What is a geographic pay differential?

by | Published on Jun 23, 2022 | Last Updated on Oct 29, 2023 | Compensation

Top Compensation Providers

The freshest salary benchmarking data by industry, location, and revenue size.

Geographic Pay Differential
Geographic Pay Differential

Geographic differential pay introduction

Geographic pay differentials are important for companies to consider when determining how they want their remote work, hybrid, or in-office workforce working conditions to operate. By definition, a geographic pay differential is “a difference in the amount of money paid to employees who work in different locations

To create an effective and efficient workplace, both in the office and remote, companies must find a way to manage these differences to ensure equity among employees.

What are the factors with geographic pay differentials?

There are a variety of factors that can contribute to geographic pay differentials, such as the cost of living in different areas, local market conditions, and employee skillsets. For example, the cost of living is typically higher in urban areas than in rural areas, so companies may need to pay employees in urban areas more money to attract and retain talent.

Salary Benchmarking Tutorial
Salary Benchmarking Guide

How do local market factors affect pay?

Additionally, local market conditions can also dictate how much companies need to pay employees to be competitive. For instance, if the job market is tight in a certain area, companies may have to offer higher salaries to attract top talent.

Employee skill set factors matter

Employee skill sets can also play a role in geographic pay differentials. For example, employees who have specialized skillsets or are in high demand may command higher salaries than employees with more general skillsets.

Additionally, employees who are working remotely in areas where there is a higher demand for their skillset may also be paid more than employees in other locations.

Methods used to determine geographic pay differentials

There are a variety of methods and factors companies can use to determine geographic pay differentials for in-office and remote work. Some common methods are listed below.

Compensation survey data

Companies can use compensation survey data to compare the cost of labor and obtain market rates for employees in various locations. This is extremely beneficial when setting remote work policies. These market rates can be used to benchmark the salaries and additional compensation in various locations and ensure pay equality. Compensation surveys will provide data for each jobs annual base salary, current and target bonus percent, additional compensation, and insights into company benefits and company pay practices.

The Top Compensation Survey Providers
The Top Compensation Survey Providers

Cost of living indexes

There are several cost of living indexes that organizations can use to compare the cost of living in various locations. The most commonly used index is the Consumer Price Index (CPI), which is published by the United States Bureau of Labor Statistics.

Local market conditions

Companies can also use local market conditions to help determine the cost of labor and establish geographic pay differentials for your jobs. For instance, they can look at factors such as the unemployment rate, the availability of skilled workers, and the salaries of similar jobs in the area.

Employee skillsets

As mentioned earlier, employee skillsets can also play a role in geographic pay differentials. Companies can use a variety of methods to assess employee skillsets, such as job descriptions, performance reviews, and tests.

Geographical location

The location of the company can also be a factor in determining geographic pay differentials. For instance, companies in urban areas may need to pay more than companies in rural areas due to the higher living costs in cities.

Geographic pay policies are receiving more attention as interest in remote work grows

The COVID-19 pandemic has led to a surge in interest in remote work, and as a result, geographic pay policies are receiving more attention from companies.5 A recent survey of human resource professionals found that nearly 60 percent of respondents said their company is either “somewhat” or “very likely” to implement a geographic pay policy in the next 12 months.

Geographic pay policies can take a variety of forms, but they all aim to create equity among employees who work for a company in different locations. For instance, some companies may choose to equalize pay across all locations, while others may weight pay based on the cost of living in different areas.

The challenge

In some circumstances, employers must ensure that internal pay equity can be preserved and the organization is working on achieving the optimal pay structure, salary bands, and pay grades for the location. However, employees may not be aware of any longer-term consequences of this decision because they desire flexible remote working.

How does remote work affect location-based pay?

The way we work is changing. With more and more companies offering remote work options, employees are no longer tied to one location. This has major implications for the way businesses think about compensation, specifically location-based pay.

Methods to consider when executing localized payments

There are a few different ways that companies use methods to approach this issue. They can either maintain geographic pay differences, adjust pay based on the cost of living, or create a global pay scale. Each option has its pros and cons, and there is no one-size-fits-all solution.

Maintaining geographic pay differences

The most obvious way to deal with location-based pay is to simply maintain the same pay differences that exist between offices. So, if someone in the San Francisco office is making $100,000 per year, someone in the London office would make £75,000 per year.

This approach has the advantage of simplicity. It is easy to understand and administer, and it doesn’t require any major changes to existing compensation structures.

Downsides

However, there are some downsides to this approach. First, it can create feelings of inequality among employees. Those who are based in lower-cost areas may feel like they are being paid less than their counterparts in more expensive cities, even if their cost of living is similar.

Second, it can make it difficult to attract and retain top talent in high-cost areas. Employees may be reluctant to relocate to a more expensive city if they know they will be paid less than those who are already there.

Adjusting Pay Based on Cost of Living Percent

This approach has the advantage of being more equitable. Those in higher-cost areas will no longer feel like they are being paid less than their counterparts in less expensive cities. And, it can make it easier to attract and retain top talent in high-cost areas.

However, there are some downsides to this geographic differential approach as well. First, it can be difficult to accurately measure the cost of living in various locations. Second, it can create feelings of inequality among employees in different parts of the world.

Creating a Global Pay Scale

Another option is to create a global pay scale. This means that everyone in the job would be paid the same compensation, regardless of their location. So, someone in the New York office would make the same compensation as someone in the London office.

This approach has the advantage of being the most equitable. It ensures that everyone in the company’s job is paid the same, regardless of their location. And, it eliminates the need to constantly adjust salaries based on changes in the living costs.

However, there are some downsides to this approach as well. First, it can make it difficult to attract and retain top talent in high-cost areas. Second, it can create feelings of inequality among employees in different parts of the world. Those who are based in high-cost areas may feel like they are being penalized for living in a more expensive city.

The Bottom Line

There is no one-size-fits-all solution to the issue of location-based pay. Each company will need to decide what approach makes the most sense for them, based on their unique circumstances and remote work policies. Whichever approach they choose, it is important to communicate with employees and make sure everyone understands the rationale behind the decision.

IT Salary Survey
Participate Today in the IT Salary Survey

Geographic pay differential approaches

Once companies determine the ability to respond to the geographic pay philosophy considerations described above, they are ready to examine the cost of labor options for applying geographic pay differentials. An employer can choose from five different methods in selecting the most appropriate methodology for the employee demographic and whether or not the employee works in the office or remote.

National

The first approach is to use the national average differential. With this approach, an employer would compare the salaries of employees in different geographic locations to the national salary average for that position. The difference between the data would be used to adjust the employee’s pay up or down by a certain percent.

For example, let’s say the national average for a marketing manager is $50,000. A company in New York City would compare the salaries of their remote marketing managers to the national salary average. If their marketing managers make $60,000 on average, then they would pay them 10% less than the national salary average.

However, if their marketing managers make $40,000 on average, then they would pay them 20% more than the national average.

This approach has the advantage of being relatively simple to calculate and administer. It also has the advantage of being transparent, since employees can easily find out what the national median salary is for their position.

However, there are some downsides to this approach as well. First, it doesn’t take into account the living costs in different geographic areas. Second, it can create feelings of inequality among employees in different parts of the world. Those who are based in high-cost areas may feel like they are being penalized for living in a more expensive city compared to remote workers.

Regional

The second approach is to use the regional average salary differential. With this approach, an employer would compare the salaries of employees in different geographic locations to the data for the regional average salary for that position.

State

The third approach is companies use the state average salary differential. With this approach, an employer would compare the salaries of employees in different geographic locations to the state average salary for that position.

City/Metro/MSA geographic location

The fourth approach companies use is the city/metro/MSA average salary differential. With this approach, an employer would compare the salaries of employees in different geographic locations to the city/metro/MSA average salary for that position.

Zip Code Work Reporting Location

The fifth and final approach is to use the work reporting location average salary differential. With this approach, an employer would compare the salaries of employees in different geographic locations to the work reporting location average compensation for that position. The difference between the two would be used to adjust the employee’s pay up or down by.

As remote work increases, questions are being raised about geographic pay policies and what counts as fair compensation.

Some companies choose to ignore geographic compensation differentials altogether. Although this may be seen as “fair” by some, it can present internal and external pay equity challenges. Employees living in major cities where the cost of labor is substantially above the average may feel like they are being penalized for living in a more expensive city.

Geographic pay differentials and the cost of labor conclusion

There are a few different ways that companies and employers can use geographic pay differentials to adjust base salaries for both in-office and remote workers.

  1. The first approach is to use the national average salary differential. This approach has the advantage of being relatively simple to calculate and administer, but it doesn’t take into account the living costs in different areas.
  2. The second strategy is for employers to use the regional average salary differential. This approach takes into account the living costs and the cost of labor in different areas but can create feelings of inequality among employees in different parts of the world.
  3. The third strategy an organization can use is the state average compensation. This approach has the advantage of being transparent since employees can easily find out what the state average salary is for their position.
  4. The fourth strategy an organization can use is the city/metro/MSA average compensation. This approach has the advantage of being transparent since employees can easily find out what the city/metro/MSA average compensation is for their position.
  5. The fifth and final approach a company could use is the work reporting location of the employee and the average compensation. With this approach, an employer would compare the salaries of employees in different geographic locations to the work reporting location average compensation for that position. The percent discrepancy between the two would be utilized to modify their compensation.

There is no right or wrong answer when it comes to using geographic pay differentials in an organization. The important thing is that companies are aware of the different options and make a decision that is best for their workforce.