DEVELOPMENT OF A BASE PAY SYSTEM

DEVELOPMENT OF A BASE PAY SYSTEM

 

Once pay policies have been determined, the actual development of a base pay system begins. 

Because most organizations use task-based systems focusing on work done in specific jobs, that is the emphasis of this discussion. If skill-based or team pay systems are used, then many of the activities discussed here must be modified.

As figure shows, the development of a wage and salary system assumes that accurate job descriptions and job specifications are available. 

The job descriptions then are used in two activities: job evaluation and pay surveys. These activities are designed to ensure that the pay system is both internally equitable and externally competitive. The data compiled in these two activities are used to design pay structures, including pay grades and minimum-to-maximum pay ranges.

After the pay structures have been developed, individual jobs must be placed in the appropriate pay grades and employees’ pay adjusted based on length of service and performance. Finally, the pay system must be monitored and updated.

 

Compensation Administration Process

 

 

1. JOB EVALUATION

Job evaluation=the systematic determination of the relative worth of jobs within an organization.

 

Job evaluation provides a systematic basis for determining the relative worth of jobs within an organization. It flows from the job analysis process and is based on job descriptions and job specifications.

 

In a job evaluation, every job in an organization is examined and ultimately priced according to the following features:

• Relative importance of the job
• Knowledge, skills, and abilities (KSAs) needed to perform the job
• Difficulty of the job

 

It is important that employees perceive their pay as appropriate in relation to pay for jobs performed by others. Because jobs may vary widely in an organization, it is particularly important to identify benchmark jobs—jobs that are found in many other organizations and are performed by several individuals who have similar duties that are relatively stable and that require similar KSAs.

For example, benchmark jobs commonly used in clerical/office situations are accounts payable processor, word processing operator, and receptionist. Benchmark jobs are used with all of the job evaluation methods discussed here because they provide “anchors” against which unique jobs can be evaluated. Several methods are used to determine internal job worth through job evaluation. All methods have the same general objective, but they differ in complexity and means of measurement. Regardless of the method used, the intent is to develop a usable, measurable, and realistic system to determine compensation in an organization.

 

RANKING METHOD

The ranking method is one of the simplest methods of job evaluation. It places jobs in order, ranging from highest to lowest in value to the organization. The entire job is considered rather than the individual components. Several different methods of ranking are available, but all present problems. Ranking methods are extremely subjective, and managers may have difficulty explaining why one job is ranked higher than another to employees whose pay is affected by these rankings. When there are a large number of jobs, the ranking method also can be awkward and unwieldy. Therefore, the ranking method is more appropriate in a small organization having relatively few jobs.

 

CLASSIFICATION METHOD

In the classification method of job evaluation, descriptions of each class of jobs are written, and then each job in the organization is put into a grade according to the class description it matches the best.

The major difficulty with the classification method is that subjective judgments are needed to develop the class descriptions and to place jobs accurately in them. With a wide variety of jobs and generally written class descriptions, some jobs may appear to fall into two or three different grades.

Another problem with the classification method is that it relies heavily on job titles and duties and assumes that they are similar from one organization to another. For these reasons, many federal, state, and local government entities, which traditionally used the classification method, have shifted to point systems.

 

POINT METHOD

The point method, the most widely used job evaluation method, is more sophisticated than the ranking and classification methods. It breaks down jobs into various compensable factors and places weights, or points, on them. A compensable factor is one used to identify a job value that is commonly present throughout a group of jobs. The factors are determined from the job analysis. For example, for jobs in warehouse and manufacturing settings, physical demands, hazards encountered, and working environment may be identified as factors and weighted heavily. However, in most office and clerical jobs, those factors are of little importance. Consequently, the compensable factors used and the weights assigned must reflect the nature of the job under study and the changes in it.

Figure helps to illustrate how the system is used.

Job Evaluation Point Chart

  

The individual using the point chart in the figure looks at a job description and identifies the degree to which each element is necessary to perform the job satisfactorily. For example, the points assigned for a payroll clerk for education might be 42 points, third degree. To reduce subjectivity, such determinations often are made by a group of people familiar with the jobs. Once points have been identified for all factors, th total points for the payroll clerk job are computed. After point totals have been determined for all jobs, the jobs are grouped together into pay grades. A special type of point method used by a consulting firm, the Hay Group, has received widespread application, although it is most often used with exempt employees. The Hay system uses three factors and numerically measures the degree to which each of these factors is required in each job.

The three factors and their sub-factors are as follows:

 

Know-How

• Functional expertise
• Managerial skills
• Human relations

 

Problem Solving

• Environment 
• Challenge

 

Accountability

• Freedom to act
• Impact of end results
• Magnitude

 

The point method has grown in popularity for several reasons. It is a relatively simple system to use. It considers the components of a job rather than the total job and is much more comprehensive than either the ranking or classification method. Once points have been determined and a job evaluation point manual has been developed, the method can be used easily by people who are not specialists. 

The system can be understood by managers and employees, which gives it a definite advantage.

Another reason for the widespread use of the point method is that it evaluates the components of a job and determines total points before the current pay structure is considered. In this way, an employer can assess relative worth instead of relying on past patterns of worth.

One major drawback to the point method is the time needed to develop a system. For this reason, employers often use manuals and systems developed by management consultants or other organizations. Point systems have also been criticized for reinforcing traditional organizational structures and job rigidity.

Although not perfect, the point method of job evaluation generally is better than the classification and ranking methods because it quantifies job elements.

 

FACTOR COMPARISON

The factor-comparison method is a quantitative and complex combination of the ranking and point methods. It involves first determining the benchmark jobs in an organization, selecting compensable factors, and ranking all benchmark jobs factor by factor. Next, the jobs are compared with market rates for benchmark jobs, and monetary values are assigned to each factor.

The final step is to evaluate all other jobs in the organization by comparing them with the benchmark jobs.

A major advantage of the factor-comparison method is that it is tailored specifically to one organization. Each organization must develop its own key jobs and its own factors. For this reason, buying a packaged system may not be appropriate. Further, factor comparison not only tells which jobs are worth more but also indicates how much more, so that factor values can be more easily converted to monetary wages.

The major disadvantages of the factor-comparison method are its difficulty and complexity. It is not an easy system to explain to employees, and it is time consuming to establish and develop. Also, a factor-comparison system may not be appropriate for an organization with many similar types of jobs. Managers attempting to use the method should consult a specialist or one of the more detailed compensation books or manuals that discuss the method.

 

INTEGRATED AND COMPUTERIZED JOB EVALUATION

Increasingly, organizations are linking the components of wage and salary programs through computerized and statistical techniques. Using a bank of compensable factors, employers can select those factors that are most relevant for the different job families in the organization.

Then these integrated systems can perform the following tasks:

• Create job descriptions that identify the compensable functions for each job.
• Link to pay survey data available on the Internet.
• Use multiple regression and other statistical methods to analyze job evaluation and pay survey relationships.
• Compare current employee pay levels in a database to the job evaluation and pay survey data.
• Develop costing models and budgetary implications of various implementation approaches.

Because of the advanced expertise needed to develop and computerize the integrated systems, management consultants are the primary source for them. These systems really are less a separate method and more an application of information  technology and advanced statistics to the process of developing a wage and salary program. Integrated systems, including the consulting expertise necessary to work through and implement them, are relatively expensive to purchase. Therefore they generally are used only by medium- to large-sized employers.

 

2. LEGAL ISSUES AND JOB EVALUATION

 

Employers usually view evaluating jobs to determine rates of pay as a separate issue from selecting individuals for those jobs or taking disciplinary action against individuals. But because job evaluation affects the employment relationship, specifically the pay of individuals, it involves legal issues that must be addressed.

 

JOB EVALUATION AND THE AMERICANS WITH DISABILITIES ACT (ADA)

The Americans with Disabilities Act requires employers to identify the essential functions of a job. However, all facets of jobs are examined during a job evaluation. For instance, assume a production job requires a punch press operator to drill holes in parts and place them in a bin of finished products.

Every three hours the operator must push that bin, which may weigh two hundred pounds or more, to the packaging area. The movement of the bin probably is not an essential function. But if job evaluation considers the physical demands associated with pushing the bin, then the points assigned may be different from the points that would be assigned if only the essential functions were considered.

 

GENDER ISSUES AND JOB EVALUATION

Critics have charged that traditional job evaluation programs place less weight on knowledge, skills, and working conditions for many female-dominated jobs in office and clerical areas than on the same factors for male-dominated jobs in craft and manufacturing areas. Also, jobs typically are compared only with others in the same job “family.” As discussed earlier, advocates of pay equity view the disparity between men’s jobs and women’s jobs as evidence of gender discrimination. These advocates also have attacked typical job evaluations as being gender biased.

Employers counter that because they base their pay rates heavily on external equity comparisons in the labor market, they are not the ones who are discriminating; they are just reflecting rates the “market economy” sets for jobs and workers. A number of different methodologies can be used to evaluate the differences in pay based on gender. Undoubtedly, with further developments in court decisions, government actions, and research, job evaluation activities will face more pressures to address gender differences.

 

3. PAY SURVEYS

 Another part of building a pay system is surveying the pay that other organizations provide for similar jobs. A pay survey is a collection of data on compensation rates for workers performing similar jobs in other organizations. An employer may use surveys conducted by other organizations, or it may decide to conduct its own survey.

 

USING PREPARED PAY SURVEYS

Many different surveys are available from a variety of sources. As the HR Perspective indicates, the growth of the Internet has resulted in a large amount of pay survey sources and data being available on-line. Whether available electronically or in printed form, national surveys on many jobs and industries come from the U.S. Department of Labor, Bureau of Labor Statistics, and through national trade associations. In many communities, employers participate in a wage survey sponsored by the local Chamber of Commerce to provide information to new employers interested in locating in the community.

When using surveys from other sources, it is important to use them properly.

 

Some questions to be addressed before using a survey are:

• Participants: Is the survey a realistic sample of those employers with whom the organization competes for employees?
• Broad-based: Is the survey balanced so that organizations of varying sizes, industries, and locales are included?
• Timeliness: How current is the data (determined by the date when the survey was conducted)?
• Methodology: How established is the survey, and how qualified are those who conducted it?
• Job matches: Does it contain job summaries so that appropriate matches to organization job descriptions can be made?

 

DEVELOPING A PAY SURVEY

If needed pay information is not already available, the employer can undertake its own pay survey. Employers with comparable positions should be selected. Employers considered to be “representative” should also be surveyed. Even if the employer conducting the survey is not unionized, the pay survey probably should examine union as well as nonunion organizations. Developing pay competitive with union wages may deter employees from joining a union.

Jobs to be surveyed also must be determined. Because not all of the jobs in all organizations can be surveyed, those designing the pay survey should select jobs that can be easily compared, have common job elements, and represent a broad range of jobs. Key or benchmark jobs are especially important ones to include. It is also advisable to provide brief job descriptions for jobs surveyed in order to ensure more accurate matches. For executive-level jobs, data on total compensation (base pay and bonuses) is often gathered as well.

In the next phase of designing the pay survey, managers decide what information is needed for various jobs. Information such as starting pay, base pay, overtime rate, vacation and holiday pay policies, and bonuses all can be included in a survey. However, requesting too much information may discourage survey returns. The results of the pay survey usually are made available to those participating in the survey in order to gain their cooperation. Most surveys specify confidentiality, and data is summarized to assure anonymity. Different job levels often are included, and the pay rates are presented both in overall terms and on a city-bycity basis to reflect regional differences in pay.

There has been some debate about how essential pay survey data will continue to be, as jobs continue to change and more “hybrid” jobs that are combinations of traditional jobs emerge. Also, as more disparate jobs are placed into broader pay bands, the difficulty of comparing diverse jobs increases.

 

LEGAL ISSUES AND PAY SURVEYS

One reason for employers to use outside consultants to conduct pay surveys is to avoid charges that the employers are attempting “price-fixing” on wages. The federal government has filed suit in the past alleging that by sharing wage data, employers may be attempting to hold wages down artificially in violation of the Sherman Anti-Trust Act. A key case involved the Utah Society for Healthcare Human Resource Administration and nine hospitals in the Salt Lake City area. The consent decree that resulted prohibits all health-care facilities in Utah from designing, developing, or conducting a wage survey. The hospitals can participate in surveys conducted by independent third-party firms only if privacy safeguards are met. Specifically, only aggregate data that is summarized may be provided, and no data from an individual firm may be identified. As a result, it is likely that fewer firms will conduct their own surveys, and the use of outside consultants to do pay surveys will continue to grow.

 

4. PAY STRUCTURES

 

Establishing Pay Structures

 

 

As indicated in that figure, one means of tying pay survey information to job evaluation data is to plot a wage curve, or scattergram. This plotting involves first making a graph that charts job evaluation points and pay survey rates for all surveyed jobs. In this way, the distribution of pay for surveyed jobs can be shown, and a linear trend line can be developed by use of the least-squares regression method. Also, a curvilinear line can be developed by use of multiple regression and other statistical techniques. The end result is the development of a market line. This line shows the relationship between job value, as determined by job evaluation points, and pay survey rates.

 

DIFFERENT PAY STRUCTURES

In organizations there are a number of different job families. The pay survey data may reveal that there are different levels of pay due to market factors, which may lead to firms establishing several different pay structures, rather than just one structure. Examples of some common pay structures are (1) hourly and salaried; (2) office, plant, technical, professional, and managerial; and (3) clerical, information technology, professional, supervisory, management, and executive. One basis for determining how many and which pay structures to have is the nature and culture of the organization.

 

ESTABLISHING PAY GRADES

In the process of establishing a pay structure, organizations use pay grades to group individual jobs having approximately the same job worth. While there are no set rules to be used in establishing pay grades, some overall suggestions have been made. Generally, from 11 to 17 grades are used in small companies. However, as discussed earlier, a growing number of employers are reducing the number of grades by broadbanding.

By using pay grades, management can develop a coordinated pay system without having to determine a separate pay rate for each job in the organization. All the jobs within a grade have the same range of pay regardless of points. As discussed previously, the factor-comparison method of job evaluation uses monetary values, so an employer using that method can easily establish and price pay grades. A vital part of the classification method is developing grades. Organizations that use the ranking method can group several ranks to create pay grades.

 

PAY RANGES

The pay range for each pay grade also must be established. Using the market line as a starting point, the employer can determine maximum and minimum pay levels for each pay grade by making the market line the midpoint line of the new pay structure (below figure). 

 

Pay Scattergram

 

For example, in a particular pay grade, the maximum value may be 20% above the midpoint and the minimum value 20% below it.

As figure shows, a smaller minimum-to-maximum range should be used for lower-level jobs than for higher-level jobs, primarily because employees in lower-level jobs tend to stay in them for shorter periods of time and have greater promotion possibilities. 

 

Typical Pay Range Widths

  

 

For example, a clerk-typist might advance to the position of secretary or word processing operator. In contrast, a design engineer likely would have fewer possibilities for upward movement in an organization.

This “expanding” approach also recognizes that individual performance can vary more greatly among people in upper-level jobs than in lower-level jobs. However, using the same percentage range at all levels can make administration of a pay system easier in small firms. If broadbanding is used, then much wider ranges, often exceeding 100%, may be used.

Experts recommend having overlap between grades, as in figure. 

 

Example of Pay Grades and Pay Ranges

 

  

This structure means that an experienced employee in a lower grade can be paid more than a less-experienced employee in a job in the next pay grade. Once pay grades and ranges have been computed, then the current pay of employees must be compared to the draft ranges. If a significant number of employees are out of range, then a revision of the pay grades and ranges may need to be computed. Also, once costing and budgeting scenarios are run in order to see the financial input of the new pay structures, then pay policy decisions about market positioning may have to be revised. As a result, changes to the pay ranges may lead to lowering or raising the ranges.

 

 

5. INDIVIDUAL PAY

 Once managers have determined pay ranges, they can set the specific pay for individuals. 

Each dot on the graph in the above picture represents an individual employee’s current pay in relation to the pay ranges that have been developed.

Setting a range for each pay grade gives flexibility by allowing individuals to progress within a grade instead of having to be moved to a new grade each time they receive a raise. A pay range also allows managers to reward the better-performing employees while maintaining the integrity of the pay system.

 

6. RATES OUT OF RANGE

Regardless of how well constructed a pay structure is, there usually are a few individuals whose pay is lower than the minimum or higher than the maximum. These situations occur most frequently when firms that have had an informal pay system develop a new, more formalized one.

 

RED-CIRCLED EMPLOYEES

Red-circled employee=An incumbent who is paid above the range set for the job.

A red-circled job is shown on the graph in above figure.

A red-circled employee is an incumbent who is paid above the range set for the job. 

For example, assume that an employee’s current pay is $10.92 per hour but the pay range for that grade is between $6.94 and $10.06. The person would be red circled, and attempts would be made over a period of time to bring the employee’s rate into grade. Typically, the red-circled job is filled by a longerservice employee who has declined promotions or has been viewed as unpromotable due to insufficient education or other capabilities. Yet the individual may have continued to receive large pay increases.

Several approaches can be used to bring a red-circled person’s pay into line. Although the fastest way would be to cut the employee’s pay, that approach is not recommended and is seldom used. Instead, the employee’s pay may be frozen until the pay range can be adjusted upward to get the employee’s pay rate back into the grade. The employee can also be transferred to a job with a higher grade or given more responsibilities. This method will result in greater job evaluation worth, thus justifying the job’s being upgraded. Another approach is to give the employee a small lump-sum payment but not adjust the pay rate when others are given raises.

 

GREEN-CIRCLED EMPLOYEES

Green-circled employee=An incumbent who is paid below the range set for the job.

An individual whose pay is below the range is a green-circled employee. Promotion is a major cause of this situation. Assume someone receives a promotion that significantly increases his or her responsibilities and pay grade. Typical promotion adjustments are 8% to 15%, but such an adjustment may still leave the individual below the minimum of the new pay range. Because the promotion represents such a significant increase in responsibilities, the employer may not work to increase the person’s pay to the minimum until all facets of the new job are being fully performed. Generally, it is recommended that the green-circled individual receive pay increases to get to the pay grade minimum fairly rapidly. More frequent increases can be given if the increase to minimum would be large.

 

7. PAY COMPRESSION

Pay compression=Situation in which pay differences among individuals with different levels of experience and performance in the organization becomes small.

One major problem many employers face is pay compression, which occurs when the range of pay differences among individuals with different levels of experience and performance becomes small. Pay compression occurs for a number of reasons, but the major one involves the situation in which labor market pay levels increase more rapidly than an employee’s pay adjustments. Such situations have become prevalent in many occupational areas, particularly those in the information technology field. Occasionally, in response to competitive market shortages of particular job skills, managers may have to deviate from the priced grades to hire people with scarce skills. For example, suppose the worth of a specialized information systems analyst’s job is evaluated at $38,000 to $48,000 annual salary in a company, but qualified individuals are in short supply and other employers are paying $60,000. The firm must pay the higher rate. But suppose several analysts who have been with the firm for several years started at $38,000 and have received 6% increases each year. These current employees may still be making less than salaries paid to attract and retain new analysts from outside with lesser experience. One solution to pay compression is to have employees follow a step progression based on length of service, assuming performance is satisfactory or better.

 

8. PAY INCREASES

Once pay ranges have been developed and individuals’ placements within the ranges identified, managers must look at adjustment to individual pay. Decisions about pay increases often are critical ones in the relationships among employees, their managers, and the organization. Individuals have expectations about their pay and about how much increase is “fair,” especially in comparison with the increases received by other employees. There are several ways to determine pay increases.

 

PAY-FOR-PERFORMANCE SYSTEMS

Many employers profess to have a pay system based on performance. But relying on performance-appraisal information for making pay adjustments assumes that the appraisals are done well, and this is not always the case, especially for employees whose work cannot be measured easily.

Consequently, some system for integrating appraisals and pay changes must be developed and applied equally. Often, this integration is done through the use of a pay adjustment matrix, or salary guide chart (see figure below).

 

Pay Adjustment Matrix

 

Pay adjustment matrices base adjustments in part on a person’s compa-ratio, which is the pay level divided by the midpoint of the pay range.

To illustrate from above figure, the compa-ratio for two employees would be:

 

Such charts reflect a person’s upward movement in an organization.

Upward movement depends on the person’s performance, as rated in an appraisal, and on the person’s position in the pay range, which has some relation to experience as well. A person’s placement on the chart determines what pay raise the person should receive. For example, if employee J is rated as exceeding expectations (3) with a compa-ratio of 89, that person is eligible for a raise of 7% to 9% according to the chart in above figure.

The sample matrix has several interesting facets that illustrate the emphasis on paying for performance. First, those individuals whose performance is below expectations receive no raises, not even a so-called cost-of-living raise. This approach sends a very strong signal that poor performers will not continue to receive increases just by completing another year of service.

Second, notice that as employees move up the pay range, they must exhibit higher performance to obtain the same percentage raise as those lower in the range performing at the “meets performance expectations” (2) level. This approach is taken because the firm is paying above the market midpoint but receiving only satisfactory performance rather than above-market performance. Charts can be constructed to reflect the specific pay-for-performance policy and philosophy in an organization. In many organizations, pay-for-performance systems are becoming a popular way to change the way pay increases are distributed. In a truly performanceoriented system, no pay raises are given except for increases in performance. Giving pay increases to people because they have 10 to 15 years’ experience, even though they are mediocre employees, defeats the approach. Further, unless the performance-based portion of a pay increase is fairly significant, employees may feel it is not worth the extra effort. Giving an outstanding industrial designer making $40,000 a year the “standard raise” of 4% plus 1% for merit means only $400 for merit versus $1,600 for “hanging around another year.”

 

SENIORITY

Seniority, or time spent in the organization or on a particular job, can be used as the basis for pay increases. Many employers have policies requiring that persons be employed for a certain length of time before they are eligible for pay increases. Pay adjustments based on seniority often are set as automatic steps once a person has been employed the required length of time, although performance must be at least satisfactory in many nonunion systems.

A closely related approach uses a maturity curve, which depicts the relationship between experience and pay rates. Pay rises as an employee’s experience increases, which is especially useful for professionals and skilled craft employees.

Unlike a true seniority system, in which a pay raise occurs automatically once someone has put in the required time, a system using maturity curves is built on the assumption that as experience increases, proficiency and performance also increase, so pay raises are appropriate. If proficiency does not increase, theoretically pay adjustments are reduced, although that seldom happens in practice. Once a person plateaus in proficiency, then the pay progression is limited to following the overall movement of the pay structure.

 

COST-OF-LIVING ADJUSTMENTS (COLA)

A common pay-raise practice is the use of a standard raise or cost-of-living adjustment (COLA). Giving all employees a standard percentage increase enables them to maintain the same real wages in a period of economic inflation. Often, these adjustments are tied to changes in the Consumer Price Index (CPI) or some other general economic measure. 

However, numerous studies have revealed that the CPI overstates the actual cost of living.

Unfortunately, some employers give across-the-board raises and call them merit raises, which they are not. If all employees get a pay increase, it is legitimately viewed as a cost-of-living adjustment having little to do with merit or good performance. For this reason, employers should reserve the term merit for any amount above the standard raise, and they should state clearly which amount is for performance and which is the “automatic” COLA adjustment.

 

LUMP-SUM INCREASES (LSI)

Most employees who receive pay increases, either for merit or seniority, first have their base pay adjusted and then receive an increase in the amount of their regular monthly or weekly paycheck.

In contrast, a lump-sum increase (LSI) is a one-time payment of all or part of a yearly pay increase. The pure LSI approach does not increase the base pay. Therefore, in this example the person’s base pay remains at $12.00 per hour. If an LSI of 3% is granted, then the person received $748.80 (computed as 36¢ per hour 2 2080 working hours in the year.) However, the base rate remains at $12.00 per hour. It is that base rate upon which overtime is figured, and keeping the base rate static slows down the progression of the base wages.

It also allows for the amount of the “lump” to be varied, without having to continually raise the base rate. Some organizations place a limit on how much of a merit increase can be taken as a lump-sum payment. Other organizations split the lump sum into two checks, each representing one-half of the year’s pay raise. As with any plan, there are advantages and disadvantages. The major advantage of an LSI plan is that it heightens employees’ awareness of what their performance “merited.” A lump-sum check also gives employees some flexibilhaving to take out a loan. In addition, the firm can slow down the increase of base pay, so that the compounding effect of succeeding raises is reduced.

Unionized employers, such as Boeing and Ford, have negotiated LSI plans as a way to hold down base wages, which also holds down the rates paid for overtime work. Pension costs and some other benefits, often tied to base wages, can be reduced as well. One disadvantage of LSI plans is administrative tracking, including a system to handle income tax and Social Security deductions from the lump-sum check. Also, workers who take a lump-sum payment may become discouraged because their base pay has not changed. Unions generally resist LSI programs because of this and because of the impact on pensions and benefits. To some extent, this problem can be reduced if the pay increase is split to include some in the base pay and the rest in the lump-sum payment.