HR Metrics – Ditch the “Compa-Ratio”
The “compa-ratio” is such a silly and deceptive “metric” that even not knowing much at 25 years old (longer ago than I care to admit) I could not bring myself to use it in a client report. HR practitioners, and the executives and managers they support, need metrics that really mean something, and for decades, this “statistic” has been purported to be the leading measure of employee compensation program effectiveness. This meaningless metric should be ditched immediately, and replaced by something that really makes sense – 1) the Compensation Effectiveness Ratio (CER) and 2) the Compensation Effectiveness Index (CEI).
The “compa-ratio” is calculated by dividing current compensation by the program target, typically a pay range midpoint. Employees paid less than the target will have a number under 100%, those paid more will have a number above 100%. The problem, of course, is that this means nothing because the midpoint is an arbitrary amount to compare to — perhaps I’m a new employee with minimal experience, and I should be paid 20% below the midpoint, or maybe I am a long-service superstar, and my “compa-ratio” of 110% still means I am underpaid. Without a performance adjustment, the number means absolutely nothing — it simply does not tell us how actual pay compares to what pay for any given employee should be.
Worse than the application of the compa-ratio to individual pay is averaging each individual’s compa-ratio to try to describe the effectiveness of the entire compensation program — basically, if all the errors average out to 100%, we can claim our program is effective. Essentially, a totally dysfunctional program can be made to look good, even when we don’t know whether “100%” is really what we should be paying.
In contrast, the “Compensation Effectiveness Ratio” (CER) measures the extent to which a pay program actually delivers what it is supposed to. Instead of dividing current pay by a range midpoint, divide it by the amount an employee should be earning, based on their performance. If your performance management program can’t tell you what an employee should be earning, you have another problem altogether. However, for those whose pay program is truly fair and equitable, and can predict pay based on the value of the job and the value of the employee’s performance, the CER provides a true measure of how close an individual’s pay is to where it should be.
Unlike averaging individual compa-ratios to create a composite company compa-ratio, the “Compensation Effectiveness Index” (CEI) measures the total variance from performance-based target compensation. This is done by taking the absolute value of the variance from target, and adding it together. A CER of 93 has a variance of -7 from the target. A CER of 107 has a variance of +7 from the target. Instead of averaging the two and coming up with the deceptive “0 variance,” we consider the two absolute values: -7 = 7, +7 = 7. Adding the absolute values of the variances give us a total variance is 14. This is a crucial difference, because in the former model, we claim that our program is a success when it is not, while in the latter, we can see it is not, and know exactly what actions to take to make it work. The objective of an organization and its compensation professionals should be to have every individual CER at 100, and to reduce the CEI to 0.
It is important for compensation practitioners to have metrics we can use to show management and employees how effective compensation programs are. The “compa-ratio” and its derivative, the average compa-ratio, are inaccurate, and typically very deceptive, metrics. On the other hand, the performance adjusted CER, which measures what pay SHOULD be, and the composite CEI, which measures the total variance from an effective pay delivery model, provide management and the profession with real tools to measure effectiveness and success.
For more information on compensation metrics, and how to tell whether your compensation program delivers what it promises, contact the author at firstname.lastname@example.org.