You’re Underpaying. Now What?

Most organizations don’t intend to pay employees low, but market shifts and legislation changes can often result in underpaid employees. If budget is tight and you’re concerned about how to tackle the problem without giving your CFO a panic attack, don’t fret. We’ve got you covered with some things to consider and tips on how to address the situation.

First, it’s important to identify what you’re underpaying to – market, ranges, pay legislation changes, or all three? This will help you pinpoint areas to prioritize when increasing pay.

The New Minimum Wage:

Many municipalities have already adopted a minimum wage that goes beyond the federal level (currently $7.25/hour). If that number seems low to you, then your city likely has a law on the books dictating higher pay. As an HR practitioner, especially one involved in compensation, it’s important to keep an eye on your compliance with wage laws in your area. One of today’s hottest topics is minimum wage so you can expect to see more cities implementing increased rates in the coming years.

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If you have employees paid below minimum wage, you should be increasing pay for those individuals before all others. Being out of compliance with minimum wage laws can result in lawsuits and end up costing the organization more in the long-term so it’s better to spend the money now vs. paying for it later.

The DOL recently passed legislation increasing the minimum salary for exempt employees. If you’re concerned about underpayment for salaried employees relative to the new law, see our post 3 Things You Need to Know about the New FLSA Overtime Rules.

Market Demands:

For many, low paid employees are discovered during a market study. Before you pull out the company checkbook, make sure you think through what it means to underpay to market.

First, consider what market is to you. Market should be the industry, company size, and location where you compete for talent. I repeat—where you compete for talent. This is an important distinction because many organizations will embark on a market study assuming they should benchmark their pay against their industry, their location, their size. Think of the market as the competitive landscape in which employers battle for employees. For some, that market is very different than the makeup of their business. PayScale is a perfect example. We’re a software as a service company in Seattle with roughly 350 employees. If we benchmark ourselves against other similarly situated companies, we would be ignoring some important influencers in our market. Yes, I’m talking about you, Microsoft. And Amazon. Even Boeing. Despite the fact that PayScale is not in the Aerospace industry, Boeing still influences the supply and demand of talent in our area and drives up the cost for employees. Same with Microsoft and Amazon. As an employer, it’s important to identify the labor competitors in your area and take them into account when defining your market.

Next, once your market is defined, consider how competitive you wish to set your pay relative to this market. Many will target pay at the 50^th percentile of the market (or market median), which is a good starting point if you’re not sure what your target should be. Your target percentile establishes whether you plan to pay at market, above market, or below market, which helps give context for your underpayment.

Now that you’ve selected a target percentile, consider that employees paid below your target are not actually underpaid. Yep, you read that right. Your target percentile should reflect where you plan to pay proficient employees. So just because someone is paid below your target doesn’t necessarily mean they’re underpaid. Think about it—are you actually going to pay every employee at the 50^th percentile of market for their job? No, you’re not. You have some employees that are new/less proficient and some that are more tenured/beyond proficiency. You’re not going to pay all those people the same. When you compare internal pay practices to your target percentile, of course you’re going to have some people paid above your target and some below. That’s okay!

So what is underpayment to market? Generally speaking, employees paid below the 10^th percentile would be considered extreme market outliers and should probably get an increase if you don’t want to lose them. Some companies will set a threshold—like all employees paid below the 25^th percentile are considered underpaid. In PayScale’s Insight Analytics, we deem an employee underpaid if their pay falls 20% or more below the target percentile. Either way, if you’re examining payment relative to market, you need to draw a line where you feel underpayment is happening (hint, it’s not the 50^th percentile).

Pay Ranges:

If you are implementing a pay structure—pay ranges, pay bands, or pay grades—you may discover some employees whose pay falls below your range minimums. The ideal solution would be to increase employee pay to at least the minimum of their pay range, provided the person is performing well. That said, it may not be financially feasible to increase everyone’s pay all at once. When that is the case, consider whether spreading out increases over several budget cycles would help to soften the blow.

You could allocate the same amount to every underpaid employee each cycle until their pay reaches the minimum. But let me suggest a more strategic approach, which would be to prioritize increases based on employee performance and/or for critical jobs or departments. Focusing on employee performance will help ensure you keep your top performers working for you—if they’re underpaid to your ranges, they are at risk of being poached away by your competitors. Focusing on critical jobs or departments ensures you are fully staffed in the areas that drive your business forward.

Last, consider whether there are special circumstances in your organization that would allow for paying employees below range and create some policies around when and how that underpayment can occur. This practice is common for jobs where new hires must complete some training or coursework before they can actually begin doing the job. When that is the case, employers may choose to set the employee’s pay below the minimum until they complete their probationary period/training. The key here is that the underpayment is only allowed for a certain period of time and under certain circumstances.

Don’t Forget the Communication:

Whatever the cause for your underpayment, when it comes time to increase an employee’s pay, make sure you are clear in your communication about the reason for the increase. Even when prioritizing increases for your top performers who are below range or low in market, you want to explain that they are receiving an equity adjustment or market adjustment. Why? Because an equity/market adjustment and a merit increase are not the same thing. You do not want employees to conflate the two and expect a 15% increase come performance review time just because they received a 15% bump to get them to range minimum.