Chapter 21:
Pricing Wage and Salary Structures

Updated as of June 2006

Traditionally, wages and salaries have been set on a barter basis, the fluctuations of supply and demand of some mystic feeling. It became more and more evident that this approach was not adequate. Some more rational and organized system was necessary. Over a period of time, systems for setting wages and salaries were devised to avoid the major drawbacks of individual negotiations.

The purpose of this article is to outline a generally accepted approach to either establishing a wage or salary pay structure or to modify an existing structure to conform to changing conditions. To this end, the steps for achieving a completely new structure have been described. If there is a wage and salary structure in existence requiring only modification, an applicable section is included. The assumption is made that some form of job evaluation or salary determination is available, so that only the bare outline of types of evaluation are presented for clarity. The Employers Group Library contains information on types of evaluation plans.

Every compensation program contains two important elements: internal equity or pay relationships, and external competitiveness. Wage and salary surveys are used to compare the pay of the company to that which is prevalent in the industry and geographic area (labor market). Of the two, the most important for acceptability by the employees is the internal relationships of pay. Significant differences in comparison with pay rates outside the company will also have severe adverse effects on turnover and morale.


Internal Value Relationships

Prior to any proper pricing or placing a dollar value on a company's wage or salary structure, a necessary preparatory step is some sort of internal relationship among the values of the jobs within the organization. It is obvious that certain jobs have more value to the company than others. For instance, a Tool and Die maker is more valuable than a Repetitive Assembler and an Accountant rates higher than a File Clerk. To properly price the pay structure, the relationship in terms of value to the company must be determined. In formal methods for determining this relationship some form of Job Evaluation or Salary Determination technique is used.

Job Evaluation or Salary Determination is a systematic approach in which each position is measured against a standard for each of the main elements common to all jobs. The total values resulting from the comparison of each of the elements determines the value relationship of one job to another. Typical standards, which are used as elements, are the experience and/or educational level required by the job, and the complexity, initiative, responsibility and working conditions encountered on the job. The factors may be further broken into levels or degrees with weighted point values for each level (Point Factor System) or each one compared to the highest demand for the factor within the job structure (Factor Comparison Method).

The most commonly used is the Point Factor System, because it is more readily understood and lessens subjective evaluations. However, either approach provides a more definitive comparison of the internal value relationship than other more subjective methods. The main criticism leveled at these methods is that comparisons are made against elements of the job rather than against the job as a whole.

Less formal job evaluation methods include variations of Job Ranking and Job Slotting. Job Ranking is accomplished by the ranking of each of the jobs in ascending or descending order of value to the company.

The primary criticism of Job Ranking is that while a determination is made that one job is more valuable than another is, there is no quantitative degree of how much more valuable it is. The criticism can be reduced to some extent if an additional degree of value is added. For instance, using a scale of one to ten, a higher degree of value relationship may be established between job "A" to job "B," job "B" to job "C" and so forth. The total of the degrees of value for the jobs in the structure results in a spectrum of job relationships.

Job slotting is a method to select a predetermined number of job groupings, for example, ten groups. Jobs are then slotted into the predetermined groupings based on the relationship of the individual job values to those jobs that have approximately the same value and are assigned the same job grouping.

In any event some form of internal value relationship must be established before effective pricing of the structure can be accomplished. Job value relationships can be expressed visually by placing all of the jobs on a scale in relation to each other.


Points

In the case of a Point Factor Evaluation program the scale is expressed in points, for example, as follows:

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The number of points at which a job is evaluated determines the job's position on the scale.


Order of Ranking

In the case of straight Job Ranking the value relationship may be expressed as follows:

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On the above scale, each vertical mark represents one job. As may readily be seen by this method, each mark is related to the next job up or down the scale by the same degree.


Order of Ranking Additional Value Applied

If an additional degree of value is applied to the Ranking System, the scale might appear as follows:

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As in the previous example each vertical mark represents a job. However, now there is a finer delineation of the internal relationship in terms of relative value to the company. Job Slotting relationships can be illustrated by the following scale:

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Job Slotting – Ten Grades

In the above instance, the jobs are assigned to a grade on the basis of determination of the overall relationship of one job to the others. This method assumes that all of the jobs that fall within each grouping have approximately the same value to the company. Additional refinement is achieved if the jobs within a grade are ranked in the order of their value.

Job Ranking and Job Slotting methods of job evaluation are useful in smaller companies. As the company size and complexity of organization increase, these methods usually give way to the more accurate and sophisticated Point or Factor Comparison systems.


Pricing the Wage or Salary Structure

Before determining the pricing of a new structure or adjusting the pricing of an old structure, it is important to determine the present position of the company's current structure. Before making any decisions with regard to pay, the company should know the resulting cost of such decisions. This can only be accomplished if the company determines the current pay structure. This determination can be made whether or not there is formal structure currently in effect.

 

DETERMINING THE CURRENT WAGE STRUCTURE

Classifying Employees

It is best if the company has a complete and accurate series of job descriptions. Job descriptions covering all of the jobs performed in the company can then be used to classify each employees' work. Unless the employee's work accurately fits the description, the employee should not be classified. If it is found that there are any employees for who there is no appropriate job description, one should be written, titled and evaluated.

For those companies that do not have job descriptions, it is nevertheless, important that each be assigned a Job Title and that each Job Title be assigned only to those employees who are doing that type of work. All employees must be classified by a title.


Scatter Chart and Trend Line

Once all of the employees in the structure under review have been classified and assigned a job title, the company's current salary or wage structure can be established. The first step is to develop a Scatter Chart of the rates currently being paid.

This is done by setting up a graph using dollars on the vertical line and value relationships on the horizontal line. Place a dot for each employee at the coordinate where the employee's currently paid rate corresponds to the value relationship of his job according to the value scale selected for use. (Exhibit 1)


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Relative Value Scale: Exhibit 1

When the Scatter Chart has been completed, including the rates paid in all classifications, draw a straight "line of best fit" through the center of the dots. Usually it is sufficient to use line of sight (approximately the same number of dots below as above the line). Disregard any dots of extreme variance. A mathematically accurate line can be drawn using the ‘least squares" method, but this is quite time consuming and resulting increase in accuracy may not be worth the effort.

Some wage and salary specialists feel that the line should curve upwards at the end of the "curve".Actually the "curve" flattens out into a straight line if the proper value of the standard against which the job is measured takes into account the higher value placed on the upper levels of the scale. The ‘line of best fit" is called the Company Trend Line and represents the company's current "salary or wage curve" or the "rate for the job".

Since there are, by design, roughly the same number of rates above as there are below the line of best fit such a line represents the rate being paid for average performance. If this line were to be retained as the company's wage structure it would probably be used in the administration of wage increases as a central point, although a higher or lower one could be used to accomplish a goal determined by company policy.

 

DETERMINING THE AREA/INDUSTRY WAGE STRUCTURES

Wage and Salary Surveys

It is important to know how the companies pay in the area and industry. This is done through the use of surveys. Some companies, in addition to the surveys available, conduct (or have conducted for them) their own special survey of companies. Frequently, labor union contracts or other companys are used as an additional guide.


Using Surveys Properly

Like all good tools, surveys should be used skillfully, with full knowledge of their capabilities as well as their limitations. A few words of caution should be noted.

  1. In any survey, there is a time lag from when the data is collected to the time of publication.Within this lag, significant events may occur, such as anticipation of wage and salary controls that are not recorded or reflected in the survey data. Also, rapid economic impact on rates being paid can significantly affect the application of the data and those using surveys should be sensitive to the occurrence of such events. It should not be overlooked that future events could have a profound impact on a company's pay structure. These could include such things as anticipated negotiated labor contract settlements, or general increases.

  2. The second area for caution is in the composition of the survey sample. Since it is usually impossible for exactly the same companies to participate each year, there will be deviations that may make trend data and indicators of tendency (Interquartile Range,Weighted Average and Median) suspect if used without interpretation. Of course, the greater the number of participants and employees reported on the jobs in the survey, the less chance there is for data to become inconsistent from year to year. Correspondingly, the fewer the number, the greater the risk of inaccurate conclusions to be drawn from the data. The latter is particularly true of the "telephone survey" conducted by many companies with their direct neighbors or local competitors. An additional factor that should be explored in any survey is the possible "skewing" of information due to the participation of one or two large companies whose incumbents in the positions surveyed may have undue influence on the results.

  3. The third area for caution is that the higher the level of the position surveyed, the less susceptible it is to exact definition of duties. Therefore, achieving direct comparability is extremely difficult. In many instances at the exempt level "the person makes the job" rather than the person fitting into a predetermined set of duties. The greater range of responsibilities in exempt positions blurs the possibility of good comparability.

  4. The fourth area for caution is that there are frequently influences outside of position requirements and performance on the job that come to bear on levels of compensation. These influences include bonuses or incentive pay not reported as base pay, heavier or lighter fringe benefits and scheduled hours of work as an influence on "take-home" pay.


Comparability

One of the more difficult things to achieve in making effective use of survey data is assuring comparability between jobs surveyed and those of the company. The best way to achieve this is to conduct the survey by calling on each company included in the survey to determine areas of difference or similarity in actual practice. Job titles alone can be very deceptive. The second best method of establishing comparability is through a mailed survey, which includes a thorough description of key jobs you wish to survey. Reply data, which deviates significantly from the majority of replies, should be rechecked to ascertain that there is no misunderstanding of job content.

Not all of the jobs in the company are normally used in a survey. Only so-called key jobs in the various levels are used. These are called "Benchmark" jobs, as they are the prime standard for determining the relationship of other similar jobs. The election of the "Benchmark" jobs is usually based on two factors.

Jobs included should be those common to most companies in the area of industry, and the type of work in these jobs should vary little from company to company.

Ideally, the jobs included should represent the company's complete range of jobs in terms of level of difficulty and responsibility to the extent that the data from the "Benchmark" jobs would result in the same "wage curve" as the entire population of jobs. Special surveys may also be conducted to include key jobs that are unique to the industry. Although survey information can form a good guide as to what is paid by other organizations, there is no substitute for good judgment.

 

DETERMINING SURVEY TREND LINE

If the data from a survey conducted by a group outside of the company (such as Employers Group surveys) is used, careful analysis should be made to assure that the positions as indicated by the job descriptions of the survey fit the same positions in the company.Where there is deviation, the data should either be dropped from consideration or the survey jobs should be evaluated using the company's value relationship scale.

A Scatter Chart similar to the Company Trend Line is then constructed by using survey data and a Survey Trend Line is developed. This is accomplished by placing a mark, representing the weighted average or median of the survey data, at the coordinate where the dollar value crosses the value relationship for that particular job. A Survey Trend Line is developed in the same manner as the Company Trend Line, by drawing a ‘line of best fit" (exhibit 2). A comparison is made between the Company and Survey Trend Lines by superimposing both trend lines on the same chart (exhibit 3). This graphically depicts the relationship between the rates paid by the company and those of the area or industry.


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Current Survey Data Possible Decisions: Exhibit 2


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Relative Value Scale Relative Value Scale: Exhibit 3

 

DETERMINING THE WAGE STRUCTURE

Establishing or changing a wage structure is a management decision based on various applicable economic and policy factors. The main factor to consider is the company's ability to pay. If the company's financial condition is such that little or no upward movement of the wage scale is permissible, all other factors are only of academic consideration. In some instances, it is company policy to "equal to or better than the going rates" for their jobs. In others, the decision may be to maintain the current structure with as little change as possible due to the company's competitive position. Decisions are affected by the company's relationship within the area and industry. Ideally, the minimum should enable the company to hire competent employees while maintaining adequate cost controls.

All of these determinations must be kept within limits established by factors outside of management, which affects the structure. For example, as a floor for the lowest paid there are legal minimums established by the state of California and the federal government under the Industrial Welfare Commission Orders, Fair Labor Standards Act, Walsh-Healey Public Contracts Act, and various prevailing wage laws. In addition, availability of applicants in the area may establish a different floor. There is no legal prohibition on the maximum that can be paid unless a wage and salary freeze is in effect. However, past practice within the company, area or industry for the highest rate paid for the most complex job in the organization usually provides the ceiling.

At best, surveys are historical in nature and reflect only what has happened in the area or industry prior to the development of the data. As discussed below, before making any final decision with respect to the company's new wage or salary structure, consideration should be given to known or probable changes that will occur in the next year. Known changes include labor contracts that have been negotiated and which establish definite increases at specified times, provisos calling for a "cost of living" increase under certain conditions and announced projected across-the-board or general increases. Useful indicators or probable changes are projections based on wage trend studies, such as Employers Group publishes, merit increases, general increases, structure increases (published in the September and January Employers Group newsletter and reported in the Human Resources Practices Survey) and forecasts of changes in the Consumer Price Index. Many practitioners of wage and salary administration feel that the movement of structures (maximums and minimums) is the best indicators of change. These may be used with the prior years' data to establish a forecast of the future.

After analyzing the various factors affecting the company's current wage structure, it may be moved higher, lower, remain the same or be given a different slope. Exhibit 3 shows examples of possible different decisions. Decision A indicates the results where a company wishes to pay slightly more than the area to achieve better selectivity of applicants. The company may wish to bring its pay structure up to that indicated by the Survey Trend Line, which reflects current rates being paid in the area or the industry. Decision C evidences a compromise increase, which does not fulfill the entire difference between the Survey Trend Line and the Company Trend Line. Of course, the company may choose to remain at their present level of pay, or in isolated instances may choose to lower the structure as indicated by a choice of Decision E. Whatever the management's decision is, this becomes the New Wage Structure.


Wage Scales

The first decision to be made is the choice between a flat (pinpoint) rate or rate range system of remuneration. A brief discussion of each may be helpful in deciding which is best adapted to a particular company. The flat rate system is older, simpler and easier to administer.

Under the flat rate or pin point system, each employee doing the same job is paid precisely the same rate or salary. To put it another way, the performance of each individual job is held to be worth so much money and the manner of employee performance can have no effect on increasing that amount of money. The diligent, high production employee receives the same pay rate, as does the marginal worker. Labor unions frequently favor this approach.

The rate range system is much more complex in its administration. However, the latter is fairer to the employee, because it permits recognition of and compensation for demonstrated performance and ability on the job.


Rate Ranges

To construct a Rate Range Wage Structure, minimum and maximum lines are drawn above and below the line representing the company's New Wage Structure. The distance (or range) between the minimum and maximum is determined by a management decision. The greater the distance between the two, the more flexible is the wage and salary assignment available. However, the larger the distance provides greater opportunity for inequities of pay to creep in and loss of wage control. Consequently, most companies try to reach a compromise, which will give them the greatest amount of control while at the same time permitting adequate flexibility to reward performance. As a consequence, past practice has established some "guidelines" for achieving this goal. In the "hourly" category, the spread between minimum and maximum is usually between 20% and 33 1/3% of the minimum range, with most companies favoring 20% to 25%.

The salaried non-exempt ranges usually vary from 25% to 40%, most falling in the 25% to 35% area. The exempt structure, due to lack of definition of job responsibility and varied level of performance, usually provides greater level of latitude of movement within the grade, i.e. 30% to 50%.

Once the decision has been made as to the percentage of spread, the usual method for establishing the lines defining minimum and maximum terminal points is by a simple mathematical procedure. To establish the new maximum, it is necessary to multiply the dollar value at the terminal points (X and Y of exhibit 4) of the company's new wage trend line by 100 percent plus one half of the percentage that has been decided upon as the desirable spread. To establish the new minimum, the dollar value at these points (x and y) should be multiplied by 100 percent minus one half the percentage of the spread. This will not work out to a mathematically exact equivalent of the determined spread but is near enough for all practical purposes.

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Relative Value Scale: Exhibit 4

In the illustration (Exhibit 4) X and Y represent the terminal points of the new company trend line. In applying this to a specific situation, X and Y would be expressed in terms of dollar value. Once the new minimum and maximum had been established by formula, a straight line would connect these points.


Labor Grades

Theoretically, each individual location for each classification along the company's continuum of the value relationship scale could have a corresponding dollar value relationship scale. This would result in "penny differentials" between jobs that would be extremely difficult to defend, since no evaluation process is that accurate. To avoid this and to provide a clear-cut line of distinction between levels, the jobs within the range of values are lumped in one group or Labor Grade. The scale of value relationships between the terminal points of the wage structure should be evenly divided by the desired number of labor grades.

The number and kind of labor grades is again a management decision. There are three kinds of labor grades: (1) overlapping; (2) butting; and (3) gapping. (Exhibit 5)

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Labor Grades, Groups or Zones: Exhibit 5

Most frequently in use and utilized here is the Overlapping system.

The number of labor grades is determined primarily by the complexity, variety and number of job classifications involved. Companies have used as few as 5 and as many as 32. For most companies, 10 to 15 are adequate. Flexibility of administration calls for the least number of grades, while control calls for the largest number. In the illustration ten grades are used (Exhibit 6). Those jobs whose value relationships fall on or very near the edges of the labor grades should be reviewed to ascertain into which labor grade the job properly falls.

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Relative Value Scale: Exhibit 6

The mechanics of determining the minimums and maximums for each labor grade are comparatively simple. Once established, the spectrum of the value relationships is divided equally by the total number of labor grades. A vertical line is drawn from below the minimum to above the maximum lines at the termination of each Labor Grade unit. Drawing a horizontal line from the beginning of one labor grade vertical line to the next either will connect with or intersect the maximum and minimum lines automatically establishes the individual Labor Grade minimums and maximums. One of these choices must be made:

  1. Start the horizontal line at the point where the maximum and minimum line intersects the vertical line at the beginning of the labor grade.
  2. Start the horizontal line so that it intersects the maximum or minimum lines half way between the vertical lines separating the grade.
  3. Regress the horizontal line from the point where it intersects the diagonal line at the termination point of the labor grade.

These choices may be illustrated as below:

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As may be seen from above, the first approach provides minimums and maximums that correspond to the lowest rated job in the labor grade, while the second utilizes average jobs in the highest rated jobs to establish the minimums and maximums. All three approaches have been used; however, it seems more logical to utilize average rather than either of the other concepts.

 

COST OF INSTALLATION

The rates actually being paid for the various jobs are superimposed on the New Wage Structure (Exhibit 7). Usually, a limited number of employees are found to be at a rate less than the minimum, some are above the maximum, while by far the majority of jobs are covered by the structure.

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Relative Value Scale: Exhibit 7

Good wage administration requires that no one should be paid less than the minimum of the job, if the employee is performing adequately all of the functions of the job. Consequently, those rates below the minimum, sometimes called "Green Circle" rates, should be brought up to the minimum, to preserve some degree of differential. By totaling the movement of such jobs, the cost of the installation of the New Wage Structure is determined.

That does not necessarily mean that all rates below the minimum should be brought up to it.Many companies provide for a "trainee" rate at less than the minimum, where the employee has not yet achieved a minimum performance level for the position. Usually, in such situations, administration provides automatic increases until the minimum is reached, or if the employee fails to warrant such and increasing work performance, the employee is terminated.

Those employees whose rates exceed the maximum, called "Red Circle" rates, usually remain at that rate until either attrition or planned upgrading can eliminate them, or until the maximum of the structure exceeds the "Red Circled".

 

MODIFYING AN EXISTING STRUCTURE

Trends

Sometimes, due to immediate pressures or circumstance, it is not feasible to have adequate, current survey data available to make a properly assessed adjustment in the wage or salary structure. In such cases, a general increase is granted frequently on one of two bases: an across-the-board increase of a single amount applied to individual rates and to minimums and maximums, or a percentage increase to be applied to all minimums and maximums and to each employee ("Red Circle" rates excepted).

The disadvantage of adding a single dollar amount across-the-board is that it diminishes the rate differential between the lower skill jobs and the higher skill jobs, many times causing internal dissension.

An additional factor is that the amount of increase at the upper level may not seem adequate when compared with the base rate being paid.

If a general increase is deemed desirable because of lack of sufficient survey data to make more accurate adjustments in the structure, it is recommended that a percentage increase be applied to the entire wage or salary structure and to the individual rates within the structure. The main disadvantage of a straight percentage application is that it does not properly adjust the slant of the structure, which may more properly reflect the true situation in the area or industry.

Some of the factors that should be examined in determining the amount or percentage of a general increase are the movement or the Consumer Price Index, wage or salary trend studies, recent labor contract settlements, changes in maximums from previous surveys, unemployment rates and possible implementation of wage-price controls.

 

ANNUAL REVIEW OF STRUCTURE

It is highly recommended that all wage and salary structures be reviewed annually to determine whether the current is adequate for proper administration.

This review should consist of developing any survey data applicable to the specific industry or area in which the company is located, as well as considering survey data developed by others that can affect the pay scales of the company. Attention should be given to the timing of contemplated adjustments and to the release of survey data conducted by others so that adequate information will be available upon which to make a decision. A comparison should be made between the resulting survey structure and the company's structure at that time (see Exhibit 3) if a determination is made that the structures should be modified, the remaining steps should be followed as though a new structure were being installed.

It should be noted that this approach permits the downward movement of the structure as well as up.

Downward movements can serve two purposes: accommodating to a company's internal financial situation while maintaining good internal relationships.

 

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