Companies with multiple workforce locations are faced with a unique set of challenges to pay competitive wages across their locations where the facts and circumstances that determine competitive pay can vary widely by region. Whether it’s developing salary structures or transferring employees from one city to another, it can be a difficult and cumbersome process to gather the data needed to make informed decisions across geographic regions.
As compensation professionals feel the pressure to balance payroll costs and ensure that their pay programs are competitive, many look to geographic pay differentials — i.e., the impact of location on market pay levels — to help support this balance.
Geographic differentials remain a popular way to manage costs and align pay to market. They are primarily used for entry-level, professional, administrative, and supervisory or front-line management employees.
Implementing geographic pay differentials is not without its own set of challenges, however. Managers need to actually utilize the data when making pay decisions and the data needs to be collected from a reliable survey source and updated regularly.
With that in mind, we’ve developed a list of six tips to keep in mind when considering how to use geographic pay differentials.
It’s a popular way to manage costs and align pay to market. Employers are increasingly using geographic pay differentials. Aon’s experience and market data suggest that more and more employees are being impacted by geographic pay differences. Organizations operating in multiple locations where the cost of labor can vary as much as 20% below or above the national average are finding that one geographic structure does not serve the organization well.
Certain factors increase the feasibility of geographic differentials in an organization. If your organization has one or more of the following characteristics, using geographic pay differentials will help you reach your goals:
- Your compensation philosophy emphasizes market competitiveness
- Your employees work across many diverse geographies
- You source talent from local labor sources
- You have sophisticated data/compensation management
Geographic pay differentials generally lead to unique geographically-based pay structures. In order to institutionalize geographic differentials, most companies incorporate them into their compensation structures. The company will create a number of different compensation structures and slot locations into each structure based on market data. It’s not uncommon to have a “base” compensation structure, which covers the majority of the population (for example, corporate headquarters). If the base structure represents a national average, then the geographically differentiated structures may be as much as 20% above or below this structure. Generally, you would leave at least 5% to 10% between each structure so that they are distinguishable.
The cost of labor, not cost of living, should determine geographic pay differentials. Employers often mistakenly assume that geographic differentials should be based on the cost of living when in fact it should be based on the cost of labor. Cost of living refers to the price of goods and services in a location, such as housing, taxes, and personal items. On the other hand, cost of labor refers to local pay levels in the location. While the cost of living and cost of labor may be related, you cannot assume they are directly correlated. For example, pay levels in a low-cost area may be inflated by labor shortages or the presence of unions and government offices.
Pay differentials should be derived from cost of labor data (i.e., localized market pay data). Cost of living may also impact pay, but it does so through relocation policies as opposed to compensation policies. Geographic pay differentials generally cover those employees who do not relocate often, so relocation policies often pick up where geographic differentials drop off — for example, at the senior management level.
Geographically differentiated pay structures generally group urban locations with nearby suburban locations. Market pay data typically shows a meaningful difference between urban and suburban/rural areas, with urban areas being higher for the same job. For example, Los Angeles traditionally has among the highest pay levels in the nation, while some areas in suburban California may be 10% to 15% lower. This creates an issue because employers may have multiple locations in a relatively small geographic area, and employees may commute from one area to another. The market data will always report where an employee works, not where they live. Geographic differentials may create an incentive for employees to choose jobs in the higher pay location, thus putting the lower pay location at a disadvantage in the labor market. For that reason, employers generally group locations together based on some radius around the center, which represents the typical commuting distance. This distance can be as large as 30 or 40 miles, depending upon the transit system.
Geographic pay differentials impact pay actions. Geographic differentials naturally impact individual pay levels when they influence compensation structures, and can help organizations cut payroll costs over the long term. It can also impact variable compensation. Companies express variable pay targets as a percentage of base pay or the range midpoint. So, if geographic differentials increase or decrease pay or midpoints, then they will by necessity impact variable pay. Additionally, employee relocations to a higher pay area may also impact pay where geographic differentials exist. Many companies will increase employee pay to maintain parity in the new structure. The pay increase may be wrapped into a promotional increase, if the employee is being promoted, or may be required because the employee falls below the minimum of the new salary range. Some organizations consider individual pay adjustments on a case-by-case basis considering the current pay level of the employee, the employee’s performance, and the skill level of the employee relative to the new position.
If paying competitive wages across geographies maters to you, consider looking at geographic pay differentials. It can help organizations manage payroll costs more effectively. If a company foregoes geographic differentials, they could be putting themselves at risk by overpaying in low cost of labor markets, or alternatively under-paying for roles in high cost of labor markets.
Aon’s Broad-Based and Nonexempt Geographic Reports gives you the ability to benchmark roles by region, state and metro area to better understand geographic differences. The 2018 report provides information on 216 metro areas - more than ever before.
In addition, if you want to take a deeper look at pay differentials within a given market, consider subscribing to Aon’s Micro Market Pay Analyzer. Using a specific address or latitude and longitude location, this tool pulls role-specific wage data for a pre-set radius (10/20/30 miles) and displays them on an interactive map.
If you’d like to purchase a copy of the report, learn about the tool or have specific questions for our compensation experts, please contact us now.