All employees expect fair compensation, but it’s not a guarantee at all organizations. Salary compression can cause long-term employees to earn the same or less than new employees filling the same position, and it happens more often than you might think. Compensation planning, incentives, and frequent salary reviews can help prevent salary compression.
What is Salary Compression?
Salary compression is the inequity that arises when an employee who’s worked with a company for years earns the same or less than an employee who begins working with the company.
To illustrate, say Sarah works for XYZ, Inc., for 15 years, with the last five years spent as a financial manager. She earns $85,000 annually. Nina joins the company as an additional financial manager this year, with an initial salary of $85,000.
Considering Nina’s and Sarah’s salary are equal, Sarah’s experiencing salary compression. Her tenure and experience with the company are not being rewarded above Nina.
Inflation plays a significant role in salary compression, but other factors include increases in the minimum wage, failure to maintain a compensation plan, and supply and demand disparities.
Salary compensation can obviously lead to employee dissatisfaction. This silent tax works similarly to inflation, requiring the same amount of work with no increase in pay. However, it also plays a more subtle role in organizations, increasing turnover rates and, therefore, decreasing revenue.
Why Does Salary Compression Happen?
Salary compression doesn’t happen overnight. Instead, it usually occurs when one problem continues to worsen or not get corrected or when multiple problems sneak up on a company. The most common factors leading to salary compression include:
- Inflation: The economy can directly affect salary compression, especially when companies don’t keep it on their radar. As costs rise, current employee salaries may need to be adjusted. When that doesn’t happen, new employees might start earning the market rate while long-term employees get overlooked.
- Minimum wage increases: When the minimum wage increases, those increases are taken into consideration for new employees. Meanwhile, current employees may not see any increase in their salaries as a result of a rise in the minimum wage.
- Outdated market data: Companies with salary compression issues might be using outdated market data to inform their current employee salaries. Although these companies may mean well, this practice could quickly lead to pay inequities that don’t fairly represent a position’s responsibilities and required credentials and experience.
- Company mergers: When two companies merge, salaries should be reviewed as soon as possible to ensure that employees in similar positions from both sides of the company are paid fairly.
- Broad salary bands: Salary bands are guidelines for each role’s salary, usually based on a level system. When salary bands don’t have clear, narrow definitions, it could result in uneven grading and pay for employees.
Inconsistent compensation practices, like not reviewing compensation annually or not having one dedicated person or team managing payroll, can worsen the natural phenomenon of salary compression.
How to Detect Salary Compression
It isn’t always obvious that salary compression exists. However, it’s probably more common than most companies realize. In fact, Robert Half found that 56% of companies experienced salary compression in the previous 12 months.
Although it’s best to avoid salary compression altogether, that’s not always practical in the modern business world. The following methods are helpful in detecting salary compression so that you can get to work on fixing it.
Your Data Isn’t Tracking
Salary data is one of your most important resources when it comes to detecting salary compression. Analyzing salary data frequently can identify salary disparities.
For instance, compa-ratios can show how close an employee’s salary is to a median range, whether the median number is nationwide or within your company. Low-salary outliers signify that pay compression may be happening in some roles. Similarly, having several employees in a similar salary range might tell you that a review and adjustments might be necessary.
You Experience Unexplained Employee Loss
If you notice an increase in turnover rates, especially when long-term or highly qualified employees resign from their positions, you could have a salary compression problem on your hands. Not all employees give a reason for leaving the company, but some might if you genuinely express concern and a desire to fix the problem.
Reach Out to Employees
Asking employees how they feel about their salary can feel intimidating—and possibly a little scary—but it’s necessary to gauge whether you might have a problem on your hands. Additionally, by keeping direct lines of communication open with your employees, you might avoid salary-related chatter between workers that could lead to resentment and bigger problems.
Send occasional surveys out to employees via email to get their feedback. You might choose to keep them anonymous to allow everyone to be transparent. Be sure to ask whether they feel pay compression is a problem at your company and whether they believe their pay is fair.
This practice could even lead to a more positive sentiment toward your company, as 58% of employees prefer their employers to request more frequent feedback.
How to Fix Salary Compression
You’ve identified that salary compression is a problem at your company, but how can you fix it? Here are a few strategies.
Compensation Planning
Compensation planning is an organized process of analyzing salary market data and using that data to create payroll budgets, salary bands, salary ranges, and other guides to follow when determining how much to pay an employee. Ideally, companies should review compensation plans each year to ensure that they’re up to date.
A compensation plan should include the guidelines you follow for applying salaries to positions, how bonuses and other additional forms of compensation at your company work, and other benefits workers receive. These benefits might include unlimited paid time off, remote work, retirement plans, or severance pay.
By detailing everything people vested in your company need to know about salary in your compensation plan, you’ll have clear rules to follow to help avoid salary compression.
Salary Reviews
At least once a year, conduct salary reviews, also known as salary competitive analysis, on every employee. Your review should compare a worker’s salary with market data for the same or a similar role to determine whether there are gaps between the fair market rate and what your employees earn.
Use the data from your reviews to create salary ranges or bands for each position, giving you firmer guidelines for new hire salaries and current employee raises.
Offer Incentives
If major disparities exist between your workers’ salaries and market rates, it might take time to move salaries up to where they need to be, depending on your company’s payroll budget. During the process, consider adding incentives to your compensation plans to bridge some of the gap.
The following are examples of benefits that can offset some your workers’ salary loss while your company plays catch-up:
- Adding better health insurance coverage or lowering your workers’ share of their premium costs
- Gifting larger or more frequent bonuses during the catch-up period
- Adding a more flexible time off policy
- Increasing the rate at which employees earn paid time off
- Allowing more remote days
- Adding dental and vision insurance policies
Benefits of Fixing the Silent Tax of Salary Compression
Addressing salary compression quickly can prevent some problems before they happen. Even if pay compression does begin to cause noticeable issues in your company, you’ll likely start to see improvements in the following areas once you correct it:
- Improved employee satisfaction: The Conference Board’s Job Satisfaction 2023 report found that competitive pay is among the leading factors affecting job satisfaction. Uneven pay among employees in similar positions can quickly reduce satisfaction, while remedying salary compression can yield positive results.
- Better employee retention: Resume Builder found that 1 in 20 workers would quit their jobs if they found out that their salary is lower than their coworkers’ salaries. A primary factor in employee loyalty is getting paid fairly, which can happen when salary compression is addressed and prevented.
- Reduced business costs: When unfair pay causes employees to leave their jobs, turnover rises, resulting in increased cost and time investments for a business’s recruitment efforts. Preventing salary compression can help companies avoid these unnecessary costs by retaining long-term employees.
- Improved company reputation: Employees with high job satisfaction who feel respected and well paid are likelier than unhappy workers to praise their companies. Offering attractive and fair salaries is a simple way to boost an organization’s reputation for caring for its workers.
Salary Compression is a Silent Tax if Untreated
If you detect salary compression at your organization, it’s crucial to control it as quickly as possible. Salary compression places a silent tax on the employees experiencing it. Their salary and responsibilities don’t change, but they also don’t reap the benefits of being loyal employees.
Leaving this silent tax untreated can lead to employee dissatisfaction, high turnover rates, a negative company reputation, and lost revenue for your business. Recruiting can also become more challenging if you don’t enact benefits and incentives for potential employees to see themselves as long-term workers for your company.
Even if your employees don’t currently experience salary compression, it’s still wise to enact a detailed compensation plan now to prevent it from happening in the future.
