Voodoo Pay Management - or the Perils of Using Structure Data to Track the Market

In yesterday's post on aging survey data, I advised against using structure adjustment data as the basis for aging.  I thought it worth a follow-up post to expand on this topic and share what I believe are the perils associated with using structure and structure adjustment data to manage your salary program.

A quick pause for definitions:

By structure, I mean the salary ranges or schedules used to manage base pay.

By structure adjustment, I mean the amount by which that set of ranges or schedules is adjusted upward, typically on an annual basis, in response to competitive trends.

Structure and structure adjustment data is often offered by surveys in addition to data on actual salaries or actual salary increases.  The key difference?  Structure data represents policy, where salary data represents actual practice.

I think this distinction is an important one.  Having practiced in this field long enough to see how a wide range of organizations actually manage pay, I can tell you that there may be sizable discrepancies between policy and actual practice.  A couple of extreme (but very real) examples to illustrate my point:

Organization A - This organization is facing financial challenges, which have translated into a struggle to keep employee pay competitive.  The organization has faithfully reviewed and adjusted its salary ranges every year, so that they are kept at market levels, but has lagged behind in delivering employee increases.  The result is that while their ranges (as evidenced by their midpoints) are competitive, actual salaries are very low in comparison to both ranges and the external market.  And so, you see, their structure tells a very different story about their pay program and practives than their actual salaries do.

Organization B - This organization has been in business for over 50 years in a relatively stable industry.  Turnover is low to nonexistent, and the average employee has been in their job for over 8 years.  The organization, because it has not experienced much competitive pressure for people, has chosen to manage its salary program and ranges at the lower end of market practices.  Employees, though, being such a long-tenured group, tend to be paid at or near (or even over) the top of their assigned ranges.  Here again, the organization's structure might tell you a very different story about the pay program and practices than their actual salaries would.

My point?  Structure data (e.g., average minimums, midpoints and maximums) and structure adjustment data (how much the average organization has moved its structure) can paint a very different - and even misleading - picture of market pay practices in comparison to using actual salary data.  Salary data - actual salaries and salary increase percents - tell you what's really being done, regardless of what kind of policy and structure posturing might be happening. 

Better to base your analysis and decisions on reality - what and how people are really being paid.  Pay decisions based on anything else ... well, my title speaks for itself!

Aging Survey Data is About Mimicking Market Pay (Not Structure) Movement

Reader Christine asks about the best way to age survey data; whether to use salary structure movement or salary (merit) increase budgets as the basis for aging.

Aging survey data, for the uninitiated, is the process used to update or bring the survey data forward, covering the gap between its actual effective date and the date you need to apply it.  Because most pay surveys are conducted on a periodic basis (the most prevalent schedule still being an annual one) and because in most cases there is a gap - minimally - between the collection/effective date and the date of survey publication, the need to age the survey data is simply an accepted fact of life.

The question that Christine poses, then, is what rate to use in aging the data.  It's a good question, since most salary planning surveys give you both sets of data (salary increases and structure adjustments) to select from. 

Since our ultimate objective is to mimic the rate at which market pay is moving, using the average salary increase amount or salary increase budget is a better indicator of how much the average employee's salary is moving in a year.  Average structure adjustments, on the other hand, reflect the degree to which organizations are moving their pay ranges in order to keep them competitive, which can and often does differ from the average increase planned or delivered.  My experience in watching this data over time would suggest that, on average, structure adjustment numbers tend to run at 60%-70% of salary increase numbers.  Using structure adjustment rates to age your survey data, therefore, puts you at risk of underestimating actual market pay growth.

(In fact, I would argue that structure adjustment data, while certainly interesting, ought to be disregarded entirely when making pay programs decisions, including how much to adjust your own salary structure(s).  Pinning your salary range movement to a rate that lags actual salary movement by 30% to 40% will ultimately leave you with a structure that lags the market.  But perhaps that's a topic for another post.)

My advice in summary: Use salary increase - not structure adjustment - numbers as your rate for aging survey data to ensure that you are simulating market pay movement as accurately as possible.

More on Implementing a Living Wage

We left yesterday's discussion of implementing a living wage at the step where your organization makes a decision on setting a living wage figure.

Once a living wage figure has been set, your next step is to ascertain where, and in what manner, it impacts your pay program and practices.  Opinions differ here, but my recommendation is that the identified living wage figure becomes, for all practical purposes, your new wage/salary floor.  No wage/salary steps, schedules or ranges should drop below this level, and no employees should be paid below this rate (with possible exceptions for situations like interns, student workers, etc.).

Most organizations who implement a living wage program will experience an increase in labor costs.  Some will be able to immediately absorb any costs involved; others may not.  As with any new pay initiative, I strongly recommend that you assess costs and affordability before any public announcement is made - internally or externally.  As with any new pay initiative, be sure that you are ready and able to put your money where your mouth is - or you risk ultimately creating more bad will than good. 

To be clear on a critical point, I do not see an incompatibility between a cost of labor based pay program and a living wage floor.  Any organization that I have worked with on a living wage initiative is very purposeful about paying for cost of labor, not cost of living, once the living wage floor has been exceeded.  We endeavor to be very clear on this when communicating to employees.

As I stated in my initial post, I do not claim to be an expert of any kind in the area of living wage.  The purpose of this post series on that topic is to set out the lessons I have learned, and then provide my readers who have knowledge and information on the topic the opportunity to chime in for the benefit of all.

And so, readers, I turn the mike to you.

On Implementing a Living Wage

Living wage is a term used to describe the minimum hourly wage (or annual salary) necessary for an individual to achieve a particular standard of living, typically to pay for the basic necessities of life.  It is different from the minimum wage set by law; it is typically established on the principle that the minimum wage fails to meet the requirement of a living wage. 

The living wage movement is an international one.  Here in the U.S., a range of government entities have enacted ordinances which set a living wage minimum for jobs within their jurisdiction.  In addition, a number of private employers have implemented a living wage policy covering their own employees, typically as a reflection of their organizational purpose and mission.

While it is indeed my typical position to advocate directing and defining compensation programs as based on cost of labor, rather than cost of living, (and, as I will elaborate later, I do not see this position as incompatible with the use of a living wage standard) I do also want to dedicate some discussion to the phenomenon of living wage, for the benefit of those organizations who decide that it behooves them and their particular mission to implement one. My intent here is not to argue the political or economic pros and cons of the concept of a living wage.  Rather, I accept that there are organizations (often, but not exclusively, not-for-profits) who have established this as an important and necessary step.  With them in mind, I wanted to take the opportunity to share some of what I've learned in this area.

I have not been involved in any public sector living wage initiatives, which is where the bulk of these efforts seem to take place, but I have assisted a few private client organizations in developing and implementing their own programs.  I have found this territory to be largely uncharted with respect to formal program development guideposts.  For this reason, I hope - with the assistance of informed readers - to shed a little light to help others starting down this path.

First of all there appears to be no universally agreed-upon standard for what comprises a living wage, or how you go about implementing one.  It is therefore up to your organization, and its governing body, to determine this.  We - my clients, their other advisors and I - have found sources such as the Economic Policy Institute and their family budget calculator to provide helpful information on detailed living costs for different geographic areas and different family configurations.  Readers, I am certain, can suggest others as well.  One of the first and most important steps your organization must take is to identify a living wage figure.

As with many aspects of implementing a living wage, there doesn't appear to be a lot to guide your decision.  I would simply recommend that you make the decision in a manner and using a process that reflects your mission and your original objectives for seeking to take this step.  If other organizations in your labor market have implemented a living wage, their decisions might provide useful precedents as well.  Finally, it may make sense to have key constituents - internal and external - weigh in with their thoughts and opinions.

Continued in tomorrow's post.

More Early Salary Budget Data: Salary Increases Look to Hold Steady in 2009

Preliminary results from the CompData 2008 survey shows pay budgets essentially remaining flat from 2008 to 2009.  According to the survey, salary increase budgets were reported at 3.60% for 2007 and 2008, and are projected to be 3.62% in 2009.

Although these early figures are a little lower than those released at the beginning of May by Economic Research Institute, which reported average 2008 salary increase budgets of 4.1% and 2009 projections of 4.0%, they do reinforce the theme of flatness.  Based at least on what we are seeing so far, it doesn't appear that 2009 increases, on average, will be substantively different from 2008. 

More to come on this, as some of the largest salary budget surveys will be releasing results later into the summer.

On Employees and Pay Maximums

Some of the most challenging conversations that I've had in the course of my compensation work have been with employees who were either at or over the top of their salary range maximums.  I'm guessing more than a few readers can say the same.  Following a comment exchange on this topic with a reader in a recent post on lump sum merit increases, I decided that a separate post might be in order.

Organizations with formal compensation programs in place typically establish salary ranges (or steps or schedules) for the purpose of managing base salary decisions in a consistent and equitable way.  Inevitably, based on continued tenure (or for a host of other reasons), employees reach the maximum salary rate for their assigned range or schedule.  On the positive side, range or schedule maximums are typically set at a premium over the "going market rate" for a position (in my experience, 15% to 20% is most common), so the employer has presumably allowed for some "extra" to reward those who have performed well in the position over time.  Also, it is good news that most organizations review and adjust their ranges and schedules on a regular basis in order to keep them competitive, thus providing even "at max" employees some opportunity for movement.  There is also the practice of providing lump sum merit awards in lieu of salary increases, in an effort to keep these employees "whole".

The undeniable bad news, however, is that employees in this situation will likely see their annual income move very slowly going forward.  Particularly in times of rising costs, this is not welcome information.

As a reward professional, I have two thought streams on this.

First, this.  It is a real but sometimes hard-to-swallow fact that different jobs and skill sets command different pay rates in the market for talent.  Accordingly, every job and skill set faces a pay limit related to its value in the market.  Want to earn more?  Then learn new skills, increase your capabilities, get a degree (all of these preferably in a high demand talent area) - in general, figure out how to bring more value to your (or any) employer.

I rarely, of course, get the standing O when I deliver this speech to a group of employees.  But I do it anyway, because I think I owe them the information and perspective, and because I think it is important for all of us to understand how the market for pay works.  And for all of us to appreciate that we each have a role and a responsibility relative to our wish to maximize our income.

Ok, then.

There is the other (second) side of the coin as well.  Employers, HR and reward professionals: If we are really about talent management (and not just personnel administration), we should be looking at these situations and asking ourselves is this a case of an overpaid employee or an underutilized asset?  Have we truly considered whether or not we can better leverage this person's talent and abilities in a higher value role?  Are we providing tuition benefits and other support that the motivated employee can tap into on their quest to continuously improve their skills?  Does our annual performance management process include (or mandate) regular conversations about stretching and development?

Certainly, it is often the case that we have set the employment stage well, with all the necessary support and assistance, and it is up to the employee to take the ownership and initiative for the next step.  But I'd like to leave you with Thomas Friedman's (he of The World is Flat, one of my favorite books) recommendation for the new employment contract between today's employers and employees, as food for further thought:

You give me your labor, and I will guarantee that as long as you work here, I will give you every opportunity-through either career advancement or training-tobecome more employable, more versatile. 

Quickie Primer on Lump Sum Merit Increases for "Over Max" Employees

A recent client question reminded me that not every HR professional is familiar with the use of lump sum merit increases as an approach for rewarding employees who have "topped out" by reaching (or passing) their salary range maximums.  With this in mind, here is a quick post on the basics.

(I suspect that a number of readers may already be well versed in this topic.  For those who are, please feel free to weigh in with your thoughts, experiences and any tips.)

Ahem.  To start with, let's define what we are talking about when we use the term lump sum merit increase. 

A lump sum merit increase is not really an increase at all, but rather something provided in lieu of a salary increase.  Rather than being added to the fixed base salary, the lump sum is delivered in the form of a single cash payment, separate from base salary.  For this reason, it is also (and probably more accurately) referred to as a lump sum bonus.

While there are other applications, the most common use for the lump sum merit increase - to the best of my knowledge - is as a substitute for a salary increase for those employees whose salaries have already reached - or surpassed - the maximum of their assigned salary range. The rationale is typically and simply this:  the employer wishes to recognize and reward employees who are performing well in their job, but whose salaries have reached a point where no further increases are allowed.  So the employer does so with a lump sum award, which does not exacerbate the "at or above max" problem by increasing the fixed base wage, but does provide the employee with a cash reward for their performance.

In most of the situations that I have encountered, the amount of the lump sum merit award is identical (as a % of base salary) to what the employee would have earned via the guidelines if they were still within the confines of their salary range.  In other words, if the merit increase guidelines suggest a 3% increase, the employee receives a lump sum award equal to 3% of their current salary.  I have seen a couple of situations where the lump sum award is reduced from that level suggested by increase guidelines (i.e. 50% of the amount suggested by guidelines).

(Note also that, in the interest of compliance with the Fair Labor Standards Act (FLSA), in situations where a non-exempt employee is involved, the organization must include this lump sum payment when determining the employee's regular rate of pay for the purposes of calculating overtime.)

That's my take.  Other perspectives and experiences?

Beyond the Compa-Ratio: Other Base Salary Management Tools & Approaches

I posted a few months back about the indefatigable compa-ratio, a simple statistic that can provide a wealth of information about your base salary practices.

A number of readers commented about related approaches and tools; I thought a follow-up post might be in order to address some of the great questions they raised.  Snooze alert for those of you who can't bear much compensation detail; here is a boatload comin' at you.

Salary Range Quartiles

Alan mentions his organization's use of quartiles to manage base salaries.  Sovan asks the question: "I am comfortable with compa-ratio but not with converting the same to quartile or vice versa. Can you suggest an article/post which can be helpful in studying this?"

Dividing a salary range into quartiles is another time-honored method for managing base salary practices, and is an approach often featured in conjunction with a merit increase matrix, as Alan points out.  I urge my clients to define their quartiles as target salary areas for different employee groups; e.g., the first quartile (lowest 1/4 of the salary range) represents the appropriate salary for new, relatively untried and inexperienced employees. 

As a salary management tool, quartiles (or quintiles, or deciles, or thirds/tri-tiles) are less precise than the compa-ratio statistic (as they describe a "chunk" or "portion" of the range, rather than a specific dollar point), but they can serve an important purpose nonetheless. 

In terms of Sovan's question about conversion, I typically define range quartiles using compa-ratio.  For example, a salary range that is 50% wide from minimum to maximum, with a midpoint exactly in the middle, will have a minimum equal to 80% of the midpoint (the same as a compa-ratio of 80%) and a maximum equal to 120% of the midpoint (the same as a compa-ratio of 120%).  You could further use compa-ratio to define quartiles in this particular salary range as follows (not in a perfect geometric sense, but in a simple and straightforward one):

Quartile 1: Compa-ratio of 80% to 90%

Quartile 2: Compa-ratio of 90% to 100%

Quartile 3: Compa-ratio of 100% to 110%

Quartile 4: Compa-ratio of 110% to 120%

Salary Range Percentiles

Lupe says: "At work we use SAP Compensation system which uses compa-ratio, but management uses percentile. As an analyst I always have a problem with translating percentile to compa-ratio. Do you have a formula for this?"

If I am correctly understanding the use of the term percentile here, I believe Lupe is referring to an alternative statistic to the compa-ratio.  A client of mine uses a percentile statistic in lieu of compa-ratio which he calls "point in range", and which he believes is a more intuitive figure for communicating with managers and their employees.  Having never heard of it before, I assumed he invented it (Dave??), but perhaps it is in more widespread use than I realized. At any rate, point in range is calculated using this formula:

(employee salary - range minimum)/(range maximum - range minimum)

And it works this way:

If an employee's salary is at minimum, the "point in range" is 0% (that is to say, he/she has not yet made any progress into the range)

If an employee's salary is at midpoint, the "point in range" is 50% (which indicates that he/she is exactly halfway through the range)

If an employee's salary is at maximum, the "point in range" is 100% (which indicates that he/she is at the top - or highest level - of the range)

The exact translation of compa-ratio to point in range will, unfortunately, vary in accordance with the width of the range - except at midpoint where point in range will be exactly half of compa-ratio.

That's it.  Thanks to all who commented on the compa-ratio post for your willingness to take a deep dive into the quantitative end of the salary management pool!

Follow-up note:  Point in range, or range penetration formula corrected above - thanks, Dan for noting the error.

Image: Jane M. Sawyer

More on The Tragedy of the Commons: Holding Managers Accountable for Good Stewardship

In yesterday's post, I shared a comparison between the challenge of making merit pay work and the classic dilemma The Tragedy of the Commons.  The tragedy is played out - and the prospect of performance based pay ultimately doomed - when individual managers put their short-term interests and those of their employees (i.e., everyone gets the maximum increase available) ahead of the longer-term interests of the overall group (the organization).  Addressing this particular version of the tragedy, I maintained, requires holding managers accountable for being good stewards of the organization's resources.

Andres Acosta, a reader and HR blogger in his own right posed some great questions in the comments to that post.  If I may paraphrase Andres:

1. How do we do it - hold managers accountable for their roles as stewards?
2. What are some processes, tools and practices that can help motivate managers to put company long-term success before the immediate compensation pressures of their team?

I know my readers will have some great thoughts on these questions.  Here are a couple of mine just to get the ball rolling:

1. I hold that accountability starts with consequences.  If, as a result of putting his/her immediate interests ahead of those of the organization, a manager encounters only positive consequences (I am a hero to my team!) and no negative ones, I would say that nobody is holding that manager accountable for doing otherwise.  Alternatively, if that manager's superior were to challenge and express concern about the action or if the manager were called to defend his/her action by/to a forum of peers or if the manager's performance were assessed as "needing improvement" directly as a result of the short-sighted and self-serving nature of the action, these negative consequences might cause the manager to rethink his/her approach.
2. One practice that I would suggest considering is incentives based on group performance (I'm a compensation consultant - what did you expect?).  Seriously, I wish I had a nickel for every senior management team (or even middle management team) I have encountered who are incented largely or entirely on individual performance, but whose CEO (or Board or HR Manager/Director) complains loudly about silos and a lack of cooperation.  Want them to act like organizational stewards?  Then pay them like organizational stewards - not individual contributors!

Let's hear what you think! 

The Tragedy of the Commons and Merit Pay

The topic of pay-for-performance came up in a recent meeting, and someone drew a comparison between the challenge of making merit pay work and the classic dilemma The Tragedy of the Commons.  It was a beautiful point and I'm not sure I can do it justice here, but I am going to give it a shot.

A little background.  The theory underlying the Tragedy of the Commons dates back as far as Aristotle, but it was popularized in modern times by the essay of the same name written by Garrett Hardin for Science.  Essentially, it describes the dilemma that occurs when the short-term interests of individuals are at odds with the long-term interests of the group. 

I like Wikipedia's summary of Hardin's article:

This story describes a group of herders having open access to a common parcel of land on which they could let their cows graze. It is in each herder’s interest to put as many cows as possible onto the land, even if the commons is damaged as a result. The herder receives all the benefits from the additional cows but the damage to the commons is shared by the entire group. Yet if all herders make this individually rational decision, the commons is destroyed and all will suffer.

As Hardin and others point out, the "tragedy" plays itself out in a wide range of modern day "commons" - beginning (but not ending) with our use of resources such as water, parks and wetlands, fish stocks and oil.  I believe we often see a similar dynamic at work among managers when it comes time to assess their subordinates' performance and hand out merit increases.

The actions of many managers would suggest to me that they see their role and their primary objective in the merit pay process to be getting the highest possible increases for each of their reports, however that might be accomplished.  If gaming the pay system is the most expedient way to get there, then so be it. 

The outcome of this behavior is that the ability of the group (the organization) to pay for performance, to differentiate and reward the employees who truly go above and beyond in their roles, is compromised in favor of the individual manager trying to maximize the pay levels of his/per particular group of employees.  Peformance-based pay ultimately fails.

Addressing this "tragedy" requires more than simply training managers in the nuts and bolts of how the performance management and pay systems work.  It requires directly dealing with the definition of what it means to be in a management role.  And I would submit that the role of a manager is one of stewardship; of being good stewards of the organization's resources - both human and economic.  Stewardship involves actively balancing the needs of both employees and the organization.  What it isn't is putting the short-term interests of their reporting employees above the longer-term interests of the larger group.

Until we hold managers accountable for their roles as stewards, we will be unable to conquer this particular Tragedy of the Commons and our pay-for-performance efforts will never really leave the starting gate.