A pay philosophy is a company's commitment to how it values employees.
A consistent pay philosophy gives the company and the employee a
frame of reference when discussing salary in a negotiation.
The goal of a pay philosophy is to attract, retain, and motivate
employees. For companies in the private sector, this usually requires
a competitive pay philosophy. For companies in the public sector,
this means a well-rounded philosophy, with a focus on benefits and
Companies attract, motivate, and retain through total compensation
The purpose of a good compensation philosophy is to attract, retain,
and motivate good people. To accomplish these goals, companies use
a mixture of the three main components of compensation: Base pay,
also called salary; incentive pay, whether in the form of cash or
non-cash award such as stock; and benefits, or non-financial rewards.
A pay philosophy is a blend of all three, since the company must
pay for whatever it delivers to employees.
For example, a company's pay philosophy might be to offer salaries
that are competitive in the market, or it might favor pay that is
structured to attract employees rather than pay that helps to retain
them. But few companies can afford to attract, motivate, and retain
via generous compensation. The challenge is to create a pay program
that acknowledges all three goals without exhausting resources.
As an example, suppose a small company with moderate cash resources
is establishing a pay philosophy. The philosophy might look something
Pay a competitive base salary - not an aggressive one, but a
salary comparable to what an employee could get somewhere else.
Offer equity in the company to all employees, so that they can
reap the rewards of the company.
Be aggressive in total overall compensation through the use
of the incentives. If, for example, an employee is below market
by $20,000 in base pay, deliver market parity via a $5,000 signing
bonus; a $5,000 retention bonus; and a $10,000 incentive. Incentive
programs should be designed so that high-performance people get
Lead-lag, lag-lead establishes timing of adjustments
Most companies review salaries once or twice a year, but the market
moves continuously. Therefore, a company's pay is likely to be at
market value just once or twice a year, similar to the hands on
a broken clock, which only tell the correct time twice a day.
As a consequence, companies must decide what time of year to offer
raises, and whether to lead the market at the beginning of the year
and lag behind at the end of the year; or to lag behind at the beginning
of the year and lead at the end. These two approaches are called
lead-lag and lag-lead.
Employee proficiency ties skills to market value
Some pay philosophies track the development of skills that lead
to proficiency in a job. The more proficient an employee becomes,
the closer to market value he or she gets. This is a way of paying
according to a market based on the value of skills.
Paying for employee proficiency is in contrast to paying for longevity,
which has fallen out of favor in many industries but prevails nevertheless.
The formula for employee proficiency involves calculating a comparatio
- the employee's salary over market, defined as the median or some
other control point. For example, if an employee earns $45,000 and
the median for that job is $50,000, the employee has a comparatio
of 90 percent.
An employee who has lingered at a comparatio of 90 percent is at
risk of leaving the job. If the company is interested in retaining
the employee, it won't cost much to bring him or her up to market.
If there is a reason the company doesn't want to pay 100 percent
of market for this job, for example if the employee is not yet fully
proficient in the job, it might still make sense to pay the employee98
percent of market. In the example above, the company would pay $4,000
more to their current employee, who might well merit the full $50,000
anyway, to insure against the cost of hiring a new employee.
There are several advantages of the pay-for-proficiency method.
Because pay is tied to the market value of a job, employees don't
get stuck with merit increases of just a few percentage points a
year. Because the market value of a job is tied to skills, the conversation
about compensation can begin from a level playing field: An assessment
of how the employee compares on each of a number of measures of
proficiency and skill.
Proficiency is not the same thing as performance. Someone who is
not yet proficient at a job may still be learning some of the basic
skills, especially after a promotion. Yet the employee's performance
may exceed expectations. Poor performers do not deliver on the expectations
of the job, and companies do not typically retain these employees
As employees become proficient in their jobs, it is important to
keep them moving to the next level. Otherwise their pay will stagnate
and they may become unmotivated or look elsewhere for a new challenge.
Program should be carried out consistently
By law, pay practices must be consistent, must not discriminate,
and must not be arbitrary. Yet a pay philosophy may include different
approaches for different types of employees.
For example, a company might decide to pay a competitive rate for
most jobs and an aggressive rate for jobs that are especially difficult
to fill and important to the bottom line. Such a company might pay
its executives and its sales personnel at the 75th percentile and
the rest of its employees at the 50th percentile.
A philosophy applied inconsistently can devalue employees and lead
to trouble. For example, suppose a company established a flat rate
of $9.90 per hour for nonexempt employees in a customer service
role. The department had 200 percent turnover. Despite the published
flat rate, some employees with college degrees successfully negotiated
for $10 per hour or more, while employees with 20 years of experience
faithfully assumed the flat rate was non-negotiable. Soon, three
women over 40, a protected class under age discrimination laws,
were earning less than three men who had just graduated from college.
The manager's defense when confronted with the disparity was that
the women never asked for more.
Legal cases involving such discrepancies often center around the
principle that it is more egregious to violate and be inconsistent
with your own pay practice than it is to follow the law. In this
example, correcting the discrepancy could cost the company tens
of thousands of dollars. If the money isn't in the budget, the department
could be forced to lay people off or freeze salaries.
Communication is part of retention
Employers benefit from communicating their pay philosophies to employees,
because a sound philosophy consistently applied creates a sense
of fairness. Some companies advertise their pay structure as a recruitment
and retention strategy. If a company publishes its pay philosophy
anywhere, it should also tell any employee who asks.
Job candidates should also be aware of a company's pay philosophy.
If a company doesn't have a pay philosophy, it will be easy to tell
during the salary negotiationSome companies even publish the philosophy
in an employee handbook, and show employees where they are in relation
to market. It makes more sense, during a salary negotiation, for
an employer to say, "My final offer is $67,000, which is 100 percent
of market," than it does to say, "My final offer is $67,000, and
I can't pay a cent more." Can't usually means won't.
It can be to a company's benefit even to communicate a two-pronged
pay philosophy where some jobs are compensated at more than the
market rate. For example, one company with high turnover in its
customer service department, a department critical to the company's
success, decided to compensate customer service representatives
above market. Customer service people got better work spaces, incentive
plans, and higher-than-market base pay. In communicating this change
in philosophy to all employees, the CEO spoke candidly about the
business reasons for the philosophy and the value to the company.
Some employees thought the change was unfair, and left the company.
But others respected the CEO for his honesty and fairness, and stayed.
It became easier to hire and keep personnel for customer service
jobs, and the plan succeeded.
Start the dialog, involve senior management
If you have questions about the philosophy behind your compensation,
ask your human resources department for a copy of the company's
pay philosophy. This should show you the link between your pay and
the company's overall compensation principles.
If your company does not yet have a pay philosophy, suggest that
the human resources department establish one. Employees need to
see the connection to understand their value. Pay philosophies are
important for companies of all sizes and stages because without
them entrepreneurs could end up underpaying or overpaying for employees.
Both problems result in a cost for the company, either in turnover
or high salaries. In most companies, a human resources person takes
responsibility for compensation; in a small company, the CEO might
become proficient in the principles of compensation.
When a new company is establishing a pay philosophy, senior management
must be involved, and the philosophy must be strongly aligned with
company objectives. The CEO and other senior management must understand
the program, agree to it, and support it consistently in order for
the effort to be successful and worthwhile.
Erisa Ojimba, Certified Compensation Professional
- Modified 11-15-2004