Time For Smaller Base Pay Increases?
Got your attention?
Based on the principles of sound compensation management spending all the currently available funds for compensation actions on base pay increases is a bad idea.
Increasing someone’s base pay is tantamount to granting them a career annuity… there will be no refunds. Fixed costs are the enemy in times of wildly vacillating revenues, and the last few decades have seen vacillating revenues. Adding this year’s base pay increases to payroll costs increases what is the largest fixed cost for most organizations.
The current turbulence in labor markets is unlikely to disappear anytime soon. Turnover is up for a lot of employers, and many are finding it difficult to attract replacements. Attraction and retention of critical talent is challenging. Yet significantly increasing the fixed cost of the workforce can force an organization to shed people when revenues decrease in the future. Whether high techs and distribution firms will regret the base pay decisions they made when they were swimming in cash depends on their ability to sustain the cost of their payrolls. Those cash bonuses for joining the organization, offered by some employers to gain a recruitment edge, will not continue to demand funding, but base pay increases will.
When responding to clients asking how they can retain their people when other employers are offering base pay increases of 6 – 7% I ask them if they can really afford to raise workforce costs permanently by a large amount. In many cases they have already set budgets and granted the base pay increases for the year, so yet another increase in one’s pay as a result of changing employers may seem attractive for those employees who are considering alternatives.
During high inflation times one of the options I suggest is to grant an “inflation offset” cash award to employees. This makes it clear the organization knows they are suffering a loss in real income and that the organization cares about that. However, at the same time, the reason the award is a one-time payment should be made clear. Management should point out that that inflation is a short-term condition, and it would be a mistake for the organization to respond with an action that would imperil its economic viability in the future. If a one-time cash outlay equal to 2 -4% of payroll is affordable it can cause employees, particularly those with longevity, to reconsider making a big change. Because inflation impacts those at lower pay levels more than those at higher levels the same amount could be granted to everyone (calculated by dividing the pool by the number of employees).
Using the inflation offset cash award approach is a one-time special payment, for specific reasons. This does not incur the negative consequences of shifting the pay administration system to one using egalitarian pay adjustments. Yet giving the same base pay increase to all employees (same amount or same % of pay), often labeled general increases, does not provide a motivation to perform well. General increases or systems that increase individual pay automatically based on time are perhaps the worst approaches to allocating awards in today’s (the future?) environment. These actions are even more disastrous if they are called “cost of living” adjustments.
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Economically sound management requires that employers administer pay based on the cost of labor, not the cost of living. The relationship of those two numbers has vacillated significantly in individual years. If employees are allowed to believe they are entitled to whichever of the two numbers is the largest in the current year the employer will not be able to sustain payroll costs over time. Now that inflation is back down to around the 2% target the hysterical reactions when it was much higher are probably a source of regret. Employees did not believe their employers when they said historical patterns make it likely an inflation surge will persist. Most of the disbelief is attributable to the lack of economic education employers do. Left to guess as to what drives their pay will result in employees believing things are worse than they are... we are all subject to that cognitive bias. Helping employees understand the realities of the business can remedy that to a large extent.
The Bottom Line
What an organization does now will have an impact on its economic future. Providing the reasons why large base pay increases to respond to short-term inflation surges are not feasible may not placate everyone. But they are likely to result in employees seeing that the organization is managing itself in a sound manner and that unsustainable actions could have a negative impact on its future ability to provide competitive compensation to its employees... and even continued employment. The increased volatility of resources may well demand that organizations reconsider having all direct compensation in the form of base pay. Variable pay programs can enable current workforce costs to be better aligned with resource levels. Using variable pay in conjunction with base pay can provide stability but also flexibility.
A review of compensation philosophy and strategy can help organizations manage better. An investment in communicating the rationale used in administering pay programs can increase employee understanding. No srategy will please all employees. The key is to ensure it is most attractive to those the organization most needs and wants to keep.
About the Author: Robert Greene, PhD, is CEO at Reward $ystems, Inc., a Consulting Principal at Pontifex and a faculty member for DePaul University in their MSHR and MBA programs. Greene speaks and teaches globally on human resource management. His consulting practice is focused on helping organizations succeed through people. Greene has written 4 books and hundreds of articles about human resource management throughout his career.