Managing Pay in Uncertainty – Addressing reward in uncertain economic times

Our View in Summary

This has been, and continues to be, a particularly challenging year for all organisational, including pay, budgeting. Making sense of it has been rather like trying to “paint a nature scene in a storm” – with lots of movement and noise, and unstable conditions. But in our view the fundamentals are largely unchanged and good business sense must prevail in these challenging times.

The pressures on budgeting, and how to distribute spend, are multiple, complex and fluid and emanate from past, present and future factors. It would be easy – and perhaps tempting – for organisations to prioritise extraordinary, “alleviating measures” to seek to address some of the most pressing and immediate issues arising from the cost-of-living crisis and tight labour market conditions. While there is undoubtedly a place for some extraordinary steps to support employees at this time – and to address workforce capability or capacity gaps – we think it is vital that these are framed in the context of a  clear pay strategy, aligned with the business strategy and priorities  and taking into account market conditions, performance, affordability, sustainability and internal equity. Getting this right requires balancing short-term needs with long-term objectives in a sustainable way.

Certainly, the evidence to date is that most organisations have been approaching the situation in this fashion. Salary increases – while higher than they have been for a very long time – remain far below inflation rates, and organisations have rightly put a lot of emphasis and effort into reviewing/enhancing and communicating their employee benefits programmes, with particular focus on enabling greater personalisation overall and better supporting employee wellbeing in a more holistic way. Enhanced job design, both for multi-skilling and to increase the value of work to employees, is another area of increased organisational attention.

There are, in our view, at least two other areas that merit care and attention in this challenging period for workforce and talent management. In regard to incentive plans, we highlight the need to weigh the impact of exogenous factors on business performance so that “real performance” is understood and rewarded appropriately, and the future credibility of incentive schemes and targets is not undermined. In regard to critical talent retention, while this is a “workforce segment” that may well merit special emphasis in an organisation’s overall pay strategy, our experience and research shows that this is best addressed at the level of the individual person – for whom personal non-pay factors may be more important. The most successful “critical talent identification and retention toolkits” enable the right conversations to happen between managers and individuals, and provide for a range of possible interventions, many of which are non pay-related.

The Business Context and Challenges

2022 – and looking forward to 2023 – has presented significant and special challenges for organisational, including pay, budgeting. We see this coming from  at least five angles :

1. The Cost of Living crisis (including inflation, high prices – which are likely to persist for some time even after inflation decreases – and interest rates): this has reset the expectations and needs of many employees to “temperature”/urgency levels not seen for forty years;

2. A tight labour market with both lower levels of labour participation since the pandemic and high levels of talent liquidity for many professional and skilled roles;

3. The challenge of accurately and fairly assessing, and rewarding, performance in a turbulent post-Covid performance year, with complex exogenous factors at play;

4. The reality that many organisations are operating in 2022 with budgets that were set prior to the steep rises in inflation – so there is the erosion of available budgets as well; and

5. An uncertain global economic outlook for 2023, with significant potential headwinds at the macroeconomic level.

This is an unusual and difficult mixture of pressures borne out of the recent past, the present, and the future outlook. Much has already been written about the Cost of Living crisis which continues to evolve month by month – taking the UK as an example, CPI inflation in the year to October rose by 11.1% (up from September’s figure of 10.1%) – although there is evidence that some of the global contributing factors to core inflation (e.g. supply chain issues) are stabilising. So this may be the inflationary peak – however high inflation (and certainly high prices) is likely to persist for some months until global factors feed into consumer prices.

The tightness of the labour market in 2022/23 is distinctive compared with previous periods. Capacity and skills shortages have originated and persist from a curious mix of business demand (to meet both supply chain rebuild and customer service needs, and heightened market pressure to innovate) and an increase in the number of “economically inactive people” (i.e. who don’t have a job and aren’t searching for one). Even well developed employee value propositions are straining in the face of talent mobility, long-term sickness and the pandemic’s further legacy on people’s changed expectations from working life.

In regard to the third point above – a turbulent post-Covid performance year – this year has been one of the most challenging to navigate as we advise Boards and Senior Executives in their compensation and bonus rounds. Exogenous factors have impacted performance and results both positively and negatively, depending on sector and circumstance. It is a significant challenge to interpret “real performance” in this context, in order both to maintain motivation levels and ensure that the payouts made are appropriate and understandable.

The fourth and fifth points above – “past” and “future” factors respectively – are adding further constraint and complexity for many businesses.

In the context of all of the above, the most common upward pressures on pay budgets that we are seeing cited are:

We look below at how businesses have been responding in this environment, including “MCR’s point of view” in a number of these areas.

Organisational Responses

Notwithstanding the current inflationary pressures, employers seem to be returning to a somewhat more “normal”  salary review  process in 2022 compared with the freezes of 2020 and 2021. The latest ONS data (Release date:15th November 2022) shows 5.7% growth in average regular pay (excluding bonuses) for UK employees in July to September 2022 (the figure is higher at 6.6% for the private sector only – a historically high rate of increase at face value). However, in real terms (adjusted for inflation) over the year, UK regular pay fell by 2.7%. Continental European and other international data on consumer vs. salary inflation show a similar, if not starker, picture. And looking ahead, many predictions forecast more of the same in 2023. Clearly, balancing the difficult factors outlined above, most organisations have been and expect to continue to implement salary increases that are well below inflation. Indeed, history shows that while pay awards track inflation they tend not to rise to inflationary peaks nor fall to inflationary troughs. While double-digit pay awards have been seen in some places in 2022 (for example where there has been an acute staff shortage, e.g. drivers) and may continue in 2023, these are unlikely to become the norm.

Certainly from MCR’s perspective, in the current economic climate most organisations would do well to  avoid increasing fixed salary costs beyond the essential , especially if there is a prolonged recession around the corner. “Prudence” is advised to avoid creating issues for the long term – for example by over-inflating salaries beyond the market value of the skills required for the job, or beyond what is sustainable for the organisation at the workforce level. Wherever possible, businesses should determine  targeted ways to address critical talent needs and to support the lower paid  (we have seen a number of examples of one-off lump-sum “cost of living payments” to support lower paid staff, and/or salary increase budgets weighted towards the more junior grades and lower paid staff in other grades). Organisations are deciding how to focus their compensation spend for the greatest impact, including both monetary and non-monetary actions to attract and retain employees – particularly for critical or high-performing talent. Pressure on pay budgets only makes it more critical for organisations to have a clear strategy for awarding pay increases. Prioritising critical employees and vital roles, differentiating for performance, and segmenting increases all help to ensure an appropriate return on investment. Pay increases and the budgets that fund them must be aligned with the business priorities and strategy considering market conditions, performance, affordability and sustainability, and internal equity.

Base pay and base pay adjustments are of course just one piece of the employee value proposition. Organisations are also paying close attention to other important components of the total reward offering and employee experience, including incentives, health and wellbeing, career progression, and learning and development opportunities.

In terms of  year-end bonus decisions  – and how to assess and reward performance in this turbulent post-Covid performance year – it is critical to understand the impact of exogenous factors (supply chain issues, inflation, interest rates, energy costs, etc), in terms of:

In MCR’s view, businesses should not “reverse-engineer” the current performance year’s targets in order to account for unforeseen externals. However – in order to maintain the credibility and motivational impact of incentive plans – it is equally important to weigh the exogenous impacts, as above, in the determination of overall bonus pool funding and the distribution of funds around the business.

In regard to  other areas of the employee value proposition , trends and responses in the current climate include:

1. Making the total reward offering and employee experience clearer, more people-centric and purpose-driven – and its delivery as “consumer grade” as possible;

mike.curtis@mcr.consulting