Salary compression is one of those technical terms that can feel abstract until it shows up in your organization.
At its core, salary compression happens when entry-level or newer employees earn either more than or very close to more tenured and/or experienced employees. Over time, the system loses meaningful differentiation across compensation levels.
Salary compression is not a failure of values. In fact, it most often emerges in organizations that are growing, adapting, and doing their best to respond to labor market pressure with limited resources. But left unaddressed, it quietly erodes trust, retention, and the credibility of your compensation system.
Table of contents
1. What Salary Compression Is — and Why It Happens
3. How to Address Salary Compression
4. Differentiating Pay Going Forward
5. External Forces That Accelerate Salary Compression
6. Final Reflection: Protect the People Who Stayed
What Salary Compression Is — and Why It Happens
Salary compression occurs when pay practices and annual increases fail to keep pace with shifts in the job market.
The most common reason we see this in nonprofits is simple:
Most organizations budget for 2 – 3% annual salary increases, but the reality is that the labor market often moves faster than that.
And in sectors like education and community-based services, that market movement is often driven by forces entirely outside your control, such as union negotiations, grant restrictions, or spikes in regional cost of living.
Imagine an employee who has been with your organization for 10 years and has received steady 3% annual increases. Over that same period, the external market has shifted more aggressively. When you hire a new employee into that same role at today’s competitive market rate, their starting salary may land surprisingly close to your long-tenured staff member’s pay.
Over time, differentiation erodes, and compensation levels flatten.
That is salary compression.
The Two Most Common Causes
We typically see wage compression emerge from:
1. Market movement outpacing annual increases: The longer this continues, the more compressed the structure becomes, especially when higher salaries are required to attract new talent in a competitive labor market.
2. Chaotic or inconsistent salary management: When organizations lack a clear compensation strategy with policies around the “why” behind pay increases, negotiation power can advantage new hires while current employees and long-tenured staff remain stuck within incremental patterns.
There are also more specific sector realities:
- Grant restrictions that impose wage floors not aligned with internal structures
- Local school districts that renegotiate union contracts with significant increases
- Labor shortages in specific roles that drive rapid market shifts
For example, a nonprofit daycare center may have been providing 2% increases annually. If the local school district negotiates a 7% union increase, the nonprofit must hire new teachers at those higher market rates, potentially bringing them in with salaries comparable to or higher than those of veteran staff.
None of this happens overnight. Salary compression is almost always the result of years of well-intended decisions made without a system designed to absorb change.
Why Leaders Should Care
When pay compression sets in, your tenured staff feel it first.
They may not use the term “compression,” but they will use words like:
- “Undervalued”
- “Unfair”
- “Why am I still here?”
Institutional knowledge holders begin to question loyalty, employee engagement declines, and turnover risk increases, particularly among experienced employees who know they could secure higher salaries elsewhere in the job market.
But this is not just a pay issue; it is also a pay equity issue.
When long-tenured employees earn nearly the same as new hires despite years of contribution, institutional knowledge, and sustained performance, differentiation disappears. The message received is not about market movement. It is about value.
And without clear structure and logic, compression can disproportionately impact staff who are less likely to negotiate aggressively, including women and employees from historically marginalized identities. Over time, this can unintentionally reinforce inequities your organization is actively working to dismantle elsewhere.
A compensation system may be legally compliant and technically defensible. But if it does not feel fair in practice, or if pay transparency reveals unexplained inconsistencies, trust erodes.
We often hear a phrase in this context: “The fastest way to earn more is to get a new job.”
When the marketplace rewards external mobility with higher pay more than it rewards loyalty among current employees, your retention strategy weakens, and your equity commitments are tested.
This isn’t just a technical issue with pay scales. It’s about fairness and whether your compensation management systems actually live up to your organization’s values.
For a comprehensive framework on building equitable, market-aligned pay systems, read Compensation with Purpose: Designing Equity-Centered Pay Structures for Nonprofits, Education, and Healthcare.
How to Address Salary Compression
Addressing salary compression requires disciplined analysis and structured sequencing. We recommend thinking about it in three phases: discovery, prioritization, and correction.
Phase 1: Discovery — Identify Where the Gaps Exist
There are three core diagnostic questions:
1. Is there an issue with my pay structure?
Look at the labor market. Ensure your salary ranges are competitive and that your structure incorporates current market data. Your compensation management approach must reflect how the job market is evolving.
Markets move, and our employee compensation framework must move with it.
2. Is there an issue with how jobs are placed within the structure?
Conduct a job analysis:
- Are job descriptions current?
- Are similar roles classified at the same level?
- Are the scope and experience requirements aligned with the pay range?
This is your annual “hygiene review.” Inconsistent job classification often compounds compression.
3. Is there an issue with where individuals sit within their ranges?
Here’s a useful exercise to help identify employee pay gaps: Imagine launching a twin version of your organization and rehiring everyone today.
Based on:
- Years of relevant experience
- Time in role
- Specialized skill set or credentials
- Performance (if applicable)
Where would each employee reasonably fall in your updated structure, and then compare that target position to their current placement. This pay gap analysis will identify compression clearly.
You should expect long-tenured, strong-performing staff to sit near or above the midpoint in their range. If they do not, you likely have compression.
Merit-Based Pay Caveat
If your organization uses merit-based differentiation, performance must be considered in placement decisions.
However, most nonprofits use either:
- A “peanut butter” approach (everyone receives the same annual increase), or
- A baseline cost-of-labor increase with a small performance-based adjustment layered on.
In many cases, performance differentiation is modest and does not fully prevent compression.
If you are considering layering performance differentiation into your annual increase strategy, read How to Design Merit-Based Compensation in a Fair and Motivating Way to ensure your approach reinforces equity rather than undermines it.
Phase 2: Prioritization — When You Cannot Fix Everything at Once
Very few organizations can immediately correct pay compression across the board. Instead, you must articulate a clear, defensible logic and apply it consistently.
Common prioritization strategies include:
- Addressing the widest gaps first
- Bringing everyone within a defined percentage of their target position
- Prioritizing roles of high strategic value
- Focusing on positions hardest to recruit
For example, you might decide:
- “We will bring all existing employees within 10% of their target market placement.”
- “We will first correct roles more than 15% below the midpoint.”
- “We will prioritize direct service and fundraising roles.”
The key is consistency. Avoid evaluating individuals one by one without a framework because that is where bias, disparities, and pay inequities creep in.
Phase 3: Correction — Iterative and Strategic
Compression is interactive, which means that when you adjust one salary, you may affect others in the same job family.
The process often looks like:
- Conduct analysis
- Make adjustments
- Re-analyze
- Identify ripple effects
- Adjust again
Every shift requires recalibration so that you aren’t making compression issues elsewhere in the organization. Because very few organizations can resolve compression in a single budget cycle, this work is typically phased.
Many organizations address it over a three-year horizon:
- Year 1: Correct the most significant gaps
- Year 2: Address secondary compression issues
- Year 3: Final alignment and stabilization
Build this plan into your financial projections. Set clear benchmarks. Communicate your timeline transparently.
What matters most is not speed — it is clarity and consistency. Staff is more likely to trust a structured, phased plan than a series of reactive adjustments.
Differentiating Pay Going Forward
In the nonprofit sector, pay differentiation typically considers:
- Time in role
- Years of experience
- Specialized credentials
- Meaningful performance differences
If you choose not to fix compression immediately, you can implement a more nuanced annual increase matrix.
For example:
Provide larger increases to:
- Long-tenured, high-performing staff below the midpoint
Provide smaller increases to:
- New hires above the midpoint
Over time, this can help close gaps.
Many organizations combine immediate adjustments with a multi-year matrix strategy.
External Forces That Accelerate Salary Compression
Grant Constraints
When funders impose wage ceilings that lag behind market rates, compression can accelerate.
We recommend:
- Bringing market data to funders
- Providing cost-of-living data
- Demonstrating how compression undermines sustainability
- Tying your compensation philosophy to mission impact
This is a moment to advocate, educate, and influence.
Cost of Living and Market Volatility
Over the past four years, the rising cost of living has driven cost-of-labor increases beyond traditional 2–3% budgeting norms.
Many nonprofits have shifted toward 4–5% annual increases just to keep pace.
Even if you are competitive with peers, if it becomes unaffordable to live in your region, staff may leave for different sectors.
Labor shortages also create sudden market spikes. For example:
If a large district negotiates a significant teacher pay increase, it affects:
- Charter schools
- After-school programs
- College access organizations
- Youth-serving nonprofits
Market forces ripple quickly. You must plan for volatility, not assume stability.
Final Reflection: Protect the People Who Stayed
When salary compression takes hold, your most loyal staff feel it first.
Addressing it is not about achieving perfection overnight. It is about making steady, principled progress toward a compensation system that pays competitively in the market, treats employees fairly relative to their peers, and visibly honors the people who have invested years in your mission.
That is how trust is rebuilt. That is how institutional knowledge is retained. That is how continuity and impact are protected.
Salary compression may begin as a technical issue within a pay structure. But its consequences are deeply human. The organizations that approach it with clarity, discipline, and equity at the center are the ones that ultimately keep their people — and strengthen their mission in the process.
If you are ready to move beyond reactive adjustments and build a compensation strategy grounded in equity, sustainability, and market alignment, explore Compensation with Purpose: Designing Equity-Centered Pay Structures for Nonprofits, Education, and Healthcare.
This eBook provides a practical framework for aligning pay decisions with your values, strengthening retention, and building systems your staff can trust.
