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Salary Compression: What it is and What You Can Do About it

Jen Dewar
Apr 8, 2021 11:35:53 AM

Compensation is arguably the most important way organizations reward their team members for the work they do. Sure, mission-based work and verbal appreciation are nice too—but those don’t help much in the way of paying for one’s mortgage, rent, food, or hobbies. And, while compensation isn’t often cited as a reason people stay at an organization, it’s one of the most common reasons they leave. Don’t let salary compression be to blame.

What is salary compression?

Salary compression is when there’s little difference in pay between team members, despite differences in things like skills, experience, performance, seniority, or tenure.

It’s commonly seen when new employees are offered starting salaries similar to longstanding employees, or as team members’ salaries approach those of their managers. It’s also common in certain industries, like academia, where opportunities for advancement are more rare.

In some cases, salary inversion occurs, in which less experienced team members outearn their more experienced colleagues—or even their managers. 

What causes salary compression?

There are many things that can lead to salary compression, and understanding the cause is key to understanding how to approach solutions.

  • Cost of market increases outpace raises. One of the most common causes of salary compression is that companies need to increase candidate salary offers to win talent, but fail to adjust current employee salaries at the same time. The result is that newer, and perhaps less experienced, employees earn similar compensation to a company’s tenured top-performers—or even their managers.
  • Inconsistent application of compensation strategy. Some stakeholders may be more liberal in their compensation decisions, while others are more conservative. Let’s say a company has a director in San Francisco who is more generous with raises, and a director in New York City who is more conservative with their budget. Individual contributors in San Francisco could end up with similar salaries to managers in New York City. In addition, the more generous manager may be experiencing salary compression within their own team if they’re not very discerning about candidate offers and raises.
  • Lack of compensation strategy. Companies that lack a compensation strategy altogether—or try to put one into effect too late—may also face salary compression. For example, an early, junior-level hire may be given a starting salary much higher than a well thought out compensation strategy would dictate. Once a strategy is in place, it may dictate that a more senior hire receives a salary similar to that of their less experienced colleague.
  • Few opportunities for advancement. When companies have few opportunities for advancement, employees may be given regular pay increases until they reach the top of their salary bands. At that point, they may stop receiving regular pay increases while others catch up—and eventually reach the top of their salary bands as well. This is particularly common in academia, where those in senior positions have long tenures, and there are fewer open positions than there are qualified internal candidates to fill them.
  • Mergers and acquisitions. When you combine teams from companies with different compensation strategies, salary compression may occur. For instance, junior-level employees at one company may earn the same as their more senior counterparts at the other company. Or perhaps individual contributors at one company earn similar salaries to their new managers from the other company.
  • Minimum wage increases. Mandated minimum wage increases could mean that a company’s lowest-paid team members receive a pay increase, while others remain at their current levels. Take Florida, for example. The minimum wage in 2020 was $8.56 per hour, but will be increasing to $10 in September of 2021. Companies struggling to make up that difference may not increase pay for team members already earning $10 per hour or more, leading to pay compression. 

How to identify salary compression

Keep an eye out for salary compression during your regular review cycles. You can spot it by looking for clusters in compa ratio distribution and salary distribution analyses. 

Since compa ratios show you an employee’s salary relative to the midpoint of their position’s salary range, this is a great metric to normalize your data. Review your team’s compa ratio distribution overall, by tenure, and by job function, and look for any irregularities. 

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For example, do you have little variability in compa ratios? Do compa ratios skew low, or high? Do newer team members have higher compa ratios than your more tenured team members? Do any managers have unusually low compa distribution? These could all be signs of salary compression, and worthy of further investigation and action. 

You might also review salary distribution by job level to see where salary compression may be occurring. Again, look for clusters and irregularities. Too many team members with similar salaries may require investigation and action. 

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What to do about salary compression

Salary compression can affect team morale, engagement, and retention. Your team members want to be rewarded for their contributions, and they want to know they have the opportunity for future earning potential. Otherwise, they may look for another role, or—worse—begrudgingly stay.

Salary compression can also affect pay equity, and may cause legal trouble if it negatively affects compensation for those in protected groups. 

If you see salary compression at your organization, here are some steps you may take to correct it:

  • Update your salary bands and make appropriate adjustments. Getting up-to-date, accurate market data is an important first step in correcting salary compression, because it provides boundaries for making corrections. Set appropriate salary ranges for each job level, and make a strategic plan around which team members will receive adjustments, and how much. This can be done over the course of multiple compensation cycles, if needed.
  • Build an approver chain for compensation stakeholders. An approver chain can help ensure more consistent compensation decisions across your organization. For instance, a VP-level approver can ensure that director-level compensation recommendations are consistent with your strategy, and each other.
  • Consider total compensation and benefits. Salary isn’t the only lever you can pull to reward your team members. Consider how you might use one-time bonuses or a stock option grant to add to a team member’s Total Compensation. You may also consider things like additional paid time off or additional contributions to a retirement plan, based on employee tenure. This can be particularly useful in situations where there is no immediate opportunity for promotion or a salary increase. 
  • Red-circle team members, as needed. Identify instances where you should halt or reduce pay increases for team members until their colleagues can catch up. Communicate why you’ve done this, so it’s clear.
  • Plan career ladders. Build career ladders for each team member so you can continue to offer them increased responsibility and earning potential long-term. This can show team members that they have a future at your organization, even if you can’t offer them anything right away. Provide development opportunities, and promote from within when it makes sense to do so.

Final thoughts on salary compression

Salary compression can lead to unfair compensation decisions that demotivate and disengage your team members. Keep an eye out for it, and take steps to address and prevent issues that could cost you employees. 

Your team members are your competitive advantage. Treat them as such.

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