Wage Compression: What Is It, How Is It Caused, and How Can It Be Addressed?

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By Damian Scandiffio

Regional Director of Business Development

Addressing wage compression has proven to be one of the most pressing difficulties facing businesses in today’s volatile labor market. Otherwise known as pay compression, this term has presented challenges to companies of all shapes, sizes, and industries. So what are the underlying causes of wage compression, how can it be rectified, and what can be done to formulate a fair compensation strategy for all employees?

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What is wage compression?

Wage compression occurs when companies hire new employees and offer them an annual salary or hourly wage that meets—or even exceeds—that of longtime staffers of the same position. Despite these tenured employees possessing more experience, know-how, and expertise, new candidates can begin their careers on a similar pay scale. In some instances, pay compression can occur when direct reports earn salaries that are equal to their manager!

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What causes wage compression?

Wage compression commonly occurs when starting salaries or hourly wages are set too close to the compensation of existing workers. In today’s labor market, companies are fighting hard to secure top talent—especially as demand is exceeding supply. Businesses are learning that increasing pay rates is an effective way to attract candidates looking for new work. But in doing so, organizations often disrupt their compensation structure, which can cause pay compression.

What are the drawbacks of wage compression?

Some of the most common drawbacks to wage compression include reduced employee morale, increased turnover, and greater difficulties in retaining talent. If your longtime workers notice that new hires in similar roles are being compensated with higher wages, they might be compelled to explore outside opportunities to boost their own pay. Make sure your organization’s compensation data is aligned with going market rates.

How have companies addressed wage compression?

This recent article from The Wall Street Journal highlighted the efforts of Chipotle Mexican Grill to overcome wage compression within its organization. After conducting a thorough wage analysis, the company said in May that it would raise hourly wages for front-line workers to $15 per hour while concurrently increasing wages for salaried managers and other tenured staff members. To atone for these rising labor costs, Chipotle boosted all menu prices by approximately four percent. This well-thought-out strategy effectively mitigated any potential negative impacts of wage compression.

How can my company perform accurate wage benchmarking?

Conducting a comprehensive wage analysis is imperative when recruiting new employees and retaining current ones. Relying on data from the U.S. Bureau of Labor Statistics could be a good place for your organization to start. If you’re seeking more in-depth compensation reporting, our Acara team can help. Contact us today to learn more about how we can help optimize your wage and compensation approach.

Summary

The success of your talent acquisition and retention efforts is largely dependent on a sound compensation strategy. Are your annual salaries or hourly wages aligned with what’s out there on the open market? Devoting ample time to refining your compensation structure can help mitigate the detrimental impacts of pay compression. Ultimately, this can help your business better emphasize its differentiators to potential candidates without worrying about the risk of employee turnover.

Looking to enhance the effectiveness of your recruiting efforts? Check out these 7 ways to attract talent despite the current labor shortage.

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