Why do new hires get paid more than existing employees?

One of the most enlightening moments in my career was when I discovered a new coworker was making more than me during my stint in S&P Capital IQ. I remembered casually asking him one day “How much is your salary?”. When I found out it was $40,000 more than mine, I felt resentful, jealous, and unappreciated. How could someone who had the same job title and the same experience make 40% more than me?

After finding out, I started to leave the office earlier than usual, justifying it by the fact I wasn’t even getting paid fairly. I eventually left the company a few months later. They counter-offered me with a promotion and a salary bump, but by then, I felt too offended. The damage was already done.

So why do companies do this? Are they purposely trying to make their employees disgruntled ? Do they really think employees won’t find out? Or that they’ll stay anyway because they’re one of the best employers in the world? As someone who spent some time working with compensation teams later in my career, and saw “how the sausage was made”, I thought I’d shared some insight into why new hires get paid more than existing employees, and why the best way to get a bigger pay is to move to a new job.

Reason 1: Companies actually want you to leave

This might sound unbelievable but it’s true. A lot of companies have attrition goals. Heck, some Big Tech companies fire the bottom 10% of their team every year. They want people who have been around for a long time, and not pulling their weight to leave. So underpaying their current employees fixes this problem, as it will ultimately lead to a % of these people leaving every year. Of course the problem with this is that this also affects high performers.

Reason 2: Salary raises are capped every year, and hiring budgets > budgets for raises

While this probably doesn’t apply for small startups with no formal compensation structure, large companies often have strict policies around the how much of a raise they can give to any employee.

So as an example, let’s say the market average salary for your position was $70K when you started 2 years ago, but it jumped up to $100K now. However, because your company can only give 5% maximum raises every year (because it’s tied to inflation, cost of living increase, or another metric), your salary will continue to lag the market average.

In addition, many managers often have a strict budget for raises/promotions every year, and it’s often lower than the budget for new hires. Even if your manager wanted to give you a large raise to match the market, they wouldn’t have the budget. And even if they had the budget, they probably would have a lot of explaining to do to their superiors on why they allocated a large part of it to your raise.

In short, there’s a lot more corporate bureaucracy in giving a raise than there is to giving a higher offer to a new hire.

Reason 3: HR teams don’t realize the long-term implications of paying new employees more than tenured employees

Trying to hire X more people is an immediate problem. And it’s a problem that recruiters are highly incentivized to solve – after all, their commissions/compensation probably depends on it. And if they can’t hire someone, they’ll simply throw more money at them. Problem solved, right? To hell with our tenured employees who will be paid much less. That’s someone else’s problem…

Unfortunately, if you talk to some HR teams, you’ll find there’s almost no consideration for how this inequity will impact their company in the long-term. They do a terrible job of quantifying the costs of employees leaving. The only cost they see in the P&L line is the extra salary required to replace them, not the “hidden costs” such as the time to interview new candidates, training new employees, and the extra time to productivity, etc. All of these are just considered “the cost of doing business”.

Reason 4: Employers overvalue experience collected elsewhere

There’s also this phenomenon I see in many companies, where experience built elsewhere is often valued higher than the one built in house. I’ve personally experienced this many times in my career, when my company would bring in a new “shiny” person from a competitor, with decades of experience and armed with fresh insights/knowledge. I would often wonder: “I have the same exact experience as that person! Like… why didn’t you just promote me?!”Unfortunately, from a company’s perspective, their thinking is: our current team led to us being in a stagnant market position: So we need someone new, exciting to revamp everything and put us in the right course!

Unfortunately, I think this is just a psychological habit among people. We hate price increases on products/services we already purchased, but easily spend more on new things. The same goes for employees.

Reason 5: Retaining employees is a problem very few want to solve because of inertia

Trying to retain your best talent is a messy, complicated, long term problem that very few people in an organization want to deal with. Unlike hiring new people, there aren’t many people if any, whose compensation depends on retention. So naturally, there’s a lot of inertia around solving it.

And they aren’t ignorant. HR and executives are often aware of the problem. They read the news, and they hear anecdotes from their peers. They even often have it on their to do list to address. But it’s a hard, complicated problem to solve. Because it involves difficult conversations that go up the chain of leadership, going through executive management, finance, HR, etc. It has a trickle-down effect on lots of people, on profitability projections, on compensation structures, and budgets and so on. It requires analyzing lots of data, research, forecasts, and approvals. So, naturally the problem slips down their priority list.

There’s also a lack of data around retention, and attributing it to compensation vs other reasons people leave (such as personal reasons, management, work/life balance, etc). After all, a certain % of your employees *will* leave every year – that’s natural. How do you filter through the “normal” activity from an “abnormal” level? It probably needs to be happening at a much larger frequency for organizations to notice. Meaning the problem can bubble along for quite a while before the scale of it becomes apparent.

When you hire someone new, on the other hand, you need to be competitive with the market. You can’t escape that. Either you pay an above market salary to them, or you lose them to a competitor. Thus, you have to look at salary data from salary surveys, or providers such as Pave and Ravio and make sure you’re competitive. Ultimately, salaries to new hires are going to keep pace at some level with market changes.

So knowing all this, what can you do as an employee if you find out you’re getting paid less than your peers in the same level?

1. Gather as much information about how compensation is managed in your company

Before doing anything drastic, you should try to understand how compensation is managed in your company. One question you should try to ask your manager, your HR department, or other employees is “What is your compensation philosophy? How is our compensation determined? Who determines it?”

How you approach the question of getting a salary bump depends a lot on how each company answers this question. For example, in certain companies like Facebook, compensation isn’t determined by managers, so engaging with your manager isn’t going to be very productive. You’re better off trying to talk to someone up the leadership chain, or finding out how to get promoted. On the other hand, other companies give managers lots of decision-making power, and you’ll need to decide how to start a conversation with them tactfully.

Likewise, if you know your company benchmark their salaries to the 75% percentile of the market median/average, and your salary is in the 50th percentile, and you’re a high performer, that gives you some data to bring to the conversation.

2. Have an open conversation with your manager about compensation

Most people are afraid of having tough conversations about pay with their manager, but it’s important to remember that good managers don’t mind being asked about compensation. After all, that’s part of their job: to keep you productive/happy as an employee. When you have that first conversation, keep in mind that most companies are probably not going to give you that 20% raise overnight. So instead of demanding a raise, you should ask in the form of “Hi, I’ve been working for X years. I’ve done X, Y, and Z while I’ve been here. I know I’m paid at X% of the market average, while my coworkers/peers are paid above the market average. What do I need to do to get a raise next year?”

In addition to having market salary data, it’s worth having some tangible data about the impact you’re having in your company. By impact, I’m not talking about trivial things like # of lines of code, or the number of tickets you fixed. I’m talking about things like did you work on a feature that improved the speed of your website by 20%, leading to 10% more conversions? Did you automate some process that led to 20% more bugs? If you can map that impact out, it makes the conversation with your manager a lot easier.

Remember, the key is not to demand a raise, but to get to a mutual understanding with your manager, on how to get that raise in the future. Do you need to learn a few crucial skills first? Do you need to start mentoring junior people in the team? Do they undervalue certain skills/experiences you might have that makes them hesitant to pay you a higher salary? Do they ask you to “prove” that you’re being underpaid or tell you that a raise is definitely not possible due to economic conditions? (this probably isn’t what you want to hear, but it’s all useful information!)

3. Hand in a competing offer

OK, so you’ve talked about a potential raise with your manager, and they said there’s just no way. Or the next year rolls around, and still no raise. What do you do?

This is going to sound aggressive, but in my experience, the #1 way to force their hand is to give your manager a competing offer. Of course this is easier said than done, but unless you’re up for promotion, it’s very very hard to get a huge raise if you don’t show them you’re seriously considering another company.

Now, that doesn’t mean you give your manager the middle finger! But tactfully, showing them your offer and saying something like “Company X has offered me this title + salary. I really enjoy working here, and don’t really want to leave. Can you come close to addressing my concerns of being underpaid relative to my peers in this company?”

This assume of course that you really want to continue working for them. If you feel you were disrespected, you probably are better off just taking the competing offer, and getting paid what you deserved in that new company. At the end of the day, it’s just not worth staying at a company that doesn’t value your knowledge/skills/experience if you can find another company that does value it.

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