Pay Structure

For employees, one of the biggest concerns is their wages or salaries. Likewise, for employers, one of the biggest decisions they can make is to define how they will pay their employees for their hard work. Employers determine their most appropriate pay structures depending on specific organizational structures and purposes. In this explanation, we will look into the concept of pay structure, its diverse types, and its far-reaching impacts at work. 

Pay Structure Pay Structure

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Table of contents

    Pay Structure Meaning

    What's the meaning of pay structure? According to the Chartered Institute of Personnel and Development, about 60% of employers worldwide utilize pay structures to enhance their companies' financial well-being policies.1

    A pay structure, also known as an internal pay structure, is a collection of organized grades, bands, or levels of employees' wages classified by their job types within an organizational hierarchy.

    A pay structure determines the amount individuals are paid based on their output, seniority, qualifications, and positions. Typically, pay structures link salary ranges with each pay grade. In other words, each pay grade has its own minimum and maximum amount of paid salaries.

    What is the purpose of companies developing pay structures?

    Commonly, companies develop their pay structures for three main purposes:

    1. Ensure fairness and transparency in determining and paying wages;
    2. Add order and clarity to career development and pay rise management;
    3. Facilitate the process of pay progression and reward programs.

    Advantages and Disadvantages of Pay Structures

    As there are always two sides to a coin, the pay structure also has advantages and disadvantages.

    Pay Structures: Advantages

    When it comes to advantages, pay structure brings tremendous benefits to businesses.

    Firstly, a clear pay structure is beneficial in cost control and planning. Specifically, well-defined pay structures provide managers with precise guidelines in pay rise management and pay decisions.

    How can pay structures help with business planning?

    The salary range incorporated in pay structures can make future cost planning easier for managers. Accordingly, managers can briefly estimate the minimum and maximum salary amounts for certain positions in their businesses. Thereby, they can forecast their upcoming human resource costs.

    Second, pay structures help to increase transparency and fairness in pay management. Employees can feel more rewarded and motivated as they understand the reasons behind their pay ranges. Further, when it comes to conversations around pay, managers can use reliable, evidence-based approaches to discuss with their employees.

    How can pay structures display fairness at work?

    When companies have clear pay structures, employers can be confident that their employees receive equitable compensation for their jobs and duties. On the side of employees, as they are aware that they are paid at consistent levels with others in similar job positions or roles, they can rest assured that their salaries are fair, honest, and unbiased.

    Pay Structures: Disadvantages

    Despite its huge advantages, pay structures still possess some disadvantages. Firstly, fair and logical pay structures may cause a tremendous burden on businesses' administrative officers.

    Why do pay structures place pressure on administrative officers?

    For example, administrative officers need to attentively align employees' current jobs and grades with pay structures while closely monitoring pay structures with market pay to ensure their consistency and fairness.

    Second, pay structures are quite rigid for high-demand industries, such as high-tech or IT industries. Accordingly, as such industries constantly need in-demand talents, pay structures cause challenges in recruiting and keeping employees.

    What consequences can rigid pay structures have on high-tech industries?

    When pay structures cannot keep pace with rapid employee pay rises, high-tech companies cannot afford the flexibility to increase their salary offers to retain their employees. Thus, these companies run a risk of losing key talent at work. Further, on a broader scale, if their pay structures fail to catch up with the market-based range, high-tech companies also lose their attractiveness to recruit new talent.

    Types of Pay Structures

    There are various types of pay structures at modern workplaces, among which there are four most common ones:

    • Traditional pay structures,

    • Broadband pay structures,

    • Market-based structures, and

    • Commission pay structures.

    Types of Pay Structures: Traditional Pay Structures

    In traditional pay structures, pay levels are categorized into multiple pay grades. Further, the pay grades are often narrow in scope.

    Traditional pay structures divide pay levels into different pay grades. The distance between each pay grade is relatively narrow.

    Within traditional pay structures, managers often define concrete requirements for their employees to move upwards to the next pay levels.

    What are the possible requirements for employees to receive a raise?

    For example, managers can define the minimum length of employment that an employee should satisfy to have their salaries increased. In other cases, managers can require employees to reach a fixed annual KPI indicator to have their salaries reviewed.

    Accordingly, the narrow distance between pay grades makes traditional pay structures highly controllable for managers. Therefore, traditional pay structures prevent scenarios in which employees can reach their maximum salaries too quickly.

    What are the disadvantages of traditional pay structures?

    Traditional pay structures can limit the number of opportunities for pay raises offered by employers. Thereby, traditional pay structures may decrease the company's overall attractiveness and threaten the company's retention scheme.

    Types of Pay Structures: Broadband Pay Structures

    Another popular pay structure is the broadband pay structure, which offers employers and employees more flexibility in pay progression and pay discussion.

    Broadband pay structures divide pay levels based on employees' job types and categories instead of job titles.

    For example, companies using broadband pay structures can determine their pay levels based on job categories, such as service jobs, technical jobs, executive jobs, and so on. Thus, there are fewer pay grades with larger flexibility in broadband pay structures. However, it is often more difficult for employers to determine pay differences between employees within a similar job category.

    What are the disadvantages of broadband pay structures?

    Given its flexible and wide salary ranges, a broadband pay structure may cause incidents of employees earning their maximum salary cap too early or quickly. Thus, employees may feel demotivated to grow at work. Further, companies frequently risk losing talent due to a lack of challenges and monetary motivation.

    Types of Pay Structures: Market-based Structures

    Sometimes, organizations can rely on the overall market average to determine their pay structures.

    Market-based pay structures rely on the current market average of similar positions to determine employees' salary ranges and pay grades.

    Contrary to broadband pay structures, market-based pay structures determine salary ranges for specific job titles and positions. However, while the salary ranges are large in market-based pay structures, their pay grades remain narrow.

    Within a marketing company, employers can use market-based pay structures to determine different salary ranges and pay grades for different job positions, such as marketing manager, performance marketing specialist, performance marketing analyst, and so on. Accordingly, employers focus on leveraging their pay structures with the average offers on the market.

    Types of Pay Structures: Step Pay Structures

    Being one of the simplest pay structures, step pay structures consider employees' time with the organization to determine their salaries and pay grades. Step pay structures are common among government organizations and law enforcement entities.

    Step pay structures determine employees' salary ranges and pay grades based on their accumulated time with the organization and adequate performance.

    Accordingly, step pay structures are popular in circumstances when detailed performance analysis is difficult. Thus, companies rely on employees' accumulated time increments instead.

    What does a real-life step pay structure look like?

    Companies may utilize step pay structures to give their employees a $3,000 pay raise for every additional three years of service.

    Commission Pay Structures

    As a part of companies' reward programs, commission pay structures are becoming increasingly popular among modern workplaces.

    Commission pay structures determine how companies compensate their employees for their work and contribution.

    While there are various types of commission pay structures, companies must preserve fairness and accuracy in all approaches. Let's look at the two most popular types of commission pay structures: team-based and individual commission pay structures.

    Team-Based Pay Structures

    Within companies where teamwork is critical to overall business success, team-based pay structures are relevant and preferable.

    Team-based pay structures tie employees' wages or bonuses to the success of their team goals.

    Accordingly, employees' wages or incentives will be similar within groups, depending on how well their groups achieve their goals and objectives.

    Which industry is most likely to use team-based pay structures?

    Various interdependent teams often work toward big IT projects in IT departments. Thereby, team-based pay structures are beneficial as they enable employers to judge the entire teams' performance and task completion rate. For example, a team can receive incentives for its solution to improve the project's speed and accuracy.

    However, there remain certain critics of team-based pay structures. For instance, opponents believe that team-based pay structures can place pressure on effective team members, as they often have to work harder to compensate for the insufficient performance of their teammates. Further, team-based pay structures create power struggles for credit regarding the failure or success of group outcomes among group members.

    Individual Commission Pay Structures

    Unlike team-based pay structures, individual commission pay structures concern individuals' performance at work.

    Individual commission pay structures rely on individuals' performance to determine their wages or bonuses.

    Accordingly, in individual commission pay structures, individuals are measured based on their own performance and contribution to the overall business outcomes. Typically, companies apply individual commission pay structures to their sales or marketing departments.

    What types of individual commission pay structures can companies utilize?

    There are various types of individual commission pay structures at work. For example, companies can utilize gross margin commission, residual commission, salary plus commission, or tiered commission types to reward their employees.

    Factors that Influence Internal Pay Structures

    Both internal and external factors can influence companies' determination of internal pay structures.

    These are summarized in the table and graphic below.

    Internal Factors

    Performance
    Experience
    Seniority
    Potential
    Job requirements and evaluation
    Organizational strategy

    External Factors

    Laws and regulations
    Labor market
    Economic factors (for example: inflation rate)
    Technological changes

    Table 1 - Factors that influence internal pay structure

    Pay Structure Examples

    Wondering what a real-life pay structure looks like? Let's look into this example of a typical pay structure at work.

    A marketing firm can develop a pay structure for junior marketing specialists ranging from $30,000 - $40,000 per year, depending on their experience and expertise. Accordingly, the pay grades within such salary range can be specified as below:

    • Pay grade 1 - junior marketing specialist with less than 3 years of experience: $30,000 - $33,000 per year
    • Pay grade 2 - junior marketing specialist with 3 - 5 years of experience: $33,000 - $36,000 per year
    • Pay grade 3 - junior marketing specialist with over 5 years of experience: $36,000 - $40,000 per year

    Plus, you can frequently see the following step pay structure when browsing for jobs in the education industry.

    A local university determines its step pay structure for professors. Accordingly, professors have their salaries increased by $10,000 after every two years of working until their salaries reach the maximum cap:

    • Year 1: $50,000 per year

    • Year 3: $60,000 per year

    • Year 5: $70,000 per year

    • Year 7: $80,000 per year - maximum cap

    • Year 8 and beyond: $80,000

    Indeed, pay structures are diverse and unique to each business' internal and external conditions. What remains even more important than having proper pay structures for businesses is constantly reviewing and improvising such structures to stay up-to-date and competitive in labor markets.

    Pay Structure - Key takeaways

    • A pay structure is a collection of organized grades, bands, or levels of employees' wages classified by their job types within an organizational hierarchy.
    • There are four common pay structures: traditional pay structures, broadband pay structures, market-based structures, and commission pay structures.
    • Team-based pay structures tie employees' wages or bonuses to the success of their team goals.
    • Individual commission pay structures rely on individuals' performance to determine their wages or bonuses.
    • Both internal and external factors can influence companies' determination of internal pay structures.

    References

    1. CIPD. Pay structures and pay progression. https://www.cipd.co.uk/knowledge/fundamentals/people/pay/structures-factsheet#gref.
    Frequently Asked Questions about Pay Structure

    What are the different types of pay structures?

    There are four common types of pay structures: traditional pay structures, broadband pay structures, market-based structures, and commission pay structures. 

    What is a payment structure?

    A payment structure is a collection of organized grades, bands, or levels of employees' wages classified by their job types within an organizational hierarchy. 

    What are the three types of pay?

    There are four most common types of pay structures: traditional pay structures, broadband pay structures, market-based structures, and commission pay structures. 

    What are the elements of pay structure?

    Both internal and external factors can influence companies' determination of internal pay structures. 

     They range from performance, experience, and seniority to laws and regulations and technological changes, and so on.

    What are two key factors to determine when developing pay structures?

    Both internal and external factors can influence companies' determination of internal pay structures. They range from performance, experience, and seniority to laws and regulations and technological changes, and so on.

    Test your knowledge with multiple choice flashcards

    A pay structure, also known as internal pay structure, is a collection of organized grades, bands, or ____ of employees' wages classified by their job types within an organizational hierarchy.

    Pay structures link salary ranges with each ____

    Can pay structures cause burden on businesses' administrative officers?

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