Pay Compression

What pay compression is

Pay compression (تضاغط الأجور), also called salary compression or wage compression, is the narrowing of a gap between two pay levels that was meant to exist: between an employee who has been in a job for years and one recently hired into the same job, or between a supervisor and the people they supervise. The organisation did not decide to bring the two closer. The gap narrowed without any decision being taken.

Pay compression is therefore a condition, not a policy. It appears in no meeting minutes and nobody signs it. It arises from a difference between two speeds: the speed at which the organisation raises the pay of the people it already employs, and the speed at which the market raises the pay it asks for the people the organisation hires from outside.

The two causes of pay compression

The first is the two clocks. Internal pay moves at an annual increase rate that the organisation sets, while the entry rate for new hires moves at whatever pace the market moves. If the entry rate moves faster, the gap narrows year after year at a pace set by the difference between the two rates, and no pricing mistake is needed for that to happen.

The second is the ceiling. Someone who has reached the top of their grade has nowhere left in the pay scale to rise to, so their pay stops while the pay of those below them keeps climbing. A closely related condition, pay frozen above the grade maximum, is known as red circled pay, and its effect on compression is that it stops one clock, not both.

A worked example of pay compression

Take a specialist hired four years ago on a monthly pay of SAR 10,000, who has received an annual increase of 4%, in a job whose market entry rate has risen by 7% a year.

• The specialist hired four years ago: 10,000 multiplied by 1.04 four times, which gives SAR 11,698.59 today.
• A specialist hired today: 10,000 multiplied by 1.07 four times, which gives SAR 13,107.96.

The gap is SAR 1,409.37 in favour of the new hire, and the specialist hired earlier is paid 10.75% less. That is an inversion of the order, not just a narrowing: four years of service now carry a negative value on the payslip.

Now look at a supervisor in the same career path, also hired four years ago, on SAR 14,000 and with the same 4% increase. The supervisor’s pay today is SAR 16,378.02. On the day they were hired, the supervisor earned 40% more than the specialist; today the supervisor earns 24.95% more than the specialist hired today. The supervisory gap has eroded by 15.05 percentage points, and nobody in the organisation took a single decision to reduce it.

The figures in this example and in those that follow are assumed. The rates of 4% and 7% were chosen to show the structure; they are not a benchmark and are not quoted from any source. The actual movement of entry rates comes from a pay survey, not from the definition of pay compression.

Why pay compression does not show in averages

In the example, average pay for the job rises, the average increase stays at 4%, and each individual’s compa ratio may stay within its range. Pay compression is not measured by the level of pay but by the gap between two pay levels, and a gap does not appear in an aggregate figure.

Pay compression is also distinct from a neighbouring effect it can be confused with. Internal pay equity holds that a uniform increase at a single rate keeps the ratio between two salaries unchanged and widens the gap between them in riyals. That is true inside one organisation and does not conflict with pay compression, because compression does not arise from the internal increase alone. Compression comes from comparing that increase with a second clock outside the organisation.

What is actually measured in pay compression

• The seniority gap: the pay of someone with five years in a job, divided by the pay of someone hired into it this quarter. A figure below 1 is the inversion.
• The supervisory gap: a supervisor’s pay divided by the highest pay in their team. What matters is its direction over the years, not its size in any one year.
• The grade gap: the midpoint of the higher grade divided by the midpoint of the grade below it in the salary structure, compared with what the market pays for both.

All three are ratios, not amounts, which is why they can be compared over time, unlike amounts, which inflation alone can move.

Thresholds for the supervisory gap are used in practice, but in the sources we reviewed we found none that attributes a specific threshold to the Saudi market. The definition of pay compression therefore sets no percentage below which a gap counts as having narrowed.

Each ratio is measured within the same job group, not across the whole organisation. In an organisation with six job families, pay compression can occur in one of them and be absent from the other five, and a single figure for the whole organisation hides that completely. Splitting the measurement by job family is the minimum that makes the figure usable, because the market for each family moves at its own speed.

What correcting pay compression costs, and why the correction gets postponed

Correcting the inversion in the example means raising the employees hired earlier to the level of the new hire. If 12 employees in the job are in the same position, the cost is SAR 1,409.37 multiplied by 12 months and by 12 employees, or SAR 202,949.28 a year. That amount stays in the base, and every later increase is calculated on it, in the same way that pay added outside the increase decision compounds under wage drift.

The size of that bill explains why the correction can be put off, and putting it off makes it larger. Every year that passes adds to the number of people affected and to the size of the gap, so the cost compounds rather than simply adding up.

Three routes to a correction differ in their effect:

• A targeted correction for the employees affected by the inversion, and for them alone. The cheapest of the three, it is also the one that invites the question of who was left out.
• A review of the whole pay scale, raising grade midpoints to match the market. Of the three it costs the most, and its effect lasts longest.
• An adjustment to the annual increase rate, bringing it closer to market movement. It does not repair what has already happened, but it prevents a repeat. It is the only route that addresses the cause, because the first two address an effect that has occurred once and will return.

The definition does not decide which of the three routes is right. That depends on the size of the effect, on where the organisation stands against the market, and on what its budget can bear.

The pay compression figure changes with the wage it is measured on

A gap between two pay levels does not give one figure. It gives a figure for each concept of pay it is measured on. In the example, take the monthly pay as each employee’s actual wage (الأجر الفعلي), and assume that the basic wage (الأجر الأساسي) makes up 60% of the earlier hire’s actual wage and 75% of the new hire’s. The basic wage is then SAR 7,019.15 for the earlier hire and SAR 9,830.97 for the new one.

Measured on the basic wage, the new hire is paid 40.06% more than the earlier hire. Measured on the actual wage, the new hire is paid 12.05% more. Two people, two figures about 28 percentage points apart, and nothing on either payslip has changed.

The reason is that the share of the basic wage in the actual wage is not fixed. It can differ with the time someone was hired and with what was negotiated. So the first decision in measuring pay compression is the concept of pay it is measured on, and that concept is held fixed for every comparison. A comparison that does not state its basis is not a comparison.

Why pay compression surfaces all at once

Pay compression builds up quietly for years and then becomes known in a day. What creates it is not what reveals it: the difference between the two speeds creates it, and a single salary becoming known reveals it. An offer mentioned in an interview, or a figure mentioned between two colleagues, is enough for the rest of the team to measure themselves against it within the hour.

In the example, none of the 12 employees knew where they stood before that day, and after it they all did. That makes pay compression a matter to manage before it becomes known, not after, because once it is out the organisation responds under pressure and can end up paying more than it would otherwise have paid.

The effect of pay compression can fall more heavily on those who stay than on those who leave. An employee who leaves takes the market rate from another employer. An employee who stays keeps working with a figure they know and cannot explain. For that reason pay compression is examined alongside retention strategy and the retention rate, not alongside the pay review alone. We found no published measurement of the effect of pay compression on employee retention in the Saudi market.

A third form of pay compression: two jobs whose markets move at different speeds

The two forms above occur within one job, or between a supervisor and a subordinate in the same career path. A third form is more confusing: two different jobs placed in adjacent grades by job evaluation (job classification is one of its approaches), after which the market for one of them moves faster than the market for the other.

Suppose a scarce specialism in the lower of the two grades, whose entry rate rises by 12% a year, and a job with a wider labour supply in the higher grade, whose entry rate rises by 3%. Taking the lower grade’s market rate as 100 and assuming the higher grade starts at 120, the two stand at 125.44 and 127.31 after two years, and at 140.49 and 131.13 after three. By the third year the market rate for the lower grade is above the market rate for the higher one, and the pay scale has not changed, because the content of neither job has changed.

Raising the grade is not a sound remedy here, because the grade describes the job, not its price, and raising it to chase the market distorts the pay scale for everyone in it. One way out is a separately named pay item, kept apart from the basic wage and reviewed on a published cycle, with its reason written down so that two years later nobody takes it for a permanent increment earned through seniority.

How to tell whether a gap is pay compression

One question sorts the cases: is the gap that narrowed a gap the organisation intended, and did it narrow without a decision? A small gap that was designed is not compression. Two adjacent grades in a pay scale built on narrow steps are a design, not a case of pay compression, and the judgement rests on the gap that was intended, not on a gap that merely looks small. A difference set on purpose by a published rule, such as geographic pay differentials, under which the same job is paid differently by location, is intended in the same way.

Variation in pay within a single grade is intended too. It is what a grade range exists for, and differences in performance and experience within the range are expected.

Low pay across a whole level is a different question, because no gap between two internal salaries has narrowed. It concerns where the organisation stands against the market, which is the subject of external pay equity, and correcting internal gaps does not remedy it.

Pay below the grade minimum is a separate condition again, known as green circled pay. It can occur together with pay compression without being the same thing.

Before a single salary is raised to correct pay compression

The first question: is the case an inversion of the order, or a narrowing of a gap that still exists? An inversion calls for a decision; a narrowing can bear another year of monitoring.

The second: what is the internal increase rate, and how is the entry rate moving? If the difference between them stays as it is, compression returns after the correction at the same speed, and the organisation will have paid once only to pay again.

The third: what will be said to the employees the correction did not cover? A targeted correction can become known inside the organisation however quietly it is made, and an answer not prepared before the decision gets improvised after it.

This is an explanation of the concept, not legal advice.

Related terms

• Wage Drift
• Geographic Pay Differentials
• Job Classification
• Career Path Ratio
• Retention Rate