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The Economics Benefits of a Pay Plan

The Economics Benefits of a Pay Plan

We understand that companies want to save money more than ever these days.  When managing your organization’s compensation decisions, it’s important to consider that establishing a customized and disciplined approach to pay administration can save you money, and also be an investment in your people.

Payroll Cost Management

There are three main ways to save money with a pay plan: (1) by not overpaying employees; (2) by avoiding the substantial and sometimes hidden costs associated with undesirable employee turnover caused by below-market pay; and (3) by preventing the potential costs of litigation associated with violations of equal pay laws and wage & hour regulations.  These benefits are primarily associated with base pay plan design, and are described in more detail below.

If you make annual “entitlement” salary adjustments for all employees without the framework of a market-competitive structure, it’s possible that you’re overpaying long-service employees. Our research on companies without current pay plans has shown that most are overpaying at least 25% of their employees.  Linking pay to performance instead of tenure works much better.

Estimates of employee turnover costs range from 50% of annual base salary to as much as 200%. These costs include lost productivity, recruitment expenses, managerial time, administrative costs, training of the new employees, etc.   Keeping even one employee from switching jobs due to low pay and/or lack of perceived opportunity would more than offset the investment of compensation plan development.

Legal landmines with respect to pay abound, especially in California. One issue is that unintentional pay inequities may be used as evidence of illegal adverse impact linked to race, gender, age, or other protected class characteristics.  The other potential legal issue relates to whether jobs are legally classified as exempt or non-exempt.  Both of these legal hazards can become multi-million dollar class action lawsuits, and, at the very least, can be expensive to defend.  An objective and fact-based approach to making pay decisions can diminish legal exposure.

Investing in People

Developing an incentive plan that links variable pay to measurable performance outcomes is one way to invest in the future success of an organization.  When done well, and treated as a management tool, such a plan can powerfully motivate employees to increase productivity, quality of outcomes, and both short- and long-term results.  Incentive plan principles can be applied at all levels in your organization, from the CEO to the lowest-paid staff.

Even the smallest incremental increase in productivity, measured in terms of quantity, quality, and/or timeliness, can lead to improved financial and operating results.

Linking pay to performance can also: (1) improve employee morale; (2) enable clearer communication about performance expectations; (3) result in real and perceived pay equity (e.g., top performers earn more); and (4) provide an additional attraction to prospective new employees.

Bottom Line

The right pay plan has tremendous potential to add value to your company.

Shari Dunn

Shari Dunn is a Managing Director with Gallagher’s Human Resources & Compensation Consulting practice. Upon receiving her B.A. degree in psychology from the University of California at Berkeley, Ms. Dunn headed to New York City to take a position in the human resources department of the Marine Midland Bank, and later worked at Nabisco in operations research. Returning to the San Francisco Bay Area, she became a Research Associate for McKinsey & Co. Next, she ...

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