A company's compensation structure is the method of administering its pay philosophy. The two leading types of pay structures are the internal equity method, which uses a tightly constructed grid to ensure that each job is compensated according to the jobs above and below it in a hierarchy, and market pricing, where each job in an organization is tied to the prevailing market rate.
A compensation structure helps answer questions about who's who, what each person's role is, and why people are compensated differently. To this end, a company needs job descriptions for all its positions so that people know where they fall within the organization. It also helps human resources personnel to fairly administer any given pay philosophy. For example, a company might want to pay everyone at market; or pay some people at market and some above it. Opportunities for incentives are also dealt with in the pay structure. For example, people with strategic roles will likely have opportunities for higher incentives.
Outsource if Necessary
Many firms have one or more in-house compensation consultants who can set up a pay structure consistent with the company's pay philosophy. Small organizations and other companies without the resources to hire a compensation consultant can either train someone in how to set up a pay philosophy, or outsource this service.
Start with a Payroll Budget
When setting up a compensation structure, most companies start with a payroll budget. Senior management usually sets payroll budgets during the annual planning.
The budget for merit increases is generally kept separate from the overall budget to allow for market adjustments. Companies research what merit increases and salary movements historically have been (approximately 3.5 percent on average in recent years) and then project the budgets for market adjustments and merit increases.
If turnover is high, a company may have to move people's salaries more quickly than if turnover is low and there is more time to implement the compensation structure.
Benchmark the Value of Each Job
Once it is known how many jobs are to be priced and the total amount allocated to spend, a company should benchmark as many jobs as possible. Benchmarking means matching an internal job to an external job of similar content. Make sure to benchmark jobs to job content, rather than job title. For example, a bookkeeper and an accountant I may seem similar, but a comparison of the job descriptions should reveal the job to which isreally being matched.
When benchmarking, the market value goes to the job, not to the person filling it. Price “spaces, not faces.” In order to make the best use of an organization's resources, it is important for a company to acquire survey data for similar companies. Salary Wizard Professional (for small businesses) and CompAnalyst (for large businesses) are a great place to get data that represents organizations of similar size, industry, and location.
In small companies people are often called upon to fill hybrid jobs - for example, a person might be asked to be both HR manager and office manager. It is important to review the data for each of the components of the hybrid job, and develop a market price accordingly.
Use Internal Equity Method to Create Salary Ranges by Pay Grade
The internal equity method of structuring pay involves creating a series of grades or bands, with wide ranges at the top of the compensaiton structure and narrower ranges at the bottom. Each grade represents a different level within the company.
A company must determine how many grades are required, choosing a reasonable number based on how many employees work in the organization today and the variety of jobs at the organization. The number of grades can always be expanded later. A company of 30 people might start with 10 grades, although small companies normally do not benefit from pay grades as much as larger companies because of the frequent instance of hybrid positions in small companies.
A company should also give each grade a spread, so that people can move within their grade as they progress in their jobs. Additionally, creating a minimum and a maximum for the whole company is recommended. The midpoint of the lowest grade should reflect the lowest value of the lowest job in a benchmarking study. The midpoint of the highest grade should reflect the highest value of the highest job.
From one grade to the next, there should be a 15 percent midpoint progression, meaning the midpoint of one grade should be about 15 percent higher than the midpoint of the grade below it. This is to ensure that promotions are accompanied by meaningful pay increases.
Benchmarked jobs are then slotted into the pay grades. Some positions are often forced into a grade, and some grades won't be fully aligned. Ideally companies look for a narrow margin of approximately 5 to 10 percent between the market median and the midpoint of the grade.
Market data may not be available for all jobs. Such jobs are often slotted into comparable grades for the company according to the scope of the job, the responsibilities, the size of the budget the position handles, etc. For example, if a suitable benchmark for a financial manager cannot be found, the job is slotted into the rough equivalent of the HR manager if they are equally valued at your organization.
Broadbanding is the pay practice of creating large ranges and control points within a grade to give people wide latitude to move within their job without outgrowing the payscale. However, studies have shown that after five to seven years of doing the same job, people no longer improve dramatically in that job. A pay philosophy might take this principle into account by stipulating that no one will be paid more than 120 to 130 percent of market, regardless of how well he or she performs.
Many nonexempt jobs are compensated in traditional pay grades. These jobs benefit from a more structured approach to pay.
Use Market Pricing to Relate Jobs to External Forces
An alternative to the traditional grid-based compensation structure is the market pricing approach, which is rapidly becoming the prevalent method of pricing jobs. With the market pricing approach, people are compensated in relation to the market value of their job, regardless of their level in the organization. The market may suggest, for example, that certain information technology workers should be paid more than chief technology officers.
The pertinent value in the market pricing method is not the midpoint of a grade, but the midpoint of that job in the market, along with the employee's compa-ratio, or salary divided by the market rate. Over time, the employee's pay should move closer to market as performance moves closer to expectations for that job. Under the market pricing method, the salary for a job may still be capped at 120 to 130 percent of market.
Labor unions also typically do market studies in collaboration with the human resources department or with a third party. A company striving to compete with the possibility of a unionized workforce might pay more than the union's market study recommends.
Speak Plainly about the Numbers to Save Time
Hiring managers should know what they can afford to pay, and they should be able to communicate that range to candidates.
With recruitment and retention so critical to the success of a business, it is to everyone's advantage for a hiring manager to disclose a salary range up front. Even in a telephone interview it may help get the right candidate in the door if the manager reads the job description and discloses the pay range. And if candidates have done thorough salary research, the conversation about compensation is likely to begin with market data anyway.