In most cases, a shrinking pay gap is a cause for celebration, except in the context of wage compression. Much like a magician’s subtle sleight of hand, wage compression baffles the audience with a mysteriously vanishing pay gap between new hires and seasoned staff, leaving businesses and HR professionals grappling with the trick of restoring the balance.
Wage compression occurs when there is only a slight difference in pay between employees regardless of their skills, experience or seniority. This phenomenon is becoming increasingly common and can lead to diminished employee morale and motivation.
If you are currently trying to decipher the mystery of wage compression, you are likely asking yourself how you arrived at this point. Below we outline a few compounding variables that factor in compression causes.
Unraveling the Causes of Wage Compression
Many employers have not yet worked through the residual impact of the turbulent economic conditions experienced during the COVID-19 pandemic. In 2022, the U.S. experienced record inflation, with the consumer price index peaking at 9.1%, and continued to place upward pressure on wages and salaries through 2023. At the same time, the labor market sharply tightened as job openings continued to rise. Employers faced hard decisions to increase their starting rates for new hires without equally increasing the rates of current employees.
Several states are also increasing their minimum wage, and the Department of Labor recently released the latest final overtime rule, raising the minimum salary threshold to $43,888 on July 1, 2024, and $58,656 on January 1, 2025. The direct impact of these changes is felt immediately at the lower-level and entry-level positions; however, adjustments made only at the bottom will only exacerbate already existing wage compression issues.
A few pay practices may also contribute to worsening compression issues, including:
- Standardized increases: Applying a flat rate or percentage increase across the board for all employees could result in higher earners receiving a smaller proportional increase than lower earners. Over time, this can narrow the pay gap between different levels of employees, leading to compression.
- Promotion without proportional pay increase: When employees are promoted, their pay increases may not always reflect the new level of responsibility, especially if the organization has tight budget constraints. This could mean that a newly promoted employee’s salary is too close to those of their subordinates or peers who have not been promoted.
- Lack of differentiation for tenure or experience: Internal equity adjustments that do not adequately differentiate pay based on tenure, experience or performance can result in employees with vastly different contribution levels earning similar salaries.
Strategies to Mitigate Wage Compression
Wage compression can decrease employee satisfaction and loyalty, as longer-tenured or more skilled employees may feel undervalued when new hires earn similar wages. This can result in higher turnover rates and challenges in attracting experienced professionals.
The cultural and legislative push for more pay transparency pressures employers to address compensation issues. If your business is experiencing wage compression, consider the following strategies to battle wage compression:
- Conduct regular compensation audits and annual salary structure reviews to identify current and potential compression issues. Based on the findings of these audits, adjust pay scales to reflect industry standards and inflation.
- Consider implementing a performance-based pay system. True to their name, performance-based systems reward employees based on their contributions to the team and the company.
- Provide more transparent communication around compensation and develop a strategy to convey your business’s compensation practices, policies and factors contributing to pay decisions. Encourage employees to raise questions or concerns to help you flag and address potential issues.
- Focus on career development programs and offer training and development opportunities to help employees advance and earn higher pay. Promote from within to recognize and reward experience and loyalty.
- Leverage a total rewards strategy by offering a range of benefits and perks to complement base pay. Tailor compensation packages to meet individual employee needs and preferences.
While compensation compression is a complex challenge, businesses cannot afford to ignore it. Organizations can ensure fair pay practices that support employee engagement and drive business success by adopting a strategic approach to compensation management.
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