Use upcoming salary increases to pay more effectively rather than just paying more

Many compensation and HR professionals are about to embark on their annual salary increase process. Some of you may already be in it. As we always do to best determine appropriate pay increases, we look at the supply and demand of labor as our guide. But this year feels like we need to look deeper as a window of opportunity has cracked open to not just pay more, but to pay more effectively.

To get to the heart of this opportunity, we need to start by looking more deeply at the state of the labor market. Today, now that we're more than two years out from the 2022 Great Resignation when 50.5 million Americans left their jobs and set a new record. Yes, that number dropped 12% to 44 million in 2023, and now things seemed comparatively sane relative to the 2021-2022 heyday for employee turnover. But the dynamics of today’s labor market are still hard to pin down.

The calm before the storm?

While it feels like a calmer job market relative to the revolving door of 2021-2022, recent employee-sentiment surveys suggest that this period of respite may be short-lived. In fact, more than a quarter (28%) of workers say they are very or extremely likely to switch employers in the next 12 months, according to a recent PwC survey. That’s a higher proportion than during the Great Resignation years, which came in at 19%.

Additionally, a closer examination shows that the slower job market is a direct result of lower demand, but the supply of workers has not changed. The worker shortage we’ve been experiencing is still with us – and will be our reality for the foreseeable future. Shortages are primarily the result of:

• Demographic swings in population (think bigger Baby Boomer population, smaller Gen X population, bigger Millennial population, smaller Gen Z)
• Increased retirement rates coupled with lower increases in population growth
• Lower labor market participation in general
• Slower immigration since 2017 until a more recent uptick

Lower labor market participation is especially troubling, as the U.S. Chamber of Commerce wrote about in June 2024: “If the percentage of people participating in the labor force were the same as in February 2020, we would have millions more people in the workforce today — and this shortage is impacting all industries in nearly every state. If every unemployed worker took an open job in their industry, there would still be millions of open jobs.”

Given all of this, it seems likely that the minute demand for labor ticks up, we will potentially feel the worker shortage as acutely as we did. If 2021-2022 were primarily about attracting new talent, 2024 and 2025 need to be about retaining existing talent.

Managing your retention risks in what now feels like the calm before the storm should help you future-proof your workforce from these inevitable labor market vulnerabilities in the coming years. How best to do this? Make your pay programs more effective, and don’t wait. Start with your upcoming pay-cycle salary increases to ensure you deploy what appears to be this year’s lower salary budgets and increases (4.1% vs. 4.5%). Then use the power of your pay programs to your advantage.

Here’s how to do it.

Understand what ‘pay effectiveness’ means

The premise of pay effectiveness isn’t new. However, given the intensity it’s taken to simply respond to market demands in the past three years, you likely haven’t had the time (or bandwidth) to think through whether your pay programs are powerful enough to address current and future labor market challenges.

This is why we recently conducted our 2024 Pay Effectiveness and Design Survey – to test how pay effectiveness is being thought of in today’s market. And, more importantly, to measure how current pay programs stack up.

Because we believe this relative period of calm is the ideal time to assess and improve the way you design, manage and govern your pay programs, the survey findings can offer some critical insights to truly turn on the power of your pay programs to your ultimate advantage. In turn, this will ensure your pay programs will withstand whatever the coming years bring.

So, what do we mean by “pay effectiveness”? The survey found that most organizations have six core objectives related to pay program effectiveness:

1. Driving employee engagement
2. Driving employee retention
3. Promoting fair compensation among employees
4. Promoting competitive compensation compared to employees at other organizations
5. Aligning with business strategy
6. Rewarding employees for current-year performance

You may have read that list and thought, “Yes, those objectives are table stakes. If my pay programs are not accomplishing those objectives, they are failing.” However, a little more than half of the nearly 1,900 global survey participants responded that they are effective at only two of those objectives. Less than half said they are effective at the other four (Figure 1).

Additionally, research shows that employees agree that pay is the No. 1 driver of attraction and retention, validating the criticality of focusing on pay effectiveness now more than ever.

Build a strong foundation with an effective (and updated) compensation philosophy

To make the most of this window of opportunity to improve pay programs, begin by looking at your compensation philosophy. You likely have one, if your organization is like most of the responding companies (71%) in the Pay Effectiveness and Design Survey. Or, perhaps you are like many other companies (40%) that haven’t updated it in more than four years. Think about everything that’s happened in the past four years!

An updated compensation philosophy is critical not only to pay program effectiveness, but also can be seen in the most successful companies. Organizations with an updated and effective compensation philosophy are more likely to report successfully delivering on their pay program objectives. They also significantly outperform their peers (Table 1).

Table 1. Performance between organizations that have an updated and effective compensation philosophy versus those that do not

Again, don’t sit on this. Start improving the effectiveness of your pay programs as you go into salary-increase season. Use the salary increase discussions you no doubt are having or will have to start updating and improving your compensation philosophy. In fact, salary-increase season is an excellent time to think through questions like:

• What is our stated competitive position versus where we have hired new employees in the past few years? If we’ve been bringing new hires in above midpoint, but our stated competitive position is to pay at median and median is what our salary range midpoints reflect in our structure, is the median really our competitive position?
• In general, how do our pay programs support our values and align with our business strategy? Specifically, how is our salary-increase program aligning to our business strategy beyond attracting and retaining talent? (And yes, there should be more than that.)
• How do we define “pay fairness”? How are we addressing demands and regulations calling for more pay transparency even with our salary increase process?

The ‘Great Decompression’? Defuse the ticking time bomb of salary compression

The annual salary-increase process is a perfect time to talk about a topic every company is facing: salary compression. Salary compression can happen several different ways, but a consistent characteristic is the degree of pay difference either between employees in the same job, or within the same job family at different levels, that feels inherently unfair or difficult to justify.

For example, during the Great Resignation, many (if not most) new hires were brought into a salary range well above midpoint. Because more highly tenured employees also sit above the midpoint, compression happens when new hires are as highly valued as employees that have been with the company for many years.

Even more disturbing are the situations in which new hires are brought in above midpoint while more seasoned but not highly tenured employees (say, those that have three or four years of experience with the organization) are paid below midpoint. Both of these scenarios feel inherently unfair to employees.

We know that salary compression has always been an issue in most companies. However, the significant growth of compression issues since the Great Resignation – and the fact that pay disclosure laws are making pay more visible to employees – is why we label this as a ticking time bomb. Most importantly, if not addressed proactively, compression could lead to significant turnover if the job market heats up again any time soon.

In fact, three out of five organizations that participated in the global Pay Effectiveness and Design Survey agreed that salary compression is an issue – and will continue to be an issue – for the next three years. However, when asked how they are addressing salary compression, most organizations say they are focusing on adjusting pay structures or policy changes rather than spending money to adjust for pay disparities.

Actions that organizations are taking or considering to address pay compression:

• Adding, adjusting or reinforcing pay setting / hiring range guidance to hiring managers, recruiters and the like
• Adjusting / recalibrating pay ranges
• Capping salary increases to a specific percentage or range position
• Conducting a formal pay equity study to identify areas of risk for internal equity
• Strategic workforce planning to anticipate future hiring needs

Obviously, affordability and cost management always are a priority, but there is no faster or more effective way to solve salary compression than with actual pay adjustments.

Bottom line: Don’t ignore your salary compression issues! And don’t think that policy and salary structure changes alone will be enough to solve them. Use this year’s salary increase budget to manage retention risks caused by salary compression. Also, take advantage of this window of relative calm to develop a broader compensation philosophy that includes how you will continue to address salary compression in the longer term.

Improve perceptions of pay fairness

At its core, salary compression is about pay fairness. Current employee sentiment suggests that organizations are extremely vulnerable when it comes to employees’ perceptions about pay fairness. In WTW’s recent Global Benefits Attitude Survey, nearly half of employees said they feel they are not valued, and two-fifths feel they are not paid fairly in the U.S.

The Pay Effectiveness and Design survey also showed that organizations are not taking advantage of the power that effective communication can bring to drive perceptions of pay fairness, as only 27% of participating companies say they communicate their compensation philosophy to employees. Even fewer (21%) said they are effectively communicating pay programs to prospective employees.

Turn on the power of your pay programs

To communicate pay programs effectively, most of us first need to feel confident that said programs are effectively designed, managed and governed. This brings us full circle to where we started this article: Most compensation and HR professionals have not had the bandwidth or time to proactively accomplish this in the past few years.

As we discussed, our research shows that your compensation philosophy is the best place to start, but also consider using an integrated framework such as the one below to turn on the power of your pay programs. The time and effort it takes to use an integrated approach will bring significant returns as we face the next wave of labor market challenges.

WTW’s compensation framework, which begins with company purpose/strategy then flows to a people strategy, total rewards strategy, compensation philosophy and compensation strategy. Compensation strategy drives program design, management and governance, and this is what is used to determine base pay, incentive pay and other cash awards.

Compensation strategy & design framework

Author

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Lori Wisper

Managing Director, Work & Rewards

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