How to conduct a pay review

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• Pay reviews vary. Some differentiate base salary according to performance measurement, while others provide an across-the-board increase.
• Pay strategies differ according to business models. For example, organisations with highly volatile business models will often have lower base salaries but bigger incentives.
• To build a business case for their pay budget, employers must analyse data, typically using both internal data from payroll and benefits, and external salary surveys and market rates.

Case study: Kent County Council keeps pay rates local

Kent County Council has an unusual approach to public sector pay. It introduced local pay rates in 1990 and, over the past five years, has allowed unions to engage in local pay bargaining.

In April 2010, the council reformed its pay structure for about 13,000 staff, excluding schools, by removing annual incremental pay points from pay grades and introduced percentage increases related to performance management. Colin Miller, reward manager, says: “The percentage increase is determined at the end of a moderation process where the organisation needs to decide what percentage to apply for each rating.”

The council has also made a significant change to its pay structure in awarding employees at the top of their grade a one-off payment that is the same as people moving up the grade. “We see that as a fair way of rewarding all our
staff,” says Miller.

The council begins its pay review process in October, meeting unions, discussing general economic data and agreeing what both sides are looking at. Subsequent meetings take into account the national perspective and what the unions expect to see from national negotiations, although the council is not bound by those decisions. Formal recommendations to the senior management team are made around January, and the review receives full endorsement from councillors in February, with the agreed settlement implemented in April.

All sectors have tightened their belts, but pay reviews are still likely to be a complicated process, requiring careful correlation of a considerable amount of data, says Tynan Barton

Pay has grabbed many headlines in recent weeks, whether relating to the public sector, gender equality or wage freezes. For example, in December, the interim report of Will Hutton’s review into fair pay in the public sector suggested senior public servants should earn no more than 20 times the salary of the lowest-paid employee in their organisation.

So in the current environment, with budgets still tight, pay reviews will be a difficult process, says Andrew MacLeod, head of reward data services at Aon Hewitt. “This year [2011] could be even more problematic than last year for private sector employees because of levels of inflation, and reductions in disposable income due to the increase in VAT and changes to the tax regime.”

The private sector has endured almost three years of pay freezes, but the public sector is just beginning that journey after the government announced, in June’s emergency Budget, plans to freeze pay for public servants earning more than £21,000 a year.

According to a survey of members of the Institute of Payroll Professionals (IPP), published in August 2010, one of the main problems is ascertaining who earns below £21,000 if the organisation uses pay grades. For example, a pay grade could range from £18,000 to £24,000. Karen Thomson, associate director of policy, research and strategic visibility at the IPP, says issues could arise over how the freeze would cut off at £21,000 if an employee is in that pay scale but is entitled to go up a grade – will they go up without their pay being frozen? “Or are they allowed to continue to go up the scale, and that not be deemed a pay rise?” she asks. “What is the definition of a pay rise, particularly in the public sector and local government when they have pay scales?”

Cut in NI upper earnings limit

In the same Budget report, chancellor George Osborne also announced a cut in the national insurance (NI) upper earnings limit to align it with the higher-rate income tax threshold, and that the default retirement age would be phased out from October 2011. Removing the default retirement age may have a significant, long-term impact on recruitment policies, promotion and career progression, ultimately impacting on the pay bill. But although the NI changes will put more pressure on pay awards, many employers have budgeted for it.

Mark Thompson, associate director, reward consulting at Hay Group, says that if the retail price index (RPI) stays ahead of pay rises, people will continue to be worse off. “The real focus will be on take-home pay, when people start to feel the impact of price rises and tax increases,” he says.

Pay reviews differ between organisations. Some will differentiate base salary based on performance measurement, while others will provide an across-the-board increase. An employer may then differentiate by using variable pay as a tool, or according to exemptions or promotions. Hay Group’s Thompson says most reward managers operate a discretionary pay review linked to “the competitive rate against the markets, and performance assessment”.

This process requires effective planning and data analysis to build a business case for the pay bill. Initially, employers need to identify the purpose of conducting a pay review, which will determine the kind of information they need to gather. First, they would need to analyse the data they hold in-house, for example, in payroll and HR systems. The IPP’s Thomson explains: “Employers have pay grades and scales to take into account, people in holiday schemes and salary sacrifice schemes. To do a pay review, they have to look at what information they have got, where it is and how they get it.”

Analysis of external data

Also, the review would typically include an analysis of external data, looking at market rates, how the organisation compares and what its competitors are doing. Aon Hewitt’s MacLeod says the UK is usually a mature, strong market for benchmarking pay, but recent times have dictated a different stance. “I think a lot of organisations have neglected to do it over the past two years because when earnings growth is very low, there is always the issue of ‘why bother?'”

If the market picks up this year, retention may be an issue for employers, particularly if they are left behind on benchmarking. To benchmark pay, an employer will typically use salary surveys, pay data and competitors’ rates. For most industries, the employer will be able to access a bespoke salary survey and will tend to focus on benchmarking that entire employee population. “A more rigorous exercise may often be carried out for front-line, mission-critical personnel, and for specific industry roles,” says MacLeod.

The two main factors an employer needs to consider in a pay review are how much it can afford, and what the market rates are. Apart from that, employers may address pay for high performers or high potentials slightly differently. Stephen Cahill, partner, executive remuneration team at Deloitte, says: “Even in tough times, organisations will always try to look after the people who are outstanding, right through the organisation, from the graduates right up to the more senior people who have the ability to go to the next level and who you want to keep.”

Pay for key talent

To address pay for key talent, an employer must first determine the identity of that talent. Professor Stephen J Perkins, director, of the business and management research institute at the University of Bedfordshire, says it is a case of whether an employer focuses on the top performers or people in core positions throughout the organisation. “Be very clear – do we really get value by getting the 80% of people to do 20% more, or simply relying on the 20% of people who we have to pay 80% to?” he says.

Once key talent is identified, reviewing pay for those employees is a similar process as for the rest of the organisation, but it is typically based around the individual, and the whole package, not just pay. “It is a more in-depth look at that person,” says Dan Wilson, director of consultancy, NorthgateArinso. “Is the employer offering them the right level of incentives in terms of providing the right career for them, training and development and leadership development?”

An employer would benchmark how that talent is positioned against the market, and those that are paid above the average rate may not require any amendment to their pay. For those on a par with the market rate, the employer may want to consider an increase in pay or bonus for the year, depending on whether it wants a fixed or variable cost. “You may decide to do something like a stock award, which invests over a three or four-year period, and that might lock them into the business for a longer period,” says Deloitte’s Cahill. “Often the receipt of these stock awards has a lot more value than the stock itself because staff were picked out of a pool of their peers to receive the award.”

Meanwhile, if key talent is found to be paid below the market rate, an employer would work to correct this quickly.

Pay reviews differ in the same way business strategies do. Employers with highly volatile business models will often have a pay structure with low base salaries but bigger incentives, so they can pay big bonuses in good times, but can reduce their cost base in bad times by not paying high bonuses, while their fixed salary costs are not that high.

Organisations in a steadier sector will often have higher salaries, but lower bonuses. “It depends on the type of business, the type of business model and the behaviours you are trying to drive people towards,” says Cahill.

Whatever the sector, a pay review requires a strategic view that encompasses total reward, and consideration of what it is trying to achieve. The University of Bedfordshire’s Perkins suggests the key to retaining talent is understanding who employees are as individuals, what their aspirations are, where they are in their career and their life outside work. “Then you can have a genuine two-way conversation, to say, we are reviewing pay in the context of total reward – how can we customise it in a way that will help satisfy the demands of talented people, but also deliver return on investment through performance the organisation wants?” he says.


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