The Most Common Compensation Mistake and How to Avoid It
Making inconsistent decisions about pay is one of the biggest mistakes an organization can make - but the reality is that it happens all the time.
Building and retaining a team is a complex thing. You will always need to make decisions and judgment calls to hire, keep, and motivate the best people.
Making consistent pay decisions does not mean that all employees in the same role must be paid the same salary.
It means that your pay practices should be consistently based on your company’s compensation philosophy and corresponding compensation structure.
How Inconsistent Pay Practices Develop
ExampleCorp is a fast growing company and they have a large hiring plan to support hitting their business goals.
When ExampleCorp was starting out, they were super scrappy. They weren’t able to pay top dollar, but many people accepted lower salaries (usually for more equity in the company) to be part of this cool new startup.
As ExampleCorp continued to grow, they made on-the-fly adjustments to their compensation when needed:
- An employee had a competing offer, so they increased her salary to retain her
- A top candidate negotiated strongly for a better offer, so they went above budget to win them over
- They started competing for talent against larger companies that were paying higher salaries, so they started to make higher new offers
- They acquired a company and took on all their employees, which introduced a lot of variation in how people were compensated for similar roles
Every individual decision was made with the best intentions and information available at the time, so ExampleCorp didn’t realize that they were creating a problem… until a member of the HR team accidentally uploaded a compensation spreadsheet to a shared drive. A few people opened this spreadsheet and found some unexpected salary data - and then it spread like wildfire throughout the organization.
In some cases, employees who had been at the company since the early days, found that they were making less than newer and more junior employees. Women in the company found a number of cases where their male colleagues were making a higher salary for the same position.
These revelations shattered the employees’ trust in ExampleCorp and many excellent people left the company feeling that they had been treated unfairly.
The Risks of Inconsistency
Inconsistent pay practices can be one of your biggest organizational risks.
They can impede your ability to hire and retain employees, expose you to legal and reputational risk, and damage your employees’ sense of trust in your company.
Increased Employee Turnover
Compensation is a common reason why people leave for a new job. And making inconsistent decisions about pay can make your employee turnover rate soar.
This happens when salary increases seem arbitrary and disconnected from performance. It can happen because employees don’t know what they need to do to make more money. It can also happen when employees worry that their pay is lagging behind the market.
Inconsistency introduces a lot of confusion and friction into your employees’ perception of compensation at your company, and this might motivate them to look elsewhere.
Lowered Employee Morale
When raises and promotions seem mysterious and unfair, employees naturally start to question “why”. You should always expect that your employees are having some private conversations about salaries behind the scenes. That means that any inconsistencies will eventually come to light.
Gossip, mistrust, and favoritism (both real or perceived) can all have a disastrous effect on employee morale. On the flip side, studies show that employees who understand and trust their company’s pay policies are more satisfied and productive.
Organizations that have inconsistent pay practices are more likely to be wasting time and energy figuring out every pay decision from scratch.
For example, getting salary approval for a job offer might involve an elaborate back-and-forth between HR (including the recruiter), the hiring manager, leadership, and the candidate.
Without clarity and consistency, managers struggle to get answers and make informed decisions, employees are distracted by worrying about their pay, and HR spends a lot of time trying to untangle the mess.
Without a consistent system to guide your pay decisions, you may find it difficult to allocate a budget to your hiring plan or be faced with nasty surprises after a salary review cycle.
You might also find that “the squeaky wheel gets the grease,” meaning that you are rewarding the people or departments who complain and negotiate the most, rather than the one generating the most value.
Salary compression is an issue that develops over time when salaries are increased for new hires, but not for existing employees. This can happen because of inflation, a competitive job market, or because of candidates who have successfully negotiated higher compensation for themselves.
This creates a highly problematic and demoralizing situation where employees who have worked for the company for a long time, have substantial institutional knowledge, more responsibilities, and demonstrate strong performance might find out that they are being paid the same (or even less) than newly hired employees.
There are endless stories of tenured and high performing employees quitting soon after learning about a disparity in their pay. You need to assume that your employees are discussing their pay with one another.
Pay Gaps and Opportunity Gaps
Inconsistent pay practices allow unconscious bias to creep into your pay process. In the absence of clear guidelines, managers must use their best judgment to give raises and promotions. This leaves the door open to decisions that unintentionally widen the pay gap for women, people of color, and other protected groups.
For example, studies show that a woman who becomes a parent might be passed over for opportunities because she is perceived as less competent and less committed to her career. By contrast, a man who becomes a parent might see an increase in wages, because of the perception that he needs to support a family.
In addition, research shows white men are much more likely to self-advocate and negotiate for higher pay than women and people of color, both at the time of hiring and during salary reviews.
Over time, the cumulative effect of these individual differences can result in pay inequity throughout your organization.
Irregular pay practices can also result in illegal differences in pay, which can expose your company to legal and compliance risk.
If you have two employees who are doing the same job for different salaries (which is quite common), you need to ensure that this pay disparity is justified by compensable factors like differences in their education, experience, or skills. But if the pay disparity routinely disadvantages people from protected classes, then it is considered illegal pay discrimination.
The best way to avoid this is to have clearly structured and defensible pay policies across your organization.
How To Make More Consistent Pay Decisions
Write Down Your Compensation Philosophy
A compensation philosophy is a document that defines your company’s approach to pay. It is a collaborative effort between leadership and HR.
It usually answers some fundamental questions, including:
- What is your company’s employee value proposition?
- How competitively do you want to pay compared to your market?
- Do you have location-based pay?
- How transparent do you want to be about pay?
The key to consistent pay practices across your organization is to develop, write down, and actually use this foundational document to guide all your future pay decisions.
Build Your Pay Structure
Your pay structure is the framework of job levels and pay bands that determines the range of pay for all your jobs.
It gives you a comprehensive overview of all the jobs in your organization, so that you can see the level of seniority of each job, how they progress into a career path, and what the min, max, and target pay is for each role.
And most importantly, grouping your roles together makes it easier to benchmark your jobs to market data, such as salary surveys.
Creating a pay structure is one of the most important and complex aspects of compensation management. But once you have it in place, it becomes much easier to ensure that all your raises, promotions, job offers, and any other pay decisions are made consistently within this structure.
Compensation can be difficult to understand and even more difficult to talk about. Your compensation philosophy and pay structure starts at the top - with important business strategy decisions by your leadership team - but it shouldn’t end there.
What do your hiring managers need to know in order to make pay decisions that are consistent with your policies? What do employees need to know to feel confident that they are being paid fairly and thoughtfully?
To make sure that you have organizational alignment around how you think about comp, develop a communication plan for each of your stakeholders.
Limit Negotiations and Exceptions
The best way to keep your pay practices consistent is to purposefully limit the opportunities to create or perpetuate inconsistencies.
Many companies have implemented a “no negotiation” strategy when it comes to new hires. Some companies don’t negotiate salaries with new hires, because they know that their salaries are competitive and they prioritize maintaining the internal equity of their teams.
Similarly, some companies avoid giving discretionary bonuses and have a clear performance-based pay system instead. In addition, managers are given a merit matrix that outlines the salary increase that each employee should get depending on their performance and their position in their pay band.
Revisit Frequently and Adjust As Necessary
One of the major causes of inconsistency is a mismatch between your pay policies and the reality on the ground.
For example, you should revisit your pay bands on an annual basis (or sometimes more often) to make sure you’re keeping up with the job market. If you don’t, you might find that hiring managers want to make exceptions and make job offers that are above your pay band.
Being proactive about making adjustments helps ensure that your compensation practices stay relevant and therefore easier to keep consistent.
Bringing Consistency to Your Organization
Inconsistent pay practices are like “death by a thousand cuts”. They’re not the result of any single decision or policy, but the cumulative outcome of many small individual decisions over time. This is a common struggle. Many organizations don’t even realize that they have a problem until it boils over and creates a mess.
The best way to avoid inconsistency is to create a pay structure that guides your pay decisions. To do this, you’ll create a compensation philosophy that defines your intent, and a compensation structure that allows you to execute according to those intentions.
You’ll also want to monitor pay across your organization on a regular basis. Using compensation management software allows you to structure, report on, and visualize pay for all of your employees. This helps you quickly spot outliers and gaps and put in a plan to address those issues quickly.
With consistent policies and a system to monitor your pay, you can build the foundation of a fair and equitable approach to compensation that will benefit your employees, attract great candidates, and safeguard your company from risks.