By: Kathryn Gombos on June 5th, 2023

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How to Avoid Pay Compression Problems

Total Rewards

Employees generally expect their company’s salary structure to curve upwards: senior team members have higher salaries than their junior colleagues, while managers earn more than their direct reports.

In practice, this doesn’t always happen. One study discovered that new hires generally earn 2-3% more than colleagues who have been on the team for 3-5 years.

This phenomenon is known as pay compression, and it can have serious consequences for your entire company.

What is Pay Compression?

Pay compression is the flattening of a company’s salary structure. Compression is usually the result of high starting salaries combined with flat wage increases.

Employee pay compression (also known as salary compression or wage compression) isn’t always apparent without a full audit. Some of the tell-tale signs of compression problems include:

  • New hires are being paid the same as or more than current employees in the same position

  • The pay difference between the current worker’s position and a promotion to the next level is not significant enough to incentivize the increased level of responsibility.

  • Minimal pay difference between a manager and their direct reports

  • Employees in lower-level jobs are paid almost as much as their colleagues in higher-level jobs

  • Non-exempt workers, who log overtime, are making more than peers in an exempt role

In this situation, your salary structure becomes flattened, with little movement for existing employees. This can create serious problems in the long run.

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How pay compression creates problems for employers

Pay compression can have serious implications for your labor budget. Compression issues generally happen when there’s a lack of fiscal discipline—for example when hiring managers offer above-average salaries.

But compression can also have deeper implications for your whole team. Some common problems include:

  • Lower engagement: Pay compression often feels unfair because everyone is being paid the same, regardless of their contribution. Fairness impacts engagement (employees are 26% more productive when they feel they’re being treated fairly) and retention.

  • Decreased involvement in professional development: Professional development is a reward in itself, but people need an attainable development goal. They’re less likely to engage in leadership development, for example, if managers are paid the same as their direct reports.

  • Liability for discrimination action: Pay compression isn’t illegal, but it can be a symptom of systemic pay equity problems. If you’re underpaying one group and overpaying another group, then this could possibly indicate discrimination or exclusion.

Now that pay transparency laws are becoming commonplace, it’s harder to disguise pay compression. This means that you have to try to avoid compression problems in the first place.  

6 tips for avoiding pay compression problems

Pay compression is the result of some unavoidable economic truths. Sometimes, the only way to recruit in a tight labor market is by offering a higher starting salary, but you can’t raise everyone else’s salary accordingly.

However, there are some things you can do to minimize the impact of wage compression and protect your salary structure. Here are six tips:

1. Review your compensation philosophy

Salary decisions are always easier if you have a well-defined compensation philosophy. This philosophy should clarify things like how much you reward things like performance and loyalty, and whether you look at individual success or team victories.

Your philosophy can also specify whether you generally intend to pay above the average job market rate or stick closer to the midpoint. It can also offer guidance on pay inequities. Publishing this philosophy will give managers and HR leaders a clear idea of how to handle salary decisions. It also helps create consistency between new employees and more tenured employees.

2. Benchmark against market data

Salary offers to new hires don’t have to be extravagant, but they do need to be competitive. Reliable compensation data will give you an idea of the pay scales currently on offer. If you routinely offer salaries close to top-of-market, then you’re likely to experience pay compression.

Benchmarking can also indicate if your current team is receiving below-market-average pay ranges. If so, then you’re likely to see increased staff turnover as your people search for higher-paying opportunities elsewhere.

3. Examine job titles and job descriptions

Pay compression issues sometimes happen because there’s a lack of clarity about what each role involves. For example, you might advertise for a senior software developer, which would require a very high starting salary. But the actual duties involved in the role might be better suited to a more junior person.

Similarly, you may have experienced employees who perform duties beyond what’s expected of their official role. Those employees may benefit from a revised title—which is also an opportunity to align their salary with their contribution.  

4. Use the full power of Total Rewards to incentivize employees

Salary is not the only way to reward employees. A Total Rewards strategy can help incentivize your team through other rewards, including benefits, professional development, work-life balance, and recognition.

Providing a Total Rewards statement to your employees can help them understand how much their work is valued. It also helps ensure that people are receiving rewards best suited to them. For example, junior employees benefit greatly from professional development.

5. Look at eligibility for additional payments

Some employees have the opportunity to increase their total compensation by earning additional payments. These payments can include overtime, performance bonuses, tips, and sales commissions on top of their base salary.

It’s important to consider who is eligible for such payments, especially in relation to their colleagues. For example, some companies have an issue where operations-level staff are paid an hourly rate while their managers are salaried. The hourly staff can potentially boost their earning with overtime, while the manager is exempt from overtime rules. As a result, direct reports might end up earning more than their team leader.

6. Use one-off payments to rebalance

Some employers are trying to lure new hires with signing bonuses that can reach as high as $75,000. This makes sense in terms of compensation structure, as the new hire is receiving a one-off payment rather than an ongoing salary.

Bonuses can also help fight the effect of pay compression on current salary ranges. Performance bonuses and team incentives help reward people for their ongoing contribution to the company without altering your current pay structure. If you’re worried about losing a key team member, you could offer them retention bonuses as alternatives to pay increases.

Need help with your compensation strategy?

Even the most experienced HR professionals struggle with issues like pay gaps and wage compression. That’s why it’s often helpful to call in some expert help.

If you want to talk about your salary structure with an experienced compensation consultant, book a call with Helios HR today!

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