KEYNOTE

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SEATTLE $15 MINIMUM WAGE: SOLVING FOR SALARY COMPRESSION

The dramatic Seattle minimum wage increase to $15.00 per hour is causing concern with quite a few

organizations, especially those in the service, manufacturing and hospitality industries. Despite the

gradual phase in period of three to seven years, at the end of the adjustment period, Seattle’s

minimum wage is predicted to be more than 50% higher than the state’s minimum wage.

Some organizations are alarmed at what this means for their bottom line, recruitment and retention,

and future growth opportunities. Undoubtedly, three reactions will be prevalent:

1. Proactive Stance: “I know I need to increase some employee pay rates to $15.00 per hour.

I will crunch the numbers and see what it costs, plan for those expenses, and I’ll be all set.”

2. Procrastinator Stance: “I still have a few years before the impact; I am not going to worry

about it.”

3. Complacent Stance: “Thankfully, it doesn’t impact us at all. We already pay our employees

more than $15.00 per hour.”

This KeyNote will address these possible reactions, misconceptions and how shrewd organizations

can adjust their compensation strategy, policies and practices to weather this change.

Reactions and Misconceptions

Proactive Stance

These organizations may be busy calculating costs, figuring out the total price tag to raise low

income employees to at least $15.00 per hour and thinking about how to phase this in over time.

Some may arrive at a number, budget accordingly, and then stop. That is their first mistake. Why?

The cost to move employees to the new minimum rate is just the first step. There are more costs to

consider, due to what is commonly referred to as “Salary Compression.”

World at Work, the nation’s leading Compensation organization, defines salary compression as “pay

differentials too small to be considered equitable”. Put differently, salary compression occurs

when there is little to no difference in pay between employees, yet a significant difference

in skill, knowledge or responsibilities. Sometimes salary compression is seen when subordinates

earn more (after incurring overtime, for instance) than their supervisors. Other times this can be

seen when employees in a “lower graded job”, or a job with fewer responsibilities, earn more than

employees in a different job that is more complex.

Clever managers will realize that increasing their lower level employees to $15.00 per hour will

cause the pay of lower paid employees to bump up against the pay of employees in jobs with a

higher skill set, or more responsibilities. Where previously a job with a relatively low skill set could

be paid $11 or $12 per hour, and a job with a moderate skill set could be paid $15 or $16 an hour,

now the jobs could all be paid within a few percentage points of each other. Likewise, after assessing

overtime usage in their organization, managers may realize that the new overtime rates will cause

subordinates’ gross pay, overall, to be more than their supervisors.

Some may not understand that this is a problem since salary compression is not illegal and the

wages are high. However, allowing salary compression to enter an organization does not make good

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business sense. It is an expensive risk that can cost an organization much more in the long run.

Salary compression can lead to a host of organizational challenges, such as:

Low employee morale

Poor employee retention

Decreased employee engagement

Loss of productivity

Weakened trust in leadership

Decreased overall job satisfaction

Damaged work relationships

Reluctance for potential supervisors to accept promotions

Studies show that employee morale and retention are impacted the most by systematic cases of

salary compression. (May 2009 survey by Pearl Meyer & Partners, Salary Compression Practices in

the United States). Much of this is intuitive: Employees can feel demoralized and resentful when

they are paid the same, or close too, another employee who has what they see as an “easier” job.

This can cause employees to be more receptive to moving on when they see a job opening, or will

propel them to actively enter the job market. Yet even if they chose not to actively seek a new job,

it is likely they will become disengaged with their current job, leading to lack of productivity. In

addition, when employees do not feel that they are fairly compensated, they are less likely to trust

leadership and more likely to experience overall job dissatisfaction.

Why might salary compression lead to damaged work relationships? Consider the difficulty new

employees may face when being hired at a pay level higher than their peers doing the same type of

work. If pay rates are known – as they often are – the new employee may face an environment that

is uncomfortable or unproductive. In addition, when supervisors are faced with hiring subordinate

employees who, with overtime pay, are compensated at a higher rate, this can also create a tense

working environment. (There are some situations, it should be noted, where Supervisors willingly

accept a pay rate lower than a subordinate. Some examples are specialized IT or scientific

positions.)

Lastly, salary compression may also cause difficulty when management wants to promote from

within. Potential supervisors, when considering an upward job change, may be faced with the

prospect of a higher “level” job that is more complex, with more stress, yet brings home less pay

after overtime pay. Unless they feel that this will be a temporary situation, it is quite possible they

will turn down the opportunity.

Some executives will counter that pay is private and if employees do not know what others are being

paid, pay disparity issues will not surface. Experts report this is no longer true. In the December

2009 edition of Workspan, “the influx of Millennial/Gen Y workers has rendered such discretion a

thing of the past.” (Addressing Salary Compression in Any Economy by Rebecca Manoli, Workspan

12/09). Younger generations have fewer qualms about sharing their pay rates with co-workers,

friends, even strangers on the Internet and social media. Managers should no longer assume that

salary rates are kept confidential just because they are a private employer, or do not have published

salary ranges. Plus, many managers have learned the hard way that negative perceptions of salary

inequality can be damaging whether true or not.

Procrastinator Stance

It is a bad idea to wait and allow other organizations the competitive advantage. Smart employers

will begin developing a plan now regarding how to phase in the salary increases, both the movement

to $15.00 per hour and any resulting increases needed to address salary compression. They will

identify the possible areas of salary compression, assess the costs, review their history of overtime

payments, make adjustments to staffing levels, take a close look at the productivity of their

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workforce, decide what compensation structure changes are needed and have a multi-year plan to

balance all factors.

Complacent Stance

While an organization may already comply with the minimum wage rate, once an organization

considers the broader market, their competitors, and how the overall wage increase will change the

competitive labor landscape, ignoring the impact of the new law may be unrealistic.

Consider the problem through the lens of a SWOT Analysis: Strength, Weaknesses, Opportunities

and Threats. If an organization already pays employees more than $15.00 per hour, this is a

strength. The organization is not faced with the same type of short-term costs that other

organizations may be faced with. That said, ignoring salary compression will quickly cause an

organizational weakness: low morale, retention concerns, and decreased employee engagement are

just a few likely results. When considering threats, realize that competitors may be taking this

moment to assess their salary levels and make alignments to the market. Competitors may be

planning to increase pay for positions that are prevalent in your organization. This will impact the

pay levels for all positions in the local market, causing employees to seek work in those

organizations that have already taken care of salary compression concerns. Suddenly, your

organization has a greater retention concern. Yet with every threat comes an opportunity. By

carefully considering the points in this KeyNote, and addressing them thoughtfully, you have the

opportunity to get ahead of the pay compression problem. Your organization has the opportunity to

be the proactive employer in your industry, with its finger on the pulse of the labor market.

What Organizations Can Do

Experts agree that pay compression is much easier to avert than it is to fix. Your organization has

time to plan, if you start promptly. The suggestions below are just a sample of what your

organization can do to weather this change.

1. Develop a compensation strategy that addresses “Salary Equity.”

Successful companies will develop a solid compensation philosophy that addresses the

organization’s outlook on internal equity. They will determine what an acceptable differential

is between employees and supervisors, considering the nature of work and the market data

for their industry. If they do not have the resources internally to do this type of analysis, they

will turn to outside consultants for support.

2. Develop compensation policies that help managers make equitable pay decisions.

Creating policies that help managers make fair, consistent, market-competitive pay decisions

will serve to make best use of limited company resources. Holding managers accountable for

these decisions, and making this clear in policy, will help employees maintain confidence in

leadership. Providing managers the tools they need, such as internal salary reports or

minimum and maximum hiring amounts, is a vital part of this strategy.

3. Understand if pay compression exists in your organization.

Pay compression can be tricky to identify, but it is worth the effort. Data can be collected

using the HRIS or payroll system and a spreadsheet program can be used to do the analysis.

Start by querying the employees currently earning below $15 per hour and the employees

earning $15 to $16. Analyze how bringing the lower paid group up to $15 per hour will

impact the higher paid group. For instance, what positions do you have that are paid between

$15.50 and $16.00 per hour? Will paying the Clerical Assistant employees $15 per hour cause

pay compression with these other jobs, given their different job responsibilities? Continue

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analyzing this “ripple effect” of pay compression from the lowest to highest paid, identify the

positions of concern, the associated costs, and a phased in approach for how to reach the

desired pay levels until you feel you have reached a point where pay compression has

leveled.

Next, analyze how supervisors’ salaries compare to direct reports’ salaries. Include overtime

pay in this analysis. Prepare reports that map out all employee positions and pay relative to

their supervisor. A common principle is that supervisors and direct reports typically have a 15

to 20% pay gap. (Market data may support a different amount, so this principle may have

exceptions.) Identify positions of concern, the associated costs and a phased in approach for

how to reach the desired pay levels until you feel you have reached a point where pay

compression has leveled.

As stated before, all of this analysis requires an understanding of internal equity. Specifically,

care should be taken to understand which positions should be paid more than others based

on the levels of complexity, autonomy, financial responsibility, education required, impact of

error, and other compensable factors.

4. Develop a formal salary structure with minimum, midpoint and maximum rates.

Some companies may realize they are ready to create a formal salary structure in order to

bring consistency to pay decisions and help phase in the move to a $15 per hour minimum.

When planning for this change, a formal salary structure can be used to map out which jobs

should be slotted at which grade according to internal and external equity. A series of salary

structures can be created, with plans in place to phase in implementation of one each year,

until the $15 per hour “floor” increase is effective. A careful analysis of proper job placement

(e.g., Job A should be in grade 1; job B should be in grade 2) will inform managers what the

proper hiring range should be as well as the top end pay maximum. Care should be taken to

make sure valid external market data is used in the design of this plan, and organizations

should steer clear of free Internet sites that provide antidotal and employee-provided data.

There are plenty of HR consulting firms that have experience doing this type of work; if

internal HR talent does not exist to create salary structures in-house, an external consulting

firm should be used to make sure the work is done according to sound compensation theory

and best practice. Archbright has the expertise to provide this service.

5. Analyze overtime usage and determine if this is the best use of resources.

The organization’s current use of overtime, including how it impacts employee pay relative to

supervisor pay, is an important part of resource management. If this has not been reviewed

by top management, now is the time. Projections should be made about what the cost would

be to maintain the same level of overtime with the proposed $15 per hour salary increase as

well as any other pay increases that may be necessary.

6. Consider variable pay options.

Sign-on bonuses, cash incentives tied to performance, and non-discretionary bonuses can all

be important tools to prevent further pay compression. Sign-on bonuses can be used to

attract candidates without paying them more than existing employees. If management is

worried about the pay compression gap between supervisors and subordinates, cash

incentives tied to performance can be used to pay employees more without adding to their

base salary, or feeling the need to keep supervisors incorrectly classified as “non-exempt” in

order to pay them overtime.

Conclusion

Whatever the situation in your organization, Executives, Managers and HR Staff must create a plan

to deal with the salary compression caused by the Seattle $15.00 per hour minimum wage

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ordinance. Allowing salary compression to enter into your organization does not make good business

sense. Negative consequences such as low employee morale, retention concerns and loss of

productivity can occur, among others. Your organization should seek to understand where and how

salary compression may exist in your organization as a result of moving employees to a $15

minimum wage. Then, management can strategize how to mitigate the impact. With careful strategy

and analysis, your organization can enter the $15 minimum wage era with a clear advantage over

your competitors.

DISCLAIMER: This information is general in nature and is meant as a guide for members of Archbright. As such, it is not intended to be, nor

should it be used as, legal or management advice. If you have a question about a specific situation, please contact an Archbright professional

staff member at 206.329.1120.