Geographic pay differentials refer to the measurement of variations in compensation for the same job in different locations. As companies globalize and embrace remote or hybrid working models, understanding and implementing location-based pay strategies has become more complex and important. While the concept seems straightforward—paying employees appropriately based on their location's cost of labor—the practical use of pay differentials requires careful analysis and administrative forethought.
Here, we'll explore the fundamentals of geographic pay differential, with a focus on U.S. examples, and provide concrete methodologies for calculating and implementing them effectively.
The Value of Geographic Pay Differentials
In today's increasingly distributed workforce, understanding geographic pay differentials allows companies to remain competitive in every market where they operate while managing compensation in a more consistent and cost-effective manner.
For example, let’s imagine a fast-growing software company headquartered in San Francisco. Until recently, their team was entirely local, so they determined compensation ranges based solely on market data for San Francisco. However, they are now setting up offices in Austin and Nashville and deciding what to pay engineers in those locations. They have a few options as follows:
Keep it Simple
Our imaginary company could decide to pay engineers in Austin and Nashville the same amount as San Francisco. This approach is administratively very easy; no extra homework is needed to assess or maintain compensation ranges in Austin and Nashville. However, this means our company will almost certainly pay more than is needed to attract talent in their new markets of operation.
Analyze Everything
Our imaginary company could decide to acquire market data for Austin and Nashville and define new location-specific compensation ranges for engineers in each market. This approach is more accurate and maximizes cost effectiveness for the company, but it requires more upfront work and long-term maintenance.
Find a Middle Ground
This is where geographic pay differentials typically come into play. Let’s say our imaginary company does a little bit of homework and discovers pay levels for engineers in Austin and Nashville are typically 13% and 16% less than San Francisco, respectively. As a result, they decide to maintain one compensation range using San Francisco market data and simply apply 13% and 16% discounts when hiring in Austin and Nashville.
As you can see from the options above, using geographic pay differentials has the potential to simplify compensation benchmarking and administration, while allowing companies to manage costs and remain competitive. Of course, this means finding and applying the right geographic pay differentials is critical.
Calculating Geographic Pay Differentials
Companies typically use one of three methods to determine geographic pay differentials:
Market-Based Approach
This method for calculating geographic pay differentials requires the collection of market data in all locations that matter to your organization, but can still reduce administrative burdens by minimizing the number of compensation ranges you need to maintain.
Typically, companies start by selecting a primary location to base geographic pay differentials on. This is usually your headquarters or largest office. The next step is to compare median compensation levels for key jobs across your locations and calculate percentage differentials between those locations.
For example, if your primary location is San Francisco and software engineers there earn a median base salary of $180,000, while the median base salary for the same role in Austin is $160,000, then the differential (or discount) for Austin is -13%. Some people might flip this statement around and say, software engineers in Austin make 87% of their counterparts in San Francisco.
Once a few key roles are examined across the San Francisco and Austin markets, a company could decide to maintain compensation ranges based solely on San Francisco market data and then apply a consistent, market-based geographic pay differential when hiring in Austin.
Index-Based Approach
This method for determining geographic pay differentials minimizes the need to collect compensation data across markets and instead relies on using government or third-party assessments of wage rates and employment costs. In the United States, the Bureau of Labor Statistics (BLS) maintains an Employment Cost Index with detailed information on the cost of labor.
For example, using the BLS Employment Cost Index, a company might find that professional services wages in Seattle are 118% of the national average, while Phoenix is at 96%, suggesting a 22 percentage point differential between these locations.
The challenge with relying solely on government or third-party data is that these sources often do not have granular information on every job that matters to you, especially when dealing with emerging skills (e.g., artificial intelligence and machine learning engineers), they often classify industry segments at a very high level (e.g., technology and telecommunications vs. software as a service, etc.), and mixing multiple government or third-party sources with varied methodologies could lead to muddled results.
Overall, this approach gives compensation professionals a general view of pay across markets but may not be detailed enough to remain competitive when considering key talent in fast-moving markets.
Blended Approach
As you might imagine, this technique blends the market- and index-based approaches described above. There is no perfect methodology for blending data, but a common blend places a 70% weight on market data, a 20% weight on cost of labor indices, and a 10% weight on cost of living factors.
Ironically, using a blended approach requires a decent amount of work, which could negate the expected time savings of using geographic pay differentials in the first place. However, a blended approach has advantages in terms of employee communication. With this approach, a company can transparently say it considers market data, the cost of labor, and the cost of living when setting compensation ranges, which is what many employees expect to hear.
Download Pave’s guide, Compensation Data Types: What They Are & When to Use Them, for deeper insights on utilizing and blending market data.
Frameworks for Implementing Pay Differentials
Once a company decides to use geographic pay differentials, the next step is selecting an implementation framework. Most companies choose one of three common approaches, each with its own advantages and administrative considerations.
Geographic Tiers
The first and most straightforward approach is using geographic tiers. Under this framework, companies group locations with similar market characteristics into distinct tiers, typically using their highest-cost location as a baseline (set to 100%). For instance, major technology hubs like San Francisco, New York, and Seattle often comprise Tier 1 markets, while strong secondary markets like Austin, Boston, Los Angeles, and Washington DC might form Tier 2 markets with pay typically set to 90-95% of the baseline. Emerging technology markets such as Charlotte, Miami, and Nashville typically fall into Tier 3 markets, with pay at 80-85% of the baseline. Many technology and life sciences companies use this approach.
Metro-Based Areas
The second approach involves creating specific differentials for each metropolitan area where the company operates or recruits. This method provides more precision but requires more ongoing maintenance. A company might designate San Francisco as their highest-cost location with a 15% premium, position New York City with a 9% premium, use Atlanta as their baseline, and apply a 10% discount for markets like Salt Lake City. This framework works well for companies with concentrated operations in specific cities but becomes more complex as the number of locations grows.
State or Country-Based Groupings
A third approach uses state- or country-based groupings, which can be effective for companies with widely distributed workforces. Under this framework, states with consistently high labor costs like California, New York, and Massachusetts might receive a 15-20% premium, while states with moderately high costs like Colorado, Texas, and Illinois might see a 5-10% premium. States such as Florida, Arizona, and North Carolina often serve as baseline locations, with remaining states typically positioned 5-10% below the baseline. A similar approach can be applied in Asia and Europe (e.g., the Nordic region, etc.). Logistics companies with large field operations are most likely to use this framework, but it is not recommended for companies with higher-cost talent pools.
Remote Work Considerations
The rapid adoption of remote work has added new complexity to geographic pay strategies. Companies must decide not only how to set pay for office locations but also how to handle compensation for employees who might work from anywhere. Three primary approaches have emerged to address this.
Employee Location-based Pricing
The most common approach is employee location-based pricing, where compensation aligns with the employee's actual location regardless of their team or office affiliation. For example, a company might pay a software engineer working remotely from Portland 89% of their San Francisco ranges, reflecting the cost difference between these markets. While this approach most closely tracks local market rates, it requires clear policies for handling relocations and can create complexity when employees move frequently.
Office-anchored Pricing
The second approach, office-anchored pricing, ties remote employee compensation to the nearest company office location. Under this framework, a remote employee in Sacramento would receive San Francisco rates, while someone working remotely from Boulder might be aligned with Denver rates. Companies typically establish maximum distance thresholds (often 50 miles) to determine which office location applies. This approach simplifies administration but may overpay in some markets while underpaying in others.
National Remote Rates
The third option, national remote rates, establishes separate ranges specifically for remote employees, typically set at 85-90% of the company's highest-cost location. While this approach is the simplest to administer and communicate, it often means paying above market in lower-cost locations while potentially struggling to compete for talent in higher-cost areas outside major metros.
Common Pay Differential Challenges & Solutions
Implementing geographic pay differentials presents several challenges. First, companies must determine how to maintain current market data across all locations. This often involves implementing a strong compensation management platform that can automatically update market rates, blend various data sources, and monitor internal pay levels against external benchmarks. Without such a system, companies risk making decisions based on outdated information that could impact their ability to attract and retain talent.
Employee communication presents another significant challenge, particularly around explaining why pay varies by location. Successful companies typically develop comprehensive communication materials including location-specific pay calculators, regular market updates, and transparent relocation policies. For example, a company might leverage a tool that allows employees to understand how their compensation might change if they moved from San Francisco to Austin, helping them make informed decisions about relocation opportunities.
Perhaps the most complex challenge involves managing pay changes for relocating employees. Companies need clear guidelines for different scenarios: voluntary relocations typically result in adjustment to new location rates, company-requested moves often maintain the higher of two locations to avoid disrupting the employee's finances, and temporary assignments usually receive short-term adjustment premiums to account for the temporary nature of the move.
Best Practices for Successful Geographic Pay Differentials
Several best practices have emerged for maintaining effective geographic pay programs over time. First, successful companies establish regular review cycles (at least annually) to assess and update their differentials based on market changes. For instance, a company might discover that Austin's technology market has heated up significantly, requiring an adjustment to their geographic differential from -20% to -15% relative to San Francisco.
Documentation proves equally critical for long-term success. Companies should maintain detailed records of their methodologies, decision-making criteria, and audit trails of pay range changes. This documentation helps ensure consistent application of policies and provides context for future decisions. For example, understanding why certain locations were grouped together in the past can inform decisions about how to handle new office locations or emerging remote work hubs.
Technology integration plays an increasingly important role in managing geographic pay programs effectively. Leading companies integrate their HRIS, ATS, and equity administration platforms to compensation management systems to automate differential calculations and generate regular audit reports. This automation not only reduces administrative burden but also helps ensure accurate and consistent application of geographic pay policies.
Finally, regular internal equity monitoring ensures the program operates as intended without creating unfair advantages or disadvantages for certain employee groups. This includes conducting regular pay equity analyses, assessing compensation impact across different demographics, and analyzing representation by location. These reviews help identify and address any unintended consequences of the geographic pay strategy while maintaining compliance with evolving pay equity regulations.
Pave is Here to Help
If you’re interested in adopting geographic pay differentials at your company, Pave can help in two important ways.
First, our premium Market Data offering includes a geographic pay differential tool that provides differentials at a job-by-job level. We can do your homework for you!
Second, our end-to-end compensation management software has the features you need to manage and deploy compensation data, including the ability to market price jobs using multiple data sources, build and maintain salary ranges, and audit trails to track changes, among many other features.
To learn more about how Pave can help you develop and implement effective geographic pay strategies while maintaining competitive compensation practices, request a demo today.
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