Geographic Pay Differential

Simeon McGee
Simeon McGee
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.

Watch the world’s largest HR encyclopedia be built in real-time

Subscribe to get a weekly roundup email of all our new entries

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.

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.

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, 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 of 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.

Cost of Labor

When factoring in the cost of labor, it can be difficult to calculate pay differentials. In reality, 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 the 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 the Silicon Slopes.

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.

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 fact 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?

Indeed, remote work has a monetary value which is defined differently by each individual and 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.

Understanding this concept is crucial to understanding why physical location plays an important factor into pay differentials.

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. Following are two widely used strategies.

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 at $60,000, the candidate in Flagstaff should receive an offer at $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.

2. Fixed-Dollar Amount

Similarly 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 Fallsafter 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.

Watch the world’s largest HR encyclopedia be built in real-time

Subscribe to get a weekly roundup email of all our new entries

Questions You’ve Asked Us About Geographic Pay Differentials

Do most companies implement 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.
How is differential pay calculated?
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 McGee
Simeon McGee

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!

Want to contribute to our HR Encyclopedia?

Posts You Might Like

The Top 4 Reasons to Change Your Payroll Provider

The Top 4 Reasons to Change Your Payroll Provider

When it comes to choosing a payroll provider, there is so much more than just running payroll. Unfortunately, many business owners rush to choose the provider without considering many alternatives. Learn more about the four reasons you should consider making a change.

Read More »
What Are Fringe Benefits

What Are Fringe Benefits?

Employee compensation can take many different forms. Most people think of it as the money that ends up in your bank account at the end of a pay period. But for many of us, the fringe benefits we enjoy from our employer play a significant role in our compensation package.

Read More »

Want to join our network of contributing HR professionals?

Scroll to Top

Submit a Question