Introduction
All organizations have a compensation plan, whether written or unwritten, formal or informal. For some organizations, the purpose of that plan may be merely to meet compliance requirements. For other organizations, the goal of the compensation plan may be to attract qualified employees, retain those employees, and motivate employees to direct their efforts towards achieving the goals of the organization. Regardless of the goal, size, and complexity of a compensation plan, there are generally many easily-identified elements to any compensation plan. This commentary reviews these elements, poses questions management can use to determine the stance it would like to take regarding compensation, and offers some advice and recommendations on implementing these ideas. The topics that will be covered are the development of a compensation philosophy, objectives of a base pay program, developing rates of pay for jobs, pay rates and increases, performance appraisal, maintaining and auditing a compensation plan.
Development of a Compensation Philosophy
Before an organization actually develops a compensation plan, there are several questions that need to be answered. Taking the time to consider and answer these questions will make both the process of developing and administering a compensation plan much easier and will result in the development of a compensation plan that more closely matches the organization's goals and objectives.
- What is the goal of the organization's compensation system? In addition to attracting and retaining qualified employees, is there an intent to reward employees for good performance, motivate good performance, and/or create or reinforce a particular type of organizational climate?
- What is the communication policy? How is the organization going to communicate the compensation plan to employees once it has been developed? Is the organization prepared to evaluate the effectiveness of any such communication? If so, how?
- How will decisions regarding pay be made? Who will be involved in these decisions? What decision guidelines will need to be developed?
- What is the organization's desired market position relative to pay? Will the organization choose to pay market rates, above market, or below market? How does the desired market position fit with other strategic goals? Are there any competitive factors involved that will determine the pay strategy?
- What is the desired mix between benefits and cash? Since benefits are an important form of compensation, how does an organization use them to maximize the effectiveness of the compensation plan?
- What does the organization pay for? Does it pay for performance or seniority or some combination of the two?
- What is the role of performance appraisal in the organization? How important is performance appraisal and why?
- How will the organization manage change to the compensation plan once it has been developed? What systems need to be in place to implement any changes including deciding when change is necessary and who will make these decisions?
- How does the compensation philosophy and plan fit with the rest of the organization? How can the compensation practices reinforce other overall management philosophies and objectives?
Objectives of a Base Pay Program
Before delving into the details of how actually to pay people, there are many factors that impact a base pay program that an organization must consider. In general, every organization's base pay program has certain objectives. The principal ones are as follows:
- internal equity,
- external equity (or competitiveness),
- individual equity,
- process equity,
- performance or productivity incentives,
- maximum use of financial resources,
- compliance with laws and regulations, and
- administrative efficiency.
As will be shown in the following, all of these objectives must be balanced in the development of a sound base pay program. As these points are being reviewed, management should ask the following questions:
- Is this point important to this organization? If so, how important?
- What are the implications of this point to the current or desired practices?
Internal Equity
Internal equity deals with the perceived worth of a job relative to other jobs in the organization. All employees compare their jobs to other jobs within the organization. Generally, they consider skill, effort, responsibility, and working conditions in this comparison to determine the value of their jobs relative to other jobs. Likewise, management must often determine the "worth" or "value" of one job in relation to other jobs for the purpose of pay programs. Maintaining appropriate pay relative to value or worth is achieving internal equity.
External Equity
External equity deals with the issue of market rates for jobs. An employer's goal should be to pay what is necessary to attract, retain, and motivate a sufficient number of qualified employees. This requires a base pay program that pays competitively. Among others, internal data such as turnover rates and exit interviews can be helpful in determining the competitiveness of pay rates.
Employees also compare their jobs and pay to the jobs and pay in other organizations. Generally, employees consider much more than base pay in determining external equity. Depending on the individual employee, serious consideration may be given to employee benefits, job security, physical work environment, commuting distance, opportunity for advancement, and the employee relations practices of the employer in determining external equity issues. In the Pacific Northwest, a frequent consideration is also lifestyle and quality of life.
An important issue to employees in determining external equity is the transferability of their skills. If an employee's skills are valued more highly in a different type of job or industry in the area, the employee may believe that they are being treated inequitably.
Note: An organization may choose to place the primary emphasis of its base pay program on internal equity, external equity, or a blend of the two. There are important ramifications to this decision that should "fit" with other organizational structure issues and overall management objectives.
Individual Equity
Individual equity deals with how individuals perceive how they are being paid relative to other individuals within the organization and perhaps within the same position. This focus of individual equity is on the merits of the person filling a job, as opposed to the job itself. In simple terms, employees want to feel that the rewards they receive for how they do their work are comparable to the rewards received by others for the same amount of effort or output, all other factors being equal. How merit rewards or increases are given strongly impacts perceptions of individual equity.
Process Equity
How employees perceive the fairness or equity in the administration of the compensation system is process equity. Process equity, in the perceptions of employees, is strongly influenced by the openness of the system, communication of the system to employees, participation in the design or administration of the system, and a grievance appeal procedure.
Performance Incentives
A significant element of a base pay program is to encourage higher or increased levels of employee performance. Pay systems need to be designed to improve organizational performance.
Maximum Use of Financial Resources
Since an organization does not have unlimited financial resources, the base pay program needs to be designed to maximize the value to the organization with a minimum use of these limited resources. In order to accomplish this, pay programs have a variety of tools such as pay range maximums, pay increase budgets, authorization procedures, compensation committees, or various internal auditing procedures available to help accomplish this objective.
Compliance with Laws and Regulations
While not the primary objective of a pay program, one of the objectives of a pay program needs to be to keep the organization in compliance with various state and federal laws and regulations.
Administrative Efficiency
Due to the limited financial resources in an organization, one of the objectives of a pay program should be to have a pay program that is easy to administer, flexible, and cost-effective.
Developing Rates of Pay for Jobs
The basis for most pay programs is a pay structure - a hierarchy of jobs with pay ranges and/or rates assigned. Pay structures are designed so that the greater the worth of a job (as determined by internal or external equity), the higher the pay grade and range. Developing a pay structure is a process with a series of steps:
- job analysis,
- job documentation,
- development of a job worth hierarchy,
- labor market data collection and analysis, and
- establishment of pay rates and/or ranges.
Job Analysis
This involves collecting and evaluating relevant information about jobs. Any data collected should clarify the nature of the work being performed (principal or essential tasks, duties, and responsibilities), the level of the work being performed, the extent and types of knowledge, skill, mental and physical effort and requirements, and responsibility required for the work being performed. There are five primary sources of data for the collection of job information: questionnaires, interviews, logs or diaries, direct observation, and work plans. All of these methods have advantages and disadvantages, and the organization must choose the method that will provide comprehensive data with administrative efficiency and cost-effectiveness.
Job Documentation
There needs to be a formalized way to document job content. In most organizations, a job description is the means used to accomplish this. Job documentation is used to evaluate job content, provide objective criteria for making pay comparisons, ensure that jobs are classified according to content as opposed to individual personalities, effectively communicate the job duties to both supervisors and employees, and help the organization defend itself against charges of discrimination. Who should write job descriptions? That will depend on the resources available to the organization, but they should always be reviewed by line management.
Development of a Job Worth Hierarchy
A job worth hierarchy is the result of job evaluation, the overall process of comparing jobs. There are 6 major methods of comparing jobs to develop the job worth hierarchy. The first three methods are "whole-job" evaluations and are non-quantitative in nature. These include ranking, classification, and slotting. The second three are "factor" evaluation and are quantitative in nature. These include point factor, factor comparison, and scored questionnaires.
Labor Market Data Collection and Analysis
Before an organization begins the process of collecting labor
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672All organizations have a compensation plan, whether written or unwritten, formal or informal. For some organizations, the purpose of that plan may be merely to meet compliance requirements. For other organizations, the goal of the compensation plan may be to attract qualified employees, retain those employees, and motivate employees to direct their efforts towards achieving the goals of the organization. Regardless of the goal, size, and complexity of a compensation plan, there are generally many easily-identified elements to any compensation plan. This commentary reviews these elements, poses questions management can use to determine the stance it would like to take regarding compensation, and offers some advice and recommendations on implementing these ideas. The topics that will be covered are the development of a compensation philosophy, objectives of a base pay program, developing rates of pay for jobs, pay rates and increases, performance appraisal, maintaining and auditing a compensation plan.
Development of a Compensation Philosophy
Before an organization actually develops a compensation plan, there are several questions that need to be answered. Taking the time to consider and answer these questions will make both the process of developing and administering a compensation plan much easier and will result in the development of a compensation plan that more closely matches the organization's goals and objectives.
- What is the goal of the organization's compensation system? In addition to attracting and retaining qualified employees, is there an intent to reward employees for good performance, motivate good performance, and/or create or reinforce a particular type of organizational climate?
- What is the communication policy? How is the organization going to communicate the compensation plan to employees once it has been developed? Is the organization prepared to evaluate the effectiveness of any such communication? If so, how?
- How will decisions regarding pay be made? Who will be involved in these decisions? What decision guidelines will need to be developed?
- What is the organization's desired market position relative to pay? Will the organization choose to pay market rates, above market, or below market? How does the desired market position fit with other strategic goals? Are there any competitive factors involved that will determine the pay strategy?
- What is the desired mix between benefits and cash? Since benefits are an important form of compensation, how does an organization use them to maximize the effectiveness of the compensation plan?
- What does the organization pay for? Does it pay for performance or seniority or some combination of the two?
- What is the role of performance appraisal in the organization? How important is performance appraisal and why?
- How will the organization manage change to the compensation plan once it has been developed? What systems need to be in place to implement any changes including deciding when change is necessary and who will make these decisions?
- How does the compensation philosophy and plan fit with the rest of the organization? How can the compensation practices reinforce other overall management philosophies and objectives?
Objectives of a Base Pay Program
Before delving into the details of how actually to pay people, there are many factors that impact a base pay program that an organization must consider. In general, every organization's base pay program has certain objectives. The principal ones are as follows:
- internal equity,
- external equity (or competitiveness),
- individual equity,
- process equity,
- performance or productivity incentives,
- maximum use of financial resources,
- compliance with laws and regulations, and
- administrative efficiency.
As will be shown in the following, all of these objectives must be balanced in the development of a sound base pay program. As these points are being reviewed, management should ask the following questions:
- Is this point important to this organization? If so, how important?
- What are the implications of this point to the current or desired practices?
Internal Equity
Internal equity deals with the perceived worth of a job relative to other jobs in the organization. All employees compare their jobs to other jobs within the organization. Generally, they consider skill, effort, responsibility, and working conditions in this comparison to determine the value of their jobs relative to other jobs. Likewise, management must often determine the "worth" or "value" of one job in relation to other jobs for the purpose of pay programs. Maintaining appropriate pay relative to value or worth is achieving internal equity.
External Equity
External equity deals with the issue of market rates for jobs. An employer's goal should be to pay what is necessary to attract, retain, and motivate a sufficient number of qualified employees. This requires a base pay program that pays competitively. Among others, internal data such as turnover rates and exit interviews can be helpful in determining the competitiveness of pay rates.
Employees also compare their jobs and pay to the jobs and pay in other organizations. Generally, employees consider much more than base pay in determining external equity. Depending on the individual employee, serious consideration may be given to employee benefits, job security, physical work environment, commuting distance, opportunity for advancement, and the employee relations practices of the employer in determining external equity issues. In the Pacific Northwest, a frequent consideration is also lifestyle and quality of life.
An important issue to employees in determining external equity is the transferability of their skills. If an employee's skills are valued more highly in a different type of job or industry in the area, the employee may believe that they are being treated inequitably.
Note: An organization may choose to place the primary emphasis of its base pay program on internal equity, external equity, or a blend of the two. There are important ramifications to this decision that should "fit" with other organizational structure issues and overall management objectives.
Individual Equity
Individual equity deals with how individuals perceive how they are being paid relative to other individuals within the organization and perhaps within the same position. This focus of individual equity is on the merits of the person filling a job, as opposed to the job itself. In simple terms, employees want to feel that the rewards they receive for how they do their work are comparable to the rewards received by others for the same amount of effort or output, all other factors being equal. How merit rewards or increases are given strongly impacts perceptions of individual equity.
Process Equity
How employees perceive the fairness or equity in the administration of the compensation system is process equity. Process equity, in the perceptions of employees, is strongly influenced by the openness of the system, communication of the system to employees, participation in the design or administration of the system, and a grievance appeal procedure.
Performance Incentives
A significant element of a base pay program is to encourage higher or increased levels of employee performance. Pay systems need to be designed to improve organizational performance.
Maximum Use of Financial Resources
Since an organization does not have unlimited financial resources, the base pay program needs to be designed to maximize the value to the organization with a minimum use of these limited resources. In order to accomplish this, pay programs have a variety of tools such as pay range maximums, pay increase budgets, authorization procedures, compensation committees, or various internal auditing procedures available to help accomplish this objective.
Compliance with Laws and Regulations
While not the primary objective of a pay program, one of the objectives of a pay program needs to be to keep the organization in compliance with various state and federal laws and regulations.
Administrative Efficiency
Due to the limited financial resources in an organization, one of the objectives of a pay program should be to have a pay program that is easy to administer, flexible, and cost-effective.
Developing Rates of Pay for Jobs
The basis for most pay programs is a pay structure - a hierarchy of jobs with pay ranges and/or rates assigned. Pay structures are designed so that the greater the worth of a job (as determined by internal or external equity), the higher the pay grade and range. Developing a pay structure is a process with a series of steps:
- job analysis,
- job documentation,
- development of a job worth hierarchy,
- labor market data collection and analysis, and
- establishment of pay rates and/or ranges.
Job Analysis
This involves collecting and evaluating relevant information about jobs. Any data collected should clarify the nature of the work being performed (principal or essential tasks, duties, and responsibilities), the level of the work being performed, the extent and types of knowledge, skill, mental and physical effort and requirements, and responsibility required for the work being performed. There are five primary sources of data for the collection of job information: questionnaires, interviews, logs or diaries, direct observation, and work plans. All of these methods have advantages and disadvantages, and the organization must choose the method that will provide comprehensive data with administrative efficiency and cost-effectiveness.
Job Documentation
There needs to be a formalized way to document job content. In most organizations, a job description is the means used to accomplish this. Job documentation is used to evaluate job content, provide objective criteria for making pay comparisons, ensure that jobs are classified according to content as opposed to individual personalities, effectively communicate the job duties to both supervisors and employees, and help the organization defend itself against charges of discrimination. Who should write job descriptions? That will depend on the resources available to the organization, but they should always be reviewed by line management.
Development of a Job Worth Hierarchy
A job worth hierarchy is the result of job evaluation, the overall process of comparing jobs. There are 6 major methods of comparing jobs to develop the job worth hierarchy. The first three methods are "whole-job" evaluations and are non-quantitative in nature. These include ranking, classification, and slotting. The second three are "factor" evaluation and are quantitative in nature. These include point factor, factor comparison, and scored questionnaires.
Labor Market Data Collection and Analysis
Before an organization begins the process of collecting labor
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