5 Ways to Eliminate Salary Compression

by Stephan Duncan - May 23, 2019
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Salary compression (also known as “wage compression” or “pay compression”) occurs when employees with different skills and experience are paid similarly. When salary compression occurs, new hires or existing employees with less experience can be paid more than tenured employees with more experience.

Pay compression typically occurs when the market-rate for a job outpaces the increases historically given by the organization to longer-tenured employees. Pay compression may also occur when an employee rapidly moves up the corporate ladder but their salary does not keep pace.

Salary Inversion

Salary inversion is a type of salary compression where the starting salaries of new employees rise higher and faster than for longer-tenured coworkers. This typically happens when demand for employees in a hot job exceed the supply of professionals in the market. For instance, many roles in IT have experienced increased demand over the last decade, allowing IT employees to earn more, faster, than their co-workers.

Companies can find themselves in a tight spot when balancing internal pay equity and competitive offers for new talent. By promoting employee engagement and internal equity, your organization can avoid the morale and flight risk issues stemming from salary compression.

Here’s five ways you can stop salary compression from ruining your internal pay practices.

1. Identify Salary Range Outliers Using Compa Ratios

Compa ratios assure that employees are paid fairly compared to the market rate. By analyzing the comp ratios within your salary bands, you can see if salary compression or salary inversion is occurring.

To calculate the compa-ratio, take the employee’s current salary and divide it by a job’s salary range midpoint. For example:

If an employee’s compa-ratio is greater than 1, they are being paid more than market rate, and there may be an instance of salary compression to address. But not all instances of salaries above market value are causes for concern. For reasons such as performance, tenure, and responsibility growth that determine employee pay increases, certain employees may deserve to earn more than the market rate.

2. Address Compensation with Transparency

Salary compression can be exacerbated by a lack of communication around company pay practices. Don’t hide your compensation structure from your organization, nor share it with only one department while leaving everyone else in the dark. Sharing your pay structure or explaining the rationale for certain compensation decisions will help ensure your compensation system is understood consistency across the organization.

If certain employees or departments within feel siloed from the rest of your organization regarding pay structures or bonuses, it could cause decreased employee engagement – a common side-effect of salary compression. When employees are confident you are promoting pay equity, they are more confident their pay is fair.

3. Seek New Hires Looking to Advance

When hiring externally, it’s worth making enticing offers to attract new talent while not overpaying for any candidates. One trick is to seek external candidates who are ready to move up quickly into higher positions. This will enable you to avoid paying a premium that could cause internal salary inversion, especially since those new employees would come in near the bottom of their job’s salary range.

To avoid salary compression between newer and experienced employees, you can take it a step further and limit how much new hires can be paid. Controlling pay from a budgetary standpoint may seem like a turnoff when seeking top talent, but it can limit liberal usage of salary increases and high-end offers for newer employees.

4. Build Incentives into Total Compensation

Stopping salary compression quickly by increasing base pay for under-compensated employees can be hard. However, one-time monetary-value rewards can be quick, though temporary, solutions. Consider:

  • Bonuses
  • Stock options
  • Additional paid time off
  • Greater contribution to benefits, such as health insurance or 401k

5. Recognize Promotions Do Not Necessarily Equate to Salary Increases

Promotions and/or title changes can increase employee engagement and improve morale. However, not all promotions justify a pay raise. For instance, a promotion may place an employee into a higher pay band where they do not receive a pay raise, but their salary potential increases.

If one department more frequently gives out pay raises and promotions than other departments, then can create salary compression over time because of unbalanced growth. Establishing and communicating a consistent recognition program will decrease the chances of salary compression and mitigate negative perceptions of pay in your organization.

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