Pay grades are a fair, effective way to manage your base compensation rates and keep you competitive within your market. But if you’re just starting to implement such a system, you may be confused about where to even begin. You also may find yourself facing employees who don’t fit into the standard pay grades for one reason or another or who have maxed out at their existing pay grade. How do you effectively and fairly manage your compensation program when compensation gets out of alignment?

In a BLR webinar titled "Compensation: How to Effectively Manage Base Compensation with Pay Grades," Dan Kleinman outlined some of the basics and rationale of using pay grades as a path to a fair and equitable compensation structure.

Why Use Pay Grades?

"A couple of idiots can bring down a company if given the managerial authority to act like idiots. Structures often help prevent that, or at least provide a tool to audit behavior and see if managers are effectively managing." When you have a system without structure, it’s often too easy for it to lack direction, which can open you up for litigation if discrimination – actual or perceived – results from that lack of structure and direction.

A salary structure with pay grades and ranges:

• Allows for base salary planning
• Provides both vertical and horizontal perspective, which allows you to ensure your salary structure is aligned with company goals and is equitable across groups
• Visibly reinforces attention to legal concerns such as equal pay, parity, ADA, FLSA, and age discrimination

Building a Rational Structure for Pay Grades

How should you go about building a rational structure for your pay grades?

"Market data has a comparative language, and that language can help us put jobs – particularly benchmark jobs – into perspective." Kleinman explained that formal market data has drawbacks, but it does allow us to compare jobs in terms of purpose, skills and attributes required, previous experience required, and so on.

That said, Kleinman warned that in order to build a rational structure in your pay grades, you need to view market data critically. "Survey companies are in the business to produce and sell surveys . . . it’s in their interest to make you believe that they’re peddling truth, and that the data is clean and pure and relevant, and that the jobs you want answers about are actually in the data."

When looking at market data on pay grades, you should consider:

• Is there a variable component to the job in question? Are there influences of variable compensation on the data you’re reviewing?
• Vertical relationships: is there a meaningful flow upward with related jobs? Sometimes you still have to make decisions around anomalies.
• What are the descriptive qualities of the data? Can you truly compare apples to apples?

These questions may leave you frustrated, because even with a lot of market data the answers aren’t always clear. This is one of the reasons it is a good idea to triangulate with trusted sources, such as the pay history of individuals coming from other companies.

Pay Grade Composition: Why Market Information is Secondary to Internal Factors

"If you consider the perception of fairness to be critical to the viability of your structures, then internal factors were always going to trump what market data implies." Kleinman advised. As you may already be thinking, market data can only get you so far, especially if it is inconsistent with something in your internal structure. "No matter how good the market data, eventually – and more now with hybrid, multi-functional jobs – you’re going to have to value non-benchmarks against benchmarks from a grade and range position."

You should always consider:

• What is the natural progress of vertical movement within your organization--i.e. how much is the pay difference at each promotion?
• Do individuals perceive parity with their counterparts at the same level?
• What are your internal advancement criteria? How much of a pay difference is justified due to the actual change in responsibilities?

Always build your ranges to reflect the reality in your organization.

For more information on creating effective pay grades, order the webinar recording. To register for a future webinar, visit http://catalog.blr.com/audio.

Dan Kleinman is the principal of Dan Kleinman Consulting, a California-based compensation and human resource consulting firm. (www.dankleinmanconsulting.com) For the past 18 years, he has served as an independent consultant for a broad spectrum of regional, national, and international companies, providing compensation, performance, organizational planning, and reward-system design services.