The ABC’s of Pay Compression

This post was co-authored by Tyler Meuwissen and Allison Julander.

Things are just peachy for Company ABC. They are operating at a consistent clip, are productive and profitable, and have no urgent need to recruit.
Suddenly, our beloved Company ABC hits a business surge! Hooray! Now they need more employees. When Company ABC peeks into the market, however, they suddenly discover that their current compensation is not at all aligned with the current market – in fact they are quite a bit behind.
As they begin to recruit the staff they need to support their growth, they must offer competitive market wages in order to attract qualified individuals for the jobs…which turn out to be higher than the wages current, seasoned employees in management roles are earning.
Yikes.
Discussing wage information is a protected concerted activity under the NLRB, so this doesn’t stay quiet. Loyal employees who have devoted years of their career to ABC Company are upset and offended. New employees are not being warmly welcomed. Morale is low as the word “unfair” is thrown about daily and company culture becomes strained.
What happened at ABC Company, what are the impacts of this problem, and how should they address and prevent it from happening again? The answers to all of these questions begin and end with two words: pay compression.

What happened?

This whole scenario is a textbook example of pay compression.
Pay compression is pay inequity that occurs regardless of skills, level, experience, or ranking. It can result when a company’s compensation structure becomes dated and unaligned with external market data and/or when supply and demand become very out of sync as the need for a skill surpasses its availability, drastically driving up the market rate for such a position.

What else could have happened?

Pay compression may also occur if an employer finds that they are paying several levels of a job the same wages or if employees in identical roles are being paid differently. It’s also possible that the HR wage policy is being disregarded, an organizational reshuffle occurred, or the company underwent a merger and/or acquisition. Any one of these reasons could create compression if the jobs aren’t integrated and reevaluated as necessary.

What’s the impact?

Pay compression can cause a huge cloud of resentment to settle over a workforce and turn employees against the employer, each other, impacting company morale and employee relations significantly.
An increase in turnover rate may also occur – seasoned employees may decide to seek better pay elsewhere and/or the new recruits have such a negative experience with their less-than-warm welcome that they soon move on as well. An increased turnover rate could make recruitment a tougher challenge and could hurt the company financially.

Tools to overcome challenges

In the aftermath, some form of better compensation must be offered to the currently underpaid employees. If raises cannot be afforded, consider creating plans for adjusting pay gradually over time and/or offering other benefits that might be valuable to an employee (such as development, flexible work schedules, PTO, etc).

Tools to prevent this

Preventing pay compression can be mitigated in a few steps, and it starts by establishing a fully developed market-based compensation plan. Here are some elements to include in such a plan:
Pay Grades – pay grades are steps within a compensation system that define the wages for each position.
What factors determine a position’s pay grade?

Job description: level of responsibilities performed, types of duties performed, authority exercised by the position
Time: how long the employee has performed this job
Performance: an employee’s performance can also impact pay grades, if desired

Pay Ranges – a determined range of pay an employee for a specific job consisting of a minimum, maximum, and mid-range opportunities for pay increases within that role.
What factors determine pay ranges?

Accurate market pay rates from studies and surveys of people doing similar work in the same region of the country

How to avoid this from ever happening?

Keep your company’s compensation structure top of mind. Maintain your compensation structure plan by doing some/all of the following:

Consistently perform a market analysis of your current wage offerings. Do this at least bi-annually, and look at each job and the functions of each job.
Ensure that hiring managers are looping in HR to consult on determining salaries and wages.
When a job opens up, look to promote from within or look for a candidate who would see the position as a promotion.