How to Analyze and Prevent Pay Compression

According to Benjamin Franklin, “An ounce of prevention is worth a pound of cure.” It is the prevailing sentiment when it comes to dealing with pay compression – the best way to deal with it is to prevent it from occurring in the first place. Pay compression, also referred to as salary compression or wage compression, occurs when there is very little differentiation between the salaries of jobs despite variations in employees’ respective knowledge, skills, and experience. Pay compression can lead to a disengaged workforce and ultimately affect the bottom line negatively. A sense of inequity erodes trust. Pay compression is one of the most pervasive pay issues that can lead to recruitment and retention challenges for an organization. If not prevented or managed as it emerges, pay compression can be difficult to address.

Pay compression occurs when there is only a relatively small difference in pay between employees regardless of skill sets, experience, direct reporting relationships, tenure, and other contributing factors. It may be the result of the market rate for a given job outpacing the increases that incumbents receive, resulting in new hire salaries that are equal to or higher than the salaries of senior professionals. There could be legitimate reasons, such as a hot skill set or technical and niche expertise, but inconsistent pay practices could also be the culprit, enabling pay compression. If new hire salaries are not vetted by the HR or Compensation team, then salaries may reflect the whims of the hiring manager whose focus is on getting a warm body in the position as quickly as possible, rather than ensuring fairness across the entire organization. When a job is deemed difficult to fill or a position has been open for a long time, recruiters and hiring managers may be focused on filling the role and overlook fit. Perhaps the candidate is overqualified, or the current incumbents are underpaid. Sometimes managers have a candidate in mind and are willing to make exceptions to bring that person on board, regardless of the impact to the existing workforce.

In a union environment, pay compression often occurs. A pre-determined schedule of regular wage increases over the life of a contract, often multi-year, are negotiated and guaranteed. Non-union jobs are often subject to fluctuations in budget and the overall job market. If the minimum wage increases, then those earning at the lower end of the range may receive a higher rate than those further along in the range, who may remain at the same rate, creating more compression issues. Jobs with a shrinking labor pool but high demand, or jobs that earn overtime and wage differentials, can outpace the salary growth rates of those managing or supervising them. The exempt manager usually has a broader scope of responsibilities without additional compensation for long hours and weekends. This can be demotivating and challenging when the manager is being paid less than those supervised. However, compression may be acceptable in some cases, such as a new manager with very limited experience supervising employees with considerable experience and years of service within the organization.

Pay compression can lead to employee disengagement, regrettable turnover, or even accusations of unfair pay practices. Some employees may even figure out that the only way to get a raise is to quit and reapply. Valued employees may start searching for opportunities that offer more competitive salaries, in which case the company is faced with losing top talent or digging deep to offer the higher salary that was appropriate in the first place.

How to Prevent Salary Compression Issues

There are many ways in which organizations can find themselves in the middle of compression issues; however, the best way to manage and ultimately avoid it is through vigilance, internal controls, and communication. Compensation must be managed consistently and intentionally. The organization’s compensation philosophy and pay practices should be formalized and reviewed for fairness and equity. It should be well communicated to leaders, recruiters, hiring managers, and the entire organization.

An evaluation of all jobs in relation to market survey data, as well as internal equity, should be performed periodically (at least annually) to assist in budgeting for necessary pay range adjustments and salary adjustments, while also anticipating salary needs for key positions when performing a salary compression analysis. Issues can be identified proactively and brought to Finance for budget considerations. It can also facilitate review of the current salary structures to determine if the market has shifted up or down significantly and if the ranges are in alignment. Do positions need better descriptions to differentiate the work performed? Do the pay rates established in the union contract outpace the salaries of supervisors and, if so, how should this be addressed? Recruiters and hiring managers are great sources of anecdotal data regarding demand for hot jobs or skill sets, as well as hard-to-fill jobs requiring competition for talent. When jobs are benchmarked to other similar roles in the relevant market, an organization can develop new hire pay strategies and regular salary increase processes (merit, equity, or market adjustments) for existing employees. Job offers should be centralized or at least vetted by a compensation professional who can review the offer for overall internal equity impact and compression. Reviewing the impact to peers, direct reports, and similar positions will allow for greater consistency and fairness.

The compensation data should be reviewed in detail. Compare the employees’ position in range or compa-ratio to experience and performance. If a new hire is deeper within the range than a long-term employee, find out the reasons why. Typically, you would expect to see employees with more experience and greater performance to be positioned higher in the range than those just starting out. Look beyond the numbers. Consult with managers and business partners to tell the story that may not be obvious on paper. Once you have determined what the issues are, develop a plan (including projected costs), in conjunction with Finance and approval from senior leadership, to adjust employee pay appropriately. It can be an expensive endeavor, but the cost of not addressing the issues can be even more.

Finally, equip front line managers with talking points to communicate the plan that addresses pay compression. Morale and engagement are often positively affected by open, honest communication and follow up. Knowing that the issues are being addressed can encourage the retention of high performers and the longest-tenured employees who may not have received pay increases, giving the organization the opportunity to do the right thing. Employees are aware of who is paid more and who is paid less for the same job. The effort to get pay compression right and prevent further issues is worth the time and effort spent by an organization. Visit SalaryExpert.com for more tips and salary benchmarking tools that you can use to prevent salary compression.