Compensation, Compensation Planning

Different Locations, Different Pay: Getting Pay Differentials Right

by Lisa Higgins, Contributing Editor

The goal for a compensation program is to set a competitive wage range for a given position, and pay the people who perform that job within the salary range. Complications arise, though, when your workforce is spread from city to city, state to state, or country to country. How can you determine what is competitive pay if you have employees doing the same job in Manhattan and in Kansas City?

pay differentials

Several factors come into play, according to compensation consultant William J. Erdle (www.erdleconsulting.net). He’s been helping companies with their compensation programs for decades, and speaks authoritatively on all aspects of creating, monitoring and updating them. We spoke with him about geographic pay differentials, and how companies can make sure they are setting pay appropriately.

BLR: Is setting pay for the same job in different geographies simply applying a cost of living adjustment?

Erdle:  No, it’s more complex than that. Cost of living plays into it, in that pay may be higher in some areas with high cost of living compared to others, but that’s not always the case. You could have areas where there is a high cost of living, but pay isn’t so high.

Rather than using the cost of living, which is based on the price of goods in an area, your pay program should be based on actual rates of pay, analyzed in reference to your competition for employees, and where you want to pay in relation to them. In short, you need to find out what the market is paying for these jobs and then decide where your company wants to pay in relation to that.

What companies really need to focus on—and typically do—is what the salary surveys they’re using say are the going rates for that particular area. For the most part, pay for a given job in a given area is determined by supply and demand. For example, if there is a shortage of some type of engineer in some part of the country and companies are fighting between one another to recruit these engineers, likely the pay is going to go up.

BLR: So cost of living doesn’t necessarily correlate to geographic pay differentials?

Erdle:  Not necessarily. I used to use an analogy to explain this. The situation has since changed, but the example is still good. A while back, if you looked at Alaska and Hawaii, both had a high cost of living. At the time, though, pay in Alaska was significantly above what the rest of the U.S. was paying, and pay in Hawaii at that time was low. So the fact they both had a high cost of living didn’t mean their pay was correlated.

BLR: How do you figure out the supply and demand aspect of the role for which you’re trying to set pay, then?

Erdle:  It depends on the type of job. Typically, pay differentials are geared more toward hourly jobs, or production jobs—the kind of jobs you would source locally, competing locally for talent. For higher-level jobs, you may compete for talent on a regional or even national basis, because you may need to look nationally to find the kinds of people you need.

For a high-level engineer, for example, you’re competing with any location around the country, so typically a salary search would be based nationally for those types of roles, although I’ve seen some clients look regionally.

So when you’re talking about higher-level jobs, you may factor in geography along with other factors. These may include industry, number of employees, revenue size, for profit/non-profit, etc, and they will likely vary by type of job.

Let’s say you’re looking for an accountant. You may end up sourcing them regionally. So for a job here in the Portland area you might look at pay levels for all of the Pacific Northwest of organizations that are in a general industry grouping—let’s say high tech, knowing that company size typically has little influence on accountant pay. Then you can assign a pay range based on where you want to compete in relation to this data.

For an even higher-level position, let’s say an executive, you would likely be looking nationally. For that, you would likely look at factors such as industry and revenue size, because revenue size is highly correlated with the level of pay for executives.

BLR: That suggests companies can compare to firms that are different than their own. Is that true?

Erdle: Absolutely. Organizations often think they need to look specifically at companies of their size—-revenue size, industry, or number of employees, and compare to those. But really what they need to be looking at is who do they compete with for talent, and where do they want to pay in relation to that.

So I might have a medium-sized company—let’s say they’re in alternative energy and they’re located where there are a lot of high tech companies. The employees they hire have previously worked at the high tech firms around them, or are working there currently.

This company needs to know where the amount they’re paying for their position ranks in relation to these big high tech companies they’re drawing from. So they may want to be at-market, or a percentage above or below, for certain jobs.

Let’s say they need engineers, and they have to compete for them with Intel® or another very large high tech firm. It’s not their industry, it’s not their size, but they still have to compete with them. So they’re looking outside their specific criteria and set their pay program in relation to that.

BLR: A lot goes into creating a salary survey. They’re expensive, because they are time consuming and data intensive. Yet people can access salary information online. How do companies answer employee questions about why they aren’t earning what the online survey says they should be?

Erdle:  You start by using very defensible and credible salary surveys in designing and updating your pay program. These surveys can sometimes cost $10,000 or more annually. The process of creating a credible salary survey is very involved, where online surveys are usually self-reported data so the report is not as valid or reliable.

These free, on-line salary surveys have issues around sampling and validity of the data primarily because of how the data is collected and audited. They may have relatively small sample sizes too. The more credible surveys involve professionals at the companies that purchase these surveys who specialize in this work [and do] a rigorous job of matching typically all employees in a company to the benchmarks in a salary survey or a couple of salary surveys.

It’s helpful when a company is putting in a new pay program to have an employee meeting to explain how it was done since people are quite anxious whenever their pay may be involved. It works really well to have someone like me, an unbiased third party who doesn’t know the incumbents, explain the process.

It’s important for employees to understand, and it’s important for compensation staff to know they have done things in a defensible way and are using credible sources of data. If the company was doing things before by the seat of their pants, their salaries were likely not very defensible.

So when people would come to HR or to their manager to complain about their pay, the company couldn’t defend what they were doing. Sometimes companies would give in to employee demands because companies had little to back up their pay decisions, or they wouldn’t explain the process (because they couldn’t defend it) and tell the employee that’s the way it is.

Once again, the process, tools, and the communication are critical to the success of an HR program. If you’re struggling with your company’s pay, look for a compensation expert to help you. You may find that, in the long run, the expertise will add more value than you expect.