28 Dec 2018
Reducing “pay variability” may be one of the most simple solutions to move the needle towards pay equity.
Also published on LinkedIn
It’s no secret that salaries are all over the map often based on a variety of factors, and it leads to widespread pay inequity, a problem that damages employee morale, impacts productivity and affects the bottom line. Now, imagine a system that simplifies the process and reduces the risk of disparity. I’m talking about “rounding.”
First, let’s look at pay equity and the widespread efforts to manage this contentious issue. It has become a hot-button simply because salaries for individuals or groups vary based on no clear, standardized rationale. Compensation experts in the private and public sectors have worked on defining ‘good rationale,’ and there are relevant “compensable” factors that commonly cause pay to differ from one person to another such as education required for the job, experience performing job, etc. The government has tried to untangle the mess many times during the last eight decades with a number of federal laws including the Fair Labor Standards Act of 1938, the Equal Pay Act of 1963, Title VII of the Civil Rights Act of 1964, and the Lilly Ledbetter Fair Pay Act of 2007. Pressure is on… always on. The Office of Federal Contract Compliance Programs (OFCCP) actively reviews corporate pay practices. The legal sector continually presses on with highly visible pay discrimination lawsuits. Recent legal cases include Nike, University of Denver, Google, Tesco, and even the NFL cheerleaders. Recent examples in the eyes of public opinion included the BBC and Carrie Gracie, Sony Pictures and Jennifer Lawrence.
Companies have worked to unpack this problem by reviewing the human behaviors of leaders and the decision factors they apply in determining pay. How do employees negotiate? How do managers make decisions about compensation? What data is provided by experts? How transparent and straightforward are the tools used to make decisions? This all leads to the question of how to facilitate better decision making. At the 2018 Pay Equity Symposium, many senior compensation leaders from companies including Nike, Marriott, Mercer, and Intel presented and shared their efforts to address this exact issue. Most large companies have implemented salary audits, leadership and unconscious-bias training, barring pay negotiations, ignoring prior or current pay in the establishment of starting or promotional pay rates, and a variety of transparent pay initiatives that provide employees with access to see their market data and even their respective placement around their peers. One common approach most companies use to create pay equity includes establishing hiring rates and setting procedures to ensure managers adhere to them. This strategy can reduce the variability of managerial decision making. It’s especially critical when determining starting pay since that often involve the most managerial discretion and hence the greatest chance for disparity. Unfortunately, the risk of variability doesn’t drop by much with this method since experts admitted that managers are clever. Typically, when a manager is pressed to make an offer to a candidate that may fall outside of the hiring rate, managers have found ways to navigate elsewhere. For example, managers have ‘upgraded’ a job or placed a candidate in a different position that may offer the candidate’s desired rate of pay. In these cases, not only is the candidate placed in a job that may be beyond their skill set, but it also creates a new problem of imbalance in a job level. What if companies unpacked the pay equity problem differently and focused on the central issue of variability?
One approach would be to reduce the number of possible salaries by simply rounding. According to Salary.Com, in the U.S., the lowest paid entry-level job is a Fast Food Cook with a salary of $20,561, and the highest paid entry-level job is a Technical Support Representative with a salary of $35,337. Both positions require 0-1 years of experience and a high school education. The difference is $14,776. Therefore, there are 14,776 different ways to be paid for a job with virtually the same requirements. Many experts have justified the differences based on ‘compensable factors’ such as market rate, availability of resources, level of technical awareness, safety risks in performing the job, interactions that may require different communication skills, training cost, and training availability.
In this example, a company could reduce the salary options to 30 versus 14,776 by rounding all salaries to or up to the nearest $500. Imagine if the decision was to round to the nearest $1,000 – reducing the variability between these two jobs to 15 levels of pay. One step further, at the higher salaries, the adjustments could be grouped to $2,000 to $5,000 levels.
The established practice of using a “merit percent increase” could change to using “merit amounts” – multiples of $500 or $1000 base salary increase adjustments. The following chart illustrates five options – (1) traditional 3% merit budget without rounding; (2) rounding all increase amounts to the most adjacent $500; (3) rounding all increase amounts up to the most adjacent $500; (4) rounding all increase amounts to the nearest $1,000; (3) rounding all increase amounts up to the nearest $1,000.
The following charts illustrate the impacts of the above using data from a company with only 80 employees. They currently have 76 unique salaries. If the company desires to significantly reduce their pay variability, they would apply the rounding to $1,000 increments, in this example; thus, reducing their number of unique salaries from 76 to 58, a 24% reduction in variability AND an overall merit increase adjustment of 3%. The impact of the other options are also shown below:
The practice would also offer greater transparency to pay alignment issues. If an employee’s salary is $26,112 and another employee’s salary is $27,897 for the same job, managers regularly focus on balancing the rate of increase of around 3%. At first glance, these salaries look and feel closer together. Yet, the difference is $1,785 which is 6.8% — should managers focus on the merit increase or the pay alignment? When pay alignment is the goal, managers can facilitate better pay alignment decisions if they observe the rates of $26,000 and $28,000 for employees in the same job.
Managers are not compensation experts. They require the right tools and communications to support their effort to recognize and reward their employees. Efforts to date, though, have not worked consistently and broadly. Perhaps, the initiatives implemented are complicated and confusing – clearly, valuable yet difficult to ensure absolute success. Rounding salaries could be a straightforward solution to minimize the resulting degree of variability. Maybe it is time to go after the low hanging fruit, implement a more standardized pay structure, and change the mindsets from valuing the percent increase to a streamlined level of pay.