When  developing a compensation structure, an organization’s compensation philosophy will determine how internal pay will compare to external competitors. There are several options when setting pay in relation to the relative market:

• Match the market by paying comparable wages.
• Lead the market by paying higher wages.
• Lag the market by paying lower wages.
• Use a combination of these three options.

Match the market

A common compensation strategy for employers is to set pay levels relative to those in the existing marketplace. By matching the pay rates of its competitors, the organization ensures its compensation structure remains competitive, therefore improving its ability to attract and retain top talent. Although this approach allows employers to better manage labor costs, it also has the potential of placing the employer in a position of having to play catch-up, requiring larger adjustments to the compensation structure during tight labor markets.

Lead the market

An employer may choose to offer compensation that is higher than the pay rates in the prevailing marketplace. This compensation strategy may increase the supply of candidates, increase selection rates of qualified applicants, increase morale and productivity, decrease employee turnover or discourage unionization efforts. However, prior to implementing a lead compensation strategy, an organization should identify the expected benefits, keeping in mind that this type of structure will increase overall labor costs. A lead strategy is often most appropriate for organizations located in highly competitive labor markets. Employers that adopt such a strategy will need to monitor it closely to determine whether the anticipated benefits of the strategy are being realized.

Lag the market

Organizations that choose to implement a compensation strategy that lags the marketplace may do so because they simply do not have the financial resources to pay higher rates. These employers may attempt to reward employees in nonmonetary ways to minimize dissatisfaction and turnover. This is not a common strategy as organizations that choose or are forced to set pay rates below the prevailing marketplace are much more susceptible to fluctuations in the labor market, risk greater difficulty in retaining and attracting highly qualified candidates, and typically experience higher rates of employee dissatisfaction, poor performance and turnover. In rare circumstances, an employer may be so highly sought-after due to their brand reputation or other factors that they are able to pay lower wages without realizing this negative impact.

Use a combination of options

For many organizations, a combination of these options may be most appropriate. For example, an employer may choose to lead the market during tight labor markets or only for specific positions that are difficult to fill. This method requires closer monitoring, and pay rates may need to be adjusted regularly.

Regardless of the option an organization adopts, the compensation strategy will guide an employer’s decisions regarding internal pay rates relative to the marketplace. There is not one strategy that will work for every employer and organizations will need to ensure the approach they choose matches their mission, vision and culture and supports the overall business strategy.