Compensation Metrics HR and Managers Need to Know
At a time when the economic fallout from the COVID-19 pandemic is creating uncertainty, it is also flattening wage growth. Open conversations about pay have become much more critical for employee engagement and productivity. In response, many companies are reworking their compensation philosophy and policies or planning to do so. In this article, we aim to provide you with useful compensation metrics to manage these challenges better.
The purpose of this article is not to teach you how to manage compensation. We’ll leave that to compensation professionals. However, with compensation having a pivotal role in your company culture, everyone should understand how compensation works, and conduct a basic compensation analysis.
It is even more important that this information enables managers, HR staff, and others to have critical conversations with employees to help them understand their pay.
This knowledge will make it easier for managers to manage pay on their teams and help their team members understand what they can do to increase it.
What are compensation metrics and formulas?
Compensation metrics are the tools you use to measure, analyze, and decide how effective your compensation practices and policies are and what you can do to improve them. They help you “understand how pay is distributed across your team, so you can make informed decisions that will help you attract and keep employees.”
Compensation formulas help you create effective pay structures and help people within your organization understand them.
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Why should you track compensation metrics?
Knowing the compensation metrics and the pay structures in your company will enable you to:
- Provide compensation packages that support your organization’s objectives and business strategies.
- Achieve a strategic advantage in talent by aligning pay to market realities. Competitive salary affects both your recruiting strategies and your current workforce.
- Create pay ranges or bands to make administration easier.
- Measure pay equity and fairness within teams and across the organization.
- Understand whether you are paying people fairly to help you prevent legal issues related to pay discrimination.
- Remain competitive in how well you attract the right talent.
- Analyze compensation and turnover to see what impact your policies are having on retaining the right employees.
- Retain productive employees, and
- Encourage poor performers to leave.
Useful compensation metrics for your organization
Let’s have a look at the formulas and metrics related to defining pay ranges, applying pay policies, and using metrics to identify areas that need your attention.
Defining pay ranges
Salary or pay bands/ranges rank job pay by experience, education, and level of responsibility.
Jobs with similar rank are grouped into bands, which are typically wider than ranges. They often include smaller market-based ranges within each band.
Pay ranges assigned to classes or groups of jobs provide both consistency and equity across jobs and the flexibility to plan to respond to market conditions.
The first step and best practice in compensation planning is defining your company’s pay policy.
Your company’s target percentile is where you pay employees relative to market rates, expressed as a percentile.
If your policy is to meet the market, your target percentile will be 50. Anything over the 50th percentile is leading the market. Targets below the 50th percentile are lagging the market.
If your policy is to pay twenty percent above the market rate, your target percentile is 20 percent above the 50th percentile. It is the 60th percentile, not the 70th percentile (50+20).
Target Percentile = Market Rate × (1 ∓ Policy Percent)
50 × (1 + 20%) = 60
Your policy defines the midpoint of pay ranges with the target percentile. That becomes the data point your company and your HR team use to assign a value to a job or group of similar positions. A seasoned employee would expect to be paid at or near that rate.
The midpoint of the salary range is a handy tool for managers to explain the progression of salaries and jobs in their development conversations with their team members.
If your policy is to pay below the market, the policy percent will be a negative number.
Leading the market:
Midpoint = Market Rate × (1 + Policy Percentage)
To lead the market by 30% if the market rate for a job group is $46,000:
$46,000 × (1 + 30%) = $59,800
Lagging the market:
To lag the market by 10% if the market rate for a job group is $46,000:
$46,000 × (1 – 10%) = $41,400
Once you have midpoints defined by the policy percentile, the next step is to calculate the spreads.
Salary survey or market data usually show you values for percentiles related to the market rate: 10th percentile, 25th percentile, on up to 90th.
You could define the range minimum as the 75th percentile and the maximum as the 75th percentile. However, salary surveys differ and change frequently. It may be better to define a consistent range spread. Business and Learning (BLR©) offers this example:
- Manufacturing or service jobs – 20% to 30%
- Clerical or technical jobs – 30% to 40%
- Supervisory or professional jobs – 40% to 50%
- Management or executive jobs – 50% or more
Once you have defined the policy midpoint and the spread, you can calculate the range.
Also known as the starting pay point, the minimum is viewed as the lowest value in the scale, typically what you would offer a new employee.
Companies sometimes raise the starting pay point to compete in the local market without adjusting the pay range definition.
Minimum = Midpoint / (1 + (Desired Range Spread / 2))
If your midpoint for a range is $50,000, and the spread is 40%, the minimum will be:
$50,000 / (1 + (40 % / 2) = $41,667 (rounded)
Your compensation and benefits managers usually define pay policy as a percent above the range midpoint.
It is the highest value in the pay range—what your executives believe they should pay the top talent in your organization.
Maximum = Minimum × (1 + Desired Range Spread)
Using the example for the range minimum above, we can calculate the maximum like this:
$46,667 × (1 + 40%) = $58,333 (rounded)
Tip: If you only have the minimum and maximum, you can calculate the spread as a percentage or a ratio.
Range calculations make it possible to create an Excel worksheet that has the information for each range in a group, as in this table: