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February 09, 2012
Market-Based Compensation: A Process
by Michael Strand, SPHR

Many employers are caught in a “Catch-22” situation. They want to pay employees enough to retain and motivate them to increase productivity…but these same don’t want to pay so much that payroll cost compromises the financial “bottom line.”

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Organizations develop important systems to evaluate positions within their hierarchy. The ranking method, the classification method and the point method can all provide a useful service in assuring internal equity. But to assure external equity and determine market pay levels, a market-based compensation methodology should take place. Market-based compensation is a method of utilizing market pay data to evaluate an organization’s pay levels. Thus, employers can make a position’s pay level more or less competitive depending on the organization’s compensation philosophy.

The compensation philosophy sets a template within which compensation decisions are made. In conducting a market-based pay study, decisions such as leading, lagging or meeting the market are made that directly reflect the organization’s compensation philosophy.

Salary Surveys: Choose and Use Wisely

The Internet and other resources offer a proliferation of sources for salary data. Sorting through the choices can be a daunting challenge. But selecting the most appropriate survey(s) is the most critical first step in a market-based pricing process. The next challenge is matching the organizations positions to survey positions. “Benchmarking” a selection of positions common in the industry can greatly assist in matching positions. If the benchmarked positions represent a range of the organization’s jobs, the ranking method of job evaluation can flush-out pay ranges for those positions where survey data is not available.

Salary surveys provide an array of data averages and percentiles. In compensation comparisons the median survey rate is most commonly used because it is less influenced by high or low pay extremes. Other data elements such as the 25th percentile, the 75th percentile and the mean can be helpful. But selecting data is a process that can be as simple or complicated as the organization elects.

Good salary surveys group data by organizational characteristics such as budget size, staff size, type organization and location. Use of the data from these groupings can create a composite average that profiles the organization. These sorts of data help to provide a match of participating survey organizations to the “profile” of the organization.

Use Market Rate to Review Incumbent Pay

The eventual median rate derived from the individual profile rates becomes the market rate. The market rate (again, subject to the compensation philosophy) is used to set the midpoint of the pay range. The range spread is typically determined by the level of the position within the organization’s hierarchy. Higher level positions such as Directors or Vice Presidents may have a range upwards to 65%. Entry-level positions may have a range approximating 35%.

Aging survey data recognizes actual and projected changes in the marketplace from the date the data was collected. Salary surveys collect data as of a designated month and year. In determining an aging factor (multiplier) for each survey, the actual and projected salary increases or cost of living increases should be used so that all data are brought to a common target date. That target date can be reflective of the organization’s compensation philosophy.

Once the market rate/range midpoint establishes the range minimum and maximum, the next task is review the pay rate of the incumbent employee(s). Is the incumbent’s rate too high, too low or appropriate based on years in position? For an incumbent’s pay rate that is too low a pay increase may be indicated; for an incumbent’s rate too high we rarely recommend a pay decrease.

Lastly, prioritizing pay adjustments and communicating those changes to employees (affected and otherwise) provides the final step in completing the market-based compensation study.

In the end, the organization has established pay ranges that are competitive and consistent with its compensation philosophy. And the pay level of incumbent employees is fairly evaluated based on market conditions. In my experience working with employers on compensation issues over the last 34 years, most employers really do want to do the “right thing” for employees and pay fairly. When I explain this process to employee groups I get many more head nods than head shakes. What more can you ask of an analytical process that recognizes external equity and is consistent with the organization’s compensation philosophy?

Please join me February 21 for the BLR webinar “Practical Market-Based Compensation: How to Structure Pay Practices that Attract and Retain the Best” to learn the ins and outs of a market-based compensation structure so you can use it to your organization’s advantage.

Michael Strand of consulting firm HR Dynamics Inc. has nearly 35 years of human resources experience at the executive level. He provides a broad variety of human resources projects and services to small and medium-sized non-profit and for-profit organizations, and specializes in compensation, employee benefits, and employee communications.

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