Dealing with Inflation: How Should Organizations Respond?

For more than 2 years the world has been experiencing inflation at rates not seen in decades. The an...

Posted by Nicholas Setser & Thomas Carnahan on August 31 2022
Nicholas Setser & Thomas Carnahan

For more than 2 years the world has been experiencing inflation at rates not seen in decades. The annual inflation rate in the US was 9.1% in June 2022, the highest rate in the US since 1981. Since March of 2020, consumer buying power has reduced by nearly 15%, and, after adjusting for inflation, workers’ hourly wages as of June were down 3.6% from where they were in June 2021. Gasoline, food, vehicles, airfare, and housing are all significantly more expensive than they were pre-pandemic, and individuals and organizations are struggling to cope. So, what has caused this rapid decrease in the purchasing power of a dollar, and what should organizations be doing in response?

Primary Causes:

  1. ‘Demand-Pull Inflation’: This occurs when the demand for certain goods or services exceeds the market’s ability to supply these items. COVID-driven disruptions to the supply chain have had much to do with this. For instance, the auto industry’s ability to produce cars over the past 2 years has been reduced via disruption in the US reliance on microchips made in China. Given that the demand for cars has remained high, this has resulted in a rapid increase in the price of both new and used cars.
  2. Record profits by US businesses: Although many businesses indicate that they are struggling to pay wages and deal with the supply chain, more companies than ever posted record profits by raising prices more than necessary.
  3. Although debunked by most independent economists, other oft-cited reasons for the current state of inflation include the rising cost of wages and the increased money supply due to increased unemployment payments and stimulus checks during the pandemic. The most reliable study of the stimulus and unemployment payments came from the Federal Reserve Bank of San Francisco which estimates that the stimulus added up to 3% to the inflation attributed to March 2021,- but much less since.

What are the Options?

Employees seeking new jobs are demanding higher wage rates than ever. Employers are in large part focused on incoming talent and are accommodating these requests from applicants. This is not necessarily an issue, but if current employee wages aren’t adjusted as well, then this can lead to wage compression and concern for turnover, brain drain, age pay disparities, and other potential consequences. What steps, then, should employers take to be more proactive in combating inflation? There are multiple options listed below, and there is no magic silver bullet. Many of these options should be used in combination to produce the best results:

  1. Market Analysis: If employers are offering higher wages than ever for new hires, then it is likely that existing employees are in need of a bump as well. A Market Analysis is a study of the market rates for each position at an organization, and thus will give employers a better understanding of which jobs are currently “hot” in the market and allow them to adjust accordingly. It can also provide information on what the current market is showing for starting pay decisions to ensure what a candidate is asking for is reasonable. Ensure that you have a market analysis database that is updated at least quarterly and does not allow for self-reporting or “peer” reporting to be included in their data.
  2. Job Evaluation: While market analysis is a study of what jobs are worth in the external market, Job Evaluation is a study of the worth of each job to your organization internally. Job evaluation studies the relative value that jobs bring to the organization by evaluating each job on objective criteria of compensable factors. When used in combination with market analysis, an organization will have a better idea of what positions are worth both internally and externally. This will result in a more systematic adjustment of wages and help the organization end the practice of systemic job devaluation that is present in raw market analysis data and greatly impacts career paths dominated by minorities and women.
  3. COLA: While almost all organizations provide merit adjustments each year, many do not provide an additional cost of living increase. Thus, in years with high inflation rates, the typical 3-4% raise can actually be a net loss for employees. Even in years where inflation is only 1-1.5%, that can eat up to half of an employee’s “merit” increase. Since 1978, after being adjusted for inflation, employees at or below Director level have only seen a net increase of 17% of wages while executives have seen a net increase of almost 1000%. Companies should consider providing a yearly inflation-based adjustment in combination with merit adjustments in order to keep up with the market, attract new talent to the organization, and retain current staff.
  4. Build a Compensation Philosophy: Pay transparency requires that you know what your philosophy is for your organization and each job. Are you a market lag, median, or leader? Do you want to reward education beyond what is required to be qualified? How do you see internal vs. external experience? All of these questions should be objective. To determine where you are and what you need to do to move forward, the organization should consider a proactive pay equity study, which provides organizations with insights as to what job-related decisions/factors are impacting pay for Situationally Similar Employee Groupings (SSEGs). A strong compensation philosophy ensures that organizations can make adjustments quickly and in an equitable way.

Record-setting numbers of employees are seeking new opportunities as a result of inflation. Many employees believe that finding a new job will put them in better position to deal with these economic forces than what their current employer can provide. In the race to attract and retain talent, organizations should be taking steps to ensure that their pay practices are sound and responsive to these changing forces.

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