Pay is a complex business. Often we only get a measure of how well a firm pays relative to the employment market when people leave. Then of course it’s too late. Pay is not the only reason why folk leave one firm and move to another but often it is high in prominence in the overall decision. This blog sets out the primary criteria in deciding how much to pay an employee for doing a job and then describes a pay model that allows these criteria to be met. If followed, this model enables a manager to set fair and appropriate wages for all staff.

Obligation to pay fairly

Managers are bound by law to pay the same to all employees for work of equal value[1]. The manager may not discriminate. Employees also expect to be treated fairly and to be paid a fair wage considering their competences and performance compared to those of their peers. This sets the first essentials of pay: that there must be a fair and non-discriminating method used to determine who gets what.

Pay is part of a bigger rewards picture covering pensions, benefits, personal development and work environment. It’s beyond the scope of this blog to cover all but pay. There is a concept today of ‘total reward’ describing the whole employer-employee remuneration relationship. Managers will need to consider the degree to which a total reward package can be built up from exchangeable elements unique to each employee. This blog concentrates however on the pay element alone.

Firms pay employees for their contribution to the success of the business. It is therefore essential that pay is linked to the business strategy and to performance. The rewards process sends a message about the expected behaviours and employment law outcomes. Whilst there are dis-benefits in paying commission-only pay or pay that is highly individual-performance based, some element of performance-related pay is valuable.

Influence of the market

The labour market sets a wage for every job. Scarce skills attract higher wages. And in times of unemployment, wage rates deflate. The market can be described by a range of rates for a given job. In assessing the market, it is important to match job for job. Where this is done, a spread can be described allowing the principal to elect where on the distribution to set their pay point. Typically firms might elect to pay at the median (about the average) of all firms or maybe at the sixty percentile representing a desire to attract good staff.

Finally, in today’s knowledge world where the firm’s performance is linked to the growth in competence in employees, some acknowledgement of the relative value of one employee over another is essential. In this case it’s also important that employees are rewarded for acquiring greater competence – for developing themselves. If nothing else this acknowledges their added value and perhaps avoids them looking elsewhere when new competence is acquired.

These four points – the need to pay fair and legal, to reward performance, to pay a market rate and to reward competence – sets the criteria for the SME pay model set out below.

Base pay

Base pay is the minimum that any firm would expect to pay for a given job. It must be determined for a job family (for example engineer, business administration, marketing). Each job family has a range of levels of seniority. In the Pay Structure for SME engineer job family, these might be assistant engineer, engineer, senior engineer, principal engineer and chief engineer. Each can be described by a job summary (a one paragraph summary of the job description) and this is then used to match between jobs in different firms in the market. The base pay is what a principal would expect to pay a new starter at the beginning of his or her career at that level.

Base pay is a single value for each job family level.

Competence-related pay

Each person brings differing competences to the job and each firm needs specific competences in order to complete given work. The competences in each job family and level can be specified. Typically jobs comprise between 5 and 10 competences. Each competence can be scored as trainee, supervised practitioner, practitioner and expert and like the levels, a statement can be made about the competence to allow a decision to be made as to where each employee sits on the competence scale.

The manager can then decide the percentage elevation above the base pay that the firm will pay for competence. A typical value is a maximum of 20%. Only an expert in every competence would be paid the whole 20%. And a trainee in every competence would be paid 0% or the base pay alone. An employee who had been in the job (at that level) for some time and was expert in some, practitioner in others and trainee in one or two competences, would be paid around 50% of the competence pay or 10%. The competences are scored by the principal but will have been the subject of the employee’s appraisal six months before.

Performance pay

That then leaves performance related pay. Performance related pay adds on top of base and competence pay and is only paid a) if the firm has a good year and b) if the employee has met all their objectives. In a good year, the firm’s management will elect to pay a sum out of net profits into a bonus pool. This bonus pool pays performance related pay. In a poor year there will be no pool and no performance related pay – it hasn’t been earned. In setting performance related pay, it would be normal to budget for employees to earn up to 20% above base plus competence pay.

Performance related pay requires that two or three objectives are set at the beginning of the year that are performance-oriented. An example is an electrician who manages jobs. He might be set an objective to manage all jobs within the price and time quoted. That would secure the gross margin for his jobs and he would therefore be contributing to profits. A salesman can of course be set an objective that they achieve a sales budget but their two others could relate to gross margin so that they don't simply drive for top line, ignoring margin and profit. In any case when performance related pay is set dependent on profit, it dissuades renegades from going all out for individual bonus.

On remuneration: a pay model for SMEs

Do remember one critical point. In this model performance related pay must always be stated in all documents as ‘discretionary’. If the firm can’t afford it, it must not be contractually bound to pay.

Finally, once the pay model described above is set up, it needs to be benchmarked against the employment market for each job family, level, competence and performance. Once done, this is a fair way of setting wages. It’s a method of rewarding competence. And it’s a way of rewarding contribution to the firm’s profits through performance. It ticks all the ‘best practice’ boxes.

This blog is brief. It sets out the principles. Any manager can use it to develop a pay model for their firm. TimelessTime has significant experience in developing and implementing pay models. Call us for assistance to implement a pay model tailored for your firm.

1. The following apply: the Equality Act 2010, the Equal Pay Act 1970 (as amended by the Equal Pay (Amendment) Regulations 1983), the Sex Discrimination Act 1975, the Pensions Act 1995 and the Employment Equality (Age) Regulations 2006.