How Compensation Decisions Are Made

Posted in Career Search Tools & Education, Dynamic Training News, Latest Leadership Posts, Leadership Development & Training, Talent Development & Training on Nov 08,2016

Understanding how employers make compensation decisions is critical if you want to be effective in negotiating your own compensation package.

Compensation has been very much in the news during this 2016 US Presidential Election season. From the fervor over a $15.00 per hour minimum wage to robots coming to take people’s jobs to the impact of the new overtime regulations, compensation is on the minds and hearts of just about everyone. Before you can begin to get a handle on any of these issues, you first must have a basic understanding of how employers make compensation decisions.

Current Factors Impacting Compensation. Like any other aspect of compensation, trends in the current market are impacting the compensation offered for specific positions. Here are five of the factors that dramatically impact compensation ranges for virtually all positions:

a. The value of the work being done. Labor costs are almost always the single largest expense item incurred by any employer, other than the costs for the goods and services produced. Labor costs include components such as base compensation (hourly or salary), variable compensation (such as bonuses or commissions), benefits, payroll taxes, and related insurances. So there is always pressure to assure that the value produced by each employee exceeds the costs associated with that employee. Because the market sets to price for the goods and services it consumes, compensation must be tied to the value of what an employee’s work produces – or the employer cannot afford to remain in business.

b. Supply vs. demand. This factor affects both industries and regions. If there is a shortage of qualified candidates for a position in a particular area, compensation will tend to be on the high end of the range, with some employers electing to pay sign-on bonuses to attract candidates. Likewise, if there is an over-supply of qualified candidates, compensation will be on the lower end of the range, with relatively few people hired in the higher ranges of compensation. You will need to understand the dynamics of your industry and region.

c. New job vs. raise. People changing employment (either inside their own company or moving to a different employer) tend to have larger compensation increases available, versus those staying in the same job or role. The typical range for an annual increase is about 3%, while the average increase achieved when changing jobs is about 10%.

d. Difficulty of filling the position. The difficulty an employer has experienced or (is anticipating) in filling the position will tend to increase what the employer is willing to pay. Highly specialized skills, experience, and education are often the largest reason behind the difficulty in filling a position.

e. Benefits add 10% to 70% to total compensation. While benefits such as healthcare have been in the headlines during the past few years, the cumulative value of non-salary benefits is significant. Here is an excellent calculator from CalcXML to determine the value of the benefits being offered.

The Mechanics of Compensation Decisions. Employers have established a range of what they are willing to pay for a particular position. For example, a position with a target average annual salary of $55,000 might have the following range:

a. Minimum – $45,000

b. Mid-point – $55,000

c. Maximum – $65,000

The interview process – the candidate’s credentials (résumé, social profile, and the like) and the results of any pre-offer background check (references, social media) – all influence where within the compensation range the initial offer will be made.

Researching compensation. This can be done via the internet by Googling salary ranges or visiting compensation sites such as salary.com, the Bureau of Labor Statistics, or payscale.com. Because information may be self-reported, tend to view these figures as optimistic for the position evaluated. While the information provided on these sites is generally accurate (± 10%), there are regional differences, as well as differences from organization to organization. Another helpful site for salary research is Glassdoor, which provides an inside look at jobs, companies, and compensation (as reported by current and former employees). When calculating total compensation, bear in mind that benefits can be worth as little as 10% of base compensation, or as much as 50% or more. Employer-paid expenses, travel allowances, hiring bonuses, tuition programs, insurances, paid time off, and other benefits add up quickly.

Some companies provide a lower starting salary, with a compensation increase once the new employee completes his/her training period (usually 90 days) and proves him/herself. In a slow economy, there is an abundance of people looking for positions, so salaries can be somewhat depressed. Likewise, when the economy is booming, starting salaries may be increased to attract better candidates.

Finally, understand that regional cost-of-living factors greatly affect the market-based compensation for any position. A $60,000 position in an average cost of living area may translate to $48,000 in a low cost area and $110,000 in a high cost area. Based on the relative cost of living of the area, the $48,000, $60,000, and $110,000 benchmarks reflect the same equivalent purchasing power.

Bottom Line

Like anything else in life, proper preparation prevents poor performance. Never enter into a compensation negotiation without first having done your homework, with includes not only understanding how compensation for the position is established and what the reasonable ranges for compensation for your position by market, but also how you can prove that you’ll be able to deliver excellent value for the compensation you desire.

This article was in part excerpted from the seventh edition of the textbook included with the Job Search Readiness Assessment.

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