Compensation Ratios for HR – Explained!

How competitive are your company’s salaries? How fair is pay among your workforce? A quick way to identify potential problem spots is with compensation ratios.

If you are not familiar with human resources lingo, a compensation ratio is found by dividing the actual salary paid to an employee by the midpoint of the salary range for that job. Here is the compensation ratio calculation:

A compensation ratio is also interchangeably referred to as comparison ratio, comp ratio, or a compa-ratio. Compa-ratio is perhaps the most common.

Your Compa-Ratio is to the Rescue

A compensation ratio is one of the most common metrics for looking at the placement of an individual’s salary within a range. Simply stated, the compa-ratio compares an individual employee’s salary to the midpoint of a given salary range. This easy-to-calculate statistic can be used in many ways to guide decisions about compensation in your organization.

For example, if the midpoint of your salary range is $50,000, and an individual within that range is paid $45,000, that individual is compensated at 90% of the midpoint:

A compa-ratio of 1.0 means that the employee is paid at the exact midpoint of the range, whereas values higher or lower than 1.0 indicate how they are paid above or below the midpoint, respectively. In this example, the employee is paid below the midpoint. Their compa-ratio is .9 (or 90%).

But what does that mean for the employee and for your business?

Compensation Ratio Evaluation Criteria

Does a 90% comp ratio tell us how well an employee is being compensated? How do we know if this ratio is appropriate for a particular individual?

To answer these questions, consider how you intend to use this indicator. Here are a few different types of salary evaluations to which you can apply a compensation ratio in order to get insight on how your organization’s salaries behave.

Determining Salary within a Pay Range

Compensation management professionals use compa-ratios to determine where an employee salary falls within a standard pay range. In many cases, companies assign jobs to a pay grade that has a pre-defined minimum, maximum, and midpoint. A typical range spread of 80 percent to 120 percent is set around the midpoint target for a given pay grade, creating the range for that grade. New hires or recently promoted employees are typically paid closer to 80 percent of the midpoint, whereas the most outstanding performers or longest-tenured employees are paid more, up to the 120 percent of the midpoint, towards the high end of the pay range.

The placement of an employee’s salary, and its progression through the salary range, may be directly related to his or her performance over time. Pay-for-performance plans use annual pay increases to reward top performers, so starting new employees towards the bottom of your pay range for a specific job gives you room to enable pay progression within the range as they perform the job over time.

Many Salary.com customers will create merit matrices to align annual performance-based increases with both employee performance ratings and their individual compensation ratios. A compa-ratio can help assess the distribution of merit increases by dividing an individual’s increase rate by the overall raise rate for that person’s unit. Ideally, individuals who routinely exceed expectations on performance evaluations are compensated such that their compa-ratios advance more quickly.

Comparing Employee Salaries to Benchmarks

You don’t need an internal salary range as a range placement indicator to benefit from compensation ratios. You can also compare your employees’ salaries to appropriate benchmarks from market compensation survey data.

Comparing the salary of your Marketing Manager, for example, to the median salary for companies with a similar job can help you determine how your organization’s pay compares for your industry. Keeping pay competitive with your local pay market can help you recruit and retain talent, and market pricing can help you ensure that you're not over-paying or under-paying your employees relative to your competitors for talent.

To assess your market competitiveness, consider the following. Is your salary range competitive, or is it time to review your compensation policy? Look at jobs and employees with high compensation ratios to determine if they are priced above the market, or if you have high concentrations of top performers in specific jobs. Also identify where you have low comp ratios compared to the market - these might be areas where you're under-paying versus the market, potentially making pay a contributing factor to high turnover.

Compare Employee Salaries to Groups of Jobs

Compensation ratios can also be used with other data sets. You can use them to compare salaries by almost any characteristic you choose, including when you're comparing groups of jobs. For example, you can divide the average pay of one sub-group of employees by the average pay of the larger group of employees to create a compa-ratio that applies only to that team or job family. The possibilities are limited only by your goals.

Do administrative personnel in one unit get compensated less than those in another unit in your organization for similar work? Are salaries equitable across gender or racial/ethnic groups within a job or set of jobs?

Although they can’t tell you why multiple groups of employees are compensated differently, these types of group-level comp ratios can help you quickly assess whether more in-depth analysis of potential problem areas is warranted.

A Comp-Ratio Alternative: Range Penetration

An alternative to compensation ratios called “range penetration” also uses a simple formula that divides the salary rate minus the minimum of the range by the maximum minus the minimum of the range. Here is the range penetration calculation:

For example, if the range is $25,000 to $75,000 and the salary is $45,000, the range penetration is 40%.

This “position-in-range” refers to the position of a pay rate relative to all pay rates in a range. Position-in-range is normally expressed as a percentile, but may be expressed relative to control points (like midpoint or salary ranges).

With the compensation ratio calculations in your back pocket, you are now empowered to better determine the equity and competitiveness of salaries within your organization.