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How to Establish Pay Ranges

    Steps to Establish a Pay Range

    Step 1: Determine the Organization's Compensation Philosophy

    Before beginning to create salary ranges for the organization, an employer must first determine the organization's approach or philosophy to compensation. How does the employer determine what it is going to pay its employees? What is the mindset that drives the pay decisions? Determining the compensation philosophy requires an in-depth look at the company's beliefs and practices regarding setting pay. The key is to create a philosophy and to be consistent in its application to the pay decisions.

    An employer can choose to lead, lag or match the market when it comes to compensation. Being a market leader means that the organization pays more for jobs than its competitors do. Typically, an organization does this to gain an advantage or to attract talent away from its competitors. If an employer decides to match the market, it is paying roughly the same as its competitors, and if an employer is lagging the market, it is paying less than its competitors for jobs. Generally speaking, an employer does not choose to lag the market as a conscious pay strategy. It is often either discovered after market research indicates that an organization is paying less than the rest of its competitors for jobs, or it may be the result of a limited compensation budget. In rare circumstances an employer's brand may be so attractive (e.g., Disney) that it allows the employer to pay lower-than-market wages without a negative impact on recruitment and retention.

    A company's attitude toward compensation will drive its decisions through the rest of this process. Therefore, it is critical to know the employer's pay philosophy and have executive buy-in from the outset. 

    Step 2: Conduct a Job Analysis

    A job analysis is a process for gathering, documenting and analyzing information to accurately describe the jobs performed at an organization. The basis of a job analysis is a job description. A job description describes the essential functions of a job as well as the frequency and importance of all tasks and responsibilities associated with a particular job. 

    A job analysis determines whether the job descriptions are accurate. The process involves comparing each written job description to the job actually being performed. This can be done through observing employees, conducting surveys or interviewing employees doing the job, or a combination of these methods. 

    Step 3: Group into Job Families

    Once an employer feels confident that it has current and accurate job descriptions, it should determine whether to group the jobs into separate job families or have one pay grade system for all positions throughout the organization. For example, an organization may have an administrative job family, technical job family, management job family and executive job family. It may have different job families based on geographic locations (different countries or regions) or different divisions. 

    Step 4: Rank Positions Using a Job Evaluation Method

    A job evaluation is the process of rank ordering the jobs, not the people, based on job content to demonstrate the relative worth and level of responsibility of all jobs to one another. There are a number of job evaluation methods; two common methods are explained below.

    Point method

    The content of jobs can be described in terms of factors. Factors are qualities of a job that are common to many kinds of jobs, such as skill, effort or working conditions. Each factor is assigned a weight, or points, according to how much of that particular factor is present in the job. Simply stated, the more points assigned to a job, the more worth the job has to the organization. Jobs with more worth are compensated more than jobs with lesser worth. There may be a group of factors to apply to all jobs or different factors for different functions or a combination of both companywide and function- specific factors. One example is the Hay point method system, which uses only three factors and measures the degree that these three factors are required for each position. The Hay system factors are know-how, problem-solving ability and accountability. 

    Ranking method

    The ranking method is a much more simplistic method of rank ordering the value or worth of each job in comparison to the other jobs within the same job family. This method is often used in smaller organizations that have fewer jobs to compare.

    Step 5: Conduct Market Research

    Conducting market research ensures that wages paid to employees are comparable to similar positions in the marketplace.

    When conducting market research on salaries, employers should consider the following:

    • Job titles vary between organizations. Employers should read the descriptions of the jobs surveyed to make sure that the related tasks, functions and level of responsibility match the positions at their organizations. 
    • To obtain current, accurate salary information, employers will need to purchase salary data or conduct their own market research. A few resources, such as the U.S. Bureau of Labor Statistics, offer free data, but the data may be older and too broad in terms of industry or geography or other factor. 
    • Whenever possible, employers should try to obtain information from more than one market survey resource, at least for benchmark positions. 
    • Professional organizations sometimes offer data at a discounted price. For example, if an employer wants to hire a large group of engineers, it could check with the local engineering association in its area to see if the association conducts salary research. If it does, it may give price breaks to members. 
    • Employers should realize from the outset that each organization has jobs that are unique and that it will be impossible to find exact matches for all of one employer's jobs. Organizations may need to consider jobs that closely fit the principal aspects of a particular job or to consider salary data for more than one type of job. 

    Step 6: Create Job Grades

    There are two ways to create job grades. Organizations can either use their job evaluation data to group positions within each job family into job grades or use their market data to group positions based on similar salary survey data. This guide uses the market banding method. 

    Employers should note the range of pay in the salary surveys and all the information that may be relevant when establishing an average salary. Often employers want to consider their midpoint of a salary range to be somewhere between the 25th percentile and the 75th percentile. Some employers will use the 50th percentile, the median, mean or mode if they want to meet the market. If a company's philosophy is to lead the market, the salary point will be above the 50th percentile for most positions. 

    Next, employers can group positions having similar market salary ranges together into the same pay grade. An employer can have as many or as few pay grades as it wants. A startup or small organization may have only three or four pay grades. The federal government, by contrast, uses 15 pay grades. 

    Step 7: Create a Salary Range Based on Research

    For each pay grade, an organization will need to establish a midpoint, a minimum and a maximum pay range. There is no hard and fast rule on creating salary ranges. In this guide, we use the midpoint as the base for developing the salary range. Other methods can also be used, such as using the minimum salary as the base.

    An easy way to come up with a proposed midpoint is to average the market data between the different positions grouped in a grade. 

    A traditional salary range is commonly 30 percent to 40 percent. It is common that top salary grades (i.e., for executives and top management) have a wider range (sometimes greater than a range of 40 percent) and that the lowest salary grades often have the most narrow range (sometimes even smaller than 30 percent). Broadbanding occurs when employers decide to have very few salary grades and make those ranges much wider. 

    The formulas for a 30 percent range using the midpoint as the base are:

    Maximum = Midpoint x 1.15                           Minimum = Midpoint x 0.85

    The formulas for a 40 percent range when the midpoint is known are:

    Maximum = Midpoint x 1.20                           Minimum = Midpoint x 0.80

    Pay grade ranges will usually overlap. The more overlap, the more cost-effective it will be for career progression; less overlap will require a larger pay increase for internal promotions. Each job family can have its own pay grades and pay ranges that are established independently from the other job families. 

    Here is an example of a few job grades: 

    Proposed Ranges  Min Mid Max
    Grade I $11.48 $13.50 $15.53
    Maintenance I  (market salary = $13.00)    
    Administrative Assistant  (market salary = $14.00)    
    Grade II $15.09 $17.75 $20.41
    Mechanic I  (market salary = $17.50 )    
    Machinist (market salary = $18.00)    

     

    Step 8: Determine How to Deal with Salaries Not Within Range 

    At this stage in the process, an employer can actually take a look at what it is paying its employees in comparison to the data it has collected and the proposed salary grades and ranges for positions. The organization may need to make some adjustments, but overall the employer can rely on the market data and its pay philosophy to set these ranges.

     

    Grade I

    Maintenance I 

    • $11.00 (green circle rate)
    • $11.50
    • $12.22

    Administrative assistant 

    • $13.72
    • $14.18
    • $15.00
    Grade II

    Mechanic I 

    • $18.00
    • $18.20
    • $18.30

    Machinist

    • 17.65
    • 18.20
    • 19.35
    • 19.60
    • 20.45 (red circle rate)

     

    After the salaries for current employees have been placed into the range, several employees will inevitably not be in line with the guidelines and ranges the employer has established. 

    "Red circle rates" are salaries/wages that are above the maximum rate the organization has established for the position's salary range. Strategies to rectify red circle rates include the following:

    1. Instead of raising the employee's base pay when increases occur, offer the employee a bonus that is roughly the amount of what the base pay increase would have been. This satisfies the employee without raising his or her base pay even more. 
    2. Explore developmental opportunities to promote the employee into the next pay grade. 
    3. Make the employee ineligible for further salary increases, or lower the employee's base pay to bring it in line with the range. This must be done with the understanding that this method will likely lower employee morale and may motivate the employee to pursue employment elsewhere. For this reason, it is important to encourage such employees to explore developmental opportunities within the organization. 

    "Green circle rates" are salaries below the minimum rate the employer has established for the position's salary range. Green circle rates are equally as problematic as red circle rates in that they go against the guidelines established. A solution is for the organization to provide employees with green circle rates pay increases to at least the minimum in the range. An exception may be if an employee has been performing below expectations. In this case, the employer may want to consider requiring successful completion of a performance improvement plan prior to receiving a pay increase.

    Step 9: Updating and Aging

    Salaries never remain unchanged. The rate of pay is constantly changing with external market and economic activity. But many companies are not able to afford the cost of several salary survey resources every year.

    Aging is the activity of increasing salary grades with the market. One way to do this is by using the Employment Cost Index (ECI). The ECI is a component of the National Compensation Survey, which is produced by the BLS. It measures changes in the cost of total compensation, which includes wages, salaries and the employer's cost of employee benefits. Another option is to use the annual Cost of Living Adjustment, published each year by the Social Security Administration. 

    In addition, salary survey data should be gathered and reviewed every two to three years so that appropriate adjustments can be made to the organization's salary ranges.