Table of Contents

Table of Contents

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If your company includes employees who live in different cities, you are probably aware that you may need to pay them differently to account for the cost of living in different places. How do you create and apply an equitable geographic differential policy? Read on to learn the basic concepts and steps of this process.

What Are Geographic Pay Differentials?

Geographic pay differential is the concept of paying different rates for employees in different locales. This is largely based on factors such as cost of living, cost of labor, and current market rates, but there are many other factors that can play a part as well. We’ll take a look at several of the key factors in the sections below.

Geographic pay differentials can make payroll complicated at times, especially with remote work becoming more and more commonplace. Let Eddy’s payroll team do the work for you so you can spend your time on other important HR tasks.

Reasons to Implement Geographic Pay Differentials

Employees may wonder why some people make more or less money than they do for the same job. While there are a lot of factors that play into this topic, geographic pay differentials are super common and easy to pinpoint. Here are three reasons why pay can legally and ethically differ for the same job at different locations.

Reason 1: Cost of Living

Imagine an employee lives in Twin Falls, Idaho, and you want to relocate them to Flagstaff, Arizona. Not only is the temperature significantly higher year-round in Arizona, but the cost of living is too. In order to maintain the same standard of living they previously had in Idaho, they will (as of this writing) typically need to earn 27% more in Arizona than they did in Idaho.

Why are some places more expensive than others? There are way too many factors to list all of them here, but some of the top contributing factors to the cost of living in a given area are housing affordability, transportation costs, food prices, and entertainment.

When considering transferring an employee from one location to another, or even opening a similar position in another area, make sure you take into account the cost of living when discussing salary. If a position pays $60,000 in Idaho, the market indicates that an employee will need closer to $75,000 to maintain the same level in Arizona. The same concept holds true for other areas of the world. The market rate varies from location to location.

Learn more about how to regularly adjust for cost of living here

Reason 2: Cost of Labor

When factoring in the cost of labor, it can be difficult to calculate pay differentials. In reality, the cost of labor fluctuates with the supply and demand of current labor within a specific role.

For example, as of this writing, Silicon Slopes in Utah is experiencing an extremely high cost of labor in the technology space. Technical-software-based positions (engineers, developers, architects, etc.) are in extremely high demand because of the boom in tech-based startup companies growing at exponential rates. This is causing the demand for these skills to increase at extreme rates, while the supply has remained fairly constant. The result is a dramatic increase in the cost of labor in these sectors.

This type of growth typically bleeds over into all other sectors as well, though at lesser values and slower rates of growth. The cost of labor will continue to increase as the demand for certain skills continues to rise. All this means that a software engineer in Silicon Slopes is likely to be paid higher than a software engineer in Phoenix, Arizona, even though most other positions in Phoenix would be paid at a higher rate than their counterpart in Silicon Slopes.

Reason 3: Market Rates

Market rates are closely tied to the above-mentioned factors. However, the market rate is largely based on how much an employer is willing to pay for a certain skill or job. Company A may need a very high-level sales professional to lead their team and build out the sales function because they are trying to generate a lot more demand for their product.

Company B may need that same high-level person to build out the function, but it isn’t as high of a priority. They will probably not be willing to match Company A’s offer because their need is not as urgent.

Similarly, the same job will have varying ranges based on the company’s geographic location, budget, market position, tenure in the market, etc.

Learn how to set the right compensation strategy for each role

Reason 4: Consumer Price Index

Regularly updated by the U.S. Bureau of Labor, the Consumer Price Index (CPI) is “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.” In other words, the Consumer Price Index keeps track of price fluctuations for things people buy on an everyday basis. It is used to measure inflation and deflation, and it’s tied to a variety of different laws and regulations.

For example, changes in CPI can affect the income of food stamp recipients and those receiving Social Security benefits, the cost of school lunches, and more. The Consumer Price Index can also be used to alter wages to account for the rising cost of goods. Since CPI is region-specific, employees working in different states will need different wage adjustments based on changes to the CPI.

How Remote Work Affects Location-Based Pay

We can’t discuss pay differentials without going into some detail on remote work and how it has changed the landscape for many companies and industries in the years since COVID-19 took the world by storm.

Prior to the pandemic, remote work was still largely a “perk” offered by companies. A Fall 2020 survey conducted by Deloitte Consulting in conjunction with EmpSight showed that 52% of companies had a remote work policy for a part of their labor force, and 7% still had no remote work policy at all. Only 18% of companies actually had a remote work policy for their entire employee base. This gives credence to the idea that remote work is still a “perk” and not a standard practice, even after all the changes brought on by the pandemic.

As remote work has become more and more popular, companies are understanding that this “perk” factors into their pay structure. Does an individual who performs the same job functions but lives in a different state merit a lower pay rate?

While the answer is different for each company, employees who put a premium on working remotely are likely to receive a lower wage depending on where they are located. In these scenarios, employees typically opt to move to smaller, less crowded cities to live and work out of. This will almost always come with a smaller paycheck due to the cost of living adjustments needed to calculate a fair wage.

But moving into the future, as working from home becomes more common, it may be helpful to think more about the relationship between wages and remote work. Between a labor shortage and The Great Reshuffling, HR should do everything they can to guide their employers to keep the great talent they have – not disincentivize them by cutting their pay.

How To Future-Proof Your Compensation Strategy

Here are a couple of ways to future-proof your compensation and benefits offerings for remote workers, hybrid workers, or anyone in between. 

Step 1: Take a Closer Look at Your Benefits Package

Wages aren’t the only incentive for employees. Reconsider the benefits you offer to your employees, and think about how those who work from home or on a hybrid schedule can fully benefit from them. 

For example, instead of the benefit of an on-site gym, think about offering a fitness- or wellness-related stipend so employees can work out (or seek out restorative time) where they want to. Or, instead of an in-office child care service, offer a reimbursement program to help offset the cost of a local babysitter. 

Better yet, you can ask your remote employees about the benefits and perks that are most important to them—and then give them those benefits and perks (instead of the ones you think they want or need). Making sure workers have useful benefits no matter where they’re working from will keep them satisfied and engaged.

Step 2: Make Remote Work (and Equal Pay) Part of Your Retention Strategy

Winning the war for talent means differentiating yourself from your competitors. And in our work-from-anywhere world, that means offering competitive pay, attractive benefits that meet your employees’ needs, and flexible working arrangements

Show your employees you value them, wherever they are working, by continuing to pay them fair and equitable wages—and not only will you retain the talent you have, you’ll attract the new talent you want, too. 

Methods Used to Determine Geographic Pay Differentials

One of the biggest factors in determining whether to use geographic pay differentials is deciding on a company strategy surrounding remote, hybrid, or in-office work environments.

In order to determine this strategy, you must assess if being onsite is an actual need for the company. This could include required collaboration to keep workflows moving forward, manufacturing plants where production is all onsite, or simply for security purposes. Many companies deal with sensitive information, and the task of keeping that information secure while allowing remote work is very high. There are countless reasons for deciding where your employee base will be located. The management team, with guidance from HR, should make the best decision for the company.

Once the strategy of where to work is defined, the company can then begin to understand what kind of differential strategy they want to deploy. The following are two widely used strategies.

Method 1: Percentage of Salary

Positions at most companies are accompanied by a base salary range. This range is often posted in the job description. While an exact dollar amount within this range is largely determined by experience level, part of the equation also includes geographic differential consideration.

For example, let’s consider Company X has posted a remote position paying an annual range of $60,000-$75,000. They have two candidates who are equally qualified in every way. Naturally, that would mean they should receive similar offers. However, Candidate A lives in Flagstaff, Arizona, and Candidate B lives in Twin Falls, Idaho. Just as in the previous example, Company X may have a percentage-based differential attached to this position for candidates in Flagstaff. Relying on the data they have collected, they have attached a 25% premium to the position based out of Flagstaff compared to Twin Falls.

If the candidate in Twin Falls is given an offer of $60,000, the candidate in Flagstaff should receive an offer of $75,000 (60,000 x 25%). Company X is holding true to the range associated with the position while simultaneously accounting for the geographic difference between the candidates.

Method 2: Fixed-Dollar Amount

Similar to the percentage-based approach, a fixed-dollar amount can be associated with each position within a company. Following our same example from above, let’s say our employee lives in Flagstaff but wants to relocate back to Twin Falls after two years of employment with the company.

During the last two years, the company switched to a fixed-dollar amount policy for the differential. Now the company has assigned a $10,000 premium to the position based in Flagstaff versus the position in Twin Falls. To adjust accordingly, the employee is dropped from $75,000 to $65,000. Again, companies need to perform surveys, research, and tests to understand what these numbers should be and how these principles should be applied.

If you’re still feeling overwhelmed, let us help! Eddy’s payroll team will make it as simple as possible to switch from your current provider and will provide everything from taxes to W-2s. Request a free, custom quote today to see if Eddy is a good fit for you

How to Implement Your Geographical Pay Differential

When deciding how to implement a geographical pay differential, you’ll need to make a plan for how you’ll divide up the areas your employees are located in. Here are the most common ways for companies to divide their workforce and determine differential pay. 

Regional

Using this method, you’ll break the country up into regions. You could create your own division, or you may choose to follow the U.S. Bureau of Labor Statistics version. They divide the United States into four main regions: the West, the Midwest, the South, and the Northeast. This method of determining geographical pay differential may prove problematic if some of your employees live in metropolitan areas, while others live in rural areas within the same region. You can work to overcome this challenge by creating more minute regional breakdowns, but you should expect that you’ll frequently need to make exceptions to the rule. 

State

This may seem like the most straightforward method of determining geographical pay differential, but it poses the same issue as regional division. If some employees live in cities while others don’t, the wages they receive won’t be as fair. 

City

Many employers prefer to use Metropolitan Statistical Areas (MSA) to determine geographic pay differentials. This method is more specific than state or regional methods, as it hones in on the specific area where an employee lives. They would only need a pay adjustment if they move out of their current MSA. With this approach, it’s fairly simple to create a pay structure based on cost of labor. For example, if the location of headquarters is set as 100%, then cities with very high markets could be set as 120%, high ones at 110%, low ones at 90%, and very low ones  at 80%. 

Location of Workplace

If employees live near the workplace, and it’s subject to similar economic conditions as the areas employees live in, this can be a good option.

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Questions You’ve Asked Us About Geographic Pay Differentials

Yes, roughly 71% of companies use some kind of differential when deciding what rate to associate with a given position and location.

There are several ways to calculate pay differentials. The most common forms are percentage of salary and fixed-dollar amounts, though there are a myriad of ways to figure out how to compensate employees. Plenty of research is required, with lots of adjustments along the way.

Simeon purposefully chose a career in HR, getting his degree in Human Resource Management with a minor in Business Management from Utah Valley University. He loves researching employment law and how it can and should be applied in the work place. His claim to fame is that Dave Ulrich called him out for yawning in the middle of a lecture!

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