1. Building Pay Structures that Recognizes Individual Contributions
Chapter # 07
Building Pay Structures that Recognizes Individual Contributions
Reference Books:
Human Resource Management (12th Edition), R. Wayne Mondy, Pearson Education.
Strategic Compensation: A Human Resource Management Approach (6th Edition), Joseph J., Martocchio Joe, Pearson Education.
Resource person: Furqan-ul-haq Siddiqui

2. Constructing a Pay Structure
Developing Pay Structures based on five steps
Deciding on how many pay structures to construct
Determining a market pay line
Defining pay grades
Calculating pay ranges
Evaluating the results

3. Deciding on how many pay structures to construct
Companies often establish more than one pay structures depending on
Market rates
Company’s job structure
Company’s pay structure includes
Exempt and non exempt ( wage – salary)
Pay structures based on job families
Pay structures based on geography

4. Exempt jobs:
are not subject to overtime
Core compensation in terms of salary
Are generally supervisory, professional, managerial or executive jobs
Contains wide variety of duties
Non exempt jobs
Are subject to overtime
Core compensation is expressed as hourly pay rates
Are generally non supervisory in nature
Duties tend to be narrowly defined

5. Pay structures based on job family
Pay structures are defined on the basis of job family, which show a distinct pattern in the market
Distinct job families include:
i. Executive
ii. Managerial
iii. Professional
iv. Technical
v. Clerical
Craft
Pay structures based on geography
a. The pay for similar positions that are within the same company, but are located in different parts of the country, can be paid differently
b. Local influences, such as cost-of-living, influence pay structures

6. Determining a Market Pay Line
Market pay line is representative of typical market pay rates relative to a company’s job structure
Pay levels that correspond with the market pay line are market-competitive pay rates
Pay rates that fall along the market pay line represent competitive pay rates on the company’s selection of a relevant labor market
These rates promote internal consistency because they increase with the value of jobs—based on job evaluation points

7. Pay Structure for Clerk Jobs
$ 36000
$ 24000
$ 21000
Market Pay line
$ 18000
$ 15000
$12000
250 points Clerk 1
500 points Clerk 2
750 points Clerk 3
1200 points Clerk 4
Job Evaluation Points

8. Defining Pay Grades
Pay grades group jobs for pay policy application based on similar compensable factors and value
There is no one formula for determining what is sufficiently similar in terms of content and value to warrant grouping into a pay grade
Job groupings are influenced by other factors
a. Management philosophy
b. Wider pay grades that include:
i. A relatively large number of jobs
ii. Minimize hierarchy
iii. Minimize social distance between employees

9. Narrower pay grades tend to promote:
i. Hierarchy
ii. Social distance
Pay grade widths are either
a. Absolute job evaluation point spreads, where pay grades are based on a set number of job evaluation points
b. As a percentage-based evaluation point spreads, where the point spread increases as the jobs move up the pay structure, in recognition of the broader range of skills that higher pay grades represent

10. Pay Grade Definitions Job Evaluation points $ 36000 $ 24000 $ 21000
$ 18000
$ 15000
$ 12000
Messenger (200)
Mail clerk ( 220)
Clerk 1 (250)
Receptionist (300)
Mail clerk ii (350) Clerk ii (500) Secretary i (650)
Mail clerk iii (675) Clerk iii ( 750) Secretary ii ( 1000)
Mailroom Sup.( 1175) Chief Clerk (1200) Ex. Secretary (1900)
Job Evaluation points

11. Calculating Pay Ranges for Each Pay Grade
Pay ranges build upon pay grades
Pay grade represent the horizontal dimension of pay structure ( job evaluation points)
Pay ranges represent the vertical dimension (pay rates)
Pay ranges include midpoint, minimum, and maximum pay rates
The minimum and maximum values denote the acceptable lower and upper bounds of pay for the jobs within particular pay grade
Mid points are established first, followed by minimum and maximum rates
The midpoint pay value is the halfway mark between the range minimum and maximum
Mid points generally match values along the market pay line representing the competitive market rate determined by the analysis of compensation survey data
Midpoint may reflect market average or median

13. Example of Pay Grades and Pay Ranges

14. Setting Pay Range Midpoints
a. If the company adopts a market lead policy, that company’s midpoint will be higher than the market average
b. If the company adopts a market match policy, that company’s midpoint will be similar to the market average
c. If the company adopts a market lag policy, that company’s midpoint will be lower than the market average

15. Setting Pay Range Minimums and Maximums
According to the market averages
By developing a pay range spread
A range spread is the difference between the maximum and minimum pay rates of a given pay grade
It is expressed as a percentage of the difference between minimum and maximum divided by the minimum
Companies generally apply different range spreads across pay grades
Most commonly they use progressively range spreads for pay grades that contain more valuable jobs in terms of companies criteria
Smaller range spreads characterize pay grades that contain narrowly defined jobs that require simple skills with generally low responsibility
Following are some of the reasons for applying larger range spreads for higher level jobs
Higher –level jobs afford employees greater promotion opportunities than entry level jobs
Employees tend to remain in higher pay grades longer
The specialized skills associated with higher pay grades jobs are considered valuable

16. Setting Pay Range Minimums and Maximums
Example: Typical Pay Range
* 20% to 25% lower-level service; production and maintenance
* 30% to 40% clerical, technical, paraprofessional
* 40% to 50% high-level professional, administration, middle management
* 50% and above -- high-level managerial, executive

17. Calculation of Range Spread
Identify the midpoint $ 20,000
Determine the range spread %
Calculate the minimum:
Midpoint/ 100% + ( range spread/2) = $20,000/ 100%+ (40%/2)
= $ 16,666.67
4. Calculate the maximum:
Minimum + ( range spread x minimum = $ 16, ( 40% x $ 16,666.67)
$23,333.37
Range Spread = 40%
Midpoint = $ 20,000
Minimum = $ 16,666.67

18. The impact of Alternative Range Spreads on Pay Range Minimum and maximum values, with midpoint of $ 25000
Range Spread
20% 50% % %
$ 22, $20, $ 17, $ 15,625
$ $ 30, $ 32, $ 34,375
$ 4, $ 10, $ 14, $ 18,750
Minimum:
Midpoint/ 100% + (range spread/ 2)
Maximum:
Minimum + ( range spread x minimum)
Difference between maximum and minimum values

19. Setting Pay Range Minimums and Maximums
Adjacent pay ranges usually overlap with other pay ranges so that the highest range paid in one range is above the lowest rate of successive pay grade
Overlapping pay ranges allow companies to promote employees to the next level without adding to their pay
Non overlapping pay range require pay increases for job promotion
Overlap is expressed as a percentage

20. Calculating Pay Range Overlap
$ 40,000
100% x Max. rate for A – min. rate for B/ Max rate for A – min. rate for A
100% x ($ 35,000 – $30,000) / ( $ $ 20000)
The overlap between range A and range B is 33.33%
$ 35000
$ 3,0000 B
100% x ( $ $ 40000) / ( $ $ 30000)
The overlap between range C and D is 0%
$ 60,000
$ 20000 A
$ 40000
$ 40,000 D
$ 30,000 C

21. Pay Compression
Pay compression can be defined as pay differentials that are too small to be considered equitable. The term may apply to differences between
the pay of supervisors and subordinates,
the pay of experienced and newly hired personnel of the same job and
pay-range midpoints in successive job grades or related grades across pay structures
Two situations result in pay compression:
The company’s failure to raise pay range minimums and maximums
Companies that retain set range maximums over time limit increase amount

22. Example: Pay Compression; Not Raising Minimums and Maximums
TAX-IT, a small accounting firm
The salary of newly hired CPAs increased 7% annually over the last five years
Minimum and maximum pay levels for entry-level CPAs, over the last five years, did not increase due to low profits
CPAs hired five years ago make less than recently hired CPAs

23. Pay Compression Scarcity of qualified candidates for particular jobs
When the supply of such candidates falls behind a company’s demand, wages for newly hired candidates rise reflecting a bidding process among companies for qualified candidates
Can threaten a companies’ competitive advantage when it results in dysfunctional turnover (high performing employees voluntarily terminate their employment)
Pay compression can be minimized by setting maximum pay rates close to the maximum paid by other companies in the labor market for similar jobs
Setting competitive maximum rates enables a company to raise pay rates for high quality employees who may consider employment opportunities with competitors
Maximum rates should not exceed maximum rates offered by competitors for comparable jobs because high maximum represent costs to the company over and above what are needed to be competitive

24. Green and Red Circle Pay Rates
Green Circle Pay Rates
Are below-minimum pay range rates
Are usually offered because applicants do not meet every minimum requirement
Red circle pay rates:
Are above maximum pay range rates
Are given to retain highly-valued employees who have lucrative job offers elsewhere
Are allowed for employees who are demoted to a position that has a pay grade maximum that is lower than the employee’s current salary
May be offered to employees who exhibit exceptional job performance, but a promotion to a higher pay grade is not granted

25. Evaluating the Results
To determine if there was any significant difference between the company’s internal values for jobs and the market’s value for the same jobs
If discrepancies are evident, the company must reconsider the internal values they have placed on the jobs
If the company’s valuation exceeds the market’s valuation, the company must decide whether its higher-than-market pay rates will undermine its attainment of competitive advantage
If the company undervalues a position, it must determine if the discrepancy is limiting its ability to recruit quality employees
Compensation professionals must also consider each employee’s pay level relative to the midpoint of pay grade
The mid point represents a company’s competitive stance relative to market

26. Compa-Ratio (Comparative ratio):  The ratio of an employee's actual salary (the numerator) to the midpoint of the applicable (the denominator) salary range. To calculate an individual's compa-ratio, divide the actual salary by the midpoint of the assigned salary range.
Compa-Ratio>1 means?
Compa-Ratio<1 means?
Compa-Ratio=1 means?

27. Pay Ranges for Pay Grades
Scatter Diagram of Evaluated Jobs Illustrating the Wage Curve, Pay Grades, and Pay Ranges
Average Pay per Hour (Current Rates or Market Rates)
$19.80 5
18.50 4
17.20 3
15.90
Wage Curve
Pay Ranges for Pay Grades 2
14.60
14.00 1
13.30
12.90
12.00
100
200
300
400
500
Evaluated Points 1 2 3 4 5
Pay Grades
Evaluated Points Pay Grade Minimum Midpoint Maximum
$ $ $

28. Designing Merit Pay Systems
Considerations
Companies must insure that employees see definite links between pay and performance,
Companies must avoid using ineffective performance appraisal methods and poor communication regarding the link between pay and performance,
Companies interested in establishing merit pay system must decide:
Merit increase amounts
Timing
Type of merit pay increase – permanent or recurring increases versus non recurring addition to base pay
Settle on base pay levels relative to base pay of functionally similar jobs.

29. Designing Merit Pay Systems
Merit Increase Amounts
Should reflect prior job performance levels
Should motivate employees to perform their best
To be seen as meaningful, the amounts should account for increases in:
Inflation
Payroll deductions
CPI

30. Managers must consider three research findings
Merit Increase Amounts (contd.)
Managers must consider three research findings
1. Boosting the merit increase amount will not necessarily improve productivity.
Research has shown diminishing marginal returns on each additional dollar allocated to merit increase
In other words, each additional merit increase dollar was associated with smaller increases in production
Employees’ perception of just meaningful difference in merit increase depends on their;
Cost of living
Attitudes toward the job
Expectation of rewards from the job

31. Merit Increase Amounts (contd.)
For the pay increase to be considered meaningful, the employee must see the increase as substantive in a relative sense as well in an absolute sense
Equity theory suggest that an employee must regard his or her ratio of merit to performance as similar to the ratio for other comparably performing people in the company
In practical terms, managers should award the largest merit pay increases to employees with best performance and vice versa
The difference between the increases should be approximately equal to differences in performance
Well designed merit pay structures will fail without adequate funding

32. Designing Merit Pay Systems
Merit Increase Amounts (contd.)
Compensation budgets
are blueprints that describe the allocation of monetary resources to fund pay structures
Are indexed in percentage terms
A 10% increase for next year’s budget means that it will be 10% greater than size of the current year’s budget
ii. The greater the increases, the greater flexibility in developing innovative systems with substantial motivating

33. Designing Merit Pay Systems
Timing
Majority of companies allocate merit increases, cost of living , and other increases annually
Companies may take one of the two approaches
Establish a common review date or period
Employee’s anniversary date
The day on which the employee began to work for the company
Most employees will have different evaluation dates
It may not monopolize supervisors time
Can be burdensome because reviews must be conducted regularly through out the year

34. Designing Merit Pay Systems
Recurring versus nonrecurring Merit Pay Increases
Companies traditionally awarded merit pay permanently
Permanent increases are associated with some undesirable side effects
In terms of cost companies are increasingly concerned with containing cost as just one initiative to attain and sustain competitive advantage
Nonrecurring increases – lump sum bonuses which lend themselves to cost containment
Lump sum bonuses strengthen the pay-for-performance link
Minimize cost because these increases are not permanent
Subsequent percentage increases are not based on higher base pay levels

35. Designing Merit Pay Systems
Present Level of Base Pay
Pay structures specify acceptable pay ranges within each pay grade
Each job’s base pay level should fall within minimum and maximum rates for its respective pay grade
Managers should be encouraged to offer similar base pay to new employees performing similar jobs unless employees’ qualification and relevant work experience justify pay differences

36. Rewarding Performance: The Merit Pay Grid
Pay raise amounts are determined by:
a. Performance ratings
The position of employees' present base pay rates within pay ranges
Employee performance ratings
a. Overall performance ratings guide the pay raise decision
b. Based on the principle of recognizing higher performance with greater rewards

37. Rewarding Performance: The Merit Pay Grid (contd.)
Employees' position within the pay range
Indexed by quartile ranking, a measure of dispersion
Quartiles allow to describe the distribution data based on four groupings known as quartiles
The lower a person’s pay falls within its designated pay grade – for example the first quartile versus the third quartile, the higher the percentage pay raise, all else being equal
The higher a person’s pay within its grade, the lower the percentage pay raise, all else being equal
Holding performance rating constant , compensation professionals reduce merit pay increase percentage s as quartile ranks increases to control employees’ progression through their pay ranges
Pay grade minimums and maximums not only reflect corporate criteria about the value of various groups of unlike jobs but also may be dictated by budgeting

38. Merit Pay Grid

40. Merit Pay Increase Budget (contd.)
1. Supervisors and managers determine how many employees fall within each performance category.
Excellent =10%
Above Average = 20%
Average = 40%
Below Average = 25%
Poor = 5%
2. Determine the percentage of employees whose pay falls into each quartile.
Q 4 = 20%
Q 3 = 25%
Q 2 = 40%
Q 1 = 15%
In other words 20% of employees earn pay that falls in the range from $55,000 - $ 70,000 ( fourth quartile)
25% employees earn pay that falls from $ 40,000 –$ 55,000 (third quartile)
40% employees earn pay that falls from $30,000 - $ 40,000 (2nd quartile)

41. Combine both sets of information (1, & 2 above) to determine the percentage of employees who fall into each cell. The Sum of these cells totals 100%.
Next Compensation professionals calculate the expected number of employees who fall in to each cell. For this example, assume the company employees 350 employees. The number of employees whose performance rating is excellent and whose base pay falls in the 4th quartile equals 7.

42. Compensation professionals now distribute the budget amount ($500000) to each cell based on the following formula.
Assume Median for each quartile as:
Q 4 $ 65,000 Q 3 $ 50,000
Q2 $ 35,000 Q1 $ 20,000

43. Excellent
Above Average
Average
Below Average
Poor
Q 4
7 x5% x = $ 22,750
14 x 3% x = $ 18200
28 x 1% x = $18,200
$ 0 Q3
$30,625
$43,750,
$2 000
Q 2
$ 44,000
$ 68,000
$ 117,600
$ 24,000
Q 1
$ 12,600
$21,000 $
$ 10,500

44. Compensation professionals check whether the expected merit increase total fits within the budgeted amount. In this example sum of expected increase exceeds the budgeted amount by 23,425 ( 523,425 – 500,000)
When such increase happens adjust the percentages in the cell with following consideration in mind;
Lowering costs
Recognizing performance
Equity

45. Traditional Pay Structure vs. Broad banding

46. Broadbanding (or 'broad grades') is the consolidation of traditional pay structures, consisting of many, narrow pay ranges into a few, wider ranges or bands.
Thus, broadbanding reduces the emphasis on ‘status’ or hierarchy and places more of an emphasis on lateral job movement within the company.
In a broadbanding structure an employee can be more easily rewarded for lateral movement or skills development, whereas in traditional multiple grade salary structures pay progression happens primarily via job promotion.
In this way, broadbanding is a more flexible pay system.