Market pricing 101: establishing a benchmark methodology unique to your organization

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July 30, 2021

For compensation professionals, market pricing sits at the core of many responsibilities and outcomes. Establishing and managing the salary structure, designing short-term incentive plans, conducting internal equity analyses, and distributing merit increases during the performance management process all rely, to some extent, on accurate market pricing. Compensation management is important because it affects so many other functions. Your market pricing activities must be thoughtful, organized, repeatable, accurate, and above all aligned with and reflective of the labor market in which your organization competes for talent. What is the best way to ensure this happens? Start by developing a benchmark methodology.1?

What is a benchmark methodology

A benchmark, or market pricing, methodology is a framework for organizing the steps you will take to accurately, consistently, and efficiently conduct market pricing activities in your organization. It is a guiding compensation tool used to ensure that anyone who sets out to market price a benchmark job will consistently use agreed-upon methods of collecting, weighting, and combining data. Part of a benchmark methodology is developing a thorough understanding of relevant labor market data, which then translates into deciding which compensation surveys are selected and incorporated.

The elements of a benchmark methodology

Although the level of detail in a benchmark methodology may vary, the following elements at a minimum will ensure market pricing consistency.

Compensation philosophy

A compensation philosophy is your starting point. If you don't have one — STOP! Do not attempt to create a benchmark methodology without understanding your organization's goals for positioning pay among their labor market competitors. A compensation philosophy statement can be something as simple as "ABC, Inc. targets pay at the median." Or, very often today, the report will include pay structure details, such as how base pay is positioned versus variable pay, a statement regarding the labor market competitors, and the role that pay-for-performance plays. In any case, you must understand your company's target pay positioning in the labor market to develop a benchmark methodology. If that's not in place, that's your first task — get to work!

Surveys

With the considerable budget you have at your disposal, it's easy to purchase loads of salary surveys, right? If that’s your situation, cheers to you! However, most of us have a limited budget and need to be strategic when selecting which salary surveys to purchase. Be sure to choose reputable surveys that reflect your labor market competitors and will job match a significant number of the positions within your organization. Visit Survey Participation: Tips for Success for additional guidance on pay elements to consider when selecting surveys.

Scope cuts and data elements

Developing a benchmark methodology includes understanding how your company recruits talent, and how that recruitment strategy may differ by employee segment. In most organizations, there is a segment of jobs where the talent may come from various background industries, meaning it's not essential that candidates have any experience in your particular industry. For example, a Human Resource job or an Administrative Support role can typically be filled by a professional who demonstrates the skills you are looking for regardless of prior industry experience. They can learn the nuances of your industry.

However, other roles require specific industry experience or even experience working in organizations of a particular revenue size or type, such as a not-for-profit organization. The survey scope cuts that you choose to use should align with the kind of experience you require for each role.

Beyond the data scope cuts, you'll want to be sure to document the data elements you will use from each survey. There's nothing more frustrating than collecting data from a survey and realizing as you are beginning to load it into your market pricing tool, whether that's a market pricing tool or a spreadsheet, that you're missing data elements you need.

Use your compensation philosophy as a starting point to identify the necessary data elements you will need to analyze your salary range competitiveness each year. Most organizations will collect some variety of base pay, short-term incentive target, long-term incentives, total cash compensation, and total direct compensation at the 25th, 50th, and 75th percentiles, although the names of these elements in each survey may vary. You may need additional details as well. Use your benchmark methodology as a place to document which data elements to pull for each data cut in each survey. Then, when you are collecting data to update your market pricing, you will have a clear survey job checklist to follow, which will improve efficiency, consistency, and accuracy.

Developing composites

Best practice has always been to collect three survey data points for every job you are market pricing. As you probably know, that can be difficult to achieve. With multiple data points for every benchmark job, you are faced with the challenge of combining those data points. Again, you can achieve consistency and efficiency by establishing a set of market pricing guidelines for blending data in your benchmark methodology.

  • All surveys have different effective dates. To use the survey data accurately, you need to apply an aging factor, which is a multiplier that uses some percentage of the coming year's predicted pay increase percentage, such as those found in Mercer's Canada and US Compensation Planning Surveys. Which aging factor you use will depend on whether you wish to lead, lag, or lead/lag the external market. If you want to lead the market, you would age your data a full year ahead, which means that as other companies are adjusting employees' pay, you have already accounted for that adjustment in your market data. If you are more cost-conscious and wish to lag the market, then you would only age the salary data to the start of your upcoming performance year. A lead/lag approach would mean you age the salary data to the mid-point of your coming performance year.
  • You can apply different weights to the individual data elements to make each element more or less important in the resulting survey data composite. For example, data from a particular survey may be discounted due to the perceived lower relevance of the participants to the role being market priced. Or, conversely, a premium may be applied to data to reflect the additional roles and responsibilities of a job family in your organization. Weights can be applied to data for a variety of reasons; it can get confusing to try to keep the reasoning straight. Documenting your methods for market pricing and capturing the weighting in your market pricing tool makes analysis and auditing repeatable and efficient.
  • The simplest method for developing composites is to average the adjusted market data2 for each pay element. Even in that case, you will need to determine how to address data anomalies, such as zeros.

Alignment to employee segments

Once you have identified the scope cuts, you now need to determine and document how to align the data to the various employee segments. Typically, it's appropriate to take broad employee groups or departments (e.g., Finance), consider the experience desired, and translate that into the appropriate data scope. However, in some cases, it may be necessary to think in terms of jobs. A sample table outlining the data cuts for jobs in a healthcare organization is provided below.

Establishing a benchmark methodology

Assuming you have a compensation philosophy to start with, the next step is to comprehend your various labor market competitors and talent strategy thoroughly. To do so, you can engage either the HR professionals that represent the multiple employee segments within your organization or the department/business leaders themselves. Gather these resources and begin by educating them on what it is you are developing — give them a little “Compensation 101.” This leads to discussing how critical their input is to benchmark methodology. Engaging the department/business leaders in the development process produces a more accurate methodology, leading to more precise market pricing, and therefore, more competitive employee compensation. It also increases awareness among members of the organization, which can be critical in communicating compensation decisions to the broader workforce.

After confirming the nuances of the competitive labor market for your various employee segments, it's up to you to begin developing the benchmark methodology, including the elements described above.

In some cases, developing a benchmark methodology for your organization may be a job that benefits from some third-party advice or review. In that case, don't hesitate to engage the likes of Mercer or one of the other reputable consulting firms. Developing a comprehensive benchmark methodology is an important step that will provide significant improvements in efficiency, accuracy, and consistency. Trust us, the time spent is minimal compared to the gains realized.

For more information on developing a benchmark methodology or similar topics, look for other articles in our Market Pricing 101 series.

1 The terms market pricing and benchmarking do have different meanings but are frequently used interchangeably. For the purposes of this article, a "benchmark methodology" is used to guide any and all market pricing activities that take place in the organization, not just those of benchmark roles.

2 By "adjusted market data" we mean the data after any premiums/discount weightings are applied.