Building Pay Structures PDF

Third Edition How-to Series for the HR Professional Building Pay Structures...

Third Edition How-to Series for the HR Professional Building Pay Structures Daniel P. Purushotham, Ph.D., CCP, CBP Stephanie Y. Wilson, CCP HT BldgPayStructures cover.indd 1 10/19/2009 12:55:07 PM  How-to Series for the HR Professional Building Pay Structures Daniel P. Purushotham, Ph.D., CCP, CBP Stephanie Y. Wilson, CCP HT BldgPayStructures UPDATE book.indd 1 10/19/2009 1:01:16 PM  About WorldatWork® WorldatWork (www.worldatwork.org) is a global human resources association focused on compensation, benefits, work-life and integrated total rewards to attract, motivate and retain a talented workforce. Founded in 1955, WorldatWork provides a network of more than 30,000 members and professionals in 75 countries with training, certification, research, conferences and community. It has offices in Scottsdale, Arizona, and Washington, D.C. Any laws, regulations or other legal requirements noted in this publication are, to the best of the publisher’s knowledge, accurate and current as of this book’s publishing date. WorldatWork is providing this information with the understanding that WorldatWork is not engaged, directly or by implication, in rendering legal, accounting or other related professional services. You are urged to consult with an attorney, accountant or other qualified professional concerning your own specific situation and any questions that you may have related to that. This book is published by WorldatWork Press. The interpretations, conclusions and recommendations in this book are those of the author and do not necessarily represent those of WorldatWork. No portion of this publication may be reproduced in any form without express written permission from WorldatWork. ©2009, 2004, 1993 WorldatWork Press ISBN 978-1-57963-197-0 (Spiral bound) 978-1-57963-247-2 (E-book) Project Lead: Wendy Anderson, WLCP Editor: Andrea Ozias Design: Melissa Neubauer Production: Deb Shenenberg www.worldatwork.org HT BldgPayStructures UPDATE book.indd 2 10/19/2009 1:01:22 PM  Table of Contents Introduction 5 1 An Ideal Compensation Program 7 2 Anatomy of a Pay Structure 13 3 Developing a Pay Structure 25 4 Pitfalls, Precautions and Trends 43 HT BldgPayStructures UPDATE book.indd 3 10/19/2009 1:01:22 PM  5 Introduction Compensation deals with establishing a meaningful and acceptable relationship between work and rewards with both employer and employee in mind. Work performed by employees should help organizations achieve their objectives. These objectives are derived from the organization’s overall business strategy, which supports the organization’s mission statement. When designed and administered appropriately, an organiza- tion’s compensation program is an effective management tool for supporting the organization’s overall business strategy. A series of steps is used in the process of designing sound compensation programs. (See Figure 1 on page 8.) This process is not a one- time event. It involves constant review and refinement in light of changing business needs and the business environment. There are two broad categories of compensation: cash and noncash. The focus of this book is on cash compensation. Cash-compensation management has two distinct but interrelated aspects: content and process. Content is managed through job analysis, evaluation and research to keep abreast of the changes in compensation levels in the external market. Process includes tools and methods for collecting, calculating, organizing, storing and customizing internal and external information pertaining to compensation. The pay structure of an organization is one such tool. Within the context of cash-compensation manage- ment, process should support and not conflict with content. HT BldgPayStructures UPDATE book.indd 5 10/19/2009 1:01:22 PM  An Ideal Compensation Program 7 1 An Ideal Compensation Program Most compensation professionals agree that the following “ideal” charac- teristics are necessary for every compensation program in order to attract, retain and motivate qualified employees. (Note: These characteristics are primarily for all positions except single-incumbent senior- management positions.) These characteristics are the foundation for an ideal pay structure: Internal equity. A measure of how an organization values each of its jobs in relation to one another. External competitiveness. A measure of an organization’s pay structure and the actual pay delivered compared to that of its competitors. Affordability. A measure of how costly a compensation program is to an organization. If pay structures are not developed responsibly, an organization could incur labor costs that exceed what it can afford to pay. Legally defensible. Compensation programs must adhere to specific laws designed to provide fairness in how employees are paid. These laws include the Fair Labor Standards Act (FLSA), the Equal Pay Act, Title VII of the Civil Rights Act, the Age Discrimination in Employment Act and the Americans with Disabilities Act (ADA). Understandable/saleable. To be accepted and understood, compensation programs must be communicated effectively. HT BldgPayStructures UPDATE book.indd 7 10/19/2009 1:01:22 PM  8 Building Pay Structures FIGURE 1 Determine Strategy Before Structure Mission Statement Business Strategy Business Plan STRATEGIC Human Resources Strategy Ongoing Communication Total Rewards Strategy Compensation Strategy Compensation Objectives Design Program Evaluation TACTICAL Compensation Program Communication Administration Implementation Efficient to administer. With increased pressure to improve productivity and reduce costs, it is important that an organiza- tion’s compensation program be as simple and straightforward as possible to maintain and administer. A balance needs to be struck between what appears to be the “best” program and what is efficient, effective and easiest to administer. Safeguard the organization’s resources. The compensation program should reward performance fairly without conflicting with the interests of the organization’s stakeholders. Rewards should reflect both individual employee and organizational performance. HT BldgPayStructures UPDATE book.indd 8 10/19/2009 1:01:22 PM  An Ideal Compensation Program 9 Human resources should be seen as an investment that should be protected and optimized. Flexible. Pay programs are tools necessary to compete for labor in the marketplace. As such, they must be flexible and capable of changing as needed, without having to be revamped completely every time a new need arises. Meets the organization’s unique needs. To some degree, each organization is unique within its own industry or geographic area. Unique characteristics need to be recognized and addressed when designing compensation programs and, particularly, pay structures. Most compensation programs, however, will not include all these characteristics. In fact, some of these characteristics may be in conflict with each other. For example, it may not always be possible to maintain internal equity when an organization is trying to be externally competitive. Therefore, it is important to recognize the possibility of such conflict and to review the business strategy to determine the appropriate balance of all features of the compen- sation program. Pay Structures A pay structure consists of a series of pay ranges, or “grades,” each with a minimum and maximum pay rate. Jobs are grouped together in ranges that represent similar internal and external worth. (See Figure 2 on page 10.) The midpoint or middle-pay value for the range usually repre- sents the competitive market value for a job or group of jobs. The organization’s base-pay policy line connects the midpoints of the various pay ranges in the pay structure. In recent years, pay policy lines have been developed to reflect base salary midpoints and to take into consideration variable compensa- tion. For the purpose of this discussion, the design and development of pay structures will be confined to base salary, representing all positions except single-incumbent senior-management positions. HT BldgPayStructures UPDATE book.indd 9 10/19/2009 1:01:22 PM  10 Building Pay Structures FIGURE 2 Pay Pay Structure Example Grade General and Specific Factors Affecting Pay Structures Pay structures are influenced by the following general factors: Corporate culture and values. An organization’s pay structure usually reflects the way employees’ work is valued. For example, does an organization always look for the best and brightest employees? If so, the pay line may be positioned to lead the market. If the organization encourages and values prudent risk- taking, the total pay line may have an additional risk/reward component. Management philosophy. Narrow pay ranges and more grades allow for more frequent promotions — and a greater perception of “growth and advancement” — than wider ranges and fewer grades. However, if management believes in promoting employees only when duties and responsibilities change significantly, the distances between midpoints of ranges may be as substantial as 15 percent or more. External economic environment. Varied supply and demand for certain skills may necessitate a multistructured pay program. HT BldgPayStructures UPDATE book.indd 10 10/19/2009 1:01:23 PM  An Ideal Compensation Program 11 Technical professionals such as engineers may have special pay structures when there is a high demand for their skills. Special structures may be merged later into the standard base pay structure once there is no longer a supply/demand issue for engineers that necessitates a more aggressive pay policy. Other external factors that may be reflected in pay structures include inflationary fluctuations and cost-of-living indices such as the Consumer Price Index (CPI). External socio-political and legal environments. The “steps” in the pay structure are likely to be more narrow and rigidly administered in a union environment than in a nonunion envi- ronment. Pay structures also are affected by regulations such as the FLSA, which mandates the minimum wage for most jobs and thereby determines the lowest possible pay scale. Several other factors that influence pay structures relate directly to the operations and culture of a specific organization: Centralized compensation policy. A corporate compensation policy may call for the organization’s overall competitive posture to always be ahead of the market. This will be reflected in the pay policy line being higher than the market at every point on the salary range. On the other hand, the strategy could be to hire employees at a rate always higher than the market but over time to bring them in line with the market. This would mean steadily fine-tuning the pay ranges at different levels. Decentralized compensation policy. An organization’s goal may be to compete within the top quartile of its competitors in a particular functional segment (e.g., sales/marketing) or product segment (e.g., jet engines or disability income insurance). In this case, the pay structure may be different for those particular functional and product segments within the organization. Short-term vs. long-term orientation. A company with long-term orientation is most likely to have well-designed pay structures with career-path capabilities and smooth transitions from range to range. The ranges themselves will be developed after much thought and research. Short-term or temporary problems need HT BldgPayStructures UPDATE book.indd 11 10/19/2009 1:01:24 PM  12 Building Pay Structures to be taken care of with temporary solutions. Solving temporary problems with long-term solutions should be avoided. This caution is necessary because employees generally have an entitlement mind-set with respect to compensation, and it may be difficult to “undo” prior actions, even though the original reasons for such actions no longer exist. All the above mentioned factors become even more relevant and complex considering the effect of globalization of organizations. HT BldgPayStructures UPDATE book.indd 12 10/19/2009 1:01:24 PM  13 2 Anatomy of a Pay Structure A pay structure, as indicated earlier, has multiple pay or salary ranges. Every pay structure has key components that are critical to its overall design. The following section defines and describes these basic elements. Pay Ranges and Range Spreads A “pay range” has a minimum pay value, a maximum pay value and a “midpoint” or central value. The difference between the maximum and the minimum is the “range spread,” or the “width” of the range. Range width usually is expressed as a percentage of the difference between the minimum and maximum divided by the minimum. For example, in Figure 3 on page 14, the range spread in dollars, where the maximum is $120,310 and the minimum is $80,210, is $120,310 – $80,210 = $40,100. The percentage is about 50 percent, or $40,100 divided by $80,210. To calculate the spread on either side of the midpoint, use the formulas shown in the box below (where $100,260 is the Grade 10 midpoint in Figure 3). Calculation of Spread on Either Side of Midpoint Midpoint - Minimum $100,260 - $80,210 = = – 20% of Midpoint Midpoint $100,260 Maximum - Midpoint $120,310 - $100,260 = = + 20% of Midpoint Midpoint $100,260 HT BldgPayStructures UPDATE book.indd 13 10/19/2009 1:01:24 PM  14 Building Pay Structures FIGURE 3 Illustration of a Pay Range and a Range Spread – 20% + 20% Minimum Midpoint Maximum $80,210 $100,260 $120,310 Range Spread (Width) = 50% (Numbers have been rounded. Actual range spread is 49.99%.) A pay range with a 50-percent range spread will have a 20-percent spread on either side of the midpoint. (See Figure 3.) That is, $80,210 is about 80 percent of $100,260, and $120,310 is about 120 percent of $100,260. While all the ranges in Figure 2 have a range spread of approximately 50 percent, the spread does not have to be uniform throughout the pay structure. Figure 4 lists common range spreads and their cor responding spreads on either side of the midpoint. FIGURE 4 Common Range Spreads Range Spread Spread on Either Side of Midpoint 20% 9.1% 25% 11.1% 30% 13% 35% 14.9% 40% 16.7% 45% 18.4% 50% 20% Note: Under a broadbanding system, range spreads may reach 100 percent or more. HT BldgPayStructures UPDATE book.indd 14 10/19/2009 1:01:24 PM  Anatomy of a Pay Structure 15 Example 1 shows how to calculate the spread on either side of the midpoint. To perform the calculation, one of the three points (minimum, midpoint or maximum) on the pay range needs to be specified along with the range width. Using a range spread of about 50 percent and a minimum of $80,210, the maximum and midpoint are calculated as in Example 1. Example 1A shows the calculation of maximums and minimums. Some Practical Considerations Range spreads vary based on the level and sophistication of skills required for a given position. Entry-level positions that require skills that are quickly mastered usually have narrower pay ranges EXAMPLE 1 Calculating the Range Spread on Either Side of the Midpoint Maximum = Minimum x (1 + Range Spread) = $80,210 x 1.5 = $120,310* (Maximum + Minimum) ($120,310 + $80,210) Midpoint = = = $100,260 2 2 Spread on either side of the midpoint = (Midpoint - Minimum) ($100,260 - $80,210) = = – 20% of midpoint Midpoint $100,260 or (Maximum - Midpoint) ($120,310 - $100,260) = = + 20% of midpoint Midpoint $100,260 * Numbers in this equation have been rounded. Actual range spread is 49.99% EXAMPLE 1A Calculating Maximums and Minimums Maximum = Minimum × (1 + range spread) = 80,210 × 1.5 = $120,310* Midpoint Minimum = 1 + ½ range spread * Numbers in this equation have been rounded. Actual range spread is 49.99% HT BldgPayStructures UPDATE book.indd 15 10/19/2009 1:01:25 PM  16 Building Pay Structures than supervisory, managerial or higher-level technical positions. Individuals in lower-level positions not only master the requirements of the job sooner, they also have a greater number of opportunities over time to be promoted to higher-level positions. Senior-level positions require a longer learning curve and often have limited opportunities for advancement. The following are typical range spreads for different kinds of positions: 20 percent to 25 percent: lower-level service, production and maintenance 30 percent to 40 percent: clerical, technical, paraprofessional 40 percent to 50 percent: higher-level professional, administrative, middle management 50 percent and above: higher-level managerial, executive, technical Care should be taken when deciding pay-range width. Assuming a constant midpoint, changing range spreads also changes the minimum and maximum. Notice in Example 2 that as the ranges get wider, the maximums increase, the minimums decrease and the midpoints are constant. Ranges should be designed to provide midpoints that reflect the “going rate” and are reasonably close to what the market establishes as the minimum and maximum for the job. Minimums that are too low will result in a company needing to pay an employee higher in the range in order to pay competitively. This narrows the posi- tion’s long-term earning potential. In turn, a high maximum may provide long-term earnings opportunities that are higher and more costly than what are needed to be competitive. EXAMPLE 2 Range Spread Minimum Midpoint Maximum 30% $27,826 $32,000 $36,174 40% $26,667 $32,000 $37,333 50% $25,600 $32,000 $38,400 HT BldgPayStructures UPDATE book.indd 16 10/19/2009 1:01:25 PM  Anatomy of a Pay Structure 17 Midpoints The midpoint is a key element in pay administration. It often is used as a reference point in salary administration decisions as a point or “target.” The midpoint usually is the reference used because it typically is set to equal the market average or median. It should not be an organization’s only market reference point for salary administration. Other factors such as performance and affordability also must be considered in salary decisions. Compa-ratio Related to the midpoint is the compa-ratio, a statistic that expresses the relationship between base salary and the midpoint. Figure 5 illustrates the calculation of compa-ratio for the same job as well as for the market average. Compa-ratios can be calculated for individuals, groups of individuals, by organizational units or functions and the organization as a whole. Most organizations strive to have the overall workforce paid at or around a compa-ratio of 100 percent. Individual compa-ratios vary according to how long the individual has been in the job, previous work experience and job performance. A mature, long- FIGURE 5 Illustration of Compa-Ratios Within Company Outside Person 1 Person 2 Person 3 Average Company Base Salary $22,500 $25,000 $27,500 $25,000 $24,500 Market Average Midpoint $25,000 $25,000 $25,000 $25,000 $25,000 Market Average Compa-Ratio 90% 100% 110% 100%* 98% ( Base Salary Midpoint ( * Company Average = Market Ratio Market Average HT BldgPayStructures UPDATE book.indd 17 10/19/2009 1:01:25 PM  18 Building Pay Structures service workforce will tend to have a higher compa-ratio (often above 100 percent) than a younger group of employees with a shorter service record. It is important for an organization to be able to explain the reasons for its current compa-ratio. Businesses monitor compa- ratios because they recognize them as an important tool for managing compensation costs. In some cases, organizations cap pay at the midpoint for the purpose of paying “at market” for base salaries. The remainder of the range is available only to high performers and often is paid on a lump-sum basis from year to year. These companies increase base salaries only when range midpoints move and their compa-ratios drop below 100 percent. Range Penetration Another way of tracking an organization’s compensation is to view employee pay in relation to the total pay range. This is known as range penetration. Unlike compa-ratios, which are calculated using a salary range’s midpoint, range penetration is calculated using the minimum and maximum of a salary range. Range penetration is shown in Example 3 below. Often range penetration is a preferred tool because it does not focus on a single number alone, the midpoint. Instead, it refers to how far into the range a particular individual’s salary has penetrated. Range profiles often are used in conjunction with either the compa- ratio or range penetration to describe where employees should expect their pay to fall relative to their pay range over time. (See Figure 6 on page 19.) EXAMPLE 3 Given a minimum of $80,210, a maximum of $120,310 and an incumbent salary of $102,000, what is the range penetration? (Incumbent Salary - Range Minimum) Range penetration = = (Range Maximum - Range Minimum) ($102,000 - $80,210) = 54.3% ($120,310 - $80,210) HT BldgPayStructures UPDATE book.indd 18 10/19/2009 1:01:26 PM  Anatomy of a Pay Structure 19 FIGURE 6 Illustration of Range Penetration Range Year Minimum Midpoint Maximum Salary Penetration 1 $15,360 $19,200 $23,040 $15,360 0.00% 2 $15,744 $19,680 $23,616 $15,974 2.93% 3 $16,138 $20,172 $24,206 $16,613 5.89% 4 $16,541 $20,676 $24,811 $17,278 8.91% 5 $16,954 $21,193 $25,432 $17,969 11.96% 6 $17,379 $21,724 $26,068 $18,688 15.06% 7 $17,813 $22,266 $26,719 $19,435 18.22% 8 $18,258 $22,823 $27,388 $20,213 21.41% 9 $18,714 $23,393 $28,072 $21,021 24.65% 10 $19,182 $23,978 $28,774 $21,862 27.94% 11 $19,662 $24,577 $29,492 $22,737 31.28% 12 $20,154 $25,192 $30,230 $23,646 34.65% 13 $20,658 $25,822 $30,986 $24,592 38.09% (Salary = Range Minimum) Range penetration = (Range Maximum – Range Minimum) Constant Range Width: 50% By changing any one of the Constant Annual Range Movement (Structure Change): 2.5% three constants, the extent of range penetration could be Constant Salary Increase: 4% increased or decreased. The Given the above constants and a starting salary of $12,800, actual progression in the range it would take: is determined by the difference between range movement and 8 years to exceed the midpoint ($22,823) of the range the amount of salary increase. 13 years to reach close to the maximum ($30,986) of the range Midpoint Progression Midpoint progression refers to the percentage difference between pay-grade midpoints. The larger the midpoint progression, the fewer the number of grades within a pay structure. Conversely, the smaller the midpoint progression, the larger the number of pay grades within the pay structure. Three Approaches to Developing Midpoints One approach to developing midpoints is the present value/future value formula, which may be used to determine the percentage between midpoints, assuming the highest and lowest midpoints and the number of grades are known. The formula shown in Figure 7 HT BldgPayStructures UPDATE book.indd 19 10/19/2009 1:01:26 PM  20 Building Pay Structures may be used, or the calculations may be performed on a business calculator or computer. Suppose a company wishes to develop a pay structure with six grades that has a highest midpoint of $84,000 and a lowest midpoint of $46,620. What is the midpoint progression? Using the formula in Figure 7, the midpoint progression is calcu- lated to be 12.5 percent. The resulting pay structure looks like Figure 8. There are two other approaches to developing midpoints and the resulting midpoint progression. The first is to use the average of the market pay rate for different jobs within benchmark-job groupings. The resulting midpoint progression would have varying percentage differences between midpoints, which reflect the market more closely than constant differences. An organization’s pay structure FIGURE 7 Present Value/Future Value Formula Definition Value PV Present value (midpoint of lowest pay grade) $46,620 FV PV = FV Future value (midpoint of the highest pay grade) $84,000 n (1 + i) n Number of desired grade intervals (one less than the total number of grades in the structure) 5 i Percentage difference between midpoints To be determined Using these values, i = 12.5% FIGURE 8 Example of Midpoint Progression Grade Midpoint Midpoint Progression 3 $46,620 4 $52,440 12.5% 5 $59,000 12.5% 6 $66,370 12.5% 7 $74,660 12.5% 8 $84,000 12.5% (Numbers have been rounded) HT BldgPayStructures UPDATE book.indd 20 10/19/2009 1:01:26 PM  Anatomy of a Pay Structure 21 need not have a constant percentage progression — it may remain uneven without being smoothed. In such instances, it should be recognized that promotional increases may be uneven and some- times difficult to administer because of the following reasons: If the percentage difference between midpoints is too high, the result could be costly promotional increases. If the percentage difference is relatively low, the result could be salary compression problems between supervisory and subordinate positions and difficulty in matching promotions with appropriate compensatory rewards. The other approach to develop midpoints in a pay structure is the use of regression analysis. The advantage of this approach is it helps align market rates more closely with company policy. Regression analysis works well when job-evaluation points are used to develop pay structures. With the advent of more sophisticated technology, much of the statistical work can be done with the use of computers or powerful calculators. Exercising salary judgments within a segment often is easier and more practical than focusing rigidly on a single point within the salary range, such as the midpoint. Pay Grades The purpose of grades is to be able to refer to a compensation range that groups together multiple jobs with similar value based on internal comparisons and external market data. Grades need not always be numerical; alpha grades can serve the purpose just as well. Pay grades can be established by a number of methods. There are many grades or levels within a pay structure. The number of grades used by a particular organization will vary based on find- ings from market research as well as the company’s compensation strategy. Does the policy call for frequent “promotions,” or does it allow for real promotions when the major functions in the new job are of a higher value to the employees? Does the company want a “flat” organization, or does it prefer multiple levels within the organization? HT BldgPayStructures UPDATE book.indd 21 10/19/2009 1:01:27 PM  22 Building Pay Structures Segmentation of Pay Grades A pay grade may be segmented or subdivided in many ways — thirds, quartiles, quintiles and so on. These segments may or may not overlap. They serve as reference points for cost control and pay administration. The number of segments within a pay grade varies by company, and it often reflects the company’s merit pay process and pay administration philosophy. Using segments within a pay grade instead of only midpoints provides more flexibility to managers in pay-related decisions. These segments serve as mini-ranges within the main range. Exercising salary judgments within a segment often is easier and more prac- tical than focusing rigidly on a single point within the salary range, such as the midpoint. Pay-Grade Overlap Pay grades usually overlap. Except for the minimum of the lowest grade and the maximum of the highest grade, minimums and maximums usually fall within adjoining ranges. The width of the pay grade and the midpoint differentials determine the amount of overlap between adjoining grades. Grade overlap is minimal when midpoint differentials are large and range widths are small. (See Figure 9A.) FIGURE 9A Illustration of No Grade Overlap Dollars $26,000 $24,626 $24,000 Width = 10% $22,000 $21,414 $22,387 $20,000 Width = 10% $18,621 $19,467 $18,000 $16,192 $16,928 Width = 10% $16,000 $14,080 Width = 10% $14,720 $14,000 Midpoint Differential = 15% $12,000 $12,800 Number of Overlapping Grades = 0 Midpoint Differential = 15% $10,000 Width = 10% HT BldgPayStructures UPDATE book.indd 22 10/19/2009 1:01:27 PM  Anatomy of a Pay Structure 23 Figures 9B and 9C are illustrations of moderate grade overlap. Grade overlap is significant when midpoint differentials are small and range spread is large. (See Figure 9D on page 24.) In a pay-for-performance or merit system, grade overlap allows high performers in lower pay ranges with longer time-in-grade to FIGURE 9B Illustration of a Moderate Grade Overlap Dollars $18,000 $17,114 $16,299 $16,000 $15,523 $14,784 $14,080 $15,558 $14,000 $14,818 $14,112 $13,440 $12,000 $12,800 Number of Overlapping Grades = 2 Midpoint Differntial = 5% $10,000 Width = 10% FIGURE 9C Illustration of a Moderate Grade Overlap Dollars $36,000 $35,820 $34,000 $32,000 $31,148 $30,000 $28,000 $27,085 $26,000 $24,000 $23,552 $22,000 $22,387 $20,480 $20,000 $19,467 $18,000 $16,000 $16,928 $14,720 $14,000 $12,000 $12,800 Number of Overlapping Grades = 4 Midpoint Differntial = 15% $10,000 Width = 60% HT BldgPayStructures UPDATE book.indd 23 10/19/2009 1:01:27 PM  24 Building Pay Structures FIGURE 9D Illustration of a Significant Grade Overlap Dollars $26,000 $24,894 $24,000 $23,708 $22,579 $22,000 $21,504 $20,480 $20,000 $18,000 $16,000 $15,558 $14,000 $14,818 $14,112 $13,440 $12,000 $12,800 Number of Overlapping Grades = 5 Midpoint Differntial = 5% $10,000 Width = 60% be paid more than a relatively new (and/or lower) performer in a higher pay range. However, overlapping more than three or four pay grades generally should be avoided. Too much overlap limits the difference between midpoints, which in turn places limits on potential earning ability and can cause differentiation problems between super- visor and subordinate pay. Multiple Pay Structures An organization may have many pay structures within its overall structure. The number of structures is primarily a function of the market and the company’s compensation philosophy. For instance, the ranges for certain professionals such as information systems and technology and investment management may call for a separate structure that cannot be force-fit into a typical “corporate” structure. Different labor markets with different levels of supply and demand may necessitate multiple pay structures. Such pay structures allow greater flexibility in pay administration. Different groupings of positions, such as clerical, blue collar jobs versus technical and professional jobs, usually reflect different labor markets depending on supply and demand. Therefore, the slope of the pay lines could be different for different job families. HT BldgPayStructures UPDATE book.indd 24 10/19/2009 1:01:27 PM  25 3 Developing a Pay Structure There are two basic considerations to factor into the design and development of pay structures: internal equity and external competitiveness. Internal Equity Internal equity refers to the relative values assigned to different jobs within an organization and how reasonable those values are, both within job families and among comparable jobs throughout the organization. Internal equity can be examined horizontally and vertically, as shown in Figure 10. In this example, Departments A and B demonstrate horizontal internal equity in all three jobs because the salaries are fairly close. These departments also demonstrate vertical internal equity because there is a similar progression within the job hierarchy. Department C, however, demonstrates neither horizontal nor vertical internal equity. FIGURE 10 Internal Equity Example Horizontal (Across departments or organizational units) Department A Department B Department C (Within departments or organizational units) Position Salary Salary Salary Vertical Secretary Level I $25,000 $26,000 $29,000 Secretary Level II $30,000 $31,000 $25,000 Secretary Level III $35,000 $36,000 $50,000 HT BldgPayStructures UPDATE book.indd 25 10/19/2009 1:01:28 PM  26 Building Pay Structures Although horizontal and vertical internal equity are presented as two separate concepts, in reality they are interrelated. While it is appropriate to pay the Secretary Level III more than Levels I and II, how much more is determined by what is being done in the other two departments. (There are other factors that also must be factored in, such as performance and time in grade.) The purpose of this illustration is to emphasize the importance of equity in salary administration and to point out the different perspectives from which equity needs to be viewed. Internal equity is a key consideration in developing pay structures not only within a job family, as shown in the illustration of secretarial positions, but also among various job families that have common job grades. The first step in establishing internal equity is job evaluation. External Competitiveness The other basic consideration in the design and development of pay structures is external competitiveness, or external equity. Busi nesses compete in a free market for products and services. The costs of these products and services include labor, which is never constant. Companies need to closely monitor labor costs to make sure that they neither overpay (leading to a higher cost than necessary in providing a product or service) nor underpay (possibly leading to higher turnover, which could hurt organizational productivity). The labor market is subject to the same external pressures as the product and services market. Organizations have to respond quickly, appropriately and consistently to survive constant changes in the labor market. It is important that the company’s pay structure be capable of accommodating such changes. Defining Competition In researching a company’s competitive posture, the first step is defining “competition.” During times of low turnover, it may be more difficult to identify organizations that compete for labor. Low turnover should not lead to the false conclusion that there are no HT BldgPayStructures UPDATE book.indd 26 10/19/2009 1:01:28 PM  Developing a Pay Structure 27 competitors for labor or that the compensation program is working perfectly for a given organization. Turnover statistics may show which skills are in demand — and, in turn, which special pay structures may be necessary. However, turnover statistics by themselves may not reveal much about competitiveness. Terminations may be taking place for many reasons, both personal and professional. If employees are leaving particular companies for reasons other than increased pay — for example, to start their own businesses — these companies should be excluded from the defined list of competitors. Once it is established that employees are moving to other orga- nizations, it is time to gather data on these organizations. In the final analysis, an organization’s human resources strategic plan must tie directly to the data gathered on any defined competition. In general, organizations tend to survey other businesses similar to themselves in all or some of the following characteristics: size (usually reflected by total assets), industry type (products, services), geographic location, revenue/income size and required job skills. Here are three ways to obtain data: Refer to published surveys. Before using published surveys, care- fully review their usefulness and applicability to the organization. It may be possible to examine the survey input documents as well as an extract of survey output. Participate in customized surveys. When possible, participate in customized surveys conducted by other companies of similar size or industry type. Conduct a survey. If data are required in a hurry, a telephone survey (by a third party) may be conducted. However, telephone surveys are not recommended for multiple jobs because the amount of phone time required may not be convenient for all participants. Before an organization decides to conduct its own survey, there are obvious considerations such as time, costs, usefulness of data and survey purpose. There also are some hidden concerns, such as the difficulty of convincing potential peer organizations to participate. HT BldgPayStructures UPDATE book.indd 27 10/19/2009 1:01:28 PM  28 Building Pay Structures Key Steps in Designing an Effective Pay Structure The following set of steps describes the specific ways in which internal equity and external competitiveness both play a role in establishing pay structures and job hierarchy. (See Figure 11.) These steps are based on the assumption that the organization is using a point-factor job-evaluation plan, one of the many methods of establishing the value of a job internally. After the description of each step, key issues pertaining to that step are highlighted and questions to be asked regarding each issue are indicated. Specific answers to these questions are not given because they would differ from organization to organization. Note that the first five steps relate to the establishment of internal equity. The last five steps relate to external competitiveness. In general, as the job level increases, the reliance on external market data — as opposed to internal considerations — also increases. (See Figure 12.) Step 1: Review Overall Point Differentials This step often is referred to as “sore thumbing” because it involves reviewing all of the job-evaluation points to see if any evaluations stand out from the group. If necessary, points are changed to better reflect the relative internal value of the job before proceeding to the second step. FIGURE 11 Steps in Establishing Internal Equity and External Competitiveness Internal Equity External Competitiveness Review overall point differentials Incorporate market data Rank order jobs by total Review market inconsistencies evaluation points Smooth out grade averages Develop job groupings Review differences between Develop preliminary point bands midpoints and market averages Check intrafamily and Resolve inconsistencies between supervisory relationships internal and external equity HT BldgPayStructures UPDATE book.indd 28 10/19/2009 1:01:28 PM  Developing a Pay Structure 29 FIGURE 12 Internal vs. External Equity as Applied to the Hierarchy of Jobs Job Level Low Middle High Internal Evaluation External Evaluation (Market-Based) In the process of establishing job levels, the proportion of internal evaluation and external evaluation used usually varies with the level of the jobs within the hierarchy of jobs in the company. As the level of the job increases, the reliance on external market data increases. Key issue: Do any job evaluations appear to be “out of place,” either with their peers across functions or with their superiors or subordinates? Key questions to ask: Do the evaluators fully understand the jobs? Is the job description or questionnaire complete? Is the job being compared to the correct peer EXAMPLE 4 Rank Order Job Title Points group? Is the rater evaluating the job or the person? 13 Claims Officer 565 12 Accounting Systems 550 Control Officer Step 2: Rank Order Jobs 11 Employee Relations Officer 545 by Total Evaluation Points 10 Team Leader 470 Rank all jobs in ascending or 9 Senior Accounting 425 descending order as shown Consultant in Example 4. 8 Project Coordinator 405 Key issue: Does the hier- 7 Accounting Consultant 355 archy of positions make 6 Accounting Technician 350 intuitive sense? 5 Records Management 345 Key questions to ask: Specialist 4 Reconciliation Technician 335 Does the hierarchy reflect 3 Service Center Coordinator 260 the differences in the func- tions of the various positions? 2 Copy Center Worker 210 Has any position been over- 1 Mail Clerk 140 rated or underrated? Do the HT BldgPayStructures UPDATE book.indd 29 10/19/2009 1:01:28 PM  30 Building Pay Structures EXAMPLE 5 differences in points reflect Job Groupings Points the degree of differences Claims Officer 565 between positions? Accounting Systems 550 Control Officer Step 3: Develop Job Employee Relations Officer 545 Groupings Team Leader 470 While developing groupings, Senior Accounting 425 Consultant look for point breaks. Make Project Coordinator 405 sure that the number of Accounting Consultant 355 levels identified is compat- Accounting Technician 350 ible with the number of Records Management 345 levels within the organiza- Specialist tion. Possible job groupings Reconciliation Technician 335 using natural point breaks Service Center Coordinator 260 are shown in Example 5. Copy Center Worker 210 Ke y i s s u e : H o w t o Mail Clerk 140 develop job groupings that are meaningful rather than contrived. Key questions to ask: Where are the natural point breaks? How many levels should there be to accommodate levels within the organization? Step 4: Develop Preliminary Point Bands Salary-grade point bands, or ranges, can be developed as either “abso- lute” point spreads or as percentage-based point spreads between point-band maximums. Table 1 is an example of an absolute point spread between maximums based on some of the jobs in the preceding examples. Notice that 39 points is the absolute value between point- band maximums. However, the percentage spread varies. A variation on the “absolute” point spread is to increase the point spread when moving up the salary-grade structure. Organizations may choose to do this in recognition of the broader range of skills represented within higher salary grades. Table 2 is an example. HT BldgPayStructures UPDATE book.indd 30 10/19/2009 1:01:29 PM  Developing a Pay Structure 31 TABLE 1 Point Bands Constant Varying Grade Absolute Percentage Minimum Maximum Points Spread (rounded) 1 137 178 39 22% 2 176 217 39 18% 3 215 256 39 15% 4 254 295 39 13% 5 293 334 39 12% 6 332 373 TABLE 2 Point Bands Varying Varying Grade Absolute Percentage Minimum Maximum Points Spread (rounded) 1 140 165 15 9% 2 166 180 35 19% 3 181 215 35 16% 4 216 250 40 16% 5 251 290 40 14% 6 291 330 An alternate approach is to develop point bands with percentage-based point spreads between point-band maximums. The percentage spread can remain constant or vary. (See Tables 3 and 4 on page 32.) Key issue: Determining the width of each point band. Key questions to ask: Wider point bands will require fewer grades, and they will group a larger number of jobs together. Is this in line with organization’s corporate policy? Are jobs with similar skill, effort and responsibility being grouped together? For the purposes of this example, a salary structure will be constructed with 11 grades. It is important to remember that this decision is not purely objective. It takes into account an organiza- tion’s internal values and other practical considerations, such as the desired number of grades or a set policy regarding the number of grades between supervisor and employee. Most importantly, the structure should work for the organization. HT BldgPayStructures UPDATE book.indd 31 10/19/2009 1:01:29 PM  32 Building Pay Structures TABLE 3 Point Bands Varying Constant Grade Absolute Percentage Minimum Maximum Points Spread (rounded) 1 126 145 22 15% 2 146 167 25 15% 3 168 192 29 15% 4 193 221 33 15% 5 222 254 38 15% 6 255 292 TABLE 4 Point Bands Varying Varying Grade Absolute Percentage Minimum Maximum Points Spread (rounded) 1 126 145 22 15% 2 146 167 25 15% 3 169 192 33 17% 4 199 225 38 17% 5 230 263 50 19% 6 275 313 The point bands in Example 6 were developed using job eval- uations and the natural breaks between jobs. A minimum of 137 points was set for the lowest grade, which is occupied by the Mail Clerk job (evaluated at 140 points). Each grade’s point-band width is a constant 39 points between point-band maximums. The 11 grades, shown in Example 6, are designed to accommodate the lowest-level job — Mail Clerk — to the highest-level job — Claims Officer. Step 5: Check Intrafamily and Supervisory Relationships The last step in the internal equity process is to check the evaluations to ensure they represent all the levels and reporting relationships within the organization. It is important to determine whether jobs of similar skill, effort, responsibility and working conditions are within the same salary level. The structure should be reviewed to HT BldgPayStructures UPDATE book.indd 32 10/19/2009 1:01:30 PM  Developing a Pay Structure 33 ensure that dissimilar jobs are not EXAMPLE 6 Grade Point Bands placed within the same level, and 11 527 + that subordinate and supervisor posi- 10 488-526 tions are not placed within the same 9 449-487 grade. 8 410-448 Key issue: Peer and subordinate/ 7 371-409 superior relationships. 6 332-370 Key questions to ask: Are there enough levels between supervisor 5 293-331 and subordinate positions? Do the 4 254-292 set levels accurately reflect relative 3 215-253 levels within job families? 2 176-214 1 137-175 Step 6: Incorporate Market Data Based on the preliminary ranking performed in Steps 4 and 5, market data are added to identify differ- ences in how your company and the market value a particular set of jobs. Table 5 is an example. Key issue: How to obtain the best fit between internal evaluation and market value. Key questions to ask: Are the market numbers reliable? Are the job matches appropriate? How many open grades are needed to meet future needs? Is it possible to keep the market comparisons current? At this point in the TABLE 5 GRADE POSITION MARKET AVERAGE process, di fferences 11 Claims Officer $57,000 between a com pany’s Accounting Systems Control Officer $53,000 Employee Relations Officer $49,000 internal values for a 10 Open 9 Team Leader $36,000 job and the market’s 8 Senior Accounting Consultant $31,600 values become apparent. 7 Project Coordinator $29,200 In Example 7 on page 34, 6 Accounting Technician $25,600 Accounting Consultant $24,300 note that there is only Records Management Specialist $23,000 5 Reconciliation Technician $23,000 a 20-point difference 4 Service Center Coordinator $20,300 between the evalua- 3 Open tions for the Employee 2 Copy Center Worker $18,000 1 Mail Clerk $15,300 Relations Officer and HT BldgPayStructures UPDATE book.indd 33 10/19/2009 1:01:31 PM  34 Building Pay Structures EXAMPLE 7 the Claims Officer but an $8,000 Job Title Market (Grade) Points Average difference in pay. Claims Officer (11) 565 $57,000 Accounting Systems 550 $53,000 Step 7: Review Market Control Officer (11) Inconsistencies Employee Relations 545 $49,000 Officer (11) At this point, the organization Open (10) must decide the importance of Team Leader (9) 470 $36,000 the internal values that have Senior Accounting 425 $31,600 been placed on its positions. It Consultant (8) also must decide whether it can Project Coordinator (7) 405 $29,200 afford to pay differently than Accounting Consultant (6) 355 $25,600 Accounting Technician (6) 350 $24,300 the market. Can the organiza- Records Management 345 $23,000 tion risk the internal integrity Specialist (6) of the compensation program Reconciliation Technician (5) 335 $23,000 by relying more heavily on the Service Center Coordinator (4) 260 $20,300 market value of these positions? Open (3) Are there enough positions within Copy Center Worker (2) 210 $18,000 a job family to justify establishing Mail Clerk (1) 140 $15,300 a separate salary structure to address these problems? Once any inconsistencies between the internal and external markets have been resolved, “raw” averages for jobs in each of the salary grades are calculated. These averages are simple means calculated from the market data. (See Table 6.) Key issue: The company must decide whether it can accept a salary structure with TABLE 6 va r y i ng p ercent- GRADE RAW MARKET AVERAGE % DIFFERENCE ages between its 11 $53,000 10 Open midpoints. 9 $36,000 13.9% Key questions to 8 $31,600 8.2% 7 $29,200 ask: Is the number 20.2% 6 $24,300 5.7% of grades selected 5 $23,000 4 $20,300 13.3% (11) still acceptable? 3 Open Can the differences 2 $18,000 1 $15,300 17.6% between midpoints be smoothed out HT BldgPayStructures UPDATE book.indd 34 10/19/2009 1:01:31 PM  Developing a Pay Structure 35 without affecting the integrity of the market EXAMPLE 8 Proposed Grade Midpoints competitiveness? How important is it to be 11 $53,000 close to the market? 10 $46,807 9 $41,338 Step 8: Smooth Out Grade Averages 8 $36,509 While smoothing out grade averages, a deci- 7 $32,243 sion has to be made on where it is most 6 $28,476 important to be competitive and where the 5 $25,149 most payroll dollars are at stake. Then test to 4 $22,211 see which midpoint-to-midpoint percentage 3 $19,616 increment is the most logical to use. 2 $17,324 Example 8 has made use of 13.229-percent 1 $15,300 increments, which allow for use of the 11 grades proposed earlier. (These increments may be derived using the “present value” formula discussed on page 20.) Key issue: The company must decide whether there is an “ideal” midpoint-to-midpoint percentage spread. Key questions to ask: Is smoothing out always necessary or desir- able? Because the smoothing-out process is one of trial and error, at what point is it advisable to stop so that the salaries generated by the structure are competitive and at the same time payroll dollars are not used ineffectively or irresponsibly? Step 9: Review Differences Between Midpoints and Market Averages The key to this step is to identify any large differences between pro - posed midpoints and individual job-market averages. (See Table 7 on page 36.) Key issue: The company must determine the percentage factor that should be used to smooth out the midpoints. Key questions to ask: Which jobs have the greater need to be competi- tively paid? Can any jobs be underpaid without affecting the company’s ability to attract and retain employees? Can the company afford to overpay some jobs? HT BldgPayStructures UPDATE book.indd 35 10/19/2009 1:01:32 PM  36 POINT MARKET PROPOSED MIDPOINT GRADE SPREAD POSITION POINTS AVERAGE MIDPOINT COMPA-RATIO ( PROPOSED MARKET AVERAGE )