Compensation 101: What Do Those Boring Terms Mean Anyway?
December 06, 2022
By: Susan Palé
Welcome to Compensation 101, where we define and give examples for those boring compensation terms we throw around all the time. You’ve heard a lot of them recently and probably experienced some of them, too, as we navigate through a volatile, often unexplainable, labor market. Let’s begin with the basics.
Compensation Strategy
Developing and implementing a compensation strategy means making decisions regarding how your organization will pay employees compared to the external market. Most large organizations have developed comprehensive compensation strategies; many small organizations have not. A key component of any compensation strategy is determining how you want to set compensation levels relative to the external market.
Lead: An organization may determine that it wants to lead the market. This means that the organization decides to pay more than competitors. That might be 10% more, 20% more, etc. The idea is that you will be known as the “best payer” in your competitive markets. This strategy works well when an organization is growing rapidly and successfully, has money to spend on recruitment and retention or faces particularly stiff competition for talent.
Match: Most organizations decide they want to match the market. To do this effectively, it’s necessary to gather compensation information about pay levels for specific jobs and geographic locations. This strategy works well for most organizations as long as salary information is regularly reviewed and updated as the market changes. For example, pay levels for entry-level employees have increased more than 10% in 2022 in some geographic areas. Salaries that matched or even led the market a in recent years may now lag the market.
Lag: Some organizations determine that their pay will lag the external market. Sometimes this happens by accident (see example above), but it can be a successful compensation strategy. Pay is important to employees, but often “perks” such as flexible scheduling, remote work and generous paid time off can be equally important. Some companies pay the full premium for family medical coverage, which can easily exceed $15,000 annually.
It's important to remember that any of these approaches can work for you if they’re well developed and maintained.
More Terms Defined
Successful compensation programs are both externally competitive and internally equitable.
Externally competitive means that an organization’s jobs are valued appropriately compared to jobs in the external market. Think of it as a deeper dive into the idea of matching the market. To be externally competitive, an organization must understand who their competitors for talent are and that these can vary significantly by job type and geographic location. For example, it’s important to know what industry pay standards are for certain positions, but if your new hires usually come from other industries and employees leave to take jobs in other industries, that information may be less valuable than information specific to a geographic area. Employees in accounting, human resources, IT and customer service, for example, can easily find jobs in other industries. Entry-level employees can also choose jobs in different industries, so if you regularly hire entry-level employees, it’s critical to understand who else is looking to hire them.
Internally equitable means employees in similar positions with similar skills are compensated similarly. That’s a lot of “similars,” but it doesn’t mean same. In organizations with formal compensation structures, internal equity is achieved by assigning specific jobs to a specific salary “grade” and salary “range” and paying individuals within that range based on performance, skills, length of service, etc. In organizations without formal compensation structures, these same factors are frequently used to determine individual rates of pay.
Salary compression occurs when the pay of one or more employees is close to or even exceeds the pay of other employees doing the same or similar work. Salary compression can occur throughout an organization but is most common when new hires (hard to come by in this labor market) demand salaries higher than incumbents with more experience and when salaries for new, entry-level employees (also in high demand) equal or exceed salaries for lead or supervisory employees.
It's easy to blame salary compression issues on COVID-19, the Great Resignation, the Great Reprioritization (Fast Company), the Great Recognition (U.S. Department of Commerce) or whatever best describes this crazy labor market. The reality is salary compression has been a problem organizations have faced for many years. It’s a complex issue that occurs over a long period of time and, as a result, doesn’t have an easy fix. Regular reviews of paid salaries and salary adjustments based on these reviews are critical steps in addressing salary compression.
Pay equity: The term pay equity is sometimes used interchangeably with internal equity. In the past, the two were pretty much the same, but pay equity has recently taken on a different meaning. The term now refers most commonly to legislation (primarily at state levels) requiring employers to pay men and women equally for “substantially similar” work. Some states have expanded this legislation to include fair-pay requirements for race and other protected characteristics. The recent labor agreements for equal pay for the U.S. men’s and women’s soccer teams represent the settlement of a pay equity lawsuit.