IN an ideal world, compensation within a company should reflect a logical structure. Employees with more experience, higher levels of skill, and greater responsibilities would naturally earn more than those newer to the organisation or in more junior positions.
However, an insidious problem called pay compression can disrupt this balance, creating a system of pay inequity with serious consequences.
A Payscale survey indicated that 82% of employees, who left their jobs cited concerns about unfair pay as a reason for their departure. Pay compression can contribute to a negative perception of fairness – Josh Bersin, a respected HR analyst, stated, "It isn't the level of pay that creates employee engagement — it's the fairness of pay.
Pay compression
Pay compression happens when the pay gap narrows between employees at different levels within an organisation. There are two common forms:
External pay compression occurs when new hires are offered salaries at or even exceeding the pay of experienced, long-tenured employees in the same or similar roles. Often, this is driven by a tight labour market where companies need to offer competitive salaries to attract talent.
Internal pay compression arises when existing employees receive small or infrequent pay increases while new hires with the same skills and job duties receive much higher starting salaries. Over time, this erodes the intended differences in compensation.
Causes of pay compression
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Several factors contribute to pay compression:
Market pressures: Companies may feel compelled to raise starting salaries to attract top candidates in a competitive job market. However, this can upset the balance with existing employees.
Limited budgets: Some companies may have small budgets for salary increases, making it difficult to reward experienced workers. This can lead to them feeling undervalued as their pay stagnates.
Rapid company growth: Fast-growing companies often hire quickly, sometimes focusing more on filling roles than maintaining pay equity across comparable positions.
Neglecting pay structures: Without regular review and adjustment of pay structures, pay compression can creep in without anyone noticing until it becomes a serious issue.
Effects of pay inequity
Pay compression isnot just a minor annoyance; it has far-reaching implications for the company and its workforce:
Demotivation and resentment: Experienced employees who see their pay stagnate while less knowledgeable newcomers earn the same (or more) will likely experience a drop in morale. They may feel undervalued and question their contributions to the company.
Increased turnover: Top performers who arenot financially rewarded for their skills and loyalty are prime targets for poaching by competitors. Losing valuable employees is costly, disrupts knowledge transfer, and erodes morale.
Recruitment challenges: A company known for pay compression will struggle to attract top talent. Candidates aware of the pay practices might decline offers or demand much higher salaries to compensate.
Best practices
Companies should be proactive in preventing and addressing pay compression, using strategies like:
Regular market analysis: Stay updated on industry benchmarks for similar roles. This ensures your pay ranges are competitive and aligned with market realities.
Transparent pay structures: Develop clear, well-defined pay grades and salary ranges based on experience, skills, and job responsibilities. Communicate these to employees for greater transparency.
Performance-based pay increases: Reward employees for their contributions through merit-based increases, bonuses, and promotions. This aligns pay growth with value addition.
Equity audits: Conduct regular reviews to identify pay compression issues, particularly across gender, race, and other factors such as experience and performance. Promptly correct any discrepancies.
Open communication: Foster a culture where employees can discuss pay concerns with HR or managers. Transparent dialogue can help identify potential problems before they become serious.
A note on fairness
Addressing pay compression isn't about slashing starting offers for new hires. It is about ensuring existing employees are valued, rewarded, and have a clear path to salary growth. It is about fostering an environment of internal equity, where the pay structure makes logical sense, and everyone feels their contributions are acknowledged fairly. When companies prioritise this, they benefit from higher employee motivation, increased retention, and a healthier workplace dynamic.
Pay Compression prevalence
Government and public sector: These sectors often have rigid salary structures based on seniority. This can limit how much new hires can be offered, regardless of the current market rates. Additionally, budget constraints might restrict the ability to give substantial salary adjustments to existing employees.
Non-profits: Organisations focused on social impact often have limited budgets. This can force them to prioritise filling immediate roles over perfectly aligning pay with experience when hiring. Also, restricted funds for raises can create internal compression over time.
Education (particularly higher education): Salary steps for faculty positions can be predefined and influenced by time in the role and degrees. This leaves less room for adjusting pay based on skillsets or market demand. Universities may sometimes need to offer a higher starting salary to attract new talent, leading to compression with existing staff roles at similar levels.
Mature or slow-growth industries: In sectors where growth is limited or technology is less disruptive, employees might stay in their roles longer. New hires can earn as much or more than experienced staff if salary adjustments fall behind the market rate.
Industries facing talent shortages: In sectors with high demand for specialised skills, companies might offer competitive salaries to attract new employees. This can outpace pay scales for existing workers, especially if the company isn't simultaneously addressing internal equity.
Conclusion
Pay compression is a persistent challenge that undermines the fundamental principle of workplace fair compensation. While market pressures and other factors contribute to its occurrence, it is crucial to recognise that it is not unavoidable. Companies that prioritise proactive strategies—like regular market analysis, transparent pay structures, performance-based rewards, and equity audits—have the power to mitigate pay compression and foster a sense of internal fairness.
Neglecting pay compression has significant consequences, including demotivated employees, higher turnover, and a less competitive edge in attracting skilled talent. By making an ongoing commitment to equitable pay practices, organisations can create an environment where employees feel valued, recognised for their contributions, and motivated to stay and progress within the company.
- Nguwi is an occupational psychologist, data scientist, speaker and managing consultant at Industrial Psychology Consultants (Pvt) Ltd, a management and HR consulting firm. https://www.linkedin.com/in/memorynguwi/ Phone +263 24 248 1 946-48/ 2290 0276, cell number +263 772 356 361 or e-mail: mnguwi@ipcconsultants.com or visit ipcconsultants.com.
