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Are You Overpaying Employees? Here's How to Find Out

For small and large business owners alike, figuring out how to compensate employees is a complex task. As businesses navigate the murky waters of employee pay, many end up making salaries too high. Unfortunately, as beneficial for the employee as this may be, overcompensating employees can quickly run a company out of business – especially if the high-paid employees aren’t star performers.


The goal isn’t to underpay people; that often just results in resentment, lower job satisfaction, and high turnover. However, overpaying employees can negate the benefits of fair pay and deeply hurt revenues. Here are some ways to tell if you are overpaying employees, as well as potential remedies.


Red flag: You’re lacking the right kind of turnover.


Although many business leaders dislike the concept of employee turnover, it isn’t always a bad thing. In general, it’s good to encourage mediocre and unproductive employees to leave the company.  Although firing bad employees is always an option, certain leaders aren’t comfortable with it and it can cause stress and lower employee morale. It’s much easier to gently allow someone to leave.


If the pay is much higher at your company than at competing businesses, however, it could be difficult to convince an employee to leave. They also don’t feel a need to work harder, as they’re already being rewarded for their current level of productivity. If you’re noticing that you’re having a difficult time gently getting rid of low-performing employees, it may be because they have no incentive to leave such a high paycheck.


Solution: Know the competing market rate for salaries.


If you base employee salaries on broad national averages, it’s easy to miss the mark. Since cost of living varies so widely state by state (it’s a lot cheaper to live in rural Oklahoma than metropolitan New York), you should compare your salaries to others at the state level.


Further, pay attention to the types of companies whose salaries are listed. The salary at your 100-person company will not be as high as those at a 1,000 or 100,000-person company, and businesses in certain industries gross more revenue than those in others. Make sure you compare the salaries of businesses similar to yours.


To get access to this information, get involved in industry groups so you can keep track of current market rates. You can also talk to members of your local chamber of commerce, headhunters, and recruiters who will often provide some free guidance.


Red flag: You’re bound to high salaries.


Due to employment law, it is extremely difficult to pay two employees with the same job at different rates. This means that if you hire someone at a higher salary than they deserve, you will undergo a lot of pressure to continue overcompensating people for that position. This is a fast way to run yourself out of business.


You can’t tiptoe around and set certain employees’ base salaries lower than others, either. For one, salary leaks happen often and people talk. Also, it is extremely difficult to prove that you aren’t discriminating against a certain employee unfairly, especially if the employee is a member of a historically underserved community. If, say, a high-performing woman at a male-dominated tech firm discovers that she is being paid less than her male counterparts with identical jobs, it will be difficult to convince her that it’s because you figured out you were paying the other employees too much. Instead, it’s more likely that you’ll become embroiled in a discrimination lawsuit.


If you find yourself in situations in which you feel obligated to overcompensate some employees because you overcompensate others, you might just be paying everyone too much.


Solution: Pay for performance.


Sometimes, there’s a gap between the compensation applicants and employees feel they deserve versus what they actually deserve. Although it is easier to fire exceptionally low-performing employees, it can be difficult for managers to get rid of employees who are just doing “OK” (but not always).


Instead of mass firings, consider implementing lower base salaries with bonuses for high performance. This way you can pay employees who are just barely getting by for the work they’re producing, while rewarding higher-performing employees with more compensation. This will give lower-performing employees incentive to work harder or leave the company, and high-performing ones to stay.

Overcompensation can be a death toll to any company, no matter the size or location. By paying attention to symptoms of overpaying employees, you can catch the problem before it becomes irreversible.