One of the critical factors that contribute to an engaged and motivated workforce is a fair and transparent compensation system. Establishing compensation bands provides structure and consistency while ensuring equitable pay within an organization. By implementing well-designed compensation bands, companies can foster a sense of fairness, attract top talent, and retain their best employees. In this blog post, we will explore the steps involved in creating effective compensation bands that align with an organization's goals and values.
Define Your Compensation Philosophy
Before embarking on the process of creating compensation bands, it is crucial to define your company's compensation philosophy. Consider factors such as internal equity, external market competitiveness, performance-based rewards, and the overall financial health of the company.
There are 3 common philosophies: leading, matching, or lagging the market. Being a market leader means paying more than competitors to attract top talent. Matching the market involves paying similar rates as competitors. Lagging the market, paying less than market rates, is uncommon and usually unintentional, discovered through research or due to budget constraints.
Note that you can have an overall philosophy and then reapply these to the different components of total compensation. For example, you can choose to lead the market in terms of total compensation and you might do so via lagging on cash, matching on benefits, and leading on equity and bonus.
With your philosophy in mind, it’s time to define the structure of jobs within your company.
Evaluate Job Roles and Responsibilities:
First, define your Job Functions. Often, these are simply your departments, but there are exceptions. For example, a data analyst who reports into Business Operations might fall into the Engineering Job Function.
Take a close look at the existing roles within your company and categorize them into Job Functions or job families that share similar characteristics. Jobs within the same Job Function usually have these things in common:
- They require similar knowledge, skills, or abilities.
- They offer a career path that progresses from entry-level to higher levels of expertise.
- They have comparable market pay conditions.
The purpose of Job Functions is to create clusters of similar jobs with shared requirements and opportunities for career advancement. Once you have identified these Job Functions, you can proceed to rank the jobs, conduct research on comparable roles, and ultimately develop your Pay Bands for each Job Function.
Determine Leveling Criteria:
Establish the criteria for grouping jobs into compensation bands. Factors such as job complexity, required skill sets, level of responsibility, and contribution to the organization's success can be considered. Develop a clear set of criteria that will guide the placement of each job within the appropriate band.
Examine the positions within each Job Function and arrange them in a hierarchy, ranging from junior to senior, to establish your Job Levels. These levels can be assigned numerical labels like L1, L2, L3, etc., for ease of reference.
You have the flexibility to determine the number of levels you need, and they can be ranked according to various factors such as required skills, years of experience, education, qualifications, and responsibilities associated with each role.
Job Levels are typically standardized throughout the organization to provide a shared understanding of the expertise expected at each level. However, the Pay Bands associated with each Job Level may differ significantly, as they are tailored to the compensation structure specific to each Job Function. See the image below for a visual of this.
Conduct Market Research
To establish competitive compensation bands, it is essential to conduct thorough market research. Gather data on industry standards, regional salary ranges, and job market trends from a variety of sources. This research will provide valuable insights into prevailing compensation practices, helping you align your bands with market expectations.
You can buy salary surveys from consulting firms and/or do a give-to-get survey, where you submit your own information to a data provider in return for aggregated data from other companies. You can also look up crowd-sourced data online. For example, you can find information for a fee via compensation tool Pave and analytics platform Radford; and for free via Salary.com, PayScale, Comprehensive.io, and government sources such as the US Bureau of Labor Statistics or the UK Office of National Statistics.
When conducting research, keep the following in mind:
- Job titles vary between firms. Don’t compare simply on title, but ensure that related tasks, functions and levels of responsibility in the data match the positions at your organization.
- To avoid violating antitrust laws, do not contact competitive organizations directly for compensation information.
- Employer-reported data is generally more reliable than employee-provided information.
Set Salary Ranges:
Once the job roles have been assigned to bands, it's time to determine the salary ranges (or pay ranges) for each band. Consider the market data gathered earlier, the existing compensation structure for employees, and the organization's financial capabilities. The salary ranges should provide a competitive compensation structure while accounting for variances based on experience, performance, and other relevant factors.
To determine salary ranges, organizations typically set minimum, midpoint, and maximum pay levels for each pay range. The midpoint often sits between the 25th and 75th percentiles, but doesn’t need to be exactly the 50th percentile. For example, if an organization aims to lead the market, the salary point will exceed the 50th percentile for most positions. Alternatively, if a firm wants to invest in junior talent, the salary will be frequently closer to the minimum.
A straightforward approach to establishing a proposed midpoint is to average the market data for positions within a grade. There are no strict rules for creating salary ranges, but in this guide, we use the midpoint as the basis. Alternatively, some methods use the minimum salary as the starting point. A typical salary range spans ~30-40 percent from min to max.
You might calculate this as follows in the 30% case:
Minimum = Midpoint * 0.85
Maximum = Midpoint * 1.15
Pay bands often overlap within a particular Job Function’s ladder. This overlap can result in more cost-effective career progression, as you can give people merit increases without necessarily promoting them to the next job level. It is common for each Job Function to have its own distinct pay grades and pay ranges, which are established separately and independently from other job families.
Transparency is vital when introducing compensation bands to employees. Clearly communicate the rationale and methodology behind the creation of bands, emphasizing fairness and market competitiveness. Employees should understand how their roles fit into the bands and how their compensation aligns with their career progression. Address any concerns or questions promptly to foster trust and maintain transparency.
Once salaries for current employees are assigned within the established ranges, it's common to find that some employees do not align with these guidelines. These situations can be addressed using strategies to rectify "red circles" and "green circles".
Red circles refer to salaries that exceed the maximum rate set for the position's salary range. How can you tackle this?
- One option is to offer star performers a bonus instead of a base salary increase, recognizing their exceptional performance without further raising their base pay.
- Another approach is to explore developmental opportunities that can lead to promotion into the next pay grade.
- Alternatively, pay increases can be frozen to restrict further salary growth. However, it's essential to consider the potential impact on employee morale and job satisfaction, as lowering an employee's base pay will likely prompt them to start seeking new job opportunities. To avoid this, encouraging valuable employees to pursue developmental opportunities that can result in promotion is crucial.
On the other hand, green circles represent salaries below the minimum rate established for the position's salary range.
- To address this, providing pay increases up to at least the minimum range is a suitable solution.
- However, if an employee's performance has been consistently below expectations, it may be prudent to require successful completion of a performance improvement plan before granting a pay increase.
By effectively managing these outliers, organizations can ensure fair compensation practices and motivate employees to strive for growth and development within the defined salary ranges.
Regularly Review and Adjust:
Creating compensation bands is not a one-time exercise. It's essential to review and adjust the bands periodically to account for changes in the market, organizational needs, and the growth of individual employees. Keep an eye on industry trends and make necessary adjustments to ensure your compensation remains competitive and aligned with the company's objectives.
Establishing compensation bands provides a structured and equitable approach to employee compensation. By defining a clear compensation philosophy, conducting market research, evaluating job roles, and setting appropriate salary ranges, companies can create a fair and transparent compensation system. Transparent communication and regular review ensure that the compensation bands remain relevant and aligned with the evolving needs of the organization and its workforce. A well-designed compensation band system not only attracts and retains top talent but also fosters employee engagement.