One of the most severe consequences coming out of our current labor market is the threat of significant salary compression amidst a potential economic downturn. However, it seems to be something that almost no one talks about.
Research from Pearl Meyer shows that 68% of companies do not address compensation differently based on skill, managerial level, or direct reports – which suggests that most companies take a one-size-fits-all approach.
In this article, we want to examine these concerns and talk about how you should be thinking about them for your business.
What Is Salary Compression or Wage Compression?
Salary compression, also known as wage compression, is a phenomenon where non-trivial pay differences emerge between your staff over a period of time. Typically this happens when a company is forced to raise starting salaries to recruit new people, resulting in disproportionate compensation relative to existing staff members.
While this is not technically illegal, it can cause plenty of ripple effects both psychologically and in a regulatory sense when operating in a jurisdiction with equal pay laws.
What Causes Salary Compression?
There are a variety of factors that can cause salary compression in an organization. Here are some of the more common factors:
1. Tight Labor Market
When a labor market is constrained, there is tremendous competition for strong talent. As the demand for talent exceeds the supply, the starting salaries are forced up – creating the conditions for salary compression.
2. Stale or Outdated Data
Compensation decisions rely a lot on internal data related to current compensation and external data related to the market conditions for your specific industry. If the data you’re relying on is out of date, you can find yourself in a position where you’re unknowingly causing pay compression because you aren’t in tune with the average salary range in the market for that same job.
3. Lack of a Compensation Strategy
If you are making compensation decisions arbitrarily without a thoughtful strategy, you can also find yourself creating pay compression because you don’t have a clear system and guidelines for salary negotiations.
4. Few Opportunities for Advancement
If you don’t have clear paths for existing employees to grow and increase their salary over time, then you can find yourself in a position where newer employees are getting paid similarly to those who have been there for a long time. Without development opportunities, this can cause a significant hit to morale.
5. The Company Is Growing Fast
High-growth companies are hiring quickly and this is often fueled by increased investment in the firm. If you don’t pay attention to the salary implications for your existing staff, the speed and scale of your new hiring can create pay compression and pay inequity.
6. The Company Goes Through a Merger or an Acquisition
When two companies are merging or one is being acquired by another – there are likely to be salary differentials because each organization might have been running with different baselines and principles. If these aren’t normalized and accounted for, you can end up with salary compression that can sour the desired cohesion between the two sets of employees.
All of these can affect what you pay employees for the same job and this imbalance within pay structures can sour relationships between new employees and tenured employees.
What Forms of Compensation are Included in Salary Compression?
One of the troubling misnomers that we encounter when discussing the pay compression issue is the belief that base salary is the only thing we should be concerned about when working towards equal pay ideals. The base salary is important of course, but it is only one component of the entire compensation package.
Here are some of the other components that play a role:
Many companies use performance bonuses to incentivize good work from their employees. In some instances, these can be significant relative to the base salary and as such, can contribute to pay compression.
When a manager gives out a discretionary bonus, it can cause some consternation within the workplace. If it’s not perceived as fair or justified, this can be a significant factor that creates pay compression.
For new starters, sign-on bonuses are often used to sweeten the deal and convince someone to join the company. Obviously, this isn’t reciprocated with existing staff though and that’s where pay compression can rear its head.
If certain employees receive stock options as a form of compensation, this can create salary compression relative to those that don’t. For fast-growing companies, the economic differentials here can be huge – so it’s important to be highly strategic and emotionally intuitive here.
Extra Time Off
Leave days are also an important part of a compensation package and if you’re giving certain employees more time off, this can be a sticking factor for those who aren’t so lucky.
In the same way as additional leave days can cause salary compression, so can increased benefits. Employees will want to feel that they are fairly treated and an imbalance here can cause trouble internally.
The Negative Impacts of Salary Compression
Now that we have an understanding of the building blocks of salary compression, let’s explore some of the reasons that it can be so damaging for an organization.
When people feel like they are being unfairly treated it can have a very damaging effect on workplace morale and culture. Compensation is a very personal thing and it can create extreme emotion that translates into a much poorer environment for work. All of this has knock-on effects on productivity, customer service, work quality, and long-term sustainability.
If staff feel like they aren’t receiving fair pay, they are simply going to move elsewhere. As such, pay compression increases staff turnover which is expensive and can cause a significant hit to profitability. This is especially true in our current state where the labor market is constrained and talent is very hard to come by – making it even more important to address pay inequities.
In many countries, there are equal pay regulations that aim to protect workers and enforce a certain degree of fairness within compensation. Thus, unchecked salary compression invites lawsuits and other legal challenges that can be very damaging to any organization.
When staff members are unhappy they tend to share that with the world through sites like Glassdoor and the like, but also in their personal circles. This negativity can sour a brand’s reputation and dissuade customers and new potential hires from engaging with the company. With the internet, this is a more pressing risk than ever because transparency is celebrated and encouraged.
These are all serious concerns and they should be enough to convince you to take the risk of salary compression seriously. For the long-term health of your company, this is a topic that should be front of mind.
How to Prevent Salary Compression
Let’s now talk about solutions. Here are some actions steps that you can consider to prevent salary compression from happening:
1. Consider Offering Variable or Incentive Pay to Current Employees
You can be creative with how you remunerate existing employees by inserting variable incentive structures into their compensation plans. This allows them the opportunity to rise to what new starters might be making and puts their destiny back into their own hands.
2. Consistently Monitor the Market Rate for Salaries and Adjust Where Needed
By keeping your eyes on what the industry considers market-related compensation and minimum wage for specific roles, you can get ahead of any frustration and make proactive adjustments that show that you care about your longer service employees.
3. Conduct Pay Equity Reviews and Make Salary Increases Where Needed
By making pay audits a regular process for your company, you’ll never find yourself in a situation where you’re unaware of salary compression that has happened. You’ll be aware of a position’s salary range and you can evaluate the situation at each point and make adjustments as required to maintain a balanced pay structure for each job function. In addition, you can always keep an eye out for any impending minimum wage increases.
4. Consider Offering Non-financial Compensation
If your company isn’t in a position to increase financial remuneration, you can always supplement with non-financial benefits. This can include leave days, additional flexibility, workplace perks, and anything else which may be of value to your employees – reducing the perceived pay inequities.
5. Look for High-potential External Candidates Who Consider the New Role a Promotion
If you can find high-potential hires who are currently in lower roles, then the job you offer them can be a win-win scenario – giving them an opportunity to move up without you having to pay a higher starting salary.
6. Control Remuneration Decisions From an HR Policy Standpoint As Well As a Budgetary One
If you don’t have any policies in place surrounding pay, you’ll find that managers will always want the more experienced higher-cost hires that fit within their budget. A robust policy from your HR professionals covering remuneration can act as a check and balance against these instincts and help to preserve the fairness of the internal compensation structure.
7. Require a Review of Equity Adjustments for Incumbents If New Hires Are Brought in at Higher Salaries
Within the hiring process, you can enforce an equity adjustment review that looks at what increases existing talent will need to get in order for the new employee to come in at this particular salary range. This will force managers to think carefully about new hires and whether other options might be a better way to go rather than paying these pay increases.
8. Plan Career Ladders
A healthy organization has clearly defined development plans for employees to grow and develop, earning pay increases as they do so. If you can demonstrate lucrative career ladders for your people, it mitigates any potential frustration about imminent salary compression.
These are all steps that you can take proactively to prevent pay compression from ever occurring. If you truly care about your employees and the working culture that you’re trying to build, this should be a key pillar of your human resources strategy.
It’s well worth the investment because your people are your main asset – and in a market where they’re very hard to come by, they are worth their weight in gold.
How to Tell if Pay Compression Exists
If you want to assess if pay compression exists within your organization already, you should undertake a company-wide audit to compare the pay levels of existing employees to those of new employees. What you’re looking for here is consistency and so whenever you find a discrepancy, note it down and do some further investigations.
Once you’ve been through your entire workforce, you’ll have a sense of where potential problems with employee pay might be and you can then start working to rectify them.
Another key sign that you should keep a look out for is whether your people are leaving because of money. This is important information to look for in exit interviews as this is often the first place that you’ll recognize that tenured employees are experiencing salary compression. If this happens regularly, it’s time to re-evaluate your compensation strategy and try to bring things back into balance.
The ROI of Addressing Salary Compression and Pay Inequities
We hope that this post has convinced you that salary compression is a serious risk to consider in our current economic climate. And while most of what we explored looked at mitigating the risk in a tight labor market, there is another side to this. If you choose to proactively address pay compression – you can show your employees that you truly care about them and the resultant pay equity will facilitate a much healthier workplace as a result.
This translates into better productivity, improved morale, increased reputation, and lower staff turnover. Thus the return on investment can be staggering when you address salary compression head-on.
If you’re looking for help with your recruiting efforts, or just want an experienced partner to walk with you on the journey to avoid pay compression, then The Renaissance Network is here to help. Get in touch today and let’s explore how we can help!