What’s the Right Pay Structure for Your Hourly Workforce?

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October 18, 2019

Today, approximately three-fifths of the U.S. workforce is paid on an hourly basis. Yet, low unemployment, increasing levels of automation, and the rapid evolution of jobs have made it increasingly difficult to attract, retain, and reward the hourly employees needed to ensure the smooth and continuous flow of operations. In response to these challenges, employers are seeking to optimize their current approaches to, and spending on, compensation and rewards to better attract and motivate employees.

Developing a solution for hourly employee pay involves three elements: pay structures – structures that define the hourly rate if/when increases are awarded, incentive awards – additional pay, commonly tied to individual or company performance, provided for work performed, and total rewards (other benefits) – health and wellness benefits, paid leave, career progression, and other programs meant to reward employees for their contributions.

This article focuses on considerations for selecting and implementing optimal pay structures for hourly employees.

Pay Structures for Hourly Employees
When developing a pay structure for hourly employees, considerations include the work environment, the type and complexity of the work performed, and preferences of the larger organization. In addition, it is also important to understand the ease in which the program can be communicated to current and prospective employees.

There are four typical structures used to manage hourly compensation:

  1. Step-based pay
  2. Wage rate
  3. Skill-based pay
  4. Pay ranges

In a recent survey of organizations with significant hourly employee populations, respondents identified that step-based pay (48%) and wage ranges (50%) are the most common. However, it’s important to note that it is common for organizations to use a combination of pay management structures to compensation employees performing different work.

Before describing each of the pay structures, it’s important to note that most structures reference and reflect market data specific to the roles within each structure. Market comparisons for hourly employees typically use data that represents the local labor market, with some adjustments for the organization’s applicable industry (or industries). Because there is a limit to the distance that workers are willing to travel for work, due to the cost of transportation, local pay data presents the most accurate picture of the competitive market rate for hourly jobs. Combining this factor with the transferable skills of many hourly workers, location-specific market data prevails as a priority.

Step-Based Pay
When? An organization is looking to retain and reward employees based upon experience. Sample jobs commonly associated with step-based pay include: machinist, operator.

How does it work? All employees enter the organization at a pre-defined wage rate. Employees receive incremental increases, or steps, based on time in job or experience level reached. Employees will eventually reach the maximum pay for their role.

What about increases? The “steps” are pay increases awarded as an outcome of tenure (time in job) or the employee’s attainment of a specific skill. Employees must fully achieve a milestone prior to receiving an increase.

Wage Rate
When? The work performed by employees has limited variability, low time-to-proficiency and/or limited ability to measure employee performance. Sample jobs commonly associated with wage rate structures include: fulfillment associate, freight handler.

How does it work? All employees in the same role receive the same hourly rate of pay (wage rate). Wage rates are defined by the value the organization places on the work performed and the local market data. Organizations that implement a wage rate may also utilize an entry rate of pay and adjust the employees’ hourly rate to the full wage rate when they become proficient in the role.

What about increases? Employees will not receive adjustments based upon performance, tenure, or other unique factors, as each employee provides the same level of value. Employees may receive an increased based on changes in market data.

Skill-Based Pay
When? An organization is encouraging and compensating workers to acquire new skills. Sample jobs commonly associated with skill-based pay structures include: operations/field technician, maintenance mechanic.

How does it work? Employees add value to the organization by acquiring skills that allow them to perform a varied set of tasks. The rate of pay is adjusted as the proficiency in each new skill is attained.

What about increases? Increases in pay are provided once proficiency in a new skill is attained. Increases are not provided based on tenure or merit.

Other considerations. These skills may be formal (requiring training and/or certifications), or informal (acquired through on-the-job-training). In either case, employees should clearly understand how the new skills can be acquired.

Pay Ranges
When? Similar to the traditional structure to which salaried employees are often aligned (as defined in this article), and use a similar methodology to develop an employee’s rate of pay. Sample jobs commonly associated with pay range structures vary widely.

How does it work? The hourly rate is determined using the employee’s respective skills and past experience, and is regularly influenced by manager discretion during the hiring process.

What about increases? While pay ranges allow for flexibility – enabling unique employee concerns and/or skills to be addressed – they may result in employees performing similar work receiving different compensation.

Other considerations. While the approach is common, it is challenging to consistently implement in an hourly environment and is sometimes problematic due to the risk of pay inequity due to potentially large variations in wage rates for employees in similar roles. Use of this approach is most appropriate in situations where there are: relatively high levels of trust between employees and management and transparent and equitable ways to evaluate good versus great performance within similar roles.

Keep in Mind
Given the complexity of many organizations, it is possible that multiple structures will be needed to best reward and motivate the population. When determining the right approach for your organization, it will be important to balance the precision associated with having a number of varying pay structures with the administrative ease of maintaining only one or two structures.

Ultimately, there is not a one-size-fits-all solution to address the needs of the hourly workforce. Therefore, focusing on the specific needs of the organization’s work environments, and the responsibilities of the hourly population, will be the best way to develop an approach for the pay structure used to effectively attract, retain and motivate your hourly employees. 

Andre Rooks
by Andre Rooks

Principal and Compensation Consultant