How Will Inflation Impact Compensation Increases

09/21/2022 Becky Foster
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Inflation is at a 40-year high. What does this mean for employers as they contemplate compensation and salary increases? Salaries are expected to rise, but by how much? Employers will need to address this in a way that aligns with company strategy, meets the needs of employees, and is financially viable.

According to the Bureau of Labor Statistics (BLS), the consumer price index (CPI) for urban consumers rose again in June 2022. The “all items” index increased 9.1 percent which is the largest 12-month increase since the period ending November 1981. The (CPI) measures average change in cost of consumer goods and services which is considered a leading indicator of inflation.

The increase in costs is putting a lot of pressure on employees to have their income stretch further which, in turn, puts pressure on employers to increase wages to cover the gap. In addition to inflationary pressures, unemployment has remained low meaning  it’s  harder than ever to find qualified candidates making retention a priority. Having a short supply in the workforce drives salaries up as well.

So, with these forces at work, employers are likely to provide higher compensation increases this year than budgeted. Making sure you have a sound compensation strategy and approach to navigate upcoming increases is vital. The approach should include a market-based philosophy, a periodic review process, and benefits/non-monetary compensation. With these elements in place, adding the inflationary variable will help inform appropriate wage increases.

David Turetsky, VP Consulting at Salary.com, says “One of the things that I think has been a misunderstanding in the world of compensation management is that merit increases have to stay in line with inflation.” So, rather than trying to keep up with inflation, employers should respond transparently in the best way they can.

In order to respond appropriately, make sure your compensation approach aligns with company strategy and is understood by employees. Review the approach, gather internal and external data, make decisions, then communicate to your employees. If employees understand you are trying to address the gap, that will reaffirm trust and help them understand they are valued.

Merit Increases

Inflation causes a lot of pressure to provide higher than normal and/or higher than affordable salary increases. And, while it makes sense to index merit increases with what’s happening in the economy, increased cost of living does not equal increased compensation. According to WorldatWork, a global compensation and total rewards association, organizations should base their salary increases on the cost of labor, not the cost of inflation.

Further, it’s important to return to a sound compensation strategy which includes a compensation analysis and research to understand what is happening in the market with each position, so the cost of labor is truly reflected.

This means investigating salary benchmarking and trends for each role in your company. Also consider information you learn about market compensation during candidate interviews and exit interviews to understand the current market for employees. With this market data, you are positioned to consider the inflationary factor as a variable for the merit increase.

If you do not have a compensation strategy and process already in place, explore defining pay ranges and increase recommendations based on contribution and performance. There are many resources available to help organizations find an approach that aligns with company strategy.

Non-monetary Compensation

This is a good time to remind employees of the benefits and non-monetary elements with your organization. When inflation hits, often immediate dollars are at the forefront of consideration, but other variables are vitally important to employees in many circumstances. Consider your approach to health benefit subsidies, HSA contributions, flexibility, vacation, paid sick leave, retirement contributions, and tuition reimbursement. Many of these elements have real value to employees. And, if your organization has generous offerings, this could help ease the impact of inflationary factors.

Larger than Normal Increases

With larger than normal increases, it will be important to check anticipated compensation budgets to see if there is an ample amount set aside to accommodate these rising costs. Consult with other leaders to determine overall economic impacts to the organization. Perhaps there is additional revenue or other increased costs that may impact the feasibility of compensation increases.

Use this data with the market salary data to determine if an overall salary differential adjustment should be made for current employees. For example, if market data shows an increase of 2 or 3%, perhaps an overall adjustment across the board is warranted in addition to merit increases.

Communication and Transparency

Once you have gathered the data and evaluated all possible alternatives, communication with employees is paramount. Understanding their perspective and expectations will help tailor the message appropriately. Make sure to speak plainly and with empathy while explaining the reality of what the business can and can’t do.

Communicate the position the company is in relative to compensation in the market. Make sure to cover which areas/positions are stronger, and which are weaker based on the data. Explain the approach being utilized to address these areas based on the revenues, costs, and profits the company is experiencing. Also highlight other elements of compensation to remind people there are other efforts being made to respond to their situation.

If companies don’t explain this to employees and instead keep compensation approaches veiled, people will assume the worst and not feel valued. This will result in people looking for other opportunities, especially if communication has not been clear overall in making an individual feel valued in their role.

Compensation analysis is never absolutely complete; organizations should always be evaluating where they are relative to the market. Make sure you have a robust strategy, sound processes, and a communication strategy. Then, when different factors arise, such as high inflation, you can incorporate that variable into the process. Let the HR Consulting Team at VonLehman CPA & Advisory Firm conduct a compensation market analysis for you. Contact HR Consultant, Becky Foster, at bfoster@vlcpa.com or 800.887.0437 to find out how we can help.

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