Pay compression creates the unintended perception that pay across the organization is unfair. It can destroy morale, lead to widespread dissatisfaction on the job and cause some of your top talent to leave. In some cases, it can even lead to lawsuits.
So, what exactly is pay compression and why does it happen? Pay compression, also referred to as wage or salary compression, can happen for a variety of reasons. The most common type of pay compression is when new hires make more than tenured employees with little regard to experience, skills, levels, or seniority. This can become somewhat of a slippery slope, especially if the more experienced employee is in a protected class. And while it may seem counterintuitive, pay compression also can occur between a manager and their direct reports.
How Do Pay Compressions Happen
Pay compression happens over time and for a variety of reasons. Sometimes they happen because pay structures are outdated compared to the market or in restructuring scenarios where jobs are not re-evaluated. The phenomenon also can occur during a merger or acquisition where both parties fail to fully integrate and also in organizations where certain departments or divisions are relatively liberal with salary increases, market adjustments, and promotions while others are not.
Budgets for salary increases across most organizations have been modest at most for the last 20 years or so. The average increase according to the Society of Human Resources Management (SHRM) states that across the board, these increases average between 2 or 4 percent. If someone changes jobs, they may expect a pay increase of more than 2 to 4 percent, which is how new hires often end up making more money than tenured staff.
How Do You Know If Pay Compression Exists?
Pay compression usually happens when time in a position is not the only factor that moves an employee through a particular salary range. Once it appears that time in a position is no longer impacting how quickly an employee moves through that particular pay range, it is time to start paying attention. When new employees are higher on a pay scale than employees who have been on board for a while, pay compression may be happening.
Upon analysis, if you determine direct reports’ salaries are 80 to 95 percent of supervisors’ compensation, you may be getting into pay compression territory.
To prevent these situations from creeping upon you, you may want to consider conducting an analysis every six months, or at least annually, to make sure everything is in alignment.
What Steps Can You Take To Avoid Pay Compression?
Preventing pay compression is much less costly than fixing it. Developing a strategic plan is key to preventing this costly scenario from unfolding. We recommend you work with your internal communications team to develop messaging around this key topic. You should be able to explain the “whys” across the workforce. Whether you like it or not, people will talk about pay rates and increases.
By taking the below actions, you can safeguard your organization and minimize the possibility of pay compression:
1. Proper Planning and Review
Take time out to review current pay practices and policies. If they need adjusting, do it then, and don’t wait. Set aside a budget to adjust salaries for high-performers and identify critical roles and key positions to determine their worth in the market for those particular jobs.
2. Pay Attention to Market Trends
Know what inflation is and other economic indicators. Review market data and adjust pay structures to keep up with the competitive market. Identify critical roles and key positions and determine their market value.
3. Promote or Transfer from Within
If possible, look at your existing pool of talent when there are positions that need to be filled. Promoting from within and giving your tenured employees new opportunities may boost morale. It also may lower the cost of hiring rather than having to spend more on hiring an outsider in a tight labor market that is demanding higher salaries.
4. Look at the Entire Package
As you evaluate pay across the board, consider what else you could offer employees rather than just pay increases. Look at Total Rewards, including flex work schedules, work from home benefits, recognition programs, and other incentives. In the post-COVID era, employees are looking for so much more than a paycheck.
Summing It Up
Pay compression happens when organizations are unsuccessful at making meaningful distinctions between different levels of experience, skills, and years at a company.
Taking time to create a strategic plan, and then communicating that plan to your team, will help minimize the possibility of pay compression, and save you a lot of headaches and pay dividends (financial and otherwise) in the long run.
Keep the Conversation Going with Tam Nguyen
Tam Nguyen is an international business management & human resources leader possessing expertise and technical knowledge in the areas of strategic human capital management and execution, including business strategy, global compensation & benefits, human capital performance and measurement, employment law, global mobility, and HR information systems integration and deployment to stabilization. Connect with Tam on LinkedIn.