In today’s Reader Question I would like to thank Miatta, one of my newer subscribers, for sending me the following comment on pay compression :
“My main struggle in Comp and Ben has been why it is difficult for recruiters or managers to understand the importance of why compensation professionals insist on making salary offers within certain point (i.e. min, mid and max) in the range. Recruiters tend to focus on making a good offer and nothing beyond that i.e. compression, effective appraisal, internal equity etc.”
Pay compression : a definition
Pay compression usually happens in two situations :
- when employees in a junior grade are paid comparably or as much as employees in a more senior position. This happens most frequently between an employee and his supervisor.
- or when newly recruited employees are paid similarly to employees who have been doing the same job internally for a while. This is also known as tenure compensation.
Pay inversion is the result of extreme pay compression, where the new or junior employee is paid more than the peers or supervisors.
The factors that usually lead to pay compression
There usually 4 main types of reasons why pay compression may happen
- in technical roles where an employee is eligible to overtime and shift payment while the supervisor, who is just as skilled and usually a first-time team leader, just moved to the role and is no longer eligible to these extra payments (for example, in the Oil & Gas industry). The manager feels that the employee is paid high compared to himself.
- when market conditions mean that some skill sets are in demand in the labour market, meaning that job candidates command higher pay due to competition for their competence. In the GCC, a factor such as nationality can also have the same effect, as Nationals get higher pay (33% on average, as per Hay) than expats for the same job.
- after a merger or acquisition, when teams from the 2 companies merge and the impact of their (sometimes totally different) compensation philosophies become visible to all,
- in countries with minimum wage laws where many industries pay low-skilled or service positions (labourers, call centre operators, retail jobs, supermarket cashiers, waiters….) barely above the minimum. Any increase in the legal minimum wage results directly in pay compression, sometimes across multiple pay levels in these companies.
The negative impacts of pay compression
Pay compression is a significant internal equity issue, whether at the individual level or in a more systematic way when it touches a whole set of your employee population.
Of course, the compressed employee (the one perceiving the lack of pay differential) is going to be affected in his morale. Managers will receive feedback and may (or may not) try to fix the issue by asking for a solution to be implemented. The HR Business Partner will have to deal with employee grievances related to this topic, and when representatives of C&B attend team meetings, they may receive questions on the topic too.
People care about their pay, and will be vocal about it – after all, pay is one of the main elements that employees receive in exchange for their work. And they will be vocal about it with their peers and colleagues too, not just with their manager.
What really matters is that this kind of internal equity issue negatively impacts the employee perceptions of pay fairness within the organisation. So when an employee or group of employees is facing pay compression, their whole environment tends to be aware of the situation, and is also negatively hit by lower perceptions of pay process fairness.
This has a significant influence on employee commitment levels, which in turn drive employee discretionary effort. In fact, a study from the Corporate Leadership Council showed that for every 10% in increase in pay fairness perception, employee commitment goes up by 5%, which in turn leads to a 2% increase in discretionary effort. In reverse, a decrease in the perception of pay fairness could therefore lead to lower results from employees.
There are two other consequences if you don’t deal with pay compression issues :
- you will face growing retention issues as in-demand, skilled employees whose pay is compressed internally will start looking for jobs outside in order to benefit from the higher pay levels in the market
- you will also face more difficulties in convincing employees to move up the ladder as they do not see a positive financial impact for their increased job responsibilities.
What can you do at recruitment point to deal with pay compression ?
Miatta’s comment specifically applies to compression driven by the labour market, and what the Compensation function can do to try and reduce its impact during the recruitment process.
Recruiters are not a bunch of evil people who are here to make your life difficult. Their objective is to “close the deal” and make an offer that gets signed by a great candidate, in the minimum of time possible. They are rarely even aware of the concept of pay compression and its impact on the company. After all, they don’t have to deal with other team members’ complaints after the new hire joins, nor do they have to face the lower morale or potential resignations – and often, they are not even informed of these negative results. So your first step is education.
Hold a lunch and learn session with the recruitment team, and explain to them the ins and outs of pay compression, and the crucial role that they play in minimising it in the company – therefore helping the organisation to maintain its financial results. Give them line of sight on their impact on the bottom line of the company and this will increase their sense of responsibility.
Give them the tools to design educated pay packages. You’d be surprised how many companies, in the name of confidentiality, don’t share aggregated salary information with recruiters, yet expect them to prepare salary offers that are in line with company actual practice. If the recruiter doesn’t know how much you pay on average/min/max for a database administrator in grade G, how is he supposed to prepare a package for a new recruit for that team ?
Sharing this information and teaching recruiters how to take into account, not only the current salary of the candidate, but also internal equity considerations, will largely decrease the cases of individual pay compression that would otherwise be driven by ignorance of the company reality.
Reinforce the employee value proposition to the hiring team, and remind them to sell, not just base pay, but other elements of the overall package such as the incentives, special benefits, company reputation, interest of the position, purpose of the organisation, quality of the supervisor etc. These points are often undervalued by the resourcing team, yet employee engagement surveys regularly show that pay is only one of the many components that attract candidates to a specific organisation.
Also establish a stronger bond with the recruitment team and ask them to report to you when they start noticing market trends to pay above your current actual pay practices in the organisation as this will help you put in place measures to deal with the situation before it becomes widespread and negatively affects the company.
Finally, you also need to educate the hiring managers about the same concepts. They are not always knowledgeable about the topic, especially if they have never faced such a situation in the past. The hiring manager faces one pain at the moment, which is the lack of one person to fulfill the deliverables required from his team. So his goal tends to be very short-term : “I need to get someone on-board, the sooner the better”.
They rarely think of the longer-term consequences as they are relieved to find a good candidate to relieve the pressure on the team, and the initial instinct may be : “Let’s make this candidate an offer he can’t refuse, so he starts as soon as possible”. This in turn can lead to an inflated offer when it’s not always absolutely necessary – and the employee value proposition, along with a reasonable, not extravagant package would be enough to sel the deal.
Discuss the company pay-for-performance approach. (I assume you apply a differentiated pay-for-performance merit matrix to drive salary reviews – if you don’t, you should). Make the hiring manager understand that an employee highly paid will normally receive significantly lower salary increases in the future even in the case of high eprformance, and the situation will last for a few years or until potential promotion. Make it clear that he will have to deal with the employee expectations regarding salary evolution. And also remind him of the effect of the salary inequity on the rest of his team.
Usually this is enough to help repel cases of offering too high a salary jus for the sake of getting someone on board rapidly. It will unfortunately not prevent compression cases that happen when the market is quickly adjusting upwards for certain skill sets that are in high demand.
There are many things you can do internally to deal with pay compression, but this will be the topic for another post. In the mean time you can refer to an article I wrote on one tactic you can use when you have to temporarily pay more when candidates possess rare competencies, as well as another one for dealing with existing employees vs new hire pay situations. And please feel free to share your own approaches in the comments section !
Related posts :
- What drives employee discretionary effort ?
- GCC Nationals pay : a lesson from the Y2K bug
- New hire vs employees : 3 salary situations and how to handle them
- Which metrics indicate a decrease in employee engagement ?
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