Cost of living adjustments, or COLA, have been common practice for a while now, however, only 21% percent of employers indicated that cost of living adjustments were their main reason for giving raises in 2015.
These adjustments to employee pay are based on the price increase of key ‘costs of living’ like housing, transportation, utilities, etc., and do not account for the value of a job—that is, the external value of that job in the market place or the internal value that the employee in that job is bringing to the organization
Like an old can of Tab, COLA increases have gone stale. Here’s 3 reasons why it’s time to pour that COLA down the drain and mix yourself up a much tastier compensation cocktail.
1.Cost of living increases may be too little, too late
Because cost of living increases are typically measured and awarded at the end of the year, COLA is always a year (or more) behind. Giving increases based on how much cost of living has already increased is a little like remembering you need to fill up the gas tank after you’ve already hit the highway.
Speaking of gas, a great example of cost of living being way behind the times is the Oil & Gas boom in North Dakota. When the formerly inconspicuous state struck oil, the cost of labor rose quickly and aggressively, not only for jobs in the oil fields, but for those in surrounding businesses as well. However, it took a little while for the cost of food, rent, etc. to follow suite, and even longer for an annual survey to calculate in increase in cost of living. If companies in the area had waited for an annual COLA to increase pay, it would have been nearly impossible to attract and retain good employees.
2.Cost of living increases reward mediocre performance
One of the unintended outcomes of cost of living increases is that they reward top performers and mediocre performers the same. If every employee is getting a 3% pay increase every year just for showing up, what does that say to those that are going above and beyond to exceed performance goals and meet company quotas?
While these high performing employees might be rewarded in other ways like bonuses & promotions—what kind of precedent does it set when everybody in the company is getting the same annual increase regardless of performance?
Also—is that how you want to spend your precious compensation budget?
3.Cost of living ? cost of labor
While cost of living measures cost of goods year over year, cost of labor measures the supply and demand for employees in specific jobs in specific markets.
Cost of living may tell you that it is roughly 4% more expensive, on average, to live in Seattle vs. Portland, but it doesn’t tell you how much more it would cost a company in Seattle to hire a Project Manager vs. one in Portland.
Cost of labor tells us what “the market” is for a job and what jobs are in high demand in certain areas that are often outpacing the cost of living. For example, even though cost of living may be higher in New York City, the cost of labor for cooks may be higher in Minneapolis because the demand for those jobs is much more aggressive in Minneapolis.
Paying based on cost of labor instead of cost of living will ensure that you’re paying what’s necessary for your jobs in your market.
But what if cost of labor is not keeping up with cost of living?
This is an important question—especially if your organization employs a large amount of minimum wage workers. Many organizations define paying fairly as paying a ‘livable wage’, which means that if the market value of a job is not in alignment with a livable wage, you’re left wondering how to design a pay policy that ensures your employees are paid fairly.
As we’ve outlined, because cost of living calculations are done after the fact, and only encompass the price increase of certain goods, a cost of living adjustment is not the answer. It is also not as simple as giving everyone an increase, as it puts you at risk of pay compression.
It’s important to make sure your pay practices are aligning with your compensation philosophy—which might mean weighting the internal value of a job more heavily for certain roles, or targeting the higher end of the market for jobs that have cooled down in the market, but you still want to reward competitively.
So what’s the solution?
Market based pay structure + performance based pay increases.
A market based pay structure ensures that pay ranges are aligned to market and fairly evaluated based on the cost of labor for your jobs in your market. Basing your pay structure on market value will encompass cost of living, cost of labor, and supply and demand for jobs in your market.
Performance based increases enable you to increase employee pay within the employee’s pay range, based on the employee’s performance—however your organization chooses to measure it—allowing you to reward top performers, ultimately increasing retention and employee satisfaction.
A pay practice that encompasses a market based pay structure and performance based increases says “we are paying fairly based on the market value for this job and we also want to reward a job well done”.
Now that’s a beverage we can all enjoy.
Click here to schedule a demo and see how PayScale can help you build a pay increase policy that aligns with the market and rewards performance.
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