Setting Competitive Compensation Amid Rising Inflation

Spiraling prices are diluting the dollar, and inflation and a tight labor market are increasing wages. How can employers determine fair pay?

Higher inflation is persistent and shows little sign of slowing down. The Consumer Price Index rose 9.1% year-over-year in June, signifying “another month of the fastest pace for inflation going back to December 1981.” These rising prices put additional pressure on employers already grappling with a competitive hiring environment, forcing many to raise pay to hire and retain talent.

The latest wage numbers from the Bureau of Labor Statistics (BLS) show that average hourly earnings increased by 5.1 percent year-over-year in June, “indicative that wage pressures remain strong as inflation accelerates.” Thus, pay is rising significantly but not keeping pace with inflation — the average worker effectively experiences a 3–4% pay cut even after getting a raise.

Many employers question how to set fair compensation amid fierce hiring competition and high inflation. Here’s a look at this complex issue, plus some tips on offering reasonable pay and benefits to attract and keep quality workers.

The challenges of rising prices and pay

Employers had already started increasing wages before analysts judged inflation durable — not the “transitory” price increases initially touted by optimistic government officials. The fast economic rebound after the pandemic’s retraction coupled with “The Great Resignation” created intense competition for quality workers by 2021.

Wages have naturally crept upward as employers sought to fill open roles, and this pressure has only increased with inflation. Workers are acutely aware of their diminished purchasing power, with Pew surveys showing “Americans view inflation as the top problem facing the country today.” Everything from food to cars to gas to clothing is more expensive, but housing might best illustrate why individuals are so concerned about devalued paychecks.

Single-family home prices “jumped more than 20% nationwide in April [2022] from the same month last year,” with the average cost of a home exceeding $400,000 the following month. And renting isn’t really an affordable alternative; the “median listed rent for an available apartment rose above $2,000 a month for the first time” in June.

Thus, if you apply the longtime standard that no one should buy a house worth more than three times their salary, the median wage would need to be $133,333 per year to afford an average home. Further, the research-based standard that housing costs should be no more than 30% of income means that an average renter needs to earn about $80,000.

Since the average household (not individual) income in the US is $63,214, while the median is $44,225, something has to give: prices or wages. But unfortunately, each reinforces the other.

Worries about an inflationary wage spiral and the payroll point of no return

Many factors contributing to higher prices have little to do with pay, such as supply chain bottlenecks and rising raw material and energy costs, the latter influenced by the war in Ukraine. But the “wage/price spiral,” aka the “inflationary wage spiral,” is a significant concern based on a simple equation. After inflation soars, wages rise in response (or vice versa) … followed by inflation growing even more as businesses pass on the increased overhead to customers.

In the most extreme projections, the wage/price spiral could cause hyperinflation as the cycle repeats over and over again. Many analysts reject the worst-case scenarios as overblown. Still, many also view the spiral as a credible threat — at least one that could prolong high inflation and contribute to a recession.

While some employers may worry about this macroeconomic theory, most have more immediate concerns. Namely, they must find and hire good employees, paying enough to get and keep them while still turning a profit. However, employers must consider pay increases carefully because once they issue a raise or high starting salary, they’re essentially stuck with it until a worker leaves or is let go. Higher wages may also persist when they set expectations for other employees and job candidates.

This payroll point of no return can significantly reduce profits, contribute to higher prices, or even make some businesses non-viable.

Tips for setting compensation and retaining and attracting talent

Defining appropriate compensation is different for every business, as pay and the demand for workers vary by industry, geography, and other factors. But there are a few universal steps that should help the process:

1. Be realistic about pay and adjust accordingly.

This advice may sound simple, but plenty of employers, especially small business owners, resist the need to increase wages. So, the crucial first step is assessing compensation practically and committing to pay people competitively. To establish a baseline, employers should research average salaries by industry, role, competitors, and geography.

2. Be mindful that pay increases are durable — but high inflation might not be.

Again, once you give someone a straight-up raise, it doesn’t go away until they leave or are shown the door. And higher salaries revealed by individuals or job ads can create expectations that also stick around. Thus, carefully weigh whether a pay increase is sustainable and realistic given profit margins.

A tactic employed by some companies is to subdivide pay increases into merit-based and cost-of-living bonuses. The latter can temporarily inflate but settle down once inflation lowers to typical levels.

3. Consider benefits that mean a lot but cost less.

Compensation should always be competitive, and fairly paid workers feel more valued and engaged. But not everyone is strictly motivated by money.

The company’s culture, work environment, and benefits can be significant motivators that retain and attract employees. For example, many individuals will opt for a flexible remote-work schedule over a higher-paid in-office job. Thus, evaluate the needs and desires of your people, and consider customized, high-ROI benefits that may soften the blow of inflation-driven pay raises.

Stay adaptable but practical on pay

Employers have been forced to make rapid pivots in the face of the pandemic, lockdowns, demands for remote work, snarled supply chains, and a tight labor market. And now, inflation is creating new hiring difficulties and demanding even more flexibility.

The best course regarding compensation is to stay adaptable enough to increase pay when necessary while remaining practical enough to live within organizational means. Offering competitive and fair wages, exploring customized, lower-cost benefits, and creating an attractive work environment increase the odds of HR success.

Karp HR Solutions helps businesses attract, retain, and motivate people through creative solutions and strategies that master the mix of finance and human resources. Contact us today for a free consultation.