What do companies with in-person and virtual employees do when many of their workers can choose their own cost of living (COL)? Historically, salaries were local because everything was local. Most people lived near — or within a reasonable commuting distance to — their jobs. But the global health crisis of 2020 upended traditional work approaches. Companies went virtual, and many employees took advantage of that new flexibility to work from anywhere, seeking less expensive places to live.
Should a company base its salaries according to where its workforce is located? Many argue that regardless of where an employee lives, employers should calculate salaries according to the value someone brings to their organization.
Whatever formula they use, how organizations pay their remote employees impacts the caliber of people they attract and retain and company culture. A location-based strategy keeps salaries competitive and cost-effective. A value-based strategy pays employees according to market rate and experience level.
There is no one-size-fits-all answer. Many factors determine which compensation strategy a company should use to compensate its employees.
Calculating location-based compensation requires companies to develop their own formulas to factor in local expenses, market rates, employee skills and experience. Typically, employees in the same roles see location-based pay differences between 3% (entry-level roles) and 90% (software engineering roles).
When setting salaries, companies analyze some — but not necessarily all — of the following variables:
- COL index: metrics of an area’s core expenses such as food, housing, meals, transportation and utilities
- Experience: the level of education, skills, and time employees have spent in their current and previous roles to more accurately determine whether their salary should sit at, above or below the current market rate
- Income tax rates: challenging to calculate from state to state because each state structures its tax rates differently; however, international employees may pay higher tax rates depending on where they live, so a slight salary boost may make sense
- Market rates: tools like Glassdoor and PayScale help HR departments research and calculate pay for specific positions locally and nationwide.
Depending on their values and capacity, companies weigh these variables differently. One organization with more remote-based employees may lean heavily on market rates rather than the COL to ensure compensation parity. Another company with limited resources may base its salary structure exclusively on experience and market rates.
A majority of employers appear reluctant to adjust salaries based on where their employees live. One survey found that only 4.3% of companies considered lowering compensation for employees living in lower-cost areas versus 56.5% saying they wouldn’t. This compensation strategy does have some benefits, however. It enables companies to keep salaries competitive while avoiding the necessity of paying the highest market rates. These organizations remain attractive without having to stretch salary budgets thin to engage and retain top talent.
Because the COL offsets pay differences, a perception of equity exists, empowering businesses to set enticing wages without having to pay the highest rates across all markets. A location-based approach allows more flexibility in compensation planning for organizations with distributed teams working in multiple countries with multiple currencies. Strategies are calculated based on region rather than the role or job.
Yet this compensation strategy presents significant drawbacks. It can lead to pay cuts, which becomes challenging for HR to justify to employees and execute. Employees may also struggle to negotiate raises if management believes other people living in less expensive areas will work for lower compensation.
Finally, by adopting this approach, companies may see higher employee turnover. Remote employees living in lower COL areas may feel alienated and have lower morale when they realize their colleagues earn more for doing the same job merely because of geography.
Value-based salaries are calculated based on the merits of someone’s work. People with the same jobs and responsibilities earn the same salary regardless of where they live.
Value-based salaries offer a powerful tool for attracting and retaining talent. In fact, 94% of employees think skill set — not geography — should determine their salaries. In addition to reducing inequalities, this compensation strategy offers employees more financial autonomy. They gain more control over their careers by choosing to upskill through professional development and training, gaining experience to command a higher salary and more promotions throughout their career.
The biggest drawback? Setting a salary scale based on value eats up more budget. But it’s possible to minimize the risk of falling below the national average — and losing out on attracting and retaining top talent — by keeping pay within the top 25% of salaries for the same position nationwide.
One other possible downside? Employees living in more expensive geographies may resent earning the same as their colleagues living in lower COL areas. The best way to address this is through salary transparency and pay bands.
The only real pay differentiator with value-based salaries is experience levels. Companies must use an objective system to fairly evaluate employee skills and knowledge.
Creating a Compensation Strategy
The following steps will help determine which compensation strategy makes the most sense for your organization:
- Use data to evaluate and analyze your company’s current strategy.
- Research market rates as well as your competition.
- Evaluate your company budget.
- Calculate how many employees you need to fill current or existing gaps.
Above all, regardless of the strategy you choose, champion salary transparency. This helps reduce workplace stress and increases employee engagement, happiness, and satisfaction. Publishing pay bands and salary ranges establishes a culture of trust and holds companies accountable. By making pay bands accessible internally, companies empower their employees to own their career paths and identify the knowledge or skill sets they need to grow and thrive. Finally, when seeking new talent, include pay ranges and specifics about employee benefits on job descriptions.
Additionally, developing the proper compensation structure requires a balance between tangible and intangible benefits. After all, employee salaries don’t include just the financial compensation. While it’s important to analyze the market rate and set the range accordingly, companies can factor in other benefits that put less strain on the budget.
Look at other benefits including flexible scheduling and remote work options, home office stipends, HSA or FSA, multiple healthcare plans and insurance options, PTO, paid family leave, professional development opportunities, quarterly or annual performance bonuses and 401(k) plans with or without company matches.
Should employee geography factor into their salaries? It’s a tough call. But how companies pay their employees has a lasting impact on organizational culture. The ultimate goal — regardless of pay structure — is to keep compensation fair and as unbiased as possible.