Why Geographic Differentials Don’t Work
For years compensation professionals have used geographic differentials to make decisions about what to pay jobs in locations where they may not have salary data. The theory stands that if you don’t have data for one location, you can use data from another location and adjust it based on the cost of labor in the two cities. While this may be a better option than making decisions without any data on salary by location – it’s not much better.
In my own experience as a manager of compensation, I was responsible for making compensation decisions in a city where there was no local data available. I was using major metro data for a location 90 miles away, and adjusting it down by 10% according to the cost of labor in the two cities. After doing this for a couple of years, a group of us got together to commission a customer survey. After the results were published, we realized that the actual difference in pay were 14-22% lower than the major metro area data. So, the 10% differential was not very accurate.
In our own research at PayScale, we’ve uncovered this happening over and over again. For example, did you know that a line cook in Minnesota makes more than a line cook in Manhattan (approx. $14 an hour)? How could this be? It costs a lot more to live and work in Manhattan. But, the real reason is that it comes down to the supply of labor willing to work for those wages. Many people move to New York with dreams of beginning a culinary career. So, there are a lot of people who will work for the lower wage.
Another example is to look at the differences in wages for Software Engineers for various cities and compare that with the cost of living for the same cities.
|Metropolitan Areas||Median Pay for a Software Engineer with 0-5 Years of Experience||Cost of
(National = 100)
|Louisville, Kentucky / Indiana Metropolitan Area||$51,900||87.6|
|Houston-Baytown-Sugar Land, Texas Metropolitan Area||$60,300||91.9|
|Detroit-Livonia-Dearborn, Michigan Metropolitan Area||$54,900||98.2|
|Phoenix-Mesa-Scottsdale, Arizona Metropolitan Area||$58,500||99.6|
|Salt Lake City, Utah Metropolitan Area||$63,500||100.6|
|Seattle-Bellevue-Everett, Washington Metropolitan Area||$73,800||120.2|
|San Jose-Sunnyvale-Santa Clara, California Metropolitan Area||$85,800||143.5|
|New York-Wayne-White Plains, New York / New Jersey Metropolitan Area||$75,300||177.7|
1. The Median Pay reported is the Median Total Cash Compensation for Software Engineers with 5 or less years of experience (median of 2.5).
2. The metropolitan areas are defined by the Office of Management and Budget
3. The Cost of Living (COL) Index is provided by The Council for Community and Economic Research. It is important to note the index reflects cost differentials for professionals and executive households in the top income quintile.
4. The higher paying metros are typically the ones with the higher cost of living.
5. Two Cities stand out as having pay higher than their relative COL:
(a) Houston's predominant industry being Oil & Gas Exploration, which is a high paying industry.
(b) San Jose is the key city in Silicon Valley, which is a top site for large, high paying tech companies (e.g. Google, Facebook, Cisco, Intel, etc.)
As you’ll see there is a lot more variability in the cost of living as opposed to wages. This goes to show that wages are influenced by the cost of living in various cities – but not as dramatically as you might expect. So using information that is only based on cost of living or cost of labor may not be the best way to price a job using data from another city.
So, what other option do you have? Find resources that can provide accurate market data for locations where your jobs are located. Doing anything different means that you may be over-pricing or under-pricing jobs.
Director of Professional Services, CCP
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