5 Approaches to Managing Compensation for Remote Work
Compensation Fundamentals
Time of posting an article for Barley Compensation Management Software
July 26, 2021
Reading time for Barley Compensation Management Software
7 min read

5 Approaches to Managing Compensation for Remote Work

The rise of remote work has changed the landscape for employers and employees alike. It has been rich with advantages: more flexibility, increased productivity, better access to clever people from diverse backgrounds, and potentially lower costs.

It also brings a whole lot of questions. Should your salaries be set globally or locally? Should someone's pay be adjusted when they move to a town with a lower cost of living?

Does work from home really mean work from anywhere?

In this post, we'll take you through 5 approaches to compensation management for remote work. You'll consider the underlying philosophy, ease of implementation, and challenges of each.

But first, did you know:

  • 39% of employees would consider quitting their job if their employer wasn't flexible about remote work. That rises to 49% among millennials and zoomers. (Bloomberg)
  • More than half of Americans would be willing to accept a pay cut, with an average value of 7%, to continue working from home 2 to 3 days per week. (University of Chicago)
  • The number 2 reason that people love working from home is the cost savings, but the number 1 reason is skipping that painful commute. (Flexjobs)

#1. Pay is based on the location of the company's head office

One pay structure for everyone. Easy peasy.

In this traditional approach, compensation is tied to the market rate of pay at your company's head office, regardless of the employee's location.

The market rate of pay for a role in a specific location includes criteria such as industry, years of experience, responsibility level, and so on. It is determined by supply and demand in that location.

The philosophy here is that employees are paid based on the contribution they make, not where they live.

Pros: This strategy is good for long-term retention, because it allows employees to live where they wish, while still making an attractive salary.

It has a positive impact on your hiring process. Top candidates value flexibility and  you can move the needle on diversity by choosing the best candidates wherever they are.

Implementation is simple, because this is probably how your company was already setting compensation when we were all in office. Plus, you only need benchmarking data for one location. This makes it easy to update over the years and easy to monitor for pay equity across the organization.

Cons: All these benefits do come at a cost. Since the company headquarters is often located in a major city with higher rates of pay, this approach is likely to be more expensive for the employer.

If your pay model results in significantly higher pay than comparable local jobs, this may create a form of "golden handcuffs" where an employee who wants to leave your company feels that they cannot, because they can't replace their salary with a local job.

#2. Pay is based on each remote employee's local market rate

Everyone gets their own pay structure. Sounds like a ton of work, huh?

Using this approach, the employer would pay based on how other organizations in the remote employee's location pay for a similar role.

Pros: This could be the most cost-effective strategy for employers from a salary budget perspective. You can pay exactly what the market requires and can source candidates from less expensive areas if desired.

For employees, their pay will continue to be competitive with other roles in the market where they live. As employers are motivated to look outside major markets for talent, employees may also find that they have increased access to interesting professional opportunities while remaining in their location of choice.

Cons: Due to the high cost of implementing and maintaining this approach, your payroll savings are offset by the administration costs. The major challenge here is that it requires a significant investment of time and resources to pull benchmarking data for every single local market. That data may not exist or be easily available at the level of comparability and granularity that you need to optimize pay. You also find yourself adjusting compensation more often through the year as employees move around. It muddies the relationship between pay and performance.

If you are not currently using this approach, switching to it can be tricky. If employees who choose to move are required to take a pay cut, you should expect a certain amount of backlash and turnover. But if you start paying new employees based on their location without adjusting the salaries of existing employees, you may develop a pay equity problem.

#3. Align pay to geographic zones

Not too many pay structures, but not too few.

To use this method, establish geographic zones with a similar cost of labor and group them together.

For each zone, research the market data to inform your pay structure. This is similar to Approach #2, because you are comparing pay to other organizations in multiple local markets, but simpler because you will be clustering them together into a few bigger buckets.

This strategy works well for a company that already has a few offices or which operates on a "hub city" model, where employees are clustered together in specific areas. The employees reporting to the New York office might be in one pay zone. The employees reporting to the Cleveland office might be in another. The employees reporting to the Atlanta office might be in a third pay zone, or you might find that the market rates of Cleveland and Atlanta are similar and group them together into one zone.

Pros: This is a middle-of-the-road approach between one global rate and many individual market rates. You are still paying competitively to market, but also incorporating some differentiations and some cost savings based on location.

Cons: Remember that this approach is based on market pay. So while it is simpler than anchoring to each individual local market, you will still need good benchmarking data for each geographical area. You can have many zones or just a few, and they don't necessarily correspond to a location on a map; this can get complicated fast.

Employees will want to understand the criteria that you are using to determine pay for each zone. According to Harvard Business Review, two thirds of employees who are being paid market rate believe they're actually underpaid. To mitigate this, be prepared to have open and transparent conversations about how pay is determined relative to the market, performance, and responsibility.

Variation: Instead of using market pay to set geographical differences, you can use cost of living.

#4. Align pay to cost of living

One base pay structure, with an up-or-down twist.

This approach is becoming more common for the increasingly remote workforce. Pay is based on the company's head office location, and then a cost of living multiplier adjusts compensation up or down based on where the employee lives.

Cost of living is the cost to live in a specific area, based on the price of housing, taxes, goods, and services. It is measured by the purchasing power that your money has in different locations.

This salary calculator from Buffer provides a great example.

As long as you keep it consistent, you can base your cost of living on whatever metrics you like. Some options include the Consumer Price Index, the housing market, or reputable national surveys. Choose something that is reliable and easy to access, so that you can update it as needed.

Pros: This approach is transparent and intuitive for employees to understand, because they can "feel" the difference in their purchasing power in different cost of living areas. This strategy optimizes compensation for each person based on where they have chosen to live, but also ensure that all employees across the organization enjoy similar purchasing power, thus preserving a sense of internal equity.

Cons: Where people choose to live and why is highly personal. Employers don't usually pay employees based on their lifestyle choices, so why should that be different for remote work? This approach can be perceived as penalizing those who choose to or can only afford to live in a lower cost of living area. There may also be an increased administrative cost to tracking and adjusting compensation every time an employee moves.

Variation: A forward-thinking twist on this method is called "gainsharing". (WorldatWork) Employers and employees split the difference between pay in different locations. For example: if an employee's salary at HQ would be $50,000, and their adjusted salary in their lower cost of living hometown would be $40,000, then you could choose to pay them $45,000. The employee enjoys better compensation and purchasing power, while the employer saves costs. Everybody wins.

#5. Pay is based on a national average or median

No headquarters? No problem.

For a company with a large distributed workforce and/or no particular head office, aligning compensation to a national rate allows you to be consistent and location agnostic across your organization. This approach works well for:

  • Industries that have well-established pay structures, such as healthcare
  • Industries where the workforce is highly mobile or transient
  • Industries which lack good specific benchmarking data in each region

Pros: This approach is appealing in its simplicity.

Cons: It requires fine-tuning if you are competing for highly-skilled in-demand workers in markets with above average pay.

Variation: Another median or "middle ground" approach would be to establish a "remote pay band" that determines the pay for all remote employees with a certain job or level.

So now you know how to develop your compensation strategy for remote work. What next?

Align compensation to business strategy

When choosing an approach to paying for remote work, consider what behavior your compensation policy is incentivizing.

What impact will it have on your company culture and employer brand? And how will it help you win in the marketplace?

Here are some examples of how others are doing just that:

  • Spotify will implement a permanent flexible "Work From Anywhere" model, while continuing to pay San Francisco or New York City rates.
  • Reddit will replace geographic compensation zones in the USA with a national pay structure anchored to a high cost of living city. Internationally, they have one national pay range per country
  • Stripe will pay employees a $20,000 bonus to relocate out of San Francisco, New York City, or Seattle, but then cut their pay by 10%. This suggests that they want employees to move, perhaps in pursuit of long-term cost savings and more distributed remote workforce, but also want to mitigate the immediate pain felt by employees

Don't stop communicatin'

Whichever approach you choose, take some time to clearly outline the new policy for your employees. You'll want to communicate what has changed, why it has changed, and how it impacts them. But you also want to illuminate how this connects to your company's vision for the future.

As remote work becomes a more common and permanent part of your company's culture, the best compensation strategy is one that proactively addresses your business goals while also making your employees feel valued.

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