Realistically, 50% of the employees in any position in any market are paid less than the median, and many positions will demonstrate variance well beyond $10,000 and into the hundreds of thousands. “Overpaid” and “underpaid” are very strong terms that should be used very carefully and require a good definition (see the section on compensation philosophy).
The surveys can at best suggest the range of values that a company wants to use as its definition of “normal.” That range can be tighter or broader, and the decision is entirely the prerogative of management as long as that definition is well known and well communicated to the staff of the firm.
It’s very important that each employee be well aware of the factors that cause changes within that range. If Brandon and Philip are in the same position, their compensation should be within the same range of values suggested by the marketplace, and it’s very important that the two both know why one pay package is higher than the other. Perhaps Brandon has more experience, perhaps he has more credentials, perhaps he has been more productive. Whatever the factors are, we should know and understand them well.
You Better Be A Good Surfer
However, no compensation system can be driven only by the marketplace. To do that would be to create a mercenary culture where internal dynamics are ignored and all team members are encouraged to constantly “mark themselves to market.” Such an atmosphere would undermine any team building. Just imagine a basketball team where all the players are free agents every season and everyone is playing for a new contract. They may play hard, but they aren’t likely to help one another, and might instead demonstrate hostility and even aggression toward their teammates.
To create a good compensation system, a firm has to also constantly review internal “fairness.” If Brandon is paid more than Philip, does that mean he is a better contributor? Ideally the answer is always “yes!” Whenever the answer is “no” (or not clear) we won’t be able to pass the fridge test.
The internal pecking order always exists, even if companies have never spelled it out explicitly. There is always a perception within a team of who the “good” players are. It seems to be inherent in any human group. I once asked a surfer in Hawaii how the flock of surfers know who is supposed to go for what wave. He explained that it has to do with where they are relative to the wave but also, very importantly, how good they are. The better you are, the more you can pick your wave and the others have to wait for you. Even surfers don’t have a “flat organization.”
The internal hierarchies are inevitable, and firms are better off spelling them out and discussing them rather than pretending everybody is on a flat playing field. The internal dynamics have to be recognized in the compensation system, otherwise it will never be seen as fair, and if the team is likely to create their own pecking order, a CEO is always better off suggesting what the rules of that pecking order should be. This is especially true in professional positions where knowledge, performance and contribution are displayed daily and fairly visible. It doesn’t matter if employees went to Harvard and worked for McKinsey—if they are not seen as good advisors capable of working with the top clients, their compensation will always affront their colleagues, even if the market numbers would suggest they should be the highest paid members of the group.
Sending Signals
It’s inevitable that every compensation system will send signals to team members—indicating whether they are doing well or not. In most firms, good performance is rewarded with bigger pay raises. A history of strong performance then takes an employee toward the higher ranges of the pay scale for the position.