Using pay grades and ranges can be an effective piece of your overall compensation strategy. When designing base pay, compensation professionals need to take both internal and external equity into consideration – pay grades can do exactly that.

Why create pay grades?

It is important to ensure that rewards systems are aligned with overall business goals. This can only be done with conscious assessment of the pay structure. "When you are developing a base pay structure, it’s important to make sure that it’s linked to what your organization is all about otherwise." Terry Pasteris confirmed in a recent BLR webinar.

In other words, what are the vision, mission, and strategy of the organization? What is the overall HR strategy to attain the organizational goals? How does this relate to your rewards strategy? When these questions are asked, it quickly becomes apparent if the pay structure is not in alignment. Pay grades and ranges can be a way to bring the pay into alignment in the big picture. Pasteris outlined some other benefits of creating a formal pay structure:

• "It helps to define the base pay opportunity for each job."
• It establishes grades and corresponding pay ranges that are reflective of both internal value and market value. As such, it goes a long way toward ensuring internal equity and external competitiveness.
• "It gives you a structure. It gives you a format. It gives you a way of organizing jobs and pay such that it’s rational and it is intentional, as opposed to haphazard."
• It helps manage cost or investment in employees.
• It provides an important management tool by eliminating the time and effort required by every manager to create their own pay structure for their group.

Establishing pay grades: How to get started

While the benefits of establishing pay grades and ranges may be apparent, it might not be obvious how to get started. In general, the first step is to decide whether internal equity or external competitiveness (or both) will be emphasized. When emphasizing external pay competitiveness, use the market pricing approach. To emphasize internal pay equity, use the job evaluation approach. Many companies use a combination.

The market pricing approach to developing a pay grade structure uses market rates to determine the level of pay for the employees. The rate information may come from survey data, for example, to determine the appropriate rates of pay for employees. Market (external) equity is the primary basis for the pay amounts. This can reduce turnover if done well.

The job evaluation approach looks at each job and rates it relative to a standard within the organization. That then determines the basis for the pay grade structure. This uses the judgment of the team about the value of the jobs instead of the market rate. Market data can be used in conjunction with internal data, but market competitiveness is not the primary reason for the pay grade levels. Internal equity is the primary basis for the pay rates in this methodology.

For more information on setting up pay grades, order the webinar recording of "Pay Grades That Work: Retain Top Talent and Stay One Step Ahead of the Competition." To register for a future webinar, visit http://catalog.blr.com/audio.

Terry Pasteris is president of TLMP Consulting Group. She is both a Global Remuneration Professional (GRP) and a Certified Compensation Professional (CCP). Ms. Pasteris’ compensation work includes developing cash, benefit and equity programs and she has also developed performance management, staffing and communication solutions.