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Lag-the-Market Compensation Strategy

Are you considering implementing a lag-the-market compensation strategy? Although lag-the-market strategies are usually rife with pitfalls, there are some benefits to implementing a temporary or mixed approach. But it has to be the right plan for you. So, if you’re considering lagging the market, read this first.

What is a Lag-the-market Compensation Strategy?

Establishing or changing your organization’s compensation strategy is an important and complex task. In addition to matching your company’s mission and values, your compensation strategy should also be financially feasible and competitive enough to prevent staffing issues.

You might consider a lag-the-market compensation strategy, also called the market-minus philosophy. Under this strategy, organizations purposely pay their workforce lower than the market average.

Lag vs Meet vs Lead-the-Market Approaches

There are two other market-based compensation strategies. In the meet-the-market compensation strategy, organizations pay their employees the market average. Companies using the lead-the-market compensation strategy pay their employees more than the market average.

What are the Advantages and Disadvantages of a Lag-the-market Compensation Strategy?

The lag-the-market compensation method is typically less popular than other market-based compensation schemes because it usually has more disadvantages than advantages. However, there are still some clear advantages to implementing the strategy, either temporarily or in combination with other plans.

Here are some of the basic advantages and disadvantages you might consider when deciding whether to implement a lag-the-market compensation method.

Advantages

  • It’s cost-effective. Paying employees slightly less than the market average saves the organization money on labor costs. This may be an important consideration if the company is experiencing financial difficulties.
  • It enables companies to invest in non-pay perks. If you pay less in compensation, you can still attract employees with other fringe benefits like generous flex time, remote work, child-care assistance, free gym memberships, or on-site health perks. Your organization may have to take on the cost of these additional benefits, but it may still cost less than increasing compensation.

Disadvantages

  • It’s less competitive. Paying your employees less than the market average will make your company less competitive and more likely to lose top candidates. In some cases, employees may not value additional non-compensation perks enough to turn down higher offers.
  • It can lead to turnover. Employees may feel undervalued by the company, leading them to look for work elsewhere. This is particularly the case if they’re aware that company leaders are paid much more than they are.
  • It creates ambiguity. Increases in turnover, even if infrequent, creates uncertainties since employees can leave vacancies without much advance notice.
  • It damages employee performance. Studies show that employees who feel underpaid and undervalued by their company tend to perform worse.

How to Know if a Lag-the-market Strategy is Right for Your Organization

If Your Organization Needs Money

If your organization is struggling financially, implementing a lag-the-market compensation method may be a necessary element of your organization’s budget planning.

If you choose to do this to save money, you’ll want to consider how far below the market average you can go without compromising your organization’s performance so much that it eliminates the cost-saving benefits of dropping salaries. You’ll also want to think about how long you’re willing to implement the strategy, since implementing lag-the-market long term will likely have diminishing returns.

If You Don’t Have a Lot of Competition in Your Area

It may be that you don’t have a lot of competition in your geographical area. This is common when you’re the only company in a particular industry in your region. If this is the case, using the lag-the-market strategy won’t have as big of an impact on retention.

If There is a Lot of Slack in the Labor Market

If there are few open jobs and lots of candidates looking for them, then you may be able to drop compensation in your organization without increasing turnover. Even if you choose to do this, you’ll want to consider the fact that labor markets fluctuate. Employees may leave when the market improves, not just because of the salary but also because they may feel that the organization took advantage of them while the labor market was bad.

It’s important to note that as of this writing in 2021, the job market in the United States is pretty tight, which means that employees have the upper hand in negotiations.

If Your Reputation is Attracting More Candidates than You Need

Some organizations have such a good reputation that they can attract top candidates without as much pay. For example, if a company is known for creating the best products or achieving notable success, their notoriety may be more valuable to the employee than the pay.

Although this can attract talent initially, notoriety sometimes leads employees to use the job for resume-building. If you choose to drop your compensation because of your company’s reputation, you’ll want to decide whether a certain amount of turnover aligns with your business strategy.

Why You Should Consider Mixing Compensation Strategies

You don’t have to use the lag-the-market compensation strategy across all job categories in your company. In fact, there are true benefits to mixing compensation strategies to focus on either acquiring top talent for key positions or to improve your company culture.

Acquire Top Talent for Key Positions

One way you can mix compensation strategies is by using the lag-the-market plan in some positions so that you can implement a lead-the-market strategy in other positions requiring top talent.

To do this successfully, you’ll have to determine which positions in your organization can handle more turnover or periods of understaffing. You’ll also have to determine how much you can depart from the market average. If you deviate too much, turnover and vacancies can damage your company too much to be sustainable. And, if your employees notice too much disparity between certain employees, they’re likely to feel less engaged, underperform, or leave.

Improve Company Culture by Reducing Disparity

You can also use the lag-the-market strategy for executive positions so that you can provide above-market salaries to the rest of your employees. This will reduce the gap between top-earning employees, like C-suite executives, and the rest of your workforce. Reducing disparity in this way generally helps improve employee morale, engagement and retention. It will also help you acquire the best talent in the positions receiving leading-the-market compensation.

Questions You’ve Asked Us About Lag-the-Market Compensation Strategies

What are examples of companies using lag-the-market compensation?
Companies that pay employees below the market average include Taco Bell, TJ Maxx, Denny’s, and others. However, it’s important to note that many companies use a mix of compensation methods.
Do I need a defined compensation strategy?
Every company should establish a defined compensation strategy. Compensation strategies help companies maintain a budget, facilitate growth and ensure compliance with pay equity laws.
Natasha Wiebusch

Natasha Wiebusch

Natasha is a writer and former labor and employment attorney turned HR professional. Her experience as a litigator and HR trainer inspired her to begin writing about anti-discrimination laws in the workplace. As a writer at Eddy HR, she hopes to provide helpful information to both employees and HR professionals who need help navigating the vast world of human resources. When she’s not writing, you might find her cheering on the Green Bay Packers or hiking in the Northwoods of Wisconsin.

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