Author: Tom Wardrip

President Biden signed a number of executive orders in his first days in office, including Executive Order 14003, "Protecting the Federal Workforce." This order states, "the Director of the Office of Personnel Management shall provide a report to the President with recommendations to promote a $15/hour minimum wage for Federal employees." This order is considered the first step toward requiring federal employees and federal contractor employees receive a minimum wage of $15 an hour. Days later, the "Raise the Wage Act" was introduced in the House of Representatives to raise the minimum wage to $15 an hour by 2025.

The growing movement in the United States to increase the minimum wages paid to workers goes by a number of names: Push to $15, Move to $15, Living Wage, Poverty Wage. President Biden’s executive order brings the issue into the national spotlight. Companies must understand how the minimum wage movement will impact their organizations.

A few large employers have taken a national stance on the issue and declared their own minimum wages. As more and more large employers announce these moves, other organizations and lawmakers will feel pressure to follow suit. The executive order seeks to lead through the example of the federal government. Is your organization considering joining the fray and increasing the minimum wage offered to employees? What will it take to do this? What kind of return will the organization receive for the additional money spent in payroll?

Getting Started: Consider Your Market

So you want to move your employees to a higher minimum wage, but what wage should you move to as a starting point? As a start, take a look at your market. Is there a large employer in your area that just announced a move to $15 an hour? Is the local government working on an increase to the minimum wage? Do you want to match the proposal in the "Raise the Wage Act"?

Employers need to think about compensation as one part of the bigger picture of total organizational wellbeing. Integrated compensation and benefits programs, often called total rewards, are defined as the total of all components given to an employee for their service. Typical components include: base pay, benefits, retirement contributions, and incentives. Cash compensation typically makes up the largest percentage of the total rewards picture, but organizations can choose to emphasize other aspects of workforce wellbeing as a market differentiator. Unfortunately, many employees never look past the cash compensation or base pay, especially in the jobs that are sensitive to minimum wage increases.

Setting a Compensation Philosophy is an important first step when considering how to pay your employees. Many organizations articulate this philosophy through formal documentation; others do it in practice. Any organization looking at raising their minimum wage is adopting a philosophy to pay an above market premium to its workers.

Implementing A New Minimum Wage

Once an organization has established a new minimum wage as a goal, it’s up to leadership to determine how to make it happen. This often involves a meeting with the Human Resources Department of the organization to begin understanding the cost to achieve this goal.

Option 1: Increase employees to new Minimum Wage only

In its simplest form, all an organization has to do is identify all employees who are below the minimum wage and increase their rate to the newly established minimum wage. This method allows companies to advertise to the community, employees, and new recruits that they pay a minimum hourly wage of $XX.XX. This is the cheapest option for an organization that wishes to pay a higher minimum wage; however implementing this option also brings the most potential to create other issues in the organization.

If employees are increased above the new minimum age and no further adjustments are made, it will create wage compression with other employees.

  Employee Tenure Current Hourly Rate
 Adjustment Needed to Reach New $15 Minimum New Hourly Rate
Employee 1 1 Year $13.80 $1.20  $15.00
Employee 2 4 Years $15.00  $0.00  $15.00

Option 2: Increase employees to new Minimum Wage and maintain employee place in range

In the example above, both employees are adjusted to the new minimum wage of $15.00. This scenario creates an issue known as wage compression. Traditionally, people are rewarded for their tenure through higher wages. These increases come through general and merit increases, among other options. Employee 2 has more tenure with the organization, which was reflected in the higher hourly rate. Without further adjustments to the wage of Employee 2, the move to an hourly rate of $15.00 has erased the increases earned during the 4 years with the organization.

If an organization wishes to avoid dramatic wage compression, it must also increase the hourly wages for employees who may already be above the new established minimum wage. These additional adjustments help to maintain the pay history of the organization.

  Minimum Midpoint
 Maximum
Current Grade $13.00 $16.25 $19.50
  Current Hourly Rate Place in Range
Employee 1 $13.80 6.15% above the Grade Minimum
Employee 2 $15.00 15.38 above the Grade Minimum
  Minimum Midpoint Maximum
Proposed Grade $15.00 $18.75 $22.50
  Place in Range Proposed Hourly Rate
Employee 1 6.15% above the Grade Minimum $15.92
Employee 2 15.38% above the Grade Minimum $17.31

Challenges

How much additional cost is reasonable to add to the organization to achieve the desired result? How can the grade structure change to minimize costs without creating additional compression?

Organizations must fully understand the impact of all changes before moving to implement those changes. Careful planning can help avoid piling on to existing issues in the compensation program. Organizations should model all wage changes down to the penny for each employee. Consider creating a working document where each element of the initiative can be adjusted in real time to see the potential impact. 

If the lowest grade starts at $10.00 and the organization wishes to move to a $12.00 minimum wage, the organization could:

  • Move all grades up by $2.00 per hour
  • Move the first grade in the structure by $2.00 per hour, and subsequent grades slightly higher to some reasonable point ($1.50, $1.00, $0.50)
  • Move grades higher, but reduce the range widths of each grade to keep the grade maximums from climbing too high
  • Remove the first few grades in the structure altogether and create one super grade

Beyond the challenge of modeling what may create the least wage compression, organizations need to afford those changes. A dynamic model will help evaluate the impact of each element, but the organization may have to consider such alternate strategies in the organization as:

  • Reducing future pay increases to employees
  • Limiting the top and end grade of ranges, and
  • Reducing headcount, and increasing productivity 

Next Steps

Moving grade structures and ranges is always a daunting task. In reality the process is simple, but can have a huge impact on your organization. Dynamic modeling and careful planning can help you support employees’ career wellbeing. Contact Gallagher’s Human Resources & Compensation Consulting practice to help your organization achieve its compensation program goals to face the future with confidence. 

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