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Base Pay Structures11

Compensation deals with establishing a meaningful and acceptable relationship between work and rewards. Work performed by employees should help organiza- tions achieve their objectives. These objectives are derived from the organization’s overall business strategy, which supports the company’s mission statement.

When designed and administered appropriately, a company’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 compen- sation programs. (See Figure 11.1.) This process is not a one-time event. It involves constant review and refinement in light of changing business needs.

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 11.2.)

The midpoint or middle-pay value for the range usually represents the competi- tive market value for a job or group of jobs. The company’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 mid- points and also to take into consideration variable compensation. 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.

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224 Base Pay Structures

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 fre- quent 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 signifi- cantly, the distances between midpoints of ranges may be as substantial as 15 percent or more.

Figure 11.1 Determine strategy before structure.

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• External economic environment. Varied supply and demand for certain skills may necessitate a multistructured pay program. Technical professionals such as en- gineers may have special pay structures when there is a high demand for their skills. However, these special structures may be merged into the general struc- ture when there is an increase in the supply of engineers in the market. Other external factors that may be reflected in pay structures include inflationary fluc- tuations and cost-of-living indices such as the Consumer Price Index (CPI).

• External sociopolitical 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 environment. Pay structures also are affected by regula- tions 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 opera- tions 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

Figure 11.2 Pay structure example.

Source: WorldatWork Certification Seminar 4: “Base Pay Management,” 2007.

General and Specific Factors Affecting Pay Structures 225

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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 in- come 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 devel- oped after much thought and research. Short-term or temporary problems need to be taken care of with temporary solutions. Solving temporary problems with long-term solutions should be avoided. 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.

anatomy of a Pay Structure

A pay structure has multiple pay or salary ranges. Every pay structure has key com- ponents 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 11.3, the range spread in dollars for Grade 10 (from Figure 11.2), where the maximum is $120,360 and the minimum is $80,160, is $120,360 – $80,160 = $40,200. The percentage is about 50 percent, or $40,200 divided by $80,160.

Figure 11.3 illustration of a pay range and a range spread.

Note: Numbers have been rounded. Actual range spread is 50.15 percent.

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To calculate the spread on either side of the midpoint, use the formulas shown in the Formula 11.1 box (where $100,260 is the Grade 10 midpoint in Figure 11.2).

A pay range with a 50-percent range spread will have a 20-percent spread on either side of the midpoint. (See Figure 11.3.) That is, $80,160 is 80 percent of $100,260, and $120,360 is 120 percent of $100,260.

While all the ranges in Figure 11.2 have a range spread of 50 percent, the spread does not have to be uniform throughout the pay structure. Figure 11.4 lists common range spreads and their corresponding spreads on either side of the midpoint.

Example 11.1 shows how to calculate the spread on either side of the midpoint. To perform the calculation, one of the three points (minimum, midpoint, or maxi- mum) 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 $66,800, the maxi- mum and midpoint are calculated as in Example 11.1.

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 usu- ally have narrower pay ranges than supervisory, managerial, or higher-level techni- cal 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

Figure 11.4 Common range spreads.

Note: Under a broadbanding system, range spreads may reach 100 percent or more.

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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:

• 20–25 percent: lower-level service, production, and maintenance. • 30–40 percent: clerical, technical, paraprofessional. • 40–50 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 mid- point, changing range spreads also changes the minimum and maximum. Notice in Example 11.2 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

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an employee higher in the range in order to pay competitively. This narrows the position’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.

midPointS

The midpoint is a key element in pay administration. It is often used as a reference point in salary administration decisions as a point or “target.” The midpoint is usu- ally the reference used because it is typically set to equal the market average or me- dian. It should not be an organization’s only market reference point.

Related to the midpoint is the compa-ratio, a statistic that expresses the relation- ship between base salary and the midpoint, or between the midpoint and market av- erage. Figure 11.5 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, and the company as a whole.

Most companies 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 in- dividual has been in the job, previous work experience, and job performance. A mature, long-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 a company 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, companies 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.

Figure 11.5 illustration of compa-ratios.

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ranGe Penetration

Another way of tracking an organization’s compensation is to view employee pay in relationship to the total pay range. This is known as range penetration. Unlike compa-ratios, which are calculated using a grade’s midpoint, range penetration is calculated using the minimum and maximum of a salary range. Range penetration is shown in Example 11.3.

Often range penetration is a preferred tool because it does not focus on one number alone, the midpoint. Instead, it refers to how far into the range a particu- lar individual’s salary has penetrated. Range profiles often are used in conjunc- tion with either the compa-ratio or range penetration to describe where employees should expect their pay to fall in relationship to their pay range over time. (See Figure 11.6.)

Constant Range Width: 50%

Constant Annual Range Movement (Structure Change): 2.5%

Constant Salary Increase: 4%

Given the above constants and a starting salary of $12,800, it would take:

8 years to exceed the midpoint ($22,823) of the range

13 years to reach close to the maximum ($30,986) of the range

Figure 11.6 llustration of range penetration.

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midPoint ProGreSSion

Midpoint progression refers to the percentage difference between pay-grade mid- points. 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. Formula 11.2 may be used, or the calculations may be performed on a business calculator.

Suppose a company wishes to develop a pay structure with six grades that has a highest midpoint of $77,820 and a lowest midpoint of $46,620. What is the mid- point progression?

Using Formula 11.2, the midpoint progression is calculated to be 12.5 percent. The resulting pay structure looks like Figure 11.7.

There are two other approaches to developing midpoints and the resulting mid- point 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 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 sometimes difficult to administer because of the following reasons:

• If the percentage difference between midpoints is too high, the result could be costly promotional increases.

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• If the percentage difference is relatively low, the result could be salary com- pression problems between supervisory and subordinate positions and diffi- culty in matching promotions with appropriate compensatory rewards.

The other approach to developing midpoints in a pay structure is the use of re- gression 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.

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 exter- nal 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 findings from market research as well as the company’s compensation policy. Does the policy call for frequent “pro- motions,” 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” organiza- tion, or does it prefer multiple levels within the organization?

Segmentation of Pay grades

A pay grade may be segmented or subdivided in many ways—thirds, quartiles, quin- tiles, 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.

Figure 11.7 example of midpoint progression.

Note: Numbers have been rounded.

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Using segments within a pay grade instead of only midpoints provides more flexibility to managers in pay-related decisions. These segments serve as miniranges within the main range. 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-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 ad- joining 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 11.8A.) Grade overlap is significant when midpoint differentials are small and range spread is large. (See Figure 11.8B.) Figures 11.8C and 11.8D are illustrations of moderate grade overlap.

In a pay-for-performance or merit system, grade overlap allows high performers in lower pay ranges with longer time-in-grade to 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 supervisor and subordinate pay.

Multiple Pay Structures

An organization may have many pay structures within its overall structure. The num- ber of structures is primarily a function of the market and the company’s com- pensation 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 atypical “corporate” structure.

Different labor markets with different levels of supply and demand may neces- sitate 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 de- pending on supply and demand. Therefore, the slope of the pay lines could be dif- ferent for different job families.

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

Pay Grades 233

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11.8B illustration of a significant grade overlap. in this illustration, the differential between grades is 5 percent and the range width is 60 percent. There is a five-grade overlap. (example: $20,000 falls within the five grades shown.)

Figure 11.8 illustrations of grade overlap.

11.8A illustration of a minimal grade overlap. in this illustration, the differential between grades is 15 percent and the range width is 10 percent. There is no grade overlap. The maximum of any grade falls only within one grade. (example: $14,000 falls only within the first grade.)

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11.8C illustration of a moderate grade overlap. in this illustration, the differential between grades is 5 percent and the range width is 10 percent. There is a two-grade overlap. (example: $14,000 falls within the first two grades.)

11.8D illustration of a moderate grade overlap. in this illustration, the differential between grades is 15 percent and the range width is 60 percent. There is a four-grade overlap. (example: $20,000 falls within the first four grades.)

Pay Grades 235

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among comparable jobs throughout the organization. Internal equity can be examined horizontally and vertically, as shown in Figure 11.9. 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.

Although horizontal and vertical internal equity are presented as two separate concepts, in reality they are interrelated. While it is appropriate to pay 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 fac- tored in, such as performance and time-in-grade.)

The purpose of this illustration is to emphasize the importance of equity in salary administration and also to point out the different perspectives from which equity needs to be viewed. Internal equity is a key consideration in developing pay struc- tures 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. Businesses 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 productivity).

The labor market is subject to the same external pressures as the product and ser- vices 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.

Figure 11.9 internal equity example.

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Defining Competition

In researching a company’s competitive posture, the first step is the definition of “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 con- clusion that there are no 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 them- selves 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 companies, it is time to gather data on these businesses. In the final analysis, a company’s human resources strategic plan must tie directly to the data gathered on any defined competition. In general, companies tend to survey other businesses similar to themselves in all or some of the following characteristics: size (usually reflected by total assets), in- dustry type (products, services), geographical location, revenue/income size, and required job skills. Here are three ways to obtain data:

• Refer to published surveys. Before using published surveys, carefully 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 sur- veys conducted by other companies of similar size or industry type.

• Conduct a survey. If data are required in a hurry, a telephone survey 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 a company decides to conduct its own survey, there are obvious consid- erations such as time, costs, usefulness of data, and survey purpose. There also are some hidden concerns, such as the difficulty of convincing potential peer organiza- tions to participate.

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 11.10.) 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 high- lighted and questions to be asked regarding each issue are indicated. Specific an- swers 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

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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 con- siderations—also increases. (See Figure 11.11.)

Step 1: review Overall Point Differentials

This step is often 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 internal value of the job before proceeding to the second step.

Review overall point differentials

Rank order jobs by total evaluation points

Develop job groupings

Develop preliminary point bands

Check intrafamily and supervisory relationships

Incorporate market data

Review market inconsistencies

Smooth out grade averages

Review differences between midpoints and market averages

Resolve inconsistencies between internal and external equity

Internal Equity External Competitiveness

Figure 11.10 internal equity vs. external competitiveness.

Figure 11.11 internal versus external equity as applied to the hierarchy of jobs.

Note: In the process of establishing job levels, the proportion of internal evaluation and ex- ternal 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.

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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 descrip- tion or questionnaire complete? Is the job being compared to the correct peer group? Is the rater evaluating the job or the person?

Step 2: rank Order Jobs by Total evaluation Points

Rank all jobs in ascending or descending order as shown in Example 11.4.

Key issue: Does the hierarchy of positions make intuitive sense? Key questions to ask: Does the hierarchy reflect the differences in the functions of the

various positions? Has any position been overrated or underrated? Do the dif- ferences in points reflect the degree of differences between positions?

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Step 3: Develop Job groupings

While developing groupings, look for point breaks. Make sure that the number of levels identified is compatible with the number of levels within the organization. Possible job groupings using natural point breaks are shown in Example 11.5.

Key issue: How to 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 “absolute” point spreads or as percentage-based point spreads between point-band maximums. Table 11.1 is an example of an absolute point spread 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 mov- ing up the salary-grade structure. Companies may choose to do this in recognition

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of the broader range of skills represented within higher salary grades. Table 11.2 is an example.

An alternate approach is to develop point bands with percentage-based point spreads between point-band maximums. The percentage spread can remain con- stant or vary. Tables 11.3 and 11.4 are examples.

TABle 11.1 Constant Absolute Points

TABle 11.2 Absolute Points increase as grades Become Higher

TABle 11.3 Percentage Spread Constant

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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 the company’s corporate pol- icy? 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 organization’s internal values and other practical consider- ations such as the desired number of grades or a set policy regarding the number of grades between supervisor and employee. Most important, the structure should work for the company.

The point bands in Example 11.6 were developed using job evaluations 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 11.6, 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 im- portant to determine whether jobs of similar skill, effort, responsibility, and working conditions are within the same salary level. The structure should be reviewed to en- sure that dissimilar jobs are not placed within the same level, and that subordinate and supervisor positions are not placed within the same grade.

Key issue: Peer and subordinate/superior relationships. Key questions to ask: Are there enough levels between supervisor and subordinate

positions? Do the set levels accurately reflect levels within job families?

Step 6: incorporate Market Data

Based on the preliminary ranking performed in Steps 4 and 5, market data are added to identify differences in how your company and the market value a particu- lar set of jobs. Table 11.5 is an example.

TABle 11.4 Absolute Points and Percentage Spread Vary

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TABle 11.5 use of Market Data

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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 appropri- ate? How many open grades are needed to meet future needs? Is it possible to keep the market comparisons current?

At this point in the process, differences between a company’s internal values for a job and the market’s values become apparent. In Example 11.7, note that there is only a 20-point difference between the evaluations for the Employee Relations Of- ficer and the Claims Officer but an $8,000 difference in pay.

Step 7: review Market inconsistencies

At this point, the organization must decide the importance of the internal values that have been placed on its positions. It also must decide whether it can afford to pay differently than the market. Can the organization risk the internal integrity of the compensation program by relying more heavily on the market value of these

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positions? Are there enough positions within a job family to justify establishing 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 11.6.)

Key issue: The company must decide whether it can accept a salary structure with varying percentages between its midpoints.

Key questions to ask: Is the number of grades selected (11) still acceptable? Can the differences between midpoints be smoothed out without affecting the integrity of the market competitiveness? How important is it to be close to the market?

Step 8: Smooth Out grade Averages

While smoothing out grade averages, a decision has to be made on where it is most important to be competitive and where the most payroll dollars are at stake. Then test to see which midpoint-to-midpoint percentage increment is the most logical to use.

Example 11.8 has made use of 13.229-percent increments, which allow for use of the 11 grades proposed earlier. (These increments may be derived using the “pres- ent value” formula discussed in Formula 11.2.)

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 desirable? 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?

TABle 11.6 Calculation of raw Averages

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Step 9: review Differences between Midpoints and Market Averages

The key to this step is to identify any large differences between proposed midpoints and individual job-market averages. (See Table 11.7.)

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 competitively 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?

Step 10: resolve inconsistencies between internal and external equity

The proposed salary structure shows how each of the evaluated positions relates to one another internally as well as how each job relates to the market. Most compa- nies are comfortable if the proposed midpoints are within 10 percent of the com- petitive market. Using this as a rule of thumb, the following positions are most out of line with the market:

• Reconciliation Technician: 24 percent. • Records Management Specialist: 24 percent. • Accounting Consultant: 17 percent.

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With these proposed midpoints, the company will pay above the going rate in the market. If internal equity is a greater concern, then the additional money spent may not be a significant issue. However, another possibility to consider is pulling these jobs out of the proposed pay structure and paying them separately. The grade level would stay the same to provide internal job level equity, but the pay midpoints would represent the market more closely.

Decisions of this nature must be made after reviewing the inconsistencies. Each company must take into account its corporate culture and ability to pay when de- ciding what adjustments to make in the balance between internal values and ex- ternal competitiveness. The key goal, as always, is to develop an acceptable pay structure that will aid the company in attracting, retaining, and motivating qualified employees.

Key issue: Determining what is more important—internal or external equity. Key questions to ask: What is the company culture? What is its stance on the consistent

treatment of its employees? Is there high turnover in the company? Is it in a low-level job family or a high-level job family?

PitfallS and PrecautionS

A pay structure is not an end in itself. In fact, it is possible for a company to pay its employees without having a formal pay structure. While pay structures help create a systematic and equitable system of cash-compensation management, it is important to keep in mind that they are only tools. Pay structures actually will burden a com- pany unless the following issues are considered:

• Competitive posture. What is the competitive posture of the company? How much above or below the market should the company pay or can it afford to pay?

TABle 11.7 Differences Between Proposed Midpoints and individual Job Market Averages

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• Decision making. Who will make the critical decisions underlying the pay structure? (For most companies, senior management tends to make these decisions.)

• Monitoring. How frequently will the pay structure be monitored and assessed for currency and appropriateness?

• Flexibility. Is the pay structure flexible enough to handle dynamic situations? This is critical in this age of constant change in corporations and in the eco- nomic environment, particularly the labor market.

• Resources. Can the company afford to allocate sufficient resources (including technology) to build and maintain current and relevant pay structures related to data?

• Communication. Is the company willing to allocate the required effort and re- sources to communicate the pay structures to employees and educate manage- ment in the proper use of pay structures?

Many companies currently are considering the broadbanding of salary ranges where applicable and appropriate. Broadbanding is the combining of existing ranges by expanding range width and reducing the number of grades. This usu- ally is done for many reasons to benefit the organization and its employees. These reasons include the following:

• Paying for performance and allowing managers greater flexibility in salary administration.

• Ease of moving people within the company. • Reduction of the demands of job evaluation as well as the time and effort re-

quired to make organizational changes.

Broadbanding is only one approach to pay administration in general and pay struc- tures in particular.

Pay structures should be developed from the organization’s mission and business strat- egy. Strategy should always precede structure development. Many internal and external environmental factors determine a company’s pay structure. The pay structure has to adopt the same positive characteristics of a company’s overall compensation program.

While designing a pay structure, a balance between internal and external equity must be maintained. Constant fine-tuning should take place. Developing pay struc- tures is more an art than a science, although many mathematical techniques and processes may be used. While it is important to be specific about structural features such as the range spread, midpoint progression, and so on, the key element of an effective pay structure is its value in functioning as a tool for managing pay.

BroadBandinG

Broadbanding has been a part of the HR field since the late 1980s and early 1990s and was developed to compress many salary grades into fewer, wide pay “bands.” Those organizations that implemented such a system were driven by the need to adapt salary administration systems and procedures to meet a new business climate and create a flatter organization.

Broadbanding can be defined as a pay structure that consolidates a large number of pay grades and salary ranges into much fewer broadbands with relatively wide salary ranges, typically with 100 percent (or more) differences between minimum

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and maximum. Simply stated, broadbanding refers to the collapsing of job clusters or tiers of positions into a few wide bands to manage career growth and deliver pay.

Broadbanding was created to help achieve several objectives, namely:

• Develop broader workforce skills. • Encourage career development among employees. • Reduce administration with job evaluation, salary structure, and merit pay.

Broadbanding usually appeals to fast-moving organizations that are undergoing persistent change. Such organizations that want to be quicker and more flexible in the marketplace have implemented broadbanding. They have found that broad- bands complement processes designed to increase company speed, flexibility, and risk taking.

Some or most of the career ladder rungs were removed and employees were encouraged to earn more by adding value to the company. This could be accom- plished by developing new skills or competencies and/or participating in a variable pay system with a line of sight to the company’s performance.

Broadbands support this evolving organizational dynamic by providing less for- mal structure. The traditional compensation approach emphasizes internal equity, focused employees’ attention on the world inside the firm, and helps them ex- perience an internal culture that more closely reflects the external, competitive marketplace. It helps make it easier for them to reorient themselves to the mar- ketplace.

In broadbanding, there is no automatic progression to the midpoint because there is no midpoint. The marketplace for talent is no longer represented by highly defined salary structures, but rather mirrored by loosely defined, ambiguous broad- bands that do not apply directly to an employee’s position. (See Sidebar 11.1.)

StartinG rateS of Pay

When pay ranges have been formally established, it is the policy of most employers to pay new hires, who appear to have only the minimum qualifications for their jobs, at or near the range minimum. The objective is to avoid paying them at rates that are too close to those paid to more experienced employees in the same job. Occasionally, supply and demand conditions are such that new hires with relatively little experience must be paid substantially above the range minimums. Addition- ally, individuals with substantial experience (or otherwise superior qualifications) frequently are hired at higher levels in the rate ranges.

increaSeS to BaSe rateS of Pay

Today’s employees typically are eligible for several types of base pay increases, such as general (or across-the-board) increases, cost of living increases, promotional in- creases, step increases, and merit increases.

General (or across-the-board) increases are those that are granted in equal per- centages or equal dollar amounts to all employees in an eligible group. For ex- ample, all employees might receive pay increases equal to 25 cents per hour, or 3 percent of their current pay. Employers might specify that some employees

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(e.g., those who exceed the maximums of their rate ranges or those whose perfor- mance is unacceptable) are to be excluded from receiving such increases. General increases are not conceptually compatible with pay-for-performance programs, and the use of general increases has diminished as performance-based programs have expanded.

A cost of living increase is a specific type of general increase that is typically awarded in equal cents per hour or percentage terms to all employees in a pay program or structure. Cost-of-living allowance (COLA) increases, however, are intended to protect employees’ purchasing power against erosion caused by inflation. These increases typically relate to increases in the Consumer Price Index (CPI). Thus, all cost-of-living increases are general increases, but not all general increases are cost- of-living increases.

Promotion increases are increases granted to employees who are promoted from one job to another job with a higher pay grade and range. The size of increase is usually influenced by the magnitude of the promotion (as measured by the difference between the pay ranges assigned to the promotee’s old and new jobs) and the pay relationships among the promotee’s peers, superiors, and subordi- nates.

Within-range increases are types of base pay increases that move employees forward in the pay ranges assigned to their jobs. Within-range pay increases are virtually

Sidebar 11.1: Broadbanding is not for everyone

Broadbanding is not a panacea for all organizations. One potential disadvan- tage is that broadbanding’s delayered approach to salary administration may not fit the culture of heavily level-oriented companies. The need to manage salaries also does not go away. Market pricing becomes even more important because it is used extensively to identify salary targets.

When broadbanding is implemented, an organization may also have to re- examine such things as management incentives, perquisites, and other items tied to the conventional salary grade. Line managers also may need to be retrained to make compensation decisions while being persuaded to accept new or greater responsibility for employee career development.

As some companies have found, pay systems are most effective when they support organizational change, not when they lead change. Some theorize if an organization is not ready for broadbanding, it will likely fail.

Other potential pitfalls exist:

• It could be possible to flatten the pay structure to the extent that super- visors and their subordinates are in the same band.

• The question of inflation arises, both of pay and of expectations, when employees are put in bands with potentially higher maximums than their previous grade maximums.

• It becomes more difficult to compare jobs to the marketplace and main- tain external equity.

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always determined by some combination of the employees’ length of service and performance. The two principal types of within-range increases are:

1. Increases based primarily on length of service (though differences in performance may also be reflected). These may be step increases, whereby the pay ranges are divided into a number of pay rates with increases related to length of service. The step increase concept is used most commonly for nonexempt employees, and there are several different approaches to this concept:

a. The first is for length of service only. Here the employee receives single-step increases up to the range maximum, which is usually at or just above the competitive market rate. If performance is unsatisfactory, the increase is de- nied and probation, demotion, or dismissal may result.

b. The second reflects both length of service and performance. One approach is illustrated in the following chart:

Performance Rating Pay Action Outstanding 2-step increase Exceeds standards 1-step increase; may accelerate timing of

next review Meets standards 1-step increase Does not meet standards No increase

c. Another approach involves two or three performance tracks through which the employee progresses to a performance zone maximum. The number of steps can be increased to allow for smaller percentage steps.

d. Finally, it is possible to add timing differences. This further accentuates dif- ferences in pay level based upon differences in performance.

2. Increases based on merit usually are administered in the form of a range of per- centages for varying levels of performance. As mentioned earlier, they also may be used in combination with step progression increases.

Inherent in most merit increase programs are the notions that:

• The speed with which employees move through pay ranges will be deter- mined principally, if not solely, on the basis of their job performance.

• Performance will also determine how far employees are allowed to progress in their pay ranges.

Thus in determining merit increases, many organizations consider the perfor- mance of the individual and his or her current rate in the pay range. As a result, the merit increase may vary in size and timing.

Many organizations use a fixed frequency and vary the increase’s size. The fixed fre- quency may vary by job level, but the most typical frequency at all levels is 12 months. Timing of increases is sometimes based on the pay policy year (focal point) or the anniversary (anniversary date) of the employee’s service or last increase date.

A smaller but significant percentage of organizations vary the size of the increase and the frequency. A minority of organizations fix the size of the increase, but vary the frequency.

The size of the increase (typically measured as a percent increase) generally varies directly with the individual’s performance (the better the performance, the bigger the increase), and, inversely, with the employee’s position in the pay range (the lower the

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position in the range, the bigger the increase as a percent of current pay). It is com- mon practice to provide supervisors and managers with increase planning guidelines. These guideline charts include a range of options, to allow managerial flexibility.

A final variation on the previous methods involves either step progression or per- cent merit guideline increases to the range midpoint, with a lump sum bonus given that varies in amount, depending upon performance.

There are, of course, many variations of these pay increase approaches. Basically, however, all known variations of in-range pay increases are some combination of these two basic approaches—step increases or merit increases.

merit Pay conSiderationS

Compensation professionals believe certain conditions generally must exist for performance-based pay increase programs to be successful:

• Individual differences in job performance should be measurable. • Individual differences in job performance must be significant enough to war-

rant the time and effort required to measure them and relate pay to them. • The pay range should be sufficiently broad (35 percent to 50 percent) to allow

for adequate differentiation of pay based upon performance, and/or level of experience and skill.

• Supervisors and managers must be trained in employee performance plan- ning and appraisal.

• Management must be committed, and employees must be receptive to making distinctions in pay based upon performance.

• Managers must be adequately skilled in managing pay. • Sufficient control systems must be implemented to ensure that merit increase

guidelines are followed.

There are potential productivity and incentive benefits to be derived from the implementation of a performance-based pay increase program. However, this type of program is more complex to administer and requires more difficult management decisions. Compensation professionals must ensure that their merit pay programs measure performance as objectively as possible. Management must carefully evalu- ate performance and make judgments regarding pay differentials. Significant com- mitments of time and effort are required by all involved in this process.

Performance aPPraiSal conSiderationS

For a performance-based pay system to meet its objectives, a well-designed and properly administered performance management system must exist. An effective performance management system includes the following characteristics:

• Performance is appraised on the basis of direct measurement of each employ- ee’s output or results. For example, the quantity and quality of work is assessed rather than the employee personality traits. Employee behavior is considered only to the extent that it is job-related and affects job results.

• Supervisors are trained in the concepts and the process involved in appraising performance.

• Measures or criteria used are as objective and quantitative as possible, to minimize the potential for varying interpretations by different reviewers.

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• Objective performance standards are established for various levels of em- ployee performance when practical.

• The relative importance (weight) of each of the performance criteria is established.

• When practical, employees are involved in the determination of perfor- mance criteria, standards, and weights to ensure greater acceptance of the program.

• Performance criteria, standards, and weights are communicated to the em- ployee at the beginning of the appraisal period, and periodically reviewed and updated for timeliness, relevance, and utility.

• The appraisal is written, and discussed by the employee and supervisor. The employee is involved in the process prior to finalizing the written appraisal. (Many organizations make a copy of the written appraisal available to the em- ployee and provide an appeals mechanism for reconciling differences between employee and supervisor.)

• Finally, the appraisal process is audited routinely and frequently, to identify and eliminate potential problems.

maintaininG and auditinG the Pay ProGram

Maintenance of pay programs is one of the most critical elements of sound base pay administration. Unless programs are properly maintained, errors occur and in- equities will eventually undermine program effectiveness. The maintenance of pay programs is inherently difficult, because of:

• Continual changes in the content of the various jobs in an organization. • Continual changes in the going market rates for jobs. • Frequent changes in organizational structure and staffing levels. • The ever-evolving and expanding regulatory framework governing pay

programs. • The inevitable turnover within the compensation function itself.

KeyS to SucceSSful Pay ProGram maintenance

There are five keys to the proper maintenance of pay programs:

• Clearly stated objectives, policies, and procedures are established and communicated.

• Proper controls are operative to ensure policies and procedures are being consistently applied.

• There is adequate support for the compensation function itself—including provision of sufficient staff and other resources, as well as the top manage- ment support necessary to ensure that the pay program is administered with fairness and integrity.

• The compensation staff properly performs administrative activities. • The pay program is routinely audited for effectiveness and efficiency.

The next sections focus on the ongoing administrative activities necessary for maintaining pay programs and the types of audits that can be conducted to ensure that the programs are functioning properly.

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onGoinG adminiStrative activitieS

The proper maintenance of base pay programs requires continual analysis of the con- tent and requirements for the various jobs in an organization. The information collected in the course of these ongoing analyses requires careful documentation by job descrip- tions, completed position analysis questionnaires, or some combination thereof.

Changes in organizational structure and staffing levels also affect the content of jobs and their relative worth to the organization. Unless job documentation is prop- erly maintained and jobs are properly evaluated, employees may be assigned incor- rect job titles, pay grades, and/or pay ranges. To ensure ongoing program success, some organizations undertake regular reviews or “desk audits” of various organiza- tional components. Others attempt to verify job-content information throughout the process of performance planning and appraisal.

Compensation professionals also continually monitor the position of the orga- nization’s pay levels vis-à-vis those of the competition. Thus, compensation profes- sionals participate in, purchase, and extract data from pay surveys. This compiled data, plus the organization’s pay philosophy and ability to pay, combine to produce decisions regarding changes in pay structures and budgets. If the monitoring of the market is neglected or poorly performed, an organization’s pay rates and/or rate ranges may be too high (causing excessive financial costs) or too low (causing exces- sive employee relations costs) when compared with those of competitors.

In addition to pay structure maintenance activities, compensation professionals create pay increase budgets, planning documents, authorization procedures, and guidelines that combine to support the organization’s pay philosophy. They also pre- pare periodic reports for top management regarding pay program results and costs.

Pay ProGram auditS

Systematic pay program audits can be invaluable for ensuring an organization’s compensation program is being properly administered and maintained. Observers of human behavior have noted “people do what is inspected, not necessarily what is expected.” In the absence of audits, policies may become wishes and pay programs may be rendered ineffective because of inconsistent practices and resultant inequi- ties, charges of illegal discrimination, employee dissatisfaction, or excessive costs.

Five Steps to Prepare for and Conduct Pay Program Audits

Step 1: Decide What to Audit

In general, pay program audits include some combination of four different types of measures:

• Process measures are used to determine the extent to which the pay program is being smoothly and efficiently administered. Some sample measures would be: • Productivity of staff. • Satisfaction of line managers with the administration of the pay program. • Cost of analytical/data collection activities.

• Job analysis. • Job documentation.

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• Job evaluation. • Survey data.

• Amount of management time required for pay program administration. • Cost of data processing/consulting support. • Error rates in databases. • Backlog of requests for evaluations/re-evaluations. • Timeliness of pay increase planning and processing. • Timeliness and quality of performance appraisal data.

• Policy compliance measures are used to determine if the pay program is being administered in accordance with policy. Several examples would be: • Actual rates and ranges versus market position specified by policy. • Pay position in range. • Percent of employees outside pay ranges.

• Green circle. • Red circle.

• Extent of compliance with salary increase policies. • Extent of compliance with starting rate policies. • Job title congruence with actual job content. • Validity of job evaluation data. • Consistency of pay grade and range assignments with job evaluation results. • Compliance with performance appraisal policies and procedures. • Quality of performance appraisal information.

• Documentation adequacy measures are used to determine the extent to which the program is committed to putting it in writing. For example: • Percent of jobs for which accurate and up-to-date documentation exists. • Percent of jobs with accurate job evaluation documentation. • Percent of jobs with valid pay grade assignments. • Percent of employees’ files containing current performance appraisal

documents. • Compliance with Fair Labor Standards Act (FLSA)/Equal Pay Act (EPA)

recordkeeping requirements. • Existence of written policies regarding:

• The design and operation of the job evaluation procedures. • The operation of performance appraisal procedures. • Pay increases. • Structure adjustment procedures. • Re-evaluation procedures.

• Overall results measures are used to assess how well pay programs achieve the established goals, such as: • Attraction and retention of qualified employees.

• Number of openings. • Duration of openings. • Quality of employees. • Number of terminations (voluntary and involuntary).

• Compliance with applicable laws and regulations. • Grievances. • Lawsuits. • Statistical analyses.

• Results of performance-based pay polices. • Turnover by performance level.

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• Percent of payroll allocated in a performance dependent manner. • Correlation between pay and performance levels.

• Protection of the organization’s financial resources. • Pay as a percent of operating budget. • Historical. • Product competitors. • Organization rates versus market rates.

• Employee perceptions of • Internal equity.

• In the same job. • In different jobs.

• External equity.

Step 2: Select the Participants

Participants should understand audit principles and processes and possess well- developed analytical, writing, and interpersonal skills. In addition, they should be disinterested parties that have no stake in a particular audit outcome.

Step 3: Develop a Data Collection and Analysis Plan

Interviews or opinion surveys can be used to determine how various parties view the pay program. Auditors also can examine a wide variety of internal and external rec- ords and reports, including human resource records, payroll data, pay survey data, accounting records, and compensation databases.

Step 4: Assemble the Necessary Data to Support the Analysis

Step 5: Analyze the Collected Data and Develop Findings and Recommendations

The audit report should present findings in an objective manner and provide ad- equate information to give readers the proper perspective.

Management’s role is to:

• Review audit results and recommendations. • Prioritize the improvements that are required. • Allocate the necessary resources. • Follow up to ensure that the work is completed.

Organizations often find that audits are useful tools for educating management groups about the intricacies of pay program administration, thus increasing their understanding and support for the pay program.

Considering the size of base pay expenditures in many organizations, it is generally appropriate to conduct comprehensive audits at least every two years. This approach will ensure organizations are continually aware of the extent to which pay programs achieve their objectives, so problems can be identified and resolved as quickly as possible.

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