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Inflation is clearly upon us and it appears it is not going away anytime soon. While inflation is not the only factor, there is upward pressure on pay at a time when many companies are still recovering from the pandemic and cautiously watching for signs of recession. But for employers, simply raising pay to keep pace with the rising cost of living may not be in the budget. 

Still, companies need to find ways to attract and retain key talent, meet employee needs, and keep the workforce energized. Dealing with inflation, the Great Resignation, and the threat of an overall economic downturn calls for new compensation and performance strategies. 

In this two-part blog series, we look at what the experts are advising to deal with inflation without busting the budget. 

(Watch for part 2, which will explore more creative strategies for compensation and beyond.)

The impact of inflation on workers

Deloitte’s recent US Economic Forecast states that inflation is likely to remain a concern. “The baseline scenario of the forecast presents an optimistic view of core inflation moderating by next year [2023]. But there is a significant possibility that it will take longer for inflation to settle back to an acceptable level.” The International Monetary Fund reports that “War-induced commodity price increases and broadening price pressures have led to 2022 inflation projections of 5.7 percent in advanced economies and 8.7 percent in emerging market and developing economies.” These factors “are expected to elevate inflation for longer than previously forecast.” The Great Resignation and inflation have a complex impact on compensation. “Worker shortages…are lifting wages, though inflation has eroded pay gains.”

Even if inflation slows, the damage has been done. The drop in buying power is significant for household budgets. One US dollar in 2019 is equivalent in purchasing power to about $1.16 today. This means that today's prices are 16% higher than average prices in 2019, according to the Bureau of Labor Statistics Consumer Price Index (CPI). In other words, today’s dollar can buy only 86 cents worth of what it could buy just three years ago.

Increasing pay is one solution – but not the only one

There’s nothing like economic stress to make employees seek greener pastures. How are employers dealing with it? Some in fact are raising wages more than normal. But others are finding creative approaches to the problem.

According to Gartner research, 63% of executives do in fact plan to make compensation adjustments in response to today’s macroeconomic conditions. The annual salary survey by Salary.com found that “the long predominant 3 percent raise, which started its decline last year, has been replaced by a median raise of 4 percent across all employee categories. Forty-eight percent of U.S. employers are planning higher year-over-year salary increase budgets for 2023, continuing an upswing that began in 2022.” But is that really driven by inflation? And is that the best solution?

Inflation is not the problem, it’s the talent wars

Mercer rewards strategists say it is not inflation that is driving up wages, but rather the demand for talent. “Employers respond to the overall labor market driven by the supply and demand for talent. It’s the talent market and changes in the cost of labor that are causing wage growth,” says Andre Rooks, Partner and Career Business Leader at Mercer. “Globally, we see inflation does not affect compensation unless it is sustained high inflation that becomes part of the economy, as in Argentina and Turkey. Economists think high inflation in the US is temporary and does not warrant intervention in compensation.”

So, inflation aside, today’s macroeconomic environment has created a kind of hyper-market for talent, with record-setting quit rates and job openings, increased retirement, and high employment levels. As a result, new talent is at a premium, which then increases the gap between new and existing employees, creating pay compression and pay equity problems, which in turn further exacerbate retention issues.

Develop market-based, not inflation-based, salary budgets

If attracting and retaining talent is the goal, and the cost of talent is driven by the job market, then it follows that employers should use intelligent, data-driven salary budgeting, based on market data. The inflation rate is not the driving factor in what a given job is worth. More relevant is the value of the position in the local job market, which can be determined by analyzing market benchmark salary surveys and comparing it to your own pay scale.

Writing in Chief Executive, Korn Ferry’s Tom McMullen and Brian Reidy note that, “Korn Ferry recommends organizations develop base salary increase budgets based on the cost of labor in relevant markets vs. cost of living and inflation.” 

Mercer says that basing pay on labor rates rather than the cost of living—typically measured in the US using the Consumer Price Index (CPI)—has actually favored workers over the long run. “While in today’s period of high inflation this may seem disadvantageous to workers, the reality is that over the last two decades, this approach has delivered larger compensation increases to workers than it would have if budgets were indexed to CPI.” While comp increases have been consistent at about 3% over the last 15 years, inflation has varied but averaged around 2%. 

Still, some companies may feel compelled to do something financially to benefit employees struggling with higher costs for food, fuel, and housing. “However,” say McMullen and Reidy, “if an organization feels compelled to adjust compensation to reflect a current inflationary environment, these adjustments should be considered as part of a variable pay program (i.e., one-time pay for a one-time event) versus a permanent and ongoing increase in base salary.”

Don’t shortchange yourself on compensation technology

Appropriate compensation management technology is essential for navigating through times of inflation and a hyper-competitive job market. The right technology can make all the difference, and enable you to analyze, plan, and execute the optimum rewards strategies. 

To make data-driven decisions on pay for local job markets you need a compensation system that can help you manage multiple salary surveys and compare the benchmarks to your own pay scale, then make recommendations. The system should give you comprehensive visibility and control over all forms of compensation, including salary, bonus, sales incentives, and long-term incentives so that you can plan and model a holistic total rewards approach. And, the system should be easy to change so that you can adapt quickly as conditions and company goals evolve.

When economic conditions are challenging, it’s more important than ever to be able to efficiently and effectively manage compensation and performance. Interested in achieving a people-centric performance and rewards culture? Download our free white paper, Continuous Performance Meets Continuous Compensation

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