Location-based compensation is a practice from the past that has to go. Let’s say it right from the beginning, straight up.

We all know that the cost of living differs vastly depending on where an employee resides in the country or the world. In its naive genesis, more than a hundred years ago or more, the concept of paying someone according to their location’s cost of living made sense.

Pay scale standardization became more commonplace in the 1960s and 1970s. Still, in recent times this now problematic practice seemed to rear its socially inappropriate head once more.

Location-based compensation was inherently fair, ensuring equal pay among employees even when they lived in diverse locations with differing costs of living. New York, for example, is vastly different in living costs from that of Pittsburgh to the West or, internationally, Mumbai to the East. As companies saw the gap to minimize costs and maximize profits, the practice started to ring alarm bells for many reasons.

Let’s look at why this system has become problematic and one which could and probably will damage business and the economy.

Decreased Employee Morale

Location-based compensation can create resentment among employees who are paid less than their colleagues in other locations, even if they perform the same job. This can lead to decreased motivation, lower productivity, and increased turnover, hurting the company’s bottom line.

Increased Administrative Overheads

Implementing a location-based compensation system can be complex and time-consuming. It requires extensive research into local labor laws, wage rates, and cost of living indexes, as well as regular updates to ensure that the system remains accurate and complies with changing regulations.

Legal Risks

Location-based compensation can also pose legal risks, mainly if not implemented correctly. For example, suppose an employee in one location is paid less than a similar employee in another location for the same work. In that case, this could be considered discrimination and result in legal action.

With remote and hybrid work so prevalent, companies have looked at different pay for employees depending on whether they are working remotely or commuting to work. They have then considered the cost of living in the location the employee is remote-working from.

This practice can cause many unintended legal and discrimination issues. According to SHRM, location-based compensation can pose legal risks if not implemented and administered in compliance with applicable laws and regulations, such as equal pay and anti-discrimination laws.

Decreased Competitiveness

Location-based compensation can make it difficult for a company to attract and retain the best talent, especially if it is located in an area with a lower cost of living. This can make it harder for the company to compete with businesses in more desirable areas and attract top talent.

Lack of Transparency

Location-based compensation can be complex for employees to understand, leading to confusion and mistrust. It can also be challenging for managers to explain why employees in one location are paid differently than employees in another, even if they perform the same job. The resultant lack of transparency can erode trust and create a negative workplace culture.

Difficulty in Determining Fairness

Determining what is fair compensation for employees in different locations can be challenging. Benchmarking cost of living indexes and wage rates can be difficult from location to location, making it tough to determine a fair and reasonable salary for each place.

Employees Can Cheat the System

Employees have unfortunately been found to cheat the system by using relatives’ residential addresses in locations that might receive higher pay to get paid more. Living in a low-cost location but receiving compensation based on a high-cost-of-living location can be seen as fraudulent. This practice, however, is difficult to pinpoint sometimes, and doing so can incur costs and unproductive use of HR time.

Moving Away from Location-Based Compensation

What should companies be focussing on when creating compensation policies? The research and opinions clearly state it; location-based policies are falling apart and irrelevant to our current society and situation.

Minimizing costs and maximizing profits is important for the financial welfare of a company, but high employee turnover will incur insurmountable recruitment and training costs in the long run. Companies need to adopt more skills and abilities-based approaches, enabling them to attract and retain top talent, regardless of location.

Taylor Moon

Taylor Moon is the Director of Content at RecruitingDaily.com. She's a seasoned Content Director with a demonstrated history of working in various industries, predominantly in digital marketing and technology. As a hiring manager throughout her career, she's worked closely with recruiters and HR and acted as a sourcer and recruiter in various roles, bringing a unique perspective into topics.