Pay transparency has become a hot topic in the current labor market, making it imperative to quickly identify and mitigate pay compression issues.
Minimum wages have increased, overtime eligibility criteria have evolved, and the dynamics of employee and employer expectations have shifted. Pay transparency is now a genuine expectation among job seekers, especially those who are recent graduates or otherwise new to the workforce. While openness about pay can promote pay equity and foster constructive conversations around merit and performance, it may also uncover challenges within a company’s pay management structure, such as pay compression. Let’s explore what pay compression means and how employers can address it within their workforce today.
What is pay compression?
Pay compression, also known as wage compression, is when a company has little to no difference in pay between employees regardless of their experience, skills, or seniority levels. Common causes for pay compression include:
- Elevated starting salaries for new hires
- Increased market competition
- Outdated pay structures
- Inflation
- Changing market data
Understanding, identifying, and addressing pay compression to ensure a fair and transparent compensation system is essential for maintaining trust and transparency in pay practices.
How to identify pay compression
Identifying pay compression and mitigating its impact in an organization starts by ensuring that your organization’s leaders have a clear understanding of the compensation drivers. These compensation drivers are the factors that influence where a job is positioned in a pay structure (that is, grade or range) or where an employee is positioned within a pay range.
Factors that influence where a job is positioned include:
- Grade: Pay grade is typically the most important factor in driving pay, especially in companies with a well-established grade/level structure.
- Job characteristics: Some organizations prioritize pay differences between job families, as the responsibilities, skill sets, and requirements (for example, education and certifications) may vary.
- Work location: Pay differentials by geography reflect differences in external labor market conditions (for example, labor costs and cost of living).
Conversely, factors that influence where an employee is positioned in a pay range are typically decided by:
- Experience: Many organizations reward general experience, but the extent to which firm-specific experience (tenure) is rewarded varies.
- Performance: Pay-for-performance companies tend to show stronger associations between performance ratings and pay. Performance ratings, more so than base salary, may drive differentiation of pay to provide short- and long-term incentives.
Once you have a clear understanding of compensation drivers, you can effectively and efficiently conduct salary audits, analyze pay gaps, compare market benchmarks, solicit employee feedback, examine turnover and retention, and review historical salary and promotion patterns. All of these actions will help reveal pay compression issues if they exist.
How to fix pay compression issues
Get ahead of it — right now. If you do not recognize and acknowledge your pay compression problems, make that a priority. Every company has compression problems. It’s something we’ve all put on our “To Do” lists to manage over time. With pay transparency becoming a common topic of discussion, getting a handle on pay compression needs to be top of the list.
There are many different approaches to identifying and handling pay compression, but here are some general steps to take:
- Get clear on your compensation and rewards philosophy. What are you paying for and what are the drivers of pay? How are individuals rewarded and how do you establish hiring pay rates? Make sure leaders are on board and that the philosophy is embedded in your administration of pay as it stands today.
- Note instances of pay compression. Spreadsheets are your friend in this situation. Resist the urge to address one-offs because there’s usually a ripple effect. Instead, document your pay drivers and expected pay differences in a consistent manner.
- Model resolution approaches. Identify where similar actions should be taken and formulas applied, and calculate the total financial impact.
- Prepare an implementation approach that considers timing, scope of financial impact, and communications planning. Be sure to obtain approval and buy-in from leadership.
- Communicate — and then communicate again. Develop a communications strategy that engages management by educating them on the organization’s compensation drivers and gives managers the confidence to explain changes to compensation.
Engage a partner
The size and scope of a company-wide pay compression project, particularly with the current state of the workforce and employee/employer contract, is complex and of critical importance. Perhaps, engaging in a partnership with a third party who has vast experience in handling pay compression would not only provide you with much-needed capacity but also lend some additional credibility and impartiality to such an important activity. Mercer is ready to partner with you and create a custom approach that can meet the needs of your unique organization. Contact us at 855-286-5302 or surveys@mercer.com.