An Argument Against Pure Market-Based Pay Structures
Workspan Daily
February 10, 2022
Key Takeaways

  • Lots of comp options. While most organizations target paying a specific market percentile for their roles, there are a variety of approaches that can be used, such as traditional pay structures, broad band pay structures, purely market-based pay structures and step scales. 
  • Abandoning market-based structures. In terms of how to approach determining compensation, no single solution for every organization, but purely market-based structures should be abandoned. 
  • It’s not always competitive. Compensation practitioners must use their discretion to assess the validity of the market value and the quality of the matches, and then have to decide how to best support the business, balancing fiscal prudence and the ability to retain talent. 
  • A costly approach. Depending on your range spread, narrowing salary bands to meet certain percentiles can carry a considerable cost when we move employees into the pay range, as compared to a pay structure that is not purely market-based.

Salary structures and pay bands are tools widely used by compensation practitioners to ensure that organizations are paying roles competitively in the labor market, while maintaining internal equity within the organization. While the vast majority of organizations target paying a specific market percentile for their roles, there are a variety of approaches that can be used — traditional pay structures, broad band pay structures, purely market-based pay structures and step scales, for example.

 

While no single solution will work for every organization, this article explains why purely market-based structures should be abandoned.

 

The availability of market data has not always been as prevalent as it is today. As the availability of market data has become more prevalent, so too have companies’ reliance on that data. It is my opinion that a large portion of organizations rely on that data too heavily, unaware of the problems with the data. Organizations that use a pure-market-based salary structure will see these problems permeate through their ability to pay competitive wages, develop meaningful career paths and manage their human capital budgets year-over-year.

 

Market data has legal limitations as well. Due to various United States laws, salary survey data is limited by antitrust rules. For example, data must be at least three months old, no fewer than five companies can participate, all data must be anonymized and no single company can account for more than 25% of the data.

Market Data Is Always Incomplete


Employer-reported salary surveys are arguably the most accurate data source available to find a job’s market value. Consider, however, that salary survey participation is typically the responsibility of a compensation analyst, a role that typically is only found in larger organizations. As such, organizations that are not large enough to have a dedicated compensation professional are underrepresented in the salary surveys. As such, one can assume that employer reported market data excludes a large percent of employers, capturing only a small segment of the market.

 

Market Data Is Volatile

One of the greatest problems with pure market-based approaches that is often ignored is that the market data changes every year. Sometimes dramatically. Sometimes unexpectedly.

 

In 2018, I evaluated the market movement of the jobs in a large technology survey used by thousands of companies to understand the year-over-year change. The results were surprising: the market median of 25% of jobs either stayed the same or decreased in market value from 2017 to 2018 in the Seattle market. Conversely, 13% of jobs increased more than 10% in a single year. The combination of jobs that decreased and jobs increased more than 10%, accounted for nearly 40% of the job catalogue. That is a material number of jobs experiencing questionable variation.

 

With this in fluctuation in mind, I conducted a poll on LinkedIn, with more than 200 compensation analysts participating, asking how companies updated their ranges if the market data decreased in one year. Of the 200 responses, 95% of respondents said they do not decrease pay ranges, even when the market data recommends it. This disregard for the market data of a “pure market-based” structure is a core problem that undermines the validity of a pure market-based approach.

 

It's worth noting that I am not suggesting pay ranges should be decreased, this is a key component of my argument against using pure market-based structures. In their truest sense, pure market-based structures leave little room for discretion and there is nothing “pure” about the structures when companies disregard the data that doesn’t align to expectations.

 

Internal Equity Is Neglected

One of the cornerstone concepts of compensation is that it is a blend of art and science. I would suggest that the benchmarking and market data is the science, and career pathing and internal equity is the art. Pure market-based pay practices disregard career pathing, internal equity and business needs, solely prioritizing market data that is inherently imperfect.

 
It’s Not Always Competitive


The job of the compensation practitioner is not to simply align a job’s midpoint to market data. Compensation practitioners must use their discretion to assess the validity of the market value and the quality of the matches, and then have to decide how to best support the business, balancing fiscal prudence and the ability to retain talent.

 

Inconsistency Breeds Discontent and Disparate Treatment

Traditional pay structures and market based typically have salary range spreads that from 20% to 40% and 30% to 80%, respectively. There are benefits and tradeoffs to narrow ranges or wide ranges. In a pay structure with a pay-for-performance model, employees’ position in range may drive performance-based merit increases.

 

In a pure market-based structure, inconsistent ranges may mean that some employees are treated differently than others, due to some jobs having wider or narrower ranges. Another benefit of traditional (or similar) structures is the controlled overlap of pay ranges allowing for tenured and skilled employees to improve their salary when a promotion is not warranted by a business case.

 

Pure market-based structures have little to no consistency, varying considerably per job and per year. Organizations that use percentile markers (such as the 25th and 75th percentile) to establish the pay ranges forfeit their ability to create meaningful career paths, distinguish performance of high performers with pay, or potentially to recognize tenured employees without unnecessary promotions.

 

The inconsistency spans beyond just the ranges. As mentioned previously, inconsistency in the year-over-year growth may also mean that employees paid high in the range one year or it may be red-circled the next year — purely due to changes in the survey data and the participants — rather than true market forces.

 

The Approach Can Be Costly

Depending on your range spread, narrowing your bands to meet certain percentiles can carry a considerable cost when we move employees into the pay range, as compared to a pay structure that is not purely market-based. Your typical salary ranges may span 30% – 50%, whereas the median range spread from the 25th to the 75% percentile is only 29%. In fact, only 17% of jobs have a spread of 40% or more, from the 25th to the 75th percentile. This compression of the ranges means that there is a greater cost to move employees into pay ranges, from previous job levels.

 

I once worked for an organization where we had meticulously created salary ranges using a traditional, market-based pay structure. Over my tenure, we market-priced each role and developed career pathing for each job family that reasonably balanced the market data from our survey sources with career pathing and internal equity. Significant discretion was applied to create pay bands that were market-competitive while thoughtfully supporting career progression and internal equity. When we were acquired by another organization that utilized a pure market pay structure with pay ranges that spanned the 25th percentile to the 75th percentile, we were mandated to change our pay structure to a pure market-based approach.

 

The Benefits of Pure Market-Based Structures


There are some benefits to pure market-based structures. But I argue that the benefits are rooted in optics and corporate politics more than improving the organization’s market competitive stance.

I once took a role with an organization that had an office in the San Francisco area with a 12-month rolling turnover rate of nearly 50%. Unsurprisingly, management cited poor pay as the culprit and consistently asked, “Did you price the job for the Bay?”

 

Without understanding the impact sample size has on the market data, nor how survey data specific to the high cost of labor markets doesn’t guarantee that the value of the job will be higher than the total sample. Leadership and managers would always cherry-pick the data that fulfilled their beliefs and ignore the data that wasn’t as expected.

 

Using a pure market structure, I could confidently say, “Yes, I reviewed this job for this specific market and can say with certainty that this job is completely tied to the salary survey data.” That was the most tangible benefit, and it would last for approximately one year.

 

After that, though, all bets were off.      

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