Precise Compensation Calibration will allow an organization to gain an advantage in the market place. Compensation Calibration begins with the Compensation Philosophy which is developed, administered, and maintained with thorough analyses of market data. This paper will demonstrate how Range Ratio is the most effective market analysis tool for compensation. Technology has made more data available through compensation surveys. Range Ratio uses the increased data to structure and administer pay programs. A properly calibrated compensation program is easier to communicate to employees and managers—resulting in greater transparency, consistency, and effectiveness.
A company must articulate its compensation philosophy so that every employee’s pay is administered in accordance with the predetermined, consistent direction set by the company. Development, maintenance, and analysis of pay ranges then become straightforward. In addition to HR’s expertise in these actions, every manager of employees must understand the company’s compensation philosophy so that they can make decisions in line with that philosophy—and explain to employees how pay is determined. The education of managers and employees is central to the smooth, consistent, and orderly administration of employees’ pay, which in turn is fundamental to the company achieving its goals and objectives for productivity, growth, and profitability.
An Example Compensation Philosophy
Consider the following example of how a company stated its compensation philosophy.
XYZ Corp believes that our employees are our most significant resource, and our continued success depends on maximum use of their contributions. We strive to have compensation policies and practices demonstrate our appreciation for each employee’s contribution.
XYZ Corp’s compensation philosophy is to:
- Reward employees based on their contribution to the company’s success.
- Consider on-the-job performance as a primary factor when determining changes to an employee’s pay.
- Provide employees with compensation opportunities that are competitive within the market.
- Provide employees with compensation opportunities that are equitable within the company.
- Ensure that all employees and management understand XYZ Corp’s policies, plans, and programs that govern compensation.
When paired with an effective communication plan, the XYZ Corp compensation program supports, reinforces, and aligns with our mission and values, business strategy, and operational and financial requirements. Our compensation program balances the needs of both employees and the business, with a goal of growth and profitability.
The XYZ Corp compensation program is designed to attract, motivate, and retain talented employees who drive the company’s success. We strive to provide base salaries that are competitive and appropriate for the market. Each position is assigned a pay range as determined by XYZ Corp based on the position’s duties, responsibilities, and qualifications. The pay range is a reflection of what the market pays for the same or similar positions. The pay range minimum approximates the 20th percentile of the market while the pay range maximum approximates the 90th percentile of the market. The pay range midpoint is an average of the minimum and maximum.
Note: Deciding to use specific percentiles of the market to set the pay range minimums and maximums is a major step in the evolution of a company’s management philosophy. Not only does this decision require a solid understanding of how the company manages employee compensation, it also requires management to put teeth in its commitment to take full control of pay—including pay plan development, communication, administration, and ensuring all managers are trained in their role of compensating the company’s employees. Whether to use the percentiles in the above example (20th and 90th) or to use some other percentiles should be a matter of enlightened discussion and definitive action by the company’s management team.
Each employee’s position within the pay range is based on that employee’s skills, knowledge, and abilities as assessed by XYZ Corp, taking into consideration the employee’s education, training, experience, and performance. All employees must meet the minimum qualifications of the position. Those employees with less experience, less-developed skills, or whose performance does not exceed expectations will be paid in the lower portion of the pay range. Those employees with significant experience, fully developed skills, and whose performance meets or exceeds expectations will be paid in the middle portion of the pay range. Those employees with extensive experience, outstanding skills, and performance that exceeds expectations will be paid in the upper portion of the pay range.
Employees of XYZ Corp who are not meeting expectations are counseled to improve their performance before any pay increase is available. Employees counseled to improve their performance and who subsequently do not improve, will have their employment terminated.
In addition to base salary, XYZ Corp uses incentives or variable pay as a way to meet the strategic goals of the company. Incentive pay will be available to some employees with consideration for a number of factors and will be based on individual goals that relate to the company objectives as well as overall company performance.
In alignment with our company culture, we strive to communicate openly about the goals of the company and the design of the compensation program. The compensation process is intended to be fair and simple so that all employees and managers understand the goals and outcomes of the process.
The pay administration program at XYZ Corp was created to achieve consistent pay practices, comply with federal and state laws, and mirror our commitment to Equal Employment Opportunity. Pay decisions and reviews are made without regard to race, color, citizenship status, national origin, ancestry, gender, age, religion, creed, physical or mental disability, or any other factor protected by law.
Several factors may influence an employee’s rate of pay. XYZ Corp considers the essential duties and responsibilities of the job, market data, as well as individual and company performance. XYZ Corp periodically reviews its pay administration program and restructures it as necessary. Merit-based pay adjustments may be awarded in conjunction with superior employee performance as documented through the performance evaluation process.
Pay, bonus, and any other type of compensation information are highly confidential. You should not discuss your compensation or other employees’ compensation with anyone other than your manager or Human Resources. You should bring any pay-related questions or concerns to the attention of your manager, who is responsible for the fair administration of departmental pay practices. Human Resources is also available to answer specific questions about the pay administration program.
Employees will not be paid below the pay range minimum unless there are issues related to the employee’s qualifications or performance. Employees will not be paid above the pay range maximum unless circumstances exist where an individual is required to fulfill specific needs of the company. Such needs may be a stated project or a specific goal to be realized in order for the company to achieve its goals and objectives. Paying below minimum (green circle) or above maximum (red circle) requires the approval of the VP of HR. Such approval will be based on the stated project or goal and upon a course of action to adjust the employee’s pay and/or classification following the achievement of the project or goal.
Managers are responsible for ensuring job descriptions are up to date for the positions that report to them directly or indirectly. HR reviews and approves the job descriptions and maintains copies for use in determining the market pay for the positions. Pay ranges are reviewed annually with respect to market pay and are adjusted to the appropriate levels for the upcoming year.
Individual employee performance is assessed through the Company’s Performance Management Program. Pay increase budgets are established based on market pay movement and the company’s finances. Based on the budgets and employees’ performance, pay increase recommendations are submitted to HR for review. Following its review, HR submits the recommendations to Management for review and approval. Approved pay increases are then communicated to employees by their manager in one-on-one meetings following the direction provided by HR.
Compensation Philosophy Potency
Given the sophistication of today’s pay surveys it is not only possible but obligatory that a company’s compensation philosophy state the range minimum and maximum as explicitly defined points in the market. The midpoint then becomes just an average of the minimum and the maximum.
A compensation philosophy can and should be very specific about what to pay employees with the basic qualifications for each position, as well as what to pay employees with outstanding qualifications. Telling your top performers that their pay opportunity is up to the 90th percentile, for example, can provide reason for such employees to invest a significant portion of their careers at your company.
Selecting a percentile at the lower end of the market data should be done with an understanding of the qualifications of employees whose pay is at the lower end. There is a point below which employees have less than minimum qualifications and minimum performance. It is possible to argue that that point is the 10th percentile or the 15th percentile or the 25th percentile. A company must arrive at a decision with the same level of sagacity as it used to determine the range maximums.
When using specific points in the market to set range minimums and maximums, the range midpoint becomes irrelevant, at least with respect to the market. It now is simply the average of the minimum and maximum.
Looking Beyond Range Midpoint
Indeed, the importance of the range midpoint is often overstated. It is not “the market,” as in the point below which employees are paid “below market” or above which employees are paid “above market.” Market is the entire pay range—all employee pay within the range is “in the market” according the company’s definition of market. All employee pay within the range is between the minimum and maximum of the market, as specified by the company’s compensation philosophy.
The range midpoint is just a mathematical mean with no intrinsic value. It’s simply halfway between the bottom and the top. Shoving employees with lower-level qualifications toward a midpoint is senseless and results in money ill spent. It is better for both company and employee if the employee’s pay increases as the employee’s demonstrated qualifications increases and as performance enhances. Employees who continue to perform have the entire range available to them. There is no value in throwing employee pay toward the midpoint nor is there value in retarding employee pay above the midpoint.
Compensation analysts have historically used compa-ratio, which tells where an employee’s pay is vis-à-vis the range midpoint, as a primary analysis tool. Compa-ratio—short for “comparative ratio”—is derived by dividing an employee’s pay by the midpoint of the pay range in which the employee’s pay is managed. As illustrated in the following table, an employee paid at exactly the range midpoint has a compa-ratio of 100%. Employees paid below or above the midpoint have a compa-ratio below or above 100%, respectively.
|Employee Pay||Range Midpoint||Compa Ratio|
Compa-ratio cannot tell when employee pay is outside the minimum or maximum of the pay range. That requires calculating the compa-ratio of the minimum and maximum, and then comparing the employee pay compa-ratio to the minimum and maximum compa-ratio.
While compa-ratio can compare one employee’s pay to other employees, it is more accurate just to compare employees’ actual pay. Aggregate compa-ratios can also be used for larger datasets, such as finding the average compa-ratio for all employees in a company to determine the average pay compared to the average range midpoint.
But that’s really the extent of compa-ratio’s usefulness.
A Better Solution
A judicious compensation philosophy requires an analysis tool that goes well beyond compa-ratio. Range Ratio tells precisely where an employee is paid in the pay range. Range Ratio is calculated by subtracting the range minimum from the employee’s pay and then dividing the result by the range maximum minus the range minimum:
(employee pay) – (range minimum)
(range maximum) – (range minimum)
The following table illustrates the clarity offered by using Range Ratio (RR):
- RR of 0% means that the employee is paid at the minimum of the range.
- RR of 50% means that the employee is paid at the midpoint of the range.
- RR of 100% means that the employee is paid at the maximum of the range.
- Negative RR indicates employee pay below the range minimum.
- RR above 100% indicates employee pay above the range maximum.
Changing the Language
Because the pay range is based on the market, RR corresponds to a position within the market. An employee with 25% RR is paid lower in the range (and thus in the market) while an employee with 75% RR is paid higher in the range and market. “Low” and “high” are absolute terms, so using the more relative “lower” and “higher” more precisely communicates pay in relation to the range and the market. In other words, saying an employee’s pay is “low” sounds like something is definitively wrong and must be fixed, but saying an employee’s pay is “lower in the range” associates the pay with qualifications and performance.
An employee whose qualifications meet only the minimum requirements of the job is positioned lower in the market and therefore should be paid lower in the range. An experienced, higher performing employee should be paid higher in the range because their skillset has positioned them higher in the market. Changing the language helps both the company and the employee better understand whether or not the employee is paid appropriately.
Using RR Effectively
To fully calibrate your Range Ratios, a company should analyze the results from them and know why an employee is at a particular point in the range and if it is the appropriate point for them.
The variables that affect pay and market position include:
These qualifications and elements of performance (Q/P) may also include other factors deemed relevant by the company’s compensation philosophy.
RR provides an immediate view of those employees who are below minimum and those employees who are above maximum. If an employee’s pay is below minimum (negative RR), the following questions must be asked:
- Is the employee classified correctly?
- Does the employee meet the Q/P for this level?
If the answer to both is yes, the employee’s pay should be increased to at least minimum. (This can be done immediately, planned for the next scheduled pay review, or addressed with step increases. Of course, a company’s budget is always a consideration.)
If an employee’s pay is above maximum (more than 100% RR), the following questions must be asked:
- Is employee classified correctly?
- Does the employee meet the Q/P for a higher level?
If the employee is correctly classified, their pay can be reduced to maximum, or maintained until the range “catches up” with future increases. (Though generally accepted, “Red Circle” must be warranted, and used only as an exception.)
If the employee meets the Q/P of a higher-level position, that employee should be reclassified to the higher level and their pay viewed with respect to the new range.
The Many Uses of RR
A well-calibrated set of Range Ratios can scale far beyond individual employee pay rates. For example, the average of all employees’ RR is equivalent to the company’s RR, and therefore shows the company’s position in the market. But remember that a low RR does not necessarily mean the company is underpaying its employees. For example, a 40% average RR does not mean the company should give pay increases to bring the average RR up to 50%. Just as with an individual employee, the company’s RR must be viewed in light of its Q/P. If the average Q/P level is low, then RR will also be relatively low.
RR is a good dashboard metric that should cause us to look for answers rather than jump to conclusions. For example, it’s useful to watch the average RR history. If a company’s annual RR average over three years went from 40% in year 1, to 42% in year 2, and then to 35% in year 3, the company must account for the sudden drop:
- Was the pay increase budget inadequate?
- Was year 3 accompanied by increased turnover?
- Has the market moved exceptionally?
- Did they lose highly paid employees?
RR can also be used to analyze pay across geographic locations. If you have pay ranges for various geographic locations that are based on that location’s market you can easily compare the RR across those locations. For instance, what is the average RR for NYC, OKC, and SLC? Why are they different, if they are? Does the staff in a lower RR location have lower Q/P? If Q/P is similar, should a larger portion of the next pay increase budget be directed to the lower RR location?
RR is also useful when analyzing the pay for employees in the same job family. What is the average RR for program managers in Austin compared to program managers in Boston or Chicago? If Austin is lower, is it due to the program management Q/P in Austin being lower? Similarly, if the average RR across all three sites is close to equal, the company should expect the Q/P also to be equal.
A well-calibrated compensation program begins with a solid Compensation Philosophy. Range Ratio is an exact tool that will improve compensation analyses, make it easier for your company to communicate with management and employees about pay rates, and endow your organization with solid guidelines to follow in the future. Make the change today to Calibrate Compensation using Range Ratio and discover the substantial benefits of consistent, precise compensation programs in today’s competitive environment.