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According to Mercer’s most recent Compensation Policies and Practices report, more than 90% of US and Canada; organizations are managing pay with a salary structure. That’s a lot of companies! There are many different structure designs and not all support the same sort of pay management. Let’s take a look at the many different types of pay management constructs and consider how they might work for various employee populations and organizational cultures.
To make sure we’re all on the same page, let’s define what is meant by a pay structure. A pay structure is a management tool used to simplify the administration and management of pay for individuals. A pay structure consists of a series of pay ranges for jobs of similar internal and/or external worth. Typically, pay structures are built using external compensation benchmark data, salary surveys, to support the guideline pay ranges included in the structure.
There are many different ways to manage pay and each has a certain set of characteristics. Each approach, when evaluated against your employee population and desired method of pay management, has certain advantages and disadvantages. Some structures work best for hot-jobs, some for hierarchical organizations, some for those that promote based on time in job, and some for executives who come with a broad range of experience and qualifications.
Let’s take a look at a few types of pay structures in a bit more detail.
Market Reference Points
When managing pay with market reference points or spot rates, there’s one primary consideration — you must love to benchmark jobs! The premise of this type of system is that you will practically match every job in your organization to market data that will allow you to develop a market reference point, +/- a percentage to allow for varying experience and performance. Within this approach, each job range is discrete, independent, and there is no clear or predetermined progression between ranges or within job families. Though less frequently used, this type of system can work well for jobs that are hard to fill, are in high demand, and are evolving, all of which are factors that causes the market rates associated with the jobs to fluctuate. However, that brings about another issue — in this type of system, you need to update all of the market reference points annually, if not more frequently. This type of system requires a significant amount of market data and solid understanding of a wide variety of jobs. However, the results of this approach provide specific pay guidance that can be very beneficial, even necessary, in certain types of organizations.
Traditional Pay Structure
For those of us who have grown up in compensation over the past 20+ years, the definition of a traditional pay structure used today may vary from the “textbook definition” we used to know. To most, though, it is defined as a collection of ranges, each with minimum, midpoint, and maximum pay guidelines. The range spread (i.e., the percent difference from minimum to maximum) typically is from 40% to 60% wide. The midpoint progression (i.e., the percent difference between the midpoint in a range and the midpoint associated with a range one level higher) typically is 10% to 20%, with the wider percentages being used for the higher valued jobs in the organization. Some have come to expect even a traditional structure to be somewhat more varied in range spread distribution, perhaps with ranges going from 30% to 100%, in order to accommodate the full organization, from the entry-level jobs up through executive-level positions. A traditional structure tends to have 10 to 30 ranges with jobs aligned to each in a hierarchical manner. You would not typically have overlap of jobs within a career path in one range.
This type of structure largely supports pay progression through the attainment of jobs in higher pay ranges. Flatter organizations that are encouraging skill development more broadly or are using more flexible approaches to work (e.g., agile) may not find the best support from a traditional pay structure. Note that traditional pay structures — and the construct of having a hierarchy of ranges all with a pattern of progressing midpoints — can be used to manage salaried or hourly pay. For hourly pay, the approach is less common. When used, however, one typically sees lower range spreads and midpoint progressions.
Broad bands, or a banded pay structure, is best suited to an organization looking to emphasize career development for roles that change less frequently and/or provide varying levels of contribution to the organization. Promotions tend to be tied to a major role change, rather than doing more of the same type of work, perhaps a little differently. The bands, or ranges, are typically 100% to 200% wide and are often organized by career level (e.g., professional, manager, executive). Broad bands allow for the greatest level of flexibility in managing pay, which has plusses and minuses. Organizations can experience challenges with broad bands because of the flexibility. Managers will always play a role in making pay management decisions, and asking them to function with such broad guardrails can cause frustration. Managers typically want to understand what the “market rate” is for a job and that is not readily apparent in a banded pay structure. This is leads us to the next type of pay structure, bands with market reference points.
Bands with Reference Points
Originally born out of a need for pay decision makers (i.e., supervisors and managers) to be given guidance and more tools to use when considering pay changes for their employees, organizations that implemented banded pay structures often now use “reference points” or mini-ranges within the bands. These ranges or reference points provide a clear view as to where individual jobs actually align along the pay band. For example, Senior Accountant may be a job that’s assigned to a professional pay band that has a minimum of $70,000 and a maximum of $140,000. The current employee, let’s call her Jean, makes $80,000. When Jean’s manager is considering whether Jean is eligible for a raise, he or she needs to understand how Jean’s pay compares to the competitive market rate. It’s helpful for Jean’s Manager to know that the market reference point for this Senior Accountant job is $85,000, which represents the rate of a fully proficient employee, with solid performance in the job. Now Jean’s manager can decide, based on Jean’s performance and how her pay compares to the market, whether a pay raise is warranted. While communicated differently, there is a limited number of practical differences between this approach and traditional pay structures.
Managing pay for the executive population, particularly the “c-suite” (e.g., CEO, CFO) is usually handled differently. Typically, pay for these roles is managed outside of the pay structure, with limited controls — in the typical HRIS sense, anyway. Or, executives’ jobs may be assigned to pay ranges but deviation from the guidelines (i.e., minimum, midpoint, and maximum) is allowed. For executives, either of these arrangements can work. These variations reflect the differential nature of the roles filled by executives. Fundamentally, the highest level of company management has a very wide array of experience and qualifications. They bring many different skills to the table and contribute to the overall achievement of the company’s success in a myriad of ways. That in itself creates a need for more flexibility in rewarding their contribution through pay. Beyond that, we’ve only been talking about managing base pay, or salary. For the “c-suite,” base pay is not always the most important component of the rewards package. A review of competitive market data suggests that it’s not uncommon for a CEO to have 50% or more of his or her pay delivered via incentive. Given that dynamic, as well as the factors listed previously, the structure used to manage only 50% (or less) of the rewards package is less important.
For the hourly population, there are several approaches to managing pay. However, in contrast to executive positions that may have a much broader range of pay based on experience and performance, hourly positions tend to have a narrower degree of pay and role variation within one job. This characteristic means that, though you could create a pay range, as noted above, fixed-wage/job rates or step-based wage structures tend to be more efficient from a pay administration standpoint, and more common, for hourly employees.
It’s important to have a pay structure that supports your hiring, promotion strategy, and performance management program — more simply put, your overall talent strategy. Trying to operate with a pay structure that is misaligned to your talent strategy can lead to frustrated managers and disengaged employees … not to mention an HR team that may feel a little beat up! Do you know how well your pay structure is aligned to your talent strategy? Give it some thought by asking yourself these questions:
Of course, there are many other measures of alignment that you can use to understand whether your pay structure is the best fit for your organization. Stay tuned for additional articles on pay management coming to the Knowledge Library but, in the meantime, take a peek at our surveys for additional insights on managing pay. And as always, reach out to Mercer with any concerns — call us at 866-605-1031. We’re here to help!
Andre Rooks is a Principal at Mercer where he is responsible for developing strategies that improve the outcomes from base pay, incentive pay and other compensation programs.
Rebecca Adractas is a Principal at Mercer with over 20 years of experience in compensation management. After 10 years of delivering consulting projects, Rebecca has recently taken on the role of content leader for imercer’s Knowledge Library.