What is Geographic Pay Differential?

A company may pay employees who have similar roles but who are located in different cities differing amounts. Alternatively, they may offer different levels of pay for a position depending on where the employee filling that position is located. This is known as a geographic pay differential. 

Geographic pay differentials are commonly used by companies with offices in different cities or countries. Companies can also use them if they have remote workers living in different cities. Geographic pay differentials are typically in response to differences in the costs of living between locations. However, they can also be due to differences in the cost of labor in markets across cities.

If your company offers different pay in different cities, it’s important to do so in a way that is equitable to employees. Otherwise, you may have difficulty hiring or retaining employees in specific markets or may be less competitive in the remote work era.

Why Use Geographic Pay Differentials?

You can implement geographic pay differentials for a variety of reasons. Let’s take a look at some of the most common reasons to offer different pay in different places for the same position.

Reflect differences in the cost of living

One of the most common reasons that your company may wish to implement a geographic pay differential is that the cost of living for your employees can be different in different geographical areas.

For example, the average cost of living in San Francisco is $62,000 per year for an individual, close to the national average cost of living of $61,334 per year. The average cost of living in Birmingham, Alabama is only $24,000 for an individual. 

So, an annual salary of $60,000 in San Francisco would just barely allow an employee to cover their living expenses. That same salary in Birmingham would give an employee a lot more disposable income each year.

Because of this, you may not wish to simply offer the same salary structure for an equivalent position in both cities. Your company could either have a difficult time attracting candidates in San Francisco or would be overpaying by a significant amount in Birmingham. Instead, a geographic pay differential can be used to reflect the differences in the cost of living between the two cities.

Be more competitive in tight labor markets

You can also implement a geographic differential to attract talent in cities where the labor market is tight. This happens when there is a plentiful supply of specific roles, but only a small supply of employees to fill them in that city.

In San Francisco—where there are many programmers to hire—your company might offer $100,000 per year for a software engineering position. In New York—which has a similar cost of living but fewer programmers looking for work—your company might have to offer $120,000 per year for the same position to attract qualified candidates.

Incentivize employees to move to specific locations

Another reason to offer different pay in different locations is to incentivize employees to move to a specific office or city. For example, if your company has an office in a rural area you could offer increased pay—relative to the cost of living differences—for employees who are willing to relocate to that office.

Alternatively, your company may value having a position in one office or location more highly than having that same position in another office. This could be the case if—for example—your company wants a graphic designer at their headquarters and views having an employee in that role at a satellite office as less valuable to the company.

Geographic Pay Differentials for Remote Employees

Before remote work became common, geographic pay differentials were typically only implemented by companies with multiple offices. Now that remote working has become much more the norm, your company may need to consider whether you should implement geographic pay differentials for remote employees.

It’s up to your company to decide whether to pay remote employees differently based on where they live and work. Some employers may decide to offer a fixed salary for a position and then allow remote employees to decide where they want to live based on that salary. Others may decide to scale a salary up or down based on the cost of living in the location where remote employees work.

In addition, many companies view remote work as a perk and may adjust remote employees’ salaries accordingly. This is not a geographic pay differential, but rather a compensation adjustment based on what the employer views as an added benefit for employees.

Geographic Pay Differentials and Employee Benefits

When you’re thinking about geographic pay differentials, salary adjustments are often the first thing that comes to mind. In many cases, offering a higher or lower salary based on location is appropriate. However, this is not the only way to implement a geographic pay differential.

You should consider total compensation, including benefits packages. Employees working in alternative locations or remotely may have different needs from employees located at a company’s headquarters. For example, they may benefit from a different health insurance plan that offers more in-network providers in their area. They may not have access to benefits like an office gym or in-office childcare.

In these cases, your company can offer different or additional benefits to remote employees and employees in satellite offices. You should consider asking current and prospective employees about the benefits they want and strive to make benefits as flexible as possible. For example, a wellness stipend that employees can spend however they want may be more useful than providing membership to a specific gym.

How to Determine Fair Geographic Pay Differentials

If your company decides to implement geographic pay differentials, it’s important to do so in a way that is fair to employees. Otherwise, you run the risk of alienating employees and making your company less competitive in hiring going forward.

Here are two straightforward ways that your company can implement a geographic pay differential that’s fair and transparent.

Fixed pay differential

A fixed pay differential assigns an amount of money to be added or removed from an employee’s base salary depending on where they are located.

For example, a company could offer a base salary of $75,000 for a position at their headquarters in Minneapolis. The company might decide that the same position has a premium of $10,000 in Seattle, pushing the base salary for an employee located in the Seattle office to $85,000. The position might also have a discount of $5,000 at the company’s office in Kansas City, pushing the base salary down to $70,000 for an employee located there.

Percentage-based pay differential

The salary premium or discount for employees in specific locations can also be percentage-based. This is often appropriate if you’re only trying to adjust salaries for differences in the cost of living.

If the cost of living in Seattle is 8% higher than the cost of living in Minneapolis, then a position that pays $75,000 in Minneapolis would pay $81,000 in Seattle.

Conclusion

Companies often use geographic pay differentials to adjust for differences in the cost of living between geographic locations where they have employees. However, they can also be used to attract talent in competitive labor markets or to incentivize employees to move to specific offices.

Geographic pay differentials often involve salary adjustments, but they can also be implemented by adjusting employees’ benefits. No matter how a company decides to go about establishing geographic pay differentials, they should be implemented equitably to retain the trust of employees.