To adjust the pay level in response to changing rates paid by
competitors.
• To set the mix of pay forms relative to that paid by competitors.
• To establish or price a pay structure.
• To analyze pay-related problems.
• Or, to estimate the labor costs of product/service market competitors.
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The Purpose of a Survey Adjust Pay Level—How Much to
Pay?
Most organizations make adjustments to employees’ pay on a regular
basis – adjustments may be based on:
• The overall movement of pay rates caused by the competition for
people in the market.
• Performance.
• Ability to pay.
• Terms specified in a contract.
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The Purpose of a Survey Adjust Pay Mix—What Forms?
Adjustments to the pay mix and the relative importance placed on each
form occurs less frequently than adjustments to overall pay level.
• Perhaps the high cost of redesigning a different mix creates a barrier.
• Perhaps inertia prevails.
• More likely, insufficient attention has been devoted to mix decisions.
The mix organizations use may have been based on external pressures.
• Some pay forms may affect employee behavior more than others.
• Good information on total compensation is increasingly important.
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The Purpose of a Survey Adjust Pay Structure?
Many employers use market surveys to validate job evaluation results.
• The job structure that results from internal job evaluation may not
match competitors’ pay structures in the external market.
• Reconciling these two pay structures is a major issue.
Rather than integrating an internal and external structure, employers may
go straight to market surveys to establish their internal structures.
• Such “market pricing” mimics competitors’ pay structures.
• Accurate information and informed judgment are vital for making all
these decisions.
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The Purpose of a Survey Study Special Situations
Information from specialized surveys can shed light on specific pay-
related problems.
• A special study may focus on a targeted group such as patent
attorneys, retail sales managers, secretaries, or software engineers.
• Unusual increases in an employer’s turnover in specific jobs may
require focused surveys to find out if market changes are occurring.
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The Purpose of a Survey Estimate Competitors’ Labor Costs
Survey data are used as part of employers’ broader efforts to gather
“competitive intelligence.”
• Companies seek to examine (that is, benchmark) practices costs,
including in the area of compensation.
One source of publicly available labor cost data is the Employment Cost
Index (ECI) - published regularly by the Department of Labor.
• The index allows a firm to compare changes in its average costs to an
all-industry or specific-industry average.
• However, this comparison may have limited value because industry
averages may not reflect relevant competitors.
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Select Relevant Market Competitors
Define a relevant labor market that includes employers who compete in
one or more of the following areas:
• The same occupations or skills.
• Employees within the same geographic area.
• The same products and services.
Some argue that if the skills are tied to a particular industry, it makes
sense to define the market on an industry basis.
• From the perspective of cost control and ability to pay, including
competitors in the product/service market is crucial.
• This becomes a problem when the major competitors are based in
countries with far lower pay rates, such as China or Mexico.
• Even with good international survey data, judgment is still required.
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EXHIBIT 8.3 Relevant Labor Markets by Geographic and
Employee Groups
As the importance and complexity of the qualifications increase, the
geographic limits also increase.
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Fuzzy Markets
New organizations and jobs fuse together diverse knowledge and
experience, so “relevant” markets appear more like “fuzzy” markets.
A company may combine technology, media, and commerce into one
company.
• What is the relevant labor market?
• Which firms should be included in their surveys?
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Design the Survey
Consulting firms offer a wide choice of ongoing surveys covering almost
every job family and industry group imaginable.
• Their surveys are getting better and better, likely due to improvements
in technology.
Designing a survey requires answering the following questions.
• Who should be involved in the survey design?
• How many employers should be included?
• Which jobs should be included?
• What information should be collected?
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Design the Survey Who Should Be Involved?
In most organizations, the responsibility for managing the survey lies with
the compensation manager, but including managers and employees
makes sense.
Outside consulting firms are typically used
as third-party protection from possible “price-
fixing” lawsuits.
Identifying participants’
data by company name
is considered price
fixing.
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Design the Survey How Many Employers?
There are no firm rules on how many employers to include in a survey.
• National surveys conducted by consulting firms often include more
than 100 employers.
In the United States, the Bureau of Labor Statistics (BLS) is the major
source of publicly available compensation data.
• The data are often not specific enough to be used alone.
The quality of some salary data on the web is unclear.
• There are some good exceptions, such as Salary.com and Glassdoor.
Many firms select one survey as their primary source and use others to
cross-check or “validate” the results.
• Without reliability and validity metrics, survey data are open to
challenge.
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Design the Survey Which Jobs to Include?
Benchmark-Job Approach.
• If the purpose of the survey is to price the entire structure, then
benchmark jobs can be selected to include the entire structure.
Low-High Approach.
• For skill-competency-based structures or generic job descriptions,
market data must be converted to fit the structure.
• The simplest way is identify the lowest- and highest-paid benchmark
jobs for the relevant skills in the relevant market and use the wages as
anchors for the skill-based structure.
Benchmark Conversion/Survey Leveling.
• In cases where a job does not match a job in the salary survey, an
employer may quantify the difference via benchmark conversion.
• If an organization uses job evaluation, then its job evaluation system
can be applied to the survey jobs.
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Design the Survey What Information to Collect?
Organization data reflects the similarities and differences among
organizations in the survey.
• Metrics of organization performance such as turnover and revenues
are being collected.
Total compensation data is required to assess the total pay package and
competitors’ practices – three alternatives are the most common.
• Base pay.
• Total cash (base, profit sharing, bonuses).
• And total compensation (total cash plus benefits and perquisites).
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EXHIBIT 8.10 Advantages and Disadvantages of Measures of
Compensation
Base pay Tells how competitors are
valuing the work in similar
jobs
Fails to include performance
incentives and other forms,
so will not give true picture if
competitors offer low base
but high incentives.
Total cash
(base + bonus)
Tells how competitors are
valuing work; also tells the
cash pay for performance
opportunity in the job
All employees may not
receive incentives, so it may
overstate the competitors'
pay; plus, it does not include
long-term incentives.
Total
compensation
(base + bonus
+ stock options
+ stock awards
+ benefits)
Tells the total value
competitors place on this
work
All employees may not
receive all the forms. Be
careful: Don't set base equal
to competitors' total
compensation. Risks high
fixed costs.
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EXHIBIT 8.11 Pay Survey Results for Different Measures of
Compensation
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Interpret Survey Results and Construct a Market Line Verify
Data
A common first step is to check the accuracy of the job matches, and then
check for anomalies, age of data, and the nature of the organizations.
Accuracy of Match (and Improving the Match).
• For jobs that match perfectly, things are easy.
• If a company job is similar but not identical, some companies use the
benchmark conversion/survey leveling approach.
Anomalies.
• Does any one company dominate?
• Do all employers show similar patterns?
• Are there outliers?
• The best way to answer questions on anomalies is to do an analysis of
them alone.
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Interpret Survey Results and Construct a Market Line
Statistical Analysis
The statistics necessary to analyze survey data includes regression.
Frequency Distribution.
• Frequency distributions help visualize information and may highlight
anomalies, or outliers.
• Shapes of frequency distribution can vary.
Central Tendency.
• A measure of central tendency reduces a large amount of data into a
single number.
• The distinction between “mean” and “weighted mean” is important.
Variation.
• Distribution of rates around a measure of central tendency is variation.
• Quartiles and percentiles are measures used in salary survey analysis.
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EXHIBIT 8.13 Frequency Distribution
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Interpret Survey Results and Construct a Market Line Update
the Survey Data
Pay data are usually
updated to forecast
the competitive rates
for the future date
when the pay
decisions will be
implemented.
The amount to
update is based on
several factors,
including labor
trends, economic
outlook, and
judgment, among
others.
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Construct a Market Pay Line
A market line links
benchmark jobs (x-
axis) with market
rates paid by
competitors (y-axis).
It summarizes the
distribution of going
rates in the market.
Regression
generates a straight
line that best fits the
data by minimizing
variance around the
line.
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Calculating a Pay Market Line Using Regression Analysis
Regression analysis
uses the formula for a
straight line: y = a +
bx, where:
• y = dollars;
• x = job evaluation
points;
• a = the y value at
which x = 0;
• And b = the slope
of the regression
line.
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Setting Pay for Benchmark and Non-Benchmark Jobs
Setting pay for benchmark jobs is straightforward to the degree that good
matches with survey jobs are found.
For non-benchmark jobs, the market pay lines
are especially useful.
• Job J has 100 job evaluation points and
matches a survey job, Eng5, with base pay
of $90,876.
• One approach is to pay Job Z 110/100 ×
$90,876 = $99,964.
• Or, use the market survey line regression
equation y = 15522.56 + 753.54x.
There is no “right way”
to analyze survey data.
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Combine Internal Structure and External Market Rates
The internally aligned
structure is shown on
the horizontal (x)
axis.
The external
competitive data are
shown on the vertical
(y) axis.
These two
components come
together in the pay
structure which has
two aspects: the pay-
policy line and pay
ranges.
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From Policy to Practice: The Pay-Policy Line
Several ways to translate external competitive policy into practice.
• Choice of measure - a company can use a specific percentile for base
pay and another for total compensation as measures in its regression.
• Updating – using a match, lead/lag, or lead policy.
Policy line as a percent of market line.
• A company may specify a percent above or below the regression line
and their pay-policy line would carry out a policy statement.
• An employer might lead by including only a few top-paying competitors
in the analysis.
• Or lead for some job families and lag for others.
• If the practice does not match the policy, then employees receive the
wrong message.
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From Policy to Practice: Grades and Ranges
The next step is to design pay grades and pay ranges.
• Grades and ranges offer flexibility to deal with pressures from external
markets and differences among organizations.
• A pay range exists whenever two or more rates are paid to
employees in the same job.
• The range reflects the differences in performance or experience that
an employer wishes to recognize with pay.
• An employee with consistently high performance ratings should move
above the market median and range midpoint.
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From Policy to Practice: Grades and Ranges Establish Range
Midpoints, Minimums, and Maximums
The first step is to group different jobs that are considered substantially
equal for pay purposes into a grade.
• Each grade will have its own pay range, and all the jobs within a single
grade will have the same pay range.
Grades group job evaluation data on the
x-axis; ranges group salary data on the
y-axis.
• Ranges set upper and lower pay
limits for all jobs in each grade.
• A range has a midpoint, a minimum,
and a maximum.
• Range spread is maximum
pay/minimum pay – 1.
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From Policy to Practice: Grades and Ranges Overlap (and
Midpoint Progression)
The size of differentials between grades should support career movement
through the structure.
• Optimal overlap between grades ought to be large enough to induce
employees to seek promotion into a higher grade.
• Not all employers use grades and ranges.
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From Policy to Practice: Broad Banding
Broad banding, consolidates traditional grades into a single band with
one minimum and one maximum – there are several advantages.
Broad bands are often combined with more traditional practices by using
midpoints, “zones,” or other control points within bands.
Banding takes two steps: set the number of bands and price the bands.
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From Policy to Practice: Broad Banding Flexibility-Control
Broad banding encourages employees to seek growth and development
by moving cross-functionally – say from purchasing to finance.
• The assumption is that this cross-fertilization of ideas will benefit the
organization.
• Hence, career moves within bands are more common than between
bands.
• The principal payoff of broad banding is this flexibility.
• But flexibility is one side of the coin; chaos and favoritism is the other.
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Balancing Internal and External Pressures: Adjusting the Pay
Structure
A job structure orders jobs on the basis of internal factors (reflected in
job evaluation or skill certification).
• The pay structure is anchored by the organization’s external
competitive position and reflected in its pay-policy line.
The order in which jobs are ranked on internal versus external factors
may not agree.
• When reconciling differences, managers weigh external market data
more heavily than internal job evaluation data.
• Sometimes, differences arise because a shortage of a particular skill
has driven up the market rate.
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Market Pricing
Market pricing sets pay almost exclusively on external market rates.
• Market prices match a large percentage of their jobs with market data
and collect as much market data as possible.
• The objective of market pricing is to base most, if not all, of the internal
pay structure on external rates.
Pure market pricing ignores internal alignment completely.
• How much or what mix of forms a company pays is no longer a
potential source of competitive advantage.
• Any unique aspects of the organization’s pay structure are
deemphasized by market prices.
• In contrast, an organization may choose to differentiate its pay strategy
from that of its competitors to better execute its own strategy.
• Balancing internal and external pressures is a matter of judgment.
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