One of the executive decisions companies need to make is to choose a strategy for their employees’ compensation. Location and position are often the main criteria that are debated on as each come with their benefits and pitfalls.
Location-based compensation
A common practice is to pay employees based on their geographic location, taking the cost of living into consideration. Often enough, employees in a region get the impression that they are getting paid significantly less than someone else based in another part of the world where the cost of living is higher. This can easily be explained by the fact that after subtracting expenses and taxes, the remaining funds are equivalent to those in the former employees’ region.
In reality, the cost of living tends to be used as a wild card to explain to an employee why they are paid less than someone in another location doing the same job as they are. There needs to be a logical calculation to determine a "fair" location-based compensation.
What does cost of living mean? Well, it is the average amount of money spent by a household in a location during a specified amount of time. Livingcost.org provides a rough estimate of the cost of living in multiple countries. If you want a more accurate value, it’s best to consult the local statistics website for each country.
Now, the cost of living alone is not valuable to us. We need the salary in the equation. So, let’s say we want the ratio of the salary to the cost of living. This value is a simplified version of the purchasing power.
Purchasing power = Salary / Cost of living
The purchasing power needs to be calculated for each job position in an arbitrary location where the employer has done extensive market research and made a financial decision about salaries they can afford. An example can make things clearer.
The company XYZ Ltd is based in the Netherlands and pays Alice, a junior full-stack developer who’s also based in the Netherlands, a monthly salary of $2,000. The company has a branch in Mauritius, where Bob, another junior full-stack developer, is based from. How much should XYZ Ltd pay Bob if they want both Alice and Bob to have the same purchasing power?
Livingcost.org says the monthly cost of living in the Netherlands is $1,945. So, Alice’s purchasing power is 1.03 ($2,000 / $1,945). We can rewrite the above formula to find out the salary that Bob should receive.
Salary = Purchasing power * Cost of living
The monthly cost of living in Mauritius is $772. So, Bob’s monthly salary needs to be $794 (1.03 * $772).
Is it that simple though? Disclaimer: Nothing really is!
The cost of living is local to a geographic location, and so is the purchasing power. They do not account for the international value of the currency in the country an employee is based from. The employee might have expenses abroad for health reasons or even holidays. At the end of each month, Alice has $55 ($2,000 - $1,945) in savings and Bob has $22 ($794 - $772). Sure, the purchasing power of $55 in the Netherlands is equivalent to that of $22 in Mauritius. Nevertheless, we’re not accounting for the international value of the savings if Alice and Bob were both in the U.S for their holidays. Over there, $22 is less than $55. Would Bob still feel that he’s paid "fairly"?
Position-based compensation
This strategy involves paying everyone with the same job position the same salary. Now, employees living in regions where the cost of living is on the higher end may complain that they are not paid "fairly", and that’s fair too!
However, the explanation can be linked to the fact that an employee is paid based on the value they bring to the company. The local taxes and expenses in a location can be argued as the employee’s choice since they choose where they want to live.
Buffer has written a detailed article about how they envisioned switching to location-independent salaries in 2022. They have a more recent article where they explain how they have set up their salary system.
Ending note
There is usually a fairness factor that comes into play in this decision. However, fairness is subjective. Hence, whichever strategy a company chooses, the risk of someone having a feeling of unfairness is inevitable. Another concern is competition. Other companies in the same space can either be paying their employees less or more. It’s up to the employer to choose whether to match what their competitors are paying. Of course, you will have pitfalls either way. Being transparent about the reasoning behind the chosen compensation strategy can definitely help candidates before applying for a job and existing employees understand their employer’s point of view on this matter, driving trust along the way.