Salary Compression Explained – A Comprehensive Guide

by | Published on Jun 3, 2023 | Last Updated on Jan 25, 2024 | Compensation

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In the world of human resources, understanding the dynamics of salary compression is not only important but also critical. It directly impacts how organizations manage compensation and morale among their employees, from new hires to experienced workers.

What is Salary Compression?

Simply put, pay compression happens when there’s minimal difference between the pay of experienced employees and new hires within the same job role. For instance, a long-tenured employee, after receiving incremental pay increases over the years, might find their salary close to a new hire who negotiated a higher starting salary due to a tight labor market. This scenario exemplifies how wage compression occurs, leading to potential pay inequities among employees.

Salary compression is a product of various factors and can be influenced by both external and internal forces. In a job market experiencing high inflation or minimum wage increases, for example, organizations may be forced to increase pay for new employees, which can inadvertently contribute to pay compression.

Internally, the company’s compensation strategy and pay structure can also result in wage compression. If a company doesn’t regularly review and update its pay practices and salary ranges, it may find that its existing employees, even high-performing workers, are being paid less than new hires.

The issue becomes even more complex when a company uses multiple pay grades and job families, leading to confusing job families and inconsistent pay practices.

Why Does Pay Compression Happen?

Let’s look at an example of how pay compression occurs with a hypothetical company called Future Corp. Future Corp is a tech firm that has been in business for over a decade. In the early days of the company, they hired a software engineer named Tim.

Tim started with a salary of $70,000 a year, and with his skills, experience, and tenure, he has seen regular annual raises of 3% over the years. After a decade at the company, Tim is now making $94,000 a year.

Due to changes in the tech industry and a tight labor market, the demand for software engineers has skyrocketed over the years. Now, to attract new talent and compete with other companies, Future Corp has to offer a starting salary of $95,000 for new software engineers.

This creates a scenario of wage compression. Despite his ten years of service and experience, Tim is now making nearly the same amount as new hires who may not have the same depth of knowledge or experience.

This could lead to dissatisfaction and low morale for Tim and other employees, potentially even causing him to consider other employment opportunities where his experience and tenure might be more adequately compensated. He may not be the only employee leaving for a higher paying job elsewhere.

The challenge for Future Corp, and any company facing wage compression, is to balance competitive starting salaries for new hires while also maintaining fair compensation for existing, experienced, and tenured employees.

Is Salary Compression Legal?

While salary compression might seem unfair, especially for tenured employees, it’s not illegal. However, it’s important to note that pay compression, when not addressed, can lead to pay inequities that might violate equal pay laws if they result in wage disparities based on factors such as gender or race.

Understanding the legality of wage compression doesn’t negate its potential negative impact on employee morale and job satisfaction. For instance, when a company does not adequately address pay compression, existing workers might feel demotivated or underappreciated, affecting their performance and the overall productivity of the organization.

Consequences of Pay Compression

While pay compression might initially seem like an isolated issue, it can have cascading effects on an organization. If left unchecked, this compression can lead to pay inequities between tenured employees and less experienced employees or new hires.

These pay inequities can have a detrimental effect on employee morale, with existing employees feeling undervalued and newer employees facing unwarranted scrutiny or resentment.

Notably, wage compression also affects a company’s ability to attract and retain top talent. In a tight labor market, new hires may demand a higher salary, and with compression issues, current employees may be lured away by higher paying jobs elsewhere.

This situation creates a pay compression problem that needs a strategic approach to resolve and address pay inequities, and maintain a competitive pay edge in the market.

What is salary inversion?

On the other hand, salary inversion, also referred to as pay inversion or wage inversion, is a more specific scenario where new or less experienced employees earn more than those with more experience or tenure in similar roles. This situation can occur due to a variety of reasons, such as a tight labor market, strong demand for certain skills, or significant increases in minimum wage.

Both pay compression and inversion can cause dissatisfaction among employees, particularly those who are more experienced or have been with the company for a longer period. They can lead to morale issues, decreased productivity, and increased turnover if not properly addressed. Therefore, organizations need to periodically review their compensation practices and make necessary adjustments to ensure fairness and retain their valued employees.

Role of Pay Structure and Compensation Strategy in Wage Compression and Minimum Wage Increases

The role of a company’s internal pay structure and its overall compensation strategy cannot be understated when discussing wage compression. If a company fails to update its compensation structure to reflect current market rates or neglects to consider the impact of minimum wage increases, it may inadvertently contribute to employee pay compression issues.

A company’s pay structure, which includes various salary ranges and pay grades, must be regularly reviewed and updated to ensure it aligns with current pay practices in the job market. This practice helps prevent wage compression, encourages pay transparency, and ensures the determination of fair compensation.

For instance, if a hiring manager sets a starting salary for a new employee based on market changes and external market data without considering the company’s existing pay practices and the salary history of similar roles, it may result in pay compression.

Similarly, compensation packages that fail to provide equity adjustments in times of economic downturns can also exacerbate the pay compression problem.

Addressing and Avoiding Wage Compression

In the first half of this blog, we delved into what salary and wage compression really is, its legality, and the potential consequences. Now, let’s address how we can avoid wage compression, resolve pay inequities, and implement practices such as compa-ratios that ensure fair pay within our organization.

How Can You Avoid Pay Compression?

Avoiding wage compression requires a strategic approach. It begins with regularly reviewing and updating your compensation strategy. The compensation plan should reflect current market changes and include data-driven salary ranges, updated pay grades, and a thorough understanding of the company’s internal pay structure. This practice will ensure you are offering competitive pay to new hires and current employees.

For instance, consider how the minimum wage laws or increases might impact your existing employees. If you increase pay for new employees due to changes in minimum wage laws, ensure to adjust the salaries of current employees doing the same job. This step will ensure pay compression doesn’t happen and keeps current workers motivated.

In a tight labor market, having more hourly workers can help manage pay and address wage compression elsewhere. Hourly workers, given overtime pay, have a more flexible pay range than salaried employees, which can alleviate some pay compression issues. However, be careful not to rely too much on this tactic, as consistent overtime may lead to other issues, such as employee burnout.

Another effective way to avoid wage compression and pay inequity is by having transparent pay practices. Ensure employees understand how their pay is determined. Increased employee awareness of the company’s pay structure and practices can lead to more trust and lower the chance of pay compression leading to pay inequities.

Resolving Wage Compression: Practical Steps

Resolving wage compression and determining fair compensation is a complex process that requires a multifaceted approach. Firstly, you must identify where compression occurs within your organization. Analyze compensation data and look for instances where new hires are making the same or more than tenured employees in the same job family.

Once you’ve identified instances of pay compression, consider the following steps to address the pay compression issue:

Salary Adjustments:

To address pay compression, make adjustments to the salaries of those affected. This approach to pay compression, often known as providing equity adjustments, involves raising the salaries of tenured employees to a higher salary range that reflects their experience and contribution to the organization.

Cash Bonus Awards:

If your organization can’t immediately adjust salaries, consider providing cash bonus awards to tenured employees affected by pay compression. This practice can boost morale and serves as a temporary solution while you work towards long-term strategies.

Employee Communication:

Transparent communication with direct reports about the issue and your plan to address pay compression can reduce dissatisfaction and distrust among employees. Ensure all direct reports are aware of the steps being taken to resolve pay inequities.

Regular Compensation Reviews:

Regularly review your compensation plan to ensure it aligns with the job market and current pay practices. Adjust pay ranges, set pay grades, and ensure starting salaries for new hires align with the compensation of existing employees.

Strategic Hiring Practices:

When bringing on new employees, consider the potential impact on existing employees. If you offer a new hire a significantly higher salary due to market demands, be prepared to address any resultant pay compression with existing workers.

How can Salary Bands help with Wage Compression?

Salary bands, sometimes also referred to as pay grades or pay ranges, can play a crucial role in preventing and managing pay compression. These bands define the minimum, mid-point, and maximum salary that an organization is willing to pay for a specific role or level.

Here’s how they can help:

Structure and Consistency:

Salary bands provide a structured and consistent approach to compensation. They ensure that all employees in similar roles or job levels are paid within a defined salary range together. This helps prevent pay compression from happening as the organization can control and manage pay increases and initial offers better.

Fair Pay:

Salary bands allow for equal pay for equal work, which is a key principle in ensuring fair compensation. They ensure that employees doing the same job are paid similarly, reducing the risk of pay inequities and potential compression.

Performance and Experience-Based Increases:

Salary bands offer room for progression within a role, meaning that an employee’s salary can be increased within the band to reflect their performance, tenure, or increased experience without necessarily promoting them to a new role. This can help keep longer-tenured employees’ salaries competitive with the market rate and rates for new hires.

Clear Career Pathways for Tenured Employees:

By defining salary bands for different roles and levels, organizations can create clear career and salary progression pathways. This can motivate employees and reduce the likelihood of pay compression as they can see a direct correlation between career progression and salary increases.

However, it’s essential to remember that salary bands must be regularly reviewed and updated in line with market changes, inflation, and internal factors. If bands are not regularly reviewed, they can become outdated and may inadvertently contribute to salary compression instead of preventing it.


Addressing and avoiding salary compression is crucial for maintaining a healthy, motivated workforce. By implementing transparent pay practices, regularly reviewing your compensation plan, and ensuring equitable adjustments when necessary, you can foster an environment of fair compensation.

Remember, in times of economic downturn or market changes, it’s essential to stay vigilant about maintaining fair pay practices. This attention to detail will not only keep your employees happier but also enhance your organization’s reputation as an employer of choice.