Simply put, a pay approach is the method an organization uses to deliver base pay to its employees. For example: job-based pay, market-based pay, knowledge/skill-based pay, and experience-based pay are all methods of pay delivery. Which one is the right one? Any of them can be a viable method, depending on the organization’s needs and goals. One of the most common methods is job-based pay.
As a general rule, job-based pay doesn’t take into consideration skills/knowledge for assigning jobs to grades. It ties employee pay to the nature and level of a narrowly defined position. Examples of job-based pay include single-rate and step-rate pay, which are defined below.
One of the easiest methods to manage, single-rate pay means each job has a flat rate of pay with no adjustment for an employee’s skill/knowledge, length of service, or performance of the job. Each job has a fixed-rate of pay for all incumbents, though a training rate may be an option with this method.
Changes in single-rate pay are tied to market adjustment or a collective bargaining agreement. This method can work well for jobs that are routine in nature and have a short learning curve or in jobs that have very limited performance variability. Examples include union covered jobs, manufacturing jobs, or sales jobs with a significant commission element.
Step-Rate Pay—Automatic and Variable
Automatic step-rate usually has five to seven steps of pay, each comprised of 3% to 4% increases. It also has a set time schedule with a structure that is updated to maintain market competitiveness. It’s best used when very little performance variation is possible and performance is not measured. Collective bargaining agreements often contain automatic step-rate scales. The downside is that they provide no way to reward employee performance improvement.
A variable step-rate scale has many of the same features as the automatic scale, with the biggest difference being the ability to reward employee performance or increased knowledge.
It allows employees to move across multiple steps within no set time frame. Variable step scales usually have five to 10 steps that are 2% to 5% apart with a performance scale that determines how many steps can be taken at a time. For example:
|Exceeds expectations||Two steps|
|Meets expectations||One step|
|Needs improvement||Zero or one step with delay pending improvement within a specific time frame|
Variable step-rate scales are best used in environments where jobs are repetitive but performance can be measured. The drawback is that they usually offer limited increase amounts or timing choices and, as with most performance-based pay scales, require validated performance improvement (e.g., increased production, sales, etc.).
These two methods are great for standard compensation practices, but sometimes there are other factors that impact pay, as defined below.
A number of hardship situations can result in pay differentials (e.g., additional pay for the same job) such as: shift, geographic, hazard, and expatriate pay.
A shift differential is paid to employees that work outside regular hours (Monday through Friday, from 8:00 a.m. to 5:00 p.m. for office work or 7:00 a.m. to 3:00 p.m. for manufacturing/service businesses).
A shift differential can be a percentage of base pay or a flat rate per hour and this additional amount is considered the norm for employees working evening, overnight, or weekend shifts, which are often harder positions for employers to fill. A shift differential can be a permanent adjustment to base pay. For example, a 10% increase for working second shift. It can also be temporary, such as an increase for all hours that are worked after a specific time of day.
A geographic differential is based on variations in the cost of living or the cost of labor across two or more geographic locations. It fits the pay for a job to the location where the work is being performed and is commonly used for hourly positions.
A geographic differential based on the cost of living is tied to the cost of a typical market basket of goods within that area vs. the same items within another area. When based on the cost of labor, it is tied to the supply and demand for employees.
It can be awarded as an adjustment to base pay or as a supplemental payment to employees. It can also be built into an employer’s job grade structure with separate pay structures for separate locations.
Hazard pay is utilized where the physical or environmental conditions could be considered dangerous to employees or where violence or other dangers are present. For example, employees working around chemicals or in extreme temperature environments often receive hazard pay. Hazard pay is administered much the same as shift or geographic differentials—a premium paid for hours worked in hazardous conditions.
Expatriate pay is provided to employees working assignments overseas to compensate them for any hardship including education for their new home country language for family members or other assignment-specific costs to the employee. Usually tied to the term of the assignment abroad, expatriate pay is temporary in nature and can be an amount added to an employee’s annual base pay.
There are a few things to consider before implementing differential pay, including:
- Does the organization’s competition offer a shift differential? If so, how will it be structured? Will third shift work garner employees a higher differential than second shift work? What about weekend work?
- Does the organization want employees in the same job to be able to maintain a comparable lifestyle across all locations? If so, will the geographic differential be to the cost of living or to local cost of labor?
- Should the company pay a premium for employees working in hazardous conditions? If so, will the company implement a sliding scale based on the level of the hazard?
- What additional costs will expats incur? Will those costs vary depending on the country?
As you can see, there is a lot to think about before an organization commits to a pay differential plan. Is it worth the effort, not to mention the cost, to design and implement such a plan? In my experience it depends on the circumstances, but is usually worth it to maintain competitiveness and recruit and retain the most qualified employees.
NOTE: Information in this article is based on the WorldatWork Certified Compensation Professional (CCP) study guide Base Pay Administration and Pay for Performance. For information on the CCP program click here.