Salary formula

This post was inspired by Management 3.0 and a very nice reading about Buffer’s policy.

Salaries are classified

Employees’ compensation is a very sensitive topic. In most organisations it’s also the most secret and the least openly discussed one.

My experience says that people don’t necessarily need to know the salaries of their colleagues, but they definitely want to know the rules that determine their wages. Regrettably, only a few organisations have an established set of clear rules and processes for calculating employees’ salaries. In most companies it’s delegated to HR departments that come up with a complex structure of pay grades and pay ranges, but the rules governing climbing the career/salary ladder is usually still very fuzzy.

The truth is that the main reason why so many companies are reluctant to make employees’ salaries transparent is the fact that it would immediately reveal how unfair current compensation system is and that many people are basically screwed. Counter to this, research confirms that long-term pay secrecy only hurts a company’s culture and results in negative morale, decreased performance, and higher turnover.

Transparency is motivating

Studies show that money is rarely a good motivator (my experience shows that it works only short-term or when somebody earns way below the market). On the other hand, money acts as a demotivator when an employee believes she isn’t treated fairly or she feels underpaid compared to her peers. And a lack of transparency makes it very difficult to influence people’s feelings and, as a result, have a company-wide perception of honesty.

A traditional approach to compensation requires employees to individually negotiate their salaries and pay raises with their managers which make this process prone to politics, short-term budgeting issues or current market demand peaks. It also favours smooth-tongued and social savvy people which doesn’t sound like a fair solution that should reward all employees for their efforts and contribution to the success of the organisation.

Salary formula

A solution to the problems discussed above is an introduction of a salary formula – an objective, incorruptible and reliable system for calculating employees’ salaries. A system in which everyone can calculate her salary (and a salary of her colleagues) and everyone knows what to do to earn more. A salary formula that everyone understands is a great step towards a compensation plan that pays people fairly for the value they create in the organisation.

It has to be pointed out that there is no simple remedy to how exactly your salary formula should look like and it’s something you need to experiment with. Above all, you need to make sure that it’s transparent and easy to adapt in a number of further iterations. And of course, before introducing a brand new salary formula, it makes sense to compare the resulting financial projections with your budgets and other internal constraints.

A good salary formula should take into account several variables, including:

• role (job category – please aim at having as few as possible)
• job level (maturity/seniority at a given role)
• loyalty (employment time)
• total experience
• relevant education
• location (very important for geographically-spread companies; costs of living and job markets are different in different locations)

An example of a salary formula can be found in this Buffer’s blog post.

Don’t include performance metrics

It may look very tempting to include some performance metrics in the salary formula, but it should be avoided. Most certainly it will lead to dysfunctional behaviours and employees trying to game the system instead of doing actual work. A salary formula is about steady, predictable monthly income, and compensation for employees’ contribution to the organisation should be resolved in a different way.

My thoughts

Personally, I like the idea of a salary formula. I’ve never worked in a company in which salaries weren’t secret, but I think that having some transparent rules around how employees’ compensation is calculated would definitely help.

However, I also understand that applying a salary formula is much easier in a young, small company rather than an organisation that hires 50k+ people around the world and that was successful in what they’re doing before I was even born.

Nevertheless, even if you’re not allowed to implement a salary formula for the whole company, in my opinion, it makes sense to give it a try at team or department level. At the beginning, you can use it as an advisory tool for checking salaries when calculating your annual pay raises or hiring new team members. And if it works well you can do another step and share it with your team(s) – I’m sure they will appreciate it.