By Susan M. Heathfield

Why organizations have pay structures

The quest to compensate employees fairly is an ongoing challenge. If your organization pays employees too little, you may risk alienating and losing valuable employees. If you pay too much, you may be unwisely spending company resources. If you earn a reputation as a poorly paying employer, you may fail to attract desirable candidates.

How much your organization can afford for employee salaries can determine the caliber of talent you attract to your organization. Salary discussion starts early in the recruiting process — sometimes as early as the initial phone screening. Why spend time on a candidate you cannot afford?

The purpose of a pay structure is to organize and demonstrate your organization’s compensation philosophy and to reflect and support the advancement of your company culture. An effective pay structure also allows you to attract and retain the people who can help achieve your business goals.

Your organization's pay structure is a visible demonstration of your compensation philosophy and strategy. Developed logically and communicated effectively, your organization's pay structure is a tool that employees can view and understand. This is important because a recent study by WorldatWork (www.worldatwork.org) shows that understanding a company's compensation strategy influences employees' satisfaction with their compensation.

There are three challenges in developing a pay structure. You should determine:

1. The appropriate data for establishing the relative value of a particular job to your organization.
2. The appropriate pay range for a job with the stated value to your organization.
3. The value of each job position within the allotted pay range.

Once you have developed a pay structure, another ongoing challenge is determining your organization's annual compensation budget.

The following are the different types of data used to determine pay structures:

Ranking data

Traditionally, organizational pay structures were developed with an internal focus on creating equitable pay ranges dependent on job evaluations. This is known as the internal equity method. A different and currently favored ranking method for job evaluation is the point-factor method. In the point-factor method, certain aspects of jobs, such as skills required, work environment, or level of authority, are assigned points. The assigned points determine the ranking of a job in the organization's job hierarchy. Higher ranking jobs are more highly compensated.

The downside to job evaluation ranking systems is that they depend largely on subjective decision-making and can be time-consuming.

Market pay data

In the past decade, pay structure development has been more externally focused and driven by market considerations. This is known as the market-pricing method. This method relies on market pay data usually obtained through commercial or professional association salary surveys.

When certain job positions, such as a software developer position, are highly valued in the market, the use of market data is critical to retaining and attracting talented candidates. However, jobs with less value in the marketplace are often overvalued when compared with data from market pay studies.

Combination approach to using data

Recently, organizations' pay structures have been developed by combining both types of ranking methods. Informally, many organizations assess ranking data and also evaluate the potential degree of difficulty in refilling the position.

Strategic work valuation data

Strategic work valuation is the current buzz in structuring pay. Strategic work valuation emphasizes both the market pay rate for the job and the value of the job to the organization. The chief difference in strategic work valuation, from earlier ranking and market pricing strategies, is that the valuation factors are specific to your organization. These valuation factors measure the impact of each job on your organization's success.

For example, your company might decide that revenue growth, external customer satisfaction, operational effectiveness, financial impact, and span of control are its most important business success drivers. In the simplest form of strategic work valuation, jobs are then strategically valued in relation to each of these drivers.

In a recent article, "Improving Pay Productivity with Strategic Work Valuation," compensation consultants Christian M. Ellis, R. Glenn Laymon, and Peter V. LeBlanc use Circuit City's valuation method as an example. Jobs are either high impact — D, drives company results; moderate impact — S, sustains company results; or limited impact — P, preserves company results.

Applied to the business success factors above, a human resources generalist's job might receive a "P" rating for preserving company results, while a plant manager's job might receive a "D" rating for driving results in each category.

Develop a pay structure

Whichever method or combination of methods are used, the result is a hierarchical valuing of each job. This valuation is used to group jobs with similar value to the organization.

Therefore, you should develop your pay structure by doing the following.

1. Group jobs with those that have a similar value in your organization.
2. Assess these groupings to determine the number of pay ranges needed to group the jobs by their value to your organization.
3. Determine the pay for each job grouping by establishing a salary range that has minimum point, midpoint, and maximum point for dollar amounts allotted within the range. Many pay structures also report the pay range in percentiles; pay is allotted at the 25th percentile, the 50th percentile, and the 75th percentile.
• Salary ranges are also determined by company policy. Each organization should ask questions such as "How much overlap in ranges will allow for career development and pay increases without promotion at each level?" and "What percentage of increase will the organization extend to an employee for a promotion?"
• The pay range for executive-level positions is normally the largest; the pay range for lower-level positions is normally the narrowest.

Once your pay structure is determined, use it to assign a dollar amount to each employee's job. For example, your organization has three roles — customer service representative, accounts payable clerk, and sales assistant — that are valued similarly within your organization. The pay listed at the 25th percentile is $26,900; it's $30,200 at the 50th percentile and $33,790 at the 75th percentile.

• Midpoint salaries in the range are often assigned to effective, but not outstanding, performers.
• Minimum point salaries are generally given to inexperienced employees.
• Maximum point salaries, or salaries above the 75th percentile, are assigned to the best performers whose job valuation best affects company business results.

Your organization's compensation philosophy and pay strategy determine the approach that you should take to allocate pay across the job ranges. Factors to consider include:

• Number of years of experience
• Number of reporting staff members
• Performance evaluation results
• Hazardous working conditions
• Undesirable shifts
• Education and degrees
• Professional certifications
• Management opinions

Forward-thinking organizations measure and pay their employees based on business results. You should annually review your salary ranges annually to ensure continued relevance to business success factors, external markets, and internal pay equity. Think about your organization's pay structure as a communication tool; it clearly defines the value of each job and communicates the relationship of jobs to one another. Activity within the pay structure demonstrates who is performing well and who is worthy of promotion.

Developed effectively, the pay structure recognizes career development in addition to promotion. It demonstrates and pays for the business results on which your organization places value. An effective pay structure is worth your time and attention. It pays to get it right.

About the author   Susan M. Heathfield is a management and organization development consultant who helps organizations strategically value and utilize people. Her company promotes business success and profitability through consultation, executive and management coaching, organization development strategies, human resources system and policy development, team building, customized training, and writing.