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How to Ensure You’re Not Overpaying Employees By Market Pricing Jobs

Posted on May 9, 2018
Paul DavisWritten by Paul Davis | Email author

Most organizations that I consult with aren’t trying to play games with how they compensate their staff. Quite simply, they just want to pay their employees fairly and competitively!

While this seemingly straightforward goal is absolutely attainable with a combination of market pricing and sensible HR administration, organizations oftentimes don’t take the proper steps to ensuring they’re paying their staff in a fair and competitive manner that is in line with the organization’s compensation philosophy.

The biggest roadblocks are 1) a lack of role clarity and 2) an unwillingness to use market-based salary survey data to ascertain going market rates for roles.

I’ve already discussed the importance of role clarity in a previous article, so in this article, I am going to talk about some of the in’s and out’s of market pricing jobs, which is really where the rubber hits the road when determining how to appropriately compensate your staff.  (If you’ve seen this referred to in different terms, market pricing jobs in HR-speak is typically referred to as ‘compensation benchmarking’.)

Before I jump into how to benchmark roles via salary surveys, I’d like to go over a quick summary of the cost to organizations of not paying employees correctly.

The Cost of Overpaying Vs. Underpaying Employees

The Cost of Overpaying Employees

The most overlooked aspect of overpaying employees is that the overpayment is typically not a one-time event. Your initial mistake at the time of making an overpriced offer to a candidate can play out across numerous years, multiplying the cost of your error. This sort of error can be even further exacerbated if the employee receives any bonuses that are indexed off of a percentage of earnings and if they receive raises on top of their already bloated wages.

For example, suppose you make an offer to an employee for $80,000, but had you market priced the role using actual market data (i.e. salary surveys) you would have instead made the offer for $73,000. That $7,000 difference could balloon to $28,000 over a mere four years without factoring in annual inflation trends. Imagine what else you could have spent that money on… Now multiply that error across your organization for all of the employees who may be overpaid, and you can quickly start to see the staggering cost savings that you can realize via following HR best practices in reviewing market-based compensation data.

The Cost of Underpaying Employees

You might think that on average your underpayments and overpayments to employees may cancel each other out and result in a net $0. The issue with this line of thinking though is that it is reasonable to assume that underpaid employees will be more likely to leave your organization in search of higher pay elsewhere. Depending on the nature of your industry and the degree to which you invest in your employees, the cost of replacing employees can be quite high. In addition to this, employees who are unhappy with their level of compensation can be less engaged in the work, which has negative consequences to the organization.

We’ve Identified How Important it is to Price Jobs Accurately. Now, How Do We Benchmark Jobs?

In order to benchmark jobs (i.e. determine how much they should be paid), you need to compare the roles within your organization to the external market. Be sure to compare market data that syncs with your organization’s situation in the market. You want to make sure that you are pulling market data for organizations you realistically are competing against for talent.

While not technically benchmarking, I’ve included additional information below regarding the importance of having a compensation philosophy and an internal equity review. This is recommended to be coupled with external market data whenever making compensation decisions at your organization. At the end of the day, you want pay decisions to be: externally competitive, internally equitable, and aligned with your organization’s compensation philosophy.

External Competitiveness

If your organization has a compensation philosophy in place, you should know how your organization pays its staff relative to the market and respective industry. Does your company want to ‘lead’ the market (i.e. target pay above the 50th percentile of compensation), or ‘lag’ the market (i.e. target pay below the 50th percentile of compensation)?

When you benchmark roles, the comparison should be based on the role expected to be performed, and should not reflect anything about the actual individual that’s actually in the role (which comes later).

Market Pricing/Benchmarking Roles

Salary surveys, which are completed by HR/Compensation professionals, are probably the most reliable way of monitoring the ‘market’. Popular salary websites that aggregate salary information based on the title, and not benchmark job descriptions (as is done with reputable salary surveys), inherently introduce methodological errors to the data summarization which can lead to their data being more misleading than informative.

To illustrate this; does your organization have clear naming mechanisms that are applied consistently across all jobs? Even if your organization does do this consistently, I can say from experience that many do not. You have to review compensation based on the description of the role, not the title.

If we can agree that titles are dissimilarly applied across companies, then let’s get out the business of comparing compensation based just on title. This is only one example, but a common disconnect on naming mechanism occurs frequently with sales jobs. There can be two individuals at different organizations in effect performing the same type and level of work, and one is called a Sales Executive and the other is called an Account Manager.

It’s important to consider when market pricing your jobs any number of factors that may weight your organization’s role in a particular manner compared to the market benchmark position.

Internal Equity

Ensuring your organization’s compensation decisions are anchored to market data makes sense, as you compete for talent within ‘the market’. The issue with using market data as the sole factor regarding pay decisions comes down to the fact that it ignores your specific organization’s current compensation landscape and culture. Jobs of similar levels of responsibility and difficulty within an organization should be paid generally the same amount. The exception is with some technical jobs that demand higher salaries due to the nature of the work and the scarcity of talent that drives up the cost such roles. If only external market data is used to inform compensation decisions, you can create a system at your organization that is not internally equitable across functions and can create a host of issues.

HR Best Practice for Reviewing Internal Equity

Compensation decisions at a company are not made in a vacuum, and making decisions which ignore current incumbents and how they’re paid is introducing an unnecessary risk to company morale. Taking internal equity into account when making pay decisions helps organizations avoid issues such as what’s called in the HR world as ‘pay compression’ (new hires being paid close-to or more than more experienced incumbents). It’s great to not have to put out fires because they’re not burning in the first place.

Putting It All Together

Organizations that practice due diligence and HR best practices in market pricing their roles put themselves in a position to remain competitive in their market since they’re not overpaying for their labor. At the end of the day though, just completing a single compensation review and making associated adjustments will create a single point in time when your compensation is set up appropriately for your organization. To ensure that you’re getting the most out of your compensation-related work, you also need to make sure that you have the correct administrative controls in place, and a recurring schedule of market data refreshes so that your compensation administration doesn’t fall into disrepair.

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