Variable pay incentive bonuses are becoming a larger part of employee compensation, but that doesn't mean organizations can ignore their base pay salary structures.
Before paying bonuses, organizations "must first have appropriate base pay as an anchor," said John A. Rubino, founder and president of Rubino Consulting Services, a global HR consulting firm based in Pound Ridge, N.Y. He spoke June 14 at the SHRM Annual Conference & Expo 2022 (SHRM22) in New Orleans.
This year, salary budgets in the U.S. have been increasing, on average, by around 5 percent to 7 percent, up from around a 3 percent average increase over several years prior to the pandemic. These increases represent "growth in fixed expenses that compound year after year" as employees receive annual raises, Rubino said, highlighting the need to get salary-setting right.
Salary structures should be appropriate for the organization, flexible enough to respond to future developments and legally defensible, Rubino said. They should align employees' efforts with business objections while serving to attract, retain and motivate workers.
Base Pay Strategies
When structuring pay, the initial decision is whether to give primacy to internal evaluations of a position's value to the organization or to market-based pay rates, which reflect supply and demand, Rubino said during the concurrent session "How to Create a Motivational Total Cash Compensation Program (Base and Variable Pay) for Your Organization."
"Organizations care about pay equity and have a hierarchy of values. Markets don't," he said. "Companies need to decide which approach is going to be primary" when creating salary structures.
Rubino favors determining internal equity first by considering intrinsic factors that add value to the organization, then folding in market data. But some organizations prefer to begin with market pay rates and then adjust with job content data based on internal evaluations, he noted.
Either way, compensation managers should define relevant labor markets for determining comparable pay rates by looking at factors such industry, organization size, revenue and geographic location.
[SHRM members-only how-to guide: How to Establish Salary Ranges]
Job descriptions should be in a standardized format and be reviewed annually to keep them up-to-date, Rubino emphasized.
Determine the organization's benchmark jobs—easily identifiable positions such as "financial analyst"—to serve as the anchor points in pay structures. At least half of the jobs in an organization should be identified as benchmark jobs, Rubino advised.
When sourcing market rate data for benchmark positions, participating in surveys published by third parties can bring costs down. Customized pay surveys have higher costs but higher reliability, as well. Online data that is free and based on input from site visitors can be fun for potential job candidates to peruse "but unreliable for building pay structures, no matter how insistent job applicants are that they found the appropriate pay for the spot they're applying for on one of these sites," Rubino noted.
Job Evaluation Methods
Another key decision for compensation managers is choosing an appropriate job content evaluation method, leading to the creation of a hierarchy of job positions. Popular methods include ranking, classification, job component and point factor.
[SHRM members-only toolkit: Performing Job Evaluations]
Regardless of the method applied, the data from job content evaluations can be used to assign job grades "using professional judgment with an underpinning of mathematics," Rubino said.
Next, develop pay ranges, again referring back to the underlying pay strategy decision regarding whether internal evaluations or market rates will be the primary consideration. Set pay policy by determining whether the organization will align pay more closely with market rates, pay above market such as at the 75th percentile, or pay below market, perhaps at organizations where other factors—e.g., mission or generous benefits—take precedence over cash compensation.
Variable Pay Rewards
With a solid base pay structure, organizations can consider Rubino's advice for developing a variable pay program.
More organizations are removing performance considerations from base pay increases, "redefining salary increases as across-the-board market adjustments only—determined by competitive position analyses—and rewarding individual performance within a variable pay framework," Rubino said. This reduces the problem of salary increases compounding annually, which can lead to "exponential growth in fixed pay costs," he noted.
Variable compensation is paid in lump sums only when performance warrants, he explained, considerably reducing ongoing fixed expenses.
Variable pay can more easily reward the extra value employees add to organizations during a given quarter or year. The reward is also viewed as more tangible.
"A 3 to 5 percent base pay increase spread out over 23 pay periods per year, minus taxes, may not seem like much of a motivator, compared to a $5,000 incentive bonus lump sum," he said.
Explain Pay-Setting to Employees
Compensation plans should be explainable to employees, "not a 'black box' that leads employees to assume they're not being fairly compensated," Rubino said during a June 13 SHRM22 concurrent session, "Communicating Successfully with Your Global Workforce: A Proven Methodology."
"You can't motivate with pay if employees don't understand how pay is determined," he noted.
Employees, Rubino said, "may feel disconnected from their organizations "when they don't understand how their reward programs work, the relationship between performance and pay, and what they need to do to get the rewards and recognition they feel they deserve."
When communicating about pay ranges, organizations should consider providing written materials with a detailed explanation and examples of the compensation plan and how pay rates are determined, he advised.
Employers also can hold training sessions for managers and employees to help them establish performance goals and behavioral guidelines tied to merit pay increases or variable pay bonuses.
Organizations can provide additional information and give employees an opportunity to ask questions through online resources and webcasts.
Related SHRM Articles:
2023 Salary Budgets Projected to Stay at 20-Year High but Trail Inflation, SHRM Online, September 2022
High Inflation Means Resetting Pay Strategies, All Things Work, June 2022