Pay Compression: Why It Happens and How to Fix It

Pay compression is a problem that often sneaks up on companies. Over time, new hires come in at higher salaries, while long-term employees' pay stagnates. In a flash, there is a slight difference in pay between new and senior employees. This occurs despite the huge gap in their experience and contributions. Pay compression kills motivation and makes it hard to retain top performers, but there is no need to worry. With careful analysis and planning, companies can unwind compressed pay scales and bring pay back into alignment.

What Is Pay Compression and Why Does It Happen?

Pay compression occurs when there is a slight difference in pay between employees, regardless of their skills, experience, or performance. It often happens when companies hire new employees at salaries comparable to those of current employees.

Existing employees will feel undervalued since their pay does not reflect their greater experience. This can damage motivation and morale, and in other cases, lead to resentment between employees. To fix pay compression, companies need to evaluate their pay structure and make appropriate adjustments.

One approach is to increase pay for current employees to reflect their experience and value. While this can be expensive, it helps ensure pay is fair based on employees’ contributions. Companies can also adjust pay for certain roles or levels to establish a more gradual pay scale. For example, adjusting pay so there are 5-10% differences between each level of experience.

Another option is to limit initial pay offers for new hires. Rather than matching a candidate’s requested salary, companies can make lower offers that still meet industry standards. They can then provide opportunities for increases over time based on performance. This helps establish a pay scale that is merit-based and sustainable.

Whatever approach companies take, addressing pay compression must be a priority. Failing to fix pay compression damages work culture, reduces productivity, and increases turnover as employees seek fair pay elsewhere. Maintaining a well-designed pay scale and policy is key to employee satisfaction and retention.

The Negative Impacts of Pay Compression on Employees and Companies

Pay compression poses major challenges for both employees and companies, including:

• Decreased Employee Morale and Productivity

When employees realize their salaries do not match their experience and skills, it can damage motivation and performance. They will feel undervalued and resentful towards the company, negatively impacting work quality and output.

• Increased Turnover

Pay compression often leads to employees seeking new jobs that can pay them fairly. The costs of hiring and training a replacement employee can be substantial. According to recent estimates, replacing an employee costs around 33% of that person's annual salary. For high-level roles, the total expense is even greater.

• Damaged Company Culture

Significant pay gaps among employees doing similar work can fracture working relationships and damage company culture. Resentment can build between those earning less and their higher-paid colleagues. This tension and infighting reduces teamwork and harms business health.

To address pay compression, companies must conduct regular pay audits to determine if salaries are fair. They can then adjust to bring pay into alignment and reward key employees. Retention bonuses, raises, and promotions are other options. It will also help to implement more structured pay policies and pay bands to prevent future imbalances.

Pay compression presents a persistent challenge. However, with proper monitoring and strategic action, companies can establish fair and competitive pay, keeping employees motivated and engaged. Doing so leads to lower turnover, higher productivity, and a healthier work environment for all.

How to Identify and Fix Pay Compression Issues

If a company suspects pay compression, it needs to conduct a pay audit to confirm it. A pay audit analyzes current pay rates and structures to identify issues. Once confirmed, fixing pay compression can take time and resources. However, it is necessary to build trust and fairness.

• Review Job Descriptions and Salary Bands

Companies must ensure all roles have up-to-date job descriptions that accurately reflect responsibilities. Then, they must group similar jobs into salary bands based on the required skills and experience. This makes it easy to spot jobs in the same band with uneven pay. For example, if two accountants with the same experience and education have a 20% pay difference, that signals compression.

• Analyze Salary Surveys

The next step involves comparing current pay rates to industry surveys. This helps check if certain jobs receive lower pay relative to the broader market. Underpaid jobs in the middle or top of the hierarchy often indicate pay compression that has occurred over time. Compression reduces motivation and productivity as employees perceive their contributions as undervalued relative to others.

• Increase Pay for Underpaid Groups

Once identified, underpaid groups must receive pay increases to bring them to the appropriate level. Companies can do this gradually over time through a series of pay adjustments. When possible, the pay of overpaid groups must remain unchanged. Reducing pay can damage morale and trust in the company. The key is developing an inclusive, data-driven plan to fix pay imbalances over time in a fair manner.

• Maintain Pay Structures

To avoid future compression, companies must maintain their pay structures through regular audits and adjustments. They must stay on top of changes in job duties, requirements, and pay trends in the overall job market. Consistent monitoring and action can minimize pay compression and maximize motivation and fairness.

Conclusion

Pay compression is a real issue that can affect employee morale and retention if left unresolved. Varied causes often result from factors such as external hires at higher salaries or uneven pay raises over time. While it can require tough conversations and budget steering, taking steps to bring pay back into alignment is crucial. This maintains fairness, recognizes employees’ value, and supports a positive workplace culture. With strategic adjustments, companies can tackle pay compression and keep their top talent happily on board.