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Compensation Corner: Pay Differentials: What They Are, Why They Matter, and How to Use Them

Pay differentials | Total Reward Solutions

As one of our valued strategic partners, we want you to know that pay differentials – when used properly – can be an important part of a successful employee compensation program. In fact, using pay differentials can signal your employees that you recognize variances in work conditions and are willing to reward employees who accept less desirable positions, shifts or work locations. But just what are pay differentials, anyway? Why do they matter? And how can pay differentials be used to create equitable compensation for your workforce? Let’s take a closer look:

What are Pay Differentials?

Simply put, pay differentials are conditions for which an employer is willing to compensate an employee with additional pay to get them to take certain assignments.

Why do Pay Differentials Matter?

Pay differentials are important because they can help entice employees to work hard-to-staff shifts such as second or third shifts. They can also encourage employees to accept jobs that must be performed in hazardous conditions. And pay differentials can also be a crucial factor that persuades employees to take jobs in geographical areas with a higher cost of living.

How Can You Use Pay Differentials?

Before establishing pay differentials for geographic, hazard or shift variances, it helps to establish a good baseline for each position using available job and market data. If your company has not performed a comprehensive position-by-position market analysis lately, it may be more challenging to effectively implement pay differentials.

Keep in mind that it is best to put pay differentials on a separate line on the employee’s pay check in case the employee changes shifts, work location, or moves to or from a job eligible for hazard pay. This separate line item helps the employee understand this component of their salary, and any differences (up or down) that appear when changing positions.

Shift Premiums

A shift premium is additional compensation paid to entice employees to work a shift considered a hardship. Shift premiums are typically paid for second or third shift hours and are normally paid as additional cents per hour or as an additional percent of pay.  Third shift premium is usually a higher amount than second shift premium. If an employee works part of second shift and part of third shift, the employee should be paid the appropriate premium for each part of the shift worked. However, some employers pay the shift premium associated with the shift where most of the hours are worked.

Hazard Pay

Hazard pay is a premium paid to employees in recognition of difficult and hazardous working conditions. It can encourage employees to work in hazardous occupations. To determine the proper amount of hazard pay, it helps to benchmark the position and understand market norms.

Geographic Differentials 

In addition to benefits of geographic differentials for employees, geographic differentials can benefit the company by making it easier to conduct internal equity reviews or discrimination analyses. When considering if geographic differentials are appropriate, it is best to benchmark position salaries and determine cost of living for each city and state where your employees work. Typically, a geographic differential is created for differences of +/- 5%. The number of differentials depends on how tight a company needs to manage its salary line. For example, to keep the number of differentials to a low number, a range for differentials between 5 to 10% could be established at an average increase to the pay range of 7.5%. Another differential could be established for 11 to 15% differentials at an average 13.5%.

If your company operates in different market territories, it is wise to consider geographic differentials even if your position benchmarking is done using national data. In this case, use geographic cost-of-living and cost of salary metrics to determine the geographic differentials.

For regional benchmarking, use a reliable third-party survey source to obtain information for each region. You will want to know how much higher or lower each region is compared to either national data or your primary headquarters location. Note that some regions could have wide disparities between specific locations, so regional averages might not be an accurate reflection of local salaries and costs of living.

Bottom Line:

Pay differentials can be an important part of getting employee compensation and total rewards right! They can make salary more equitable based on work shifts, job hazards or work location. Just be certain to use appropriate market analyses and job benchmarking specific to your industry and job locations when you create pay differentials. To learn more about this important part of compensation and pay programs, contact us at Total Reward Solutions today at 317.589.8529.

Cassandra Faurote


About Total Reward Solutions:

Have a referral for us? Total Reward Solutions is your trusted partner for compensation and benefit services. As you recall, Total Reward Solutions offers a broad range of compensation, benefits, performance management, and reward/recognition consulting services to help your organization attract top talent, motivate employees and retain top performers. We can partner with you on a project basis, on retainer, or as your total outsourced solutions provider for compensation services.

Call us today at 317.589.8529 to discuss how we can help your organization develop and implement competitive and effective compensation and total reward programs.