Three Compensation Errors To Avoid
Reprinted From The August, 1994, Issue Of Contractors Compensation Quarterly
A contractor’s single biggest operating expense is usually payroll. So if payroll is not carefully controlled, it becomes a competitive problem. Here are three common errors to avoid.
Error 1 — The Title Game
Contractors frequently underpay or overpay relative to the industry as a whole because they base pay on titles rather than functions performed. For example, one contractor has four estimators, each with a different title and pay. After reviewing duties performed, however, only one estimator warrants a different classification and pay range. The contractor is paying on average $5,000 over prevailing industry rates. Over five years, this accumulates to $26,380 (not including bonus and salary riders) or just short of a full time estimator.
Direct pay for estimators averages from $34,000 to $74,000. That’s a $40,000 margin for error. This kind of error can be avoided by tying pay to job content, responsibility, and experience rather than titles.
Error 2 — The Case Of Henry
In time, employee pay can exceed the market value of their skills. For example, Henry, a buyer, has been with the firm 20 years. Henry has averaged cost of living, merit and longevity pay of 7% a year. Starting at $15,000, Henry is currently paid $58,845. Today’s pay range for Henry’s duties is $28,000 to $40,000. Ironically, Henry’s loyalty and good performance have gotten him into trouble. He is not marketable at his current salary and the contractor is paying excessively for the duties he performs. This longevity problem can be avoided by establishing pay ranges comensurate with the industry.
Error 3 — When 2+2 Does Not Equal 4
Typically employee pay increases are based upon cost of living, average industry increases and merit. Once individual increases are determined, the sum of employee pay equals the payroll cost. Right? If you think so, look again. Individual pay AND TOTAL PAYROLL must both stay within a competitive range. Here is what happens if they don’t.
ACME and ZYCOM are competing construction firms having a total 1983 payroll of $600,000 and payroll riders (FICA, Retirement, etc.) of 20%. ACME uses industry increase averages each year for 10 years. With no personnel changes, ACME’s payroll goes from $600,000 in 1983 to $1,022,848 in 1992. From 1983 to 1992, ACME pays an accumulative total of $8,140,466 in base pay and $1,628,093 in riders.
On the other hand, ZYCOM construction uses a pay structure increase method which ties aggregate payroll cost to average pay structure increases. In 1992, ZYCOM’s payroll has increased to $887,292 with an accumulative total of $7,487,613 in base pay and $1,497,527 in riders over the same ten year period.
By adjusting total payroll before assigning individual increases, ZYCOM has achieved a competitive advantage over ACME. ZYCOM maintains market pay rates, saves $652,853 base pay and $130,566 rider costs, and continues to be advantaged over ACME year after year until ACME restructures its pay rates.
The Best Solution
The best way to avoid all three of these common errors is to institute a simple but formal wage structure and use it. At PAS, we have the experience and resources to assist you in establishing a system that’s both practical and effective.