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Pay compression can cause morale problems and hamper retention unless employers remain on guard.
It all began with a racial discrimination complaint. About 30 employees in the grounds department of The Citadel accused the military college in August 2003 of not paying them fairly, recalls Patricia McArver, the school’s vice president for communications.
The problems stemmed from a labor shortage in the heating and air-conditioning (HVAC) department, which is part of the same physical plant division as the grounds department. Starting salaries were too low to compete with other employers in Charleston, S.C. When the HR department agreed to raise starting salaries for HVAC employees, those new hires were suddenly making more than some more experienced employees who had worked in the college’s physical plant for 10 or 20 years, and most of whom were black.
The senior employees’ Equal Employment Opportunity (EEO) complaint quickly grabbed the attention of the school’s president, who appointed a committee to review the allegations, and McArver, who chairs the campus human affairs commission, was put in charge.
After reviewing physical plant employees’ salaries, tenure, and annual performance reviews and ratings over the previous five years, “it became quickly apparent that this did not seem to be a racial issue,” McArver says. Instead, those who had been at the school a long time and hadn’t changed jobs were at a disadvantage when it came to pay.
To get an objective assessment of the findings, a panel of local outside HR experts was brought in to conduct a review. After meeting with employees and reviewing the data, the HR experts agreed that it was not an issue of discrimination, but an issue of pay compression, McArver recalls.
That’s often how it goes with pay compression. Employers are usually unaware that pay compression exists until problems surface. Most companies and organizations “don’t set out to do this, they just fall into it,” says Craig Rowley, vice president and practice leader of the Hay Group consulting firm in Dallas. Still, there are steps employers can take to recognize whether pay compression exists and to avoid the negative side effects it creates in the workplace.
Pay compression occurs when less experienced people earn as much as or more than longer-term employees due to rising starting salaries. It also can occur when someone earns overtime and makes as much as or more than their exempt supervisor.
The problem cuts across workplaces and employment levels—from government institutions to low-wage service jobs to manufacturing facilities to higher-demand positions like auditors, experts say.
“Of 100 organizations today, 100 or 98 have pay compression problems,” says Jim Fox, chair of Fox Lawson & Associates LLC of St. Paul, Minn., which specializes in compensation issues, particularly in the government sector. “It’s an overwhelmingly large number, whether they admit it or not. It’s a little bit more noticeable in government because salaries are more public.”
If a problem with pay compression is identified, the government typically addresses it openly and systematically, Fox says. In the private sector, it is often dealt with on a case-by-case basis.
Catherine Dovey, SPHR, head of Dovey HR Strategies in Seattle, says the problem may crop up when a company has a job it can’t fill. It may be a supervisory position at a manufacturing facility that no one applies for because they will no longer receive overtime. Or, it could be a store manager’s position that no employee will take because the pay isn’t high enough to compensate for the additional duties.
Typically, the company will come up with an individual solution, such as deciding a particular employee is the perfect person to be a store manager, so he is offered more money. When other store managers who have been in the job for years realize the new manager is making more, they get up in arms. In this way, companies often “fix one problem [of filling the position], but they end up with another set of problems,” Dovey says.
Working on Solutions
Often, employers seek outside help in dealing with compression problems.
Diane Gerard, the practice leader for the Central/West compensation consulting practice at Aon in Chicago, currently is working to devise a solution for a Midwestern client with 2,500 employees that has seen its turnover rate double in the past couple of years.
A review by Aon found that those who have worked for the company for five to 10 years are earning above market rate, while those working there for one to just under five years are making below market rate. “Those coming in within [the past] 12 months are at or above pay levels of those coming in five years ago,” Gerard says.
Some of the company’s employees were lured away by other businesses, then quit and returned to the first company, where they were hired back at a higher rate of pay. Aon is still working on analyzing the problem and finding a solution. But the company has learned one valuable lesson: “Everything you do with pay is a form of communication with employees,” says Gerard.
The Houston Community College System learned that the hard way, after its faculty senate raised the issue of pay compression. “Compression leads to morale issues,” says Daler Wade, the college system’s director of compensation and benefits.
“Seniority is very important in higher education,” she says, but “the difference between being here 10 years vs. 30 years was not measurable, not substantial.”
So the college system set up a faculty and staff committee working in collaboration with the HR department, and Wade was made chair. Fox Lawson & Associates was brought in and conducted focus groups with deans, department chairs, staff and faculty to determine what they did and didn’t like about the pay system. The Fox Lawson consultants then redesigned the compensation system, measuring performance and linking performance to pay.
Jim Fox recalls it took about 40 hours for the consultants to come up with a proposed system, and six to nine months for the Houston Community College System to hash out the details to make it work in an organization that employs about 1,870 full-time faculty and staff.
In 2003, the college system allocated $2.1 million in salary increases to 1,073 faculty and staff. The next year, $1.1 million was given to 921 employees. In 2005, $400,000 was granted to 580 people. Some employees received one increase followed by another the next year; others did not. “We realize we can never completely cure it all,” Wade says.
It’s not clear yet whether further salary adjustments will take place in the coming years. “We can’t guarantee there will be payments in the next fiscal year, but I am certain that there will be a proposal to the board to consider it,” Wade says. (The college’s board needs to approve the pay increases.)
But the decision to address pay compression “was actually the genesis of something much bigger” than simply making salary adjustments—namely, redesigning the pay structure and putting methods in place to measure and manage performance, she says.
Houston Community College System also began issuing compensation updates, sharing information via e-mail and one-on-one sessions, conducting question-and-answer sessions with all the colleges, and training supervisors about compensation “to try to take the mystery out of it all,” Wade says.
To mitigate the effects of pay compression, Elwood “Chub” Dietz, consulting manager with Corporate Compensation Partners in Sewickley, Pa., recommends that employers use the entire salary range when making compensation decisions, and place those with the greatest experience and skills at the higher end of the range.
Employees also should be compensated for their performance. “When the same ‘whopping’ 3.5 percent pay increase is given to the mediocre performer as well as the exceptional performer, the exceptional performer will feel there is not a significant differential between his or her salary and that of those he or she is probably helping to get by,” he says.
Dietz also suggests using employee development programs to help workers enhance their opportunity for future promotions and the salary raises that come with them. Cost savings for employers result “by allowing internal investments to continue to grow.”
Lump-sum bonuses, project incentives and noncash awards also can be used to enhance compensation without increasing base pay, particularly for those at the higher end of the salary range, Dietz says. This will also help prevent pay compression.
If pay isn’t competitive, an employee may stay for a year or two and then move on. “They’re your most expensive investment. They’ve gotten all the training, but you’ve gotten no return,” says Hay Group’s Rowley.
He adds that employees expect reasonably competitive pay and expect to be paid fairly compared to those doing similar work. When that doesn’t happen, “it has a really damaging impact on your culture,” he says.
The Citadel learned that firsthand with its disgruntled grounds department employees. Dennis Carpenter, the college’s HR director, says problems cropped up at the public college because the state of South Carolina didn’t provide cost-of-living adjustments while health insurance premiums rose. “People were losing money.”
One of the biggest challenges was to “convince folks it’s not something we intentionally did. It’s just something that happened over time,” Carpenter says.
Rowley says every time an organization is deciding on a new hire’s salary, HR managers should look at “how it lines up with what they are currently paying.”
The Citadel brought in Palmer & Cay consultancy, which developed a system that looked at every employee’s years of experience and performance ratings, to make sure that all full-time employees were earning at least 80 percent of the market rate for their position, McArver says.
“Everybody [not just those in the grounds department] thought they were compressed,” McArver says. “They thought when the numbers were run they would get a raise.” But it didn’t turn out that way, initially generating a hostile response.
At Palmer & Cay’s recommendation, the school decided to give out all raises deemed necessary at one time. With a staff of about 450, nearly 40 percent received raises, some as high as $5,000 to $7,000. All those who filed the EEO complaint received raises, many of them by several thousand dollars. Of the 165 faculty members, almost two-thirds got raises. Altogether it cost the school nearly $1 million in 2004, Carpenter says.
The Citadel also bought software that tracks the market value of various college and university jobs, both on a national and state level, with the aim of always being within 80 percent of market value, Carpenter says.
Meanwhile, a training program was set up specifically for employees who work in the physical plant to help them learn about job openings and training opportunities. While rules and compensation and promotion policies previously were available online and in the HR manual, the college learned that employees didn’t necessarily have access to the Internet or weren’t reading policy manuals, McArver says.
The college also rewrote procedures so employees could better understand how to qualify or apply for a job, or, if they increased their skills, how they could be eligible to earn extra pay, she says. “People on the bottom of the pay scale were the most disadvantaged by the way the system was.”
Ultimately, because of The Citadel’s actions to resolve the pay compression problems, the grounds department complainants who stayed at the college formally withdrew their charges.
Surviving the Talent Wars
Fox says he expects pay compression to become more of an issue in a recovering economy. For the past four years, there have been relatively low pay increases and not much job movement. But as the economy opens up, movement will take place. “Now is the time to make sure you’ve got things in order,” he says.
Aon’s Gerard says the consultancy surveyed 140 Midwestern companies about what they considered the hot jobs, and found sales, health care, audit, and middle- and senior-level managers were in demand. “It’s sort of the beginning of a new war for talent. For the first time since 9/11, employees are more comfortable changing jobs.”
She says that in the last talent war of the 1990s, companies across the board responded with higher bonuses and premium pay levels. Today, “individual negotiations will create administrative burdens down the road” as well as pay compression as companies do whatever it takes to get someone in the door.
Gerard urges companies “to make sure they are not reacting, but can be at the point where they can anticipate what is happening.”
Susan Ladika has been a journalist for more than 20 years in the United States and Europe. Now based in Tampa, Fla., her freelance work has appeared in publications such as the Wall Street Journal-Europe and The Economist.
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