COMPENSATITION MANAGEMENT

LESSON 6:
INTRODUCTION TO WAGE DETERMINATION PROCESS
AND WAGE ADMINISTRATION RULES

Learning Objective When this is hard to do directly, the person compares his or her
• To know the Factors Affecting wage determination process I/O ratio with some other I/O ratio. Anything the person
perceives as relevant goes into these input and output consider-
• To understand the Wage Determination Process
ations.
• To know the Concept of Wage Surveys
Inputs and Outputs
• To understand the Preparation of a Wage Structure
Compensation decisions often focus upon the value of the job,
Introduction to Factors Affecting Wage both in the marketplace and within the organization. Although
Determination Process these are critical input factors, neither organizations nor
Individual Wage Determination individuals would be satisfied by making the employment
From the viewpoint of the employee, the end product of any exchange solely on this basis.
compensation program is a paycheck. The decision regarding the To explain, compensation inputs can be classified into three
type of salary administration and/or structure system to be general areas:
used do not, by themselves, deliver a paycheck to the employee. • Job;
The wage determination must be personalized by making a • Performance; and
further set of decisions.
• Personal.
The first compensation decision, the wage level, is an external
Pay system decisions must incorporate the performance and
organizational decision that determines the organization’s
personal factors into compensation, in order to provide a
competitive posture toward its human resources.
regular paycheck perceived as equitable to the employee.
The second major compensation decision is an internal
organizational decision involving the structuring of the jobs Equity as a Cognitive Process
within the organization. Experiencing equity is a cognitive process. People’s perceptions
determine whether their pay situation is equitable. Not all
Putting these two decisions together in a wage structure
individuals within an organization are likely to perceive their pay
provides the wage or range of wages that the organization
situation the same, nor is the organization (through its
perceives as equitable for each of its jobs. Although pay rates are
management) likely to see the situation the same as the
determined for jobs, it is people who receive paychecks.
employees. This makes the creation of equity in the organiza-
So the next decision to be made is whether all people on a tion a difficult and recurring problem, not one that is
particular job are to receive the same pay or different pay; and if determined once and for all.
different, on what basis and how? These are not trivial ques-
tions. Influence
Organizations are not powerless in this cognitive process. They
The great majority of workers are paid through systems that
can influence the perceptions of the person in a number of
provide for variable payment for the jobs. Such systems reflect
ways.
the realization by management and employees that it is
important to reward more than just minimal performance on First, they can define clearly the inputs required of the person.
the job. This allows the person to accept or decline the exchange in the
way that a student stays or leaves a course after the professor
Thus management seeks to reward performance through merit-
hands out a syllabus.
based and incentive pay systems, while employees and their
unions seek to have learning, proficiency and seniority rewarded. Second, organizations can affect (through communication and
influence) the inputs and outcomes the person focuses on.
The Decision to Participate Third, they can make certain responses to inequity more likely to
The decision to participate assumes maintenance of an equilib- occur than others. If an organization wishes to retain people, it
rium between the inducements the organization offers and the may make quitting an unattractive way to solve feelings of
contributions the person is asked to make. The organization inequity.
must maintain, as a minimum, a balance of these two in the
mind of the person, and, more realistically, a balance in the The Decision to Produce
person’s favor. D. Katz claims that organizations seek three things from
The ideas of J. G. March and H. A. Simon have been translated employees:
into equity theory. Pay system decisions can be regarded as 1. Membership,
focusing on individual equity. Equity theory states that a person 2. Role behavior and
compares his or her “inputs” or contributions with the
“outcomes” from participation (I/O ratio).

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34 11.622.1
3. Innovative and spontaneous behavior. Membership appraise whether these outcomes have occurred. In short, the

COMPENSATITION MANAGEMENT
includes remaining with the organization and being present definition of performance is difficult in and of itself.
for work regularly. It provides consistency to the The individual must understand what is requested and see its
organization’s labor force and reduces staffing and training connection with the reward. This, like all understanding based
costs. on communication, is hard to realize perfectly. Most organiza-
Role behavior consists of doing the job as it is described and/ tions claim they have a merit system of pay, but most
or assigned. This is also needed for consistency and coordina- employees do not perceive that merit is the primary basis on
tion of activities within the organization. To the extent that role which pay adjustments are made.
behavior is explicitly spelled out and is seen as the basis for the In some cases this perception is valid in that the organization
person’s input to the organization, this requirement is also says it uses merit but does not; in other cases the organization
covered under the decision to participate. is rewarding merit but is not accurately communicating this fact
However, not all required role behavior is easily spelled out in to the employees.
jobs, and all jobs have areas of discretion that allow the person
The Performance-Effort Connection
freedom in accomplishing tasks.
People must feel that their efforts will affect their performance.
Innovative and spontaneous behavior addresses the This connection may seem obvious but it is not. There are
organization’s need for the person to adapt what he or she is many jobs in which variations in performance are impossible or
doing, and how it is being done, to the constantly changing inconsequential. To try to connect performance to reward in
circumstances within the organization. Clearly this requirement such jobs frustrates the incumbent.
is not covered in the decision to participate.
Also, individual effort is not a useful gauge in the many jobs
The decision to produce, then, moves the person beyond the whose tasks take two or more people to accomplish. Finally, the
minimum required just to maintain membership. It is what effort-performance connection highlights the fact that the
most managers call motivating their employees. A useful person must perceive that he or she can adequately perform the
framework for this decision is provided by expectancy theory. task.
This theory has three basic parts: All of these subjects should be taken into account in designing
1. Valence, a pay system (and will be taken into account in some manner,
2. The performance-reward connection and even if by the default copying of some other organization’s
design and definitions).
3. The performance-effort connection.
The Wage Determination Process
Valence
Usually, the steps involved in determining wage rates are:
In expectancy theory valence means the strength of a reward.
performing job analysis, wage surveys, analysis of relevant
Does the person want the reward the organization is offering?
organizational problems forming wage structure, framing rules
Since our subject is pay, we can be confident that the answer is
of wage administration, explaining these to employees,
yes – but not the same size yes for all people. People differ in
assigning grades and price to each job and paying the guaranteed
how valuable money is to them compared with other things on
wage.
and off the job.
Content theories help us understand how people’s need for
money may be very different. The advantage of pay as reward,
though, is that it is seen as a path to many different types of
need satisfaction.
How much increase or difference in pay does it take to make the
person respond?
This is the difficult question of the proper size of a meaningful
pay increase. The organization must worry not only about
whether pay is a motivator but also about whether it is offering
enough to make it worthwhile for the person to produce
beyond the minimum.
The Performance-Reward Connection
This may be the most important part of the decision to
produce, since if the individual does not see the rewards he or
she wants as being contingent on the behaviors or outcomes Fig.1 Steps Involved in Determination of Wage Rate
the organization wants, then the organization is not likely to
obtain those outcomes.
The Process of Job Analysis
Results in job descriptions which lead to job specifications. A
This connection would seem to be obvious, but in fact it is not. job analysis describes the duties, responsibilities, working
Managers find it difficult to always define the results and conditions and inter-relationships between the job as it is and
behaviors they desire. Also, it is difficult to measure and/or the other jobs with which it is associated.

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11.622.1 35
 It attempts to, record and analyze details concerning the evaluation, whether the organization would recruit new
COMPENSATITION MANAGEMENT

training, skills, required efforts, qualifications, abilities, experi- employees after revised wage structure; are the prevailing rates in
ence, and responsibilities expected of an employee. After industry or community inconsistent with the results of job
determining the job specifications, the actual process of grading, evaluation?
rating or evaluating the job specifications, the actual process of What will be the result of paying lower or higher compensa-
grading, rating or evaluating the job occurs. tion; and what should be the relationship between the wage
A job is rated in order to determine its value relative to all the structure and the fringe benefit structure? Belcher has listed 108
other jobs in the organization which are subject to evaluation. variables which can affect levels of compensation and the wage
The next step is that of providing the job with a price. This structure
involves converting the relative job values into specific monetary
Preparation of Wage Structure
values or translating the job classes into rate ranges.
The next step is to determine the wage structure. For this,
Wage Surveys several decisions need be taken, such as:
Once the relative worth of jobs has been determined by job a. whether the organization wishes, or is able, to pay amounts
evaluation, the actual amounts to be paid must be determined. above, below, or equal to the average in the community or
This is done by making wage or salary surveys in the area industry;
concerned.
b. whether wage ranges should provide for merit increases or
Such surveys seek to answer questions like what are other firms whether there should be single rates;
paying?
c. the number and width of the ‘pay grades’ and the extent of
What are they doing by way of social insurance? overlap;
What is the level of pay offered by other firms for similar d. which jobs are to be placed in each of the pay grades;
occupations? etc, by gathering information about ‘benchmark
e. the actual money value to be as signed to various pay
jobs’, which are usually known as good indicators.
grades;
There are various ways to make such a survey. Most firms either
use the results of “packaged surveys” available from the
research bodies, employer’s associations, Government Labour
Bureaus, etc., or they participate in wage surveys and receive
WAGE LINE
copies of results, or else they conduct their own.
WAGE RATES

These surveys may be carried out by Mailed questionnaire,

telephone, or personal interviews with other managers and
personnel Agencies.
A wage survey to be useful, must satisfy these points:
(a) Frequency
Affected by rapidity of changes, current and contemplated. Once Plotting jobs on a curve (Some points fall
per year is common. well off wage line)
(b) Scope (number of firms)
Influenced by the geographic area from which people are drawn, f. differentials between pay plans; and
the number of units competing for this labor, accuracy require- g. what to do with salaries that are out of line once these
ments, and willingness of organizations to share information. decisions have been made.
(c) Accuracy There are though no hard and fast rules for making such
The diversity in job titles and specific job duties is staggering. decisions, and procedure commonly used is the two-dimen-
The greater the accuracy and detail needed, the greater the sional graph on which job evaluation points for key jobs are
requirements for careful description and specification and plotted against actual amounts paid or against desired levels.
surveyor’s reliance on person-to-person ‘interviewing rather
Plotting the remaining jobs then reveals which jobs seem to be
than mailed questionnaires.
improperly paid with respect to the key jobs and to each other.
Such wage surveys provide many kinds of useful information
In the above figure, wage rates are shown on the vertical axis
about differences in wage levels for particular kinds of occupa-
while pay grades (in points) along the horizontal axis. The
tions. This can have a great influence on an organization’s
‘wage curve’ shows the relationship between:
compensation policy.
i. the “value” of the job; and
Relevant Organizational Problems
ii. the “average wage rates” of these grades (or jobs).
In addition to the results of job analysis and wage surveys,
several other variables have to be given due consideration in The following steps are involved in drawing a wage curve:
establishing wage structure. 1. Finding out the average pay rate for each pay grade, for each
For example, whether there exists well-established and well- pay grade may have several jobs and chances are that each of
accepted relationships among certain jobs which can upset job these jobs is currently being paid a different rate.

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36 11.622.1
2. Plotting the wage rate for each pay grade. or the sales girls in a department store or the stenographers in.

COMPENSATITION MANAGEMENT
3. Drawing “Wage Lines” through the points plotted. These an office (Social custom).
lines may be straight or curved; if the pay grade comprise a Certain job clusters may be more closely related to some rather
single job cluster, a straight line is usually employed. than to other clusters. In this sense, clerical rates as a whole may
4. Pricing jobs: Wages along the “wage line” are target wages or be closely related to other clerical rates than to managerial or
salary rates for the jobs in each pay grade. It is possible that factory rates...”
some of the plotted points may fall off the wage line. This will Livernash described that: Broad groups may be illustrated
mean that average for that grade is too high (or too low), given within manufacturing as:
the pay rates for other grade. 1. Managerial- executive, administrative, professional, and
If the plot falls below the line, raises for jobs in this pay grade supervisory;
may be required. Such a raise may be given either immediately or 2. Clerical; and
in one or two steps.7 If the plot falls above the wage line, that
3. Factory, within each broad group, narrower groups are
indicates rates are high and the over paid employees are often
obvious.
called “red circle,” “flagged,” or “overrates.” This will necessitate
either: Within the factory group are maintenance, inspection, transpor-
tation and production. Within production are certain smaller
i. To freeze the rate paid until general salary increases bring the
groups, varying with the nature of the industry.
other jobs into line with it, or
This indicates the need for having several pay ranges for each
ii. To transfer or promote the employee to a job where -he can
organization. Such a range usually has several advantages:
legitimately be paid his current rate; or
i. The management can take a more flexible stance with
iii. To cut to the maximum in the pay grade.
respect to the labour market.
It is a standard practice to establish ‘pay grades’ or equal width
ii. ‘It makes it easier to attract experienced employees from
or ‘point spread,’ i.e., each grade might include all those jobs
other organis9.tions.
falling between 50 to 100 points, 100 to 150 points, 150 to 200
points, and so forth. Since each grade is of the same width, it is iii. It helps to ensure that there is an. overlap between the pay
necessary to determine how many grades there should be. In an rates and those prevailing in the labour market.
industry, the number varies from as few as five to as high as iv. It also allows the management to provide for performance
thirty. differences between employees.
Two points need consideration when deciding the number of While determining pay ranges the following consideration
grades. They are mentioned below: should be attended to:
First, the size of the organization, i.e., if there are 1,000 jobs to 1. It is important to keep in mind that there is an adequate
be graded, more ‘pay grades’ will be needed, than where the differential, between superiors and subordinates - whether
jobs are few, say 100. they are paid under the same pay plan or under different
Second, the broadness of the grades. For instance, in the case ones.
of hourly jobs, the maximum of individual pay grades may 2. When the pay-range of one group is changed, equal
vary from 10 to 20% above the minimums; while in case of attention must be given to the pay-level of the other.
salaried employees the maximum of pay grades may vary from 3. Because of the continuous rise in wage and salary levels, a
15 to 75% above the minimum. rise resulting from a variety of environmental pressures,
Some authorities feel that there should be only one comprehen- considerable attention must be given to handling upward
sive ‘pay grade’ for each organization. But it is probably more changes in wage-structure.
realistic to have several pay. grades/ranges Several wage. Some firms give general percentage or “across the board”
structures are developed - one for each type of job or “job pay increases shortly after wage increases are negotiated.
cluster Others give increases based on merit or length of service.
Dunlop describes the cluster concept as follows: The sound thing is to make general adjustments in wage
“A job cluster is defined as a stable group of job classifications structure according to the price index number.
or work assignments within a firm... which are linked together 4. The existing pay structure should be regularly reviewed and
by: revised. This will make job evaluation programme more
1. Technology, acceptable to employees.
2. The administrative organization of the production process, 5. Regional differences in wages should invariably be
including policies of transfer, lay-off, and promotion, or maintained. Forces that favour regional differences are: low
mobility; lower skill jobs; major cost of living differences
3. Social custom that they have common wage-making
between areas; added sources of income or characteristics
characteristics....
(rural versus urban or industrial); seasonal occupations as in
“Thus, the employees on a furnace or a mill and the crew of a agriculture versus stable occupations.
train or a plane can constitute a job cluster (technology); so also
However, several forces work to level these differences. The
may employees in a department (administrative organization),
forces that favour uniformity in wages are: High mobility

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11.622.1 37
 between regions and/or employees; access to timely, reliable This is illustrated in figure 16-1, option a.
COMPENSATITION MANAGEMENT

information, wide spread unionization efforts, (often along

industry/ occupational lines).
Rate Ranges
‘Rate ranges’ can be developed in various ways. The one usually
adopted approach is to use the “Wage Curve.” A maximum
and minimum rate for each grade, such as 15% above and
below the wage line, may be arbitrarily decided. The maximum
and minimum

Figure 16-1. Alternative types of rate ranges

If a job rate is used, the wage line provides the job rate. The
individual is paid in accordance with the number of points
assigned the job by the job evaluation system, by the competi-
tive value discovered in a review, a salary survey, or by the
competitive value provided by a research analysis product.
Where the grade rate prevails, the individual is paid in accor-
dance with the grade level assigned to the job.
This type of system is useful where performance variation and/
or other personal characteristics are nonexistent or unimportant.
Not all jobs allow for a significant difference in performance.
Setting of Rate Ranges Some assembly-line positions and lower-level service positions
have very little discretion, so concern with differences in output
lines may then be drawn on the curve; the ‘range’ may be
or behavior are minimal. Other circumstances that lead to use
allowed to become wider for the higher pay grades. This reflect
of single-rate systems are:
the greater demands (and performance variability) inherent in
jobs in these grades. Most organizations structure their rate 1. a strict technology that controls the output and
range to overlap a bit. Thus, a person who has been on the job 2. jobs for which the training time is short a couple of hours
larger and is more experienced may earn more than a fresh or so hereby making a learning curve inoperative. The
employee in the next higher pay grade. individual in this type of system is paid for his or her time
The major way in which organizations allow for factors other on the job and for completion of the job as directed.
than the job to enter into the determination of an individual’s Single-rate systems are simple to administer: once the pay rate
pay is to develop a range of pay for each job or grade of jobs. A of a person’s job is identified, no further decisions need be
rate range is a range of pay determined by the organization to made as to how much he or she is to be paid. The system can
be appropriate for anyone who occupies a particular job. operate successfully if:
A rate range consists of a minimum pay rate (the beginning hire 1. there is little variation in output and
rate), a midpoint (the market or job rate), and a maximum (the 2. it is acceptable to the parties involved. Unions often like
highest rate the organization is willing to pay for the job). single rates because they eliminate judgment-based
Now let us study further single-rate wage systems, the rationale differences in pay.
for rate ranges, two types of rate ranges, the manner in which a Rationales for Rate Ranges
pay rate is set for individuals within a range, and the dimen- Any time individuals on the same job differ significantly in
sions of range rates. performance or personal characteristics that are perceived as
Single-Rate Wage Systems relevant to either the organization or the person, differentiation
Before discussing various aspects of rate ranges we should first by means of rate ranges may be in order.
consider situation in which there is no range. There a single rate One study reported that the rationale for rate ranges in most
is paid for the job and the individual receives just that rate. This large organizations was the need for performance differences,
pay rate is the market rate and may be paid to either a job or a but in some cases industry practice was a major reason.
pay grade. Thus labor-market demands may also be a significant factor.
Rate ranges can serve other purposes for organizations.
Retention is one of the most important of these. Experienced
personnel can be made difficult to hire away by paying them
above the market rate for the job. This is seen by the person as a
significant reward for membership.

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Where there is a significant quality variation among people on The future challenge of compensation managers is clear for the

COMPENSATITION MANAGEMENT
the job, a rate range may represent an attempt by the organiza- next ten years – employees walking into their offices with salary
tion to retain the best employees by paying them on the basis increase requests based upon free data from the Internet.
of quality.
Types of Ranges
Although performance is the reason most often given for rate Having made the argument that rate ranges are useful and
ranges, this rationale should be scrutinized. Is movement in the expected, we turn to how to develop rate ranges.
range in fact related to performance?
Step Ranges
One major study challenged this assumption and found that A common form of pay range consists of a series of steps,
performance was a very poor predictor of pay rate. There must usually a specified distance apart, either in percentages or flat
be more than just an actual connection between pay rate and amounts. Step ranges may vary considerably in number of steps
performance: there must also be a perception by the individual and the total range the steps cover.
that this connection exists.
Clearly these two in combination will determine the size of each
The need for this perception makes communication very step. The point is that there are three variables present, and the
important in pay systems. determination of any two will decide the third.
A further rationale for rate ranges is employee expectations. Few Two basic types of step ranges are common:
people are content to make the same wage and be dependent on
The first consists of a starting rate and a job rate (assumed to
changes in the total wage structure for raises. In particular, they
be the market rate), as in the single-rate system. New employees
may see that length of time on the job is an important input
are brought in at the starting rate and then moved up to the job
and expect a reward for it. But they may also see a number of
rate in a series of steps. If done properly, this movement
factors other than performance as relevant to movement within
corresponds with the learning curve of the job.
the range.
The market rate is the maximum, since it is assumed that once
Personal factors having to do with the job are a good example.
the person has learned the job, performance differentials are
For instance, many employees who are going to school part
minimal. This kind of system is illustrated in figure 16-1,
time perceive that they should receive something for this.
option b. In this situation there would be a number of steps,
Employees may also perceive that they should receive more pay
most commonly three, between the starting rate and the job
for a variety of non-work-related factors.
rate. This type of step system is most common in semiskilled
Some of these factors, such as the birth of a new baby may be blue-collar jobs.
very important to the person but seen as irrelevant by the
The second type of step system places the market rate not at the
organization. Others, such as the person’s sex, may be illegal to
top of the range but in the center of it. Other places, such as the
use as a differentiator of pay. It should also be noted that
one-third point or the two-thirds point, are also possible, but
although some employees perceive the need for a rate range,
the middle is the most common.
they do not feel that performance should be the basis for this
range. Employees are hired at the starting rate, as in the other step
system, and progress to the midpoint over time is on the basis
Another rationale for rate ranges may be collective bargaining. In
of learning job proficiency. Thus, a person at the midpoint of
contract negotiation the organization may agree to rate ranges or
the range is assumed to be a satisfactory performer. Movement
to an expansion of rate ranges as an alternative to a general
above the midpoint is assumed to be for performance, or other
increase. The union is likely to bargain for ranges in terms of
characteristics beyond the normal or average.
movement within the range by seniority. The connection of
performance and reward is not well served in this case. This type of system is illustrated in figure 16-1, option c. It is
used in a wide variety of office nonexempt jobs and lower-level
Finally, the Internet has produced a wide array of sources by
exempt jobs where performance is important but not critical.
which employees can gain access to information regarding the
competitive pay for their positions. While in the 1990’s These two types of rate ranges are not mutually exclusive in an
employees knew little about the competitive value of their jobs, organization. Lower-level pay grades may have the type of range
the plethora of job/career information freely available on the that ends at the midpoint, while higher grades have ranges
Internet has changed this. extending beyond. The rationale for such a system is that the
discretion in higher-level jobs in the organization allows for
If there were ever a reason for organizations to have a formal-
performance differences not permitted in lower-level jobs.
ized method of administering salaries, it would be to forestall
the number of hours wasted by management trying to Movement within grades will be discussed later, but one point
disprove inflated salary averages reported on free Internet sites. should be made here. A person who is moved from one step
to the next usually retains the new step even when the overall
More importantly, management must protect the organization’s
wage structure is changed. In this way, adjusting the wage
bottom line by guarding against overpaying employees based
structure to meet labor-market changes automatically becomes a
upon the high rates reported by Internet sites focused on
general increase for employees in a step system.
increasing their visitor hits to enhance their IPO values.
There is a further consequence of this type of system: all people
tend to move to the top of the grade over time. Even if
movement is by performance, a person can eventually reach the

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 top and stay there regardless of future performance. This amounts or in percentages. The latter is more common and will
COMPENSATITION MANAGEMENT

phenomenon in turn has a dramatic effect on the total wage bill. be used here. The breadth of the range should vary with the
In a period of normal growth and turnover the average wage criteria for movement within the range.
for the job classification will probably match the market rate as Assuming that performance is the criterion, the breadth would
people start to climb the ladder while others leave. But in a low- represent the opportunity for performance differences in the
turnover, no-growth situation the organization may soon be job. Where ranges are narrow, the assumption is that perfor-
paying above market rate even if it sets the midpoint of the mance differences are narrow and vice versa. In practice, hourly
range at the market, because all the employees in the job are in jobs have ranges of 10 to 20 percent, office jobs 15 to 35
the top steps. percent, and managerial jobs 25 to 100 percent.
Open Ranges
In order to focus more clearly on performance and to avoid the
problems of step ranges, more and more organizations are
using an open-pay range. In this system the organization
defines the midpoint, the maximum and the minimum of the
range. Any one employee may be paid anywhere within this
defined range.
The function of the midpoint, as in the second type of step
system, is that the average performer would be paid at this rate.
Also as in the second step system, new employees would start
at the bottom and move to the midpoint as they learned the
job and became average performers. Payment above the
midpoint can be reserved for above-average performance.
Unlike the second step system, the person’s wage is not
automatically adjusted when the wage structure is adjusted. At
this point, the person’s performance is reviewed and adjust-
ment is made in relation to that performance.
Figure 16-1, options d and e, illustrate two types of open pay
ranges. Option d has a series of steps up to the midpoint and
an open range above the midpoint; option e has an open range Fig. 16.2 Parts of a wage structure
from minimum to maximum. Factors other than potential performance differences may also
With the increased emphasis on performance in organizations, affect range breadth. Organizations that promote intentionally
open-range systems are becoming more popular. They provide fast encourage narrow ranges, since people do not stay within
more flexibility than a step system in granting pay increases and one grade very long. A wide range is encouraged if adjustments
are more resistant to automatic increases. Finally, open ranges need to be large to be noticed by employees.
not only may make it easier to reward performance but are also Higher grade levels tend to have broader ranges for this reason.
useful when criteria other than performance are to be used. Broad ranges can accommodate a wide variety of jobs, as well as
Dimensions of Ranges variable starting rates among jobs. These broad ranges indicate
Any wage structure has a number of rate ranges and pay grades. that the process of determining the market rate is not a precise
This number can be a matter of the policy of the organization. one.
Small organizations tend to have a small number of pay grades Establishing range maximums is particularly difficult. There is
accompanied by wide pay ranges, broad definition of job titles, some logical maximum value for any job, regardless of how
a great deal of movement within pay grades, little overlap well it is performed. Ideally when this point is reached the
between grades and limited promotion to higher grades. Some person is promoted, either to a new job or by upgrading the
organizations have many grades, which tends to create an tasks of the present job.
opposite set of characteristics. Unfortunately, this may not be possible at the appropriate time.
When examining pay ranges we can determine the total wage Realistically the person should be told that this is as high as he
structure with the help of three characteristics: the breadth of or she can go in the rate range and that any further salary
the rate range, the number of pay grades and the overlap (see adjustments will come from general increases.
figure 16-2). If one knows the bottom and top of the wage Some organizations provide steps beyond the maximum of the
structure, the slope of the pay line, and any two of the three range. There are usually two rationales for this – seniority and
characteristics just cited, the third will be determined. recruiting. Long-term employees who will never be promoted
Range Breadth and whose performance remains good are sometimes granted
The breadth of the rate range is the distance from the top to the longevity increases beyond the maximum of the range.
bottom of the range a to b in figure 16-2. It is the vertical These usually take place after five or ten years at the top of the
dimension of the range. The breadth may be stated in dollar grade. Trouble in recruiting and retaining professional and

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40 11.622.1
managerial employees can be ameliorated by starting these figure 16-2). Overlap allows people in a lower pay grade to be

COMPENSATITION MANAGEMENT
people quite a ways up in the rate range; in order to retain them paid the same as or more than those at a higher grade.
the organization must go beyond the maximum to provide any The rationale for such a phenomenon is that a person at a lower
significant movement in grade. pay grade whose performance is very good is worth more to the
Number of Grades organization than a new person at the higher pay grade who is
The total number of pay grades in the wage structure can be a not yet performing effectively. This reasoning seems to work:
result of other calculations (mainly range breadth and overlap) seldom are there complaints about overlap.
or a conscious decision that forces the other two variables to As with the number of grades, overlap can be either a determin-
adapt. ing variable or the determined variable. Overlap will work well
The number of pay grades is reflected in the horizontal where there are many wide pay grades. A conscious decision to
dimension of figure (a to c). At one extreme, a structure with keep overlap to some maximum (such as 50 percent) will reduce
a single pay grade would have a minimum and maximum one of the other two variables.
embracing the total wage structure and would include all jobs. Some overlap is desirable, but there are problems. The main
At the other extreme, each job evaluation point on the horizon- one comes about in promotions. A person high up in a rate
tal axis would constitute a separate pay grade. range who is promoted may start in the new rate range higher
In the latter circumstance two jobs would occupy the same pay than the job rate of the new grade. But not to give the pro-
grade only if they had identical job evaluation points a situation moted person a pay raise is hardly to have promoted him or
that would assume a very accurate job evaluation plan. her.
A large number of pay grades often coincides with a narrow Organizations generally set some policy that any promotion be
range, permitting a large number of promotions and multiple accompanied by some specified minimum increase, such as one
classifications in job families in the organization. A small step in the new rate range or a specified percentage. The
number of pay grades allows for flexibility, in that it assigns designers of career paths in some organizations reduce this
people to a wide range of jobs without changing their pay problem by placing the next job in the sequence more than one
grade. pay grade above the present one.
Not surprisingly, number of pay grades is associated with size Moving Employees Through Rate Ranges
and number of levels in the organization. It also seems Rate ranges make possible different pay rates for individuals in
reasonable that organizations with a fluid, organic structure the same job and/or grade level. Operating such ranges calls for
would have a minimum of pay grades whereas more structured some method that differentiates between employees. Such a
and bureaucratic ones would have more. method must provide a decision framework for positioning
Clearly there is no optimum number of pay grades for a each person within the range.
particular job structure. In practice, the number of pay grades Open rate ranges facilitate a pay-for-performance approach to
varies from as few as 4 to as many as 60. But 10 to 16 seems to individual pay determination. The present section will focus on
be most common. With few grades there are many jobs in each movement within grades in a step system. It should be noted,
grade and the increments from one grade to another are quite though, that an open range system can also accommodate the
large. The presence of many grades has the opposite characteris- methods of progression discussed.
tics. Step Rates
A number of considerations help to determine the appropriate Most government and some private organizations divide their
number of grades. One is organization size: the larger the entire rate range into a number of steps. (One should always be
organization, the more pay grades. A second is the comprehen- aware of the influence of government systems in compensa-
siveness of the job structure. A structure that covers the whole tion. For example, with half the paychecks in Canada being
organization will tend to have more pay grades than one that written by governmental agencies, one cannot overlook these
deals only with one job cluster. Third, the type of jobs in a step approaches).
structure makes a difference. Production jobs whose pay policy This number is a function of the breadth of the rate range, the
line is relatively flat will tend to have fewer pay grades than a time required to achieve proficiency in the job, whether there are
managerial structure that has a steep slope. to be steps beyond the market rate, and a determination of the
The last determinant is the pay-increase and promotion policy size of a meaningful pay increase. At least three steps are almost
of the organization. A large number of pay grades allows for always used. A general step system is illustrated in option c in
many promotions but entails narrow ranges and a narrow Figure 16-1.
classification of jobs. A small number of pay grades, accompa- Step rates facilitate the granting of pay increases by determining
nied by wide ranges was traditionally thought of as the amount that any increase will take. Of course, it may be
unreasonable in that cost control of salary administration possible to move a person two steps, but this is always done in
would be lost. In the late 1980’s, this reasoning was badly predetermined amounts. Such increases can be considered a
shaken. disadvantage as well as an advantage. Many organizations prefer
Overlap to be able to grant a wide variety of increases to better relate pay
The final pay range determinant is the degree of overlap to their pay-increase policy
between any one pay grade and the adjacent grade (c to d in

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11.622.1 41
 Methods of Progression market rate. Organizations make much more use of automatic
COMPENSATITION MANAGEMENT

All methods of progression specify how a person moves from progression than might be assumed.
the bottom of the range to the top of the range. The major Studies indicate that in most areas of the country and in most
difference among them is the criteria for movement. The major industries, automatic progression is the norm and not the
methods are automatic progression, a combination of merit exception. But this may be changing. The emphasis on produc-
and automatic progression and merit progression. tivity in the United States is translating itself into a search for
An organization does not have to restrict itself to only one ways to make employees more productive. Focusing on
method; it may use different methods for different jobs or even performance instead of longevity is part of this trend.
different methods for a single job at different parts of the rate
Combinations of Automatic and Merit Progression
range.
We have just seen that some introduction of merit is possible
Automatic Progression even in automatic progressions that focus on longevity. It is
This type of progression (sometimes referred to as scheduled possible also to design progressions that try to balance merit
increases) consists of wage increases based automatically on and longevity. These progressions usually let employees focus
length of service. In some situations, such as basic industries, on different criteria at different places in the pay range.
there are a small number of increases often in rapid succession Probably the usual combination is automatic progression to the
(every three months) to the maximum rate for the job. midpoint – the market rate – and progression beyond the
These are jobs in which proficiency can be gained in a short midpoint on the basis of merit.
time. On the other hand, some governmental organizations The rationale for this method of progression is that all
may have many steps (five or more) and grant increases once a employees can be expected to reach average proficiency within a
year. In these situations longevity on the job leads to higher certain time on the job; this period matches the automatic
proficiency, and the organization wishes to reward continuity of movement to the midpoint.
employment.
However, not all employees exceed average performance on the
A major source of variation in automatic plans is the nature of job, and movement from the midpoint on should be based on
the maximum rate – whether it is the market rate or an above- performance that is above average. If the organization does a
market rate. Organizations that move only to the market rate good job of matching time taken to reach the midpoint with
tend to have rate ranges with a small number of steps and a time taken to reach proficiency in the job, then labor costs are
short time frame for progression. They are interested not so equalized; if these are out of balance, then labor costs are higher
much in rewarding longevity as in encouraging learning the job. or lower than is optimum.
Organizations that move beyond the market rate are specifically The rate range can take one of two forms in this case. The first
rewarding longevity on the job; they tend to spread out the looks like option c in figure 16-1, with a series of steps from
progression to the top of the grade over a long period. bottom to top and the market rate as the middle step. The
Automatic progression does not have to be totally automatic. distinguishing feature of this form is how movement is
A fully automatic progression plan is actually a variation of the determined after the midpoint has been reached.
single-rate or flat-rate system. If all employees can expect to In the second form there is a series of steps up to the midpoint
reach the maximum of the rate range after a given period on the but an open range from that point on with movement of any
job, the assumption is that the maximum is the real rate for the degree possible and decided by merit. This form is illustrated in
job. figure 16-1, option d.
Variation can be introduced in two ways: Another method is to combine longevity and merit at all points
First, the time period may vary from step to step. For instance, in the range. Under this arrangement all employees receive an
some systems move people rapidly to the midpoint and then automatic adjustment, but those with above-average perfor-
much more slowly; the extended steps beyond the midpoint are mance receive more, such as a two-step jump. It is also possible
clearly tied to longevity. to hold back those who are not performing well. The latter
action is rare but can be effective in probationary situations.
The second variation introduces a little merit into the system by
either denying movement to the next step for poor perfor- The areas of prevalence of these different methods are hard to
mance, giving good performers a double-step jump, or determine. It appears that automatic methods are most typical
shortening the time period between step increases. of factory jobs and combination methods most typical in office
situations.
Merit considerations in automatic plans should not be overem-
phasized. The system is designed to be automatic, and Automatic-progression methods are simple to administer since
variations are seen as exceptions, not the rule. In most systems they are purely mechanical adjustments made by time in grade.
that allow either movement ahead or denial of increases, these Introducing merit complicates the pay decision by adding a
alternatives are rarely used: the problems they pose for adminis- judgment about how well the person is doing the job. Then a
tration of the workplace are not perceived by supervisors to be way must be developed to incorporate this judgment into a
worth the advantages they offer. wage increase.
Unions commonly accept rate ranges but insist on automatic This makes administration more complex and, if the judg-
progression and encourage maximum rates that are above the ments are perceived as arbitrary, raises concerns about the equity

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42 11.622.1
of the system. The advantage is that a connection is made problem is compounded when management mixes up general

COMPENSATITION MANAGEMENT
between performance and reward, and this may be worth the pay increases with merit pay.
trouble. Granting all employees the same pay increase and announcing it
Merit Progression as a merit increase destroys the concept of merit. Lower-level
A pure merit progression employs an open rate range with only supervisors, in particular, find it uncomfortable to deal with
the minimum, maximum, and midpoint defined, as in option e merit pay, which requires him or her to make competitive
in figure 16-1. Movement within the range is based strictly on distinctions between employees.
performance, and there are no adjustments for general increases. For these supervisors it is often cooperation and not competi-
This pay-for-performance system requires an integration of tion that is important. Because of the inflation of the late
performance appraisal with pay determination. What we cover 1970s, annual pay increases are almost institutionalized in
here is movement between steps of a pay grade, as in figure 16- organizations today.
1, option c, on the basis of merit. This makes merit progression something of a misnomer,
The rationale for merit progressions is that the movement to especially where organizations simply call all pay adjustments
proficiency is actually an improvement in performance and merit increases.
should be treated as such; people differ in their rate of improve-
Rate Ranges and Recruitment
ment to proficiency, and this should be taken into account; it is
To this point we have assumed that the organization has been
performance that the organization wants and should pay for.
hiring people who are just qualified and moving them up in the
In practice, a merit progression is usually a combination of range as they learn the job. But what if it hires a person who can
merit and longevity. The initial decision to move a person from do the job from the beginning?
say, step 3 to step 4 is based on performance, but from that
Clearly this person should be hired at the market rate (the
time on the person retains step 4 when adjustments to the
midpoint). In actuality, then, people are likely to be brought
wage structure are made, thereby remaining at the same relative
into the organization anywhere up to the midpoint of the
position in the range.
range, based upon their qualifications. Thus a system that ends
If step 4 is one step above the midpoint, the assumption is at the market rate has a flat rate for hiring fully qualified
that this person is always above average in performance, but employees.
actually the person needs only to maintain a level of perfor-
The labor market may complicate the rate range when there is a
mance that will not result in termination.
shortage of applicants. When it is hard to recruit, one way
Further, unless the performance-appraisal system is tied organizations adjust is to raise the starting pay to wherever in
consistently to the merit pay adjustments, either the system the range it must go in order to obtain people. This may result
tends to be seen as arbitrary or supervisors tend to grant the in hiring rates at the top of the rate range or above.
same increase to all employees and thus destroy the perfor-
This extreme situation makes any upward movement within
mance-reward connection.
the grade difficult or impossible for the person. A person who
In a Bad Economy is then expected to stay in the grade for three or more years
In all step systems most employees eventually get to the top of before promotion can only look forward to general increases.
the pay range. In a merit progression method the good
Correcting Out-of-Line Rates
performer should get there faster than the average or poor
The rate range defines the minimum and maximum that a
performer. This phenomenon of getting to the top of the
person may be paid for a given job. For a number of reasons an
range tends to be hidden when the organization is growing and
individual’s pay may be more or less than the prescribed range.
times are good.
The organization needs policies for dealing with these out-of-
But when growth stops, then promotions slow up, employees line rates.
stay on their current job, movement to the top of the range is
accelerated, and the organization finds that all employees are at Terms of the trade
the top of the range. Many a new compensation analyst has been tested by manage-
ment with the question.
Labor costs thus become very high at exactly the time the
organization can least afford them. From the employee’s “Do You Know What a Green Circle Is?”
perspective, the only pay increases received are those that occur This question separates the college student from the practitio-
through wage structure adjustments, and these are likely to ner. It refers to the case in which a person is paid less than the
decrease in these circumstances. This lack of wage increases minimum of a grade. This occurs, for example, when a person
makes the potential for feelings of inequity increase consider- is promoted into a position in a higher pay grade, but not given
ably. a pay increase (because all increases may have been frozen by top
corporate management).
Actual Practice
Most organizations and their management claim that they use a Underpaid Employees
merit progression system. But studies show that up to 80 As stated, a person paid below the minimum of the rate range
percent of employees are at the top of their rate range. The for his or her job is said to carry a green-circle rate. This situation

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11.622.1 43
 usually occurs when the wage structure is changed upward and the difference between his or her rate and the maximum of the
COMPENSATITION MANAGEMENT

the individual was at the bottom of the rate range. range.

Little question exists regarding the appropriate response: the The employee is given 100 percent of the differential the first
underpaid employee should have his or her pay raised to the year, 75 percent the next year, and so on until there is no
minimum of the range, immediately if possible or in a couple differential. The advantage of the adder is that the top rate for
of steps. If the person is performing adequately, the difference the job is made clear and both the person and the organization
between his or her rate and the minimum of the range should are aware of the exceptional and temporary character of the
be made up by the employer. differential.
Of course it is possible, for a number of reasons, that the Another possible solution is a lump sum payment. For
employee is not worth the minimum of the range. Even so, example, the employee may be paid the difference times 2080
there are usually adjustments that can be made. For instance, if hours and have his or her pay rate brought immediately into
the labor market is very tight and marginal workers must be line. Any solution to overpay involves questions of equity.
hired and retained, a lower classification involving job redesign Overpayment is usually not the fault of employees, and any
to accommodate the person’s skills would be in order. reduction in pay will be seen as unfair by them.
This same reasoning could apply to older and handicapped On the other hand, there is also the perception of equity by
employees who cannot fully carry out their jobs. On the other other employees, so some action is always called for. All the
hand, redesign may be unnecessary where there is already a actions just described try to balance these two perceptions in
lower-level job to which the person can be assigned. Or a trainee arriving at an equitable solution.
rate may be appropriate if the employee is still learning the job. Failure to correct red-circle rates means that range maximums are
Usually there will be a few underpaid employees, and a policy of meaningless; people may be paid more than their job and
bringing their rates into line immediately protects the integrity performance are worth to the organization; and organizational
of the pay system. But if many employees are underpaid, a resources are being diverted into paying these rates rather than
careful review is required not only may the costs of adjustments rewarding others’ good performance.
be high but also equity between the newly raised employees and
Tutorial Activity 1.1
other employees on the job may require a phasing in of
increases. Questions
Also, all underpay situations should be examined for racial or 1. Discuss the factors affecting wage determination.
gender discrimination. 2. Explain wage determination process in detail.
Overpaid Employees 3. What do you understand by rate range? Discuss the types
A person paid above the maximum of the range for his or her of rate ranges.
job is said to receive a red-circle rate. Other names for this 4. Discuss the importance of wage administration rules in
situation are ringed, flagged, or personal rates, red allowances, organizations.
overrates, and personal out-of-line differentials.
The variety of terminology suggests that this is a common
problem in organizations, that it stems from a number of
sources, and that it is more difficult to deal with than the
problem of underpaid employees.
Solutions to overpay vary from doing nothing to reducing the
pay to the top of the range. Both approaches can cause equity
problems, both in others and in the person affected.
The most common solutions are the following:
1. Freeze the pay until general increases catch up with the
current pay;
2. Transfer or promote the person to a job in an appropriate
pay grade;
3. Freeze the pay for a limited period, such as six months.
Then attempt either of the previous strategies. If this is
unsuccessful, reduce the pay at the end of the period. Red-
circle the job and not the person.
Eliminate the differential after a period such as a year or
gradually over time.
A number of less common arrangements also exist. One, the
adder, is a payment to the employee in quarterly installments of

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