Think Carefully about “Total Compensation” Pay Ranges

 In Compensation, Incentive/Bonus

I’m not nearly as big of a fan of fruit as I should be, but it is my tendency to always want to compare apples to apples (which is my favorite fruit, by the way).  That makes me very leery of base pay ranges based on “total cash compensation” and my suggestion is that you should be too.  It’s not that anyone who’s pushing this concept on you is evil, perhaps… misguided.  You should always be aware of total cash compensation, because it is a factor that comes into play in recruiting and retention, but paying it out automatically is not a good practice.

The concept works like this.  Employers provide some type of base compensation.  Employers may also pay some type of incentive or bonus.  Therefor, there is a measure called “total cash compensation” that tells you the bottom line that an employee receives during the year.  To be competitive, it is said, you must ensure that not only do your employees receive a salary or hourly wage that allows you to attract, retain and motivate them, you must also make sure that they receive the competitive bottom line.  So, if you prefer not to have some type of incentive plan, you’re going to have to pay a base rate that is equivalent to the market total cash number.

Makes sense, right?  Why not do it?  Well, let me count the ways:

1. First off, you’re going to pay for performance you’re probably not getting.  Incentives, by definition, are rewards given for the completion of objectives.  That is, they are supposed to reward performance above and beyond how the employees are already compensated for doing their job.  Presumably, those employees that earned incentives out in the market did so by providing better than average results (or were lucky enough to work for a company that did really well, thus generating extra cash to pay out in bonuses).  If you pay your employees as if they were providing you “stretch” results, when they aren’t, you’re just paying extra.  Not that anyone is going to complain, mind you, but if you do decide later that you want to have a real incentive plan, you’re going to have to layer it on top.

2. Market comparisons will need to be very precise.  Even within industries, some segments have very different incentive practices.  One with which we’re familiar is in health care — specifically, the difference between hospitals and non-profit community health centers.  Because the non-profit health centers compete with hospitals for clinical staff, its natural to look at compensation data for a broad health care market.  In the base pay context, that’s okay (although hospitals still pay more, and caution is advised), but in the total compensation context, it isn’t.  Hospitals pay bonuses, often at high levels, and particularly at senior management levels.  Community health centers typically do not, for any number of reasons, one of which is their business model.   The total cash comparison is just wrong — it presumes a business model that allows for payment of that kind of compensation, which apparently exists in hospitals.  A community health center, which already pays out 65 to 75% of its income to employment expenses, simply could not afford to add on that additional cost.

3. You’ll need to watch your market statistics carefully.  Total cash compensation statistics are notoriously unreliable compared to base salary statistics.  Just look at the number of cases reported and you’ll see the difference — many employers do not report the amount of  incentive payments actually made, or just toss in a rough number (e.g., 5%) because they’ll have to dig into a separate database.  The result may be something we see frequently in small sample sizes… a “total cash” number that’s lower than “base pay.”  How does this work?  Simple, really.  If I have a sample size of six, and one of my participants fails to report their bonus, a reputable statistician is going to exclude their response from the  “total cash number” (remember, a number plus an “unknown” is an “unknown”).  If that one participant had a base wage at or above the median, removing that number from the total compensation calculation will result in total comp appearing to be less than base pay.  Of course there are always those survey analysts who didn’t take STAT101, and will convert N/A into “0” and thus understate total cash compensation.

4. You’ll have to figure out a way to deal with your own business realities.  Lets say the economy is in an upswing, but your organization is not.  Bonuses and incentives rise with company performance, so total cash compensation statistics likely will go up.  Just because others are doing well doesn’t mean you can afford to raise pay when you aren’t.

Let’s stop at four ways, to avoid gratuitous piling on.  Just so there is no confusion, however, there are times when some type of total cash compensation ranges make sense.  When would that be?  Well, lets say that you’re in an industry that regularly provides incentives without really demanding performance, and you don’t want to perpetrate that fiction in your own organization.  Paying a base rate competitive with total compensation will give you an advantage, as the “guaranteed” pay an employee receives will be higher than your competitors.  Of course, many employees like getting that big check at the end of the year and think that spreading it out over 24 or 26 pay periods waters it down… so it may not be an advantage after all.

Another place to think “total cash compensation” ranges would be for employees paid on “commissions” that are really almost guarantees.   If an inside sales person is going to generate 80% of their target just by showing up and answering the phone, you might as well call it what it really is — base pay.  Also consider this kind of approach when your organization is more or less “at risk” than your competition.  If the typical mix of base and bonus for a job is, say, 80/20, and you prefer that your employees compensation is more at risk, you could start with a total cash compensation range and then pay 60% in base and let them earn the rest.

Of course the place where total cash compensation truly makes sense, and which I’m sure is the place where the idea came from, is in a high performing environment where employees are held to higher standards than the norm in the marketplace.  If the organization already knows its going to get top notch results, and wants to hire to notch people, they will be able to do that with higher ranges that will generate an income comparable to what others in the market are going to earn with base and incentives combined.  Unfortunately, few organizations are really run that way, and many don’t keep up the communication that is required to make that approach work.