Compensation management, sometimes referred to as reward management, remains one of the most challenging areas for HR practitioners. Perhaps it is the absolute need for precision, equity, and return on investment involved in it, or the difficulty in arriving at a process that can facilitate their achievement.
Precise Compensation Calibration is one process that will allow an organization to gain an advantage in the market place. This paper will demonstrate how Range Ratio is the most effective market analysis tool for compensation.
Technology has made vast amounts of data available through easy–to-obtain and easy-to-utilize compensation surveys that are quickly and efficiently disseminated to a global audience. Range Ratio uses this increased amount of data to structure and administer pay programs.
A properly calibrated compensation program is easier to communicate to employees and managers, resulting in greater transparency, consistency, and effectiveness.
Looking Beyond the Range Midpoint
The importance of the range midpoint is often overstated. It is not “the market,” as in the point below which employees are paid “below market” or above which employees are paid “above market.” Market is the entire pay range—all employee pay within the range is “in the market” according to the company’s definition of market which is detailed in the company’s compensation philosophy. Without a compensation philosophy, there will be confusion among leaders about what the organization is striving for with respect to pay.
The range midpoint is just a mathematical Mean with no intrinsic value. It is simply a point halfway between the bottom and the top of the pay range. Shoving employees with lower-level qualifications toward a midpoint is senseless and results in money ill spent. It is better for both company and employee if the employee’s pay increases as the employee’s demonstrated qualifications increase and as the employee’s performance enhances. Employees who continue to perform have the entire range of compensation available to them. There is no value in throwing employee pay toward the midpoint nor is there value in retarding employee pay above the midpoint. At the same time, it is important to recognize the efforts of talented employees who are able to show valued performance or improvements in performance. Or what happens if the company is not able to find the right kind of talent? A good compensation policy provides for all contingencies.
The Compensation Philosophy can be extremely potent given the sophistication of today’s pay surveys. We no longer need to base pay structures on one data point by adopting the market median as our pay range midpoint. We can state the pay range minimum as a specific point in the market data, 10th percentile, 20th, or 25th.
Selecting a percentile at the lower end of the market data should be done with an understanding of the qualifications of employees whose pay is at the lower end. There is a point below which employees have less than minimum qualifications and minimum performance.
We can also state the pay range maximum as another specific point in the market data, 75th percentile, 80th, 85th or 90th. Telling your top performers that their pay opportunity is up to the 90th percentile, for example, can provide a reason for such employees to invest a significant portion of their careers at your company.
Stating the pay opportunities for employees with outstanding qualifications with a pay range maximum targeted at a specific percentile in the market is more reasoned than arbitrarily calculating the pay range maximum as a function of the midpoint. When analyzing higher market percentiles as a function of lower market percentiles, we seldom see the 150% spread that has been the standard method of calculation for decades.
It is not only possible but obligatory that a company’s compensation philosophy state the range minimum and maximum as explicitly defined points in the market.
Compensation analysts have historically used compa-ratio which denotes where an employee’s pay is vis-à-vis the range midpoint as a primary analysis tool. Compa-ratio—short for “comparative ratio”—is derived by dividing an employee’s pay by the midpoint of the pay range in which the employee’s pay is managed. As illustrated in the following table, an employee paid at exactly the range midpoint has a compa-ratio of 100%. Employees paid below or above the midpoint have a compa-ratio below or above 100%, respectively.
|Employee Pay||Range Midpoint||Compa Ratio|
Compa-ratio cannot tell when employee pay is outside the minimum or maximum of the pay range. That requires calculating the compa-ratios for the minimum and maximum, and then comparing the employee pay compa-ratio to the minimum and maximum compa-ratio.
While compa-ratio can compare one employee’s pay to other employees, it is more accurate just to compare employees’ actual pay. Aggregate compa-ratios can also be used for larger datasets, such as finding the average compa-ratio for all employees in a company to determine the average pay compared to the average range midpoint.
The extent of compa-ratio’s usefulness is viewing pay vis-à-vis one data element, the midpoint.
A Better Solution
A judicious compensation philosophy requires an analysis tool that goes well beyond compa-ratio. Range Ratio tells precisely where an employee is paid in the pay range and within the market. Range Ratio is calculated by subtracting the range minimum from the employee’s pay and then dividing the result by the range maximum minus the range minimum:
(employee pay) – (range minimum)
(range maximum) – (range minimum)
The following table illustrates the clarity offered by using Range Ratio (RR).
- Range Ratio of 0% means that the employee is paid at the minimum of the range.
- Range Ratio of 50% means that the employee is paid at the midpoint of the range.
- Range Ratio of 100% means that the employee is paid at the maximum of the range.
- Negative Range Ratio indicates employee is paid below the range minimum.
- Range Ratio above 100% indicates employee is paid above the range maximum.
|Employee Pay||Range Minimum||Range Maximum||Range Ratio|
Changing the Language
Because the pay range is based on the market, Range Ratio corresponds to a position within the market. An employee with 25% Range Ratio is paid lower in the range and correspondingly, lower in the market, while an employee with 75% Range Ratio is paid higher in the pay range and the market. “Low” and “high” are absolute terms, so using the more relative “lower” and “higher” more precisely communicates pay in relation to the range and the market. In other words, saying an employee’s pay is “low” sounds like something is wrong and must be fixed, but saying an employee’s pay is “lower in the range” associates the pay with qualifications and performance. It can also facilitate an analysis of why exactly is it low so that corrective action can be suggested. For instance, employee A and B share a designation but have a difference in their pay. HR practitioners may be able to assess and report that the difference is because of a lack of qualifications or performance.
An employee whose qualifications meet only the minimum requirements of the job is positioned lower in the market, and therefore, should be paid lower in the range. An experienced, higher performing employee should be paid higher in the range because their skillset has positioned them higher in the market. Changing the language helps both the company and the employee better understand whether or not the employee is paid appropriately. This understanding can lead to creating any necessary corrective action.
Using Range Ratio Effectively
To fully utilize your Range Ratio calibrations, a company should analyze the results to know why an employee is at a particular point in the range and if it is the appropriate point for that employee.
The variables that affect pay and market position include:
These qualifications and elements of performance (Q/P) may also include other factors deemed relevant by the company’s compensation philosophy.
Range Ratio provides an immediate view of those employees who are below the minimum and above the maximum. If an employee’s pay is below the minimum (negative Range Ratio), the following questions must be asked:
- Is the employee classified correctly?
- Does the employee meet the Q/P for this level?
If the answer to both is yes, the employee’s pay should be increased to at least the minimum level. (This can be done immediately, planned for at the next scheduled pay review, or addressed with step increases. Of course, a company’s budget is always a consideration.)
If an employee’s pay is above the maximum (more than 100% Range Ratio), the following questions must be asked:
- Is the employee classified correctly?
- Does the employee meet the Q/P for a higher level?
If the employee is correctly classified, their pay can be reduced to the maximum or maintained until the range “catches up” with future range updates. (Though generally accepted, “Red Circle” must be warranted, and used only as an exception.)
If the employee meets the Q/P of a higher-level position, that employee should be reclassified to the higher level and the pay should be viewed with respect to the new range
The Many Uses of Range Ratio
A well-calibrated set of Range Ratios can scale far beyond individual employee pay rates. For example, the average of all employees’ Range Ratio is equivalent to the company’s Range Ratio, and therefore, shows the company’s position in the market. But remember that a low Range Ratio does not necessarily mean the company is underpaying its employees. For example, a 40% average Range Ratio does not mean the company should give pay increases to bring the average Range Ratio up to 50%. Just as with an individual employee, the company’s Range Ratio must be viewed in light of its Q/P. If the average Q/P level is low, then Range Ratio will also be correspondingly low.
Range Ratio is a good dashboard metric that should cause us to look for answers rather than jump to conclusions. For example, it’s useful to watch the average Range Ratio history. If a company’s annual Range Ratio average over three years went from 40% in year 1, to 42% in year 2, and then to 35% in year 3, the company must account for the sudden drop.
- Was the pay increase budget inadequate?
- Was year 3 accompanied by increased turnover?
- Has the market moved exceptionally?
- Did they lose highly paid employees?
The answers to these questions will provide a logical explanation for any action the company takes to ensure that the workforce is appropriately paid vis-à-vis the market and with respect to qualifications and performance.
Geographic Pay Analysis
The following chart shows the position of Program Manager in three locations in which the company does business. The job is the same in all locations. The company has created pay ranges based on the market for each location in order to recognize the difference in the cost of labor by market.
The first two evident items are:
- Robin Banks is paid below the minimum of the pay range and
- Annie Body is paid above the maximum of the pay range.
As stated earlier in the article, the classification, qualifications, and performance of these employees should be reviewed to determine if any pay action is necessary.
As can be seen from any employee pay report, the average pay in Boston is higher than the average in the other locations.
This seems reasonable given that the cost of labor in Boston is higher. The higher pay range acknowledges this. What is not noticeable from a standard pay report is that Boston Program Managers are paid lower in the market than the other locations.
|Location||Average Range Ratio|
Again, we cannot draw a conclusion based on this one fact. We need to ask questions that will explain why this is the way it should be or if we need to take some action to correct an inequitable situation.
What is the answer to the following questions for each location?
- What is the average experience?
- What is the average seniority?
- What is the average education level?
- What is the average performance rating?
- What is the average competency rating?
There may be other factors demonstrating qualifications and performance that the company may want to take into consideration. The key is to select objective and quantifiable factors that are job related and can be compared.
This process is much easier with a well-developed HRIS and an effective employee performance management system. Yes, employees and managers alike hate performance review and performance appraisals. But when performance is a determinant of pay, nothing is more effective, not to mention more legally and ethically defensible, than a performance management system that sets performance expectations, provides continuous coaching to ensure employee success, and recognizes employee results in a fair and objective manner. Perfecting Employee Performance means providing every opportunity for employees to be successful thereby making the companies they work for successful.
All qualifications and performance ratings being equal, it is reasonable to expect Range Ratios to be equal. In order to bring that about the company may allocate a larger portion of the upcoming increase budget to the locations with lower Range Ratios. In the above case study for Program Managers, that would mean giving more to Boston and Chicago and less to Austin. The following chart demonstrates an option for directing more funds to the lower locations.
Without taking into consideration any pay range update, the change in Range Ratio is more dramatic for Boston. The relationship of the locations’ Range Ratio is in the same order (Austin, Chicago, Boston) but the difference is lessened. Of course if the pay increase budget were to be larger more changes would be possible.
Range Ratio is an additional statistic that can be added to the numerous data elements used to analyze pay equity for Executive Order 11246 compliance, gender equity analyses or other pay bias investigation. In so doing, geographic pay differentials in cost of labor can be reasoned.
The following data can be used to conduct a statistical analysis of pay.
|Date in job.||Pay grade.|
|Date in pre-promotion job.||Performance rating.|
|Date of birth.||Post-promotion department.|
|Date of hire.||Post-promotion exempt/nonexempt|
|Date of most recent pre-promotion performance evaluation.||Post-promotion full time/part time|
|Date of performance evaluation.||Post-promotion job code.|
|Department.||Post-promotion job group, EEO category, etc.|
|Educational level (e.g., high school, A.A.S., B.A., M.A., Ph.D.).||Post-promotion job title.|
|Effective date of merit increase.||Post-promotion pay grade.|
|Effective date or promotion.||Pre-promotion department.|
|Employee ID.||Pre-promotion exempt/nonexempt.|
|Exempt/nonexempt status.||Pre-promotion full time/part time.|
|Full time/part time.||Pre-promotion job code.|
|Gender.||Pre-promotion job group, EEO category, etc.|
|Job code.||Pre-promotion job title.|
|Job group, EEO category, etc.||Pre-promotion pay grade.|
|Job title.||Promotion increase amount ($).|
|Merit increase amount ($).||Promotion increase percentage.|
|Merit increase percentage.||Race/ethnicity.|
|Most recent pre-promotion performance rating||Range Ratio.|
|Original date or hire.||Starting pay grade.|
|Pay basis (e.g., per hour, year).||Starting pay rate.|
A well-calibrated compensation program begins with a solid Compensation Philosophy. Range Ratio is an exact tool that will improve compensation analysis, make it easier for your company to communicate with management and employees about pay rates, and will endow your organization with solid guidelines to follow in the future. Make the change today to Calibrate Compensation using Range Ratio and discover the substantial benefits of consistent, precise compensation programs in today’s competitive environment.