Wage Compression: The Retention Risk to Combat
Tech salaries, and salaries in general, have been rising in the last few years, especially with unemployment rates low and tech professionals in demand. In 2021, 61 percent of tech professionals received a pay raise, leading to a record high for tech compensation. Further, insights from our Tech Worker survey in partnership with Brandata show that 57 percent of workers think compensation is a top consideration when looking for a job, with nearly 80 percent of employees indicating that the main reason they would search for a new job is for more money.
Stats like these have caused many organizations to boost salaries for new employees as a way to stand out against talent competitors and hire the technical talent they need. However, this short-term fix can cause lasting problems, especially when it comes to retaining the talent you’ve fought for and who’ve given you years of work. Therefore, organizations need to be careful about just how much more money they are offering tech candidates they’re attempting to hire. Otherwise, wage compression can occur.
This article shares the ins and outs of wage compression and how it might be affecting your business. You’ll also learn how to catch it before it happens.
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What Is Wage Compression?
When employees who have been in a job for a while make close to or less than new hires in the same position, you have wage compression, also referred to as salary compression and pay compression. The wage compression definition implies there are small differences in pay between employees, specifically new hires and current employees, that ignore knowledge, skills, experiences and performance. Wage compression can occur between coworkers in similar positions and can also occur between managers and their direct reports, where a manager’s direct reports make as much as or more than the manager does.
Wage Compression Issues
- Tenured employees are paid less than newly hired employees.
- The value of one’s experience and skills is lessened.
- Pay transparency is more difficult to maintain and tough to get re-adjusted if rolling out a plan.
- Employers need to budget more money to retain more experienced employees at a higher compensation and thereby run the risk of not being able to keep up with raises, bonuses, and other forms of compensation growth.
- Financial challenges can cause a scenario where there are fewer roles you can hire for because they require more money.
How to Calculate Wage Compression
Many wage compression calculators are available online. However, all you need is a simple formula to determine if wage compression is a concern.
To calculate wage compression, you must first know the salary range you have for the position. This should be determined based on what current employees are paid in these roles and what the going market rate is for the position, as well. With these numbers in mind, you’re able to come up with a range of compensation that is fair for the role. The range from highest to lowest compensation level can be a difference of $10K, $20K, or more, depending on the role.
Once you have the salary range, you are now able to start calculating wage compression.
First, you must identify the mid-range of your salary band. This can be done by taking the highest compensation in your salary range added to the lowest compensation in the range, then dividing this number by two. Now, you have the midpoint, or median, of your salary range.
Next, you’ll need the exact salary you’re considering to evaluate for wage compression. This could be the salary you’re thinking of using for a new job or the salary of an employee who already works for you. Whatever the situation, take that salary and divide it by the middle salary you just calculated, then multiply that number by 100. This will tell you the percentage of how far off the role is from the average salary for the position.
Wage Compression Examples
1. First, determine the midpoint of your salary range. Let’s say the salary range for a Product Manager role is $100K – $140K. To determine the midpoint, you need to add 100K to 140K and divide by two. After you’ve done this, you should have your midrange, which in this case is $120K.
2. Next, take the salary of your current employee, which is $130K, and divide it by the midpoint range we just calculated, which is $120K, then multiply by 100. This gets us to 108 percent. This means your current employee is being compensated eight percent more than the midpoint salary range for the role.
3. Now, it’s time to determine where the new employee would fall on this scale if their starting salary was $115K. Using the same calculation as above, take $115K and divide it by the midpoint range of $120K, then multiply by 100. This provides a value of 96 percent. This means your new employee would be compensated four percent less than the midpoint salary range.
How to Mitigate Wage Compression Issues
Tout compensation benefits during the interview process. Discuss the other financial benefits that are a part of your total rewards compensation package, especially if the salary you’re offering is lower than other offers the candidate is considering. Compensation doesn’t just include an employee’s annual salary. There are many other benefits and factors to an employee’s overall compensation package. Make sure you are proactively communicating this to the candidate so they can accurately assess your offer against others.
Show the career growth the candidate could have with your organization. Share the compensation growth they can expect, like raises and bonuses, in addition to what your organization offers in their development as a professional. Allowing them to see how their work could impact their compensation and career path growth could help push them toward your job offer vs those of your talent competitors.
Talk about compensation at the beginning of the interview process. Include the salary in your job description and bring up compensation on your phone screen — both why the number is what it is and how your team came up with it. Having this conversation early on will help you to not waste time on a candidate who isn’t aligned with that compensation level and will also allow them to decide sooner rather than later whether it’s an opportunity they want to pursue.
Wage compression is a real issue facing many employers in today’s highly competitive job market. It’s essential to get ahead of wage compression to avoid the risk of losing current employees that are an essential part of your team.
