978-1259532726 Chapter 8 Lecture Note Part 1

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CHAPTER EIGHT

DESIGNING PAY LEVELS, MIX, AND PAY

STRUCTURES

Overview

This chapter focuses on the major decisions and techniques involved in determining an

organization’s external competitiveness policy—establishing pay levels and pay mix forms

and designing pay structures. Most organizations survey other employers’ pay practices to

determine the rates competitors pay. Based on the survey results, an employer considers

how it wishes to position its total compensation in the market: lead, match, or lag its

competitors. This policy decision may differ for different business units and even for

different job groups within a single organization. An organization’s competitive position

policy is translated into practice by setting pay-policy lines which serve as reference points

around which pay grades and ranges or bands are designed.

There are seven major decisions involved in setting externally competitive pay and designing

the corresponding pay structures. They include:

Specifying the employer’s competitive pay policy

Defining the purpose of the survey

Selecting relevant market competitors

Designing the survey

Interpreting survey results and constructing the market line

Constructing a pay policy line that reflects the external pay policy

Balancing competitiveness with internal alignment through the use of ranges, flat rates,

and/or bands

The chapter concludes with a discussion on the issues associated with combining the internal

structure (job evaluation results) with external market rates. Internal alignment and external

competitiveness merge together in a pay structure which has two aspects:

Pay-policy line

Pay ranges

The pay-policy line translates an organization’s external competitive policy into practice. Use of

pay grades and ranges or bands offers flexibility to deal with pressures from both external and

internal pressures on pay decisions. The process of balancing internal and external pressures is a

matter of judgment. De-emphasizing internal alignment may lead to unfair treatment among

employees and inconsistency with the fundamental culture of an organization. On the other

hand, neglecting external competitive pay practices will affect the ability to attract and hire

applicants who match an organization’s needs. External pay relationships also impact labor

costs and hence the ability to compete in the product/service market.

Learning Objectives

Identify and discuss the seven major decisions in setting externally competitive pay and

designing the corresponding pay structures.

Interpret the pay-policy line, including choice of measure, updating, and relating the

pay-policy line to the market line.

Discuss developing grades and ranges, including establishing range midpoints,

minimums and maximums, and any overlap.

Understand the need for adjusting the pay structure.

Lecture Outline: Overview of Major Topics

I. Major Decisions

II. Specify Competitive Pay Policy

III. The Purpose of a Survey

IV. Select Relevant Market Competitors

V. Design the Survey

VI. Interpret Survey Results and Construct a Market Line

VII. From Policy to Practice: The Pay-Policy Line

VIII. From Policy to Practice: Grades and Ranges

IX. From Policy to Practice: Broad Banding

X. Balancing Internal and External Pressures: Adjusting the Pay Structure

XI. Market Pricing

XII. Review

XIII. Your Turn: Google’s Evolving Pay Strategy

IX. Still Your Turn: Word-of-Mouse: Dot-Com Comparisons

Lecture Outline: Summary of Key Chapter Points

I. Major Decisions

The major decisions in setting externally competitive pay and designing the

corresponding pay structures are shown in Exhibit 8.1:

oSpecify the employer’s competitive pay policy

oDefine the purpose of the survey

oSelect relevant market competitors

oDesign the survey

oInterpret survey results and construct the market line

oConstruct a pay policy line that reflects the external pay policy

oBalance competitiveness with internal alignment through the use of ranges, flat

rates, and/or bands

II. Specify Competitive Pay Policy

Chapter 7 covered the first decision, determining the external competitive pay

policy.

Translating any external pay policy into practice requires information on the

external market. Surveys provide the data for translating that policy into pay levels,

pay mix, and structures.

Definition: A survey is the systematic process of collecting and making judgments

about the compensation paid by other employers.

III. The Purpose of a Survey

An employer conducts or participates in a survey for a number of reasons:

oTo adjust the pay level in response to changing rates paid by competitors

oTo set the mix of pay forms relative to that paid by competitors

oTo establish or price a pay structure

oTo analyze pay-related problems

oTo estimate the labor costs of product/service market competitors

A. Adjust Pay Level—How Much to Pay?

Most organizations make adjustments to employees’ pay on a regular

basis.

Such adjustments can be based on:

oThe overall movement of pay rates caused by the competition for people in

the market

oPerformance

oAbility to pay

oTerms specified in a contract

B. Adjust Pay Mix—What Forms?

Adjustments to the different forms of pay competitors use (base, bonus,

stock, benefits) and the relative importance they place on each form occur less

frequently than adjustments to overall pay level.

It is not clear why changes to the pay mix occur less frequently than

changes in the pay level.

oPerhaps the high costs of redesigning a different mix create a barrier.

oPerhaps inertia prevails.

oMore likely, insufficient attention has been devoted to mix decisions.

The mix organizations use may have been based on external

pressures such as health-care costs, stock values, government

regulations, union demands, and what others did.

Some pay forms may affect employee behavior more than others. Good

information on total compensation, the mix of pay competitors use, and costs

of various pay forms is increasingly important.

C. Adjust Pay Structure?

Many employers use market surveys to validate their own job evaluation

results.

The job structure that results from internal job evaluation may not match

competitors’ pay structures in the external market. Reconciling these two pay

structures is a major issue.

Rather than integrating an internal and external structure, some

employers go straight to market surveys to establish their internal structures.

Such “market pricing” mimics competitors’ pay structures. Accurate

information and informed judgment are vital for making all these decisions.

D. Study Special Situations

Information from specialized surveys can shed light on specific

pay-related problems.

A special study may focus on a targeted group such as patent attorneys,

retail sales managers, secretaries, or software engineers. Unusual increases in

an employer’s turnover in specific jobs may require focused market surveys to

find out if market changes are occurring.

E. Estimate Competitors’ Labor Costs

Survey data are used as part of employers’ broader efforts to gather

“competitive intelligence.”

To better understand how competitors achieve their market share and

price their products/services, companies seek to examine (i.e., benchmark)

practices costs, and so forth against competitors, including in the area of

compensation.

One source of publicly available labor cost data is the Employment Cost

Index (ECI), one of four types of salary surveys published regularly by the

Department of Labor. The index allows a firm to compare changes in its

average costs to an all-industry or specific-industry average.

oHowever, this comparison may have limited value because industry

averages may not reflect relevant competitors.

IV. Select Relevant Market Competitors

To make decisions about pay level, mix, and structures, a relevant labor market

must be defined that includes employers who compete in one or more of the following

areas:

oThe same occupations or skills

oEmployees within the same geographic area

oThe same products and services

Exhibit 8.3 shows how qualifications interact with geography to define the scope

of relevant labor markets.

oAs the importance and complexity of the qualifications increase, the geographic

limits also increase. Competition tends to be national or international for

managerial and professional skills but local or regional for clerical and production

skills.

oHowever, these generalizations do not always hold true:

In areas with high concentrations of scientists, engineers, and managers,

the primary market comparison may be regional, with national data used only

secondarily.

Some larger firms ignore local market conditions. Instead, they

emphasize internal alignment across geographic areas to facilitate the use of

virtual teams.

Some writers argue that if the skills are tied to a particular industry—as

underwriters, actuaries, and claims representatives are to insurance, for example—it

makes sense to define the market on an industry basis, and some research agrees.

If accounting, sales, or clerical skills are not limited to one particular

industry, then industry considerations are less important.

From the perspective of cost control and ability to pay, including competitors in

the product/service market is crucial. However, this becomes a problem when the

major competitors are based in countries with far lower pay rates, such as China or

Mexico.

While the quantity of data available for international comparisons is improving,

using the data to adjust pay still requires a lot of judgment. Even with good

international survey data, judgment is still required.

A. Fuzzy Markets

New organizations and jobs fuse together diverse knowledge and

experience, so “relevant” markets appear more like “fuzzy” markets.

Organizations with unique jobs and structures face the double bind of

finding it hard to get comparable market at the same time they are placing

more emphasis on external market data.

V. Design the Survey

Consulting firms offer a wide choice of ongoing surveys covering almost every

job family and industry group imaginable.

Designing a survey requires answering the following questions:

oWho should be involved in the survey design?

oHow many employers should be included?

oWhich jobs should be included?

oWhat information should be collected?

A. Who Should Be Involved?

In most organizations, the responsibility for managing the survey lies

with the compensation manager.

Outside consulting firms are typically used as third-party protection from

possible “price-fixing” lawsuits.

oLawsuits have been filed alleging that the direct exchange of survey data

violates Section 1 of the Sherman Act, which outlaws conspiracies in

restraint of trade.

oSurvey participants may be guilty of price fixing if the overall effect of the

information exchange is to interfere with competitive prices and artificially

hold down wages.

oIdentifying participants’ data by company name is considered price fixing.

B. How Many Employers?

There are no firm rules on how many employers to include in a survey.

oLarge firms with a lead policy may exchange data with only a few (6 to 10)

top-paying competitors. A small organization in an area dominated by two

or three employers may decide to survey only smaller competitors.

oNational surveys conducted by consulting firms often include more than

100 employers. Clients of these consultants often stipulate special analyses

that report pay rates by selected industry groups, geographic region, and/or

pay levels.

Publicly Available Data

oIn the United States, the Bureau of Labor Statistics (BLS) is the major

source of publicly available compensation (cash, bonus, and benefits but

not stock ownership) data. The BLS publishes extensive information on

various occupations in different geographic areas.

oWhile some private sector firms may track the rate of change in BLS data

as a cross-check on other surveys, the data are often not specific enough to

be used alone.

oTailoring analysis to specific industry segments, select companies, and

specific job content is not feasible.

“Word of Mouse”

oBefore computers, individual employees had a hard time comparing their

salaries to others’; gathering information haphazardly, via word of mouth.

oThe ease of access computers provide means managers must be able to

explain salary variations among employees.

oUnfortunately, the quality of much salary data on the Web is highly

suspect. Few sites (except the BLB) offer any information on how they

collected their data. There are some good exceptions, Salary.com.

Many Surveys (But Few That Are Validated)

oOpinions about the value of consultant surveys are rampant; research is

not.

oThe fact that companies typically use three or more surveys (for all job

types) suggests that different surveys do, in fact, imply different pay levels.

Many firms select one survey as their primary source and use others to

cross-check or “validate” the results.

oSome employers routinely combine the results of several surveys and

weight each survey in this composite according to somebody’s judgment of

the quality of the data reported.

oNo systematic study of the effects of differences in market definition,

participating firms, types of data collected, quality of data, analysis

performed, and/or results is available.

oFor staffing decisions, employment test designers report the test’s

performance against a set of standards (reliability, validity, etc.).

oJob evaluation’s reliability and validity (or lack of) has been much studied

and debated. For market surveys and analysis, similar indices and

standards do not exist.

C. Which Jobs to Include?

There are several approaches to selecting jobs for inclusion.

Benchmark-Job Approach

oBenchmark jobs have stable job content, are common across different

employers, and include sizable numbers of employees.

oIf the purpose of the survey is to price the entire structure, then benchmark

jobs can be selected to include the entire structure. In Exhibit 8.7, the more

heavily shaded jobs in the structures are benchmark jobs.

oThe degree of match between the survey’s benchmark jobs and each

company’s benchmark jobs is assessed by various means. One approach is

benchmark conversion/survey leveling. As another example, the Hay

Group has installed the same job evaluation plan in many companies that

participate in its surveys. Other surveys simply ask participants to check

the degree of match.

Low-High Approach

oIf an organization is using skill-competency-based structures or generic job

descriptions, it may not have benchmark jobs to match with jobs at

competitors who use a traditional job-based approach.

oMarket data must be converted to fit the skill or competency structure. The

simplest way to do this is to identify the lowest- and highest-paid

benchmark jobs for the relevant skills in the relevant market and to use the

wages for these jobs as anchors for the skill-based structures.

oWork at various levels within the structure can then be slotted between the

anchors.

Benchmark Conversion/Survey Leveling

oIn cases where the content (e.g., job description) of an organization’s jobs

does not sufficiently match that of jobs in the salary survey, an effort can

be made to quantify the difference via benchmark conversion.

oIf an organization uses job evaluation, then its job evaluation system can be

applied to the survey jobs. The magnitude of difference between job

evaluation points for internal jobs and survey jobs provides an estimate of

their relative value and thus guidance for adjusting the market data.

D. What Information to Collect?

Three basic types of data typically are requested:

oInformation about the organization

oInformation about the total compensation system

oSpecific pay data on each incumbent in the jobs under study

Exhibit 8.9 lists the basic data elements and the logic for including them.

No survey includes all the data. Rather, the data collected depend on the

purpose of the survey, and the jobs and skills included.

Organization Data

oThis information reflects the similarities and differences among

organizations in the survey. Surveys of executive and upper-level positions

include financial and reporting relationships data, since compensation for

these jobs is more directly related to the organization’s financial

performance.

oThe competitors’ data have not been used to compare competitors’

productivity (revenues to compensation) or labor costs.

oBut this is changing. Metrics of organization performance such as turnover

and revenues are being collected.

oOther outcomes such as earnings per share, market share, customer

satisfaction, employee pay satisfaction, and recruiting yield ratios are not

included. Financial data are gathered from other, often publicly available

sources (e.g., Google Financial, Thompson Financial). Examples include

metrics on organization success (revenues, net income, customer

satisfaction), turnover (voluntary quit rates), and recruiting (yield ratios).

Total Compensation Data

oInformation on all types of pay forms is required to assess the total pay

package and competitors’ practices.

oThree alternatives—base pay, total cash (base, profit sharing, bonuses), and

total compensation (total cash plus benefits and perquisites)—are the most

commonly used measures of compensation. Exhibit 8.10 draws the

distinction between these three alternatives and highlights the usefulness

and limitations of each.

oExhibit 8.11 shows some results of conducting a pay survey that includes

these three measures on a sample of engineers:

Base pay: This is the amount of cash the competitors decided

each job and incumbent is worth. A company might use this

information for its initial observations of how “good” the data appear to

fit a range of jobs.

Total cash: This is base plus bonus. Total cash measures reveal

competitors’ use of performance-based cash payments.

Total compensation: This includes total cash plus stock options

and benefits. Total compensation reflects the total overall value of the

employee (performance, experience, skills, etc.) plus the value of the

work itself.

VI. Interpret Survey Results and Construct a Market Line

The greatest challenge of total compensation surveys is to understand how to

evaluate the information.

After the survey data are all collected, the next step is to analyze the results and

use statistics to construct a market pay line.

A. Verify Data

A common first step is to check the accuracy of the job matches, and

then check for anomalies, age of data, and the nature of the organizations.

Accuracy of Match (and Improving the Match)

oIf a company job is similar but not identical, some companies use the

benchmark conversion/survey leveling approach; that is, they multiply the

survey data by some factor that the analyst judges to be the difference

between the company job and the survey job.

Anomalies

oPerusal of salary data gives an analyst a sense of the quality of the data and

helps identify any areas for additional consideration.

oAnomalies may include:

Does any one company dominate?

Do all employers show similar patterns?

Outliers?

oThe best way to answer questions on anomalies is to do an analysis of them

alone.

B. Statistical Analysis

While the statistics necessary to analyze survey data, including

regression, are covered in basic statistics classes, a number of websites are

probably more fun.

A useful first step in the analysis is to look at a frequency distribution of

the pay rates.

Frequency Distribution

oThis helps visualize information and may highlight anomalies.

oShapes of frequency distribution can vary. Unusual shapes indicate may

reflect problems with job matches, widely dispersed pay rates, or

employers with widely divergent pay policies.

Central Tendency

oA measure of central tendency reduces a large amount of data into a

single number. Exhibit 8.14 defines commonly used measures.

oThe distinction between “mean” and “weighted mean” is important.

If only company averages are reported in the survey, a mean may

be calculated by adding each company’s base wage and dividing by the

number of companies.

Weighted mean is calculated by adding the base wages for all 585

engineers in the survey and then dividing by 585. A weighted mean

gives equal weight to each individual employee’s wage.

Variation

oThe distribution of rates around a measure of central tendency is called

variation. Variation tells us how the rates are spread out in the market.

oStandard deviation is probably the most common statistical measure of

variation, although its use in salary surveys is rare.

oQuartiles and percentiles are more common measures in salary survey

analysis.

C. Update the Survey Data

Because they reflect decisions of employers, employees, unions, and

government agencies, wages paid by competitors are constantly changing.

Additionally, competitors adjust their wages at different times.

A survey that requires three months to collect and analyze is probably

outdated before it is available. The pay data are usually updated (a process

often called aging or trending) to forecast the competitive rates for the future

date when the pay decisions will be implemented.

The amount to update is based on several factors, including historical

trends in the labor market, prospects for the economy in which the employer

operates, and the manager’s judgment, among others.

Some recommend using the Consumer Price Index (CPI). It is not

advisable to do so because the CPI measures the rate of change in prices for

goods and services in the product market, not wage changes in labor market.

Exhibit 8.15 illustrates updating.