Webinar Recap: How to Choose the Right Location-Based Compensation Strategy

Pave recently hosted a webinar on how to help organizations determine the right location-based compensation strategy. We partnered with Meghana Reddy, an advisor at Alamere Compensation and former VP, People at Loom.

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Here are some of the key highlights from the session. To view the webinar in full, click here. 

Why You Need a Location-Based Compensation Strategy

Remote work is reshaping compensation. Before 2020, most employees were required to live within commuting distance of the office or relocate to be closer to the office. As such, compensation was relatively easy to determine: Bay Area employees were paid a rate competitive with the Bay Area market, Chicago employees were paid a rate competitive with the Chicago market, etc. 

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Once the pandemic hit, the requirement to go in or even be near the office disappeared. In response, some companies did away with their office altogether and became remote-first, while others adopted a hybrid model that only required employees in the office sometimes. While this shift happened fairly rapidly, compensation strategies adjusted more slowly, with many employees maintaining their Bay Area or New York City salaries despite moving to areas with much less competitive labor markets.

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In a remote-first world, a compensation strategy that ignores where employees actually live is financially unsustainable long term. Businesses pay a premium for talent in noncompetitive labor markets and are less able to attract high-value talent in more competitive markets due to misallocated payroll budget. So why have many businesses been slow to adopt a location-based compensation strategy? 

Employees feel location-based pay is unfair

Employees generally want everyone in the organization to be paid on the same scale, regardless of where they live. This way, everyone feels their pay reflects their value to the organization and nobody is “penalized” for choosing to live in a low-cost area. 

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While these concerns are reasonable, paying everyone on the same scale ignores a few economic realities:

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• Compensation is based on supply and demand. A common misconception is that compensation reflects an employee’s value or impact to the organization. While value-add is absolutely a factor, compensation is primarily determined by the size of the talent pool and the number of people hiring. This is why Bay Area engineers can command top dollar.  
• Location does matter. While many companies are now remote-first, not all employees want to work remotely, and not all businesses allow them to. As such, salaries must still reflect the higher labor cost in certain markets. If an organization tried to pay everyone based on the national average, it’d put them at a disadvantage when hiring talent based in the Bay Area or New York City. 

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For these reasons, paying everyone on the same scale is unsustainable for an organization—either because it leads to overspending, or because it makes it difficult to hire talent in high-cost areas. 

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That’s not to say transitioning to a location-based compensation strategy won’t come with some challenges. To mitigate the impact of this transition, it’s important to acknowledge that there’s an inherent unfairness in how compensation works, and that the fairest thing the business can do is demonstrate consistency in how compensation decisions are made.

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Paying based on an employee’s local labor market prioritizes the long-term viability of the business. 

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If your organization is ready to transition to a location-based compensation strategy, here are a few approaches to consider:

Location-Based Pay Structures: Within Country

When it comes to determining a location-based compensation strategy for employees who are all based within the same country, there are generally three options for the business:

National compensation structure

A national compensation structure means all employees have the same salary band regardless of location within the country. This is a good structure if:

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• The company is remote or remote-first: Employees aren’t required to live in a specific location.
• The company has high margins: The business can support a high payroll cost.
• The company requires hard-to-find talent: It’s easier to attract talent if the business has high pay and is remote-first.

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You’ll generally see early-stage startups utilize this type of compensation strategy. While it’s an easy structure to maintain and explain to employees, a national compensation structure generally becomes less sustainable as the business scales. 

Local compensation structure

A local compensation structure calls for creating salary bands based on the different metro areas where employees are based (e.g., Bay Area, New York City metro area, Chicago metro area, etc.). A local compensation structure is good for:

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• Companies that primarily hire for in-person roles: Employees are required to be based in a specific area.
• Companies that want to lower payroll costs: Local compensation is generally more cost-effective than national compensation.
• Companies that don’t need to compete for top talent: A local compensation strategy generally makes hiring harder for in-demand roles. 

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A local compensation structure is generally utilized by companies in healthcare, retail, life sciences, and other roles that require employees to be in office. 

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When creating salary bands for local compensation, companies generally pay a percentage of the top-ranked metro area based on the competitiveness of the local job market. Here’s an example of a local compensation structure from Gitlab:

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Source: Alamere.io

Tiered compensation structure

A tiered compensation structure calls for creating 2-4 salary tiers based on employee location. Locales in competitive job markets are “tier 1,” while locales in less competitive job markets are lower tiered. This is the most common location-based compensation structure used by startups because:

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• It enables companies to hire in competitive markets while remaining cost-conscious: Companies can offer top talent compensation that’s competitive in their market without also spending big in less competitive markets.
• It attracts top talent: Employees in the most competitive markets expect to be paid top dollar.

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Generally, the more employees you have in different areas, the more tiers you’ll need. When constructing tiers, consider where your existing employee base is, and where you anticipate hiring in the coming years.

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Similar to a local compensation structure, lowered-tiered bands pay a percentage of the top-ranked metro area based on the competitiveness of the local job market. For example, locales in tier 2 might pay 90% of the tier 1 band. 

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With both a tiered or local compensation structure, it’s important to revisit the numbers periodically to ensure you’re remaining competitive in the markets where your employees are based. Additionally, if you have employees move to a location that puts them in a different tier, you must be prepared to adjust their pay accordingly. 

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Remember: The fairest thing an organization can do for its employees demonstrate consistency in how compensation decisions are made.

Location-Based Pay Structures: International

When it comes to international employees, things tend to get a bit more complicated. Different countries have different tax rates, exchange rates, and regulatory burdens which can affect how much it costs to compensate for a comparable role. For example, to hire an employee in the Netherlands with a $100k annual USD salary would actually cost the business $112k+ USD.

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Source: Alamere.io

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As such, there are generally two different location-based compensation strategies companies use for international employees:

Global pay

Global pay is when the company pays the same salary band across all countries where employees are located. Similar to the national compensation structure, this is good for companies that are:

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• High margin: The business can support higher payroll costs.
• Need to hire in-demand talent: Assuming your company is based in the U.S., a domestic salary is typically attractive to talent in the EU and Asia. 
• Remote-friendly: Employees aren't required to relocate for the role.

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Early-stage startups and remote companies that hire internationally are the best fit for the global pay model. 

Local pay

For businesses that choose not to do global pay, local pay will be the best fit. In this compensation structure, salary bands are based on a given country’s job market. Similar to a local compensation structure within a country, local pay means paying employees within that country a percentage of the pay in the “top” country. 

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Local pay also means maintaining consistency across international markets. So if the company pays in the 70th percentile for talent in the U.S., it should also pay in the 70th percentile for talent in the U.K., for example.

Last Word on Location-Based Compensation

Source: Alamere.io

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As the above chart illustrates, the “right” location-based compensation strategy depends on the type of business, its financial flexibility, and its hiring strategy. If you’re ready to build your location-based compensation strategy, Pave can help!

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Pave enables location-based compensation with free benchmarking data, streamlined compensation band creation, guidance around merit cycles, and customized rewards portals. 

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Learn more or request a demo.

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