Benefits and Compensation

What Is Pay Compression?

Pay compression is the situation in which an organization has negligible differences in pay between people who have differing skill sets and/or experience levels. It often happens when current employee pay raises don’t keep up with increases in the market pay rate—resulting in a situation in which new hires are hired in at levels similar to employees who have been with the organization for many years.

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Pay compression is the situation in which an organization has negligible differences in pay between people who have differing skill sets and/or experience levels. It often happens when current employee pay raises don’t keep up with increases in the market pay rate—resulting in a situation in which new hires are hired in at levels similar to employees who have been with the organization for many years.

Pay compression can also occur when there is some type of disconnect in how the pay structure is designed and how it works in reality. For example, if a sales team has a high level of pay that is at-risk and is meant to be rewarded only when specific goals are met, on paper this should result in pay variability in which those with the most expertise and skill will be paid more than those with less. But in some cases, these types of incentive pay structures don’t result in much pay variability at all, regardless of the skill level and years of experience for the individuals on the team. This can be a form of pay compression.

 

Problems with Pay Compression

Pay compression can cause problems for employers. For example, it can lead to turnover if employees feel they’re being undervalued by not getting paid much more than new hires. This is especially troublesome when it’s the best employees who decide to jump ship.

Pay compression can also cause employees to lose motivation, even if they’re not actively looking for a new job. This can translate to productivity losses in some cases.

Pay compression can also hamper recruiting efforts. This happens when there is a disconnect in the organization about what the appropriate pay rates for a given level of experience might be versus what the market is really paying. If a current employee with x years of experience has not been receiving pay raises commensurate with market rates, then the organization may try to hire a new person at that experience level at the same rate as the current employee—only to discover that a new hire may not be willing to come on board at that rate.

 

How to Address Pay Compression in Your Organization

Pay compression is a major issue, and solving it is not simple. But there are steps that employers can take to first determine what pay rates are more appropriate and then move toward better pay equity. Here are some steps to take to start the process of getting back on track:

  • Do a full assessment of the pay structure and see where there are inconsistencies. Assess areas where pay differences do not make sense within the business structure.
  • Compare pay levels with the overall business vision and goals, and see what needs to change to get pay levels back in alignment with those goals.
  • Compare in-house pay levels with market levels for the same roles, and see where there are discrepancies.
  • Reconsider how to use incentives and at-risk pay. As noted above, at-risk pay may be one culprit behind pay compression because the at-risk amount may vary significantly (giving the illusion of pay differences on paper), but the real amount paid may not vary that much from person to person. This often occurs if the at-risk pay is too easy to achieve, thus nearly everyone gets the full amount, resulting in no variability. It can also occur when the at-risk portion is too difficult to achieve, creating a situation where many employees are only paid the base rate, and the at-risk amount is serving no purpose.
  • Review changes in job descriptions over time, and assess whether or not pay changes have kept up with responsibility changes.
  • Assess whether there are discrepancies that may appear to be discriminatory that have evolved over time, such as gender-based pay differences.

After the entire pay structure has been assessed, work out a plan to bring employee pay and benefits in alignment with the market and with organizational goals. This plan may take time to implement. Once it is corrected, take steps to avoid pay compression in the future by monitoring market pay rates and keeping current employees at appropriate levels.

One more tip to remember: Be careful not to actively discourage employees from discussing pay. Doing so could actually be a violation of employee rights. Under the National Labor Relations Act, employees have the right to discuss working conditions—which includes pay rates.