There are remuneration professionals that feel benchmarking and designing pay scales based on basic salary is suitable and defensible. This is an argument that will most probably continue for as long as pay scales are around. Should an organisation base their pay scales on basic salary? The typical consultant answer will be “it depends”.

One needs to take care when designing and benchmarking pay using basic salary. Only when it “makes sense” for the organisation to do so, should you consider using basic salary as the benchmarking component. The issue here is that benchmarking using basic salary is not as accurate as you may think. Using Total Cost to Company (Also known as Total Guaranteed Package) is the appropriate component of pay to use when benchmarking and designing pay scales.

The reason is simple. TCTC covers the entire portion of fixed pay, whereas basic salary only refers to the cash portion of fixed pay. It does not take into account the benefits portion of fixed pay, which can differ enormously from company to company depending on the of the benefits and allowances programme. In other words, it is not possible to compare apples with apples when benchmarking on basic salary.

Note: when it comes to designing pay scales at bargaining unit level, there will be tremendous pressure to use basic salary as the benchmarking component.

You will need to decide where you want to pitch your pay within the market. This will determine the midpoint of your pay scale for each grade. This decision should be based on the company’s business and remuneration strategy. The following considerations are noteworthy:

Lagging the market – this scenario is typical of a company that consciously sets or equates its pay equal to the current market level at the beginning of the year or at the date of annual increase. The reason for this is that the guaranteed fixed pay of the remuneration mix is not considered to position the company competitively in the market. Instead variable pay is used to incentivise a performance driven culture or to drive certain behaviours to align with the business objectives and strategy. In this case variable pay makes up a large portion of the overall pay, meaning that the sum of fixed pay and variable pay positions at a more competitive level against the market. This type of an approach is typically found in companies that are in the growth phase of the companies’ life cycle.

Lead-lag the market – this scenario is typically found in companies that consciously sets or equates their guaranteed fixed pay at the mid-year anticipated or projected market level. The philosophy in this scenario is to lead the market with regards to fixed guaranteed pay, for half of the year and lag the market the other half. The reason for this is to position the companies’ pay levels competitively against the market to attract talent that will drive the sustainable growth of the organisation. This is a typical philosophy and strategy associated with a company that wants to position them against the market at a moderate to aggressive position. This type of an approach is typically found in companies that lean towards the mature phase of the company life cycle.

Lead the market – in the event that the company decides to take on an aggressive competitive position against the market the lead approach requires consideration. This scenario is typically found in companies that consciously sets or equates their guaranteed fixed pay at the anticipated market level. The company will then lead the market until the next year or until the next pay increase date.

Pay Policy Line / Reference Point / Midpoint
The pay policy line is an indication of where in the market you wish to benchmark against. This is normally stipulated in an organisations remuneration policy and philosophy. The definition below provides some explanation:

LOWER QUARTILE – This is the 25th percentile value of remuneration. 75% of the sample receives a higher value of remuneration and 25% receives a lower value.

MEDIAN – This is the middle value of remuneration. 50% of the sample receives a higher value of remuneration and 50% receives a lower value.

UPPER QUARTILE – This is the 75th percentile value of remuneration. 25% of the sample receives a higher value of remuneration and 75% receives a lower value.

The following should be taken into consideration deciding on the pay policy line:

• Current internal salaries’ pay policy line positioning against proposed new pay policy line (based on 50th Percentile);
• Take into account internal employee salaries, but at the same time attempt to come as close as possible to the target market midpoint;
• Affordability / cost to align to the minimum of the pay ranges;
• Strategy to move employees to the minimum of the new ranges;
• How competitive you wish to be against external market and peers?;
• A different midpoint / reference point closer to the internal pay policy line?; and
• Company life cycle.

How Many Pay Scales
When deciding on how many pay scales your organisation requires to consider the following:

• Different target markets. To what market are you benchmarking the organisations internal pay? One needs to consider whether your organisation needs to benchmark to a national market or perhaps a more industry related market.
• Diversity of jobs. It is important to know what jobs you have within your staff compliment. The type of jobs will dictate whether you may require a separate set of pay scales for a specific job that may be industry specific, a short skill or is a key job that warrants a separate pay scale from other jobs. One also needs to consider if there are job levels that will share the same pay scales. Some organisation, for example, split their pay scales according to bargaining unit vs general staff etc.
• Culture of the organisation may affect number of pay scales/structures required.
• Internal equity vs external competitiveness. Separate pay scales may be developed for certain skills / professions / key skills / core / critical skills.
• Industry type. Does the specific industry warrant separate pay scales, for example, core jobs vs support jobs?
• Organisational structure. Pay scales per holding company vs per business units.

Range Spread
The range spread in the context of pay scale is the maximum and minimum cut-off points to which the organisation is willing to pay employees that fall within a specific grade. The range spread will also guide the remuneration team, HR and line management on pay decisions. The width of the range spread will be determined by whether the organisation uses a narrow or broad banded approach.

Midpoint-to-midpoint differential (slope/gradient)
In order to set the midpoint of the pay scales you need to apply the regression analysis to the market data. The reason for this approach is that when you plot raw market data on a graph the market 50th percentile relationship between each of the grades does not follow a smooth regression. It is not uncommon for market data to have a relative degree of volatility with regards to the 50th percentile relationship. One cannot set the midpoint of the pay scale using the raw market data. One needs to apply regression analysis in order to find the best line of fit which is represented as an exponential pay curve. This minimises the effect of market data volatility to set midpoints that progresses smoothly from the lower levels to the higher levels. Take cognisance of the following:

• 16% to 20% is generally accepted and appropriate slope in narrow graded structure
• 20% to 35% generally at executive levels (higher levels). You would find that the slope would be higher due to higher challenges, responsibilities & market value.
• Market competitiveness – align smoothed midpoints as close as possible to the market data
• Company promotion policy i.e. 10% capped increase

It is also not uncommon to adjust the slope to –

• Align as close as possible to the market 50th percentile
• Attempt a pay slope that is reasonably consistent across all levels OR gradual increase towards the higher levels
• To accommodate potential negotiated minimum wage

Range Overlap
Range overlap is an indication of by how much the maximum of the grade exceeds the minimum of the next grade level. Range overlap is a direct function of the pay slope (midpoint-to-midpoint differential) as well as the range spread. The smaller the pay range spread the smaller the range overlap, the wider the pay range spread the larger the range overlap. In addition, the steepness of the midpoint-to-midpoint differential (slope) will determine the range overlap; the steeper the gradient becomes, the smaller the range overlap and vice versa.