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Solving The Pay Compression Conundrum: How To Identify & Overcome This Trend

Companies such as Whole Foods, Salesforce, and Buffer are breaking the mold of secretive salary and bonus structures by embracing pay transparency. They offer their employees easy access to salary and bonus information, encouraging transparency in the workplace. While the idea of revealing your salary to colleagues may seem uncomfortable, especially for those not accustomed to pay transparency, it is becoming an important step towards establishing a fairer workplace, particularly for younger employees. The underlying principle behind pay transparency is that it becomes harder to unjustly compensate employees when their salaries are publicly available for scrutiny.

As pay transparency regulations broaden, and companies begin to include salary ranges in job postings, it’s becoming increasingly likely that employees will discover what their colleagues are earning. As a result, the concept of pay compression has emerged and is now a buzzword in HR circles.

Why Pay Compression is a Major Hurdle for Employee Retention and Organizational Growth

Pay compression refers to a situation where there is little to no difference in pay between employees who perform different job roles within an organization. This often results in experienced employees receiving the same compensation as new hires who may have less experience or expertise. Employees are likely aware of the discrepancies in pay, even if they are not familiar with the term “pay compression.” They may discuss these discrepancies among themselves and perceive compensation and raise policies as unfair or disorganized.

This can affect organizations, as it results in reduced employee motivation and engagement.  It can be demoralizing to learn that a new hire is earning more than you or that your subordinates are earning more than you. Risk management firm Gallagher reported that it witnessed a case where a 2,000-employee organization estimated that it would require $11 million to substantially reduce or remove pay compression over a three-year period. Unless addressed through reforms in the employee’s salary, the only way for the employee to receive a salary increase may be to leave the company. Consequently, pay compression can lead to high turnover rates and difficulties in attracting and retaining top talent.

Moreover, an employer’s power to prevent employees from discussing their salaries is weakening day by day. For example, in the USA, the National Labor Relations Act (NLRA) protects employees’ right to do so. If employees do not discuss their salaries at work, they may do so outside of work or on social media platforms. Companies can expect issues with pay equity and pay compression to be reflected on these platforms.

How to Identify Pay Compression at Your Company

To know if pay compression is beginning to impact your workforce, compare new offers to the pay of existing employees. Are new hires being offered the same or higher pay as current employees with similar titles and responsibilities?

Another way is to look at the distribution of employees within your salary ranges. If you have salary ranges where employees are clustering at the top or above the range, this might indicate that the difference between your ranges is compressing. In that case, you might need to update your salary ranges to more accurately reflect actual salaries and market conditions.

Fair Opportunities for All: How to Address Pay Compression

Communicate transparently with employees

It is crucial for companies to explain the reasoning and process behind their compensation strategy to employees. This includes addressing questions about salary increases and efforts to address pay gaps. By openly communicating with employees, trust and goodwill can be established even if their budgets do not allow for every issue to be immediately resolved.

To ensure transparency, either inform employees directly or provide training for managers to have such conversations with employees. Additionally, employers can establish clear criteria for pay raises. If a company makes a commitment to address pay compression, it is important to implement necessary changes as soon as possible. Failing to do so will only result in a loss of confidence from employees and deteriorate the company’s value to them.

Resolve pay inequities

One solution to the problem of pay compression is to ensure that employees are compensated fairly based on their skills and experience. This can be achieved by addressing pay inequities and implementing merit and market increases for critical roles. To achieve this, companies must allocate a budget for pay increases in areas where pay inequity exists. It is important to consider the long-term costs of not doing so, such as the expense of replacing underpaid employees who leave and the loss of productivity during the recruitment process. Even if a company believes it cannot afford to increase salaries, it is important to consider the potential costs of not doing so.

Make a plan

To tackle pay compression, a comprehensive approach is needed, which may involve conducting benchmarking analysis to identify pay gaps, developing a compensation philosophy, establishing clear guidelines for awarding pay raises, and training managers to communicate the company’s compensation strategy. The most effective way to avoid future pay compression is to create a consistent compensation strategy across the organization. In cases where pay compression arises due to financial constraints, companies can create a plan outlining how they will adjust compensation once financial conditions improve. Additionally, investing in improved pay communication efforts can help disseminate the company’s compensation strategy.

Consider variable or incentive pay

If you’re struggling to address pay compression due to budget constraints, consider what other incentives could boost employee morale and loyalty. Some employees may be interested in developmental opportunities, flexible work arrangements, or paid time off for volunteering. Get creative and explore different options that could be offered instead of or in addition to base pay increases.

Another option to consider is variable or incentive pay. Bonuses or other incentives tied to strong performance, especially in areas such as revenue generation or renewals, could help to increase productivity and restore employee confidence that pay compression and pay inequity issues will be addressed as soon as possible. While this doesn’t solve the underlying problem, it can help to alleviate some of the negative impacts in the meantime.

Conduct a benchmarking analysis

To stay competitive and ensure fairness in compensation, it’s important to regularly research the market rates for pay and establish salary ranges that align with your company’s compensation philosophy. This involves analyzing external market competitiveness and internal equity, and addressing any discrepancies, such as two employees in similar roles being paid differently due to arbitrary factors like job titles or education. Research what other companies are paying for similar roles in your industry and geographic area, and adjust your pay accordingly if you’re offering less than the market average.

Another important factor to consider is the potential impact of counteroffers. If your salaries are not competitive, employees may receive competing job offers and attempt to negotiate a counteroffer from you. However, offering a raise alone may not be enough to retain an employee who is already considering leaving. In fact, studies show that within six to 12 months, 80% of employees who accept a counteroffer end up leaving anyway. This is another reason why it’s important to proactively address pay discrepancies and ensure your salaries are competitive.

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