Selecting a compensation strategy for distributed teams is like Choose Your Own Adventure. Compensation teams can pay team members based on their location, set company-wide bands regardless of location, or combine the two approaches.

‍

If you’re considering implementing a compensation strategy based on geographic pay zones, you’re not alone. According to Pave data,* 88% of companies take location into account when determining compensation. Keep reading to learn more about building a location-based compensation strategy, and how to think about tier one cities.

‍

Why do companies use a location-based pay approach?

‍

By grouping major cities into tiers, organizations can pay employees in each location based on the cost of labor. This is a huge plus, enabling businesses to accurately pay for talent in more expensive labor markets like San Francisco and New York City, and ensuring they avoid overpaying in less competitive markets.

‍

A location-based pay strategy that uses tiers is also easier for comp leaders to manage. If market data shows that P3 software engineers in New York are paid very similarly to those in San Francisco, you can create one salary range for both cities, rather than having separate ranges for each city. Having fewer tiers and ranges to maintain reduces the operational burden for comp teams. 

‍

Some companies also opt to combine location and job function when developing their approach, particularly in tech:

Source: Alamere.io

‍

Using location-based pay can also help organizations enact their talent strategy. For example, say your company is planning to recruit and grow in Omaha. It’s likely that roles there won’t fit into the same ranges as tier one cities, but you want to intentionally pay above market because it’s a focus area for the business. In this case, you might add Omaha to a higher tier to support that goal through your compensation strategy.

‍

As this example illustrates, a location-based pay approach is both an art and a science. You should design your compensation strategy in a way that is manageable and effective for your business. 

‍

What are location tiers?

‍

Groupings of US cities are made based on similarities in cost of labor, market trends, labor force dynamics, and often the internal talent strategy. Roles in tier one cities (such as San Francisco and New York City) are typically paid more relative to lower-tier cities (like Tampa and Houston). 

‍

The tier methodology varies from organization to organization. Where organizations do use location tiering, most use between two and five tiers.

‍

Tiers often apply to salary ranges, and some companies may extend their location tiering to include equity as well, meaning tiers can apply to total compensation. Pave data indicates that whether organizations have official tiers or not, they are taking location into account when adjusting cash and equity compensation in particular.

Pave CEO and Founder, Matt Schulman, discussed the topic of equity grant differentials on LinkedIn – read what the community had to say.

‍

What cities are included in the tiers?

‍

The cities included in each tier vary by organization, but more competitive markets (like San Francisco and New York City) are often considered tier one cities, and metro locations where cost of labor is lower (like Cleveland and Charlotte) are often categorized as tier three cities.

‍

At Pave, we looked at our market data to understand the cost of labor by location, and we created three tiers. This designation is based on several factors, with more weight given to the cost of labor vs cost of living. Here are the cities we consider tier one cities, tier two cities, and tier three locations. 

Some cities are often on the cusp of tiers, so while these are general guidelines, be sure to review the market data on a somewhat regular basis. In today’s fast-moving labor market, it’s not uncommon for cities to move between tiers. Staying on top of these changes helps companies to stay competitive when recruiting and hiring. 

‍

Regardless of your approach to creating tiers, it’s important to be transparent and communicate the “why” behind pay decisions with employees. Employees who understand how they’re being paid (and the reasoning behind critical pay decisions) are more likely to trust the organization and feel motivated to do their best work. 

‍

Build a location-based compensation strategy with Pave

‍

Creating tiers isn’t a set-it-and-forget–it exercise. Using a combination of relevant market data and the guardrails of their internal compensation strategy, many companies will review their location tiering every year to stay ahead of the curve. 

‍

Pave’s Market Data gives you access to real-time compensation benchmarks from over 7,500 companies. And, Pave helps you create the compensation strategy that’s right for your business. You can use Pave’s existing tiered data or build your own tiers using our location differentials tool. 

‍

Explore Pave Market Data for free. 

‍

‍

*Sample size: 301 companies managing bands in Pave's Workflows tools