How to Address Geographic Pay Differentials With a Remote Workforce

Introduction to Remote Work and Compensation Design

The COVID-19 pandemic required many employers to implement work-from-home mandates when and where possible. While these mandates were initially expected to be temporary, they have continued for over 18 months. Some employees considered the shift to working from home as an opportunity to work from anywhere. This could include locations outside the primary residence such as a parent's home, vacation home, Airbnb, rental within or outside the employee’s home state, and in some cases, outside the country. Advances in technology have enabled employees to conduct work from virtually any location and to move amongst a variety of places (work sites) in a somewhat nomadic fashion.

Concurrently, the demand for talent escalated at an unexpected rate and employers saw the work-from-home mandate as an opportunity to recruit from locations well outside the commuting distance of a brick-and-mortar office location. These changes evolved quickly, and some employers reacted before considering potential consequences and developing and implementing remote work policies. Now companies must respond to this situation and consider, among many other things, alternatives related to geographic compensation adjustments that may be costly for the employer to maintain or that are poorly received by employees.

With remote work likely to continue for the foreseeable future, many employers face fresh challenges related to remote work alternatives, an issue that may be viewed as one of the largest disruptors of 2020 and 2021. Employees have grown accustomed to working from home and the benefits this provides, and many are resistant to returning to the traditional onsite work environment. However, the issues are more nuanced than one might realize and have implications that may not be immediately apparent for either the employer or the employee.

As a starting point, it is helpful to distinguish between work from home and remote work. Work from home refers to an arrangement for employees who historically commuted to an office and now work at home due to COVID-19 restrictions or have the option to work from home on a periodic or regular basis. Their work-from-home arrangement typically includes coming into the office as needed. Remote work has developed a slightly different meaning. These are arrangements by which an employee permanently works from a remote location, which is not necessarily near a brick-and-mortar office. The employee may have been hired on the basis of this arrangement or made arrangements during their tenure with the company. A common scenario is when a current employee needs to move due to the relocation of a spouse and the company decides to allow the employee to work remotely from the new location.

 

The Challenge with Remote Work and Geographic Pay

Some employers are faced with a new set of circumstances in which they need to ensure that internal pay equity is preserved and that the organization has a cohesive and workable approach to handling location-based pay that allows them to attract and retain the best candidates. On the other hand, employees want the flexibility remote work provides but may not fully understand the long-term ramifications of this choice. One of the primary compensation issues that companies are grappling with are geographic pay differentials – should a differential be considered, and if so, how and when should it be applied?

Geographic pay differentials are changes to the level of base salary paid to an employee to account for variations in the cost of labor in different locations. The cost of labor is based on the local demand for and the supply of labor. The geographic pay differential may track with the cost of living, which is based on the local demand for, and the supply of, goods and services.^[1] However, it may be very different; for instance, in New York City, the cost of living is over 200% of the national average, while the cost of labor runs around 20%-25% above the national average depending on the organizational level of the employee and industry.

This leads to the questions of whether the organization should revisit its compensation strategy and whether the organization is ready to develop a remote work pay policy. This assumes that the organization has already evaluated managers' roles and their abilities to lead remote teams, and the ability of employees to work effectively from home (e.g., employee has a work arrangement that enables them to meet the needs of the job); thus, the issue comes down to the ability to track employee locations and the impact this has financially and from a quality of work perspective. Ultimately, the goal should be to develop a policy that provides clear guidance for managers and employees and reduces the need for ad hoc decision making.

There are a number of factors to consider when developing a geographic pay philosophy, including:

1. Current number of office locations
2. Number of positions impacted (structured such that working from a remote location is feasible)
3. Number of employees impacted
4. Limitations of the current human resources information system (HRIS)
5. IT and security concerns
6. Tax consequences

A detailed discussion of these factors is outside the scope of this article, but recognizing the complexities associated with each is critical.

Geographic Pay Differential Approaches

Once an organization has determined its ability to address the geographic pay philosophy considerations discussed above, it is ready to consider the alternatives for applying geographic pay differentials. There are five alternatives an employer can consider when determining the methodology that is the best fit with their current employee population:^[2]

1. National (U.S. average)
2. Regional
3. State
4. City/Metro/Metropolitan Statistical Area (MSA)
5. Work Location (reporting location)

 

National

The easiest approach is to use national labor market data and ignore geographic pay differentials. While the simplicity may be appealing to the employer (especially if employees are relocating on a regular basis) and could be interpreted as "fair," it presents internal and external pay equity risks. Employees who reside in a large city where both the cost of labor and the cost of living are substantially above the national average may be paid below market, whereas employees located in an area with lower pay differentials may be overpaid relative to the market. The national labor market approach is better suited for executive level positions where recruiting takes place at a national level, and whose base salaries often represent a smaller portion of the total direct compensation package than incentive awards, which often are primarily performance oriented.

 

Regional

The next option is to apply a regional adjustment. This would require a methodology for dividing the country into regions unless utilizing the Department of Labor’s segmentation recommendations. While certain portions of the country would have higher differentials (East and West coasts), the Southeast and South Central regions would lag the national average. This could present a challenge if large portions of the employee population reside in metropolitan areas such as Atlanta or Miami, both located within the Southeast region with cost of labor and cost of living differentials well above the region’s average.

 

State

Using statewide differentials presents similar issues as regional data in that employees residing in cities would be negatively impacted while those in rural areas would be less affected.

 

City/Metro/MSA

Using the MSA to establish pay differentials is often the best approach for remote work employees. It captures the cost of labor in the area in which they are located without getting too granular (as would be the case using a zip code). An adjustment would need to be made only if an employee moved out of the MSA (rather than requiring a potential pay adjustment if the employee moves to a new location within the MSA).

 

Work Reporting Location

The final alternative is to use the reporting location for the employee. This is a good choice if the employee lives near the physical worksite and is subject to the same economic factors driving the cost of labor / living in the reporting location. This is the most common approach for employees who are working from home (rather than remote work employees).

   

Implementation of Geographic Pay Differentials

Once the methodology for determining the geographic pay differentials has been selected, the next question is how to apply them. There are three areas to consider:

1. Salary Structure vs. Individual Adjustments
2. New Hires vs. Existing Employees
3. Employees Categories (executive, exempt, non-exempt)

These decisions are a function of the sophistication of the current salary administration system and the number and type of impacted employees/jobs. If there is a clearly defined salary structure and a large number of impacted employees, then applying the geographic differential to the salary structure makes the most sense. The compa-ratio (salary divided by midpoint) is calculated based on the geographically adjusted midpoint, and individual pay rates can be adjusted accordingly. For small organizations, it is significantly easier to make adjustments on a case-by-case basis.

Another issue is whether to apply a newly developed geographic pay policy to the entire employee population or to limit it to new hires. Limiting it to new hires could become problematic due to the potential for pay inequities that could create legal risk related to paying substantially different amounts for like roles at the same grade or level.

The last consideration is how to tailor the geographic pay policy to the employee level and/or Fair Labor Standards Act classification. The best approach may be a dual approach such as using national labor market rates for executives who will be working remotely without having a physical presence at the headquarters location, while at the same time developing regional or local geographic differentials for workers expected to be on-site at least one time per week.

Any individualized geographic pay adjustment for existing employees, whether up or down, should also factor in performance and overall contributions. It is a good idea to have a policy that addresses scenarios such as an employee moving to a location with a higher or lower pay differential even though the company does not have a business need in that location. The company may want to consider the employee’s performance, how critical the role is and risk of losing the employee before implementing a change in pay.

Voluntary relocation is another way of accommodating changes in work location that recognizes the employee’s desire for flexibility. This may come at a cost to the employer if the employee is fully remote, as the employee no longer has commuting or wardrobe costs and now may want the compensation to reflect these new costs. A recent WorldatWork survey indicated that in cases such as this, 67% of employees expect pay to be based on geographic location, while 50% said a resulting pay adjustment would be very influential on their decision to relocate.^[3] Twenty-seven percent of employees surveyed expect their pay to be adjusted by up to 10% as a result of a relocation.^[4]

The timing of the pay adjustment is also a critical factor to consider, with 48% of employers selecting an effective date that coincides with the rollout of the policy. Other practical alternatives include:

• At the time of the annual review
• At the beginning of the calendar / fiscal year
• Phased approach / transition period

An issue closely tied to voluntary relocations are stipulations related to the need for employees to be physically present at the work site. If physical presence is required on a regular (weekly) basis, geographic differentials reflecting the cost of labor in the reporting location are more significant than for those whose presence is required infrequently (monthly or quarterly).

 

Conclusion

There are a variety of factors that go into setting compensation, from job responsibilities, education, experience and special skill requirements to employee performance and market pay rates. Ultimately, the purpose of the geographic pay policy is to help employers institute a fair, consistent and equitable standard, and address the question of how location-specific pay issues should factor into internal pay decisions. Because every company has a unique business profile and a wide variety of employee issues to contend with, a well-constructed and highly customized geographic pay policy should take these into account and lend consistency to the decision-making process and help ensure access to a robust and resilient workforce.

 

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[1] ERI website, Glossary of Terms, August 2021.
[2] Although it is possible to calculate the cost of labor and cost of living for specific zip codes, this is generally counterproductive, as most organizations recruit from a broader metropolitan area (MSA - metropolitan statistical area).
[3] WorldatWork Geographic Pay Policies Study, April 2021.
[4] WorldatWork Geographic Pay Policies Study, April 2021.