Pay Compression—Is It Losing You Talent?

In today's competitive job market, retaining and attracting top talent is crucial for any company's success. However, one of the most significant obstacles to achieving this goal is pay compression. This term refers to a group of employees making the same income regardless of tenure or skill. This practice impacts employees' morale and costs companies valuable talent. 

Read on to learn about pay compression, how it may prevent you from retaining top talent, and how you can combat it. 

Understanding Pay Compression

Pay compression occurs when employees have little or no difference in pay despite factors that should make a difference—such as seniority or level at an organization, experience, or skills. In other words, employees who should be better compensated find themselves being paid the same or less than new hires, direct reports, or entry-level workers.

This may happen due to various reasons, such as the organization's inability to keep up with market rates or a lack of differentiation between employees' skill sets. 

Pay compression often occurs when new hires are offered higher salaries than experienced employees. In this scenario, the new hires are often paid more because they have more bargaining power and demand higher salaries. As a result, long-term employees who have yet to receive significant raises are left feeling undervalued and may look for opportunities elsewhere.

LaborIQ published a study in May 2022 that surveyed 20,000 job titles. It found that new hire salaries were 7% higher on average than salaries for employees in similar positions. That difference went up to 20% for more in-demand jobs, like those in the finance and tech industries.

Sam Reeve, CEO and Founder of CompTeam, recently posted a video discussing some of the causes of pay compression. He says:

“With inflation, minimum wage increases, and pay transparency, it's more important than ever for companies to prioritize fair and competitive pay structures. Don't let wage compression negatively impact employee morale, engagement, and retention. Stay ahead of the curve and develop a pay infrastructure that attracts and retains top talent.”

Pay compression also impacts employees who have been promoted within the company. If they receive only a slight increase in pay for the new role, it is unlikely to motivate them to stay with the organization in the long term. This scenario often results in employees feeling demotivated and searching for new opportunities that offer better compensation and opportunities for advancement.

Why Does Pay Compression Matter?

Pay compression matters because it can lead to lost talent. When experienced employees feel undervalued and underpaid, they are more likely to leave the company for better-paying opportunities elsewhere. This can be costly for the organization, as replacing talented employees can take a lot of time and money. 

Furthermore, pay compression can also lead to decreased motivation and productivity among employees who feel undervalued. This can lead to a decrease in overall company performance.

A common thought is, “well, this wouldn’t be a problem if no one knew what anyone else was making. Why don’t you just ban pay discussions between employees?”

First of all, it’s illegal under the National Labor Relations Act—or NLRA:

Employees have the right to communicate with other employees at their workplace about their wages…. You may have discussions about wages when not at work, when you are on break, and even during work if employees are permitted to have other non-work conversations. You have these rights whether or not you are represented by a union.

A written company policy banning pay discussions does not provide legal cover, either. For example, when an employee at a diaper supply company in St. Louis, Missouri, was fired for violating such a policy, the National Labor Relations Board—which enforces the NLRA—investigated and found in the worker’s favor. The company had to change its policy, issue the worker full backpay for her time off, and offer her her job back. She refused to return.

So, it’s a common misconception that employers can ban employees from discussing pay. I imagine it’s so common because, in practice, employers often don’t need to forbid it outright. Most employees are too uncomfortable bringing up compensation in conversations, anyway. Unfortunately, many organizations rely on that silence for their compensation practices.

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The Cost of Losing Talent

Losing talented employees can significantly impact a company's bottom line. According to the Society for Human Resource Management (SHRM), the cost of replacing an employee can range from 50% to 200% of their annual salary. Additionally, losing key employees can result in decreased productivity, decreased employee morale, and increased stress on the remaining staff. These factors can result in a loss of revenue and an overall negative impact on the company's culture.

Furthermore, the loss of talented employees can have long-term effects on the organization's success. High-performing employees often bring unique skills and perspectives that are difficult to replace. Losing these employees can result in a loss of institutional knowledge, decreased innovation, and reduced competitiveness in the market.

Strategies to Combat Pay Compression

The answer to pay compression is actually the opposite of secrecy—it’s transparency.

The percentage of job postings that include salary information has been rising, especially in the wake of the “Great Resignation.” But it’s still only about 17 percent overall.

Why? By including salary information in job postings, many employers fear they’ll offer more than a candidate is willing to take, while others worry current employees will feel underappreciated by offering new hires more. There’s also the concern that they could be disclosing information to their competitors. It’s also likely that some hiring managers are concerned that qualified candidates might self-filter too early if they post wages up front. Even with the best of intentions, it can be a little deceptive.

Of course, compensation isn’t the only reason to accept a particular job offer, but transparency can help set expectations for both candidates and hiring managers, making for a much smoother recruiting process. 

Compensation transparency mitigates pay compression as it discourages new hires from negotiating inflated starting salaries, and it lets current employees know they’re not being left behind since they can see what the new hires will make. Some candidates may scoff at not being able to negotiate a higher starting salary, but a reputation for underpaying current employees is arguably worse for recruitment.

If the posted salary is no longer competitive and needs to be increased, then current employees should know they’re worth more, too. Employers committed to fair and transparent compensation practices may even choose to initiate those raise conversations.

A  2021 report found that 58% of employees would consider leaving their current company for better pay transparency elsewhere. Employees feel respected when they know how their salary was calculated, and they also appreciate a commitment to equality and nondiscrimination. Clearly, transparent compensation practices—and not just a particular individual’s compensation—are a matter of retention.

Pay compression is a compounding problem. Yes, addressing it could add to what is likely already your biggest expense: payroll. But not addressing it will only make compensation more complicated, deceptive, and expensive down the line.

Additional Resources

You can also stay informed, educated, and up-to-date with compensation strategies and other important topics by using BerniePortal’s comprehensive resources:

• BernieU—free online HR courses, approved for SHRM and HRCI recertification credit

• BerniePortal Blog—a one-stop-shop for HR industry news

• HR Glossary—featuring the most common HR terms, acronyms, and compliance

• HR Guides—essential pillars covering an extensive list of comprehensive HR topics

• HR Party of One—our popular YouTube series and podcast, covering emerging HR trends and enduring HR topics