Let’s dive into a few common compensation practices like reference points, pay bands and a traditional salary structure.

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.

What is a pay structure?

A pay structure is a tool used to simplify the administration and management of pay ranges for employees and their individual pay rates. A pay structure consists of pay grades for jobs of similar internal and/or external worth. Typically, pay structures are built using external compensation benchmark data, market pricing, and salary surveys, to support the guideline pay level included in the structure.

There are many ways to make pay decisions, 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.

Let’s look at a few types of pay structures in a bit more detail.

Market Reference Points

Market reference points, or spot rates, is a type of pay structure where you match every job in your organization to market data that will allow you to develop a market reference point. Within this approach, each job range is discrete, independent, and there is no clear or predetermined progression between pay ranges or within job families. Though less frequently used, this type of system can work well for jobs that are hard to fill, in high demand or require higher pay and competitive salaries. 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, benchmarking, and a solid understanding of a wide variety of jobs. The biggest benefit of using market reference points is that the results provide specific pay guidance that can be very beneficial, even necessary, in certain types of organizations.

Traditional Pay Structure

Traditional pay structure is defined as a collection of pay ranges, each with minimum, midpoint, and maximum pay levels. 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%, 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. 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, however for an hourly employee, the approach is less common.

Broad band pay structure

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 pay bands. These reference points provide a clear view as to where individual jobs 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 market value, 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 grades for different employee levels

Executives

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. 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.

Hourly Employees

For the hourly population, there are several approaches to managing pay. 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.

• Fixed wage / Job rate: A set hourly wage for each job. This approach is common among hourly roles where jobs are highly defined, there is limited variation of job responsibilities, and the time-to-proficiency is low.
• Step-based pay structure: A schedule of discrete hourly wages for each job. Pay progression is typically determined by time-in-job, skills obtained, performance, or a combination of these factors. This approach is common in union and non-union environments where experience must be obtained before workers become fully proficient.

Does your Pay Structure Fit?

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 a human resources 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:

• Are the majority of our employees within the construct of our pay structure? Except during periods of transition, you want a well-functioning pay structure to contain almost all of your employees (i.e., upwards of 90%). If you have a significant portion of employees outside of your pay ranges, and a lot of exceptions, then your structure is probably in need of some tweaking.
• Do managers struggle to make pay decisions? As an HR professional, you are likely responsible for partnering with managers to make pay decisions for their employees. How does that process work? Can you easily guide managers through the “how and why” of pay increases? Or are there blind spots that take a lot of extra explaining? If the encounters with managers dealing with pay have been consistently frustrating, perhaps this is due to misalignment between the pay structure and talent strategy or company culture.
• Do employees understand how their pay is determined, or how a pay increase is decided? Let’s be honest, everyone wants more pay. So, simply asking if employees are “happy with their pay,” seems a bit futile. However, having a pay structure, along with an element of pay transparency, can provide employees with an understanding of how their pay is determined. This transparency can go a long way towards improving your employees’ overall satisfaction with the pay they receive.

Learn more about Mercer’s salary surveys and data

About the Author

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.