Professional Documents
Culture Documents
Daniel Purshottam Book
Daniel Purshottam Book
Daniel Purshottam Book
Edition
How-to Series
for the HR Professional
Building
Pay
Structures
Daniel P. Purushotham, Ph.D., CCP, CBP
Stephanie Y. Wilson, CCP
Building
Pay
Structures
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Introduction
Compensation deals with establishing a meaningful and acceptable
relationship between work and rewards with both employer and
employee in mind. Work performed by employees should help
organizations achieve their objectives. These objectives are derived
from the organization’s overall business strategy, which supports
the organization’s mission statement.
When designed and administered appropriately, an organiza-
tion’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 compensation
programs. (See Figure 1 on page 8.) This process is not a one-
time event. It involves constant review and refinement in light of
changing business needs and the business environment.
There are two broad categories of compensation: cash and noncash.
The focus of this book is on cash compensation. Cash-compensation
management has two distinct but interrelated aspects: content and
process.
Content is managed through job analysis, evaluation and research
to keep abreast of the changes in compensation levels in the
external market.
Process includes tools and methods for collecting, calculating,
organizing, storing and customizing internal and external information
pertaining to compensation. The pay structure of an organization
is one such tool. Within the context of cash-compensation manage-
ment, process should support and not conflict with content.
1
An Ideal
Compensation Program
Most compensation professionals agree that the following “ideal” charac-
teristics are necessary for every compensation program in order to attract,
retain and motivate qualified employees. (Note: These characteristics
are primarily for all positions except single-incumbent senior-
management positions.) These characteristics are the foundation for
an ideal pay structure:
• Internal equity. A measure of how an organization values each
of its jobs in relation to one another.
• External competitiveness. A measure of an organization’s pay
structure and the actual pay delivered compared to that of its
competitors.
• Affordability. A measure of how costly a compensation program is
to an organization. If pay structures are not developed responsibly,
an organization could incur labor costs that exceed what it can
afford to pay.
• Legally defensible. Compensation programs must adhere to specific
laws designed to provide fairness in how employees are paid.
These laws include the Fair Labor Standards Act (FLSA), the Equal
Pay Act, Title VII of the Civil Rights Act, the Age Discrimination
in Employment Act and the Americans with Disabilities Act
(ADA).
• Understandable/saleable. To be accepted and understood,
compensation programs must be communicated effectively.
FIGURE 1
Mission Statement
Business Strategy
Business Plan
STRATEGIC
Compensation Strategy
Compensation Objectives
Design
Program Evaluation
TACTICAL
Compensation
Program
Communication
Administration
Implementation
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 2 on page 10.)
The midpoint or middle-pay value for the range usually repre-
sents the competitive market value for a job or group of jobs. The
organization’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 midpoints and to take into consideration variable compensa-
tion. 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.
FIGURE 2
Grade
2
Anatomy of a Pay Structure
FIGURE 3
– 20% + 20%
A pay range with a 50-percent range spread will have a 20-percent spread
on either side of the midpoint. (See Figure 3.) That is, $80,210 is about
80 percent of $100,260, and $120,310 is about 120 percent of
$100,260.
While all the ranges in Figure 2 have a range spread of approximately
50 percent, the spread does not have to be uniform throughout
the pay structure. Figure 4 lists common range spreads and their
cor responding spreads on either side of the midpoint.
FIGURE 4
20% 9.1%
25% 11.1%
30% 13%
35% 14.9%
40% 16.7%
45% 18.4%
50% 20%
Note: Under a broadbanding system, range spreads may reach 100 percent or more.
* Numbers in this equation have been rounded. Actual range spread is 49.99%
EXAMPLE 1A
Midpoint
Minimum =
1 + ½ range spread
* Numbers in this equation have been rounded. Actual range spread is 49.99%
Midpoints
The midpoint is a key element in pay administration. It often is
used as a reference point in salary administration decisions as
a point or “target.” The midpoint usually is the reference used
because it typically is set to equal the market average or median.
It should not be an organization’s only market reference point
for salary administration. Other factors such as performance and
affordability also must be considered in salary decisions.
Compa-ratio
Related to the midpoint is the compa-ratio, a statistic that expresses the
relationship between base salary and the midpoint. Figure 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, by organizational units or functions and the organization
as a whole.
Most organizations 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 individual has been in the job,
previous work experience and job performance. A mature, long-
FIGURE 5
Illustration of Compa-Ratios
Within Company
Outside
Person 1 Person 2 Person 3 Average Company
( Base Salary
Midpoint (
* Company Average
= Market Ratio
Market Average
Range Penetration
Another way of tracking an organization’s compensation is to view
employee pay in relation to the total pay range. This is known as
range penetration. Unlike compa-ratios, which are calculated using
a salary range’s midpoint, range penetration is calculated using
the minimum and maximum of a salary range. Range penetration
is shown in Example 3 below.
Often range penetration is a preferred tool because it does not
focus on a single number alone, the midpoint. Instead, it refers to
how far into the range a particular individual’s salary has penetrated.
Range profiles often are used in conjunction with either the compa-
ratio or range penetration to describe where employees should
expect their pay to fall relative to their pay range over time. (See
Figure 6 on page 19.)
EXAMPLE 3
($102,000 - $80,210)
= 54.3%
($120,310 - $80,210)
Range
Year Minimum Midpoint Maximum Salary Penetration
1 $15,360 $19,200 $23,040 $15,360 0.00%
2 $15,744 $19,680 $23,616 $15,974 2.93%
3 $16,138 $20,172 $24,206 $16,613 5.89%
4 $16,541 $20,676 $24,811 $17,278 8.91%
5 $16,954 $21,193 $25,432 $17,969 11.96%
6 $17,379 $21,724 $26,068 $18,688 15.06%
7 $17,813 $22,266 $26,719 $19,435 18.22%
8 $18,258 $22,823 $27,388 $20,213 21.41%
9 $18,714 $23,393 $28,072 $21,021 24.65%
10 $19,182 $23,978 $28,774 $21,862 27.94%
11 $19,662 $24,577 $29,492 $22,737 31.28%
12 $20,154 $25,192 $30,230 $23,646 34.65%
13 $20,658 $25,822 $30,986 $24,592 38.09%
Midpoint Progression
Midpoint progression refers to the percentage difference between
pay-grade midpoints. 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.
Definition Value
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 external 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 find-
ings from market research as well as the company’s compensation
strategy. Does the policy call for frequent “promotions,” 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” organization, or does it prefer multiple levels within
the organization?
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 adjoining 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 9A.)
FIGURE 9A
Dollars
$26,000
$24,626
$24,000
Width = 10%
$22,000 $21,414 $22,387
Dollars
$18,000 $17,114
$16,299
$16,000 $15,523
$14,784
$14,080 $15,558
$14,000 $14,818
$14,112
$13,440
$12,000 $12,800
Number of Overlapping Grades = 2
Midpoint Differntial = 5%
$10,000 Width = 10%
FIGURE 9C
Dollars
$36,000 $35,820
$34,000
$32,000
$31,148
$30,000
$28,000
$27,085
$26,000
$24,000 $23,552
$22,000 $22,387
$20,480
$20,000
$19,467
$18,000
$16,000 $16,928
$14,720
$14,000
$12,000 $12,800
Number of Overlapping Grades = 4
Midpoint Differntial = 15%
$10,000 Width = 60%
FIGURE 9D
Dollars
$26,000
$24,894
$24,000 $23,708
$22,579
$22,000 $21,504
$20,480
$20,000
$18,000
$16,000
$15,558
$14,000 $14,818
$14,112
$13,440
$12,000 $12,800
Number of Overlapping Grades = 5
Midpoint Differntial = 5%
$10,000 Width = 60%
3
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 among comparable jobs throughout
the organization. Internal equity can be examined horizontally and
vertically, as shown in Figure 10. 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.
FIGURE 10
Horizontal
(Across departments or organizational units)
External Competitiveness
The other basic consideration in the design and development of
pay structures is external competitiveness, or external equity.
Busi nesses 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 organizational
productivity).
The labor market is subject to the same external pressures as the
product and services 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.
Defining Competition
In researching a company’s competitive posture, the first step is
defining “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 conclusion that there are no
Internal
Evaluation
TABLE 3
1 137-175
Step 6: Incorporate Market Data
Based on the preliminary ranking
performed in Steps 4 and 5, market data are added to identify differ-
ences in how your company and the market value a particular set of
jobs. Table 5 is an example.
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 appropriate? How many open grades are needed to meet
future needs? Is it possible to keep the market comparisons current?
At this point in the
TABLE 5
va r y i ng p ercent-
GRADE RAW MARKET AVERAGE % DIFFERENCE
ages between its
11 $53,000
10 Open midpoints.
9 $36,000
13.9% Key questions to
8 $31,600
8.2%
7 $29,200 ask: Is the number
20.2%
6 $24,300
5.7% of grades selected
5 $23,000
4 $20,300
13.3%
(11) still acceptable?
3 Open Can the differences
2 $18,000
1 $15,300
17.6% between midpoints
be smoothed out
10/19/2009 1:01:32 PM
Developing a Pay Structure 37
TABLE 8
Range
Job Title Market Rate Minimum Midpoint Maximum Spread
Corporate
$79,000 $63,200 $79,000 $94,800 50%
Accountant
Customer
Service $60,000 $48,000 $60,000 $72,000 50%
Supervisor
Computer
$48,000 $38,400 $48,000 $57,600 50%
Operator
Groundskeeper $30,000 $24,000 $30,000 $36,000 50%
Midpoint to
Grade Midpoint
Level Job Title Minimum** Midpoint** Maximum** Differential
Corporate
11 $63,200 $79,100 $94,500 12%
Accountant
Compensation
10 $56,600 $70,700 $84,900 12%
Manager
Customer Ser-
9 $50,500 $63,100 $75,800 12%
vice Supervisor
8 Open $45,000 $56,300 $67,500 12%
Computer
7 $40,200 $50,300 $60,300 10%
Operator
6 Open $36,700 $45,800 $55,100 10%
5 Open $33,300 $41,600 $50,000 10%
4 Drafter $30,200 $37,800 $45,300 8%
3 Secretary $28,000 $35,000 $42,000 8%
2 Open $26,000 $32,400 $39,000 8%
1 Groundskeeper $24,000 $30,000 $36,000 NA
* Market jobs are slotted into the closest midpoint that represents the market value for the job.
** Numbers rounded to the nearest hundred.
4
Pitfalls, Precautions
and Trends
(Maximum + Minimum)
Midpoint =
2
(Compa-ratio can be calculated for individual employees, for each salary range,
for organizational units/departments or for functions)
Midpoint – Minimum
Spread on Either Side of the Midpoint = [expressed as a
Midpoint negative percentage]
In the case where midpoint progressions The matrix shows that the constant
are to be calculated repeatedly over difference between midpoints would
the long run, it is possible to develop be 25.85 percent. Remembering that
a matrix for ready reference purposes. $10,000 represents the midpoint of the
One such matrix is shown below. This lowest pay grade and $50,000 represents
matrix was developed using the “present the midpoint of the highest pay grade,
value/future value formula.” The vertical midpoints for all eight grades can be
axis represents present value (PV), the assigned by spacing them apart by
horizontal axis represents future values 25.85 percent.
(FV) and the number of grades used is
If the number of grades changes, a
eight (the number of intervals between
new matrix can be constructed using
grades, “n,” is 7). The percentages listed
a different value or “n.” Matrices can
are “i” values, where “i” is the percentage
be developed quickly using a business
difference between midpoints.
calculator or computer.
For example, consider a present value of
$10,000 and a future value of $50,000.
FV
PV =
(1 + i)n Highest Midpoint (FV)
$50,000 $55,000 $60,000 $65,000 $70,000 $75,000 $80,000 $85,000 $90,000 $95,000 $100,000
$10,000 25.85% 27.58% 29.17% 30.66% 32.05% 33.35% 34.59% 35.76% 36.87% 37.94% 38.95%
$10,500 24.98% 26.69% 28.27% 29.75% 31.13% 32.43% 33.66% 34.82% 35.92% 36.98% 37.98%
$11,000 24.15% 25.85% 27.42% 28.89% 30.26% 31.55% 32.77% 33.92% 35.02% 36.07% 37.07%
$11,500 23.36% 25.05% 26.62% 28.07% 29.44% 30.72% 31.93% 33.08% 34.17% 35.21% 36.20%
$12,000 22.61% 24.30% 25.85% 27.30% 28.65% 29.93% 31.13% 32.27% 33.35% 34.39% 35.38%
$12,500 21.90% 23.57% 25.12% 26.56% 27.90% 29.17% 30.37% 31.50% 32.58% 33.61% 34.59%
$13,000 21.22% 22.88% 24.42% 25.85% 27.19% 28.45% 29.64% 30.77% 31.84% 32.86% 33.84%
Lowest Midpoint (PV)
$13,500 20.57% 22.22% 23.75% 25.17% 26.51% 27.76% 28.94% 30.06% 31.13% 32.15% 33.12%
$14,000 19.94% 21.59% 23.11% 24.52% 25.85% 27.10% 28.27% 29.39% 30.45% 31.46% 32.43%
$14,500 19.34% 20.98% 22.49% 23.90% 25.22% 26.46% 27.63% 28.74% 29.80% 30.80% 31.77%
$15,000 18.77% 20.40% 21.90% 23.30% 24.62% 25.85% 27.02% 28.12% 29.17% 30.17% 31.13%
$15,500 18.21% 19.83% 21.33% 22.73% 24.03% 25.26% 26.42% 27.52% 28.57% 29.56% 30.52%
$16,000 17.68% 19.29% 20.78% 22.17% 23.47% 24.69% 25.85% 26.94% 27.99% 28.98% 29.93%
$16,500 17.16% 18.77% 20.25% 21.64% 22.93% 24.15% 25.30% 26.39% 27.42% 28.41% 29.36%
$17,000 16.66% 18.26% 19.74% 21.12% 22.41% 23.62% 24.76% 25.85% 26.88% 27.87% 28.81%
$17,500 16.18% 17.77% 19.25% 20.62% 21.90% 23.11% 24.25% 25.33% 26.36% 27.34% 28.27%
$18,000 15.71% 17.30% 18.77% 20.13% 21.41% 22.61% 23.75% 24.83% 25.85% 26.83% 27.76%
$18,500 15.26% 16.84% 18.30% 19.66% 20.94% 22.14% 23.27% 24.34% 25.36% 26.33% 27.26%
$19,000 14.82% 16.40% 17.85% 19.21% 20.48% 21.67% 22.80% 23.87% 24.88% 25.85% 26.78%
$19,500 14.40% 15.97% 17.42% 18.77% 20.03% 21.22% 22.34% 23.41% 24.42% 25.38% 26.31%
$20,000 13.99% 15.55% 16.99% 18.34% 19.60% 20.78% 21.90% 22.96% 23.97% 24.93% 25.85%
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