Geography or the physical location of the employee’s job plays a role in determining the pay levels for the job. The geographic definitions used are mainly cities, states, broad region or territory, country etc. To control costs the company bases its pay variations on verifiable differences in competitive salary levels, i.e. pay is more in areas where the market is higher that national average and vice versa.
Geographic Differentials should not be confused with Cost of Living as the company’s compensation philosophy intends to pay competitively and not on the employee’s living expenses. The two however are related (Cost of Living is the cost of goods in one location relative to another, whereas Geographic Differential is cost of labour in out location relative to another). According to compensation consultants Culpepper and Associates three common methods are used to implement Geographic Differentials:
Different salary structures in different locations
Individual adjustments to base salaries
Supplemental geographic differential payments
Also, according to Culpepper factors used to calculate the Geographic Differentials are mainly local salary surveys (cost of skill in market), local cost of living, inflation, unemployment or employment data etc.
Geographic Differentials are expressed as percent of the base-line data point. For example if by research it is learnt that a particular geographic location pays 75% of national average for a job, then Geographic Differential would be -25% and Geographic Differential Ratio would be 75%.