Pay Policy Line - The Pot of Gold in Compensation

by David Creelman | Posted | Total Rewards

Pay Policy Line - The Pot of Gold in Compensation

If you are head of the compensation function, how much leverage do you have over the fortunes of the organization? If you do a great job, how much better is that than doing a good job?

A good compensation leader might run the department with slightly fewer headcount than an average one, they may do a better job of managing the relationship with the CEO, or they might create a streamlined compensation system that saves managers time. What’s clear though, is that none of those things has a really big payoff. They are well worth doing, but they are not the pot of gold at the end of the rainbow.

The impact of the pay policy line

So where is the pot of gold in compensation? I would love to hear your ideas, but the one compensation decision that seems to have the most impact is what is often called the pay policy line—in other words are you paying at, above or below the market average. If you could safely reduce you pay policy by 5%; and pay is 60% of your organization’s costs, then that would move 3% of your costs to profits—and that will make your CFO fall off her chair.

Of course, bringing down the pay policy line may not be safe. It may result in serious costs due to problems with retention and candidate quality or stretch the time it takes to fill vacancies in a damaging way. There is a lot at stake and the great compensation leader will spend a good deal of time pondering how to optimize that pay line.

Surprisingly, in my experience, most compensation leaders do not spend a lot of effort figuring out what is optimal.  The decision usually seems preordained to be to pay, more or less, the same as everyone else—or if the company is particularly well off (as the oil companies were when I worked in that industry) to decide to pay better than everyone else. In terms of risk management, that is not a bad strategy. If you think “We really have no idea how deviating from the industry norm would affect us” then perhaps sticking to the middle is the safest strategy.

A deeper analysis of the pay policy line

However, given that the policy line is where the pot of gold is, it would seem to justify much deeper analysis. Here are my thoughts on how to do so:

Segment mercilessly

There are some jobs that are crucial to the success of your organization and it makes no sense to try to save money on these. You need to know which jobs these are. In other jobs, the variation in performance between high and average performers is small, in which case you can afford to hire average performers. It is probably impossible to assess the impact of a change in the policy line on the whole population, but segment by segment you can determine how much room you have to manoeuver.

Think about a suite of coordinated changes to HR practices

A change to reward might only work if we change other things. So if we wanted to cut pay we might have to change our source of hire; if we wanted to increase pay we might have to give more training so the best could really shine. It’s usually the case in all of HR, that changes to one dimension are only useful if you change other dimensions as well.

Gather data and experiment

You might think, “We don’t know in which jobs there is a big variation in performance between average and high performers”—well that’s data to be gathered. Maybe you don’t know if you could attract qualified staff in a cheaper part of the country—well that’s an experiment to be run.

These ideas are at odds with the historic roots of compensation practice. The roots are in a single system for all (not a system focused on segmenting the population), that focuses on fairness (not pay optimization) and follows “best practice” (rather than gathers data and runs experiments). Maybe it is time for a change. Compensation leaders should wonder where the pot of gold is in their work; and whether they have a chance to seize it.

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