Regardless of the economic conditions there will always be shortages of skilled workers for one job or another. At various times we have seen shortages of staff in high technology, retail, nursing, and teaching.   The question faced by many employers today is how to adjust internal pay rates for "critical skills" without disturbing internal equity.

There are a number of approaches to adjusting employee pay when a particular job/ job family is no longer competitive within the company´s relevant labor market.   The appropriate choice depends on the company´s overall compensation philosophy and pay delivery system, and whether the supply/demand imbalance is perceived as a temporary or permanent situation.

 "Temporary" or "Permanent" Changes in Pay Structure?

The most important issue for an employer to consider is whether the current imbalance in the labor supply/demand is short or long-term.   In instances such as technology jobs, it is advisable for the company to administer "critical skill" job families in a separate structure.   But, when there is a "temporary" shortage of certain skills, an organization may not need to create a separate structure.

The following case studies provide a brief overview of techniques that can be used to ensure that internal pay rates for "critical skill" jobs remain competitive with the market.

Case I: Company ABC Faces Temporary Market Imbalance.

Situation

ABC Company has adjusted its exempt pay structure to reflect a projected market movement of 5%.   Under its base pay program, ABC administers salary adjustments based on performance and position in salary range (compa-ratio).   Currently, ABC employs a number of paralegals that require (on average) an additional 5% adjustment in base pay in order to remain competitive with that specific labor market.   Believing the current imbalance in supply/demand is temporary, ABC has decided not to pull the "critical skill" jobs out of the overall pay structure.   Also, ABC would like to continue with its current pay-for-performance philosophy but does not want to incur   "permanent" increases in salary related costs.

The following is ABC´s merit increase matrix, after it raised the salary structure midpoints by 5%.  

Merit Increase Matrix

Alternatives

Approaches that ABC could use are: short-term retention plans, enhanced annual bonuses and / or enhanced stock option grants.

1) Short-Term Retention Plans

One approach commonly used to retain critical employees is to establish a temporary, short-term (3 to 5 years) retention plan.   Instead of being paid immediately, the market differential is mandatorily deferred.   ABC accrues interest on the deferred amounts at the one-year Treasury bill rate.   The accrued balance is paid out at the end of the third year.     In addition to its retention value, another advantage to this approach is to preserve cash until the payment is made.

2) Enhanced Annual Incentives

Another approach would be to increase the annual target incentive.   For example, "critical" ABC employees currently are eligible for short-term incentives, so the Company could increase the incentive targets to offset the estimated market shortfall in base salaries.   This assumes that ABC´s pay strategy is to be competitive with the market on a total cash compensation basis.

3) Enhanced Stock Option Grants

A third alternative is for ABC Company to make adjustments using long-term incentives, i.e. stock options.   The company is still in the early stage of its growth and cash is tight.   However, it has a broad-based stock option program.   It may decide it is more consistent with its total compensation philosophy to make adjustments using stock options rather than short-term retention awards or enhanced bonuses.

The following is a hypothetical incentive multiplier based on performance and position in the salary range.   The factors are applied to the target stock option award.   For example, assume a critical employee is "Above Standard and in the Lower Third of the salary range - if the annual stock option target is 500 shares, the target number of shares would be increased to 1,000.

Performance Based Stock Option Target Multiplier

The same or a similar matrix could be used to enhance bonuses.   For example, assume a critical employee is "Above Standard" and in the Middle Third of the salary range - if the target bonus, adjusted for performance relative to bonus goals is 15%, the "critical skill" adjustment would bring it to 22.5%.

Case II: Company XYZ Faces Permanent Market Imbalance

Situation

Company XYZ faces what they believe to be a "permanent market" supply/demand imbalance for technology based jobs.   While it plans to move the overall pay structure 5% to reflect market changes, XYZ has decided to pull the technology jobs out of the overall pay structure and put them in a separate structure to more accurately track that specific labor market.

Alternatives

1) Across-the-Board Increases

Some companies choose to provide across-the-board percentage increases in order to ensure incumbent salaries are competitive with the market.   In the case of XYZ, this would be a reasonable approach after placing the technology jobs in the new structure, whose salary range midpoints are now 10% higher.

XYZ could make an across the board salary increase of 5% to its technology employees, representing one-half of the market shortfall.   Therefore, employee compa-ratios (ratios of salary to midpoint) would remain the same in the new structure as they were in the old, and any additional adjustments would be based on performance. Although this is a good way to maintain everyone within a specific job family competitive with the market, there are immediate costs associated with it and the opportunity to reinforce pay-for-performance is partially missed.