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Understanding Wage Compression & Tips to Address It

Understanding Wage Compression & Tips to Address It

Wage Compression

A major challenge for organizations of all sizes is finding a fair compensation scale to attract and retain top talent. As an HR professional, you understand wages don’t just come into play at the hiring stage. How a person is compensated through pay raises, benefits and other perks all affect an employee’s level of job satisfaction. 

However, where things become complicated is when the demands and expectations of new hires begin to slowly close the gap between your existing employees’ level of pay and that of new hires. Here we look at the idea of wage compression and what your organization can do to help fight it.


What is Wage Compression?

Pay, salary or wage compression happens when your company develops an employee compensation issue. This often happens over time, slowly seeing the compensation gap between your existing, experienced employees and your new hires tighten. Employees expect to be paid fairly based on their skills, experience, tenure, performance, and responsibility. Compression adds to fewer variants between two common compensation markers:

  1. Long-time employee’s vs new hires
  2. Managers vs their direct reports

This is a problem as your long-time employees and managers feel undervalued.

How Wage Compression Occurs

Wage compression occurs over time for three reasons:

  1. Minimum Wage Increases: This is out of your organization’s control. It can bump new hire wages upwards while those already making above minimum wage do not see increases.
  2. Tight Labor Market: When talent is harder to come by your organization might start to increase your starting wage offer. Meanwhile, those already employed either suffer from lower raises to compensate for the higher wages of new hires or end up with less of a gap between them and the new hire despite filling comparable or even identical roles.  
  3. Arbitrary Pay Increase Systems: Organizations who fail to have a fair and standardized pay structure are more likely to see wage compression occur. Whether employees are only given pay raises when they ask, you provide increases based on a percentage but don’t take into consideration adjustments to increases to hiring wages, or negotiate with some but not others, all of these policies or lack thereof lead to wage compression.

Unfortunately, as long-time employees get wind of these discrepancies, they will become unhappy in their work. This can either lead to morale and productivity issues or a major retention problem.

How to Avoid Wage Compression

Your organization can fight wage compression and help balance the scales again by adopting a better pay equity strategy:

Pay Practice Assessment

First review your current pay scale. You want to ensure the following:

  • You are closely meeting market demand as best you can
  • You are paying above minimum wage even if it is just slightly
  • You have fewer wage inconsistencies between managers and staff
  • You don’t have pay equity issues between male and female employees
  • You have a formal raise policy in place

For any areas you fall short, you can develop policies and a formal compensation practice to reduce the risk of increasing wage compression. A formalized performance review tied to your wage increase policy also helps ensure increases are given to those who deserve it.

Analyze the Labor Market

Continue to analyze the labor market each year so you can continue to meet demand and expectations. Your compensation structure has to remain fluid so you can keep up with the labor market.

Analyze Your Own Labor Force

Keep an eye on job descriptions and titles and how often you change responsibilities without adjusting compensation. These are the types of issues that contribute to wage compression as your long-time employees are not being paid fairly. An employee database is a key to tracking these changes and the status of your employee’s pay levels.

Review Incentives

At-risk pay tied to performance can lead to wage compression if it is too easy for employees to meet their goals. As well, you can look at ways to incentivize employees through non-monetized means such as flexible hours, work-from-home options, benefits, etc. that can improve morale.

Budget for Increases

Your HR and finance teams need to work together to ensure adjustments in pay are within the budget. A sound salary structure that works within the organization’s budget identifies economic restraints that can interfere with consistencies in pay structure and raises. You can collaborate to justify higher pay for those whose positions directly contribute to revenue, are required for special projects, or whose roles are crucial to the company’s success.

Organizations whose culture acknowledges a responsibility to their employees to offer fair pay create a more positive work environment. Fair pay practices also improve retention, morale, and productivity.

About the Author

Kayla is the Marketing Manager at Paypro Corporation overseeing all inbound and outbound marketing and sales efforts. She has 7+ years of experience working within the B2B and SaaS based solutions space and thrives on creating messaging and campaigns that introduce products and services to those who need them most.

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