CIPD - Pay levels: market pricing

Pay and reward

Revised February 2010

This factsheet gives introductory guidance. It:

explains the concept of the market rate in relation to pay
discusses issues around choosing a pay policy and deciding what constitutes ‘pay’
sets out the different approaches to market pricing that might be used
looks at what to consider when undertaking a market pricing exercise.

The concept of the ‘market rate’

Market pricing exercises collect pay data for equivalent jobs to establish their market rate or ‘price’, the speed by which it is changing, and the direction of change. Although the concept of a market rate for a job is fairly common, there is no such thing as an accurate or scientific single rate of pay for a job or role, and rates may vary even for the same occupation and in the same location. The reasons for this are:

Different organisational practice about where to position pay levels in relation to the labour market.
Different labour markets for different groups reflecting industry, geographical or occupational factors.
Individual employees having their own market value based on unique factors such as talent, expertise and performance.
Cash pay is only part of remuneration and there are other pecuniary and non-pecuniary elements of the total package.
Employee inertia - people tend not to move employment for small changes in pay because they may lose a valuable benefit, such as a company pension.

The markets for labour

There are external and internal markets for labour, and both can influence pay rates. The wage in the external market is determined by labour supply and demand. Their importance to individual employers depends on recruitment and retention factors such as the use of external candidates to fill vacancies, or the ease with which existing and potential employees can find satisfactory work elsewhere.

The impact of the external market on an organisation’s pay levels partly depends on the relative importance of the internal labour market which has certain characteristics:

(Some) internal rates of base pay may be relatively unresponsive to supply and demand factors in the external market for similar jobs.
Vacancies tend to be filled by promotions from the pool of existing staff, creating a series of career ladders.
There is a positive relationship between the levels of pay and benefits and length of service.
Employees and employers enter into a long-term relationship.

The internal market explains the differences in pay rates for similar jobs between different organisations. In theory, the stronger the internal market, the weaker the impact of the external market. Indeed, where the internal market is very strong, the external market might only impinge as a determinant of starter rates, for example, new graduates.

In practice, the external market always has some influence on an organisation’s pay levels and movements, with the value placed on individuals affected by factors such as contribution, responsibility, productivity etc, and the levels of expertise and skill that they have.

Equity and fairness

Employees have perceptions of their intrinsic value related to the extent to which they believe their qualifications, experience and performance are ‘fairly’ rewarded. This is tricky because ‘fairness’ can only be measured relative to something else, typically internal and external comparisons of treatment, including pay treatment. The external market therefore has importance here, not only in the sense that it affects recruitment and retention, but also because of its influence on motivation and morale. This concept also applies to pay movements.

Consequently, few organisations in the private sector, and increasingly in the public sector, can afford not to attempt to assess and track market rates. However, pricing to the external market rate carries the danger of importing into pay structures any gender and other discriminations that exist in the wider labour market. Organisations should therefore regularly check for signs of bias.

What is ‘pay’?

Market pricing involves the analysis of pay data. An important initial decision is the definition of ‘pay’ to be used. Basic pay is the simplest concept, but a wider definition could also be important. Many surveys provide total cash data, and the provision of key fringe benefits is usually given separately (for example, pensions, company cars and allowances, medical insurance, share options). The concept of total remuneration is also gaining ground as organisations seek to widen the definition of benefits they provide to employees. Find out more on some of these aspects of reward in our factsheets on pay and reward generally, pay structures and total reward.

The wider the definition of pay, the more complicated is the data analysis.

Organisations usually want data wider than a single pay definition, for example, base pay and total reward (such as variable pay plus fringe benefits). This reflects a number of trends over recent years, particularly the growth of contingent pay systems, such as ‘at risk’ pay or variable payments which can go down as well as up year-on-year. In addition, pay systems have become organisation-specific with the emphasis more on business needs than, necessarily, on market demands alone, although the two do overlap. The result is, as Fay¹ argued over 15 years ago, ‘base pay is becoming a smaller part of the total compensation package for an increasingly broader range of employees, making it unclear what incumbents in a job actually [earn]. It is certainly more difficult to make comparisons across very different pay systems. When 'at risk'pay may take the form of lump sum bonuses, payments into employee stock ownership or savings plans, or additional time off with pay, comparison of salary figures which may include only base pay or direct cash payouts becomes misleading’.

Choosing a pay policy

The second decision relates to how the data will be interpreted, and for this organisations need to consider where they wish to position their pay levels in relation to the market.

Because employees are not homogenous and have varying skills, attributes and abilities, and employers themselves vary in terms of their cultures, performance and ability to pay, there is often a range of pay rates in the market, even for the same jobs. Consequently, all organisations decide where they wish to position themselves in the labour market to achieve their business and staffing objectives.

A key strategic decision is the planned level of pay relative to the market rate. Risher²notes ‘the most common policy…is to maintain 'competitive' – or average – pay levels. Some employers, albeit a decreasing number, pay above average salaries (fo example at the 75th percentile). It is rare, however, for an employer (deliberately) to pay less than average wages and salaries’ as that would affect the calibre of employees that can be recruited.

Pay policies are normally expressed in terms of position relative to the median for the sector, occupation or locality, rather than the average rate. This is to avoid the employer’s own pay decisions directly affecting pay rates, which would be the case if the average were used as the benchmark. To simplify the task, employers might also concentrate on key ‘anchor rates’, such as the recruitment rate and base pay after three or five years, rather than comparable rates at every point in the structure.

Approaches to market pricing

There is a range of options to market pricing ranging from basic data gathering based on job titles through to using analytical job evaluation schemes. Sources of pay data can correspondingly vary from specifically collected survey information to more general commercial data. Data sources are not mutually exclusive. For example, national survey data might help set and maintain pay structures for management grades; locally collected data might be used to set rates for secretarial, clerical and process staff, and occupational-specific data might inform pay decisions for groups such as IT staff or accountants.

Market pricing exercises require that comparable pay data exists that is easily obtainable and accurate. This is, of course, not always the case: some jobs are so specialised that few, or even no, external comparators exist and assumptions have to be made about ‘comparable’ job content which may compromise the accuracy of the data. By and large, however, it is possible to access or establish pay databases covering most occupations.

Job matching

Market pricing requires a degree of job matching designed to provide comparable pay data. Job matching can use analytical or non-analytical approaches.

Non-analytical job matching

The least sophisticated of these collects data by job titles only and is often used for fairly junior, common and uncomplicated jobs, typically in local labour markets (such as cleaners, counter staff, van drivers). It may amount to no more than visiting the local Job Centre Plus to gather information on offered rates, or reading the vacancy columns in the local press. Whilst this can provide valuable data, it is of little use for a generic job title such as ‘manager’ that covers a wide range of responsibility levels.

To improve the data, some survey companies and employer pay ‘clubs’ back up the job title approach by providing short ‘capsule’ job descriptions capturing the key characteristics of posts. They can help produce a more accurate match but the descriptions are rather general. In addition, jobs and their characteristics change over time, and many jobs involve levels of flexibility that make simple definitions misleading. Capsule job descriptions tend to be used most to collect pay data in specialist areas.

A further approach is to use zones of responsibility to provide a better understanding of where a job stands in relation to others. Survey organisations seeking to provide comparable data, particularly for managerial and professional jobs, often use this approach. However, there is still a weakness given the scope for interpretation during the matching process.

Finally, it might be possible to use a non-analytical job evaluation based on whole job comparisons. These require complete job descriptions and considerable time and effort to prepare them. Moreover, comparator organisations may not have the same descriptions and may be unwilling to prepare equivalent versions.

Analytical job-matching

Analytical job matching uses job evaluation to determine comparable jobs. It assumes common characteristics are present in all jobs to a greater or lesser degree to enable comparisons to be made between them. These characteristics include factors such as knowledge and skill, decision-making, and accountability.

Under this approach:

jobs are analysed in terms of the identified factors
a points scale is attached to each factor and weighted to reflect the relative importance of the factors
jobs are ‘scored’ factor by factor by reference to job analysis and the factor points scale
the total points score gives the ‘size’ of the job relative to others.

For more information on job evaluation, see our factsheet on that topic.

Go to our job evaluation factsheet

Analytical job matching exercises are usually based on evaluating a benchmark range of representative jobs. The proportion of these jobs in the total employee population depends on the number of different posts being assessed, with a larger proportion of benchmarks being required where the range of functions is wide. Benchmarks act as standards or guidelines for other jobs within an organisation. They should therefore have functions to which it is fairly easy to relate other jobs. The appropriate proportion of benchmarks to use will vary.

Determining market pay

Job matching does not actually determine pay rates, it merely provides a ranking of jobs within an organisation. Giving jobs a ‘price’ is a separate exercise requiring appropriate pay and benefits data.

Sources of pay data

For pricing purposes there are four key sources of pay data:

Published data from pay surveys and similar organisations can give some indication of going rates. Their usefulness is limited because of problems in comparing like with like, but these data can help with periodic reality checks on levels and movements, and they are particularly valuable sources of data on specific occupations or localities.
Pay clubs of employer groups who regularly exchange information on pay levels. They generally only allow participants access to the data.
Special surveys funded by individual organisations from specialist pay consultancies but, again, access is usually limited to the contractor and participants.
Consultants’ pay databases containing data collected on a systematic or ad hoc basis which they relate to the results of their job evaluation schemes to compare pay rates across organisations on a common basis: this ability is one of the attractions of job evaluation to many organisations. To be viable it is important that the factors measure common job/role characteristics and can enable comparisons to be made across different jobs/roles and organisations; the data is based on an adequate sample; and the job analyses are carried out systematically and conscientiously.

Our Reward management 2007 survey report gives some information on the prevalence of these approaches for by broad occupational groupings.

Go to our annual Reward management survey report

Considering the options

Analytical job evaluation is time-consuming, labour-intensive, expensive, and relies either on the cooperation of comparator organisations, or on access to common job evaluation scores held by, for example, a consultancy. There is also always the risk of subjectivity in job evaluation exercises – despite claims that are made about its scientific basis – and scores can be manipulated.

However, an analytical approach may well be the most accurate method there is, especially for pricing more senior jobs/roles. Many consultancies offering propriety job evaluation also hold pay data for evaluated jobs in other client companies. This enables them to benchmark positions against the pay data for comparable jobs. The validity of this approach depends on the quality of the database and its ability to provide a satisfactory standard of matches at all levels, and this needs to be demonstrated. Alternatively, consultancies can be asked to prepare a specific pay database derived from information about salaries for jobs that are separately evaluated as comparable.

A non-analytical approach involves agreeing in advance the organisations with which the benchmark jobs should be compared. Job descriptions need to be prepared for the benchmark jobs, and the comparator organisations would be asked to provide pay data on jobs that matched the descriptions, with an indication of major mismatches. This information would then be interpreted to establish the degree of comparability, with emerging pay levels based on these interpretations. The pay database could be kept up-to-date by regularly gathering information from the comparator organisations.

Whilst this approach might appear simpler to implement, in fact it is likely to be just as time-consuming as analytical job evaluation, with the interpretations probably more prone to subjective influences.

Organisational practice

There is actually very little published information on organisations’ market pricing practices. Two small informal pieces of research carried out by the Office of Manpower Economics, covering the civil service and some large private sector organisations, suggested that the biggest difference between the two sectors is the emphasis the private sector places on individual worth, so that, all other things being equal, higher performers are paid more than lower performers.

Private sector companies tend to benchmark against their own industries, and against companies of similar size (internationally as necessary). They often ‘age’ pay databases up to a common date by applying a multiplier based on annualised salary movements in the market. Some companies use job families and match generic jobs to a management consultancy database.

Approaches in the civil service vary, but there is common reference to a wide range of pay databases. Some bodies take on board a local dimension – see our factsheet on local pay for more information.

Go to our factsheet on local pay

In all these cases it is clear that:

Organisations rely on more than one source of data for their market pricing exercises.
Reading across to data based on analytical job evaluation is only part of the exercise, and is often not part of the process at all.
Data-gathering exercises are on-going and the results implemented annually, (or in-year if recruitment and retention problems are severe).

Points to consider

When undertaking a market pricing exercise some questions organisations will want to consider are:

Who are the appropriate comparators?
How should comparisons be undertaken?
What are the appropriate sources of data on pay levels and movements, and how should they be accessed?
How often should such an exercise be undertaken?
How ‘refined’ does the data need to be in any particular year and over time?
What definition of pay is appropriate for data collection purposes?
Where do they want to position pay in respect of the market?

References

FAY, C.H. External pay relationships. In: GOMEZ-MEJIA, L.R. (1989) Compensation and benefits. Washington DC: Bureau of National Affairs.
RISHER, H. (1993) Strategic salary planning. Compensation and Benefits Review. Vol 25, No 1, January-February. pp46-50.

Pay levels: market pricing