chapter 8

MAJOR DECISIONS

The major decisions in setting externally competitive pay and designing the corresponding pay structures are shown in Exhibit 8.1. They include (1) specify the employer's competitive pay policy, (2) define the purpose of the survey, (3) select relevant market competitors, (4) design the survey, (5) interpret survey results and construct the market line, (6) construct a pay policy line that reflects external pay policy, and (7) balance competitiveness with internal alignment through the use of ranges, flat rates, and/or bands. This is a lengthy list. Think of Exhibit 8.1 as a road map through this chapter. The guideposts are the major decisions you face in designing a pay structure. Don't forget to end with, So what? "So what" means ensuring that pay structures both support business success and treat employees fairly.

FROM POLICY TO PRACTICE: THE PAY-POLICY LINE

There are several ways to translate external competitive policy into practice. You have already made some of the choices that help you do this. Choice of Measure - If Lincoln Electric practices what it claims at the beginning of the chapter, then we would expect Lincoln Electric to use the 45th percentile for base pay and the 65th percentile for total cash compensation as compensation measures in its regression. updating - Look again at Exhibit 8.15. The arrows on the right side of the exhibit show how updating survey data reflects policy. If the company chooses a "match" policy but then updates survey data to the end of the current year/start of the plan year and keeps this rate in effect throughout the plan year, the company will actually be lagging the market. It will match its desired market pay level only at the beginning of the plan year. The market rates continue to rise throughout the year; the company's rates do not. - Aging the market data to a point halfway through the plan year (middle arrow in Exhibit 8.15) is called lead/lag. The original survey rates are updated to the end of the current year plus half the projected amount for the plan year ($48,431). An employer who wants to lead the market may age data to the end of the plan year ($49,612) and pay at this rate throughout the plan year. Policy Line as Percent of Market Line - Another way to translate pay-level policy into practice is to simply specify a percent above or below the regression line (market line) that an employer intends to match and then draw a new line at this higher (or lower) level. This pay-policy line would carry out a policy statement, "We lead the market by 10 percent." Other possibilities exist. An employer might lead by including only a few top-paying competitors in the analysis and then matching them ("pay among the leaders") or lead for some job families and lag for others. The point is that there are alternatives among competitive pay policies, and there are alternative ways to translate policy into practice. If the practice does not match the policy (e.g., we say one thing but do another), then employees receive the wrong message.

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. Our favorite lets us click anywhere we want on a graph to see how adding that new data point (the mouse click) changes a regression line.33 A useful first step in our analysis is to look at a frequency distribution of the pay rates. Frequency Distribution - Exhibit 8.13 shows two frequency distributions created from the data in the Exhibit 8.12 survey. The top one shows the distribution of the base wages for the 585 engineer 1s in increments of $1,000. The second one shows the total compensation for 719 engineer 5s in increments of $10,000. (The wide range of dollars—from under $90,000 to over $900,000—is the reason that many surveys switch to logs of dollars for higher-level positions.) Frequency distributions help visualize information and may highlight anomalies. For example, the base wage above $79,000 may be considered an outlier. Is this a unique person? Or an error in reporting the data? A phone call (or e-mail) to the survey provider may answer the question. Shapes of frequency distributions can vary. Unusual shapes may reflect problems with job matches, widely dispersed pay rates, or employers with widely divergent pay policies. If the data look reasonable at this point, one wag has suggested that it is probably the result of two large errors that offset one another. Central Tendency - A measure of central tendency reduces a large amount of data into a single number. Exhibit 8.14 defines commonly used measures. The 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. While use of the mean is common, it may not accurately reflect actual labor market conditions, since the base wage of the largest employer is given the same weight as that of the smallest employer. Weighted mean is calculated by adding the base wages for all 585 engineers in the survey and then dividing by 585 ($46,085). A weighted mean gives equal weight to each individual employee's wage. Variation - The distribution of rates around a measure of central tendency is called variation. The two frequency distributions in Exhibit 8.13 show very different patterns of variation. Variation tells us how the rates are spread out in the market. Standard deviation is probably the most common statistical measure of variation, although its use in salary surveys is rare. Quartiles and percentiles are more common measures in salary survey analysis. Recall from the chapter introduction that someone's policy was "to be in the 75th percentile nationally." This means that 75 percent of all pay rates are at or below that point and 25 percent are above. Quartiles (25th and 75th percentiles) are often used to set pay ranges. More on pay ranges later in this chapter.

THE PURPOSE OF A SURVEY

An employer conducts or participates in a survey for a number of reasons: (1) to adjust the pay level in response to changing rates paid by competitors, (2) to set the mix of pay forms relative to that paid by competitors, (3) to establish or price a pay structure, (4) to analyze pay-related problems, or (5) to estimate the labor costs of product/service market competitors. Adjust Pay Level—How Much to Pay? - Most organizations make adjustments to employees' pay on a regular basis. Such adjustments can be based on the overall movement of pay rates caused by the competition for people in the market. Adjustments may also be based on performance, ability to pay, or terms specified in a contract. 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 (without good research) why changes to the pay mix occur less frequently than changes in the pay level. Perhaps the high costs of redesigning a different mix create a barrier. Perhaps inertia prevails. More likely, insufficient attention has been devoted to mix decisions. That is, 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. Yet some pay forms may affect employee behavior more than others. So good information on total compensation, the mix of pay competitors use, and costs of various pay forms is increasingly important. Adjust Pay Structure? - Many employers use market surveys to validate their own job evaluation results. For example, job evaluation may place purchasing assistant jobs at the same level in the job structure as some secretarial jobs. But if the market shows vastly different pay rates for the two types of work, most employers will recheck their evaluation process to see whether the jobs have been properly evaluated. Some may even establish a separate structure for different types of work. IBM sets pay according to market conditions for each separate occupation (finance, engineering, law). Thus, 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 market data are increasingly important as organizations move to more generic work descriptions (associate, leader) that focus on the person's skill as well as the job. Former relationships between job evaluation points and dollars may no longer hold. Accurate information and informed judgment are vital for making all these decisions. 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.1 Estimate Competitors' Labor Costs - Survey data are used as part of employers' broader efforts to gather competitive intelligence.2 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 on its website at www.bls.gov/ncs/.3 The ECI measures quarterly changes in employer costs for compensation. The index allows a firm to compare changes in its average costs to an all-industry or specific-industry average. However, this comparison may have limited value because industry averages may not reflect relevant competitors.4

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. Universities typically adjust to match the academic year. Unionized employers adjust on dates negotiated in labor agreements. Some employers operating in competitive locations (e.g., Minsk, Shanghai) update every quarter or even every month. Many employers adjust each employee's pay on the anniversary of the employee's date of hire. Even though these changes do not occur smoothly and uniformly throughout the year, as a practical matter we assume that they do. Therefore, 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). We do not. The CPI measures the rate of change in prices for goods and services in the product market, not wage changes in labor markets. Chapter 18 has more information on this distinction. Exhibit 8.15 illustrates updating. In the example, the base pay rate of $45,000 collected in the survey was in effect at January 1 of the current year—already in the past. The compensation manager will use this information for pay decisions that go into effect on January 1 of the plan year. So if base pay has been increasing by approximately 5 percent annually, and we assume that the future will be like the past, the rate is multiplied by 105 percent to account for the change expected by the end of the current year (to $47,250) and then by an additional percentage to estimate pay rates for the plan year. Construct a Market Pay Line - Look again at Exhibit 8.11. It shows the results of the FastCat analyst's decisions on which salary survey jobs to include that are judged to closely match internal benchmark jobs (the seven jobs on the x [horizontal] axis), which companies to include and which measures of pay to use. For each of the compensation metrics, a line has been drawn connecting the pay for the seven jobs. Jobs are ordered on the horizontal axis according to their position (i.e., number of job evaluation points) in the internal structure. Thus, the line trends upward to create a market line. A market line may be drawn freehand by connecting the data points, as was done in Exhibit 8.11, or statistical techniques such as regression analysis may be used. Regression generates a straight line that best fits the data by minimizing the variance around the line. Exhibit 8.16 shows the regression lines that use the pay survey data in Exhibit 8.11 as the dependent variable(s) and the job evaluation points of matched FastCat jobs as the independent variable. Compare the data tables in Exhibit 8.11 and Exhibit 8.16. Exhibit 8.11 shows the market rates for survey jobs. Exhibit 8.16 shows the job evaluation points for the FastCat jobs that match these survey jobs plus the regression's statistical "prediction" of each pay measure for each job. The actual base pay for the survey job Tech A is $22,989 (Exhibit 8.11); the "predicted" base pay for the job is $23,058 (Exhibit 8.16). A market line links a company's benchmark job evaluation points on the horizontal axis (internal structure) with market rates paid by competitors (market survey) on the vertical axis. It summarizes the distribution of going rates paid by competitors in the market. In Exhibit 8.17, we focus in on the regression results that use base pay from the survey as the dependent variable. The diamonds are the actual results of the survey and the solid line is the regression result. Regression smooths large amounts of data while minimizing variations. As the number of jobs in the survey increases, the advantage of the straight line that regression provides becomes clear. Setting Pay for Benchmark and Non-Benchmark Jobs - Setting pay for benchmark jobs is straightforward to the degree that good matches with survey jobs are found. Once it is known what other organizations pay for each job, a pay level can be chosen that is a function of what other organizations pay and what role the job plays in executing the strategy of one's own organization. For non-benchmark jobs (i.e., those jobs for which there is no good match among jobs included in the pay survey), the market pay lines in Exhibit 8.16 are especially useful. For example, take a job, Job Z, that has no match, but for which we have assigned a job evaluation points score of 110. How might we estimate its base pay? From Exhibit 8.16, we know that FastCat Job J has 100 job evaluation points and matches a survey job, Eng 5, that has a base pay of $90,876. So, one approach is to pay Job Z 110/100 × $90,876 = $99,964. Or, we can use the market survey line regression equation shown in Exhibit 8.17. The predicted base pay = $15,522.56 + $753.54 (110 job evaluation points) = $98,412. The results are close, but not identical. (Remember, the regression line smooths the relationship, resulting in a small difference in predicted base pay.) So, our market line is very valuable. Even though only benchmark jobs in our company can be directly matched to the survey, the market line allows us to estimate the market pay for non-benchmark jobs. (See also our discussion of survey leveling earlier in this chapter.) Before we leave survey data analysis, we must emphasize that not all survey results look like our examples and that not all companies use these statistical and analytical techniques. There is no one "right way" to analyze survey data. It has been our intent to provide some insight into the kinds of calculations that are useful and the assumptions that underlie salary surveys. (We are now beyond the halfway point of this long chapter. For those of you who are still going strong, great! But, for those of you who need at least a brief diversion from so much compensation material, perhaps a brief detour to the wizarding world would be welcome. Perhaps you would like to consider resorting to the Puking Pastilles, one of the Weasleys' Wizarding Wheezes described in the fifth Harry Potter book? The Puking Pastilles make you just ill enough to convince your professor to give you an extension on an assignment before you magically recover to enjoy your illicit time off.)34 Combine Internal Structure and External Market Rates - At this point, two parts of the total pay model have merged. Their relationship to each other can be seen in Exhibit 8.18.35 - The internally aligned structure (developed in Chapters 3-6) is shown on the horizontal (x) axis. For this illustration, our structure consists of jobs A through P. Jobs B, F, G, H, J, M, and P are the seven benchmark jobs that have been matched in the survey. Jobs A, C, D, E, I, K, L, N, and O have no direct matching jobs in the salary survey. The salaries paid by relevant competitors for those benchmark jobs, as measured by the survey—the external competitive data, are shown on the vertical (y) axis. - These two components—internal alignment and external competitiveness—come together in the pay structure. The pay structure has two aspects: the pay-policy line and pay ranges.

DESIGN THE SURVEY

Consulting firms offer a wide choice of ongoing surveys covering almost every job family and industry group imaginable. Their surveys are getting better and better.17 While we would like to attribute this to the fact that our textbook has improved the sophistication of compensation education (the first edition of our book was published in 1985, and at least some of those early readers ought to be in power positions by now), it is more likely that the improvement is the result of technological advances. Increasingly, consultants offer clients the option of electronically accessing the consultants' survey databases. Clients then do whatever special analysis they need. General Electric conducts most of its market analysis in this manner. Exhibit 8.5 provides some factors to consider in designing a pay survey and/or in choosing a pay survey vendor/consultant.18 Designing a survey requires answering the following questions: (1) Who should be involved in the survey design? (2) How many employers should be included? (3) Which jobs should be included? and (4) What information should be collected? Who should be involved? - In most organizations, the responsibility for managing the survey lies with the compensation manager. But because compensation expenses have a powerful effect on profitability, including managers and employees on the task forces makes sense. Outside consulting firms are typically used as third-party protection from possible "price-fixing" lawsuits. Suits 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. Survey 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. Identifying participants' data by company name is considered price fixing.19 How many employers? - There are no firm rules on how many employers to include in a survey. Large firms with a lead policy may exchange data with only a few (6 to 10) top-paying competitors.20 Merrill Lynch aims for the 75th percentile among 11 peer financial firms. A small organization in an area dominated by two or three employers may decide to survey only smaller competitors. National 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 (e.g., top 10 percent). Publicly Available Data - In 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. While some private 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. Tailoring analysis to specific industry segments, select companies, and specific job content is not feasible. "Word of Mouse" - Once upon a time individual employees had a hard time comparing their salaries to others'. Information was gathered haphazardly, via word of mouth. Today, a click of the mouse (or trackpad) makes a wealth of data available to everyone. Employees are comparing their compensation to data from the BLS or Salary.com or occupation-specific websites.21 This ease of access means that managers must be able to explain (defend?) the salaries paid to employees compared to those a mouse click away. Whole Foods confronted this issue via an "open book" list of last year's pay of all employees.22 Unfortunately, the quality of some salary data on the Web is unclear. Few of the sites (except the BLS, of course) offer any information on how the data were collected, what pay forms are included, and so on. Most are based on information volunteered by site users. Some popular websites even misuse the cost-of-living index when making geographic salary comparisons.23 On the other hand, Salary.com includes a compensation glossary, identifies where the site's information comes from, and explains what the statistics mean. Put in programmer for Birmingham, Alabama, and you will be asked to choose from 43 job descriptions. Exhibit 8.6 shows the Salary.com results for just three (different levels) of those programmer jobs, both at the national level and in Boston. Importantly, it also provides data on not only salary, but also bonus pay. (Glassdoor.com is another website that can provide this sort of detailed salary-by-job description data.) By comparison, all programmer positions are included in a single category in the BLS survey, making it all but impossible to get a good match and there is no breakout of compensation components. Many Surveys (But Few That Are Validated) - Opinions about the value of consultant surveys are rampant; research is not. Do Hay, Mercer, Towers Watson, and Aon Hewitt surveys yield significantly different results? The fact that companies typically use three or more surveys (for all job types) suggests that different surveys do, in fact, imply different pay levels.24 Many firms select one survey as their primary source and use others to cross-check or "validate" the results. Some 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.25 No 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. Issues of sample design and statistical inference are seldom considered. For staffing decisions, employment test designers report the test's performance against a set of standards (reliability, validity, etc.). Job evaluation's reliability and validity (or lack of) has been much studied and debated. Yet for market surveys and analysis, similar standards do not exist.26 Without reliability and validity metrics, survey data are open to challenge.

MARKET PRICING

Some organizations adopt pay strategies that emphasize external competitiveness and deemphasize internal alignment. In fact, we saw in Chapter 5 that this approach is now quite common. Indeed, it has been said that "the core change" in compensation from the past "is the diminished concern with internal salary relationships."42 Called market pricing, this approach sets pay structures almost exclusively on external market rates.43 Market pricers match a large percentage of their jobs with market data and collect as much market data as possible. The competitive rates for jobs for which external market data are available are calculated; then the remaining (non-benchmark) jobs are blended into the pay hierarchy created by the external rates ("rank to market"). Pfizer, for example, begins with job analysis and job descriptions. This is immediately followed by market analysis and pricing for as many jobs as possible. After that, the few remaining (non-benchmark) jobs are blended in and the internal job relationships are reviewed to be sure they are "reasonable in light of organization work flow and other uniqueness." The final step is pricing the non-benchmark jobs. This is done by comparing the value of these jobs to the Pfizer jobs already priced in the market. Market pricing goes beyond using benchmark jobs and slotting non-benchmarks. The objective of market pricing is to base most, if not all, of the internal pay structure on external rates, breaking down the boundaries between the internal organization and the external market forces. Some companies even match all forms of pay for each job to its competitors in the market. For example, if the average rate for a controller job is $150,000, then the company pays $150,000. If 60 percent of the $150,000 is base pay, 20 percent is annual bonus, 5 percent is stock options, and 15 percent is benefits, the company matches not only the amount but also this mix of pay forms. Another $150,000 job, say, director of marketing, may have a different pattern among market competitors, which is also matched. Business Strategy (More than "Follow the Leader") - Pure market pricing carried to this extreme ignores internal alignment completely. Gone is any attempt to align internal pay structures with the business strategy and the work performed. Rather, the internal pay structure is aligned with competitors' decisions as reflected in the market. In a very real sense, the decisions of its competitors determine an organization's pay. Why should competitors' pay decisions be the sole or even primary determinant of another company's pay structure? If they are, then how much or what mix of forms a company pays is no longer a potential source of competitive advantage. It is not unique, nor is it difficult to imitate. The implied assumption is that little value is added through internal alignment. Any unique or difficult-to-imitate aspects of the organization's pay structure, which may have been based on unique technology or the way work is organized, are deemphasized by market pricers. Fairness is presumed to be reflected by market rates; employee behavior is presumed to be reinforced by totally market-priced structures, which are the very same as those of competitors. In contrast, an organization may choose to differentiate its pay strategy from that of its competitors to better execute its own strategy.44 We saw earlier that organizations may choose different overall pay levels, depending on their business strategy. We also saw earlier that an organization may choose to pay some of its jobs above market, but other jobs at or below market.45 For example, according to resource dependence theory, employees who are more central to strategy execution in terms of their criticality in obtaining resources from the environment would be expected to be paid better relative to the market than would other employees. For example, in a study of universities, it was found that private universities, which rely more on private fundraising to operate, paid their chief development (fundraising) officers more than did public universities, which rely more on state funds. On the other hand, public universities, which typically rely more heavily on athletic programs to build alumni relations, paid their athletic directors more than did private universities.46 Other evidence shows that in capital intensive and highly diversified firms, where finance expertise is especially important, compensation for managers in finance jobs was higher relative to market than for other jobs on average. Likewise, managers in marketing were paid more in firms with large expenditures on marketing and advertising, and managers in research in development were paid more relative to market than other managers in firms focusing on product innovation.47 In sum, the process of balancing internal and external pressures is a matter of judgment made with an eye on the pay system objectives. De-emphasizing internal alignment may lead to unfair treatment among employees and inconsistency with the strategy and fundamental culture of the organization. Neglecting external competitive pay practices, however, will affect both the ability to attract applicants and the ability to retain valued employees. External pay relationships also directly impact labor costs and hence the ability to compete in the product/service market. Thus, while differentiating pay strategy from competitors can lead to competitive advantage, the reasons for being different must be clearly reasoned and articulated. Otherwise, being different may only lead to lack of competitiveness in the product market or labor market, hindering organization success and strategy execution.

FROM POLICY TO PRACTICE: GRADES AND RANGES

The next step is to design pay grades and pay ranges. These analyses are usually done with base pay data, since base pay reflects the basic value of the work rather than performance levels of employees (see Exhibit 8.10 for a comparison of metrics). Why Bother with Grades and Ranges? - Grades and ranges offer flexibility to deal with pressures from external markets and differences among organizations. These include: 1. Differences in quality (skills, abilities, experience) among individuals applying for work (e.g., Microsoft may have stricter hiring requirements for engineers than does FastCat, even though job descriptions appear identical). 2. Differences in the productivity or value of these quality variations (e.g., the value of the results from a software engineer at Microsoft probably differs from that of the results of a software engineer at Best Buy). 3. Differences in the mix of pay forms competitors use (e.g., Oracle uses more stock options and lower base compared to IBM). In addition to offering flexibility to deal with these external differences, an organization may use differences in rates paid to employees on the same job. A pay range exists whenever two or more rates are paid to employees in the same job. Hence, ranges provide managers the opportunity to: 1. Recognize individual performance differences with pay. 2. Meet employees' expectations that their pay will increase over time, even in the same job. 3. Encourage employees to remain with the organization. From an internal alignment perspective, the range reflects the differences in performance or experience that an employer wishes to recognize with pay. From an external competitiveness perspective, the range is a control device. A range maximum sets the lid on what the employer is willing to pay for that work; the range minimum sets the floor. In Chapter 11, we will see that many organizations use a merit increase grid or salary increase matrix, which uses two factors, employee performance rating and position in the salary range, to guide pay increases. The goal is to continually adjust employee pay so that it is appropriately positioned relative to the market. Thus, an employee with consistently high performance ratings should move above the market median and range midpoint, whereas an employee with consistently average performance should be near the range midpoint. Develop Grades - The first step in building flexibility into the pay structure is to group different jobs that are considered substantially equal for pay purposes into a grade. Grades enhance an organization's ability to move people among jobs with no change in pay. In Exhibit 8.18, the jobs are grouped into five grades on the horizontal axis. The question of which jobs are substantially equal and therefore slotted into one grade requires the analyst to reconsider the original job evaluation results. Each grade will have its own pay range, and all the jobs within a single grade will have the same pay range. Jobs in different grades (e.g., jobs C, D, E, and F in grade 2) should be dissimilar from those in other grades (grade 1 jobs A and B) and will have a different pay range. Although grades permit flexibility, they are challenging to design. The objective is for all jobs that are similar for pay purposes to be placed within the same grade. If jobs with relatively close job evaluation point totals fall on either side of grade boundaries, the magnitude of difference in the salary treatment may be out of proportion to the magnitude of difference in the value of the job content. Resolving such dilemmas requires an understanding of the specific jobs, career paths, and work flow in the organization, as well as considerable judgment. Establish Range Midpoints, Minimums, and Maximums - Grades group job evaluation data on the horizontal axis; ranges group salary data on the vertical axis. Ranges set upper and lower pay limits for all jobs in each grade. A range has three salient features: a midpoint, a minimum, and a maximum. Exhibit 8.19 is an enlargement of grade 2 in Exhibit 8.18, which contains the engineer 1 job. The midpoint is $54,896. This is the point where the pay-policy line crosses the center of the grade. The range for this grade has been set at 20 percent above and 20 percent below the midpoint. Thus, all FastCat engineer 1s are supposed to receive a salary higher than $43,917 but lower than $65,875.36 What Size Should the Range Be? - The size of the range is based on some judgment about how the ranges support career paths, promotions, and other organization systems. Top-level management positions commonly have ranges of 30 to 60 percent above and below the midpoint; entry to midlevel professional and managerial positions, between 15 and 30 percent; office and production work, 5 to 15 percent. Larger ranges in the managerial jobs reflect the greater opportunity for individual discretion and performance variations in the work. Some compensation managers use the actual survey rates, particularly the 75th and 25th percentiles, as maximums and minimums. Others ensure that the proposed range includes at least 75 percent of the rates in the survey data. Still others establish the minimum and maximum separately, with the amount between the minimum and the midpoint a function of how long it takes a new employee to become fully competent. Short training time may translate to minimums much closer to the midpoints. The maximum becomes the amount above the midpoint that the company is willing to pay for sustained performance on the job. In the end, the size of the range is based on judgment that weighs all these factors. Overlap - Exhibit 8.20 shows two extremes in overlap between adjacent grades. The high degree of overlap and low midpoint differentials in Exhibit 8.20(a) indicate small differences in the value of jobs in the adjoining grades. Being promoted from one grade to another may include a title change but not much change in pay. The smaller ranges in Exhibit 8.20(b) create less overlap, which permits the manager to reinforce a promotion into a new grade with a larger pay increase. The downside is that there may be fewer opportunities for promotion. Promotion Increases Matter - The size of differentials between grades should support career movement through the structure. A managerial job would typically be at least one grade higher than the jobs it supervises. Although a 15 percent pay differential between manager and employee has been offered as a rule of thumb, large overlap and possible overtime in some jobs but not in managerial jobs can make it difficult to maintain manager-employee differentials. We are cautious about such rules of thumb. They are often ways to avoid thinking about what makes sense. What is the optimal relationship between grades? The midpoint progression (differential between midpoints of adjacent grades) ought to be large enough to induce employees to seek promotion into a higher grade (and the grade/range overlap should not be too large, again to induce interest in promotion to a higher grade/range). However, there is virtually no research to indicate how much of a differential or midpoint progression is necessary to influence employees to do so. Tracing how an employee might move through a career path in the structure (e.g., from engineer 1 to engineer 2 . . . to manager 3) and what size pay increases will accompany that movement will help answer that question. Not all employers use grades and ranges. Skill-based plans establish single flat rates for each skill level regardless of performance or seniority. And many collective bargaining contracts establish single flat rates for each job (i.e., all senior machinists II receive $17.50 per hour regardless of performance or seniority). This flat rate often corresponds to some midpoint on a survey of that job. And increasingly, broad bands (think "really fat ranges") are being adopted for even greater flexibility.

SPECIFY COMPETITIVE PAY POLICY

The first decision—determining the external competitive pay policy—was covered in Chapter 7. 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. A survey is the systematic process of collecting and making judgments about the compensation paid by other employers.

Which Jobs to Include?

There are several approaches to selecting jobs for inclusion. - Benchmark-Job Approach= In Chapter 5 we noted that benchmark jobs have stable job content, are common across different employers, and include sizable numbers of employees. If the purpose of the survey is to price the entire structure, then benchmark jobs can be selected to include the entire job structure—all key functions and all levels, just as in job evaluation. In Exhibit 8.7, the more heavily shaded jobs in the structures are benchmark jobs. Benchmark jobs are chosen from as many levels in each of these structures as can be matched with the descriptions of the benchmark jobs that are included in the survey. Exhibit 8.8 indicates that about one in three organizations are able to match over 80 percent of jobs to salary survey jobs, with the remaining organizations report less success in matching. The degree of match between the survey's benchmark jobs and each company's benchmark jobs is assessed by various means. One approach, benchmark conversion/survey leveling is discussed below. As another example, the Hay Group has installed the same job evaluation plan in many companies that participate in its surveys. Consequently, jobs in different organizations can be compared on their job evaluation points and the distribution of points among the compensable factors. Other surveys simply ask participants to check the degree of match (e.g., my company's job is of moderately less value, slightly less value, equal value, etc.). A good survey will include this information in its results. A consultant friend insists that when the compensation manager of a company changes, the job matches change, too. - Low-High Approach= If 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. Market 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. Work at various levels within the structure can then be slotted between the anchors. For example, if the entry market rate for operator A is $12 per hour and the rate for a team leader is $42 per hour, then the rate for operator B can be somewhere between $12 and $42 per hour.27 The usefulness of this approach depends on how well the extreme benchmark jobs match the organization's work and whether they really do tap the entire range of skills. Hanging a pay system on two pieces of market data raises the stakes on the accuracy of those data. - Benchmark Conversion/Survey Leveling= In 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. If 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. (Again, a judgment.) - What Information to Collect?= Three basic types of data typically are requested: (1) information about the organization, (2) information about the total compensation system, and (3) specific 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 that will be discussed. Rather, the data collected depend on the purpose of the survey and the jobs and skills included. Organization Data - This 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. Typically, financial data are simply used to group firms by size, expressed in terms of sales or revenues, rather than to analyze competitors' performance. These data are used descriptively to report pay levels and mix by company size. The competitors' data have not been used to compare competitors' productivity (revenues to compensation) or labor costs. But this is changing. The increased gathering of "competitive intelligence" is changing the type of organization data collected and the way it gets used. Metrics of organization performance such as turnover and revenues are being collected. Other outcomes that may or may not be included are 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., Finance-Google, Yahoo Finance). Examples include metrics on organization success (revenues, net income, customer satisfaction), turnover (voluntary quit rates), and recruiting (yield ratios).28 Total Compensation Data - Information on all types of pay forms is required to assess the total pay package and competitors' practices.29 The list shown in Exhibit 8.9 reveals the range of forms that could be included in each company's definition of total compensation. As a practical matter, it can be hard to include all the pay forms. Too much detail on benefits, such as medical coverage deductibles and flexible work schedules, can make a survey too cumbersome. Alternatives range from a brief description of a benchmark benefit package to including only the most expensive and variable benefits to an estimate of total benefit expenses as a percentage of total labor costs. Three 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. Exhibit 8.11 shows some results of conducting a pay survey that includes these three measures on a sample of engineers. - It is no surprise that for all seven jobs, total compensation is higher than base pay alone or base plus bonus. However, the variability and magnitude of the difference may be a surprise: from $7,842 (34 percent) for the job of technician A to $244,103.38 (182 percent) for the job of manager 3. Base pay is, on average, only 35 percent of total compensation for the manager 3s in this survey. So the measure of compensation is an important decision. Misinterpreting competitors' pay practices can lead to costly mispricing of pay levels and structures.

SELECT RELEVANT MARKET COMPETITORS

We are up to the third of our major decisions shown in Exhibit 8.1: Specify relevant markets. 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: 1. The same occupations or skills 2. Employees within the same geographic area 3. The same products and services5 - Exhibit 8.2 shows how Microsoft and Google select relevant market competitors in establishing executive compensation. Both explicitly include product market ("technology") and labor market competitors. The geographic level is national or international. - Exhibit 8.3 shows how qualifications interact with geography to define the scope of relevant labor markets. As the importance and the complexity of the qualifications increase, the geographic limits also increase.6 Competition tends to be national or international for managerial and professional skills (as in Exhibit 8.2) but local or regional for clerical and production skills. - However, these generalizations do not always hold true. In areas with high concentrations of scientists, engineers, and managers (e.g., Boston or San Jose/Silicon Valley), the primary market comparison may be regional, with national data used only secondarily. As Exhibit 8.4 shows, pay varies among localities (i.e., there are geographic differentials).7 A job (computer programmer in this example) that averages $87,350 nationally can pay from $73,100 in Buffalo, New York to $104,470 in Silicon Valley (San Jose, California). However, some larger firms ignore local market conditions.8 Instead, they emphasize internal alignment across geographic areas to facilitate the use of virtual teams. But it turns out that team members in different locations compare their pay. What a surprise. - 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.9 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.10 However, this becomes a problem when the major competitors are based in countries with far lower pay rates, such as China or Mexico. But a segmented labor supply (see Chapter 7) requires multiple country comparisons.11 Legal regulations, tax policies, and customs vary among countries. Because of tax laws, managers in Korea and Spain receive company credit cards to use for personal expenses (groceries, clothing). In the United States, these purchases count as taxable income, but they do not in Korea and Spain. While the quantity of data available for international comparisons is improving, using the data to adjust pay still requires a lot of judgment. Labor markets have emerged relatively recently in some regions (China, Russia). Historically, state planning agencies set nationwide wage rates, so there was no need for surveys.12 Japanese companies historically shared information among themselves but not with outsiders, making surveys unavailable.13 But even with good international survey data, judgment is still required. For example, salaries at international companies in developing economies are low by U.S., Western European, and Japanese standards, but they are often very high compared to salaries at domestic companies in those countries. Pay practices of foreign companies can disrupt emerging local markets in developing economies.14 IBM software engineers in India told us that while they are paid very well by Indian standards, they feel underpaid compared to IBM engineers in the United States who work on the same projects.15 Fuzzy Markets - Walk through a bay of cubicles (plastered with Dilbert cartoons) at Yahoo! and you are likely to find former kindergarten teachers, software engineers, and sales representatives all collaborating on a single team. Yahoo! combines technology, media, and commerce into one company. What is the relevant labor market? Which firms should be included in Yahoo!'s surveys? Even within traditional companies, unique talent is required for unique jobs. West Publishing, a provider of legal information to law firms, designed the position of Senior Director of Future Vision Services. The holder of this mouthful title is responsible for ensuring that West's customers (litigious lawyers) increase their purchases over the Web plus increase their satisfaction with West's services. The job was filled by a software engineer with e-commerce, marketing, and theater experience. Try finding that job in the market. These new organizations and jobs fuse together diverse knowledge and experience, so "relevant" markets appear more like "fuzzy" markets.16 Organizations with unique jobs and structures face the double bind of finding it hard to get comparable market data at the same time they are placing more emphasis on external market data.

INTERPRET SURVEY RESULTS AND CONSTRUCT A MARKET LINE

Survey data today are typically exchanged online. Technology has made processing data and spitting out reports easy. The greatest challenge of total compensation surveys is to understand how to evaluate the information. In the best total compensation projects, each firm sees the survey as a customizable database project where they can specify the characteristics of the employers and jobs to analyze. After the survey data are all collected, the next step is to analyze the results and use statistics to construct a market pay line. More than 20 years ago, Belcher interviewed compensation professionals to discover how survey data are actually analyzed. He reported: Every organization uses its own methods of distilling information from the survey; uses different surveys for different purposes; and uses different methods for company surveys. I could find no commonality in these methods of analysis by industry, by firm size, or by union presence. For example, some did nothing except read the entire survey, some emphasized industry data, others geographic competitors (commuting distances), some made comparisons with less than five competitors, some emphasized only large firms, others threw out the data from large firms.30 - His conclusion still holds today. We hope this diversity reflects flexibility in dealing with a variety of circumstances and the use of improved compensation software. We worry that it reflects expediency and a lack of business- and work-related logic. Verify Data - A common first step is to check the accuracy of the job matches, and then check for anomalies (i.e., an employer whose data are substantially out of line from data of others), age of data, and the nature of the organizations (e.g., industry, size—State Farm Insurance versus Google). Exhibit 8.12 is an excerpt from the survey used to prepare Exhibit 8.13. The survey was conducted at the behest of FastCat, a small start-up familiar to many readers. While there were a number of jobs included in the survey, we use information for just one job—engineer 1—to illustrate. As you can see, surveys do not make light reading. However, they contain a wealth of information. To extract that information, step through the portal . . . to being the FastCat analyst.31 Accuracy of Match (and Improving the Match) - Part A of the survey contains the description of the survey job. For jobs that match perfectly, things are easy. However, in most cases, the match is either poor or not perfect. In the latter case, one does not need to make a yes/no (all or nothing) decision. Rather, if the company job is sufficiently close to the survey job, especially on the most fundamental aspects, the benchmark conversion/survey leveling approach discussed earlier in this chapter can be used; that is, multiply the survey data by some factor that the analyst judges to be the difference between the company job and the survey job.32 One way to execute this process is to conduct a job evaluation of the organization's benchmark job and the corresponding survey job and then determine their relative values. Anomalies - Part B of the survey shows actual engineer 1 salaries. Perusal of salary data gives the analyst a sense of the quality of the data and helps identify any areas for additional consideration. For example, Part B of Exhibit 8.12 shows that no engineer 1 at company 1 receives stock options, and five receive no bonuses. The bonuses range from $500 to $4,000. (Because there are 585 engineer 1s in this survey, we have not included all their salary information.) Individual-level data provide a wealth of information about specific practices. Understanding minimums, maximums, and what percent actually receive bonuses and/or options is essential. Unfortunately, many surveys provide only summary information such as company averages. Part C of Exhibit 8.12 provides company data. Again, the first step is to look for anomalies: 1. Does any one company dominate? If so (i.e., company 57), a separate analysis of the largest company's data will isolate that employer's pay practices and clarify the nature of its influence. 2. Do all employers show similar patterns? Probably not. In our survey, base pay at company 1 ranges from $36,500 to $79,000 for a single job. This raises the possibility that this company might use broad bands (discussed later in this chapter). While seven of the companies have a bonus-to-base-pay ratio of around 2 to 3 percent, company 15 pays an average bonus of $8,254 for a bonus-to-base ratio of over 6 percent. 3. Outliers? Company 51 gives one of its engineers options valued at $74,453 on top of base pay. An analyst may consider dropping a company with such an atypical pay practice. The question is, What difference will it make if certain companies are dropped? What difference will it make if they are included? - The best way to answer questions on anomalies is to do an analysis of them alone. They may have deliberately differentiated themselves with pay as part of their strategy. Learning more about competitors that differentiate can offer valuable insights. Combining outliers' pay data with their financials may reveal that the most successful competitors also use larger bonuses for their engineers. Part D at the bottom of Exhibit 8.12 contains summary data: five different measures of base pay, cash, and total compensation, as well as the percent of engineers who receive bonuses and options. The data suggest that most of FastCat's competitors use bonuses but are less likely to use options for this particular job. Summary data help abstract the survey information into a smaller number of measures for further statistical analysis. Statistics help FastCat get from pages of raw data (Exhibit 8.12) to graphs of actual salaries (Exhibit 8.13) and from there to a market line that reflects its competitive pay policy.

FROM POLICY TO PRACTICE: BROAD BANDING

Exhibit 8.21 collapses salary grades into only a few broad bands, each with a sizable range. This technique, known as broad banding, consolidates as many as four or five traditional grades into a single band with one minimum and one maximum. Because the band encompasses so many jobs of differing values, a range midpoint is usually not used.37 Contrasts between ranges and broad bands are highlighted in Exhibit 8.22. Supporters of broad bands list several advantages over traditional approaches. First, broad bands provide flexibility to define job responsibilities more broadly. They support redesigned, downsized, or boundary-less organizations that have eliminated layers of managerial jobs. They foster cross-functional growth and development in these new organizations. Employees can move laterally across functions within a band in order to gain depth of experience. Companies with global operations such as 3M and Medtronic used bands to move managers among worldwide assignments. The emphasis on lateral movement with no pay adjustments helps manage the reality of fewer promotion opportunities in flattened organization structures. The flexibility of banding eases mergers and acquisitions since there are not a lot of levels to argue over.38 - Broad bands are often combined with more traditional salary administration practices by using midpoints, zones, or other control points within bands.39 Perhaps the most important difference between the grades-and-ranges and broad-banding approaches is the location of the controls. The grade-and-range approach has guidelines and controls designed right into the pay system. Range minimums, maximums, and midpoints ensure consistency across managers. Managers using bands have only a total salary budget limiting them. But as experience with bands has advanced, guidelines and structure are increasingly designed into them (e.g., reference market rates or shadow ranges). Bands may add flexibility: Less time will be spent judging fine distinctions among jobs. But perhaps the time avoided judging jobs will now be spent judging individuals, a prospect managers already try to avoid. How will an organization avoid the appearance of salary treatment based on personality and politics rather than objective criteria? Ideally, with a well-thought-out performance management system. Banding takes two steps: 1. Set the number of bands. Merck used six bands for its entire pay structure. Band titles range from "contributor" to "executive." A unit of General Electric replaced 24 levels of work with 5 bands. Usually bands are established at the major "breaks," or differences, in work or skill/competency requirements. Titles used to label each band reflect these major breaks, such as "associate" (entry-level individual contributor), "professional" (experienced, knowledgeable team member), "leader" (project or group supervisor), "director," "coach," or even "visionary." The challenge is how much to pay people who are in the same band but in different functions performing different work. 2. Price the bands: reference market rates. The four bands in Exhibit 8.23 (associates, professionals, lead professionals, senior professionals) include multiple job families within each band, for example, finance, purchasing, engineering, marketing, and so on. It is unlikely that General Electric pays associates and professionals with business degrees the same as associates and professionals with engineering degrees. Usually external market differences exist, so the different functions or groups within bands are priced differently. As the pop-out in Exhibit 8.23 depicts, the three job families (purchasing, finance, and engineering) in the professional band have different reference rates, drawn from survey data. - You might say that this is beginning to look a lot like grades and ranges within each band. You would be correct. The difference is that ranges traditionally serve as controls, whereas reference rates act as guides. Today's guides grow to tomorrow's bureaucracy and perhaps lack of cost control. Not surprisingly perhaps then survey data show that grades/ranges are used almost 10 times more often than bands by organizations (86% versus 9%).40 Flexibility Control - Broad banding encourages employees to seek growth and development by moving cross-functionally (e.g., from purchasing to finance). The assumption is that this cross-fertilization of ideas will benefit the organization. Hence, career moves within bands are more common than between bands. According to supporters, the principal payoff of broad banding is this flexibility. But flexibility is one side of the coin; chaos and favoritism is the other. Banding presumes that managers will manage employee pay to accomplish the organization's objectives (and not their own) and treat employees fairly. Historically, this is not the first time managers have sought greater flexibility. Indeed, the rationale for using grades and ranges was to reduce inconsistencies and favoritism in previous generations. The challenge today is to take advantage of flexibility without increasing labor costs or leaving the organization vulnerable to charges of inconsistent or illegal practices.

BALANCING INTERNAL AND EXTERNAL PRESSURES: ADJUSTING THE PAY STRUCTURE

Up until now, we have made a distinction between the job structure and the pay structure. A job structure orders jobs on the basis of internal factors (reflected in job evaluation or skill certification). The pay structure, on the other hand, is anchored by the organization's external competitive position and reflected in its pay-policy line. Reconciling Differences - The problem with using two standards (internal and external) to create a structure is that they are likely to result in two different structures. The order in which jobs are ranked on internal versus external factors may not agree. Differences between market structures and rates and job evaluation rankings warrant a review of the basic decisions in evaluating and pricing a particular job. This may entail a review of the job analysis, the evaluation of the job, or the market data for the job in question. Often this reanalysis solves the problem. Sometimes, however, discrepancies persist. Survey data may be discarded, or benchmark-job matches may be changed. One study of how differences are actually reconciled found that managers weigh external market data more heavily than internal job evaluation data. In light of all the judgments that go into internal evaluation, market data are often considered to be more objective.41 Yet this chapter and research show that market data are also based on judgment. Sometimes differences arise because a shortage of a particular skill has driven up the market rate. But reclassifying such a job into a higher salary grade, where it will remain long after the supply/demand imbalance has been corrected, creates additional problems. Creating a special range that is clearly designated as market responsive may be a better approach. Decisions made on the basis of expediency may undermine the integrity of the pay decisions.