007: ✏️ Three Approaches to Location-Based Compensation
007: ✏️ Three Approaches to Location-Based Compensation
A guest post from Shelby Wolpa, People Leadership Advisor to Series A-C Companies.
This week’s newsletter comes to us from People Leadership advisor, Shelby Wolpa. I’ve long admired Shelby’s thorough and actionable writing and wanted to highlight this fantastic resource initially published on her blog about location-based compensation options.
💡 Similar to Shelby, I have also shifted from a default to tier-based compensation to paying everyone the same no matter location. I believe we’ll see this become the norm and expectation.
I’m passing the mic! Everything below the divider is from our friend Shelby. 👇
— Mary
As remote work becomes the new normal, this transformation comes with a whole host of considerations companies will need to formalize around their remote work policies and programs - including your compensation philosophy.
Redefining Your Compensation Philosophy
Office-based work was historically designed where employees were compensated based on a company’s physical office location. Companies with multiple locations would typically pay local rates based on each office location. For example, an employee working out of the New York office would be paid rates appropriate for their local New York market. Another employee based out of the Pittsburgh office would be paid a lower, but still fair rate for their local market.
Companies providing remote work flexibility have the ability to reimagine their compensation philosophy to support their new workforce. Allowing employees to “work from anywhere” adds complexity, as employees may no longer be bound by a defined number of offices. Before defining your compensation philosophy, you should make sure your hiring and employee move guidelines are set so you know where employees are based, now or in the future.
Some considerations:
What is your “future of work” plan? Will all employees be returning to the office? Will you allow remote work flexibility? Will employees be allowed to move to new work locations?
How do you define “fair compensation”? Some companies believe that employees should receive the same compensation for the same work, regardless of location. Others believe employee compensation should vary by location or cost of labor. There’s no right answer here -- each approach has pros & cons -- companies should decide which approach aligns with their values and company goals.
Do you already pay people differently based on location or when they relocate? If yes, you may already have a jump start on establishing location-based compensation.
Three Approaches to Location-Based Compensation
There are three approaches companies can consider when designing their compensation philosophy.
1. Pay everyone the same no matter where they are based
Some organizations use a single rate to determine everyone’s compensation. They often choose where the company is headquartered, if that’s where the majority of employees are based or peg their compensation to other markets or a national average.
The argument for this approach is that jobs (especially hard-to-fill tech jobs) are no longer tied to a location so why should their compensation? Given workers now have many more options for where they can be employed there are shifts happening in how companies compensate employees.
PROS: Easiest to explain, manage and administer. You only need to maintain one salary range for each job. Great for small teams, especially if you are based in high-wage markets such as San Francisco or New York. This approach is also the simplest when navigating new laws around pay transparency. If you only have one rate of pay for each job, you only need one job posting and can more easily explain your compensation philosophy to candidates and employees.
CONS: For larger organizations, paying one rate of pay adds significant costs. For example, if you were to pay everyone San Francisco or New York rates of pay, you’d be paying ~15-20% more for every job across your organization which may impact your company's financials. This can add up fast. Another con is that paying this way creates “golden handcuffs” for those in low-wage markets since they are earning more working for you than a company that localizes pay, which may cause them to stay at the company when they are disengaged and unhappy.
2. Pay employees based on tiered zones
Most companies group geographical areas with a similar cost of labor into zones. Each employee is mapped to a zone, based on their location.
The approach for how to set tiers is flexible, but most companies start by using national data as a baseline. Here’s an example of a 3-tiered structure in the United States:
115%: Add a 15% premium for cities like San Francisco and New York City
110%: Add a 10% premium for cities like Los Angeles, Seattle, Austin & Boston
100%: Use the U.S. National average data for all other cities
PROS: Provides a simple, flexible and scalable approach to location-based compensation. Takes into account the cost of labor, but is not overly complex to manage and explain. If your company already pays different rates of pay across your office locations, this is likely the easiest model to transition to. Remote employees can be quickly mapped to the closest zone.
CONS: Although simple, you will overpay and possibly underpay for some roles. This approach isn’t as exact as a fully location-based model and could result in compensation being over- or under-market value. However, creating a wider pay range can often account for these differences. There may be times when you have to make exceptions to your pay policy to close and retain hard-to-fill talent. To overcome this, you can have different tiers for different departments. For example, higher premiums for tech roles versus non-tech roles. Just be mindful of pay parity issues so there is internal equity.
3. Use granular location-based compensation for each market
Companies that want to be really precise will use local market data to differentiate pay for employees across different locations. One of the most well-known fully distributed companies, GitLab, maintains its approach to paying local rates.
Setting up a localized pay structure can either be done by:
Creating custom pay ranges per market, using local market data from a credible source
Using an algorithm to determine an individual’s compensation
Numbeo is a free site that can help inform your client's cost of living adjustments. It's not perfect as it's crowd-sourced data but helpful if you don't have the time or resources to do a detailed study with a compensation expert
You can also purchase a geo-differential report from a reputable source such as Willis Towers Watson for North America or other regions
PROS: Best for companies trying to preserve cash. More precise compensation means you’re less likely to under- or over-pay employees in their local market, leading to a more consistent standard of living across regions. Team members across numerous regions will have a similar amount of discretionary income since their rate of pay takes into account specific cost of labor differences. You can attract equally those in high-wage and low-wage regions to attract the largest pool of candidates. You will also spend less on your compensation budget.
CONS: Most difficult approach to support and manage, since you’re establishing individual rates of pay per city. This gets complex fast and requires dedicated team members to manage the program to ensure your pay data is accurate and consistent. If you’re purchasing data for every location, this can get costly fast. Consider this when/if purchasing market data. As you get more granular with market data, the quality of the data in each local labor market can be limited, inaccurate, or lagging what’s actually happening in that market. Be prepared that candidates may push back or negotiate their local rate of pay. Using location-based compensation is also the most complex approach when complying with recent pay transparency laws.
Recent Trends
Although I’ve been an advocate for tiered-based compensation for distributed teams for many years, I can’t ignore the recent trends. In my recent LinkedIn poll, I was surprised to see that 38% of companies were paying everyone the same rate of pay.
Lattice's 2023 State of People Strategy Report also confirmed that the majority of survey respondents, 49% pay employees the same compensation range regardless of location or remote status.
Tools
There are quite a few tools out there to help you standardize and automate location-based compensation and provide high-quality market data. Here are a few of my favorites:
ChartHop - compensation planning, talent planning, and people intelligence platform -- my favorite for distributed teams!
Kamsa — software providing real-time global market data and resources for job leveling and compensation planning
Pando — career framework software to structure, measure, and accelerate employee growth, includes functional templates and competency library; goal setting; 360s / performance reviews
Pave, Pequity, Complete, or Agora — compensation planning, management, total rewards statements, visual offer letters, and benchmarking
Lattice Compensation — performance management, goal setting, engagement, compensation, leveling, and career paths
Radford — most widely used global database for private and public company data; requires considerable time and resources to participate and interpret data; data is often lagging in-the-moment market trends versus more modern solutions
Executing Your Plan
Once you’ve evaluated each approach and selected which approach is right for you, it’s time to execute your plan.
Some considerations include:
Hiring strategy - what locations can you hire new talent? Make sure Hiring Managers and Recruiters are aware of where they can and cannot hire.
Employee moves - where are current employees allowed to relocate to? Will compensation be adjusted up/down when employees move or will they be “grandfathered” into their current compensation?
The financial impact - what impact with this new compensation strategy have on your compensation budget? How will it impact the company financially?
Consider total compensation - remember that salary is not the only consideration. Total compensation consists of salary/wages, bonus programs, stock grants, benefits & perks. Remember to take all factors into consideration when revising your compensation philosophy.
Some companies may choose to make more gradual changes over time if adjusting compensation as employees relocate to areas with a lower cost of labor. This helps to reduce the financial impact on employees and helps with retention.
Communication
When making changes around compensation, you should communicate early, often, and clearly.
Some best practices are:
Document your compensation philosophy and location-based compensation approach. Once you’ve aligned on your approach, you should document your Compensation Philosophy and share it transparently with managers, employees, recruiters, and candidates. No matter what approach you take, be clear on how individual compensation is determined. Share what data sources you use to inform your market ranges. The more transparency you can provide, the better.
Provide advance notice of any changes. Give employees as much notice as possible (at least 60+ days) about your compensation policy and how it may impact them. Employees need to have time to plan accordingly as changes to their compensation could have big impacts on their personal finances and future plans.
Over-communicate. In a remote company, you cannot communicate too much. Often people need to hear things five times for it to sink in. Repetition is key. Use various communication channels to update employees on your compensation approaches, such as HR systems, company intranet documentation, All Hands meetings, email, and messenger.
Compensation is often a company’s largest operational expense. It can also be a very emotional topic for employees. Be proactive in setting your future compensation approach, and remember to listen every step of the way!
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Want to dive deeper into your compensation philosophy?
Here are three ways Shelby can help, whenever you’re ready:
Schedule an "Ask Me Anything" micro consulting session to get 1:1 advice
Buy a Remote Work Playbook to leapfrog your progress
Work with Shelby as an Advisor to your leadership and people team to build a strong people operations foundation and best-in-class employee experiences