Salary Compression and Pay for Performance

One of the biggest compensation challenges during times of suppressed budgets around compensation increases (i.e. the standard 3 percent) centers around salary compression. This occurs when new employees or recently promoted workers receive a salary similar to or higher than their more experienced colleagues in the same position. With some market rates moving faster than others, this can inevitably happen if you are looking to hire an individual from the market into a role with other incumbents. Though it may be perceived as unfair, paying new employees the current market rate for their positions is key to attracting new talent, even if the salary of those already employed doesn’t increase simultaneously.

So, how can companies address this issue and maintain a fair and merit-based compensation strategy? The key is to base salary on competitive market rates and individual performance. Looking at our CompAnalyst Market Data, we find that the market rate for software engineer 4 has increased from July of 2015 to July 2016 by 4.5 percent. With a 3 percent increase allocated uniformly across an organization, you can see that longer service employees will be paid less than your new hires.

Read: Tie Comp and Performance Management to Attract and Keep Employees

If a current employee is performing at or above expectations, then their salary should increase to more than what their new colleague is making. Meanwhile, if the more experienced engineer is underperforming, then their performance may merit a 0 percent merit increase; management can work with the individual to help them increase their performance and earn a higher salary.

It’s important to note that salary compression isn’t limited to within a single department, it can be perceived across the organization if a department collectively receives a higher raise than others. As with individual performers, certain job families bring more value, or certain roles are in higher demand. This means the company will have to raise the salaries for some positions faster than others to attract and retain top talent.

Key to success is having the insight into the market and movement of the respective jobs in the organization, as well as tracking individual’s performance levels. Equipped with accurate data into positions, pay levels and an individual’s performance, the company can invest in its people wisely and have the data to back up why people may be paid differently.

— Mark A. Szypko