Is Your Compensation Structure a Victim of Pay Compression?

and   |   May 5, 2022

Insights from REDW’s Human Resources Consulting group for Human Resources Managers 

Compensation structures that are effective in fighting pay compression are not only externally competitive and internally equitable; they also align with organizational values and stakeholder interests, and are readily administered and maintained.

First of all, what is pay compression?

Pay compression (or salary compression) happens when:

  • There is little difference in pay between employees, regardless of differences in their knowledge, skills, experience, and/or abilities.
  • New hires join an organization at compensation levels similar to long-time employees.
  • The legally mandated minimum wage rate increases, throwing off the pay scale for the entire organization.
  • Inconsistent compensation practices build up over time.
  • The organization offers lower-than-competitive salaries to high-demand professionals.

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Yesterday’s standard compensation structure differs dramatically from what’s to come…

Old Versus New

After 20 years of conducting compensation studies across Indian Country, our experts have uncovered a pattern in human resources practices. It’s a pattern we suspect may also be found in organizations outside of Indian Country, as well as in organizations that struggle to keep pace with changing times. Our findings? No matter the geographic area or size of the tribe (or tribal enterprise), levels of compensation are generally not market-competitive or internally consistent.

We’ve helped a number of tribal human resources groups change that. Learn more»

Prior to the pandemic and our current highly competitive job market, compensation structures tended to be very narrowly defined. It was not unusual to find that every job position (or maybe even every person at an organization) had a different salary range. This situation naturally frustrates both employees and employers, as it does not support an atmosphere of transparency and makes it difficult to appropriately reward high performance. Employees need to know their potential for advancement within an organization and their range of compensation.

Today’s compensation structure relies on market-based salary ranges that are internally equitable and reflect where employers compete for talent. Also, compensation ranges for similar positions align and offer the same opportunities for advancement and additional compensation. The compensation structure of today aspires to fairness.

As employees take on more responsibility, what they do for your organization becomes more valuable.

The compensation structure of old immediately falls behind market rates when dropped into an industry-standard compensation matrix.

For example: In 2021, with some tribal employers, we discussed the need to increase their ranges for minimum wage, entry-level positions by 40%. This kind of radical change results from compensation ranges that are dramatically out-of-date.

Transitioning to a New Understanding of “Work”

“You’re lucky to have a job, and it will pay you what it will pay you.” This is an outdated and unrealistic (not to mention discouraging) perception under the old system of thought. As a result, employees trying to operate under old compensation structures often do not feel there is much upside for them in terms of their career and end up back in the job market. Top talent today is on the hunt for a job that will not only be meaningful but will help facilitate their professional and personal growth. Successful compensation structures facilitate direct links between performance and compensation, speaking specifically to the types of skills, experience, and expertise needed to advance an organization’s goals, and value individual and team contributions.

Have you read our article on The Great Resignation?»

Becoming an “Employer of Choice”

So often, under the compensation structure of decades past, business strategy was not related to the compensation paid to team members. As a result, many entities experienced extraordinarily high turnover rates, because their compensation was not aligned with the growth plans of their business. Compensation structures that make employees want to stick around support real-time rewards and career paths. And as responsibilities change and grow, respected employers consistently look for ways to sweeten the pot (if you will) and to make their compensation and reward structure meaningful to employees. The goal? Become an “employer of choice.”

Dig Deeper: Think about the effect of salary compression on one of your most loyal employees—one who has worked hard over the years, gaining responsibilities and earning compensation increases from their once entry-level position. Consider how demoralizing it would be for this valuable team member to witness a new hire (with limited experience) onboarding and receiving a wage similar to their own. It is easy to see how pay compression becomes a deflating detriment to an employee’s motivation and ability to advance.

A successful compensation structure helps an organization to attract and retain key talent by supporting employee growth. It celebrates employee advancement and tenure with the employer by helping them acquire new skills and develop leadership capabilities.

Forces That Drive Pay

When we consider the most effective compensation structures, we note that they use both external market data and internal equity factors to evaluate positions. This approach ensures that the market will drive pay and benefits, and that your organization will be able to be a competitive recruiter of top talent.

Internal Equity refers to the criteria assigned to each position, relative to its value to the organization. Establishing internal equity forms a solid basis for communicating compensation ranges for job postings, determining increases, and assessing rewards.

 

Dealing with Hard-to-Fill Roles

Many hard-to-fill roles remain in high demand because they’re difficult to recruit for. Factors that have complexified the market prices for candidates include:

  • Significantly changing roles (due in part to varied impacts of the COVID health crisis on today’s work environment)
  • Geographic location of the job (or the workplace coverage area) is not appealing
  • Lack of a competitive salary and/or benefits
  • Scarcity of qualified candidates

In some instances, qualifications for a job position may be overly specific or too broad, with job descriptions that don’t always make sense. Company culture also plays an important role in finding candidate matches, as employers of choice seek to attract employees whose experience and skillsets align to the organization’s values.

How Organizational Values Relate to Your Compensation Program

When employees understand the reason for why their job exists, they’re better able to come up with innovative ideas and solutions to improve the work they do. In an environment with transparency and a functioning infrastructure, they are given the support they need to display professionalism—being calm, strategic, and well-spoken—as well as demonstrate integrity and the ability to problem-solve.

For example: At REDW, we value teamwork because the ability to work with others and foster healthy, professional relationships helps us achieve organizational goals. We also value being open to new ideas and sharing personal insights with our colleagues.

Mentoring and the sharing of experiences and expertise are characteristics that indicate who will likely be a high performer.

A rising leader who displays hard-earned skills and honorable ethics is a tremendous asset to any organization.

Best Practices to Confront Pay Compression? Make Compensation Count!

  1. Ensure that market-based compensation creates value for your clients. This value can best be achieved with the alignment of your stakeholder interests, organizational mission (or vision), and values.
  2. Internal equity is determined by the relative worth of all jobs within your organization, including an assessment of the impact of each, and is based on the compensable factors for all measures of job-tested complexity. Compensation that is internally aligned with similar job positions supports the perception that compensation is fair and equitable.
  3. When we discuss “externally competitive,” we mean gathering data from multiple reliable sources (industry-specific compensation resources that are comparable to your organization’s revenue, size, location, and operating environment) to create salary ranges. Externally competitive salaries also facilitates high employee morale and a strong sense of fair compensation practices.
  4. Make sure your compensation structure is easy for your HR team to administer. A successful compensation system facilitates salary budgeting, structure updates, human resources cost analysis, and a recurring review of policies and practices.
  5. To ensure your compensation remains equitable, make sure your structure is easily maintained. Good follow-up supports the evaluation of new jobs and existing jobs, and adjusts methodology when market differences inevitably occur.

Call On Trusted Compensation Experts for Help with Reducing Pay Compression

We welcome your questions and recommend that you review your organization’s current compensation program to identify if pay compression is present and move forward with areas of opportunity.

Contact REDW Principal Carol Cochran or Mini Antony to discuss how you can use your compensation program to resolve pay compression issues and begin building a stronger future for your organization.