An employee walks into your office and says, "The news is reporting that inflation is over 8%, but my pay increase is only 4%. I need a cost-of-living adjustment (COLA)!" How do you respond?
There is no easy answer. While linking your salary increases to a cost-of-living index seems like a simple, data-based response, it may not be the best solution for your organization. Compensation is both an art and a science. It's important to consider economic factors and align with your organization's total rewards strategy to arrive at a response that works for you.
Let's begin by examining economic factors. According to the U.S. Bureau of Labor Statistics (BLS), inflation can be defined as the overall general upward price movement of goods and services in an economy. The BLS has various indexes that measure different aspects of inflation, with the Consumer Price Index for All Urban Consumers (CPI-U) being the one most often reported by the national media. The CPI program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services, some of which consumers buy regularly and others they do not. For example, we don't buy a house or a car every month. The purpose of using CPI is to preserve the purchasing power of employees.
The BLS also produces an Employment Cost Index (ECI), which may be better suited as an economic indicator to adjust wage rates. It includes wages, salaries, and employer costs for employee benefits. ECI measures private-sector wage increases.
For a comparison of the two measures, Employers Council prepares a monthly Economic Perspective summary to assist the decision-makers of member organizations. The economic data in these charts summarize the most-watched economic and compensation indicators from the BLS.
Which index should you use to set your salary increase budget? Your choice may depend on whether your goal is to maintain employees' standard of living (CPI) or to align pay with the broader labor market issues (ECI). These indicators are only part of the analysis.
Another economic factor is internal: What is your organization's ability to pay? Although labor is often the single largest expense, inflation has broad impacts beyond labor costs. Supply chain, sales, and monetary policy can affect your ability to offer increases. If your sales and prices are increasing, employees may assume you can afford higher wages.
By itself, a salary increase percentage likely understates growth in your compensation expenses. Understanding how pay has changed in your organization comes from studying year-over-year compensation levels for the entire organization. For example, if total pay was analyzed over a year, it's likely to show changes above the 3% budgeted for that same time. That's because employees get promotions, bonuses, and market adjustments. Most of these are not reported as part of a merit budget.
After economic factors, consider whether a cost-of-living increase aligns with your total rewards or compensation philosophy. Your philosophy defines a competitive market position of the organization in relation to base pay, variable pay, and benefit opportunities that are unique to your organization and reinforces your business strategies, values, culture, and goals. Your compensation philosophy may be a formal written statement or simply defined by past practice and leadership intent. Either way, it defines how you reward employees. There can be many reasons for giving wage or salary increases, as shown in our Miscellaneous Benefits and Pay Practices Survey:
A cost-of-living raise differs from a traditional raise or bonus in that it is given to all employees equally, not based on individual merit, productivity, or performance. Cost-of-living raises are much more common in the public sector, where they are legally required of certain employers. In the private sector, however, they're optional and relatively uncommon. Across industries, merit increases are much more common. If you're one of the many organizations that prefer to pay for performance, taking inflation into account as part of setting salary budgets is a significant departure from this philosophy.
Of course, employers pay the job rates needed to attract and retain talent. So, what are other employers doing? Employers Council recently conducted a brief survey of its members to identify the strategies employers are using to assist employees with the high cost of living. Forty-eight percent of respondents indicated they had no plans to adjust their 2022 pay increases due to inflation. Forty-one percent of the respondents said they were adjusting their 2022 pay increase budgets to add an additional cost-of-living increase anywhere from 1% to 5% or more. Employers are reporting the average 2022 projected pay increase for typical employees is 3.9%, as reported by all respondents in the survey.
A March survey of employers by compensation data and analytics firm Salary.com shows that most U.S. organizations (73%) were targeting a payroll budget increase of 4% or more this year, and a plurality of organizations (43%) grew their merit salary increase budgets by 5% or more. The survey was conducted among 1,173 compensation decision-makers, such as HR and compensation managers.
Along with the economic factors mentioned above, salary budget projections are just one way to understand how others are setting salary budgets. Consider the employee experience. Often, it's not compensation but underlying issues that drive workers to start looking for a new employer. Going back to your total rewards philosophy, pay is not the only reason employees choose to work for your organization. Benefits, career advancement, flexible working arrangements, and work-life balance are big priorities for workers today and should be considered along with pay increases.
What alternatives are there to cost-of-living increases? The Employers Council salary budgets survey mentioned above also asked what other strategies employers were using to assist employees. The responses included one-time bonuses, absorbing health insurance increases, flexible work arrangements, and coverage of commuting costs.
Is a COLA right for your organization? It depends on:
Whatever your decision, be prepared to explain how your reward programs work, the relationship between performance and pay, and how your organization's business strategy is reflected in your compensation programs.
Employers Council has many resources and services available to assist your organization: HR Consultation, Benchmark Survey Data, Compensation Planning, Pay Equity Audits, Legal Services, and Training. If you have any questions, please email the Member Experience team.
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