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A Crash Course in Key Compensation Metrics
While some of us may not be big fans of math and statistics, a crucial part of managing your organization’s compensation plan is understanding compensation metrics. This post will compare and contrast two of the key metrics that are frequently used in compensation today.
First is the immortal compa-ratio. Although its name is not very descriptive of its meaning, it is one of the most referenced compensation metrics there is. A compa-ratio measures the relationship between the salary of an employee or a position, and the midpoint of the pay range for that employee or position.
The formula to calculate a compa-ratios is as follows:
Compa-Ratio = the salary divided by the range’s midpoint
Therefore, if someone is earning the exact amount of the midpoint of their salary range, their comp-ratio will be 1.0 (or 100%). Anything less than 1.0 means they are earning less than midpoint and if the compa-ratio is more than 1.0 they are earning more than the midpoint. For example, let’s say the range for Bob’s position is $40,000 – $80,000 and the midpoint is $60,000. Bob’s current salary is $55,000. His compa-ratio would be 55,000 ÷ 60,000, which equals .92. This tells us that Bob is currently earning 92% of the midpoint of his salary range. If you have a lot of employees, sorting your compa-ratios in ascending or descending order can be a useful way to quickly see which of your employees is earning significantly less or more than the midpoint of their range.
It can also be useful to look at your compa-ratios at the group level. You can group your employees into any number of categories and compare their compa-ratios. For example, I find it a very useful exercise to group employees by performance rating and see if the company is really paying for performance the way they say they are. Other useful groupings could be by functional area or geographic location.
Using Salary Range Penetration
Range penetration is another important compensation metric to look at in conjunction with a compa-ratio. Rather than just being a comparison to one piece of data (the midpoint), range penetration looks at a salary in relation to the whole pay range.
Calculating Range Penetration
The salary range penetration formula is as follows:
Range penetration = (Salary – Range Minimum) ÷ (Range Maximum-Range Minimum)
Using Bob as an example again, his range penetration would be (55,000-40,000) ÷ (80,000-40,000), or approximately 38%. This means that Bob’s salary is 38% into his range. This could be useful in talking to Bob about where he stands in his range and how much more room there is for him to move up in pay.
A key difference here is that range penetration has nothing to do with the salary midpoint. Rather, what determines range penetration is how you’ve set your ranges and how wide they are. While range penetration can be useful on an individual basis, looking at where all of your employees fall within each of your ranges can also be a useful indicator that maybe your ranges are too wide or too narrow. In addition, range penetration can be useful if you use portions of the range as target levels for certain categories of employees, i.e. you want new hires to be in the first 25% of the range, and experts or consistent high performers to be in the top 25% of the range.
Focusing too heavily on one or the other of these two metrics can lead to some interesting and potentially unwanted thinking on the part of your employees. If you only focus on and talk about compa-ratio, you will be encouraging employee thinking to be “I need to be at the midpoint.” While this may be okay at times, it can be healthier for the organization if employees think about their ability to grow and move through a range vs. being fixated on one point. On the other hand, focusing too heavily on range penetration could encourage employees to think, “I need to get to the 100% mark.” Having employees focused on reaching the maximum of their range could set up unreasonable and impractical expectations.
As is the case with all analytics, decisions shouldn’t be based on metrics in a vacuum. Statistics do not tell the whole story. Rather, they should cause you to ask questions about your employees, your pay practices and your overall compensation philosophy. But understanding what exactly the metrics are and why they matter is a crucial first step.
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