Wow! Can you believe it that we’re half way through our 4-Part Comp Glossary bringing you closer to ‘comp’lete mastery of the compensation language?! In part 3, we bring to you: Pay Structures.
1) PAY RANGES, PAY GRADES, and PAY BANDS
Definition: A pay range is the upper and lower limits of compensation, typically including a minimum, midpoint, and maximum. A pay grade is an identifier of a range and multiple jobs can be grouped into the same grade. A pay band is the broadest grouping and often includes several grades and ranges with a spread of 100% or more between the minimum value in the lowest range to the maximum value in the highest range.
Why it matters: A pay range is really the starting point for any pay structure – it identifies what spread of pay can apply to a given job. Some companies will build out a range for every job, referencing the market value for each job and building a range around that market value. This is a good approach if your company has fewer than 20 positions. Any more than that and administering and maintaining your ranges can be a bit of a challenge. Not to mention that if you have more than 20 jobs, you will probably start seeing some patterns in your ranges (several jobs having roughly the same range of pay). At that point, a good option to ease up on administration demands as well as allow for more flexibility is the creation of grades and ranges. Jobs with similar internal and market value are assigned the same range of pay and in the same grade. Using this method means jobs with no market value can be placed in the structure, grouped with jobs that have a similar internal value. Some organizations prefer to use broad pay bands, where multiple grades and ranges are grouped together in a pay band. While this practice was common in the 80s when there was budget to allow for large wage growth in a single band, it is a less common practice today.
2) RANGE MIDPOINT
Definition: The exact middle of the range, equidistant to the range minimum and range maximum, and aligned to the market value for the job.
Why it matters: The midpoint of your range is probably one of the more important details in your compensation plan. The range minimum and range maximum are built around the midpoint. If you are building pay ranges for your jobs, then your range midpoint should be the same as the market value for your job at your target percentile. In a grade and range structure, all jobs of a similar market value are assigned to a grade with a range midpoint that is closest to the average market value. The midpoint is also considered the proficiency point for the job – employees should be hired in at the range minimum and as they gain proficiency, their pay should approach the midpoint. The midpoint should be evaluated annually and is the point in your ranges that you would adjust to keep your structure competitive with your pay strategy.
3) RANGE WIDTH (OR SPREAD)
Definition: The distance between the minimum and the maximum salary values in a range.
Why it matters: The range width is built around the range midpoint and is used to ensure your structure is mathematically sound (and therefore legally defensible). The width of a pay range reflects the extent of salary opportunity for the jobs in the range. Wider ranges are usually for higher level jobs where there is a greater need to differentiate how incumbents in that range are paid. Narrower ranges are more common for jobs where there is not a lot of variance in how the market pays that job and there is less need to differentiate between how incumbents in a single job are paid. While there is no hard and fast rule on what range spreads should be, it is common to use 30-40% for hourly administrative or production positions, 40-60% for entry to midlevel professional or managerial positions, and 60-70% for executive positions.
Definition: How an employee pay rate compares to the midpoint of their range. Calculated as Pay Rate ÷ Range Midpoint.
Why it matters: The compa (or comparative) ratio is often used to evaluate how closely a company is following its compensation plan. While there are often several exceptions, companies usually strive to have a majority of their employees paid within close proximity to the midpoint. Reviewing your compa-ratios can help you assess if you are in fact doing so, and/or if some employees are too high or too low in their range. It is not possible to know your compa-ratio without first knowing your range midpoint. A ratio of 1.00 means the employee is paid at midpoint. Ratios above 1.00 mean the employee is paid above midpoint – so a ratio of 1.10 means the employee’s pay is 10% above the range midpoint. Ratios below 1.00 mean the employee is paid below midpoint – a ratio of .80 means the employee’s pay is 20% below the range midpoint.
5) RANGE PENETRATION
Definition: An individual’s pay compared to the complete pay range, or how far into a pay range an employee’s pay has progressed. Calculated as (Pay Rate – Range Minimum) ÷ (Range Maximum – Range Minimum). Also known as position-in-range.
Why it matters: Range penetration is another way of evaluating how well the company is adhering to its pay plan. Usually expressed as a percentage, a range penetration of 30% means that an employee is 30% of the way into his/or her range and has 70% more of that range to move through. This can be a useful measure to assess overall if your employees are mostly in the lower parts of their range and have a lot of room before they reach the maximum or if there are certain employees or groups of employees who are being paid toward the top of the range, which could become a problem. A range penetration of 0% means the employee is paid at range minimum, a range penetration of 100% means the employee is paid at range maximum, and a range penetration of 50% means the employee is half way through the range – at midpoint.
6) GEOGRAPHIC DIFFERENTIALS
Definition: The percent difference between pay for the same job in two or more locations.
Why it matters: Due to the demand for and supply of labor, an employee may be paid more or less depending on where he or she physically works. Generally speaking, jobs in major metropolitan areas tend to pay more than jobs in rural areas, but that is not always the case. Consider that areas which require further employee travel may be compensating people more to get them to make the commute. If you operate in more than one location, it’s a good idea to evaluate the geographic differential between your two (or more) locations and adjust your pay structure accordingly.
Check out our final lesson: Pay Concerns and Pay Raises!
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