Designing Pay Levels, Mix, and Pay Structures Chapter 8 Designing Pay Levels, Mix, and Pay Structures

Learning Objectives After discussing Chapter 8, students should be able to: Identify the major decisions in establishing externally competitive pay. Describe the purpose(s) of a salary survey. Discuss the importance of defining the relevant market in a pay survey. Explain the steps involved in designing a pay survey. Describe the key issues involved in interpreting the results of a pay survey. Explain how the market pay line combines the internal structure with external market rates. Discuss the use of pay grades and pay ranges and their relationship to internal alignment and external competitiveness. Discuss the pros and cons of the market pricing approach to establishing a pay structure.

Exhibit 8.1: Determining Externally Competitive Pay Levels and Structures External competitiveness: Pay relationships among organizations Merge internal & external pressures Competitive pay levels, mix, and structures Draw policy lines Select market Design survey Set Policy Some Major Decisions in Pay Level Determination Determine pay-level policy. Define purpose of survey. Specify relevant labor market. Design and conduct survey. Interpret and apply results. Design grades and ranges or bands.

Specify Competitive Pay Policy Pay with Competition (Match) Lead Policy Lag Policy Flexible Policies For a discussion of the competitive pay policy options, see text, pages 216 - 223 Employer of Choice Shared Choice

What Is the Purpose of a Salary Survey? Systematic process of collecting and making judgments about compensation paid by other employers Provides data for Setting the pay policy relative to competition Translating that policy into pay levels and structures

Why Conduct a Salary Survey? Adjust pay level – How much to pay? Adjust pay mix – What forms? Adjust pay structure? Analyze special situations Estimate competitors’ labor costs

Select Relevant Market Competitors Relevant labor market includes employers who compete For same occupations or skills For employees in same geographic area With same products or services Examples Exhibit 8.2: Relevant Labor Markets by Geographic and Employee Groups Exhibit 8.3: Pay Differences by Location Fuzzy markets

Exhibit 8.2: Relevant Labor Markets by Geographic and Employee Groups Geographic Scope Production Office and Clerical Technicians Scientists & Engineers Managerial Professional Executive Local: Within relatively small areas such as cities or MSAs Most likely Regional: Within a particular area of the state or several states Only if in short supply or critical Likely National: Across the country International: Across several countries Only for critical skills or those in very short supply Sometimes

Exhibit 8.3: Pay Differences by Location

Design the Survey Who should be involved? How many employers? Publicly available data “Word-of-mouse” Exhibit 8.4: Salary Data on the Web Where are the standards? Which jobs to include? What information to collect?

Exhibit 8.4: Salary Data on the Web

Benchmark-job approach Benchmark conversion approach Which Jobs to Include? Benchmark-job approach Low-high approach (skill-based) See the Lawler article, PP.. 15 - 16 for details on these points. Benchmark conversion approach

What Information to Collect? Nature of organization Total compensation system Specific pay data on incumbents in jobs under study

Exhibit 8.6: Possible Survey Data Elements and Rationale Nature of organization Financial performance Size Structure Nature of total compensation system Cash forms used Non-cash forms used Incumbent and job Date Job Individual Pay HR outcomes Productivity Total labor costs Attraction & retention Employee views See Exhibit 8.9, page 247

Exhibit 8.7: Advantages and Disadvantages of Measures of Compensation Base Pay Tells how competitors are valuing the work in similar jobs Fails to include performance incentives and other forms, so will not give true picture if competitors offer low base but high incentives Total Cash (base + bonus) Tells how competitors are valuing work; also tells the cash pay for performance opportunity in the job. All employees may not receive incentives, so it may overstate the competitors’ pay; plus, it does not include long-term incentives. Total Compensation (base + bonus + stock options + benefits) Tells the total value competitors place on this work All employees may not receive all the forms. Be careful; don’t set base equal to competitors’ total compensation. Risks high fixed costs.

Interpret Survey Results (1 of 2) No single best approach Verify data Check accuracy of job matches Survey leveling Check for anomalies Does any one company dominate? Do all employers show similar patterns? Outliers? Example Exhibit 8.9: Survey Data

Interpret Survey Results (2 of 2) Statistical analysis Frequency distribution Exhibit 8.10: Frequency Distributions Measures of central tendency Mode Mean Median Weighted mean Measures of variation Standard deviation Quartiles and percentiles Exhibit 8.11: Statistical Measures for Analyzing Survey Data Update survey data Exhibit 8.12: Choices for Updating Salary Data Reflect Pay Policy

Construct a Market Pay Line Exhibit 8.8: Salary Graphs Using Different Measures of Compensation Definition of market pay line Links a company’s benchmark jobs on horizontal axis (internal structure) with market rates paid by competitors (market survey) on vertical axis Approaches to constructing a market pay line Freehand approach - Exhibit 8.8 Regression analysis - Exhibit 8.13 and Exhibit 8.14

Exhibit 8.13: From Regression Results to a Market Line

Exhibit 8.14: Understanding Regression 16 14 12 10 Survey: Salary ($000) 8 6 4 2 20 40 60 80 100 120 140 160 180 Job Evaluation Points Tech A Sr Tech Eng 1 Eng 3 Eng 5 Mgr 1 Mgr 3

Combine Internal Structure and External Market Rates Two parts of the total pay model have merged Exhibit 8.15 Internally aligned structure - Horizontal axis External competitive data - Vertical axis Two aspects of pay structure Pay-policy line Pay ranges

Exhibit 8.15: Develop Pay Grades AB CDEF External Competitiveness: Salaries paid by competitors Pay Policy Line 30,000 35,000 40,000 45,000 50,000 55,000 GHIJK LMN OP Internal Structure: JE Points

From Policy to Practice: Pay Policy Line Approaches to translate external competitive policy into practice Choice of measure 50th percentile for base pay 75th percentile for total compensation Updating Policy line as percent of market line Specify a percent above or below market line an employer intends to match Other options Pay among the leaders Lead for some job families and lag for others

From Policy to Practice: Grades and Ranges Why bother with grades and ranges? Offer flexibility to deal with pressures from external markets and differences among firms Develop grades Exhibit 8.15 Establish range midpoints, minimums, and maximums Overlap

Why Bother with Grades and Ranges? External pressures Differences in quality (KSAs) among individuals in external market Differences in productivity or value of quality variations Differences in mix of pay forms of competitors Internal pressures Recognize individual performance differences with pay Meet employees’ expectations that their pay will increase over time Encourage employees to remain with organization

Develop Grades Grades group job evaluation data on horizontal axis All jobs considered substantially equal for pay purposes placed in same grade Each pay grade has its own pay range and all jobs in a single grade have same pay range Enhances ability to move people among jobs within a grade with no change in pay How many pay grades? Number of jobs Organization hierarchy Reporting relationships

Establish Range Midpoints, Minimums, and Maximums (1 of 3) Ranges group salary data on vertical axis Establish upper and lower pay limits for all jobs in each grade Exhibit 8.16 Midpoints correspond to competitive pay policy Point where pay-policy line crosses center of each grade Often represents base pay for a seasoned employee

Exhibit 8.16: Range Midpoint, Minimum, and Maximum

Establish Range Midpoints, Minimums, and Maximums (1 of 3) Size of range based on judgment about how ranges support Career paths Promotions Other organization systems Typical range spread Top-level management positions – 30 to 60% above and below midpoint Entry to midlevel professional and managerial positions – 15 to 30% above and below midpoint Office and production positions – 5 to 15% above and below midpoint

Overlap Importance of overlap Exhibit 8.17: Range Overlap High degree of overlap and low midpoint differentials Exhibit 8.17(a) Small ranges with less overlap Exhibit 8.17(b)

Exhibit 8.17: Range Overlap

From Policy to Practice: Broad Banding Alternative to traditional salary structures Involves collapsing salary grades into a few broad bands, each with a sizable range One minimum and one maximum Range midpoint often not used Purposes Provide flexibility to define job responsibilities more broadly Foster cross-functional growth and development Ease mergers and acquisitions Example Exhibit 8.18

Exhibit 8.18: From Grades to Bands

Exhibit 8.19: Contrasts Between Ranges and Bands Ranges support . . . Some flexibility within controls Relatively stable organization design Recognition via titles or career progression Midpoint controls, comparatives Controls designed into system Give managers “freedom with guidelines” Up to 150 percent range-spread Bands support . . . Emphasis on flexibility within guidelines Global organizations Cross-functional experience and lateral progression Reference market rates, shadow ranges Controls in budget, few in system Give managers “freedom to manage” pay 100 – 400 % spreads See Exhibit 8.19, page 267

Steps Involved in Broad Banding 1. Set number of bands Determine number of distinct levels of employee contributions within organization that actually add value Challenge - How much to actually pay people in same band who are performing different functions and work 2. Price bands: Reference market rates Exhibit 8.20: Reference Rates Within Bands

Exhibit 8.20: Reference Rates Within Bands

Balancing Internal and External Pressures: Adjusting the Pay Structure Internal Pressures External Pressures Job Structure Pay Structure

Market Pricing Approach Issues Sets pay structures almost exclusively by relying on external market rates Emphasizes external competitiveness (market-based factors) and de-emphasizes internal alignment Issues Validity of market data Use of competitors’ pay decisions as primary determinant of pay structure Lack of value added via internal alignment Difficult-to-imitate aspects of pay structure are deemphasized Fairness