What Is Pay Compression?

What Is Pay Compression?

Do you have a pay compression program in your company? Pay compression occurs when either of the following happens:

  • A new hire earns nearly the same amount as a more experienced employee in the same role.
  • A subordinate earns close to what their manager or supervisor makes.

Pay compression: Example No. 1

A job candidate has everything you’re looking for, including hot skills. You know they would be a wonderful asset to your team. However, they are highly sought after.

To attract this candidate, you offer them a higher starting rate, which happens to be very close to what a longer-service employee earns for a similar role. You’re more concerned with how the candidate’s strengths can boost your profit margin than how the longer-service employee will feel should they discover the pay differential.

Pay compression: Example  No. 2

Under federal law, employers must pay salaried-exempt employees no less than $35,568 per year, effective Jan. 1, 2020.

Prior to that date, a salaried-exempt administrative employee at your company earned $30,000 for the year, while their manager (who’s also salaried-exempt) earned $38,500. To comply with the federal overtime rule, you hiked the administrative employee’s salary up to $36,000. That’s only a $2,500 difference between the administrative employee and their manager — and it’s too close for comfort.

Pay compression: Example No. 3

A salaried manager is required to work 50-60 hours per week, and is exempt from overtime pay. Their salary barely exceeds what their hourly subordinates earn in regular and overtime wages.

Whether it’s intentional or not, pay compression can lead to:

  • Employees viewing the employer’s pay practices as unfair.
  • Affected employees developing hurt feelings.
  • Decreased employee morale and engagement.
  • Employees losing trust in the organization.
  • High employee turnover.
  • Employees filing lawsuits or wage-and-hour complaints, citing pay inequity.

On the bright side, pay compression is fixable.

Pay compression stems from a number of circumstances — including discrepancies in salary increases and adjustments, and outdated pay practices that do not reflect current market data. Several strategies can be employed to rectify the issue.

You can, for example, review the salary range for each employee and compare it with the market rate for the position. Make sure you pay attention to the midpoint progression.

According to Salary.com, “A consistent midpoint progression in your salary structure means there is equal and consistent pay increases between salary grades as employees move up from one range or position to the next. Consistent midpoint progression also helps when you give job promotions or salary increases to employees.”

If a longer-service employee’s salary is within the first or second quartile, and a new hire’s salary (for the same job) is within the third or fourth quartile, then pay compression is likely present.

Also, compare managers’ salaries with subordinates’ pay. If a subordinate’s pay is too close to his or her manager’s salary, then there is cause for concern.

Pay compression can be corrected in many ways, such as by modifying base salaries, making off-cycle midyear salary adjustments, providing cash bonuses or allocating more money toward merit increases.

This information is provided with the understanding that Payroll Partners is not rendering legal, human resources, or other professional advice or service. Professional advice on specific issues should be sought from a lawyer, HR consultant or other professional.