DEALING WITH ANOMALIES | Reward Management Procedures

Within any pay structure, however carefully monitored and maintained, anomalies will occur and they need to be addressed during a pay review. Correction of anomalies will require higher-level increases for those who are under-paid relative to their performance and time in the job, and lower levels of increase for those who are correspondingly over-paid. It is worth noting that over-payment anomalies cannot be easily corrected in fixed incremental structures, and this is a major disadvantage of such systems.

The cost of anomaly correction should not be huge in normal circumstances if at every review managers are encouraged to 'fine-tune' their pay recommendations to ensure that individuals are on the right track within their grade according to their level of performance, competence and time in the job. It is important, therefore, that managers should be given the scope to carry out such fine-tuning by making adjustments to the rate of progression as necessary. Of course, they may need guidance on what they can and should do, and they also need clear information on the relative positions of their staff in the pay structure in relation to policy guidelines as a basis for decision making. The conduct of pay reviews can make a major impact, not only on motivation and commitment, but also on the perceptions of employees about the fairness of the whole process of reward management. It should not, therefore, be carried out mechanistically.

In a severely anomalous situation, which may be found at the implementation stage of a new structure or at major review, a longer-term correction programme may be necessary either to mitigate the demotivating effects of reducing relative rates of pay or to spread costs over a number of years.

As well as individual anomaly correction there may be a need to correct an historical tendency to over-pay or under-pay whole departments, divisions or functions by applying higher or lower levels of increases over a period of time. This would involve adjustments to pay review budgets and guidelines and, obviously, it would have to be handled with great care.

PROCEDURES FOR GRADING JOBS AND FIXING RATES OF PAY

Job Grading

The procedures for grading new jobs or regrading existing ones should lay down that grading or regrading can only take place after a proper job evaluation study conducted by a member of the personnel department or a job evaluation panel advised and assisted by a specialist. An appeal system should be built into the procedure.

The steps which can be taken to control grade drift are discussed later in this chapter.

Fixing Rates of Pay on Appointment

Managers should have a major say in pay offers and some freedom to negotiate when necessary but they have to take account of relevant pay policies, and the amounts should normally be confirmed by a member of the personnel function and/or a higher authority.

Policy guidelines should set out the circumstances in which pay offers above the minimum of the range can be made. It is customary to allow a reasonable degree of freedom to make offers up to a certain point, eg the 90 per cent level in an 80–120 per cent pay range. Most pay systems allow offers to be made up to the reference point depending on the extent to which the recruit has the necessary experience, skills and competences. Offers above the reference point should be exceptional because this would leave relatively little room for expansion. They are sometimes made because of market pressures, but they need to be very carefully considered because of the inevitability of grade drift unless the individual is promoted fairly soon.

Promotion Increases

Promotion increases should be meaningful, say a minimum of 5 per cent but often 10 per cent or more. They should not normally take the promoted employee above the reference point in the pay range for his or her new job so that there is adequate scope for performance-related increases. One good reason for having reasonably wide differentials is to provide space for promotions.

PLANNING AND IMPLEMENTING PAY REVIEWS

Non-negotiated Pay Reviews

The steps required to plan and implement a non-negotiated pay review are:

1. Agree budget.
2. Obtain and analyse data - market rates of pay, market pay increase trends, distribution of existing levels of pay in relation to pay policies, compa-ratios, attrition, performance ratings, etc.
3. Prepare and obtain agreement to review guidelines - budget, distribution of variable pay awards, dealing with anomalies, use of market rate and other data, dates for completion, procedure for reviewing and agreeing proposals, etc.
4. Issue budgets, data, guidelines and timetable to reviewing managers.
5. Provide advice and support.
6. Set up peer review processes.
7. Iterate to achieve acceptable proposals in relation to budget, pay policies and review guidelines.
8. Summarize and cost proposals.
9. Obtain approval.
10. Update payroll.
11. Generate letters from managers to employees.
12. Inform employees.

Negotiated Pay Reviews

1. Obtain and analyse data on pay settlements and movements in market rates.
2. Agree target settlement, taking into account affordability; comparability; effect, if any, on other units, divisions or employee groups in the company; and the balance of power between management and trade unions.
3. Prepare negotiating brief.
4. Negotiate to achieve best settlement in accordance with targets.
5. Reach agreement.
6. Implement.

INDIVIDUAL REVIEWS | Reward Management Procedures

Individual reviews determine contribution or performance-related pay increases or special achievement or sustained good performance bonuses if they are allowed as additions or alternatives to base pay rate increases. They also take into account the position to which performance pay progression has brought individuals in their pay ranges or curves - this may influence the size of the performance award or a decision to give a lump sum bonus rather than a pay increase.

The reviews are conducted by reference to performance reviews and/or ratings. The four main issues concerning individual reviews are timing, budgeting, guidelines for reviewing managers, and control.

Timing of Individual Reviews

As mentioned above, individual reviews can be integrated with general reviews or conducted separately. In either case they may take place at a fixed date, typically once a year, although fast-moving organizations may prefer more frequent reviews, say twice a year. The review date can be varied to suit the circumstances of the organization. This approach can be used to advantage in rapidly growing organizations but it can also be adopted in periods of high inflation or when employee turnover is excessively high. Some organizations like to hold rolling reviews for individuals based on their birthday or starting/promotion date in order to allow more attention to be given to the individual's review. But this system is more difficult to budget for and control and it is particularly hard to give individual attention to ensuring that their pay increases reflect relevant movements in market rates.

Individual Review Budget

The individual performance review budget should be expressed overall in terms of the percentage increase to the payroll that can be allowed for performance-related increases. The size of the budget will be affected by the following considerations:

• The amount the organization believes it can afford to pay on the basis of budgeted revenue, profit, and payroll costs.
• What the organization thinks it ought to do to address a discrepancy between pay practice and pay policy. For example, group compa-ratio analysis may reveal that the total of actual rates of pay is less or more than the average of reference point rates of pay. If average actual rates are too low (and this is not because of a high influx of new starters) allowance may have to be made in the budget to redress the difference in full or in part, depending on how much the organization can afford to spend. Conversely, if the average of actual pay is above the policy level, the budget may be restricted.
• The organization's policies on pay progression - the size and range of performance-related increases. These policies will have influenced the design of the pay structure, and the factors affecting their development and application. Account should clearly be taken, when budgeting, of fundamental considerations concerning how much the organization should be prepared to pay to make performance-related pay a worthwhile basis for motivating employees and awarding them according to their contribution. There is no point in having PRP unless the organization truly regards performance payments as an investment to provide for increased prosperity in the future. To skimp on them unduly in periods of temporary recession could be short-termism at its worst.

The basic budget would be set for the organization as a whole but, within that figure, departmental budgets could be flexed to reflect differences in compa-ratios or any other special circumstances.

Individual Review Guidelines

Guidelines for managers are necessary on how they should distribute their pay increase budget among their staff. The aim is to achieve as much consistency and equity as possible between departments while still allowing managers a reasonable degree of freedom to manage the distribution of rewards within their departments. The latter principle is in accordance with one of the fundamental tenets of human resource management (HRM) philosophy - that the performance and delivery of HRM is a line management responsibility. How can they exercise this responsibility if their freedom to act in one of the most important aspects of human resource management is unduly constrained?

There will, however, always have to be some limits to freedom, and managers generally prefer some guidance on how to distribute performance awards.

The guidance should start with rating practices - methods of helping managers to rate fairly and to achieve consistency in reviews and ratings.

The main guidelines on linking pay increases to ratings are described below. In each case, ultimate control would be exercised by imposing an overall budget limit on the increase in the departmental payroll arising from performance-related payments.

Average and Min/max Guidelines

These indicate the average performance award - say 5 per cent (when market movement is 4–5 per cent), with restrictions on the maximum and minimum pay increases that can be awarded, eg 3 per cent minimum and 10 per cent maximum. This is the simplest form of guideline and gives a fair degree of freedom to managers. It can work well, especially in the absence of an elaborate performance rating system.

Reward/rating Guidelines

These relate performance pay increases or bonuses, if they are given, to ratings by the use of a scale such as the one set out in Table 1.

Rating	% Increase
Outstanding	10
Very effective	7–8
Effective	5
Developing	3

The guidelines would also emphasize that anyone whose performance is rated as ineffective should not be eligible for an increase and, in fact, should be going through the disciplinary procedure.

This form of guideline is more directive than the min/max approach. It can help managers to achieve a more consistent relationship between the rating and the reward but it does not achieve any control over the distribution of awards between the guideline increases.

It must also be accepted that managers can and do decide in advance what increases they want to award and adjust their ratings accordingly. It is in recognition of this phenomenon that some organizations conduct pay reviews quite separately from performance reviews and use the ratings purely as a means of indicating pay increases. The ratings can simply signal an exceptional, above average, average or below average increase or no increase at all.

The problem with this approach is ensuring that pay decisions are properly and fairly linked to performance; it is, after all, a process of paying according to performance and not according to managerial whim. It is necessary to emphasize to managers that there should be a proper read-across from their performance review and they should be required to justify their recommended pay increases on this basis.

Forced Choice Distribution Guidelines

These, as the name implies, indicate the way in which different performance ratings and awards should be distributed among employees by defining the percentage who should be rated at each level.

This distribution would produce an average award of about 5 per cent. It is based on the normal distribution  and this could be challenged as being an unjustifiable assumption. It is certainly one that has attracted a lot of criticism when exposed in PRP evaluations. Intelligence may be distributed normally in large populations (although even that is not universally accepted) but there is no reason for assuming that the distribution of people according to the way in which they apply their intelligence follows the same pattern. In any case, can anyone be confident that the population of any single organization, let alone a department within that organization, conforms to this shape?

In recognition of this situation, organizations often skew their recommended distribution by increasing the proportion at higher levels on the assumption, which may or may not be correct, that they employ higher than average people. Another approach, possibly with more justification, is to avoid forcing ratings into a nil award category and simply indicate that the lowest rating category should apply to, say, 10 per cent of the population. The awards in that category can be 3 per cent for developing or below average employees while ineffective employees should get nothing. The distribution between the two categories would not be forced.

Forced distribution provides the most rigid guidelines and is the easiest to control if the objective is to achieve the greatest degree of conformity. But we cannot favour an approach which puts managers in straitjackets and ducks the issue of managing diversity, which is a challenge to which those responsible for reward management policies have to respond positively. 

Performance Matrices

Performance matrices, can be used to define performance-related increases according to ratings and position in the pay range. Control can be exercised over performance review costs by analysing the distribution of ratings first (usually with the help of a computer) and then adjusting the figures in the matrix to ensure that the increase to the payroll would be within the budget. Software is available which can adopt an iterative or 'what if' approach to calculating the cost implications of different configurations of the matrix in the shape of variations in the amount and distribution of awards and/or variations in rating distributions.

Ranking

This is a form of forced distribution. Managers are asked to rank staff in comparable categories in order of merit (this approach is often associated with an old-fashioned system of merit rating which allocates points according to the assessed level of merit). The rank order is divided into groups and the percentage increase is dependent on the group in which individuals are placed. Thus someone in the top 10 per cent of the rank order might get a 10 per cent increase while someone in the next 10 per cent might get a 7 per cent increase and so on.

Pay Modelling

The use of software packages for modelling pay systems has enabled organizations such as government agencies and insurance companies with formal pay structures and performance or merit rating procedures to relate pay increases precisely to the ratings they use.

Choice of Method

The choice between these methods depends on the degree to which the organization believes that the benefits of uniformity and consistency are more important than the benefits of giving a reasonable degree of choice to line managers. It is a matter of opinion. But as we have made plain earlier, our view is that forced distribution systems, if they are operated rigidly (and if that is not the case, the process can hardly be called one of forced distribution), go too far in the direction of constraining the rightful responsibility of managers in this important area. It is better to produce guidelines on appropriate increases for different ratings which can be varied at the discretion of managers as long as (a) total increases are within the pay review budget, (b) an upper limit for increases is not exceeded unless the circumstances are exceptional, in which case the proposed increase has to be justified, and(c) the distribution of awards looks sensible overall, ie it is not skewed unreasonably in either direction.

PAY REVIEWS

Objectives

Pay reviews are a major means of implementing the organization's reward policies for improving performance and ensuring the continued motivation and retention of employees. They are also the manifestation to employees of these reward policies.

It is important, therefore, that the way in which reviews are conducted and the outcome for employees reflect these policies and the organization's culture. So far as employees are concerned, the review should, within reason, meet the expectations the organization has created among them as to how they will be rewarded in relation to their performance and contribution. However, the extent to which this can be achieved in practice may be limited by budgetary constraints on the amount of money available for pay increases, which will ultimately be derived from the business performance of the organization, or, in the public sector, government guidelines on pay increases. The review policy and practice will also be affected if pay is negotiated with trade unions.

When planning and conducting a pay review, consideration should be given to the need to:

• provide general 'across-the-board increases' in response to market trends, increases in the cost of living or negotiated pay settlements;
• conduct a review of the pay structure to reflect the need to respond to external pay market forces or to change differentials;
• provide individuals with performance-related pay increases;
• deal with increases in market rates affecting particular occupations or job families.
  
  

An Integrated Approach

We discuss these aspects of the review separately in the next four sections of this chapter. But this does not imply that they should necessarily be treated as discrete activities. There is an increasing tendency for organizations to relate pay increases entirely to the combined impact of individual performance and any changes in the individual's market worth (sometimes called performance-only or merit-only increases). Market worth is affected by movements in the market rate applicable to the individual's job and by the fact that the value of individuals to other organizations will increase as they gain experience and achieve higher levels of performance and competence.

An integrated approach means typically that there are no general increases, either for market rate movements or for increases in the cost of living. Everything is done on an individual basis. Clearly, this is more appropriate where the type or level of jobs and the culture of the organization are in accord with the concept of individual contracts and, therefore, pay reviews. An integrated approach may be adopted for senior or highly specialized roles where performance is very much related to individual abilities and competence and more account has to be taken of market forces. It may also be appropriate in smaller and rapidly growing organizations that rely on individual endeavour and contribution. But many larger and more bureaucratic organizations are adopting this approach because it does provide them with greater flexibility in targeting pay increases where they are most likely to produce a marked impact on organizational performance.

MONITORING EXTERNAL RELATIVITIES

One of the most important pay policy decisions an organization must make is its competitive stance - how it wants its pay levels to relate to the market. Its stance may be to pay above the market, to match the market or to pay less than the market.

Information on competitive rates and trends can be obtained by means of pay surveys. These can be used to establish the extent to which pay levels are generally keeping pace with the market or whether any particular groups of employees are out of line. The information can be obtained from published, specialized or 'club' surveys and databases. Attention should be paid to trends as well as the distribution of market rates for individual jobs.

Care should be taken to include in the selection of benchmark jobs chosen for comparison purposes any occupations or market groups which are particularly sensitive to competitive forces.

The information on external relativities together with general data on current pay practices can be summarized and charted as illustrated in Figure 1. This shows:

• the pay practice line - the average of the actual pay of job holders in each grade;
• the pay policy line - the line joining the reference points in each grade;
• the median and upper quartile market rate trend lines applicable to the benchmark jobs which are used for pay comparisons.

 

Figure 1: Analysis of pay structure policy and practice in relation to market rates

Particular attention should be paid to the market relativities of key jobs in the various occupations or job families.

This analysis will indicate any need for general market rate increases or a case for looking at the competitive position of particular job families or individual jobs.

Whenever any action is taken to deal with market forces by, eg setting up separate market groups, paying market rate premia or deliberately paying high in the range for some market-sensitive jobs, the aim should be to make explicit and identifiable any compromises with internal equity that have been made in response to market pressures.

Market-place Matching

A decision has to be made on the point in the review period when the aim will be to achieve the chosen competitive stance. An organization is most competitive at the start of the review period and gradually loses ground as pay inflation inevitably takes place in the market. It is necessary for the organization to project the point in the review period where it wants to achieve its competitive position.

There are three basic approaches to making this projection:

1. Lead/lag - project the position to half-way through the review period, which means that the organization will lead the projected market for the first six months and lag the projected market for the next six months.
2. Lag/lag - select the start of the review period, in which case the organization will lag the projected market for the whole of the review period as the market pulls ahead of the policy.
3. Lead/lead - project the position to the end of the review period so that the organization will lead the market for the full review year as the market gradually catches up with the policy.

Clearly, the lead/lead approach is the most competitive but also the most expensive.

COMPA-RATIO ANALYSIS | Reward Management Procedures

A compa-ratio (short for comparative ratio) measures the relationship in a graded pay structure between actual and policy rates of pay as a percentage.

The policy value used is the reference point in the grade structure which represents the target rate for a fully competent individual in any job in the grade. This reference point is aligned to market rates in accordance with the organization's market stance policy. The reference point may be at the mid-point in a symmetrical range (say 100 per cent in a 80-120 per cent range), or the top of the scale in an incremental pay structure. Reference points need not necessarily be placed at the midpoint; organizations are increasingly positioning them at other points in the range.

Compa-ratios provide a shorthand way of answering the question: 'how high, or low, is an organization paying its employees (individually, in groups or in total) relative to its policies on pay levels?' Compa-ratios are calculated as follows:

A compa-ratio of 100 per cent means that actual and policy pay are the same; less than 100 per cent means that pay is below the reference point and greater than 100 per cent means that pay exceeds the reference point.

Types of Compa-ratios

There are three types of compa-ratios:

1. The individual compa-ratio, which describes the individual's position in the pay range against the pay policy reference point for the range and can be used to reposition an individual's pay in the range if it is too high or low.
2. The group compa-ratio, which quantifies the relationship between practice and policy for the whole organization or a defined population group (function, department, occupation or job family). It is a calculation of the sum of actual pay as a percentage of the sum of job reference point rates. This ratio has an important part to play in the overall pay management process. It can be used to establish how pay policy has been implemented overall and identify differences between parts of the organization which may indicate problems in the policy itself or in the way it has been implemented by managers. It can also be used to plan and control pay budgets.
3. The average compa-ratio, which is the sum of each individual's compa-ratio divided by the number of individuals. It is therefore not the same as a group compa-ratio which is based on the relationship between the sums of actual rates of pay and the sums of job reference points of pay. The average compa-ratio can therefore differ from the group compa-ratio according to the spread of individual compa-ratios at different job sizes. The group ratio is more frequently used.

Interpretation of Compa-ratios

Compa-ratios establish differences between policy and practice. The reasons for such differences need to be established. They may be attributable to one or more of the following factors:

• differences in aggregate performance levels or performance ratings;
• differences in average job tenure - average tenure may be short when people leave the job through promotion, transfer or resignation before they have moved far through the range and this would result in a lower compa-ratio. Or a higher ratio may result if people tend to remain in the job for some time;
• the payment of higher rates within the range to people for market reasons, which might require recruits to start some way up the range;
• the existence of anomalies after implementing a new pay structure;
• the rate of growth of the organization - fast-growing organization might recruit more people towards the bottom of the range or, conversely, may be forced to recruit people at high points in the range because of market forces. In a more stable or stagnant organization, however, people may generally have progressed further up their ranges because of a lack of promotion opportunities.

Some differences may be entirely justified, others may need action such as accelerating or decelerating increases or exercising greater control over ratings and pay reviews.