Wage Compression: What it is & How to Fight it

With the rapid changes going on in market pay right now, many employers are finding themselves offer...

With the rapid changes going on in market pay right now, many employers are finding themselves offering the same or even higher pay rates to new hires than what they currently provide to their existing employees. Their reasoning is simple enough: If a higher rate of pay is what it takes to attract talent, but I can get away with keeping my current employees at the same rate, then that sounds like a good business decision. However, this is an example of wage compression, a situation in which the pay between similar employees differs minimally regardless of differences in skills, knowledge, or experience. Wage compression is not in and of itself illegal, however, it can be a slippery slope to other harmful or illegal practices.

One group in which wage compression is commonly seen in the current market is among lower-paid hourly workers. Take an example of a retail store that has bumped starting pay from $14/hour to $17/hour due to market forces. However, the existing employees who have a significant leg up in terms of organizational knowledge, customer skills, and experience, have just recently reached $16/hour through yearly performance raises. This will, of course, be frustrating for those experienced employees, and will frequently lead to an increase in turnover. This is especially concerning if the turnover tends to be from the most knowledgeable employees, also known as “Brain Drain”. Replacing these skilled workers with new hires will tend to cause productivity, efficiency, and customer success to decrease.

Beyond that, however, there is the potential that this creates a pay equity problem. If the experienced employees are mostly of a protected class, such as over 40-years old, and the newer employees are mostly under 40, then there is an age disparity in pay. Younger employees are being paid more than older employees despite the fact that the job-related factors that should matter to pay would predict the opposite. Additionally, with these factors no longer being reliable predictors of pay, building a compensation philosophy becomes more difficult. If an organization conducting a pay equity study believes that Time in Job and Overall Experience are key to predicting pay within a job, but their actual pay reflects the opposite, it will be more difficult to build the algorithms that reflect this stated philosophy.

So how can employers prevent salary compression? The first step is having a structure that dictates ranges for every job. This structure will provide guidance to managers bringing in new hires—anyone who is just above the minimum qualifications for a role should be offered pay that is near the bottom of their range. If the start of that range needs to be bumped to compete in the market, then the entire range should shift and employees in the same or similar jobs should have their pay increased as well. This is the second step—making adjustments. During this step, organizations need to ensure that any market-based adjustments are applied fairly, that any other increases are due to objective & job-related factors, and that all of these decisions are documented. The final step is monitoring: In what jobs or functions do employees appear to be receiving similar pay regardless of experience? Are there any supervisors with pay that is very similar to that of their direct reports? Any area in which the pay does not seem to reflect the stated pay philosophy of the organization is an area worth investigating. All of this work should be done in a structured manner, and tools such as Market Analysis & Pay Equity can be very useful in this regard.

The current market and inflation have led to numerous challenges for employers, and wage compression is one of the most common and most significant. It is imperative for any employer that has seen starting pay offers rise to examine their pay to determine whether compression is an issue. While compression isn’t illegal on its own, we have seen that it can result in many damaging outcomes at an organization. With regulatory agencies and employees focusing on pay more than ever, now is a great time for employers to study their practices and get pay right.

Nick Setser, HR Consultant – Compensation Services
Nick Setser, HR Consultant – Compensation Services
Nick Setser, M.A., Industrial & Organizational Psychology, is a Compensation Services Consultant at Berkshire Associates Inc. Nick regularly advises clients on compensation best practices, offering practical guidance on how to navigate OFCCP risk, market analysis, and pay equity.

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