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3 Common Types of Pay Compression

This piece was updated in November 2018. In the most basic terms, pay compression refers to a situation where pay isn’t differentiated enough (i.e. “compressed”) where it should be and for a very compelling reason. When pay compression is present, you may find that your employee morale or engagement takes a dip, leading to a dip in performance and business results. Their “sense of fairness” alarm may go off and rebuilding trust with employees at that point takes much more time and effort than getting it right the first time.

3 Common types of pay compression

Here are three common ways in which compression could happen.

  1. Am I hiring people in too close to or higher than existing employees in the same role?  Pay compression in this case refers to bringing in new talent at a rate that is near or even above (also called inversion) employees who have much more experience in the role and often much more tenure in the organization.  Sometimes you just have to have that newest brightest talent. Unfortunately, that can sometimes come at the cost of paying competitively for your existing talent.
  2. Am I paying managers less than those they manage (unless that’s right for the role)?  Wage compression in this case refers to managers being paid at a rate lower than those that they supervise.  This may make sense in some technical roles where the market values the individual technical skills higher than management skills.  In most functional areas, however, it’s challenging to motivate a manager when they are being paid less than those they supervise. As we move into an era where more millennials are entering management roles, this type of compression is especially troublesome.
  3. Am I paying multiple levels of a job essentially the same thing?  Do you have an Software Engineer 1, Software Engineer 2, and Software Engineer 3?  If so, are there clear differences between each level of the job? I’ve worked with many organizations that fail to differentiate the jobs, merely creating multiple levels so they can create a sense of mobility.  While it’s true that millennials, and in fact most other employees as well, like to be promoted, they also want to feel a substantive change to both the nature of the job and the compensation associated with it as well.

There are some things that make salary compression even more challenging. Mergers & acquisitions will often make it challenging for the new organization to level-set pay across different versions of the same job, leading to the first type of compression. Companies with highly skilled hourly jobs, that often earn high amounts of overtime, often struggle with the second type of compression.

And finally, a lot of organizational leaders still struggle with what I think of as the ostrich syndrome: if I keep my head in the sand and don’t look for potential problems, they’ll all go away.  This is absolutely not true and in fact the number one step towards both identifying and remedying compression is to ensure your company has a good market-based compensation plan and processes to evaluate the plan in place.

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So, what do you do?

Ways to Prevent Future pay Compression

1. Use market data to inform your compensation plan

A great way to avoid pay compression is to have a market-based compensation plan in place and evaluate that plan at least annually to ensure it stays current to the market. What is the location, organization type, company size, and industry that you typically compete with for talent? When you define your competitive set upfront and benchmark your jobs to other similar roles in that market, you are able to identify the “going rate” for each position you need. Those numbers should inform both the new hire pay strategy and the regular salary increase process for existing employees.

When you pay all employees in the same or similar job according to the market, you can avoid pay compression.

[Related resource: How to Perform Salary Benchmarking and Set Salary Ranges ]

2. Leave room in your salary range to reward growth and support career development 

In a tight talent market, it’s common for organizations to compete for new hires by giving them top-of-the-range starting salaries. But when this happens, it’s often done at the expense of the budget to give increases to existing hires. Part of your plan to prevent pay compression should involve establishing a range for new hires that is an abbreviated portion of the full range. Rather than starting a new employee at the top the range, make sure you make room in the range to reward employees for continued growth.

When employees know that they will be rewarded for gaining new skills and achieving proficiency, not only are you able to avoid pay compression, you’re using your comp spend to effectively motivate performance.

Also, you may need to provide market-based equity adjustments for existing employees if the market shifts significantly year over year.

3. Look at the pay differentials between jobs closely

You’ll want to make sure your plan provides fair pay for each job – including the distance between levels. The right distance is going to vary from organization to organization and depends on how wide your ranges are. If you have different levels of a job (e.g. data analyst I, data analyst II, senior data analyst), make sure you are clear on the factors that distinguish one level from the next. Additionally, if the market shift is causing the “going rate” for a position to increase, remember to shift the pay ranges for the other levels of that position as well.

As a general rule, differentiating jobs by less than 10 percent (between range midpoints) doesn’t seem to capture substantive differences between job responsibilities.

4. Compare an employee’ position within range to their performance

Once you plan is solid and in place, look job by job and job function by job function. Plot position in range versus experience (or performance or proficiency). People with more experience and greater performance should show up significantly higher in range than those with less. Remember to look both within and between jobs in a career path. Once you know what your issues are, be sure to develop a plan to bring people to the right place in range.

Okay – you’ve built the plan and evaluated how you’re doing relative to that plan.  Now that you know the types of pay compression and where your compression issues are and how you intend to resolve them, it’s time to communicate to staff.  Communicate what you’re doing right, acknowledge what you can improve, share your plan to get there, and remind people that they are your priority – without whom your organization wouldn’t find success.

How have you handled pay compression in your company? Let us know in the comments below!

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Mykkah Herner
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This is a great article! I linked to it from Twitter and I admit I did not know the definition of pay compression. That being said I have definitely been witness to the scenarios in both the private sector and in civil service – state & federal.

Thank you.

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