Proactive Approaches to Address Pay Compression

Is your organization suffering from low employee morale? Poor employee retention? Weakened trust in leadership? Your organization may be experiencing pay compression.

What is pay compression?

Typically pay compression is defined as pay differentials too small to be considered equitable. In other words, pay compression occurs when there is little to no difference in pay between employees regardless of their skills, seniority, experience, or responsibilities.

The most common reason for pay compression is when the market rate for a given job outpaces the increases provided by an organization, creating a situation where new hires must be paid at a rate close to current long-tenured employees. Most organizations have experienced at least one of the examples of pay compression:

  • A newly promoted manager who is no longer eligible for overtime is now paid very at a low rate compared to the employees they manage who continue to earn both base salary plus overtime.
  • The pay difference between the current employee’s job and a promotion into the next level is not significant enough to incentivize the increased level of responsibility.
  • Employees in lower-level jobs are paid almost as much as their colleagues in higher-level positions. This is a common occurrence in states with increased minimum wages because employers are required to pay minimum wage, but they do not adjust the wages of the employees in higher-level jobs.
  • “Hot skill” jobs in the labor market demands higher starting salaries to attract talent. This is common in IT and engineering/science jobs, where technology and in-demand skill sets change rapidly.

What organizational challenges does pay compression cause?

Pay compression is not illegal. However, allowing pay compression to enter an organization does not make good business sense. It is an expensive risk that can cost an organization much more in the long run. Salary compression can lead to a host of organizational challenges, such as:

  • Low employee morale. Employees can feel demoralized and resentful when they are paid the same or close too, another employee who has what they see as an “easier” job.
  • Poor employee retention. Employees may be more receptive to moving on when they see a job opening, or they will feel compelled to actively enter the job market.
  • Diminished employee engagement. Even if they chose not to actively seek a new job, it is likely they will become disengaged from their current job, leading to a lack of productivity.
  • Weakened trust in leaders. When employees do not feel that they are fairly compensated, they are less likely to trust leaders and more likely to experience overall job dissatisfaction.
  • Damaged work relationships. Consider the difficulty new employees may face when being hired at a pay level higher than their peers doing the same type of work. If pay rates are known – as they often are – the new employee may face an environment that is uncomfortable or unproductive.
  • Lastly, salary compression may also cause difficulty when management wants to promote internally. Potential supervisors, when considering an upward job change, may be faced with the prospect of a higher “level” job that is more complex, with more stress, yet brings home less pay after overtime pay. Unless they feel that this will be a temporary situation, it is likely they will turn down the opportunity.

How do we address pay compression challenges?

Your organization should seek to understand where and how salary compression may exist; then, management can strategize how to mitigate the impact and determine the appropriate course of action. You should:

  • Review the organization’s compensation philosophy. It is still relevant to how you do business and how you want and need to pay your employees.
  • Revisit the salary grade structure, which may be structurally adding to pay compression. Ensure that your ranges are keeping in step with the external marketplace. Review the midpoint progression if the pay grade midpoints are too close; this may create compression with promotions, among other issues.
  • Analyze jobs and review job descriptions to determine if the duties are an accurate representation of the work being done and reassess salary grade and pay range.
  • Perform an internal equity audit of your employees’ pay rates. Identify employees whose performance level and pay rate are not in the proper relationship. Consider “equity adjustments” to accelerate pay levels of long-tenured, high performing employees. Consider promoting employees only if the employee qualifies for promotion and could contribute to a job with higher responsibility. Consider freezing compensation of employees whose performance contribution is less than it should be.
  • Review your compensation program to ensure your pay practices are the best solution for your organization’s talent needs.

Pay compression has serious business implications. It can lead to increased turnover, a decrease in discretionary effort, employee dissatisfaction, a negative impact on productivity, and even potential discrimination and pay equity claims. With super-low unemployment rates nationwide and as you aim to recruit top talent, retain and motivate the best, you need to be mindful of pay compression because employees do not want to work for companies with inequitable pay programs. Being strategic, fiscally responsible, and deliberate with your compensation decisions is extremely important to ensure your organization can compete for high-quality talent.