A Crash Course in Key Compensation Metrics
As HR professionals, we may not need to be experts in math and statistics—but most of us need to have an understanding of compensation metrics. After all, understanding the key metrics is a crucial part of managing your organization’s compensation plan.
In this piece, we’ll dive into the eight most common and useful compensation metrics and show you how to apply them in your compensation plan.
1. Pay Range
A pay range is the upper and lower limit of compensation and includes a minimum, midpoint, and maximum.
Why It’s Useful
The pay range is really the starting point for any pay structure. Some companies will build a range for every job, referencing the market value for each and building a range around that market value.
If you have so many jobs that the administration and maintenance of job-based ranges are too cumbersome, you can create job grades and ranges. Jobs with similar internal and market values are assigned the same range of pay and the same grade level. Using this method allows you to place jobs with no market value into the structure, grouped with jobs that have a similar internal value. For more information on building a pay structure, see PayScale’s Leveling Guide.
2. Range Midpoint
The range midpoint is the exact middle of the range, equidistant from the range minimum and range maximum, and aligned to the market value of the job.
Why It’s Useful
The range midpoint is one of the most important details in your compensation plan. If you’re building pay ranges for your jobs, then your range midpoint should be the same as the market value for your job at your target percentile (we’ll explain that in a bit). In a grade or job and range structure, all jobs of similar market value are assigned to a grade with a range midpoint that is closest to the average market value.
The range midpoint is considered the proficiency point for the job. Employees should be hired in at the range minimum and as they gain proficiency, their pay should approach the midpoint. The midpoint should be evaluated annually and is the point in your ranges that you would adjust to keep your structure competitive with your pay strategy.
3. Range Width or Spread
The range width or spread = range maximum – range minimum
Why It’s Useful
The width of the range reflects the extent of salary increase opportunity for the jobs in the range. Wider ranges are usually used for higher level jobs where there is a greater need to differentiate how incumbents in that range are paid. Narrower ranges are more common for jobs where there isn’t a lot of variance in how the market pays for that job and there is less need to differentiate between how incumbents in a single job are paid.
While there is no hard rule on what range spreads should be, it is common to use 30-40 percent for hourly or contract positions, 40-60 percent for entry to mid-level professional or managerial positions, and 60-70 percent for executive positions.
Compa-ratio is one of the most referenced compensation metrics out there. This metric measures the relationship between the salary of an employee (or a position) and the midpoint of the pay range for that employee (or position).
Campa-Ratio = The Salary Divided by the Range’s Midpoint
Therefore, if someone is earning the exact amount of the midpoint of their salary range, their compa-ratio will be 1.0 (or 100 percent).
Anything less than 1.0 means that they’re earning less than the midpoint. Anything more than 1.0 and they’re earning more than the midpoint.
For example, let’s say the range for Sally’s position is $60,000 to $90,000 and the midpoint is $75,000. Sally’s pay is $70,000. Her compa-ratio would be $70,000 / $75,000, which equals .93.
This tells us that Sally is currently earning 93 percent of the midpoint of her salary range.
Why It’s Useful:
Use this metric to see which employees are earning significantly less (or more) than the midpoint of their range, and thus need a raise (or a pay freeze).
When you look at your compa-ratios at the group level, you can start to gain more insight. For example, you can group employees by performance rating and see if your company is truly paying for performance the way you intended. Other useful groupings could be by functional or geographic location.
5. Salary Range Penetration
Range penetration is a compensation metric you should look at in conjunction with a compa-ratio. Rather than just being a comparison to one piece of data (the midpoint), range penetration looks at a salary in relation to the whole pay range.
Range penetration = (Salary – Range Minimum) / (Range Maximum – Range Minimum)
Using Sally as an example again. Her range penetration would be ($70,000 – $60,000) / ($90,000 – $60,000), or around 33 percent. This means that Sally’s salary is 33 percent into her range.
Why It’s Useful
Range penetration could be useful in talking to Sally about where she stands in her range and how much more room there is for her to move up in pay. What determines range penetration is how you’ve set your ranges and how wide they are. You can set one range for every position you have, or set group your jobs into several groups (known as a “grade”) and set a range for each “job grade.”
While range penetration on an individual basis can be useful, looking at where all of your employees fall within each of your ranges can help you determine if your ranges are too wide or too narrow.
Also, you can use this metric to set target levels for different categories of employees. For example, you may say that you want new hires to be within the first 25 percent of the range, and experts or consistent high performers to be in the top 25 percent of the range.
Take Compa-Ratio and Range Penetration With a Grain of Salt
Focusing too heavily on either compa-ratio or range penetration could unintentionally encourage employees to foster counterproductive, negative thoughts. If you only focus on compa-ratio, employees may start thinking “I need to be at the mid-point” or “Why aren’t I at the midpoint?” Instead, you want employees to think about their ability to grow within the organization and move through a range.
On the other hand, focusing too heavily on range penetration could encourage employees to think “I need to get to the 100 percent mark.” Having employees focused on reaching the maximum of their range could set up unreasonable expectations.
6. Target Percentile
Your target percentile is the exact point in the market where you intend to pay proficient employees. When evaluating your pay ranges to market data, the target percentile is what you will compare your midpoints against to determine if your pay ranges are competitive.
The 50th percentile – a favorite among comp professionals- is the exact middle (or median) of the market. Half of companies pay more and half pay less. When someone says they want to “meet the market” they are referring to the 50th percentile. When someone says they want to “lead the market,” they might be targeting 75th or 90th percentile. Anything under the 50th percentile is considered “lagging the market.”
It’s important to note that there cannot be a percentile greater than 100. So if your executives say they want to pay at 105 percent of market, that doesn’t mean the 105th percentile. Instead, what they likely mean is they want to pay 5 percent above meeting the market (assuming that 100 percent is meeting the market).
The market ratio is the comparison of internal pay to the market pay rate for a job.
Market-Ratio = Pay Rate / Market Rate at Your Target Percentile
A ratio of 1.00 means that the employee is paid at the target percentile. Ratios above 1.00 indicate employee pay exceeds the market value for their job and ratios below indicate employee pay is below the market value for their job. For example, a ratio of 1.07 means employee pay is 7 percent above the target and a ratio of .93 means employee pay is 7 percent below the target.
When to Use This Metric
Use this metric to evaluate how closely your organization is paying to where it’s targeting to pay. Most organizations strive to pay the majority of their employees within close proximity to their target percentile, though there are cases where it makes sense to pay employees higher or lower than your target (in the case of newer employees still in training or more tenured employees performing beyond their role).
8. Geographic Differentials
Geographic differential is the percent difference between pay for the same job in two or more locations.
Why The Metric is Useful
Due to the demand for and supply of labor, an employee may be paid more or less depending on where he or she physically works. Generally speaking, jobs in major metropolitan areas tend to pay more than jobs in rural areas, but that is not always the case. Consider that areas which require further employee travel may be compensating people more to get them to make the commute. If you operate in more than one location, it’s a good idea to evaluate the geographic differential between your two (or more) locations and adjust your pay structure accordingly.
As you already know, decisions shouldn’t be made based on metrics in a vacuum. Statistics do not tell the whole story. Rather, they should prompt you to ask questions about your people, your pay practices and whether your overall compensation strategy is still working for you. A compensation strategy should be tailored to your specific goals and needs. Understanding what exactly the metrics are and why they matter is a crucial first step to creating an effective compensation strategy.
This article originally appeared on PayScale.
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