Using market-related pay effectively

Setting pay rates according to the labour market may be appealing to many employers, but it can entail a substantial amount of research without any guarantee of success. We consider some of the key issues.

Market-related pay allows employers to set salaries in line with those in the wider labour market. Such a practice is broadly based on the laws of supply and demand: all things being equal, when demand exceeds supply prices rise and where supply exceeds demand they fall. However, as we discuss below, the operation of the labour market, and its impact on both employers and employees, is often more complex than this simple equation suggests.

Indeed, it is arguably both incorrect and misleading to view the labour market as a single, homogenous entity. In reality, it can be a bewildering matrix of often separate but interlinked markets influenced by numerous factors including skills, occupation, location and employee mobility. Clearly, the market for chief executives is not the same as that for domestic and care staff. However, there may be similarities between the market for care workers and that for supermarket checkout staff, particularly within a specific geographical area.

Most importantly, labour markets can be fluid and, as such, employers can find it an onerous, and seemingly never-ending, task to track movements in pay and other benefits to ensure they can recruit and retain sufficient employees of the right calibre.

Remuneration not only factor

Before implementing a market-related pay policy, organisations need to establish what comparisons they want to make when gathering the information necessary to establish a "going rate" for a job or group of jobs. Are they only concerned with base pay, or would a more rounded view of remuneration, perhaps including company car provision and share options, be of greater relevance? While the latter may be appropriate when comparing the overall reward packages of, for example, senior managers, it is unlikely that such detailed information would be necessary when setting a market rate for supermarket checkout staff who are unlikely to be eligible for such benefits.

Further, remuneration, however defined, may not be the only factor taken into account by employees when deciding whether to join, or remain, with a particular organisation. Less tangible benefits such as job satisfaction; the scope for promotion; the availability of flexible working arrangements; the reputation of the employer; and security of employment may be just as important.

In any case, decisions as to whether or not a potential employee decides to join a particular organisation (or stay with his or her existing employer) may be based on the worker's perception of their value to the organisation, and how much they think they can earn elsewhere. This may or may not correspond to reality.

Despite this, there is little doubt that market-related pay is of interest to many employers. In our 2010 annual review of pay prospects, almost half (44.9%) of the 296 respondents said that they operated some form of market-linked wage policy, with a further one in 20 (5.1%) planning to introduce it during 2011.

Deciding on a pay policy

Before introducing market-related pay, employers need to decide on their reward strategy. Do they want to position salaries at the upper quartile for a particular job (the point at or above which the top 25% of salaries for the particular post is located), at the median, or elsewhere? If an organisation paying below what is deemed to be the market rate finds it difficult to recruit and retain staff, the logical response is, all things being equal, to increase salaries sufficient to remedy the problem. However, this may not always be possible as it presupposes that the employer actually has the ability to match the "going rate". If it cannot, it may have to, for example, recruit a lower calibre of employee, or choose to take on less qualified (and so lower-paid) workers and train them. Alternatively, it may choose to offer enhanced non-pay benefits compared with their labour market competitors.

Consultants, salary surveys and other data sources

Employers considering the introduction of a market-related pay policy may choose to benchmark certain key jobs within the organisation and then compare the attached salaries with those elsewhere - perhaps focusing most attention on the rates offered by their closest rivals. Comparisons can be made by company size, region, industry and occupation. Whatever the ultimate goal, information is the key.

It is likely that the type and complexity of the required data will vary according to the nature of the post. For example, details of local terms and conditions for sales assistants may be sufficient, but national (and, in some cases, international) information on the pay and benefits of senior managers may be required.

Some organisations choose to conduct their own pay research, although this may be resource-intensive, particularly where data is hard to come by. In such circumstances, they can turn to a wide variety of other sources. These include:

• Consultants Organisations such as Towers Watson and the Hay Group provide tailored, paid-for, information drawn from their often extensive databases. These firms can provide detailed statistical breakdowns not only of base pay but also other elements of remuneration such as bonuses, company cars and pension provision.
• Salary surveys These are paid-for publications covering specific industries and/or occupations. Commonly, they also provide information on the benefits offered those covered by the survey. When using such reports, employers should take care to ensure that the information is based on an adequate sample, and that they cover the appropriate job titles and occupational groups.

  XpertHR Salary Surveys is one of a number of organisations publishing remuneration data based on payroll data. It allows employers to spot check pay rates using an online job pricing tool, and to complete comprehensive company level remuneration reviews. Surveys are participation-based.

• Pay clubs These are forums where employers meet to exchange information on a confidential and not-for-profit basis. Such gatherings may be based on a specific sector, as is Hotel Employers Group. Alternatively, they can cover certain geographical locations. Club membership is commonly required.
• Other published data XpertHR is one of several organisations producing paid-for information on salary rates, benefits packages and pay settlements. Free sources of data on inflation, earnings and the state of the labour market can be found on the Office for National Statistics website. In addition, limited salary information can also be gleaned free of charge via external websites such as Monster and Jobsite (external websites) or by monitoring recruitment adverts.

It should be noted that different data sources may provide different results for the same or seemingly similar posts - even assuming there is a "correct" single rate for a particular job. This may be due to mundane reasons such as variations in the methodologies used by different organisations. This being the case, employers often find it prudent to use more than one source when seeking to establish a market rate.

Job evaluation

Job evaluation (JE), in the most common use of the term, is a method of analysing and ranking jobs within a particular organisation, and then slotting these into a pay and grading structure. However, other JE exercises have an external focus - identifying the precise nature and content of a particular job so that it can be accurately compared with the same or similar posts outside the organisation to establish a market rate. While this may lead to higher salaries for some employees, it may also create, or entrench, inequality - particularly if equal pay audits are not conducted at the start and conclusion of the JE process.

One of the main advantages of an internally focused JE exercise is that, provided it is carried out correctly, it gives employers a measure of protection against what could prove to be costly equal pay claims. The downside is that it may do little or nothing to help an organisation deal with specific recruitment and retention problems. In recognition of this, many internally focused schemes allow for the payment of what are commonly known as "market premia".

In essence, these are non-contractual and non-consolidated payments applied to certain posts (not individual employees) in cases where it can be clearly demonstrated that there is a difficulty recruiting and retaining employees. The actual level of market premia for a particular post or group of posts is normally established through the same information-gathering mechanisms as outlined above (salary surveys, pay clubs and the like).

Reviewing market premia

However, some labour market problems can be transient. Indeed, one major employer in the publishing sector told XpertHR that, while movement in market salaries is a factor when it comes to making its pay decisions, "significant changes in external market rates are likely to be rare and [market supplements] will only be applied where there is evidence that the external shift is likely to be sustained over time". When premia are paid, they are usually reviewed after a set and relatively short period (eg every two or three years) to ensure they are both a necessary and proportional way of dealing with the problem, and so can be objectively justified. If they cannot, they should be removed to preserve the integrity of a job-evaluated pay and grading system to ensure it does not become tainted by discrimination.

Organisations paying market premia, and who are concerned about the potential impact on the design and maintenance of a non-discriminatory salary structure, can access the Equality and Human Rights Commission guidance.

Employers should not lose sight of the fact that even though market rates can fall as well as rise, it may be difficult to justify the decision to withdraw market supplements, even if such action is necessary to avoid a potential equal pay claim. This may be particularly true if the organisation has no formal, written, policy or procedure on such matters.

The introduction of job-specific, JE-related, market premia is not the only way of using pay to address specific recruitment and retention problems. Location allowances can also be used to deal with labour market difficulties, although these are primarily paid on the basis of geographical location rather than in relation to a particular post or group of posts.

Drawbacks of market-related pay

Having a remuneration strategy based on market-related pay, while appealing to some organisations, does have its drawbacks. Firstly, employers have to find a way of matching a particular job or jobs with other similar (and commonly external) positions so that a meaningful comparison can be made before a market rate can be set. This begs the question of what happens when the going rate is to apply to a unique role that has no direct comparator, neither internally or externally. Further, job titles for the same or similar posts can vary between different organisations, making direct comparisons difficult, if not misleading.

Finally, there is also a potential difficulty for those employers that set salaries as a result of collective bargaining. Trade unions are often opposed in principle to market-related pay as, they argue, it can lead to, at the least, the suspicion that the organisation's salary structures are less than transparent. Indeed, many unions prefer higher pay rates across the board, rather than a market-based approach to wage setting.