Salary compression refers to a situation in which there is a minimal or negligible difference in pay between employees in higher-ranking positions and those in lower-ranking positions within an organization. This phenomenon often occurs when new hires are offered salaries that are close to or equal to the salaries of existing, experienced employees who have been with the company for a longer time.
In a company, a senior software engineer with five years of experience earns $90,000 annually. Due to market demand, the company hires a new software engineer with similar qualifications and offers them $85,000 per year. This creates salary compression, as the new hire's salary is only slightly lower than that of the more experienced engineer, diminishing the incentive for the senior engineer to stay with the company or seek promotions.