Key Steps for Establishing a Sound Base Pay Program
By Barbara D. Morrow, MBA, CCP
I. Job Analysis
The first step in determining a base pay program is to understand the jobs and their requirements. This process requires writing job descriptions which require supervisory input. Job descriptions are written statements that describe reporting relationships, duties, responsibilities, and qualifications for positions. Job descriptions have many purposes and are used in recruitment, staffing, training, performance management, and compensation decisions.
II. Job Evaluation
After defining jobs, the second step is determining the worth of the positions. There are two major schools of thought regarding job evaluation: market-driven and job worth. In a market-driven compensation system, the “market-rate” for the position is the primary determinate of pay. The ‘market-rate’ is the best estimate of the wage rate that is prevailing in the external labor market for a given job or occupation. The quality of external comparisons is critical.
Not all positions exist in all organizations; in these cases, determining job worth is difficult and slotting may be required. Since pay levels can jump substantially in a particular year due to labor shortages, most organizations prefer to wait out these changes rather than immediately increasing pay. Market-driven systems should be monitored closely to track changes in pay.
In a job-worth system, the primary determinate of pay is the value of the job to the organization. In some cases, a job-worth system can result in pay differences from the external marketplace. In job-worth systems, jobs are ranked or assigned points by various factors (i.e. skills, effort required to achieve results, scope, etc.). These factors may be weighted. In this type of system, internal equity is more important than external market conditions.
III. Market Analysis
Identification of ‘benchmark’ jobs to survey in the job market is a key step in a market analysis process. Benchmark jobs are easily identified in the marketplace for pay comparisons and reflect a good representation of positions within the organization, both vertically and horizontally. Examples of vertical representation may be: Accountant, Senior Accountant, and Accounting Supervisor. Horizontal representations include jobs by functions, such as engineering, accounting, HR, etc. Many companies participate in salary surveys conducted by third-party consulting firms which collect average salaries and bonuses paid in the generic survey benchmark jobs. Also provided are results on overall pay practices. Survey results are usually displayed by all companies, industry, location, and size. Specialized ‘cuts’ of survey results may be requested showing aggregate information by competitor organizations. Companies are able to use the salary survey results in determining the competitiveness of salaries paid to employees in their company.
IV. Salary Structure Development
The fourth step after conducting a market analysis of benchmark jobs is to develop a salary structure. A salary structure represents grouping benchmark jobs into salary grades based on the salary survey median salaries. The determination on the number of salary grades (or levels) within a salary structure is also predicated on an internal ranking of the importance of the jobs to the organization. This ranking is based on job responsibilities, complexities, skill, and experience required for the jobs. Each salary grade is assigned a salary range based on the market data from the cluster of jobs assigned to each grade.
Understanding the fundamentals of a salary range is critical. Every salary range has a minimum, midpoint, and maximum. The minimum is often used as the starting salary, and most compensation systems gear merit increases to move employees to the midpoint of the salary range. The midpoint, which represents the middle data value of given salary range or pay grade, targets a composite market rate for the jobs assigned to a salary grade. The maximum is the highest rate paid for a position in that grade.
Employees’ salaries above the maximum are often “red-circled,” meaning that their pay is frozen until salary-range adjustments place current salaries below the maximum. Typically, salary ranges are reviewed and updated annually. The difference between the minimum and the maximum is called the ‘spread’.
In an effort to reflect flattening organizational structure, some organizations have adopted a small number of extremely wide salary ranges called salary bands. While traditional ranges are from 30-50 percent wide, bands may be as wide as 100 percent or more. Salary ranges also are used to determine the size and frequency of merit increases.
V. Performance Management Process
The fifth step is having a sound performance management process. Managing employee performance involves the planning and assessment of individual and/or team effort toward the achievement of individual and organizational goals. Managers are responsible for ensuring that individuals understand what work results are expected and how their job performance will be evaluated. Ongoing feedback is essential in motivating employees to improve performance.
VI. Merit Increase Administration
The sixth step is linking pay for performance. This includes designing a process of determining merit increases based on a distribution of individual performance ratings. This can be accomplished by designing a ‘merit increase matrix’. A ‘merit increase matrix’ is a process for giving managers a uniform tool to determine the size of merit increase for each employee. This matrix is based on performance rating distribution in relation to the employee’s salary position in their salary range (salary index). In developing this matrix, it is important to determine where the organization pays in relation to the market.
A company with high turnover will have many employees near the lower ends of its salary ranges. A company that pays far below the market may need a higher-than-normal merit matrix to increase pay to the appropriate levels. Top performers should receive merit increases that are significantly higher than employees who are meeting expectation – if possible, these increases should be double the size of increase received by employees who meet expectations. Employees who are significantly below performance expectations generally do not receive increases.
VII. Salary Management
On an annual basis, it is important to review pay equity situations within departments, divisions, and the company to ensure if there are any pay problems that need resolution. This analysis is often combined with a diversity program analysis, which reviews actual or perceived inequities between various groups or individuals.
Source: WorldatWork’s Handbook of Compensation, Benefits & Total Rewards
Barbara Morrow is a Compensation Consultant with Strategic Workplace Consultants. She helps organizations understand total reward strategies and develop base and incentive compensation programs.