Wage growth, record-high inflation and an extremely competitive labor market have all put business leaders in a difficult position. Anyone involved in hiring and retaining employees is torn between important and seemingly contradictory objectives:
- Address employees’ pain and concerns about the increased cost of living so you can prevent them from disengaging or leaving the company in search of a higher salary elsewhere. (The Great Resignation is ongoing, after all.)
- Win the war for top talent that’s driving wage growth – and be able to entice new hires across the finish line, sometimes with great urgency to overcome other job offers on the table.
- Be smart with company financials and stick to budgets, especially in the face of a potential recession.
In these uncertain times, how can leaders make optimal compensation decisions for their employees’ benefit while still controlling business costs and maintaining compliance?
1. Understand cost of labor versus cost of living – and decide which will drive your company’s compensation philosophy
Although cost of labor and cost of living are two distinct concepts, employees and the general public tend to conflate the two.
So, what’s the difference between the two terms?
Cost of labor: How much a company must spend to hire and retain employees in a particular market. It has to do with supply and demand, and can be industry and role specific. Information for individual markets can be obtained from various sources, including labor market competitors and published data from survey vendors.
Cost of living: The measure of the average change over time in prices paid by consumers in a particular market for goods, such as food, gas, housing and transportation. The Consumer Price Index (CPI), an economic indicator released each month by the U.S. Bureau of Labor Statistics, puts inflation at a 40-year high, having increased 8.2% over the prior year.
Traditionally, the cost of living isn’t a factor for companies in determining wages and pay increases. Instead, the cost of labor has usually been companies’ predominant consideration.
However, the current climate is forcing many business leaders to reconsider that stance and wrestle with these questions: How do we keep up with the rate of inflation in our salaries and be competitive? What will we do going forward to help employees?
As business leaders undergo the budgeting process, they must consider whether salaries and pay increases will be based on the cost of labor, cost of living, or some combination of two.
Then ask yourself what your company can reasonably afford.
Your decision on this point will help to inform your overall compensation strategy.
2. Establish a compensation strategy
Every business needs a sound and proactive compensation strategy to:
- Protect the long-term interests of business
- Meet the needs of team members in the here and now
Your company’s compensation is one of the most important elements of a clearly defined human capital management strategy. Given today’s climate, it’s more critical than ever in creating discretionary effort in employees and preserving the discretionary income that businesses will need for the future.
Whether you realize it or not, if you’re hiring employees or giving out pay raises, your company already has a compensation philosophy. So, why do you need a formalized strategy? Because it:
- Serves as the foundation and principles for how your company pays its people
- Is important to document your strategy in writing in the case of disputes
- Acts as a guidepost in times of stress or change
- Aids in the consistent application of compensation policies
All of this helps you treat employees equitably and avoid legal problems down the road.
Here are a few simple steps to get started creating a compensation strategy:
- Assess your current pay practices, including base pay along with any bonuses or incentive plans. Consider how your pay program aligns with your business strategy, competitive outlook and human capital needs.
- Examine why your pay practices are in place. Did you decide to base your compensation philosophy on cost of living or cost of labor?
- Define the competitive market position of your organization. A lot of companies will say that they target the 50th percentile, to be right in the middle of what other companies pay. However, you’ll want to consider certain factors, including:
- Who your competitors are
- The size of your business
- Where you hire (locally, regionally or nationally)
- Your budget and pay capabilities
All of these factors go into the development of a compensation strategy and establish a framework to attract and retain employees and motivate them to do their best.
Your compensation strategy should:
- Align with your company’s vision and values
- Promote equity and fairness for employees
- Ensure fiscal sensitivity for the organization
- Be legally compliant
- Be easy to communicate and explain to employees
- Be applied consistently
3. Ensure pay equity
As you contemplate increasing employee pay or setting salaries for sought-after new hires, be careful to maintain pay equity within your organization.
Pay equity means compensating employees in similar job functions with comparably equal pay, without regard to protected classes, such as gender, race or ethnicity. Of course, not all employees will be paid precisely the same amount, even if they occupy the same job function. Salary differences often come down to other unique, individual factors, such as:
- Work experience
- Education
- Specific skills that are relevant to a position
- Responsibilities of a position in the organization’s long-term financial stability
Pay equity is often mandated by state law, so maintain awareness of your company’s legal obligations. Nearly all U.S. states have enacted equal pay laws to varying degrees. Some states, such as California, have even gone on a step beyond the “substantially similar job functions” standard to also require employers to provide pay rates for employees by department. It’s likely that other states’ pay laws will enact similar, more stringent measures in the future.
But when compliance and best practices run up against flexibility in adapting to market demands, pay equity can become a tricky issue for businesses.
Especially in an ultra-competitive labor market, it can be tempting to offer a talented job candidate more money when you’re under pressure to fill a position fast and they’re the perfect fit. However, don’t overpay in a moment of urgency or desperation. In fact, this can be a slippery slope.
Pay compression is when there’s little to no difference in pay between employees despite differences in their experience, knowledge and skills. If you pay new employees at the same level or more than tenured, experienced employees in a bid to secure a job candidate, pay compression may be the result. This can cause many unintended consequences among your employees:
- Weakened trust in the company and management
- Lower morale and satisfaction
- Disengagement
- Reduced productivity
- Loss of valued, long-term employees
- Potential discrimination claims
Quick decisions need to be made in a competitive hiring process, but taking the time and effort to ensure internal pay equity is worth it.
What can your company do to preserve pay equity and avoid trouble?
- Regularly update job descriptions and ensure their relevancy to the actual duties performed by employees. Job descriptions are how companies identify similar job functions.
- Conduct a pay-equity analysis to identify pay gaps in your organization, with the engagement of internal or external counsel.
- Prohibit salary negotiations, which enable organizations to drive up the costs for new hires to bring them onboard. Instead, establish set pay ranges for each position with recruiters – and don’t deviate up or down from those ranges.
4. Embrace pay transparency
More than anything, employees and job candidates want your company to be transparent about your pay practices. They also want to understand the reasoning behind these decisions and gain assurance that your decisions are based on objective data that reflects the relevant markets.
This desire is reinforced by a growing trend in state legislatures to enact pay-transparency laws, with the intention of closing pay-equity gaps.
What is pay transparency? It’s the willingness of companies to:
- Explain the how and why behind their compensation strategy and practices
- Disclose pay ranges for positions or departments
- Allow employees to share their salary information with others
To some degree as mandated by regulations, leaders must share pay ranges with employees and be prepared to explain to employees:
- Where they fall within the set pay range
- Why their pay is set at the current level
- How they can direct their efforts to increase their compensation
How well your organization accomplishes pay transparency depends on:
- The quality and regularity of manager training for these types of conversations
- Executive leadership support and buy-in
- Your culture
- Communication capabilities of the organization
- The level of sophistication of the compensation strategy
5. Implement variable pay programs instead of base pay increases
Sometimes, it’s just not financially feasible to deliver on pay raises for current employees, or a job candidate simply wants too much money. But all is not lost.
If you aren’t able to offer a higher base salary, there are other ways to acquire talent and motivate current employees without damaging the integrity of your compensation strategy and practices. A great – and, perhaps, less risky – solution is to implement variable pay programs.
Unlike salary, a fixed cost that the company pays out regardless of performance or achievement of goals, variable pay is distributed to employees contingent on their contribution to the organization’s success. It’s a win-win – employees can earn more money and are incentivized to perform at a high level, and it serves the need of your business with less impact on the company budget.
Additionally, variable pay isn’t as “sticky,” or permanent, as an increase in base salary. If your company’s financial outlook changes or external conditions shift, you can easily end or modify variable pay programs and avoid overpaying employees for the long term.
Here’s how you can started:
- Start at the top and engage executive leadership in conversation to get everyone on board. Decide which behaviors or results you want to reward and align them with the goals you want to meet.
- Include the financial team in all discussions so everyone is on the same page in terms of funding – and ensure that there are no unpleasant surprises ahead.
- Create a variable pay plan in writing. This plan should be:
- Adaptable. Reserve the right to make changes, including downward adjustments, at any time based on employee performance or company finances. You should also be able to adapt the plan to change goals and strategies to achieved your desired financial objectives or re-incentivize employees.
- Finite. Tie incentives to clear goals, at a defined frequency and with an end date. Open-ended goals are more difficult to measure.
- Limited. Establish a cap, or maximum, on payouts to avoid putting the company in an unexpected or challenging financial position.
- Simple. The more complex the plan is, the greater the potential for confusion and misunderstandings.
- Communicate with employees consistently. Everyone should know the expectations and what the rewards are for meeting them.
6. Shift towards a “total rewards” strategy
What else can you do to engage and motivate employees and entice new talent that doesn’t involve cash compensation? Get creative!
What else does your organization bring to the table that brands you as unique and differentiates you from competitors? Think about what job candidates and your employees value most in their work environment.
The possibilities run the gamut. Some examples:
- More competitive benefits, such as more family- and caregiver-friendly benefits or better healthcare coverage
- Special perks
- More time off
- Remote working options
- Workplace flexibility
- Opportunities for career development and growth
- Employee recognition
- Wellness programs
- Employee assistance programs
- Commitment to diversity, equity and inclusion
- Greater opportunities for collaboration
- Support for volunteerism
- Any initiative that improves work-life balance
This is known as “total rewards,” or the cumulative value of all the rewards and the overall positive experience that employees can enjoy at your workplace.
This can drive motivated, productive workforces who feel appreciated and rewarded for contributions, which in turn can improve the relationships between employees and company leadership.
7. Account for the removal of geographic limitations
Remote work has enabled recruiters to source job candidates from across the U.S., without regard for geographical limits.
But, when compensation strategy is largely dictated by the local, specific market, how do you handle payment for employees in varied locations? You can’t have a different payment standard for each individual employee – the larger your company is, that’d be a nightmare to manage.
If your company offers remote work, you may need to modify your compensation strategy to account for this scenario. Come up with an approach that is
- Consistent
- Easy to manage
- Easy to communicate to employees and candidates
A few common options:
- If you have one office, set pay rates based on your main office location.
- If you have multiple offices, choose the regional office that is closest to an employee and establish a geographic differential based on the corporate office to account for variations in the cost of labor or cost of living in other areas.
- Establish geographic differentials for various locations around the country. Many organizations are moving toward a strategy of looking at a national average and establishing geographic differentials for major metropolitan cities.
- If employees leave major metropolitan areas to work remotely in less expensive markets, you have the option of either reducing that employee’s pay (the less popular choice) or lowering annual salary increases.
8. Rely on a professional employer organization (PEO)
Overwhelmed by the idea of implementing a compensation strategy and need help thinking through complex issues surrounding budgeting, logistics and compliance? A PEO with dedicated compensation professionals can help!
Summing it all up
Between unprecedented inflation, and a competitive job market that’s driving wage growth, employers are in a tremendously difficult position. How can they meet the expectations of job candidates and employees and not get left behind while controlling costs and maintaining fiscal prudence? Here, we’ve outlined eight strategies to help employers navigate these tough times. To learn more about making your company appealing to employees, no matter the current work environment, download our free magazine: The Insperity guide to attracting, recruiting and hiring top talent.