What is salary compression?

Salary compression can be problematic and lead to turnover if employees feel that they are being undervalued. This is more likely to happen in the scenarios listed above, such as a long-time employee discovering that a new hire is receiving the same level of compensation. This can cause employees to lose motivation or choose to leave.

Salary compression can also be troublesome when recruiting new hires. For example, if there is a significant disconnect between internal pay rates and what the market indicates is acceptable, you are likely to lose out on top talent.

There are four main causes of salary compression:

1. Minimum wage increases: when low-level employees receive a legally mandated pay increase, that action can throw off the pay scale for the entire company. Ideally, whenever minimum wage increases, all jobs within the organization should be reviewed to ensure pay levels make sense.

   Many companies, however, are not always capable of making pay increases across the board, especially for small business owners. Over time, this can cause pay levels to converge.

2. The market rate for starting salaries increases: sometimes, a new hire is brought in at a starting salary or hourly wage that is close to (or maybe even higher) what the employee's manager earns.

   This typically happens in a tight labor market where companies must offer competitive salaries to lure high-demand professionals. Salary compression results when the market rate for starting salaries increases faster than the organization can afford to give raises to existing employees.

3. Inconsistent pay practices over time: market forces may drive a company to pay a higher salary to attract new employees; however, if a company continually fails to account for how that higher salary impacts the compensation levels of other employees in comparable positions, you can create salary compression.

4. Increased employee awareness: employee awareness about the topic of salary compression and transparency regarding the salaries of comparable roles can grow the issue of low morale, decreased productivity, and talent loss. Employers cannot prohibit employees from discussing pay.

   To that end, employees will learn about pay inequalities, even if you don't openly discuss them. It may come up in the wake of a new hire or when someone does online research, but it will likely come out.

To combat salary compression, companies need to:

• Assess current pay practices

• Consider market conditions

• Encourage collaboration between HR and finance staff

• Consult legal counsel

• Communicate new policies

• Maintain best practices