As long as you work with employee pay and benefits, you cannot avoid using the compa ratio as a tool for managing pay. As I continue to work with clients every day on salary and benefits, I use the compa ratio daily to assist my clients in understanding their pay and benefits. Before I go into detail about how you can use the compa ratio in your day to day management of pay I will start by defining what compa ratio means. I will also share my experience helping clients leverage the power of the compa ratio.
What is a compa ratio?
A compa ratio is a tool for assessing the competitiveness of an individual's pay in relation to a market reference point. The market reference point could be the market median (50th percentile), 75th percentile, or any other reference point desired by the organization. A compa ratio can also be defined in relation to internal use within an organization. When described regarding internal use, a compa ratio assesses the relative position of an individual's salary relative to the grade midpoint salary of an internal pay structure. The compa ratio is expressed as a percentage.
How is the compa ratio calculated?
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Many of you may be wondering how the compa ratio is calculated. The formula for calculating the compa ratio is very simple. When calculating a compa ratio use the formula below:
Let's start with a formula for calculating the compa ratio in reference to the market position of interest to the organization:
Compa ratio = individual salary/Market median X 100.
Let us use an example to illustrate how this calculation is done in practice. Let's assume John earns 8 000 united states dollars per month as a software engineer and the market pay for his role is 11 000 united states dollars. This translate to a compa ratio of 73%, which is calculated as follows: 8 000/11 000 X 100 = 73%.
When using the compa ratio internally to asses the relative position of individual salaries in relation to the midpoint of the pay structure use the following formula:
individual salary/Grade mind point salary.
Let's illustrate this with an example. Let's assume that the same John above who earns 8 000 united states dollars is in grade 6 of the pay structure and the midpoint salary for that grade is 6 500 united states dollars. This means that John's compa ration, in this case, is 123%.
Interpreting the compa ratio
To interpret and understand the significance of a compa ratio, you need to understand what a good compa ratio is. The first question is whether there is a good compa ratio. A compa ratio is interpreted within a range. The compa ratio range often considered normal is between 80% and 120%. The target compa ratio or ideal compa ratio is 100%. So when looking at compa ratio, we say a compa ratio on the lower end shows that the salary earned by the employee is less competitive. However, before you make a definitive conclusion, you may need to put context to that number. For example, if the employees are less experienced, that compa ratio is normal. The lower end compa ratio but above 80% is normal when you are dealing with a poor performer. If you are dealing with a consistent top performer and they have a compa ratio close to 80% it could mean they are under paid relative to the market or your internal pay structure.
What about a compa ratio of 100%? A compa ratio of hundred would be ideal for consistent performers. At this stage it is important to note that a compa ratio of 100% represents your target market pay for your consistent performers whether you are refencing the external market or an internal pay structure. The cardinal rule that I share with my clients all the time is that do not pay non-performers anywhere near a compa ratio of around 100%. It's irresponsible to pay a less value adding person a premium salary as the 100% compa ratio represents.
A compa ratio of over 100% is possible but should be reserved for your consistent top performers. Any employee who has a compa ratio of over 100% must be checked to see if it's deserved based on performance. If they ended up there for other reasons than performance, you may want to keep an eye on them and adjust their salaries with less cost of living as you move into the future.
Practical application of the compa ratio
Now that you know what a compa ratio is and how to calculate it, you may be wondering how you can apply this to your work as a Human Resources professional. I advise my clients to do a compa ratio audit once a year when assessing internal pay structure compliance. You also do another once a year when assessing the market competitiveness of your pay.
Let's start with practical application to check market competitiveness of the organization's pay. When an organization commission a market salary surveys the service provider normally would calculate compa ratios for various market positions {media and 75th percentile most of the time}. That is what I do when I am giving a client a customized salary survey. In this instance, I will report compa ratios for the median and 75th percentiles per role and, sometimes, by internal grades. In addition to this analysis, I also show my clients what I call bring to market, which is the difference between the target 100% compa ratio and the employee salary, and this normally applies to those being paid below the 100% compa ratio. Remember my advice earlier on: When an employee is paid below 100% compa ratio, it does not automatically mean they need an upward salary adjustment. Look at their performance and other factors of interest to your organization before you recommend an upward salary adjustment. If you have purchased an off-the-shelf salary survey as an HR Professional, you can also calculate compa ratios for the market reference points that interest you. Should you decide to adjust to close the gap for all or some of the employees, do not forget to look at the budget for such an adjustment.
The other way to apply the concept of the compa ratio is in relation to an internal pay structure. In this instance, using the formula I shared above for internal use, you put all your employees in a spreadsheet as follows and calculate the compa ratio. You can present the results as presented below.
Again, as I explained at the beginning, you must take action only after having examined the context. Do not rush to adjust salaries without examining the context. For those below 100% compa ratio, check why they are there, and if it's due to poor performance, leave them there. Also check those above the midpoint. These should ordinarily be your top performers, and if they are not, you need to manage them. Sometimes when I deal with clients I find that they may have individuals above 120% compa ratio and those must be classified as anomalies unless the individuals have been put there deliberately to retain them. Only such individuals can be accommodated to this extend if they possess significant skills that have an enormous impact on business performance. In ordinary circumstances we say you should not have such cases.
In some instances, you may also find individuals with a below-80 % compa ratio. Those should be pulled up so that they earn at least above the 80% compa ratio. We say these individuals are underpaid unless they are perennial underperformers who must be managed out of the organization.
Conclusion
As you can see the compa ratio is an important tool for assessing competitiveness of salaries against external market benchmarks or an internal pay structure. This will help your organization check if the wages are competitive and if not, corrective measures can be taken taking into consideration affordability and sustainability. The assumption for doing the same competitiveness analysis on the internal structure is that the grade midpoints, which are basically the pay spine derived from market data, are also a reflection of your preferred market position for your pay. This tool comes in handy to every human resource professional, and I urge you to use it.
