South African renumeration: The compound interest issue South African renumeration: The compound interest issue

South African renumeration: The compound interest issue
31 Mar 2015

Recent amendments to South Africa's Employment Equity Act have put a sharp focus on equality in salary structures. The effect of compound interest can create problems in your salary structure.

Let me use an example to explain. Assume a specific job pays R120,000 per year. Dave started a year ago and Nozipho starts today. Nozi is being paid R120,000 and Dave has just received an 8 per cent increment and is earning R129,600.

This everyday scenario holds the seeds of a very tricky situation. Both Dave and Nozi receive an eight per cent increment annually for the next ten years. At the end of the decade Dave will earn R19,190, nearly a month’s salary more each year and more than R139,000 extra over the period. That’s a lot of money that Nozi does not have due to having started a year later than Dave.

This stealthy creep in salaries can lead to breaking the law. The Employment Equity Act requires that ‘work of the same or similar value to the company must be paid the same’. I believe that if you have two employees, like Dave and Nozi, doing the same job and producing the same output one would be hard pressed to defend this pay difference in court.

The options

So, what are your options? One is to give Nozi a 10 per cent annual increase (or to give Dave a six per cent increase) until the salaries are on a par. This is bound to make Dave unhappy. He will argue that he has been in the job longer and therefore has seniority and they both perform the same job with equal output so why should the increase be different? The only remaining option is to equalise the salaries for the same job annually.

But this creates a different problem. What do you do if Nozi is an outstanding worker and consistently produces more product with less scrappage than his counterpart? The traditional solution would be to give Nozi a bigger increase at annual review time, but if you continued this for three or four years you will have an exact same scenario as outlined in the introduction.

The solution

The solution is a different approach to remuneration, one that includes a portion of the remuneration being related to productivity. Simply put, this means that you split the salary to pay a basic amount and an output-related monthly bonus linked to performance.

In the case of Nozi and Dave, they would be paid the same basic and a bonus for each item produced (units produced minus scrappage) based on their productivity. This works equally well for all categories of staff from debtors clerks to operators to line managers.

But this creates a different problem. What do you do if Nozi is an outstanding worker and to implement this new structure you can use the compound interest effect to your benefit by freezing the basic pay and paying annual increments as a production bonus.

After four years at eight per cent, a quarter of the annual remuneration will be production based and after five years almost a third. And production is almost guaranteed to increase as performancebased incentives drive performance increases.

Torpedoes

There are, however, several issues that can sink your plan to restructure remuneration:

• Line managers have been and are able to make arbitrary changes to job grades to increase the pay of a favoured employee
• Salaries are not controlled against the effects of compound interest leading to excessive overlaps on the curve
• Job descriptions do not exist or are out of date leading to unsubstantiated differences in subgrade (often based on legacy discrimination such as colour or gender).

It should consist of a single line with the smallest possible overlaps in the pay grades without the line being broken. Frequently the overlaps on the curve are so large as to make the curve meaningless and may hide large pay differences in the same jobs.

Restructuring

Restructuring salaries starts with a recognised job evaluation system and well written, accurate and concise job descriptions. Without these there will be no objective hierarchy against which to measure the relative worth of the jobs in the organisation.

A grading system involves a functioning grading committee that has the sole responsibility of allocating job titles and grades. When management changes a job specification they should submit a new job description to the committee for evaluation. The committee must also ensure that any two jobs with the same job title are within the same subgrade.

Once the organisational hierarchy has been fairly established, the policies behind the salary structures have to be defined. The company may decide to pay 12 per cent more on the lower quartile of the industry median. These complex decisions need to take into account the location of the company, skills shortage in the industry and competition.

Tony Pace set up his own consulting company with a bias towards HR in 1983. Since then, he has been extensively involved in all aspects of HR and strategic planning. In 2000, he began the HR Forum, a free e-mail discussion group where HR professionals can ask questions of the most experienced HR people in South Africa. 

 

 

Recent amendments to South Africa's Employment Equity Act have put a sharp focus on equality in salary structures. The effect of compound interest can create problems in your salary structure.

Let me use an example to explain. Assume a specific job pays R120,000 per year. Dave started a year ago and Nozipho starts today. Nozi is being paid R120,000 and Dave has just received an 8 per cent increment and is earning R129,600.

This everyday scenario holds the seeds of a very tricky situation. Both Dave and Nozi receive an eight per cent increment annually for the next ten years. At the end of the decade Dave will earn R19,190, nearly a month’s salary more each year and more than R139,000 extra over the period. That’s a lot of money that Nozi does not have due to having started a year later than Dave.

This stealthy creep in salaries can lead to breaking the law. The Employment Equity Act requires that ‘work of the same or similar value to the company must be paid the same’. I believe that if you have two employees, like Dave and Nozi, doing the same job and producing the same output one would be hard pressed to defend this pay difference in court.

The options

So, what are your options? One is to give Nozi a 10 per cent annual increase (or to give Dave a six per cent increase) until the salaries are on a par. This is bound to make Dave unhappy. He will argue that he has been in the job longer and therefore has seniority and they both perform the same job with equal output so why should the increase be different? The only remaining option is to equalise the salaries for the same job annually.

But this creates a different problem. What do you do if Nozi is an outstanding worker and consistently produces more product with less scrappage than his counterpart? The traditional solution would be to give Nozi a bigger increase at annual review time, but if you continued this for three or four years you will have an exact same scenario as outlined in the introduction.

The solution

The solution is a different approach to remuneration, one that includes a portion of the remuneration being related to productivity. Simply put, this means that you split the salary to pay a basic amount and an output-related monthly bonus linked to performance.

In the case of Nozi and Dave, they would be paid the same basic and a bonus for each item produced (units produced minus scrappage) based on their productivity. This works equally well for all categories of staff from debtors clerks to operators to line managers.

But this creates a different problem. What do you do if Nozi is an outstanding worker and to implement this new structure you can use the compound interest effect to your benefit by freezing the basic pay and paying annual increments as a production bonus.

After four years at eight per cent, a quarter of the annual remuneration will be production based and after five years almost a third. And production is almost guaranteed to increase as performancebased incentives drive performance increases.

Torpedoes

There are, however, several issues that can sink your plan to restructure remuneration:

• Line managers have been and are able to make arbitrary changes to job grades to increase the pay of a favoured employee
• Salaries are not controlled against the effects of compound interest leading to excessive overlaps on the curve
• Job descriptions do not exist or are out of date leading to unsubstantiated differences in subgrade (often based on legacy discrimination such as colour or gender).

It should consist of a single line with the smallest possible overlaps in the pay grades without the line being broken. Frequently the overlaps on the curve are so large as to make the curve meaningless and may hide large pay differences in the same jobs.

Restructuring

Restructuring salaries starts with a recognised job evaluation system and well written, accurate and concise job descriptions. Without these there will be no objective hierarchy against which to measure the relative worth of the jobs in the organisation.

A grading system involves a functioning grading committee that has the sole responsibility of allocating job titles and grades. When management changes a job specification they should submit a new job description to the committee for evaluation. The committee must also ensure that any two jobs with the same job title are within the same subgrade.

Once the organisational hierarchy has been fairly established, the policies behind the salary structures have to be defined. The company may decide to pay 12 per cent more on the lower quartile of the industry median. These complex decisions need to take into account the location of the company, skills shortage in the industry and competition.

Tony Pace set up his own consulting company with a bias towards HR in 1983. Since then, he has been extensively involved in all aspects of HR and strategic planning. In 2000, he began the HR Forum, a free e-mail discussion group where HR professionals can ask questions of the most experienced HR people in South Africa. 

 

 

Leave a Reply

All blog comments are checked prior to publishing