With inflation and increasing minimum wages boosting starting salaries across the United States, employers must remain vigilant that they don't fall into the pit of wage compression. Compression is a slow-brewing problem that can tank morale, drive away experienced employees, and damage a company's brand and reputation if allowed to grow out of control. It’s a damaging phenomenon to be sure, but what is wage compression, exactly?
Also called pay or salary compression, wage compression describes a situation where newly hired employees with less experience and fewer responsibilities earn salaries that are close to or the same as more experienced employees in similar or even higher-level roles.
Expanding wage compression's definition, if new hire pay exceeds rates for long-term employees, it becomes pay inversion. Both compression and inversion are highly damaging, lowering engagement and productivity and increasing turnover. Thankfully, wage compression is easily caught and can be fixed no matter how far along it’s progressed.
Wage Compression: Contributing Factors
Ultimately, wage compression is caused by base salaries for new hires rising while compensation for current employees stagnates. Pay compression is typically slow-moving, happening over years rather than overnight, making monitoring compensation rates crucial.
Here are some potential factors to watch for:
A tight labor market and high demand for talent will necessarily raise starting salaries for positions at companies wanting to stay competitive, and organizations may find themselves budgeting much more for a role than they had been offering just a few years or even months prior.
A specific job skill comes in demand, raising competitive starting salaries for those positions.
Minimum wage increases will give new hires a sudden pay bump that can lead to compression or even inversion, depending on the existing compensation structure.
Occasionally, mergers or restructuring can result in pay compression if compensation integration is overlooked.
Below-market average salary increases will lead to wage stagnation for veteran employees.
The lack of a standardized compensation structure can result in inconsistent compensation across roles and departments.
Failure to adhere to an established compensation structure, such as allowing candidates to negotiate for pay outside their band, can cause compression.
The Considerable Impact of Salary Compression
Salary compression can impact every part of business, from tanking morale and productivity to opening your organization up to discrimination lawsuits.
Morale, engagement, and productivity will tank if workers feel pay rates are unfair.
Turnover will jump as employees leave for opportunities offering higher base pay. High-performing talent, in particular, is more likely to leave for higher-paying opportunities when wage compression is an issue.
Increased costs of hiring new employees to replace the ones that are leaving.
Damage to the company brand or reputation can occur if pay compression grows out of hand and current and former employees relay these details to peers.
Difficulty recruiting and retaining talent, particularly if existing employee unhappiness is obvious during interviews or reflected on sites like Glassdoor.
In cases where employees who are part of a protected class are earning less due to compression, you could open your organization up to pay discrimination lawsuits.
Don’t let the heavy impact of wage compression intimidate you. If compression has set in at your organization, there are steps you can take to reverse it.
Effectively Combating Pay Compression
Beating or preventing wage compression is all about having a dynamic plan.
Ensure Current Employees Are Included in Base Pay Increases
When base pay increases, avoid pay compression entirely by ensuring that existing employees also receive that pay boost. Chipotle did this in 2021 as part of their expansion efforts, raising wages for in-store crews by $2 across the board to combat compression.
Develop a Standardized Compensation Structure
When adhered to, a compensation structure with clearly defined differentiation between roles and pay bands can prevent (or fix) wage compression. A strong compensation structure should:
Clearly define tiers within roles. For example, junior, mid-level, and senior developer, or cashier, head cashier, and senior head cashier.
Include a pay band, or range, for each tier, ensuring that new hires are less likely to be earning the same as or more than current employees who have more experience and responsibility.
Limit how high within their range new hires can be paid – this may feel like an unpopular move, but according to SHRM, many effective organizations are implementing this limit.
Possibly include non-monetary compensation options. Remember, though, that compensation is a chief concern for workers, especially as the cost of living skyrockets. Perks won’t solve pay compression, but popular benefits options like expanded PTO, greater flexibility, and remote work options may help alleviate its symptoms.
Be adhered to. New candidates should not be able to negotiate outside of their band, and existing employees should be kept up to date based on their experience and responsibilities.
Conduct Regular Pay Audits
Annual or biannual reviews of your current compensation offerings are crucial to catching or preventing pay compression. When auditing, research current market averages for salaries in your industry. You should be doing your best to match those rates (if you can). Each employee's compensation package will need to be reviewed, as well.
You may discover that pay for certain roles needs to be updated – perhaps because a given skill has come into demand – or that you need to revise your compensation structure to create more role definition to account for employees with greater experience.
Embrace Greater Pay Transparency
Being secretive about compensation changes can exacerbate existing issues brought about by wage compression. Your organization stands to benefit from remaining transparent about pay in several ways:
Clearly stated pay ranges in job descriptions eliminate the potential for candidates negotiating out of their band.
Being honest with employees promotes a culture of trust, potentially improving engagement. At the same time, an employee’s right to talk with coworkers about their salaries is protected. You cannot legally stop or punish employees for discussing what they earn.
Improved communication between departments – something as simple as a chart mapping pay rates – can synchronize compensation and ensure that future decisions remain in line with your established compensation strategy.