Typically, when contractors consider improving their organization’s compensation plans, they focus on incentive compensation. Incentive plans are an important aspect of a firm’s compensation offering and often represent a large financial investment on the part of the company.

In many cases, bonus plans do not encompass the entire employee population and are not the largest compensation expense for the company. That honor lies with base pay. Almost every employee has a base salary and companies are at risk for losing employees if base pay levels fall below those of their competitors.

It is true that, unlike incentive pay plans, companies do not typically change base pay rates across the board to reflect company performance. However, companies can adjust base pay rates and pay practices over time to support the organization’s mission. Regardless of the current state of base pay at a company, careful planning and the appropriate actions can move base pay to the desired state. Conversely, just letting base pay decisions “happen” can result in pay levels that are out of line with the market and result in legal issues due to internal inequities.

The most common question asked regarding base pay surrounds base pay structures. A base pay structure is simply an administrative tool used for ensuring that pay levels, opportunities and administration are externally competitive, internally fair and cost effective.Base pay structures typically group like-positions based on value (both internal and external) and assign pay ranges for these groupings. Base pay structures range from narrow grades to broad bands. The organization’s size, strategy, culture and administrative resources typically determine its base pay structure, as well as the type of pay structure. The table in Exhibit 1 shows the most common structure types. Of the three, grades are by far the most common. 

Exhibit 1

Grade Structure

In a grade structure, jobs are assigned to grades based on either their value to the organization or value in the market. The simplest way to assign jobs to a structure is to rank all jobs in the organization. This ranking, with the highest valued job at the top, is called a job hierarchy. When considering the value of a job, companies must be careful to consider the entire range of functions and not focus on a single aspect. Additionally, take care to base the value attributed to a position on the job itself and not on the incumbent(s). For instance, XYZ Contracting has an up-and-comer in the project manager role and is planning on promoting her to senior project manager soon. XYZ should be careful not to rank the project manager job higher than others simply due to that particular incumbent.

Jobs are then grouped based on value and ranges are assigned. Typically, pay ranges have at least three control points: minimum, midpoint and maximum. Range spreads are commonly smaller for the lowest grades and increase in size up through the executive ranks. This difference in spread reflects the developmental time required for jobs in the grade. For instance, receptionists need little time to learn the processes; thus, a new employee can perform as well as an experienced incumbent in little time. On the other hand, a construction executive takes years to develop; therefore, the range spreads are wider to accommodate this learning curve. The midpoint of a grade represents the pay for a fully functional employee and is the company’s worth for all jobs in that grade. Companies may also have hiring ranges or points that dictate new hire/transfer/promotion rate of pay.

        
Exhibit 2 – Grade Structure Example 

Exhibit 2 is a simple illustration that shows grades one through four. In this example, the grade with the lowest midpoint is grade one. Grade 3 has a minimum of $68,850, a midpoint of $81,000 and a maximum of $93,300. Structures will typically have 12 to 20 grades, with many companies having multiple pay structures (e.g., one for exempt and another for non-exempt positions.)  

Administering grade structures has the greatest impact on shaping manager and employee response to them. For the company that favors discretion, managers may be allowed to pay employees below the minimums and above the maximums. This flexibility would allow for favorable treatment of certain employees, which might please the target of the treatment but displease others in the same grade. In another company, rules might be king, thus managers could not deviate from the structure. An unfortunate outcome from this scenario would occur if high-performing employees with salaries over the maximums were not allowed to receive merit increases. Employees and managers alike might feel the system is too restrictive to accommodate unique situations as they arise. The most effective base structures are those designed to address day-in, day-out occurrences, with flexibility built-in to address one-off events. Contractors must consider their cultures when designing a base pay structure. 

Why implement a grade structure? Grades provide control around base pay levels. They reduce the occurrence of pay creep, which is the phenomena where pay for one employee in a job is increased, then pay for another is adjusted upward in response to the first, et cetera. The minimums and maximums can be very effective at keeping pay within the range. Grades are recommended for any company that wants to control payroll costs, ensure that employees in similar jobs are receiving similar pay and that jobs are paid competitively to the market. 

Salary Bands

Similar to grades, a banding structure simply has fewer grades with wider ranges. Bands shift the focus from the job to the employee’s knowledge, skills and abilities (KSAs) to perform the job. Because multiple jobs reside within each band, there is not necessarily a hard and fast minimum, midpoint and maximum for each job within the band (See Exhibit 3). In most instances, market data is emphasized when setting pay levels.  

Exhibit 3 – Salary Band Example

A common misperception is that bands require less administrative effort than grades. This is typically not the case. Depending on the organization’s level of trust with managers, band structures can require more administration than grade structures. If managers are able and willing to set pay levels to maintain internal equity across the structure, the administration of bands requires only that a competitive rate be set for each position. If an organization requires more control, then each job needs high and low control points, which results in a pay range for each position versus a range for each grade in the grade structure. For example, if XYC Contractors has 60 jobs in the banding structure, the company would have to maintain control points for each of the 60 jobs. 

Companies that adopt band structures typically do so to encourage employee movement in jobs in the band, similar to lateral moves in a grade structure. Typically, jobs are grouped in bands based on skill and knowledge requirements. For example, Band A would be entry level, Band B practitioner and Band C experienced practitioner. 

Market-based Structure

Market-based structures involve setting a range based on market rates for each job in the structure. This is done by tying the midpoint for the particular job to salary survey data (requiring that the company has resources for collecting and interpreting salary surveys for every job in that structure). Every job has its own range, which is both a major advantage and disadvantage over grade structures. In a grade structure, the midpoint of a range is based on a rate that approximates the job worth for all jobs in the range. In the market-based structure, all midpoints are set based solely on the market value for that position. The drawback of these types of structures is that they require a high level of administrative resources to maintain the midpoints and ranges for all jobs. Although these structures may be more difficult to administer, they ensure that turnover due to market competitiveness issues is minimal. This type of structure is most appropriate for companies in industries where there is strong competition for talent.  

Annual Base Pay Increases

A discussion of base pay structures would not be complete without touching on annual pay increases. The most common increase types are cost-of-living (COLA), promotional, equity, structure adjustment and merit. These can be divided into two groups, entitlement and pay-for-performance.   

Entitlement base pay increases are not based on employee performance and are consistent in amount from year-to-year. COLA, or general adjustments, are designed to offset the erosion of pay due to increases in the cost of living. These are typically granted annually and do not vary greatly in amount from year-to-year. Structure adjustment increases arise when pay ranges are adjusted up to reflect changes in the wage market.  

Pay-for-performance increases, on the other hand, are driven by an employee’s actions and/or performance. A true merit increase is one where the amount is determined primarily by the employee’s performance to goals, standards or competencies. To enable a true merit system, the organization must have clearly defined performance metrics for each employee and utilize a performance management process. Consistently tying merit increase amounts to performance ratings gives credibility to the performance management process and effectively drives employee performance.   

To help solidify the link of pay-to-performance, companies may develop a merit matrix. This matrix provides a range of increases commensurate with performance ratings. To ensure that pay remains competitive year-over-year, the increase amount recommendation for the average rating could be set at least to equal the cost-of-living adjustment amount. 

For example, in an effort to quantify the value of each rating, XYZ Contractors has developed a merit matrix. This matrix provides managers with guidelines for assigning merit increase amounts. 

Exhibit 4: Merit Matrix

Using the merit matrix in Exhibit 4, a manager who rates an employee as a strong “3” might award a 4% increase, whereas another manager might award a high-performing, recently promoted employee rated as a “4” with a 3% merit increase. In a third case, a long-tenured employee who is underperforming with a “2” rating might receive no increase for the year. The shock of not receiving an increase might be sufficient to cause the employee to improve his/her performance to expected levels. 

The key point here is that, although base pay is a fixed cost, companies can use base pay increases to drive employee behavior/performance by tying merit increase amounts to performance or goal attainment ratings. This is a good time for contractors without formal base pay structures and salary administration plans to consider the merits of adopting these tools. Questions to ask include: Is base pay competitive for ALL jobs across the company? Are we paying employees in like jobs like wages? Are managers making good decisions around pay?  Those who do have formal structures can take this time to evaluate the effectiveness of these tools.  Do they effectively balance the need for structure with flexibility to respond to unusual circumstance?  Is more communication needed?  Do the structures need to be adjusted?  

Do not neglect base pay by focusing on incentives. Yes, incentives are important. However, competitive base pay is a requirement for most employees, and a pay structure goes a long way to ensure that base pay is competitive across the organization. Additionally, having an effective base pay structure that compliments and supports the company’s culture and mission is the cornerstone of any organization’s overall compensation philosophy and strategy.

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