How to Address New Hire Pay Compression to Stay Competitive in Today's Job Market

In today's tight labor market, compensation practices are undergoing significant changes. With minimum wage increases and intense competition for talent, many companies are offering higher pay rates to attract new hires, especially in industries with a large hourly workforce. This shift poses challenges for employers, particularly those with a substantial hourly workforce, as they strive to navigate these evolving compensation trends effectively.

So how does pay compression happen, and how do we address it? This article covers everything you need to know about salary compression, from its definition to its impact on tenured employees, and how Salary.com can help address this challenge.

What is pay compression

Pay compression, also known as pay or wage compression, arises when both new employees and existing employees receive the same wage, sparking discontent and tension among the existing workforces.

This scenario typically unfolds when companies boost starting salaries to attract new talent but fail to adjust the wages of existing employees, accordingly, thus minimizing the pay gap between newcomers and veterans.

How does pay compression happen?

Pay compression occurs accidentally due to factors both inside and outside a company's control. Here's how:

• Minimum wage increases: When minimum wage goes up, it can affect employee pay, leading to overlapping salaries over time.

• Overtime changes: When the Department of Labor raises the overtime threshold, it can mean hourly workers earn as much or more than others when working overtime.

• Higher starting salaries: In a competitive job market, companies may offer higher starting salaries, leaving existing staff with similar or lower pay.

• Inconsistent pay practices: Confusing job categories and ranks can cause pay disparities. Discrimination based on gender, race, or disability can also contribute.

• Other factors: Other employees becoming more aware of fair compensation practices.

What are the causes of pay compression?

Pay compression occurs unintentionally and sometimes even for valid reasons. For instance, companies undergoing rapid growth, which is typically positive, may find themselves needing to swiftly fill numerous positions. However, in competitive labor markets, this can result in inflated starting salaries.

The causes of pay compression typically include:

• Infrequent salary adjustments: When salaries fail to keep pace with inflation, market trends, or the accumulation of experience and skills among employees.

• Elevated starting salaries: When new hires are offered salaries nearly identical to those of current employees who possess greater seniority.

• Limited salary range: Certain organizations impose pay ceilings for specific roles, leading to compression as employees at different levels approach these limits.

• Merit-based pay systems: Poorly structured merit systems can sometimes shortchange experienced employees.

• Fluctuating market conditions: Changes in labor market conditions can affect compensation in various ways; for example, if there's an oversupply of labor, businesses may feel less inclined to reward long-serving employees.

Is pay compression illegal?

While pay compression itself is not illegal, its consequences can profoundly affect employee morale and job satisfaction, leading to challenges in talent acquisition, retention, and productivity. It's important to note that although there is no specific legislation directly prohibiting pay compression, there are numerous laws addressing compensation discrimination that employers must adhere to.

Impact of pay compression on employees

Pay compression can greatly affect employees in several ways:

• Feelings of unfairness and demotivation: Employees may feel unfairly treated and lack motivation when they perceive that their pay is not commensurate with their experience or performance.

• Sense of undervaluation: When less experienced colleagues earn the same or higher salaries, employees may feel undervalued and unappreciated for their contributions.

• Decline in morale and job satisfaction: Pay compression often leads to a decline in morale and job satisfaction, as employees may feel disillusioned and unfulfilled in their roles.

• Increased turnover and legal risks: The negative effects of salary compression can result in higher turnover rates and potential legal challenges for organizations.

How to calculate salary compression

To calculate salary compression, you need to assess the salary range within a specific department or position. For example, consider a marketing department where salaries range from $35,000 to $100,000 USD.

Determining the midpoint

The first step is to find the midpoint of the salary range. This is done by adding the minimum and maximum salaries together and then dividing by two.

For instance: Midpoint = ($35,000 + $100,000) / 2 = $67,500

Calculating compression percentage

The compression percentage is determined by comparing an employee's actual salary to the midpoint of the salary range and then multiplying by 100.

Formula:

Compression Percentage=(Actual Salary/Midpoint of Salary Range)×100

For example, if an employee earns $55,000

Compression Percentage=(55,000/67,500)×100≈81%

Interpreting salary compression results

Understanding the compression percentage helps organizations make informed decisions regarding employee compensation:

• Newly hired or promoted employees: Typically fall around 80% of the midpoint.

• Long-term or exceptional employees: Often earn closer to 120% of the midpoint, reflecting their experience and contributions.

• Identifying salary discrepancies: Employees earning below their position's midpoint may be candidates for salary adjustments to ensure fair compensation and reduce dissatisfaction.

Example of a salary compression

Wage compression often becomes evident in industries or companies experiencing rapid growth or significant shifts in market conditions. Consider this scenario:

Company A hired John as a software engineer three years ago, starting him off at $80,000 annually. Over time, John gained experience and honed his skills, yet his salary saw only a modest increase, reaching $85,000 per year.

Now, facing a shortage of software engineers, Company A needs to recruit a new engineer. To attract top talent, they offer Sarah a starting salary of $90,000 per year, even though she possesses qualifications and experience similar to John when he was hired.

Consequently, despite John's tenure and proven contributions, he finds himself earning just $5,000 more than Sarah, the new hire. This scenario exemplifies wage compression within the company.

How to address new hire pay compression in your organization

Addressing wage compression is critical to prevent employee dissatisfaction, protect your company's reputation, and minimize legal risks. Fortunately, solutions like Salary.com's Compensation Software offer actionable steps to tackle this issue within your organization.

Here’s how to address pay compression issue:

1. Step 1: Evaluate current pay practices

   Conduct a thorough assessment of your current pay practices to identify areas of wage compression. Utilize Salary.com’s Compensation Software to analyze your compensation frameworks and compare them with prevailing market standards to ensure alignment. Review salaries for managers, direct reports, and new hires within the framework provided by the salary structure feature to pinpoint any disparities.

2. Step 2: Implement equity adjustments

   Take proactive steps to rectify pay differentials by implementing equity adjustments where necessary, leveraging features like Merit Modeling available in Salary.com's Compensation Software. Ensure that pay is commensurate with employees' contributions, whether in terms of skill level, experience, or performance.

3. Step 3: Introduce additional rewards

   In cases where pay increases alone may not suffice to avoid wage compression, consider introducing additional rewards such as bonuses or enhanced benefits. These incentives can help bridge the pay gap for tenured employees and demonstrate your commitment to fair compensation practices.

4. Step 4: Monitor salary ranges carefully

   Regularly monitor salary midpoints to ensure that your pay structures remain competitive and equitable. Pay particular attention to companies experiencing wage compression, as this phenomenon can lead to tenured employees falling within salary ranges intended for less experienced staff.

Take advantage of the Job Range Wizard feature to utilize benchmark internal pay ranges and compare them with current employee salaries against frequently updated market rates. This helps your pay structure uphold internal fairness and competitiveness within the broader market.

Handling pay compression involves recognizing external factors like a competitive labor market and rising starting salaries. Employers need to adjust compensation strategies to promote a positive workplace, mitigate legal risks, and ensure fair pay practices. Utilizing tools such as Salary.com’s Compensation Software helps analyze market trends and maintain fair compensation practices through proactive adaptation.