Although determining an employee’s base pay may seem straightforward, this seemingly simple decision becomes complicated when factoring in the current labor market, internal equity, and your organization’s compensation philosophy and pay practices. To establish base pay while maintaining compensation best practices, consider each of the following:
1. Market position
Establish a well-defined market position based on where your organization intends to fit into the employment landscape. Does your organization need to lead the market—setting pay rates higher than other organizations competing for the same talent? This approach can increase your lure, bringing more candidates to your doors. Does your organization want to keep pace with the market? You will be less likely to lose talent over pay rates and be able to focus on other aspects of your employee value proposition to differentiate yourself from the market. Does your budget or current business state require you to lag the market? If so, you can attract and retain talent based on compelling aspects of working for your organization that go beyond pay. Understanding where you fit in the market will direct base pay decisions and enable you to focus on the appropriate differentiators that will attract suitable talent.
2. Geographic differentials
When hiring from different geographic regions, establish a strategy for how and when pay will be adjusted based on the employee’s work location. Your organization may choose to hire all employees at rates based on the salary data for national averages or the location of your headquarters. Alternatively, you may decide to adjust salary rates to the local rate or only adjust when the work location is required for the position or the local rates are significantly different from headquarters. Many approaches can be taken when applying geographical differentials. Regardless of your approach, ensure it is defined and applied in an equitable manner that adheres to local employment laws.
3. Current market
Many organizations have compensation structures and pay grades that are not keeping pace with the market. Checking market salary rates with each new hire or pay decision can lead to pay inequities and inconsistencies. Instead, ensure base pay is aligned with your organization’s market position and the current labor market. It is crucial to refresh your organization’s compensation structure at least annually. This includes conducting a compensation study to ensure that salary ranges are aligned with current market salary data, evaluating new and revised jobs to verify they are appropriately placed in the salary structure, and assessing if substantially similar positions are placed in the same pay grade to support pay equity.
4. Pay mix
Consider the employee’s earning potential but don’t skimp on base pay. Many employees are applying for or working in roles where they expect a portion of their income from variable compensation, such as tips, commissions, or bonuses. In positions where variable pay is commonplace, base pay may comprise only a portion of the overall pay mix. However, employees rely on base pay to be competitive with the market and will likely feel less secure or motivated in a role where they cannot rely on competitive base pay. When a position comprises both base and variable compensation, ensure your pay mix is aligned with the organization’s pay philosophy and industry practices.
5. Compensatory factors
When an employee is initially placed in their salary range or receiving a pay increase, the pay rate should be informed by compensatory factors relevant to the job. For example, the pay rate when hiring an accountant may be informed by relevant experience, education, and certifications. In contrast, the pay rate for a customer service representative may be informed by relevant experience or specific skills such as fluency in Spanish. Compensatory factors should be applied consistently for employees in the same or substantially similar roles.
6. Internal equity
Beyond maintaining pay competitive with the market, internal equity emphasizes creating equity amongst employees performing in the same or substantially similar roles. Any pay differences for those employees should be based on bona fide factors such as experience, seniority, education, training, or performance rather than differences that occur because of pay practices (or lack thereof) or discrimination. Organizations can avoid unintentional internal inequities by shoring up pay practices, conducting a pay equity audit, and increasing pay transparency.
7. Pay grade placement
Evaluate where employees are placed within their pay grade. For example, consider if employees with less experience and seniority are placed lower in the pay grade while employees with more experience and seniority are placed higher in the pay grade. Consider if employees who are performing well and sufficiently established in their role are near the midpoint of the pay range. When used correctly, a pay grade will typically allow room for growth and tenure in the position without quickly reaching the top of the pay range.
8. Pay compression
Avoid introducing insufficient differences in pay between employees with different compensatory factors or job levels. This often occurs when employee pay needs to be adjusted due to minimum wage pay increases or labor market shortages. Pay inversion is a type of pay compression that occurs when new hires are brought in at a higher rate than existing employees in the same or substantially similar role. Pay inversion is likely to happen when employee pay increases are not keeping pace with rising market salary rates and typically erodes employee engagement and loyalty.
When making base pay decisions, carefully considering these key factors will ensure alignment with compensation best practices and pay equity laws. Most of these factors require forethought and are contingent on understanding your organization’s approach to compensation. However, taking the time to dig deep will attract and retain talent that is a good fit for your business.
Base pay is just one component of a well-thought-out compensation structure that lays the foundation for pay decisions throughout the employee lifecycle. Learn more about the importance of a compensation structure in our article, Why do you need a compensation strategy?