What is salary compression?

Salary compression describes the phenomenon where one or more employees receive a salary close to that of someone in a similar position but with far more experience. It’s common for new hires to be brought on board with salaries similar to those of people with more experience, despite the new hires needing extensive training to become as productive as the more experienced worker.

In some cases, the phenomenon is even more extreme, and the new hire is paid more than a person who could be considered their superior. This is known as salary inversion.

It’s natural for an employee to feel disenfranchised or even exploited if they discover they’re being paid less than someone who is less experienced. When this practice is allowed to continue unchecked, it spreads discontent, reduces worker motivation, and can lead to the loss of valuable senior employees who choose to move on to other organizations where they feel their efforts are more valued.

Why does salary compression happen?

In many cases, wage compression isn’t a deliberate decision but rather something that’s caused by a lack of proactive pay reviews for longstanding workers. Common causes of salary compression include:

• Mergers and acquisitions: When companies merge, workers at one organization may be brought in on a much higher (or lower) salary than workers in similar roles at the other company.
• Talent acquisition: When a company is hiring for a highly skilled role, it may research the salaries offered in the current job market and advertise the position with a competitive salary to fill the position quickly, without considering what existing employees are paid.
• Existing wage increases: Pay rises for existing employees may be steady and in line with inflation. This is unlikely to keep up with the increases used to attract talent in a competitive job market.
• Departmental differences: Where individual departments have their own budgets, someone working for a department with limited funds may find themselves stuck at the bottom of a pay band for a long time, while someone in a different department could earn more for similar work.

How to spot salary compression

Salary compression can easily go unnoticed, especially given the cultural taboo in many parts of the world regarding talking about compensation. If you want to identify and eradicate salary compression in your organization, you need to be proactive.

Review the salaries of employees at different pay scales charted against their time in position. In general, newer employees should be in the lower quartiles of the pay band, while those with longer tenures should be in the upper quartiles. This isn’t a hard-and-fast rule, and there are good reasons for a new hire to be paid more or a longstanding employee to be at the lower end. However, if this is happening with the majority of employees rather than one or two outliers, it’s a warning sign there could be an issue with the way compensation is being calculated for your employees.

Another area to be mindful of is the salaries of managers and team leaders versus their direct reports. If you see occasions where managers are making less than their direct reports or are on similar salaries, this is a clear sign of salary compression. It’s reasonable for a manager to expect to earn more than those reporting to them, although how much more should depend on the manager’s responsibilities and number of direct reports.

Is salary compression happening at your organization?

If your salary reviews highlight instances of potentially underpaid employees with long tenure or managers earning a similar amount to their reports, it’s worth following up and looking at the pay on a case-by-case basis. Not all pay outliers are a simple issue of poorly calculated compensation.

This is true for managerial positions too. It’s worth monitoring the relative salaries of team leaders and their reports, especially if the difference is small, to make sure the gap doesn’t shrink any further.

Should you become aware of evidence of true salary compression, it’s important to take action promptly. Do a performance review of those who are thought to be victims of salary compression and use this opportunity to alter their pay to be a true reflection of their responsibilities, seniority and performance.

How to prevent salary compression

Even with the best of intentions, salary compression can creep in when a company has several departments and lots of employees. It’s an issue that’s more likely to occur in a business with high turnover , and acquisitions, mergers or expansion can make the problem more severe. If your business is dealing with any of those issues, you need to perform regular organization-wide pay reviews to monitor for salary compression. You may also wish to consider your overall compensation strategy and how else you can reward your employees.

Managing salary compression while sticking to a budget

In an ideal world, it would be possible to simply pay your existing people more to make up for any salary compression caused by hiring experienced outsiders. This isn’t practical for most businesses, however. The simplest solution is to have a clearly defined promotion policy that encourages managers to promote someone internally rather than paying a high salary to a new hire. Bring in external talent at the lower end, where experience is less important.

When hiring externally is required, consider the following:

• Where possible, choose an external employee for whom the new position would be a promotion so they can be paid a salary that’s at the lower end of the band.
• Set company-wide limits on the salary that new hires can be paid (for example, not allowing someone to enter the company and earn more than the second quartile of a pay band).
• Give department heads clear hiring budgets, and have a policy where existing employees must have their salaries adjusted if a new hire is paid more. These limits will encourage department heads to think more carefully before pouring money into attracting talent for positions where motivation and training can do the job just as well.
• Encourage communication between department heads and implement more transparency when it comes to discussing salaries so issues are noticed and fixed more quickly.

Fair salaries improve morale

Whether wage compression happens as a result of simple oversight or deliberate cost cutting, the resulting hit to morale is not a good thing. By implementing a culture of transparency and communication and making an effort to review employee salaries regularly, you can spot issues before they cause ill feelings and help workers feel more motivated.

If your organization already has issues with salary compression, you may need to increase some people’s salaries to rectify the problem. In the long term, however, the most effective way to reduce salary compression is to manage the compensation packages of the less senior employees. Revisit your hiring and training practices and consider how you go about attracting quality talent. With the right approach, you can attract applicants who are highly motivated and willing to learn and who’ll be loyal to your company in the long term.