We’re well into budgeting season, which means it’s about time for many HR and comp pros to start scrambling around to calculate the necessary information for next year’s comp budget. In yesterday’s How-To webinar on budgeting, we got such great questions from attendees that we thought we’d share them with everyone.
For some context, in the webinar we provided some ways to sell the need for a decent compensation budget. From there we overviewed the components of what a typical compensation budget should include.
Then we focused in on 4 key numbers that every base comp budget should include:
- Range Adjustments – do you need to adjust your comp plan ranges, and if so by how much, to stay current to the market?
- Market Adjustments – do you have some jobs that are moving fast in the market, and if so will you do a semi-permanent change (pay range) or a more temporary fix (market premium bonus)?
- Equity Adjustments – do you have any compliance or compression issues you need to fix at the employee level, or other ways that you may not be paying fairly according to your plan?
- Increases – what will you budget for increases to base pay for the year?
We’ve grouped the questions we received from webinar attendees. Hopefully you’ll find something here that answers your question too! If not, feel free to reach out to us.
Terms and System Capability
Our webinar started at the point after a compensation plan exists. As a result, naturally there were some questions about key terms like “market value,” range midpoint,” “range penetration,” and “compression,” which usually get defined during the process of setting up a comp plan. Briefly:
- Market Value refers to how much a particular job would be worth for a specific talent market (industry, size, location, organization type) at a specific or target percentile. In the example above, the market value might be $68,943.
- Range Midpoint is the middle of a pay range; the midpoint typically aligns to the market value for the job. Applying a strategy to the market data helps organizations set the value for their positions, and then build a range to represent that value. In this example, the range spans from $56k-$84k. PayScale’s Insight and Benchmark products can set up job-based ranges with the click of a button based on market data points.
- Range Penetration is how far an employee has progressed through the pay range. So for example $70k is 50% range penetration. Once organizations decide how they value their jobs, based on the market data inputs, individuals are appropriately differentiated along the range by skills, education, performance, etc.
- Compression is most commonly thought of as when a new person enters into the organization at or above the pay of someone who is currently in the same role in the organization. It can also exist when you have two jobs in the same job family with someone in the “lower” job earning more than the person in the “higher” job. There are some families in which this may make sense such as software development where a senior developer may appropriately earn more in base than a manager of the function.
We’ve put together a dictionary of comp terms to help make it easier to talk the talk when you have to.
Market Adjustments Based on Hot Jobs
In this section of the webinar we talked about the fact that some jobs move much faster in the market than others, and some skills have a premium associated with them as well. One suggestion we made to resolve this was to move the range for the job. Moving a range results in a semi-permanent change to expected pay for the job, which begs the question “what happens when the skills aren’t hot anymore?” The less permanent change would be to offer a clearly-articulated, temporary market premium for the position.
One question that came up was whether that premium should be tied to performance in any way. 100% yes. At this point we’re just budgeting. Just because we’ve allowed for that payout to happen, doesn’t mean we’ve in any way guaranteed that it should. The bigger question for me is why would you have a hot job with a low performer in it? If the job is that hot and pay is moving that much for it, consider having stricter performance metrics.
Another question asked when one might use a premium vs moving the range or moving the job to a new grade. For this it depends on the trend. Has the job been moving up in the same direction for 4 quarters in a row? That’s a good indicator for an adjustment that might hit base pay. In the example we shared, we have found that in some jobs there’s a 29% premium placed on pay for those who have Scala skills (a programming language) vs those in the same jobs that don’t. Tech is fast-moving and ever-changing. This may be a better case for a market premium paid out in variable pay vs added to base pay.
One last job-based question that came up was how to account for regional pay differences for the same job. In this case it will depend on whether the job is highly mobile, and whether the location of it is at the company request or more of an accommodation. It’s most common that companies identify the going local market rate for a job and clearly communicate a geographic market differential. Others decide to pay to national rates or to the rate of pay at the HQ or Corporate location.
Base Pay Adjustments for Employees
In this section we talked about the various considerations to keep in mind when deciding to budget for adjustments to base pay for employees. One question that came up, and that often comes up when we talk about pay ranges, is how to freeze pay at the top of range. Should you use the terms “min and max”? Should you freeze pay at all? And if you do, how should you communicate that to the employee.
Unfortunately, there’s no hard and fast rule here. The choices you make are going to depend on your organizational culture, your budget flexibility, and how well you and your managers can communicate the freeze. For some organizations, the Min and Max are absolutes. For others, they have a policy of hiring in the green (below range) for some jobs during an orientation period. Some have a plan that freezes base pay and moves the potential for additional performance-based earning into variable pay. Still others use the Min and Max as “nice to know” numbers, but proceed as usual when employee pay hits the top of the range.
One attendee asked, how do you account for red circle (above range) employees in a budget? It will depend on how you budget (year-over-year or zero-based) and how you decide to handle your red circles. It may also depend on how closely you follow your budget. For some, they allow managers more discretion to allocate their budget as they see fit, so you would allocate a pool of money to that team and let them decide if they want to reward someone in the red. An easy way to do this is to keep the 3% (or whatever amount) in your base pay increases line item, and then for those in the red convert their increase portion to a results-contingent bonus when it comes time.
I should mention, “freezing” pay is language that I would probably not use directly to employees, rather “holding” or “pausing” may convey a less chilly message. Min and Max are pretty common terms to mark the low and high ends of a range. As companies get more transparent in communicating about pay, it’s likely that employees will already be familiar with the terminology.
We talked through using a merit matrix, which allocates increases across a group based on performance and position in range. One attendee asked if there were any guidelines about how much you want to differentiate pay for exceptional vs average workers. The magic number that I’m always aiming to meet or exceed in the top left corner is 7%. This is the number at which employees feel that the increase is meaningful, and the folks who you want to get the most out of their increase are those high performers who fall low or below range. From there, you want to differentiate top from average as much as possible.
We also talked about the different ways to do adjustments for employees: at a focal date (all eligible employees adjusted at the same time) or on the employee anniversary date. For those who do adjustments on the anniversary date, we gave a friendly reminder to be fair when giving out increases. It may be tempting to give lower increases during the times of year when cash is tight and higher increases when cash is flowing, but employees catch on quick.
Another attendee asked about the proper response when someone threatens to leave over pay. How should you handle that? While not strictly a budget question, it bears mentioning at budget time because ultimately it’s the real people situations that create the need for comp budget. So, it is common practice now that employees go to get another offer to negotiate higher pay in their current organization. From there it’s up to you and your organization to decide how you want to handle that situation. First thing to consider is whether they’re a good performer or not. Then, behind their intent to leave is some dissatisfaction with something. While they may be saying pay, consider all the other reasons they may be leaving. If you want to retain the employee, talk about it. If not, wish them luck and let them go.
One last thought on base pay adjustments for employees: once you get to calculating needed adjustments for individuals, take into account prior adjustments you already have planned to see if there’s still a problem. Ideally use a software that allows you to apply scenarios before finalizing adjustments.
Incentive or Bonus Budgeting
At a couple of times during the webinar we talked about the option to switch from a base pay (more permanent) adjustment to a (more temporary) incentive or bonus payout. One thing to consider with this option is that in the US, bonuses are taxed and reported to the IRS at a much higher rate than base pay. So employees will see less take home pay from the same amount allocated via base pay than via bonus.
If you’re thinking about doing a market premium, you could add it as a line item on their paycheck and pay it as a market differential payment, which would alleviate that problem. Then the premium payment is visible and separate from the non-premium base pay, which makes it easier to remove when there is no longer a driving need for that premium.
One attendee asked our opinion about giving year end Christmas bonuses that aren’t performance based? Is it a waste of money? While I mostly think they are a waste of money that could be better spent elsewise and used to reinforce key organizational priorities, there are some things to consider. Are they integrated into the fabric of your organizational culture? If so and you do want to move away from them, spend a fair amount of time with your communication plan.
During the webinar, we talked about a trend we’re starting to see where organizations use the market to drive base pay and performance to drive variable pay. This is another place where, if it fits your organizational culture, it may provide the opportunity to connect results with rewards in a much timelier fashion. One attendee reinforced this trend, and asked, “we are looking at paying for project performance, but it is complicated based on length of project and client payment cycle because we don’t want to pay bonus before receiving payment. Any suggestions?” Great question, as it really digs into the details. One suggestion is to handle the payouts similarly to commissions, which often already have a payment framework in place. That may or may not help, as often commissions are paid out swiftly, but with a clawback in the event that the deal falls through. I’m curious for other suggestions and invite people to share in the comments section.
One Last Question
“Most of these issues seem to be geared more towards larger companies. How can smaller (less than 50 employees) benefit from putting a compensation program in place?” Another great question. In this case, many of the things we talked about do, actually apply to smaller organizations. I find that in smaller organizations, the need for a tight budget are often even more critical, so having a compensation program helps ensure that every dollar spent towards compensation is in some way driving an organizational objective. Here are a few more things to consider in building out your comp plan at a smaller organization. It doesn’t have to be complex, but should definitely start with a philosophy and strategy, incorporate market data, be fair, and get communicated to employees well.
Thanks to all who joined and participated. We’ll have the webinar posted on our site soon. In the meantime, join the conversation below!