Radford Compensation 101

Chapter 3: How Much to Pay

Market Benchmarking

 

How much you should pay someone is a relative term. Some companies can afford more than others based on their business model. Companies also balance a variety of reward opportunities based on their overall strategy. After all, pay is only one part of the employee value proposition. Knowing that a pool of resources exists, the next step is to determine exactly how much to pay.


Base Salary Ranges

Special circumstances might allow you to pay a prospective employee high above or below the norm, for the most part, you’ll want to establish a base salary grade range that limits the amount paid for a job. Jobs of equivalent value to the organization are placed in the same grade. The range is set so the floor is the rate below which we don’t pay and the ceiling is the rate above which we don’t pay. The midpoint, halfway between the minimum and maximum limits, is generally defined as the target rate of pay for the jobs assigned to that grade.

Should an employee move into a job and find their salary below the established limits, they are considered green circled and should be targeted for adjustment into the range. Those paid above the maximum (i.e. red circled), are typically ineligible for a salary increase. Companies may instead offer a lump sum bonus award until the range moves higher or until the employee is promoted into a job in a grade with a higher range maximum. These limits serve to promote fairness by ensuring that all employees performing jobs of equal value to the company are paid within reason and that no one is taken advantage of. As illustarted below, Figure A shows the range divided into four equal pieces, or quartiles, which is a way of identifying where pay is set relative to the middle of the range. The midpoint is generally considered the target pay level for a job.

Figure A: Illustration of red circle and green circle pay.

Another, more specific measurement term is the compa-ratio. This is the common term used to define the ratio between the employee's salary and the midpoint of the range. A compa-ratio of less than one means the employee is paid less than midpoint or below target for the job while a compa-ratio above one means the employee is paid above midpoint.


Salary Ranges: What Paying at Market Means

Paying at market means exactly what you might think it means — to pay at a level that matches the market average salary for a specific job. If you have employees being paid with a compa-ratio of one, then your company is paying at market. That sounds simple, but it is not because market prices fluctuate throughout the year while your target pay (salary range midpoint) is usually fixed during the year. Your company might be paying at market one month and below market a few months later. Figure B below illustrates how a company goes from paying above market in the beginning of the year to below market by the end of the year.

Figure B: A company might lead the market in pay one month and lag it in another.

As you can see from the diagram, the company midpoint, represented by the horizontal line, stays the same throughout the compensation planning year. The market average salary, represented by the upward slanting line, generally continues a steady, although certainly not always linear, move upward as different companies offer pay increases, promote their employees, or hire new ones. In this example, the company midpoint is above the market in January, leading the market, then matches the market around July and then trails or lags the market in December. If a company moves its midpoints higher to leapfrog the market as part of their market analysis, it will begin the next year as a market leader again. What is shown is a lead-lag position since the company is targeting pay above the market in the first half of the year while being behind it in the second half. If the midpoint is set to be at or above the market the whole year, it is considered a lead-lead strategy. If it is below the market the whole year, it is considered a lag-lag strategy.


Pricing Jobs to Market

Once you pull the correct data for salary analysis, you can decide how best to relay your findings to managers for decision making. One common approach used by about two-thirds of technology companies is the salary grade structure. In this approach, formal ranges are used to target salaries and limit the range of pay that’s allowed. In addition, formal salary grades effectively share the same allowed range of pay with several positions considered of equal value. This approach makes communications easier and works well when many jobs are paid about the same or when market data is scarce. One example is a company choosing to put both quality and design engineering jobs in the same pay grade even if the market data suggests that product design employees typically earn more.

Movement of the ranges can be made periodically by increasing midpoints at a consistent percentage or by re-computing salary range midpoints for each grade separately using updated market data. The consistent percentage approach assumes that every job increases in value at a constant rate. While this assumption does not always hold true, this approach simplifies the ongoing maintenance or administration of the ranges. Diligent review of survey results and midpoint adjustments keeps market value balanced with internal job value.

Alternatives to traditional salary ranges include setting target pay levels without the associated minimum and maximum boundary, the use of broad bands to control pay for a family rather than a single job level, or providing line managers with specific guidance for individual jobs when pay decisions are made, such as consulting market data when a requisition is being filled.

Establishing a specific target rate of pay for each specific job is referred to as setting market reference points. The use of market reference points requires computing a salary range midpoint or determining a target pay point for each job individually rather than sharing the same pay range for a group of positions of similar value. The reference point approach is fine when nearly all jobs are benchmarked to a survey, data samples are of adequate size for analysis and survey participation is consistent enough to avoid unexpected swings and results.

Want to dive deeper? Read our related paper
Is it Time to Ditch Your Salary Structure for Market Pricing? We Debate the Pros and Cons


Challenges to market reference points include establishing pay levels for non-benchmark jobs and determining a plan of action when market data goes down from one period to another. The market reference approach is certainly more precise, but it also requires more time for analysis and system maintenance.

Salary Grade Structure

Practice of creating a set of pay ranges that can be used throughout the organization

  • Works better when data is scarce or peer matches vary
  • Works when similar jobs pay about the same amount

Market Reference Points

Practice of using specific survey data for each job to determine the "going rate" for the position

  • Works better when most/all jobs are "benchmarks"
  • Works well when data comes from reliable sources that do not fluctuate wildly between survey publications

Figure C: Comparison to using salary grade structure to market reference points.


Common Philosophy but Varied Practice

Whether you choose to use salary grades or market reference points, you need to decide which market data to use for your analysis. The numbers you decide to use are dictated by your company’s pay philosophy.

The chart below shows results from three separate surveys highlighting how consistently companies report targeting their base salaries in the United States at the 50th percentile or “market median” of their specific labor market. The left side of this chart shows executive targets. In 2015, 67% of companies targeted the executive salary position at the 50th percentile. That figure increased to 78% of companies in 2017. The 75th percentile was sought by 10% of companies in 2015 and fell to just 6% in 2017. Below the executive ranks, shown on the right half of the chart, 85% of companies reported following the median pay target in the trend survey conducted in 2017. Only 2% of companies say they aim to pay at the 75th percentile.

Percent of Companies Targeting Selected Salary Positions

Target Market
Percentile		 2017 2016 2015 2017 2016 2015
Executive Non-Executive
75th/plus 6% 7% 10% 2% 2% 4%
65th 3% 4% 4% 3% 3% 3%
60th 10% 9% 14% 7% 8% 10%
50th 78% 77% 67% 85% 82% 76%
Other 3% 4% 5% 3% 5% 7%


How is it that 75% to 80% of companies target the median of the market and yet we see pay vary widely within the published results? One reason is that each company defines the market differently. One company may aim to pay at market, but uses high paying companies as their benchmark. Another company may aim to pay at market, but actually pays less because they compare themselves against lower paying firms. Since the average rates change when people enter or exit the job market or receive salary increases, the market really is a moving target. Philosophically, some companies target higher or lower market position for salaries based on their needs, their ability to pay, as well as their use of other forms of compensation.

The trend in this data shows an increasing number of companies targeting the 50th percentile of their market. This may be an outcome of companies realizing just how expensive leading the market in pay really is. Using the whole US market as a source, it costs about 5% more on a job-weighted basis to pay at the 60th percentile. Those aspiring to pay at the 75th percentile must make a significant investment in labor cost. One analysis showed this pay level would require 12% higher salaries. When operating margins are slim, those funds may simply not be available.

In summary, while it sounds great to say we want to pay at market, we must recognize that pay can mean many different things and is not limited to salary alone. Enough is a relative term too, both in terms of amount and timing. You may need to pay more for some jobs than others. You can have a competitive program and still be behind the market at the end of your plan year. Where you set your targets and how you measure them needs regular calibration too. All in all, having a competitive compensation program takes a lot careful planning and effort.

 


Chapter 3: Market Benchmarking Summary

  • Establish a base salary range to control salaries
  • The "compa-ratio" is the ratio between the employee's salary and the midpoint of a job
  • Paying above the market is known as "leading" the market, while paying below is known as
    "lagging" the market
  • The two main approaches to pricing jobs to market are assigning jobs to salary grades or
    using market reference points
  • Companies define the market differently, hence pay may vary widely even if everyone
    is targeting the median
  • Compensation programs, in aggregate, take a lot of effort. Pay is not so simple!

 

Go to Chapter 4

 

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