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Salary Compression: Is it Happening in Your Organization?

Salary compression, also referred to as pay or wage compression, is occurring in almost every organization.  For nearly a decade, wages have remained constant and organizations and employees have pushed this idea aside. With the unemployment rate at the lowest that it has been in the last ten-years, the issues related to salary compression are abundant.

First of all, let’s define what salary compression means.  It is the situation that occurs when there is only a small difference between employee’s pay regardless of their skills or experience.  It is generally the result of the market-rate for a given job outpacing the increases historically given by the organization to skilled and experienced employees.

One of the most common causes of salary compression is when pay increases for current employees are low, but new employees are paid a higher wage to attract them to an organization.  This problem generally becomes more severe during an economic downturn when pay increases are limited, but may also occur in even better economic times.  Example:  Over the last ten-years, the average merit pay increase across the board for all employees has been around 3%.  However, the market has out-paced the average increase, thus employers have had to offer new hires higher wages in order to attract them, compared to the increases that they have given to current experienced employees.  Specifically, salary compression is a result of when a subordinate’s base pay is very close to or more than their supervisor’s, or when a less tenured employee is equal to or paid more than a senior employee in the same position.

When the job market is weak, meaning there are fewer qualified candidates to fill jobs, employers have had a tendency to hire candidates who have done the same job in a different organization, thus eliminating the need for training.  In this situation, employers generally start the individual out at a higher wage compared to experienced employees. Instead of hiring an individual with high potential and molding them for the long-term, employers have opted for hiring candidates who are able to “hit the ground running” regardless of their overall potential. These candidates should have been hired into the organization at a lower wage.  This scenario not only creates salary compression, but also may create significant pay inequities within an organization, which in turn could violate equal pay regulations.  In situations where new hires make more money compared to experienced employees, it could create a severe pay equity issue, if the experienced employees belong to a protected class.  History has shown that over the long-term, organizations that ignore salary compression, pay for problems related to it at some point.

So how may organizations avoid salary compression? Here are a few ideas that may help an employer to avoid this issue:

  • Communicate pay actions and be transparent with pay. Employers should communicate their organization’s compensation philosophy, strategy and practices, so that employees understand how their pay is determined.  This may help to avoid the employee’s perception that they are being paid unfairly? An employee’s ability to understand that their organization is using tools and procedures to avoid problems with salary compression reinforces an employees’ confidence that their own pay is fair. (Note: Keep in mind that an employer may not restrict employees from talking about their pay. Doing so is considered to be restricting an employee’s protected concerted activity.)  Employers should also provide in-depth training for all managers on their compensation philosophy, strategy and practices, so that they don’t quickly make hiring decisions that may result in salary compression.
  • Use a wider variation of compensation practices depending upon the situation. When making an offer to a potential candidate, or providing pay increases to current employees, instead of getting into the salary compression trap, utilize sign-on bonuses, variable pay options, and other performance-based merit awards instead of base pay.
    • Merit pay increases for existing high performing employees should be sufficiently higher compared to existing average or poor performing employees, in order to avoid salary compression. Example: High performing employees receive a 4-5% increase, average performing employees receive a 2-3% increase, and poor performing employees receive a 0-1% increase.
    • Variable pay plans, e.g. commissions, incentives, and planned or non-discretionary bonuses, provide ongoing targets to improve performance. This allows employees the opportunity to increase their earned income without adding to their base pay and may also have a direct impact on the organizations bottom line financial results.
    • Sign-on bonuses for new hires are a one-time premium payment that will not impact base pay.
    • Nonmonetary rewards are very impactful for existing employees. Things like onsite chair massages, free healthy snacks that employees have access to during their work day, the ability to complete community service-related tasks during their work day, telecommuting, games, e.g. ping-pong, air hockey, board games, jigsaw puzzles, etc. onsite that employees may utilize during break times, etc. are all ways to enhance the organizations total rewards package and the employee’s work experience without having to increase wages.
  • Keep a pulse on the market by making sure that salary structure adjustments are completed each year and market rates for individual jobs remain competitive. Competitive market data may be obtained from several salary survey data companies and utilized to ensure that base pay rates are in line with labor market trends.
  • Adjust the organizations salary administration plan, as needed. Adjust salaries for key jobs and employees, as needed, in response to the market, or if an employee’s contributions have increased significantly. An employer’s actions in these situations may be considered an equity adjustment to pay.  If an organization has pay grades and an employee is above the maximum of the pay grade, i.e. red-circled, then a lump sum payment may be warranted.  Lump sum payments allow employers to recognize the performance of an employee who may be at the top of their pay grade, but also deserving of an increase without creating a salary compression issue.

While this article is informative, it is not all-inclusive of the reasons for salary compression, or the options that may be available.  Employers who believe that they may have salary compression issues within their organization are encouraged to review their payroll records now and to make the corrections, as appropriate.  Doing so now may result in fewer pay equity issues in the future.

For additional information related to salary compression, please contact us at www.newfocushr.com.

Written by: Kristen Deutsch, M.B.A., CCP










New Focus HR is a human resources consulting and training company that services all organizations. Our expert team collaborates with businesses to attract, motivate, retrain and retain their biggest assets, employees. While engaged with an organization, our focus is to find solutions that improve the company’s internal HR-related practices while increasing results at the same time! Our focus. Your results.