Red Circle Policy: A Penny-Wise Choice for Your Company

After you create your employee compensation policy, you may discover employees within your organization who, rather than being underpaid compared to the market, are actually overpaid. Salary faux pas like this can cost your company plenty of money.  Among the many company cost-cutting ideas out there, implementing a red circle policy is likely your best option in this case.

What Is a Red Circle Policy?

When an employee is overpaid, salary lingo describes their base pay as a “red circle rate,” or a rate of pay that is above the maximum salary for a position. A red circle policy is a common approach to addressing this situation and allowing the market to catch up with the employee’s pay. Once red circled employees are identified, organizations normally freeze their salaries at their current level. In other words, red circled employees will not receive pay increases while their salaries are above the maximum salary range for their positions.

Situations That Usually Call For Red-Circling

It’s possible that employees at your organization have been paid above market rate for many years and, in better economic conditions, business leaders are often reluctant to deal with these situations. But now, more and more businesses are recognizing the need to deal with overgrown salaries. The following conditions often call for implementing a red circle policy:

• Change in market conditions. When your particular industry, or the economy in general, struggles, you may see the market data for positions actually fall lower than previous levels. Especially in industries that are seeing slower or negative growth.
• Employees have long tenure. Your organization may have long-term employees that have received consistent pay increases over time and, through these steady increases, now earn more than the maximum salary range for their position.
• Job responsibilities decrease. It’s possible for an employee’s role to change and their job responsibilities decrease, such as when a client takes their business elsewhere or a project is completed. This change in job responsibilities can occur while this employee still remains in the same job position at the organization. Their salary may need to be frozen as a result.
• Shifts in philosophy. If new leadership takes over the company or current leadership decides to improve upon the current compensation philosophy, new salary ranges may be implemented and lead to red circling for some employees.

Factors Involved in Implementing a Red Circle Policy

Including a red circle policy as part of your overall compensation strategy brings many benefits. It protects employees from alternative, less-pleasant company cost-cutting ideas, like reducing base salaries. Plus, reducing an employee’s existing salary can cause personal hardship for the employee, as well as negatively affect the morale of the organization. Therefore, a red circle policy is often a reasonable cost-cutting option for both employer and employee.
As you apply a red circle policy at your organization, keep the following issues in mind:

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• Be careful. Red circle policies should generally not be used in cases where employee discipline is a factor. This can cause confusion about the issues at hand. Also, use red circle policies with care and in a way that does not discriminate against those that belong to a protected class of employees.
• Try partial application. Partial application of a red circle policy only partially freezes employee salary increases. In other words, you apply the policy to merit-based salary increases, but not to standard cost-of-living or incentive compensations. This more conservative approach may be a good alternative if you’re not comfortable with fully freezing a salary.
• Consider morale. Besides being an obvious cost-saving measure to the organization, red circling can also improve employee morale. Red circling a salary that’s above the range for a job position helps prohibit claims of pay discrimination from employees who are on the lower end of the pay range for their position.

How to Identify Red Circle Rates

The first step in identifying a red circle rate in your organization is to maintain a formal compensation plan that is based on market data. There are generally three sources of salary market data, and ideally you want to have at least two sources to work from that will help improve the accuracy of your results. The three common sources are:

• Published, traditional surveys. These come from the government, associations or consulting firms and offer a broad perspective, though they may not be entirely up-to-date or match your organization’s structure, location or size.
• Internet surveys. Since the advent of Web 2.0, there are now online resources that offer self-reported salary data from employees. These sources are very timely, easy-to-use and inexpensive options for comparison. PayScale is an example of this sort of online tool.
• Custom surveys. Several firms are available who can custom design a survey just for your business. These types of surveys are often very accurate and very expensive.

Using these resources to create market-based salary ranges for every job position in your company makes it easy for you to then identify which workers are above the salary range for their position. You can then red circle their rate, as needed.

Step-By-Step: How to Implement a Red Circle Policy

1. Confirm with your organization’s decision-makers that they will support a policy of red-circling employees who are above the upper end of their job’s salary range.
2. Construct a statement that outlines how you will identify, apply, and maintain red circle rates. Be sure to include the statement in your employee compensation policy.
3. Conduct market analysis in order to create and/or update your formal employee compensation policy.
4. Identify each employee’s pay in comparison to the salary range for their position.
5. Inform the decision-makers of the company of employees that will be subject to red circling, and advise against a “pick and choose” application of the policy.
6. Notify red circled employees with information that clearly explains the policy and how it will affect them.
7. Develop a method for consistently evaluating changes in the market that affect compensation.

Reap the Benefits of Red Circling

While the thought of freezing current employees’ salaries may seem too risky or controversial a move for your company to make, as long as you do it with a high degree of transparency and apply is equally across all departments and employees, it simply makes good business sense. Red circling can help you reach your long-term goals and is worth considering.

For further reading, here is a clip from the Equal Employment Opportunity Commission on Red Circling:

EEOC Guidance:
“Red circling” means that an employee is paid a higher than normal compensation rate for a particular reason. Such a practice does not violate the EPA if sex is not a factor and it is supported by a valid business reason. For example, an employer might transfer a long-time employee who can no longer perform his regular duties because of deteriorating health to an otherwise lower paid job, but maintain the employee’s higher salary in gratitude for his long tenure of service. Similarly, an employer might assign employees in skilled jobs to less demanding work temporarily until the need for the higher skill arises again. As with all factors other than sex, the investigator should determine whether the red-circle rate is consistent with the respondent’s business justification or whether, instead, the employer’s reason is pretextual. If the red-circling defense is satisfied, the employer may continue to pay the employees their original salaries, even though opposite sex employees perform the same work for lower pay.

EEOC Compliance Manual Chapter 10-IV, Section F, subsection E.

Regards,

Stacey Carroll

Director of Customer Service and Education at PayScale.com

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