New Compensation Metrics – A 2017 Resolution

Posted January 4, 2017

The compensation profession suffers from a severe lack of effective metrics. To be frank, the typical measures used in describing compensation program success really have nothing to do with success. This year, try something that makes more sense — focus on metrics that actually tell you if your compensation program is achieving its mission.

Traditional compensation “metrics” include:

“Compa-Ratio” – the ratio of a current employee’s pay to range midpoint/target. This measure only means something if current pay SHOULD be at midpoint/target; without performance information, it’s meaningless, and potentially very deceptive.
“Average Compa Ratio” – the average of individual compa-ratios. This is even worse. Its underlying statistic is meaningless because it doesn’t take into account performance. Average things together and all your errors actually wash out — talk about a way to be deceptive! If you’re bound and determined to use something like this, consider using absolute values.
“Average Increase” – simply, the average increase given in the past year. Typically deceptive, since it only describes what was done for people who are still there, you also can’t compare it to other organizations. If you have a workforce that is relatively new in their jobs, you should be giving larger increases to reach competitiveness in a timely way; if the workforce is experienced and already well paid, all you need to do is maintain them.

The mission of your compensation program should be to help your organization attract and retain the staff it needs. Your compensation program should ensure that people are paid according to their value to the organization. Let’s assume you have a compensation philosophy that sets the right targets and that you have pay ranges that incorporate both internal and external job values — in short, assume your target rate for each job actually represents the value of an employee who has mastered performance of the job.

Here are some great metrics to use to see if your program is working for you:

Current Pay to Value (CtV)

The employee’s current pay divided by what they should be paid (the value of their performance). To do this effectively, you need a performance management process that should end yielding a score that tells you what percent of job mastery an employee has achieved. For example, an employee who is running on all cylinders should be at 100% (or even more), someone who is almost there would be in the 90%s, a brand new, inexperienced individual at 10% to 15%. To test your own program, even without a performance management process that does it formally, simply assign an approximate percentage or mastery to each employee.

To calculate CtV, measure the difference between current pay and the projected pay based on value. Let’s say the employee is paid $50,000, and the range target is $54,000 (range minimum is $43,200). If the employee’s performance score is 96%, they should be paid 96% of the way from the minimum to the target: ((($54,000 – $43,200) * .96) + $43,200), or $53,568. Since current pay is $50,000, the CtV is 93.3% ($50,000/$53,568). Note the difference between this figure and the “compa-ratio,” which would have been 92.6%. That might not seem like a big deal, but it means that the employee’s pay is closer to what it should be that using the compa-ratio approach. To make it more obvious how the compa-ratio fails as a useful measure compared to CtV, think about an employee who is only about 60% toward mastery (perhaps a newer, or less motivated person) but earning $50,000. The appropriate “value based” pay for this employee would be $49,680, and the CtV would be 100.6%! From a “compa-ratio” perspective, the employee is seven percent underpaid, from a more realistic perspective, the program has done just about as good a job as it possibly could!

Percent with Compensation on Target (PoT)

How many employees are near where they should be? Pick a percentage within which you want to be (say +/- 2%), and simply count up the number of employees whose CtV is within that range. Divide that by the total number of employees and you can see what percent of the workforce is on target for pay. The goal of the program should be to get to 100%, where every employee is paid the right amount based on their job and performance; the tighter your acceptable range, the better.

Total Pay Variance (TPV)

It’s great to know what percent of the workforce is on target, but it is also important to know how far you have to go to get to target. That’s where a measure of variance that covers the entire workforce comes in. You can’t make this a simple average of each employee’s CtV, however, because that actually washes out, rather than highlights, the variance. Say, for example, you have four employees with the following CtV measures: 87.1, 94.3, 106.5 and 112.5. The average of these four is 100.1. You could pat yourself on the back for your program doing an outstanding job, except we already know it didn’t — your PoT score is 0%!

To provide a useful metric, we need to take into account the absolute value of the variance from the targets. For mathphobes, the “absolute value” is the magnitude of the variance without regard to sign (positive or negative). For example, the variance on our employee with an 87.1 CtV might be expressed as -12.9 since that is how far it is below the target of 100. To avoid variance being washed out through averaging, we want to simply note that it is 12.9 off. If we take our four employees just mentioned, we’d get variance scores of: 12.9, 5.7, 6.5 and 12.5. Our total variance is 37.6, or an average of 9.4. Whether we use the total or an average, this shows us exactly how far we are off in applying our pay program to our employees, and is a perfect companion metric for the PoT.

The important thing about metrics is that they provide a simple picture about how something is being done — whether it is achieving its goals. For a compensation program we want to be able to show that we are paying people what they are worth. Comparing to midpoints, or to a market rate, doesn’t account for performance and effectively is meaningless. Measuring performance on a 100% scale isn’t difficult, it just requires thinking about value rather than what an employee did last year. In the long run, that is a far more important measure of performance.

The metrics described above give you an ideal tool for communicating the effectiveness of a pay program:

Current Pay to Value (CtV) is an individual measure that ties performance directly to pay, and shows you how close you are to being on target for each individual.
Percent with Compensation on Target (PoT) is the first measure of effectiveness — what percent of your workforce does your compensation program correctly compensate? and
Total Pay Variance gives you the magnitude of the effort you need to bring PoT to 100%.

Add improving these metrics to strategic or operational plans, and your organization will have objectives that everyone can buy into.

Happy New Year, and Happy Compensating!