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Pay Compression Concerns Linger Heading into 2022


Editor’s Note: As 2021 winds down, a tight labor market, inflation and various other compensation concerns are confronting organizations amid salary budget planning and financial forecasting for 2022. For these reasons, Workspan Daily’s “Compensation Crossroads” series will provide current salary data, expert insights and actionable plans to better prepare compensation professionals during this tumultuous time.

As the year winds down and organizations finalize their budgeting and forecasting for 2022, salary budgets are of utmost concern this year.

While the tight labor market proved profitable for many employees who switched jobs at fervent levels during the “Great Departure,” it’s put employers in a particular pickle for 2022 and beyond. New hires in the past year came aboard many organizations with the perks of salaries well above the usual market rate.

To wit, an analysis by the Federal Reserve Bank of Atlanta indicates that in the past 12 months wages have risen by around 8% for workers aged 16-24 and 4% for workers aged 25-54.


Though this was necessary for many employers that were desperate to fill open positions, it may have simultaneously compromised pay structures at these places.

Pay compression, a compensation term that describes when pay differentials become too small to be considered equitable, is on the minds of many compensation professionals as they consult with their chief financial officers (CFO) before the end of the year. Pay compression is one of many worrisome compensation issues currently facing organizations because existing employees in similar roles will likely need their salaries adjusted upward to account for higher salary levels outside hires were brought in at during the past year.

When coupled with concerns around inflation, which rose at its fastest pace since 1982, according to the most recent Consumer Price Index report, organizations are approaching salary budget increase projections with more uncertainty than ever.

“This year companies face dual pressures on compensation,” said Mallory Vachon, Ph.D., senior economist at ThinkWhy. “High inflation means an employee’s paycheck might not go as far as it used to, and the tight labor market means employers need to increase wages to attract talent.”

Pay compression, of course, isn’t a new concept. There are various actions organizations can take, though it’s important to view this version with the appropriate context of inflation, an ongoing tight labor market and internal pay equity.

Fixes to Consider

The best way to fix pay compression issues is to prevent it from happening in the first place. However, an unusual concoction of events may have inadvertently caused compression issues during the past year, as employers struggled to fill roles and to keep business afloat.

“It’s an employee market and in some cases [organizations] have to do whatever it takes and often that means bringing people on with very high starting salaries,” said Rebecca Toman, vice president of the survey business unit at Pearl Meyer. “This can be an OK strategy, but if you don’t take a second look at those folks who are within the organization and make adjustments to their pay it can blow up and become a problem.”

There is a thought that compression issues can be solved through standard salary increase budgets, where organizations will try to solve for pay compression issues through merit increases for tenured employees. However, current market projections indicate those budgets are falling short of anticipated market needs.

Lori Wisper, managing director, rewards at Willis Towers Watson, noted that when companies raise salaries, that isn’t typically factored into merit budgets.

“You shouldn’t use the salary budget projections data you see as the pure barometer for what’s happening in the market, because it doesn’t tell the whole story,” Wisper said. “If you really want to understand how your market has moved and how it’s impacted what you spend, you have to do your own trend analysis of looking year after year for multiple years.”

Wisper said organizations can approach this in two ways. First, do the analysis by holding the organizational population constant, which means taking turnover out of it, and seeing how salaries have gone up as a labor cost during this time. Second, do the same analysis with the turnover statistics factored, as that will most likely indicate the people who left your organization were not as expensive as the people you’ve gained.

“By doing your own trend analysis, you can compare what your actual salary costs are and how they’ve actually moved. It doesn’t say how the market is moving, but it’s showing your costs have moved and I guarantee you they are higher than 3%,” Wisper said in response to salary increase budget projections.

“The 3% represents a point in time and pay changes every day. People come and go, and they switch jobs, so it’s a little more of an accurate barometer of all of this. That’s the case even more so for the 2022 projections because there is so much going on.”

To identify where to best apply potentially necessary merit increases, Tauseef Rahman, a partner and career business leader at Mercer, added that regular pay reviews of employees performing similar roles is a “simple way to identify and make pay adjustments to existing employees relative to new hires.”

Keep Pay Equity in Mind

At the crux of pay compression is the idea of pay fairness. When you bring in new people at salaries close to or above what tenured people at your organization are making in the same job, there’s going to be a fairness issue. Given the increased transparency around compensation among employees and job review sites such as Glassdoor, existing employees are more likely than ever to become aware of pay fairness issues, which will further exacerbate turnover issues for an organization. 

“Disengagement and attrition due to perceived or real inequities can be a serious concern for organizations,” Rahman said. “It is understandable that budgets are limited, so as much as possible, it’s important to take into account a more complete picture of what it costs to bring in new hires. That is to say, there’s the increased costs associated with higher pay of new hires, but then the downstream cost of making pay adjustments for existing employees. In my experience organizations sometimes do not fully consider that latter downstream cost of pay adjustments.”

Organizations also must remain cognizant of pay equity in the compliance sense. Employees must be paid fair and equitably for substantially similar work, which means organizations will also have to be diligent in identifying potential pay inequities affecting protected classes because of significant turnover and larger-than-usual starting salary offers during 2021.

“It has the potential for compliance and fairness issues,” Wisper said. “Besides wanting to be fair about how you pay people to maximize the employee experience, you want to make sure you’re allowing hiring managers and talent acquisition to make the optimal pay decisions for you as an organization.”

Lastly, as companies head into 2022 looking to solve pay compression issues that might have come about from this year’s crazy labor market, it would behoove them to be especially mindful of retaining employees. Holding onto valuable existing employees is imperative to limit your exposure to the costs of attracting outside labor to replace them.  

“Don’t be overly focused on attraction when you could have retention issues. Don’t give up retaining employees for attracting new ones — that’s a no-win proposition,” Wisper said. “Focus first on retention, as hard as that is. If you focus on retention first, you will have fewer people leaving you. And that’s not just about pay. It’s about the overall employee experience and how you’re valuing and treating employees.”

About the Author

Brett Christie II.jpg Brett Christie is the managing editor of Workspan Daily. 

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