Just discovered that a large portion of your workforce is overpaid compared to the market and not sure what to do? Read through our helpful guide on what can trigger overpayment, correcting the problem, and how to avoid going in the red altogether.
Consider the Cause:
Believe it or not, many organizations face the challenge of overpayment to market. A common culprit is the ubiquitous across-the-board 3% increase. Whether performance-based or framed as a COLA, dolling out a consistent 3% increase without much attention to market trends can put your organization at risk for overspending—particularly if your employees tend to stick around. Even if you are diligent in allocating increases based on merit, if your managers are not calibrated on their performance evaluations, you may find yourself with several departments comprised of “top performers” paid well outside market. Whatever combination of factors are causing your overpayment, it is important to identify them before establishing a plan of attack. Otherwise, you may implement short-term solutions that don’t address the underlying problem.
To Freeze or Not to Freeze:
The most common strategy to address overpayment is to freeze base pay for red-circled employees. Before taking this approach, it’s a good idea to evaluate those in the red to see if there are any trends regarding the employees falling into this category. Are the majority in the same department? Were they all hired around the same time? Do they report to the same manager(s)? If you see a trend regarding which employees are overpaid, take note of it and develop a plan of action to correct the problem. If you find that overpayment is truly across the board, then freezing base pay is a good idea to get your budget under control.
Keeping the Cream of the Crop:
You’re a company of top performers—you hire the best of the best on purpose because you want highly talented people driving your business forward. So how can you possibly freeze pay and expect to keep your all-stars around? Consider offering performance-based incentives to employees in the red as a way to continue motivating their performance without compounding your compensation problem. This strategy is particularly helpful if your company has struggled with performance management and has a lot of “on paper” top performers. Communicating that base pay will be frozen and tying additional compensation to well-written goals will help weed out any red-circled employees who’ve just been dialing it in.
Are all your employees above market because they’re all top performers? Then consider whether your organization really wants to pay at market. Remember—you get what you pay for. If you want top people, then building a market strategy around the 50th percentile isn’t going to cut it. Consider targeting higher in the market for base pay and see if that reduces the number of employees in the red.
Does the idea of freezing base pay seem a little too radical for your company (queue angry mob outside HR’s office)? Consider adjusting how increases are given and allocate more budget to employees who are low to market, which will ultimately leave less for those high in market. Your overpaid employees will still be in the red—you are simply slowing down the rate of their wage growth and your company’s overspending.
Turn Back Time:
What about decreasing base pay? This less-common approach could be adopted depending on the severity of the problem and your company’s commitment to internal equity and market-based pay. In this case, employees above range would have their pay reduced to the maximum of the range and kept there until when/if the market moves for their job. Keep in mind that adopting this strategy can open the door to legal issues and there is a very high risk of turnover, particularly among top performers who are in the red. So it is not typically recommended unless there is a strong policy desire for it.
Staying in the Black:
Even if your employees are currently paid at market, don’t kick up your feet up just yet. Assuming your company’s current compensation status isn’t subject to change puts you at risk for overspending. Instead, consider formalizing pay practices to help ensure pay doesn’t get out of control in the future.
First, consider developing a formal set of pay ranges based on the market. Doing so will provide a framework for how employees in each position can and should be paid.
Second, begin evaluating the career paths that exist in your organization and plan for how rapidly you expect employees to move from job to job and range to range. If you are a relatively flat organization with very little upward mobility, you may want to consider developing wider pay ranges to accommodate employees staying in the same job for longer periods of time.
Third, consider writing up a set of policies (or guidelines) regarding employee movement within a range. For example, new hires should be paid lower in their range then those who have been in the job for a while. That allows your new people to increase their earnings year-over-year without maxing out too quickly. If every employee is hired at the maximum of the range, you’re not providing them much room to grow their wages before being capped.
And finally, make sure to take the time to train your managers—not just on the pay ranges themselves, but on how the ranges should be used and who is eligible for what type of increase. Make sure managers understand the difference between a job’s pay range and a hiring range. And be sure to build in time to have managers calibrate on what is considered great performance, good performance, or bad performance. Doing so will help make sure you continue to allocate larger chunks of your budget to the right people (leaving less for underperformers).
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