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The competitive labor market has impacted compensation in a variety of ways. Minimum wage has increased, and talent wars have driven up new-hire pay rates as companies choose to extend select offers above their typical hiring pay to stand out in a limited pool of job seekers. This problem is challenging for most employers but is even more of an obstacle for organizations with a significant hourly workforce.
Pay compression is when there is a small difference in pay between employees who have different levels of experience or skills. It occurs when new employees are hired at higher salaries than existing employees who have been with the company for a longer period of time. Pay compression can happen due to various reasons, such as changes in the job market, inflation, or the need to attract and retain new talent.
When pay compression occurs, the expected pay differences based on the organization’s identified compensation drivers (which often include experience and performance) are not followed due to recruitment and retention pressures.
Several different things can result in pay compression. Recent changes to minimum wages in 20 states has certainly created instances of compression within jobs. These changes in minimum pay compress existing pay differences between employees (mostly for those lower wage roles that are affected by the increased minimum wage).
Compression within a job can happen if hiring pressures, such as a real (or perceived) limited supply of candidates, cause organizations to bring in new hires at pay rates equal to or sometimes even higher than more experienced, high-performing employees.
Compression between jobs can happen if high pay rates for certain “hot jobs” cause unintentional pay compression between managers and their direct reports, between peer jobs within an organization, and/or between job levels within a progression (e.g., Accountant I, II, III).
Finding and mitigating pay compression issues starts by ensuring the organization has a clear understanding and agreement on the compensation drivers at play and how they should be influencing pay. These compensation drivers are the factors that influence where a job is positioned in a pay structure (i.e., grade or range) or where an employee is positioned within a pay range.
Factors that influence where a job is positioned include:
On the other hand, where an employee is positioned in a pay range is typically decided by:
With pay transparency becoming more of a must than a nice to do in both the US and Canada, what happens when compression exists and pay ranges are revealed to employees?
Pay compression can create a perception of unfairness among employees. When individuals with different levels of experience or skills are compensated similarly, it can be seen as undervaluing the contributions of more experienced or skilled employees.
Whether it's an overstated understanding of performance or a genuine correlation between experience and salary range penetration, there is usually not a single answer as to why an employee is positioned where they are in a salary range. And let's be real, in many cases, especially with pay compression, they are not in the appropriate position within the pay range.
Another issue arises when employees start discussing their pay with their co-workers. This initiates internal (and sometimes external) dialogue regarding who is a better performer or more experienced. When employees perceive that their skills and experience are not being adequately recognized or rewarded, it can lead to demotivation and a decrease in productivity. This can wreak havoc on employee morale and company culture.
Pay compression can have a significant impact on pay transparency within an organization. Addressing pay compression and ensuring a fair and transparent compensation system are essential to maintain trust and transparency in pay practices.
Get ahead of it — right now. If you do not know where your pay compression problems are, make that a priority. Every company has compression problems. It’s something we’ve all put on our “To Do” lists to manage over time. But pay transparency is pushing compression to the top of the priority list.
There are many ways to approach identifying and handling pay compression, but here are some general steps to take:
The size and scope of a company-wide pay compression project, particularly with the current state of the workforce and employee/employer contract, is complex and of critical importance. It’s not necessarily something you should feel you have to manage internally. Perhaps, having a third party with vast experience in handling pay compression to partner with you would not only provide you with much-needed capacity but also lend some additional credibility and impartiality to such an important activity.
Mercer is ready to partner with you and create a custom approach that can meet the needs of your unique organization. Contact us at 855-286-5302 or email@example.com.