In recent years, employees and HR managers have gained a stronger position at the hiring table. Businesses are realizing the importance of offering more desirable pay and benefits to make them more competitive.
How do you determine if your compensation offerings are competitive? By comparing your compensation package to that of your labor market competitors. Sounds simple, right? Well, there are a few things you need to take into account, and it all starts with your compensation strategy.
Defining competitiveness for your organization
In order to determine whether your pay is competitive, you first need to define what competitive means for your organization. Once you have your definition, you can then compare your pay data to the market to determine your competitive position.
1. Establishing the ideal future state
As an employer, you need to determine how you want to approach compensation and how you want the pay you offer to employees to compare to that of your market competitors. The first step is to develop a compensation philosophy, followed by a more detailed plan, called a compensation strategy.
What is a compensation philosophy?
Your compensation philosophy explains why your organization approaches compensation in a particular manner. Typically, your compensation philosophy will include who you want to hire, what type of culture you want to drive, and how your target positioning is reflected in the market. It could be something like the following:
At XYZ company, our compensation philosophy is to provide rewards that are:
- Fair and equitable
- Able to attract, retain, and motivate the employees we need to support our business objectives
- Easily communicated to and by managers and employees
- In line with our labor market competitors
Some compensation philosophies may go into additional detail, perhaps being more specific about the target market percentages for different job families or even pay elements. (Don’t worry if that sounds confusing, we’ll go into it later.)
Compensation philosophy vs. compensation strategy?
A compensation strategy takes you a step further, documenting specifically how you will achieve the stated goals of the compensation philosophy.
Typically, a compensation strategy includes directives on some or all of the following elements.
- Segmentation: Segmentation is the degree of differentiation needed in the compensation strategy to support various functions, geographies, and more. For example, for IT positions, we will target the national, or 60th, percentile versus the median, or 50th, percentile for the general population.
- Role of each element: The purpose of each element in the total rewards package will be defined, including base pay, short-term incentives, and long-term incentives. For example, base pay reflects the value of the job in the relevant job market, including adjustments for skills and experience. Short-term incentives (e.g., annual bonus) are used to reward an employee for achieving annual objectives and will include a portion tied to company goals, team goals, and individual goals.
- Comparator group: Who the organization competes with for each business unit/function should be clearly defined. For example, for HR positions, the organization will recruit from general industry nationally.
- Internal equity: Internal equity defines the degree of comparability across business units and geographies. For example, the sales organization will have a significantly higher percentage of variable pay than other functions.
- Competitive positioning: Competitive positioning determines the target positioning of each compensation element, including pay mix. For example, base pay for administrative positions will target the median (50th percentile), with total compensation also positioned at or slightly above the median.
- Governance: Governance defines the decision-making structure and responsibilities of business managers and HR. For example, a manager will complete a request for pay review and provide a rationalization to an HR business partner, who will then work with the compensation team to determine whether or not a pay adjustment is required.
- Communication: Communication defines the approach and commitment to clarity and transparency. For example, we will provide a salary range to an employee who requests it, but for their job only.
All of these elements play a critical role in establishing your compensation strategy. In the absence of a formal compensation strategy, many businesses target the median, or 50th percentile, of the market; however, they might just end up with that target by default, thinking it’s the safe choice. Where in fact, a differentiated or segmented approach may be more desirable to target critical employee groups.
There is no one definition of competitive and your organization should establish your own. The degree to which you are competitive is determined by how you compare to that target.
With a well-constructed compensation strategy in place, you’re ready to go from theory to practice. The next step is to determine the gaps in the compensation strategy by selecting data to market price your positions.
2. Choosing the right market pricing data
To determine how you compare to your target market positioning (e.g., 50th percentile), you have to select the data to use in the comparison. The data is typically found in salary surveys. Knowing which and how many salary surveys to compare can sometimes feel like an overwhelming task. Both general industry and industry-specific data are available. Your goal should be to select data that reflects who you compete with for employees, often referred to as your market comparators — who is recruiting for the same types of roles, where did your employees come from, and where do they go when they leave your company?
General industry data
General industry salary surveys like the Mercer Benchmark Database (MBD) give you the ability to narrow your data by selecting specific industries, such as Consumer Goods or Life Sciences. From there, you may be able to refine your search by company size or geographic location. However, you would also use this survey data to reflect jobs where you compete with a broad range of industries and, perhaps, a national labor market. For example, if you are a hiring an HR Generalist, do they need to have experience in your industry and would you be willing to hire them from anywhere, or just locally?
For some roles, you need the more specific data that would be derived from organizations in your industry. You would use this data for jobs that require knowledge and skills gained by working in a specific industry. For a Registered Nurse, you would look at Healthcare data, perhaps even refining it further by the type of healthcare organization or the population served. Industry-specific surveys frequently include more compensation variance than general surveys.
Typically, in order to accurately reflect your labor market, you will use a mix of general industry and industry-specific data. It’s best to lay out what industry and other scope cuts you will pull from each survey, the percentiles you will use for comparisons, how you will combine the data into composites, and how this all varies for each segment of the workforce. Many compensation teams document all of these decisions in a benchmark methodology. For more information on using general and industry-specific data, please read “Using general industry and industry specific market data” on the imercer.com blog.
3. Market pricing your positions
Market pricing is the act of comparing your compensation to the market via readily available market data. Utilizing the compensation philosophy and strategy and the collected survey data, you must determine your competitiveness against the strategy and market competitors. In order to determine competitiveness to the compensation strategy and market competitors, you must market price your jobs to the external market. More information on the specifics of market pricing can be found in, “A comprehensive guide to market pricing.”
Calculate your competitive position
There are two key ways to analyze your compensation offering against the market: calculate the market ratio (a.k.a. market index) or calculate the market variance.
Let’s take this example, if the average pay for a job is $52,000 and the market data at the 50th percentile (i.e., your target market position) is $50,000 you can follow the below calculations:
Calculate the market ratio
Average base pay or midpoint for your job/market data at the target position = market variance.
(52,000/50,000) = 104%
Calculate the market variance
(Average pay or midpoint for your job / market data at the target positioning) − 1 = market variance
($52,000/$50,000) − 1 = 4%
Typically, you would consider anything that’s +/− 10% of the market (or 90% to 110% in the case of the market index) as competitive. However, you may determine that +/− 20% works for your organization. As long as you can document your decisions, communicate them effectively, and apply your policy consistently, you’ll be in good shape.
Moving forward with your competitive positioning
Once you have a clear picture of how competitive your pay may or may not be to your compensation strategy across your organization, you can now make decisions on how to adjust the rest of your total rewards package. As you know, base pay is just the foundation of the wonderful total rewards pyramid.
There may be times when defining your market pricing and competitive position would benefit from a third-party perspective. This is where Mercer can help you. We are one of the leading compensation consulting firms in the United States. We offer extensive salary data updated annually. In addition, we help business improve their performance by forecasting their talent needs, engaging employees, rewarding performance, and developing employee skills.
Explore our complete library of surveys and reports to find what works best for your business. You can also contact us at 866 605 1031 with any questions.
Paula Inglis specializes in advising clients on market best practice Total Rewards solutions that fit the various client talent needs. Paula has also worked on a broad scope of projects, including Market Pricing, Short-Term and Long-Term Incentives, and Executive across multiple industries such as manufacturing, consumer goods, energy, high-tech, and retail.
Michalla Nolan is a Senior Associate in Mercer’s Career business in Charleston, SC. She supports the US Career business and Workforce COI contributing to the development of market-leading solutions and intellectual capital.