How to structure employee compensation
Pay structures define employee compensation for different jobs or groups of jobs. They involve setting salary ranges and pay grades based on market data and job roles. Here’s our guide on why and how to set up a pay structure:
Why you need structured employee compensation
Pay structures (also know as salary structures or compensation structures) help companies offer equitable, competitive salaries and map out employees’ path to growth and higher pay. They enable companies to attract and retain talented people.
Compensation structures create a fairer and more predictable process for determining an individual’s compensation. The alternative to setting up formal pay structures is to determine salaries based on:
- Candidates’ salary history. This may perpetuate the gender pay gap and, as a result, create systemic pay disparities that prompt discrimination lawsuits. Plus, the practice of asking for salary history has been banned in several U.S. states (most recently in California.)
- Arbitrary figures. Competitive compensation packages play an important part in persuading candidates to accept job offers. Also, companies may end up paying managers the same salary as what their direct reports should earn, or even paying employees more than the maximum salary for their job.
Both methods would confuse managers and team members regarding pay levels and career development and raise suspicions of discrimination. To avoid these issues, it’s a good idea to set up a pay structure, especially once companies reach 200-250 employees.
How to set up a pay structure
Conduct job analysis and job evaluation
Internal job titles and job descriptions may not always be aligned with the market (e.g. a director in your company may actually be considered a mid-level manager in the market.) Knowing what each job entails and its value to your company helps you benchmark salaries more effectively. As a first step, conduct a:
- Job analysis. If you don’t already have job descriptions in place, start by outlining job duties, requirements and qualifications for each position. Talk with your department heads about positions within their departments and look at common job descriptions in your industry.
- Job evaluation. Determine the relative value of positions in your company with the help of senior leaders (e.g. VP of HR, CFO.) This means comparing each role with others according to important criteria like necessary knowledge and skills, effort required, level of responsibility and impact on revenue. In this stage, it’s best to bring in an external consultant (e.g. an Organizational Expert) to help you avoid biased decisions. An external observer will ensure you distinguish jobs from employees.
Determine the form of your employee compensation structure
There are two ways companies can create their compensation plans for base salary:
- Benchmarking (or market pricing) where each job is assigned an individual salary range based on market trends.
- Pay grades, where jobs are grouped and salary ranges apply to each group.
Many companies use both methods to determine their compensation structures, doing market pricing first to aid the process of creating pay grades. Here are both approaches with examples and how you can combine them:
Benchmarking helps make your salaries more competitive. For example, paying higher salaries than the market can result in hiring the best candidates and retaining your best employees.
This approach revolves around market salary research, usually according to geography and industry. Websites like Glassdoor, PayScale (employee-reported data) and Salary.com (HR-reported data) are good places to look for this information. These websites provide insight on the minimum, midpoint and maximum salary for each role that you can use to create your own ranges. Before you collect the data, compare the job description provided by the website to the one from your job analysis to ensure they refer to the same role.
If you want more detailed data reported by employers, consider surveys like the Radford Global Technology Survey for the technology sector. There are also similar reports by governmental institutions. For example, the U.S. Bureau of Labor Statistics (BLS) reports average salaries per hundreds of jobs. O*NET OnLine reports data from BLS along with detailed job descriptions.
This research helps you create salary ranges for each individual job. Here are two examples:
Pay grades are groups of jobs (often sorted by business function) that have the same or similar internal value as defined by your job evaluation process. For example, customer support specialists and customer support technicians may belong in the same grade if they demand the same skills and education and have the same level of responsibility. In this case, the salaries of every customer support role in the same grade would fall between the same minimum, midpoint and maximum range.
There are two ways to set pay grades:
- Using benchmarking to set salaries. For example, you could use market data to determine a pay grade’s salary range. If a pay grade includes three different positions (e.g. administrative officer, office manager and personal assistant), you can average the salary midpoints of these three positions to find the midpoint in your pay grade’s range.
- Creating grades according to existing salaries. Companies can look into their existing organizational levels and salaries and group jobs accordingly. For example, if you have various roles with similar value on the same hierarchical level, put them in one grade. The average of those salaries can be the midpoint salary of the grade. The minimum and maximum is largely at your company’s discretion, but could be from +/- 5% to +/- 20% of the midpoint. The midpoints of each grade can also be determined by increasing the midpoint of the previous grade by a percentage (the mid-point differential.) For example, if the midpoint of Grade 1 is $40,000 and the established mid-point differential is 15%, then the midpoint of Grade 2 can be $40,000*15% + $40,000 = $46,000.
Here’s a scenario where pay grades are created based on existing salaries. Imagine your company has the following HR roles:
- HR Assistant with salary of $30,000
- HR Manager with salary of $60,000
- HR Generalist with salary of $40,000
- Recruiter with salary of $50,000
Through your job evaluation process, you may decide there are three grades:
- Grade 1 includes HR Assistant and midpoint is $30,000.
- Grade 2 includes HR Generalist and Recruiter and midpoint is $45,000 (average salary of these two positions.)
- Grade 3 includes HR Manager and midpoint is $60,000.
Grades might often overlap. This means that the maximum point of one grade could be higher than the minimum of the next grade (or even the midpoint.) Here’s an example based on the previous pay grades about HR roles:
The number of grades depends on the number of positions, your company’s size and its hierarchical levels. Few grades with large ranges often result from broadbanding – a process that reduces hierarchical levels and pay grades and leaves a lot of room for salary increases. Broadbanding has drawbacks though, so consider how useful it is to your company.
After you have set your pay grades, assign a grade to every new position that’s created.
Also, you can divide each grade and assign salary ranges within that grade. Large companies and governmental institutions often divide a grade in “steps” according to criteria like experience and performance. For example, assuming the salary range of Grade 3 is $52,000 to $66,000, here are three steps of experience and skill:
- Entry-level from $52,000 to $57,000.
- Mid-level from $57,000 to $63,000.
- Experienced from $63,000 to $66,000.
These steps indicate how employees can receive salary increases. When someone in Grade 3 is given a promotion, they move to the next pay grade and have greater room for pay increases.
Plan to update pay structures
As market conditions change and unemployment rates fluctuate, companies need to update salary ranges. Revise pay structures every 12 to 18 months and ask questions like:
- Are our salaries competitive?
- Are there new positions that need to be placed within our pay structure?
- Do our employees have room to receive raises as performance rewards?
- Are our salary ranges aligned with the proper organizational levels?
- Is our pay structure synced with our succession plans and career development plans?
- Do our employees perceive our pay structure and compensation plans as fair?
Also, after you readjust your salary ranges, use your pay grades’ midpoints to calculate compa-ratios for your employees. This will help you determine the competitiveness of their salaries:
- If you discover some employees are overpaid, you may decide to freeze their base salary until it must be adjusted due to market changes.
- If some employees are being underpaid, plan to raise their salary in the next performance review cycles so that you bring them up to the correct step in their pay grade. If performance review periods are too far away, consider giving those employees an immediate raise (if you have the budget and senior management approval) to prevent loss of morale.
Managers should understand your compensation philosophy and how they can administer pay raises and promotions. Also, those who serve as hiring managers should know the value of new positions. Schedule 1:1 or group meetings with managers to discuss:
- How your company’s benchmarking and/or pay grades work.
- The process your company uses to evaluate job roles.
- Why your company chose this particular pay structure.
- How managers can administer pay raises according to experience levels.
- Whether hiring managers could diverge from established salary ranges when hiring new team members and by how much.
Arrange to discuss these topics after revising your pay structure or when compensation plans and payroll budgets change. Ensure your managers understand how they should act when hiring or promoting employees.
Frequently asked questions
What are four common pay structures?
The Four Major Types of Direct Compensation: Hourly, Salary, Commission, Bonuses. When asking about compensation, most people want to know about direct compensation, particularly base pay and variable pay.
What is the pay structure of an employee?
Pay structures, also called salary structures, are organized levels, or grades, of employee salaries divided by job type. Pay structures typically incorporate salary ranges for each pay grade, which is bracketed by a minimum and maximum salary amount.
What is the purpose of a pay structure?
A pay structure creates a basis for pay decisions and allocation. Understanding where your employees fit against the pay structure – within, above, or below the band – informs your pay decisions and allows for effective allocation of pay budgets. If not always saving you money, it ensures you get the most value from it.