Establishing the appropriate wage for an employee takes a lot more into consideration than one might think. Many organizations “wing it” or estimate pay for employees and while that can work for the smallest companies or companies with simple organizational structures, it is not as effective for growing or larger organizations.
HR consultant Arlene Vernon works with business owners and managers who want a reliable, responsive human resource expert to counsel or assist on issues just like this – understanding how to set salaries and compensation packages.
“The best way to establish pay for a particular job is to evaluate the position without the employee in it,” says Vernon. “That way you’re evaluating what the job is worth to the organization, not what that particular person should be paid – that’s the last part of the equation.”
Vernon said a very simplified approach to help set and determine salaries such as this can help get the process started (read a more detailed four-step approach to setting salary/pay grades at the end of this article)
A. Write job descriptions for all your positions, then,
B. Evaluate/rank the positions by level of responsibility and
C. Place them into a compensation structure, clustering positions with relatively equal weight into one classification or tier of positions.
Next you would research legitimate salary surveys to learn what other employees of similar revenue, industry, size, for/non-profit status (and other factors deemed important) pay for similar positions. Then you build your salary structure around this “market” rate.
The structure around the market rate should be what an experienced, solid performing employee is paid. Entry-level employees may be paid 75-80% of the market rate (depending on a variety of factors) and highly-experienced employees would max out around 120-125% of the market rate. And everyone else should spread out across that range based on experience, knowledge, performance and perhaps what they’d been earning in previous positions and what they negotiated coming into the organization.
According to the Society of Human Resource Management, while there are no regulations or set standards regarding the establishment of pay grades, there are some basic, customary steps involved in doing so. Key components in establishing and maintaining pay grades include:
- Getting a commitment and participation from management and/or the executive team in establishing company minimum and maximum pay for the organization.
- Using the company’s compensation philosophy to create pay grades that support that philosophy (will you lead the market, lag the market or pay at market?).
- Determining how often you will adjust grades due to inflation or market changes going forward.
Consider Pay Equity
Pay equity is also something that needs to be considered, says Vernon.
“Employers should pay close attention to internal pay equity when determining what to pay employees,” she says. “The market analysis portrays external pay equity. If you sorted all the wages you pay for your employees in one position, evaluate whether pay amount matches experience, expertise and performance. Then figure out the reasons for this inequity. If you see a pattern of inequity between gender, race, or other State or Federal protected class, you want to address the inequity with pay adjustments before someone else figures out that your pay looks discriminatory.”
If you’re a larger organization starting from scratch on this type of project, Vernon recommends hiring an experienced compensation consultant to evaluate jobs more scientifically. If you’re using a salary-focused web site for your market data, you’re using random data entered by anyone, says Vernon.
“There are no checks and balances on the validity of these open pay sites,” says Vernon. “You want to use an employer-reported, validated survey to help you determine compensation.”
Then, you consider the individual, where they fall in your ranges related to experience, skill and performance and determine how their pay should compare to the external market as well as to your internal employees.
It’s a complicated process, especially for those inexperienced with the many details that go into setting salary and compensation levels.
“Now that I’ve gone through all of this detail, it’s probably why so many employers wing it,” says Vernon.
Understanding salary surveys – what to look for
As for using salary surveys – something many employers do – it’s important to utilize the most relevant information you can so that there’s a better match to the job you’re evaluating. The criteria to consider includes:
- Job summary: This should be as close as possible to the actual position.
- Industry: If you’re a manufacturer, you should be looking at manufacturing surveys. If you’re a banking association you should look at general association data but also if there is a banking association survey, you should look at that survey as well.
- Location: National information may be useful if you’re a national organization, but the most relevant information will be the city/state in which you live. For example, in Minneapolis Vernon typically looks for Twin Cities Metro data. That data is much more relevant than National data or even data across Minnesota, which includes rural areas that pay less than the Cities.
- Revenue Size: These are usually in ranges, so that you’re comparing organizations with the same business volume.
- Employee Size: This is also in ranges. You may find that your 50 employee company pays less than a 1000+ employee company.
- For-profit/Non-Profit: No surprise here that non-profits pay less than for-profits. However, if you’re evaluating a position, such as an Administrative Assistant, you may want to look at for-profit rates because you may be competing to attract candidates from both segments.
“I also look at as many surveys as possible, within budget constraints, since there’s a cost for the surveys and some are very expensive,” says Vernon. “Then you can weight average the relevance of each survey to find your market wage. Using more surveys, rather than relying on one, adds more validity to your data.”
How to set Pay Grades: Four steps to follow
Source: SHRM.org
Step 1: Establish overall pay range
Determine a company minimum and a company maximum pay. The minimum will be for the first and lowest grade and the maximum will be for the last and highest grade. Use a listing of all company positions or job groups and current salary survey data relative to those positions to set these parameters and incorporate the company’s compensation philosophy to lead, lag or pay at market. (Paying at market means your midpoint will match the average salary for that position; lagging the market will set a midpoint below the average salary for that position; leading the market will set a midpoint above the average salary for that position). A pay range will generally spread +/- 15-20% from the midpoint, but any range the employer feels is appropriate is acceptable, and ranges may be different for different grades. For example, if your lowest paid position is an administrative assistant and you wish to pay at market, and salary survey data for that position shows an average salary of $25,000, a 15% spread for that job would be $21,250 (min), $25,000 (midpoint) and $28,750 (max), making $21,250 your overall minimum salary. Do the same for the highest paid position to set the overall maximum salary the company is currently willing to pay.
Step 2: Establish number of grades
Select the number of grades to be used based on the size of the company, job diversity, job evaluation results, etc. Large companies may find it more practical to use more grades (the federal government has 15 grades); small companies might elect to use fewer grades. For example, a small company with a CEO, managers who report to the CEO and administrative assistants might have three pay grades. A similar, larger company, perhaps with administrative staff, exempt professionals, supervisors, managers, directors and chiefs, may have six pay grades. An international company may have more than one pay grade system to reflect geographical differences. There is no one right number of pay grades; choose the number that makes most sense for your organization and its structure. Typically, however, the number of pay grades will depend on the size of your organization and the difference between the highest paid and lowest paid jobs.
Step 3: Establish a range per grade
Set a minimum and maximum for each grade. The maximum of one grade may overlap the minimum of another and vice versa. A common spread is +/- 15-20%, but it can be set at whatever the employer feels is acceptable. Many companies will average the midpoints (from salary survey data) of jobs in that grade to help establish a range for that grade. For example, a customer service position, a receptionist position and a mail clerk position may all be included in the same grade, and the averages of their midpoints from salary survey resources may be the midpoint you wish to set for that grade. Alternatively, if you are a software development company with many programmers on staff, you may have a range just for programmers and, if paying at market, may wish to use the midpoint directly from the salary survey resources for programmers as your midpoint of that grade. A range that has room for many experience levels and room for advancement will make for a balanced range.
Step 4: Create pay grade chart
Using the sum of the minimum and the maximum, calculate the midpoint by simply dividing that sum by two ([Max + Min] / 2 = Midpoint). You now have the key elements of your pay grade range determined, and your pay grade chart should look something like this:
| Grade | Min | Mid | Max |
| 1 | $20,000 | $30,000 | $40,000 |
| 2 | $34,000 | $43,000 | $52,000 |
| 3 | $50,000 | $75,000 | $100,000 |
| 4 | $80,000 | $100,000 | $120,000 |
| 5 | $110,000 | $140,000 | $170,000 |
Step 5: Review and amend
Determine how often the pay grade will be reviewed and how often adjustments will be made. Annual salary and salary structure increase projections can be used to adjust as needed. Pay grades are typically reviewed every one to three years.
Keep in mind there are a number of discrimination laws that affect compensation, including the Equal Pay Act, Title VII of the Civil Rights Act and The Age Discrimination in Employment Act. It is extremely important to review your compensation plan to ensure there is no adverse impact to protected groups.
A typical method of calculating whether adverse impact exists in compensation plans is to use a multiple regression analysis. However, the use of such a statistical analysis is complex and beyond the scope of this guide. You should consult with a compensation professional to determine which approach is best for your organization.
